Central banks could learn more from experience

My column from last week’s Fin, over the fold

Central banks could learn more from experience

The Reserve Bank of Australia is fifty years old, having been separated from the old Commonwealth Bank in 1960. The anniversary has been a happy event, given the Bank’s success in managing the Australian economy, at least since the ‘recession we had to have’. Through the Asian financial crisis, the dotcom boom and bust and the global financial crisis, Australia has enjoyed almost uninterrupted economic growth.

But the world as a whole has not done so well. As Janet Yellen of the Federal Reserve Bank of San Francisco observed at a symposium held in Sydney to mark the anniversary, a few years ago, central bankers in general would have been congratulating themselves on a job well done. Thanks to the adoption, in the mid-1980s, of inflation targets and ‘Taylor rules’ for setting interest rates, the world had entered a ‘Great Moderation’ in which the volatility associated with the business cycle had been tamed.

While few believed that the Australian experience (nearly twenty years without a recession) could be replicated, or sustained indefinitely, there was widespread confidence that the future was one of stability. With the Asian financial crisis and the dotcom boom and bust fading into the rear-vision mirror, calls for a ‘new global financial architecture’ were quietly forgotten. The handful of policy responses to the excesses of the 1990s, such as the Sarbanes–Oxley legislation in the US were derided as unnecessary over-reactions.

There was a similarly benign attitude to global macroeconomic imbalances, and to the massive growth in liquidity that sustained them. The ‘consenting adults’ school of thought held that, as long as growth in international indebtedness was driven

But, as Yellen observed, that was then. Now, with much of the developed world in deep recession, and the global financial system still on life support, the self-congratulation was more muted.

The key ideas that have debated policy debate since the 1970s were found wanting in the global financial crisis. The Great Moderation turned out to be an illusion. The idea that macroeconomic policy could be run on the basis of judicious interest rate adjustments was abandoned as policymakers resorted to massive purchases of fiscal assets and, in Australia and elsewhere, equally massive fiscal stimulus.

The efficient financial markets hypothesis, which provided the theoretical basis for deregulation, has been abandoned by all but its most dogmatic advocates. And the general belief that governments should keep out of the way and let markets do their work has been replaced by the recognition that in a crisis, governments provide the last line of defence against systemic collapse.

In attending the symposium, on the topic ‘What have policymakers learned over recent decades, and what needs to be reconsidered’, therefore, I was rather more interested in the second part of the question than the first. What, I wondered, did central bankers see as the key weaknesses in the theoretical and policy frameworks that led us into the global financial crisis, what policy responses to the crisis had worked well or badly, and what were the most promising new lines of thinking about the future?

On the whole, I was disappointed. The only issue that received serious reconsideration was the question of whether central banks should target asset prices. As RBA governor Glenn Stevens correctly pointed out, it’s misleading to phrase this question, in terms of the desirability of using interest rates to ‘prick asset price bubbles’. By the time an asset price bubble has emerged, policy has already failed and all the options are bad ones.

For a central bank with only one instrument, interest rates, the implication is that rates should be raised early in the business cycle, before asset price inflation has a chance to get going. That’s a reasonable judgement, and Jean- Trichet of the European Central Bank engaged in some justified preening at the expense of critics of the ECB’s similar tightening. There was also some discussion of ‘open mouth’ operations of the type undertaken by former RBA governor Ian Macfarlane in the early 2000s when he warned housing investors not to count on ever-rising prices.

But surely the deepest global recession, since the 1970s, and on some measures since the 1930s, calls for a bit more reconsideration than that. As long as we combine unrestricted financial innovation with an effective guarantee that no systemically important firm will be allowed to fail

On the contrary, the main message from Trichet was ‘…’

The handful of policy responses that might make a serious difference to the operations of the financial system were dismissed the panelists. Proposals for a tax on international financial transactions, first put forward back in the 1970s by Nobel laureate James Tobin, are finally on the global policy agenda, but they got no support at the symposium. Although there was general agreement that financial market outcomes were far away from those predicted by the efficient markets hypothesis, and that huge transaction volumes were part of the problem, the Tobin tax was rejected because ‘it would impede market efficiency’.

Paul Volcker’s proposals to separate the ordinary financing activities of the publicly guaranteed banking system from the speculative ventures of hedge funds and investment banks received similarly short shrift.

Coming out of the symposium, it was clear that the lessons of the 1970s and 1980s had been learned well, perhaps too well. By contrast, it seems that little or nothing has been learned from the failures of the past decade.

John Quiggin is an ARC Federation Fellow in Economics and Political Science at the University of Queensland. His book, Zombie Economics: How Dead Ideas still Walk Among Us will be published by Princeton University Press later this year.

176 thoughts on “Central banks could learn more from experience

  1. Pig shooters in our national parks are among other atrocities – such as regular and ever more extensive “controlled [laugh] burns” – the thin edge of the big wedge, the aim of which is to so degrade these tiny remnant slivers of biodiversity that there will be little to no effective protest when sections and eventually the whole kit and kaboodle will be open up to development.

    Goodbye Blue Mountains, Bouddi, Brisbane Water, Garigal, Kuring-gai Chase, Lane Cove River. Georges River, Royal and probably Sydney Harbour National Parks in oh, I reckon 50-100 years tops.

    Capitalism fouls things up.

  2. Alicia,
    The indigienous Australians conducted controlled burns for millenia before my relatives arrived here. To a great extent the flora and fauna of Australia as you see them now are the result of that system which was only gradually stopped over the last 200 years.
    From my perspective it is the ones opposed to controlled burns that are looking to change the country.

  3. Andrew there is no such discrete entity as “indigenous Australians” who did any one thing everywhere so your premise transposed into a conclusion is false – and racist – for starters.

    Secondly carbon dating in relatively high population density pre-colonised coastal areas (e.g.) shows that large scale burns, induced or otherwise, were rare, i.e. they occurred hundreds of years if not more apart and on a much smaller scale. This is a far different situation from extensive burns deliberate or “accidental” that occur today ever more frequently over and over in the same place in the tiny bit of bush left on this continent that has not been permanently obliterated.

  4. Philomena,
    I was thinking how to respond to your accusation of racism but all of my thoughts may have breached the site comments policy. I will instead explain my thinking in this line.
    It is difficult to talk about all of the various peoples that lived in the country we now know as Australia before my ancestors arrived without reverting to some generalisations. I am told by people that I believe should know (including some Nyoogar) that this was the practice of the Nyoogar people of the south west and that the practice was widespread elsewhere. I do not propose to create a thesis length discussion of precisely which peoples did this (the Pitjantjatjara, for example, would not have as they lived in arid territory that was simply not capable of being treated in the same way), so in trying to fit the discussion into a blog comment I thought some brevity and lenience with the formalities of this discussion (i.e. referring to “indigenous Australians” rather than producing an exhaustive listing of all of the peoples) as well as some generalisations could be allowed.
    As for your actual point, I would be interested in a link to this research as it contradicts what I have been told and this is an area that interests me. I would like to read it.

  5. Philomena,
    Unfortunately, your first link just goes to a list of publications.
    The second one is interesting. Benson and Redpath are obviously trying to argue against Reid (as is stated in the abstract) about it being burnt “every year or so” and that the clearing by the early settlers was merely removing the trees that resulted from the lack of fire.
    I have not read Reid to be able to comment whether he made those claims, but that was not the argument I was making. In WA at least there is plenty of evidence that burnings happened not every year, but every 3 to 5 years over wide areas that were inhabited by the Nyoogar (I refer to David J. Ward, Byron B. Lamont, Chantal L. Burrows in “Forest Ecology and Management” 150 2001 for example).
    Having refreshed the page, I see you have added another link and it makes reference to the study I just mentioned – not disputing the main finding but arguing that it may not have been quite every 3 to 5 years.
    In none of those studies is there much argument that the pre-European settlement inhabitants of the country we now know as Australia (personally I think “indigenous Australians” is a good generalisation, but if you object let me know what term you think acceptable) managed large amounts of the land to at least some extent through the controlled and intentional application of fire.
    While there is some legitimate disagreement over the extent of this, AFAICS none of what you have linked to contradicts the statement in my original comment. The dispute should be over how much and where, not if, IMHO.

  6. “Graeme – I agree we bought at a good time and this was mostly down to luck. However I still think if people live within their means and borrow modestly it isn’t hard to have a good live. Big TVs are nice but far from essential.”

    No it is hard. You think about it. If they lived within their means then they can never buy a house at all. If they try and save the 20% deposit for it, so far since 98 the house price would have gone up in all likelihood faster than their savings.

    But your comment is besides the point. Life should be getting easier. But its not going to get easier if people like you and Andrew keep supporting ruthless bank parasitism. The banks have got enough influence as it is without your support.

    Dennis Kucinich has this bill before the American Congress for the government to take all the benefit of new money creation off the banking system. Its critical that he succeeds. Because then the banking industry won’t have a vested interest in always trying to deceive everyone. They will atrophy down to a more appropriate size for their industry. And then we only have to worry about one vested interest getting in the way of better monetary policy. Rather than this two-step between the banks and the government.

  7. @Andrew Reynolds

    Restricting access to credit for buying houses to only those with a relatively large amount of existing wealth will mean only one thing – those with existing wealth (i.e. the rich) will be the ones to capture the gains in equity that will occur given the restricted supply of the housing stock in the face of an increasing population.

    Your reasoning is flawed. The gains may be tiny or non-existent, especially if the perception amongst potential buyers is that other areas of investment with comparable capital security offer better returns. The buyers have to sell into the same market they buy from. The dog simply stops chasing its tail.

    To me, the only real solution to all this is to increase supply – reduce planning restrictions on medium- and high-density living and then allow people to make their own minds up on what is right for them.

    I agree with that, obviously, if you leave out “only real” and sub “a part of the” for “the”.

    Stuffing about with prudential ratios will merely change the allocation of credit, not (at least not much) the amount of it.

    Doubtful. It might improve credit quality and that might push down rates, but the fund sources are now global so we are talking a ripple in the pond that will be lost in the noise.

    Nobody is going to a loan shark to get housing finance, Andrew.

  8. @Andrew Reynolds

    I will see your CCS media coverage and research funding and raise you $250 million in straight cash handouts to the TV networks early in an election year.

    This is curious coming from you, an ostensible defender of property rights. The networks were giving up valuable spectrum, which was theirs to sell or use. The state was, in a sense merely honouring the principle of acquiring property on just terms.

    It is also doubtful if any of the networks would have a way of contriving to help the government in repsonse, which is surely your implication. Murdoch is predictably unhappy, but then, that’s hardly surprising since Fox has nothing to gain from it.

  9. Fran – did the networks own the spectrum or was it merely leased? In my view all spectrum should be privatised and we should not have any fee for broadcasting licenses (except perhaps a minor admin fee comparable to company registration). However what Conroy did still looks dodgy due to a lack of clarity. If nothing else he needs to do a better job of selling reform.

  10. smiths,
    I hesitate to speak for Terje, but IIRC the principle would be similar as for land – you acquire the right to own a parcel of spectrum from the government and then it is yours to do with what you will, either to use it, sell it or leave it unused as you will.
    The handouts were not to acquire spectrum – the ostensible reason that Conroy gave was to protect Australian content. However, there was no actual requirement put on them to do anything as a result of receiving the $250m rebates.
    If it was to acquire the spectrum then he may have a case (I am not saying he does, I do not know) but that was not the case he made.
    If I was handing out someone else’s money (as Conroy is effectively handing out our money) I would try to make damn sure that I got something for it. The fact is he did not. That is, at the best interpretation, pandering.

  11. who acquires that right, every australian citizen?

    and who could you sell it to if everyone gets it for free?

  12. Andrew, please present evidence that indigenous Australians “managed large amounts of the land to at least some extent through the controlled and intentional application of fire”.

    Oh and define “managed”.

  13. Philomena,
    I presented some evidence in my previous response. I cannot locate a freely available web publication of it, but a quick check at your uni library might turn a copy up.
    As for definition, perhaps a perusal of a dictionary would assist in your understanding of the language.
    I take it, BTW, that you are now happy with the term “indigenous Australians” as you did not scarequote it. If not, please give an alternative term.
    As I indicated the government sells it in a similar way to the way the government sells land. Whoever buys it buys the rights to the exclusive use of it. They can sell it or use it or not use it.
    Some more radical libertarians might look at a homesteading model, but I am not that much of an anarchist.

  14. @Andrew Reynolds

    Andrew, you asserted that: “The indigienous Australians conducted controlled burns for millenia before my relatives arrived here. To a great extent the flora and fauna of Australia as you see them now are the result of that system which was only gradually stopped over the last 200 years.”

    I replied that there is no such entity as indigenous Australians whose behaviour, language, customs and traditions were identical and so they could not possibly have done such a thing across this vast continent nor is there in fact any evidence for these disparate groups having done any such thing intentionally or otherwise pre-invasion as claimed by you.

    If you have actual evidence for what you’ve claim, please present it now. Thanks.

  15. The central bank has blown it again. There is now as we speak an outrageous new property frenzy going on in Sydney.

  16. Smiths – privatising spectrum isn’t overly radical. You can subdivide spectrum (just as you subdivide land). The division is based on geography and frequency. The government would break the spectrum in large chunks, divided by frequence and region, and auction them off to the highest bidder as they do when they privatise land. The new owner may then lease the spectrum to others or subdivide it and sell it. It is pretty straight forward. As with other property you would be free to use it in the manner you saw fit.

    None of this need circumvent existing broadcasting standards. Governments routinely regulate what you can do with land (it is called zoning) and limit your usage of the land according to certain public decency criteria. If you broadcast porn on channel 3 at 5pm they could still whack you with a fine and close you down. However if you own the spectrum there is no case for charging an obscene amount for a broadcasting license. It should merely be a formality with a modest fee similar to a drivers license.

    If economic demand meant closing your TV station and selling the bandwidth to a WiMax operator was a better financial option then spectrum would flow to the area of greatest demand. This ought to be good for economic efficiency and ultimately for prosperity in general.

    Building a particular communications platform around a particular chunk of spectrum is much less risky if you own the spectrum rather than merely borrowing it. Privatised spectrum ought to see people building new communications platforms with much less hesitation.

  17. @TerjeP (say tay-a)

    The spectrum was leased. In fact, the rebate was not so much a handout of money as relief from the payments for the spectrum to which they hitherto had access — much the same in principle if one rented a house, a dam and a parcle of land, and then the owner decided he wanted to use some of it to agist horses and reduced your rent to reflect your loss of utility.

  18. Philomena,
    I have presented some evidence, but this is very off topic and I do not propose to give a long comment on it here. If you want to continue to discuss the burning practices of the pre-European inhabitants of this continent then I suggest a move over to the open forum.

  19. Fran,
    Don’t forget that they were also handed the exclusive access to a huge amount more spectrum (more as you can get more channels through it) as part of the digital rollout. The government could have broken up the rights and allowed many, many new players into the industry. The fact they did not to me at least represents a huge implicit subsidy.
    It is a subsidy we will all be paying for as long as choice is being artificially limited in the way it is.

  20. @Graeme Bird
    Graeme – dont believe Real Estate institute articles…Ill warrant there has never been a year since 1995 there wasnt a real estate frenzy going on. Its bunk. Its a buyers market now and its slow and there are interest rate rises on the horizon. Ive been watching it long enough. It doesnt make sense at the upper end…where ludicous prices are still changing hands but more slowly…but for the ordinary suburban house I would fall for the line that its a fast market.

  21. The International Monetary Fund has long preached the virtues of keeping inflation low and allowing money to flow freely across international boundaries. But two recent research papers by economists at the fund have questioned the soundness of that advice, arguing that slightly higher inflation and restrictions on capital flows can sometimes help buffer countries from financial turmoil.

  22. “Its a buyers market now and its slow and there are interest rate rises on the horizon.”

    But members of my family have been out looking. Thankfully they appear to have missed out and won’t be digging themselves in further. Hopefully its a buyers market everywhere else. But Sydney its turning nasty and inflationary.

  23. It is the case that restricting banks borrowing from foreign banks could be helpful smiths. It is not to be assumed that conclusions based on the free market have validity when applied to a cartelised banking system, that debauches the price system by way of the trading of phantom money, based on pyramided money, based on cash, based on nothing. This sort of trading has some ways to go as a method for distributing information via a valid price mechanism.

    But they surely have it wrong with advocating more inflation. One doesn’t want to be putting the economy through excessive pain or sado-monetarism. But having said that you don’t want any more monetary growth then what you really need to avoid too much pain.

    Since banks without a reserve asset ratio borrow as an afterthought for purposes of liquidity, and not with forethought for purposes of long-range investment, then it follows that stopping them from borrowing off foreign banks would indeed be a buffer. It would prevent the sort of prosperity delusion which comes from having a needlessly overvalued currency.

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