OLD THINKING IS NOT ENOUGH

In decades to come we'll look back on the predictable causes of the current economic turmoil and be able to say precisely how institutions should have reacted. 

But the real problems are embedded in the economic system. This story simply considers the dysfunction of a central bank which considers fighting inflation one of its primary tasks . . . 

RIGHT SETINGS, WRONG MODEL

In a couple of hours, the Reserve Bank board will have decided if interest rates should be cut or simply remain steady. This means if you’re listening to the radio or passing a television screen you’re likely to be treated to lots of economic experts wearing bespoke suits. Everyone’s pontificating there’s a “good chance” the Reserve will reduce rates another “one quarter of one percent” or, in the preferred jargon, “twenty-five basis points”.

The more confident ones will even provide odds on the chance of a move. “There’s a fifty percent chance of a reduction”, one will announce, another way of saying “I don’t have a clue, you might as well toss a coin”.  They’ll be quickly trumped by better odds from another. “We believe the Reserve should move quickly to bolster confidence in the economy”, they might say. “I’d put the odds of a significant cut at seventy-five percent”. Delivering a verdict like this, with just the right amount of gravitas, a soupcon of insider knowledge and just a hint that you know more than you’re saying, should be enough to ensure our favourite expert manages to lead the electronic media’s coverage.

Because that’s their job – performance. Understanding what’s happening and interpreting it for the punters of course, but also spruiking the bank’s cause. Not overtly, naturally. Their entire credibility rests upon accuracy and a willingness to deal in truth . . . although perhaps not the whole truth. Going there might involve an honest critique that trespasses on the entire economic and political system. And that’s not in anybody’s interests. Certainly not the banks’, anyway.

Which is the point of the entire exercise. This focus on monetary policy – interest rates – inevitably conditions us to accept interest rates as an appropriate means of determining a key economic setting. This is exactly what Peter Costello intended when he established (with much fanfare) the independence of the Reserve, and gave it the prime task of targeting inflation, keeping it at an annual rate of between two to three percent “over the cycle”.

The Bank’s done this. And, if you choose to believe the official inflation statistics, it hasn’t done a bad job either. Yet here, once again, your lived experience may not necessarily reconcile itself with the dry numbers produced by the ABS statisticians. That’s because of the central role houses play in our lives.

The Bureau’s very good at measuring the basket of goods we buy each week, right down to the bananas we impulsively pick up for a special treat in the middle of winter. But it’s not very good at all when it comes to calculating how we feel. It had no means, for example, of estimating how brilliant everyone thought they were a couple of years ago as house prices doubled.

We were happily assured that inflation was well under control right through the Howard years. Interest rates remained low, banks loaned money freely; yet house prices levitated ever-higher; worth more and more with each passing year. We confidently found new reasons to justify this strange economic phenomenon. Multiplying the increasing population by the extra wealth the country was generating seemed to justify pushing auction bidding higher. Soon it seemed entirely reasonable to compare the price of a three-bedroom, suburban house on the fringe of one of our megalopolises with the cost of a gracious residence in Virginia or a refurbished sixteenth-century manor house a similar commute from London or Paris.

There was nothing economically ‘wrong’ about this, because economics isn’t about moral judgements. There would be consequences, naturally, but we were simply exercising our free will to spend money on houses and there’s nothing ‘bad’ about that. But inevitably it was going to turn out like bungee jumping off a tall tower tethered to an elastic cord. At some point we were always going to over-shoot and feel the sharp pull of recoil. That’s what’s happening now. The expansion’s come to an abrupt halt. The easy money’s gone. And it won’t be back for some time, no matter what the Reserve Bank board decides to do today.

Let’s just look at a few of the depressing figures. Home values across the country are down 5.3 percent over the last twelve months (although only by 0.9 percent here in Canberra). Premium dwellings – ones journalists can’t afford to live in – have fallen by more than 6 percent. Coupled with this, sales volumes have crashed. Three years ago some 50,000 properties changed hands every month. Today that turnover’s collapsed to just 34,000 transactions monthly.

Against this background, recent headlines like “hot start to winter sales” take on the character of boosterism rather than reality. Australia garnered kudos by escaping the first bout of contagion while the GFC paralysed the rest of the western world. We correctly attribute this to quick government action coupled with the continuing mining boom. Just as important, however, was the obvious resilience of the property market. While houses held up everything was OK. Today we question everything.

Over the long term diminishing our focus on property is a positive. Living in a bigger house won’t buy a better life. Everyone knows building better personal relationships is far more important than the construction of ever-larger edifices. But this transition’s causing pain. Undoubtedly it lies beneath much of the white-hot anger directed at Labor at the moment. The last time house prices were shaky, back in 1998, similar smouldering rage resulted in the Liberal government losing the popular vote. It didn’t make the mistake again. First homeowner grants and the halving of capital gains tax ensured the support of property prices.

Today the financial markets are again being gripped by fear and paralysis. This time we won’t be able to rely on property to get us through. The nine board members of the Reserve will weigh up lots of advice this morning as they make their decision, but in the end they’ll just follow their gut instinct. It’s all they can do.

It’s a question of which is more important: quashing inflation or keeping life in the economy. Perhaps unfortunately, housing will be central to the answer.