Reserve Bank

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<div>An extraordinary speech in Sydney from the Reserve Bank's Luci Ellis which could almost be an advertorial for what experienced property investors already know - when it comes to property investment, location really is everything.</div>
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<div>The supply of prime location land, explains Ellis, is essentially fixed, yet with a growing population in Australia the demand for it grows by the year.</div>
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<div>The inevitable result therefore has been that inner ring land values and therefore house prices continue to rise faster than those in the outer suburbs, and not only by a small margin. </div>
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<div>Ellis explains that even releasing more land around the capital city fringes may not be effective at bringing down inner ring house prices since the prime location land which everyone seems to want to get their hands on remains fixed in both place and supply.</div>
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<div>Research by the Reserve Bank shows that<strong> <em>place</em></strong> is nearly always more important than <em><strong>space</strong></em>when it comes to driving property prices, and buyers will always pay a premium for inner suburban housing.</div>
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<div>Moreover, significant increases in demand cannot be absorbed by new supply of prime location land, quite simply because there is none.</div>
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<div>In the words of Ellis: "The newly buily supply is simply not the same as the existing stock, because it is somewhere else".</div>
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<div>Indeed. I wrote about this very same issue - "substitutability" - some time ago. </div>
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<div>There is nothing particularly new about this idea, of course, but the Reserve Bank provides the research to prove the point by comparing the growth in "<em>prices of inner ring properties to those further out, particularly in Sydney</em>".</div>
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<div>The gap in the relative price action performance is both material and ongoing, with the data from 2006 to 2014 proving the point and ending any arguments.</div>
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<div>Within the above framework if outperformance is what you are seeking it obviously helps to find suburbs which are set to improve in some way (for example, a gentrifying location, or set to benefit from a new light rail link).<br><br>Over recent cycles, house prices have also outperformed apartment prices in most capital cities, although with initial rental yields often 1 per cent or more lower on average for inner suburban houses generally the growth needs to be stronger to compensate for the weak initial cash flow.<br><br>The old adage is true. When it comes to property, it really is first and foremost about "location, location, location".</div>
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<p><span><em>PETE WARGENT is the co-founder of <a href="https://allenwargent.com/" target="_blank" rel="nofollow">AllenWargent</a> property buyers (London, Sydney) and a best-selling author and <a href="https://petewargent.blogspot.com/" target="_blank" rel="nofollow">blogger</a>.</em><br></span></p>
<p><em>His latest book is <a href="https://www.bigskypublishing.com.au/Books/General-Interest/Four-Green-Houses--and-a-Red-Hotel/1015/productview.aspx" target="_blank" rel="nofollow">Four Green Houses and a Red Hotel</a>.</em></p>
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RBA: Location, location, location! Pete Wargent

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<h3 class="post-title entry-title"><span style="color: #333333; font-family: Tahoma, Helvetica, Arial, sans-serif; font-size: 12px;">It's become traditional at this time of year for the media to mention all the potential gloom and risks facing the economy - the auto assembly industry shutting down is an old favourite, and resources construction declining, of course.</span></h3>
<p>Thing is, we've known about these issues for aeons now.  </p>
<p>What is rarely mentioned is that if the all of the downside events do play out the declining Aussie dollar would bear the brunt of the adjustment, quickly declining to 40 to 50 cents.</p>
<p>Given that the Reserve Bank seems unwilling to cut interest rates further, a strong increase in business investment over the next couple of years admittedly doesn't seem all that probable. </p>
<p>Regardless, nothing is all good or all bad, and here are a few possible upside risks for the economy.</p>
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<p><span style="text-decoration: underline;"><strong>1 - Manufacturing jobs increase </strong></span></p>
<p>The car industry will see some manufacturing jobs go this year. Still, manufacturing employment soared by +102,000 last year, and the PMI gauge is in positive territory too. Any more to come where this came from with the lower dollar?</p>
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<div><span><strong><span style="text-decoration: underline;">3 - Mining investment bust ends</span></strong></span></div>
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<div>Commodity prices soared by 45 percent last year, and bulk commodities ripped higher by 145 percent, so it wouldn't be a huge surprise if the nadir is in sooner than expected, possibly before the calendar year is out.   </div>
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<div><strong><span style="text-decoration: underline;">4 - LNG price increases 50pc</span></strong></div>
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<div>LNG export volumes are forecast by Treasury to triple between 2015 and 2021. </div>
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<div>The Henry Hub natural gas spot prices is up by more than 75 percent from one year ago, and there could be more to come yet as oil prices rebound. </div>
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<div><span><strong><span style="text-decoration: underline;">5 - Property prices rise 12pc in 2017, unleashing a wealth effect</span></strong></span></div>
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<div>SQM Research see strong price gains nationally as possible, with prices in Sydney to rise by as much as 18 percent.</div>
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<div><span><em><span style="text-decoration: underline;">Source: SQM Research</span></em></span></div>
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<div>The wealth effect on household expenditure doesn't seem all that likely, but stranger things have happened, especially with household wealth passing a record $9 trillion last year.<br><br>
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<div><span><strong><span style="text-decoration: underline;">6 - Infrastructure booms</span></strong></span></div>
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<div>The NSW state government has zero net debt for the first time on record on the back of the biggest stamp duty boom in Australia's history, which should fund some serious infrastructure investment. </div>
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<div><span>Nationally, an infrastructure boom could be underway...</span></div>
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<div><span><strong><span style="text-decoration: underline;">7 - China unleashes its capital account</span></strong></span></div>
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<div>China has a rapidly urbanising population of 1.4 billion. If the capital account ever gets unleashed to buy international assets in earnest... well, there are only 24 million of us...</div>
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<strong><span style="text-decoration: underline;">8 - Tourism &amp; education boom</span></strong><br><strong><span style="text-decoration: underline;"><br></span></strong>Tourism and international student arrivals are already booming, and arrivals could rise 10 to 15 per cent over the next year following a streamlining of student visa rules, helping to send annual population growth back towards 450,000 per annum. Chinese visitor spend is also already exploding. <br><br><strong><span style="text-decoration: underline;">9 - Global growth accelerates, Australian GDP to above 5 percent</span></strong>
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<div>The Trump victory becomes a global turning point, and a combination of expansionary policy overseas and a revival of the animal spirits sees Australia's GDP growth accelerate to above 5 percent.</div>
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<div><strong><span style="text-decoration: underline;">The wrap</span></strong></div>
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<div>We won't see all of these unfold of course, but four or five of them could easily play out. </div>
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<div><em><span>PETE WARGENT </span>is the co-founder of <a href="https://allenwargent.com/" target="_blank" rel="nofollow">AllenWargent</a> property buyers (London, Sydney) and a best-selling author and <a href="https://petewargent.blogspot.com/" target="_blank" rel="nofollow">blogger</a>. </em></div>
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Nine upside risks to the Australian economy in 2017: Pete Wargent

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<p>GUEST OBSERVER</p>
<p>A significant number of wealthy individuals have used the ability of self managed super funds (SMSFs) to borrow for property and other investments to supercharge their funds.</p>
<p>It is not something done by retail and industry funds.</p>
<p>According to freedom of information documents obtained by the <a href="https://www.afr.com/companies/financial-services/richest-smsfs-are-leveraged-to-the-gills-20200421-p54lrg">Australian Financial Review</a>, in 2018 the largest 100 self-managed super funds had borrowings averaging around A$10 million each.</p>
<p>Given the tax benefits granted to superannuation, this exploitation of the system by Australia’s super-wealthy is scandalous, albeit legal. In 2018 more than 200 members of those biggest 100 self-managed super funds were members of the <a href="https://en.wikipedia.org/wiki/Financial_Review_Rich_List_2018">Financial Review Rich List</a>.</p>
<p>Along with other members of the 2014 <a href="https://treasury.gov.au/review/financial-system-inquiry-murray/the-panel">Australian Financial System Inquiry</a> chaired by David Murray, I voted enthusiastically for a recommendation to ban borrowing by funds.</p>
<p><strong>Normally, borrowing creates risk</strong></p>
<p>Unfortunately, after intense lobbying from the self-managed super fund sector, the Coalition government <a href="https://www.afr.com/companies/financial-services/richest-smsfs-are-leveraged-to-the-gills-20200421-p54lrg">rejected that recommendation</a>.</p>
<p>I am sure that each of the panel members put different weights on the arguments as to why “no leverage in super” would be good policy.</p>
<p>I focused on two.</p>
<p>First, leverage can lead to funds taking excessive risk, and it also enables some to “rort” the system by getting more assets into the tax-preferred status of super at the expense of the taxpayer</p>
<p>The second argument is about financial sector stability. Leveraged (indebted) financial institutions can be at risk of insolvency and exposed to runs by creditors. A highly levered financial system with lots of interconnectedness can face problems of fragility. Keeping super “un-levered”, as is generally the case for institutional super funds, would be good for stability.</p>
<p><strong>These are not normal times</strong></p>
<p>But even funds that can’t borrow, such as retail and industry funds, face problems if there is a “run” of members wishing to withdraw money.</p>
<p>That could arise because, believing that there are legislated limits on when members can access funds, they have invested significant amounts in longer term, illiquid assets such as toll roads, airports and office buildings in order to produce superior long term returns.</p>
<p>Changing the rules on when members can withdraw funds, such as with the current change to allow <a href="https://treasury.gov.au/sites/default/files/2020-04/Fact_sheet-Early_Access_to_Super.pdf">withdrawals of up to $20,000</a>, pressures funds to sell off assets they had planned on holding to generate enough cash to meet withdrawals.</p>
<p>Between $30 billion and $50 billion may have been <a href="https://www.propertyobserver.com.au/https://www.abc.net.au/news/2020-04-28/superannuation-early-withdrawal-risks-retirement-system-collapse/12192580">pulled out already</a>.</p>
<p>It isn’t a good time to be selling assets. Depressed sale prices mean the value of all members’ accounts will be further depressed.</p>
<p>Super funds could borrow to obtain the cash needed to meet withdrawals. But that would expose their members to considerable risk if asset prices fell further. They would have to have to pay back the loan from assets that were worth less.</p>
<p><strong>For now, I’ve changed my mind</strong></p>
<p>But if the liquidity problem is purely temporary, brought on by a temporary change in legislation, borrowing might not be such a bad option compared to a forced sale of assets.</p>
<p>While I have not changed my view on prohibiting borrowing in general, I think current circumstances warrant a limited exception.</p>
<p>That exception is that where there is a temporary liquidity problem, brought on by a government change in rules, the institutional super funds should be able to borrow from the Reserve Bank.</p>
<p>Banks can borrow from the Reserve Bank in emergencies. Why not super funds?</p>
<p>In this regard, I am at variance with commentators like David Murray and indeed the Reserve Bank itself. Moreover, I think there are reasonable arguments for making access to the Reserve Bank ongoing.</p>
<p>Bank access to the Reserve Bank, often referred to as the Reserve Bank being a “lender of last resort” is not about bailing out insolvent institutions. It is about providing temporary liquidity, at a price, to solvent, but illiquid institutions.</p>
<p>And the current issue is one of illiquidity, not insolvency. In principle at least, unlevered accumulation funds can’t go insolvent. If the value of assets falls, liabilities (amounts due to members) fall correspondingly.</p>
<p>The government should fix a problem it created</p>
<p>When an unexpected policy change creates a liquidity problem for super funds, it behoves policy makers to find a solution that avoids the need for funds to generate cash by selling assets at depressed prices.</p>
<p>Allowing super funds to borrow from the Reserve Bank using <a href="https://www.investopedia.com/terms/r/repurchaseagreement.asp">repurchase agreements</a> would be such a solution. And since the need for liquidity is a consequence of the policy change, those borrowings should not attract a penalty interest rate.</p>
<p>It is important to note that these borrowings are different to the type we argued against in the financial system inquiry.</p>
<p>There, we were concerned about funds increasing the size of their portfolios by borrowing and taking on additional risks.</p>
<p>Here, the borrowings would enable funds to avoid shrinking their portfolios and enable them to reduce the risks and costs they (more precisely their members) face.</p>
<p><strong>And consider making the fix permanent</strong></p>
<p>My suggestion is that while borrowings by super funds should generally be prohibited, accessing temporary liquidity support from the Reserve Bank should not be part of that prohibition.</p>
<p>If access to such a facility is made ongoing, there would be a case for offering it at penalty interest rates and subjecting funds to liquidity regulation. But those are questions best left for reasoned discussion in more settled times.</p>
<p>Oh, and there has to be a severe crackdown on the ability of wealthy individuals to rort the tax benefits of super by borrowing through their self-managed super funds.</p>
<p>For the government to allow such borrowings but not support institutional funds by allowing borrowing from the Reserve Bank in times of crisis seems, at best, anomalous.<img src="https://counter.theconversation.com/content/137240/count.gif?distributor=republish-lightbox-basic" alt="The Conversation" width="1" height="1" style="border: none !important; box-shadow: none !important; margin: 0 !important; max-height: 1px !important; max-width: 1px !important; min-height: 1px !important; min-width: 1px !important; opacity: 0 !important; outline: none !important; padding: 0 !important; text-shadow: none !important;"></p>
<p><span><a href="https://theconversation.com/profiles/kevin-davis-3497">Kevin Davis</a>, Professor of Finance, <em><a href="https://theconversation.com/institutions/university-of-melbourne-722">University of Melbourne</a></em></span></p>
<p>This article is republished from <a href="https://theconversation.com">The Conversation</a> under a Creative Commons license. Read the <a href="https://theconversation.com/why-the-reserve-bank-should-fund-super-funds-during-the-covid-19-crisis-137240">original article</a>.</p>
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Why the Reserve Bank should fund super funds during the COVID-19 crisis

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<p>The Reserve Bank Governor Philip Lowe has indicated that the current level of interest rates is low enough to support the economy.</p>
<p>He hasn’t ruled out further rate cuts – especially if the jobless rate were to rise. But Governor Lowe has indicated that policy is appropriate for now.</p>
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<p>The Governor is well aware that low rates are affecting <em>“confidence of some people”.</em> He also recognises that low rates could encourage further borrowing to buy homes and that this could to <em>“problems down the track”.</em> </p>
<p>So for now – with the jobless rate coming down and inflation gradually lifting – the Reserve Bank is happy to remain on the interest rate sidelines.</p>
<p>Despite bushfires, drought and the threat of coronavirus, the Reserve Bank is tipping economic growth near 2.75 per cent this year – near the economy’s speed limit.</p>
<p>The bushfires may cut economic growth by 0.2 percentage points across December quarter 2019 and March quarter 2020. </p>
<h1><span>Global economy</span></h1>
<p>The Governor is more upbeat on the global economy: <em>“These </em>(US-China trade agreement and Brexit)<em> are encouraging developments and provide a reasonable basis to expect that this year will be better than last year.”</em></p>
<p>Governor Lowe also reflected on one of the themes that CommSec has been focussing on over the past year: <em>“we find ourselves in a world of low unemployment, low inflation and low interest rates. I expect that we are going to remain here for quite some time given the structural factors at work, although it does remain possible that a re-acceleration of growth in economies with little spare capacity could see inflation re-emerge.”</em></p>
<p><a href="https://www.propertyobserver.com.au/images/2020/2/5/global%20economy%20.jpg" target="_blank">Click here</a> to enlarge:</p>
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<p><em>“Some investors are also taking on more risk as they search for higher returns in a low interest rate world. Both higher asset prices and a willingness to take more risk can be good for the global economy, especially if they lead to more investment, not just more borrowing. </em></p>
<p><em>"We do, though, need to remember that it is possible to have too much of a good thing. So this is also an issue that international bodies, including the Financial Stability Board, are keeping a close eye on.”</em></p>
<h1><span>Local economy</span></h1>
<p><em>Our central forecast is for the Australian economy to expand by 2¾ per cent over 2020 and 3 per cent the following year. These growth rates are a little above our current estimate of medium-term growth in Australia, so some inroad into spare capacity should be made.”</em></p>
<p><em>“The expected pick-up in world growth should help us, the resources sector is in expansion mode again and we are expecting consumer spending to pick up. The outlook is also being supported by ongoing high levels of investment in infrastructure and the likelihood that the downswing in residential construction will come to an end later this year. Further increases in resource exports and continuing solid growth in public demand will also help.”</em></p>
<h1><span>Specific topics</span></h1>
<p>Governor Lowe focussed on three issues:</p>
<p><span><span>Ø<span>  </span></span></span><span>the ongoing adjustment in household balance sheets</span></p>
<p><span><span>Ø<span>  </span></span></span><span>the bushfires, the drought and the coronavirus outbreak</span></p>
<p><span><span>Ø<span>  </span></span></span><span>the importance of continuing to invest in our future.</span></p>
<h1><span>Household balance sheets</span></h1>
<p>The Governor said “we expect consumption growth to strengthen as households become more comfortable with their balance sheet positions. <em>“Higher home prices and lower unemployment will assist in lifting spending growth.”</em></p>
<p><span><span>·<span>         </span></span></span><em>“So it is reasonable to expect that things improve from here, although it is hard to be precise about how much longer this period of balance sheet adjustment will continue.”</em></p>
<h1><span>Bushfires &amp; coronavirus</span></h1>
<p>On the bushfires, the Governor said <em>“In assessing the impact of this on the Australian economy as a whole we have taken into account that there will be a material rebuilding effort and that government grants and insurance payments will assist many people. On this basis, our assessment is that GDP growth for 2020 as a whole will be largely unaffected. </em></p>
<p><em>"There is, however, likely to be a noticeable effect across the December quarter last year and the current quarter. While it is still difficult to be precise, we estimate that the effects of the bushfires will reduce GDP growth by around 0.2 percentage points across the two quarters.”</em></p>
<p>On the drought, Lowe said: <em>“A further decline of around 10 per cent in farm output is expected in 2020, representing a drag on GDP growth of around a quarter of a percentage point.”</em></p>
<p>On the coronavirus Governor Lowe said: <em>“It is too early to tell what the overall impact will be, but the SARS outbreak in 2003 may provide a guide. On that occasion, there was a sharp slowing in output growth in China for a few months, before a sharp bounce-back as the outbreak was controlled and economic stimulus measures were introduced.”</em></p>
<h1><span>Investment</span></h1>
<p>The Governor again stressed that Australian businesses and governments need to invest.</p>
<p><em>“As I have said on other occasions, low interest rates should make it easier for both the public and business sectors to contemplate long-term investments, given that future returns don't need to be discounted as much. They also mean that financing costs are lower. With interest rates at record lows and likely to remain low for quite some time there are plenty of opportunities here.”</em></p>
<h1><span>Monetary Policy<br></span></h1>
<p>The Reserve Bank Governor said that “<em>Over the next couple of years we expect further progress to be made towards full employment and the inflation target, although that progress is likely to remain quite slow.</em></p>
<p>Governor Lowe went on further saying that <em>“The gradual nature of this progress reflects some significant structural shifts in the global economy related to technology and globalisation and, as I discussed earlier, a period of adjustment in household finances in Australia.” </em></p>
<p>Lowe added: <em>“Monetary policy has already responded to this and is providing considerable support to the Australian economy.”</em></p>
<p><a href="https://www.propertyobserver.com.au/images/2020/2/5/gdp%20growth.jpg" target="_blank">Click here</a> to enlarge: </p>
<p><em><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2020/2/5/gdp%20growth.jpg" alt=""></em></p>
<p>So monetary policy has acted. But what about further reductions?</p>
<p>Governor Lowe noted: “<em>Given the outlook I have outlined today, the Board has, however, continued to discuss the merits of further monetary stimulus in an effort to speed the pace of progress and to make it more assured. </em></p>
<p><em>"On balance, though, the Board has decided to hold the cash rate steady, recognising the significant monetary stimulus already in place and the long and variable lags associated with monetary policy.”</em></p>
<p><em>“This decision also reflects a judgement about the benefits from a further reduction in interest rates against some of the costs and risks associated with very low interest rates.”</em></p>
<p><em>“It certainly remains the case that a further reduction in interest rates would help with the balance sheet adjustment by households with existing debt, which should help bring forward the day that consumption strengthens. It would also have a further effect on the exchange rate, which would boost demand for our exports and therefore support jobs growth.”</em></p>
<p><em>“On the other side of the equation though, there are risks in having interest rates at very low levels. Internationally, there are increased concerns about the effect of very low interest rates on resource allocation and their effect on the confidence of some people. </em></p>
<p><em>"Lower interest rates could also encourage more borrowing by households eager to buy residential property at a time when there is already a strong upswing in housing prices in place. If that occurs, this could increase the risk of problems down the track. So there is a balance to be struck here.”</em></p>
<p><em>“The Board recognises that the nature of this balance can change over time and that it depends very much upon the state of the economy. So it is continually looking at both sides of the equation. </em></p>
<p><em>"If the unemployment rate were to be trending in the wrong direction and there was no further progress being made towards the inflation target, the balance of arguments would change. In those circumstances, the Board would see a stronger case for further monetary easing. We will continue to monitor developments carefully, including in the labour market, as we seek to strike the right balance in the interests of the community as a whole.”</em></p>
<h1><span>What are the implications for interest rates and investors?</span></h1>
<p><span>Interest rates are set to remain low. But further rate cuts are ruled out for now. As a result investors will continue to favour investment in shares and property, rather than cash.</span></p>
<p><span>Watch the jobless rate. If it starts rising again, then the Reserve Bank may act on rates. But for now the jobless rate is falling, forward indicators are positive and housing demand is rising.</span></p>
<p><span>Consumer spending remains one of the big uncertainties for 2020 together with the coronavirus impact on the global economy.</span></p>
<p><a href="https://www.propertyobserver.com.au/images/2020/2/5/uneployment%20.png" target="_blank">Click here</a> to enlarge: </p>
<p><span><img src="https://www.urban.com.au/images/2020/2/5/uneployment%20.png" alt=""></span></p>
<p> </p>
<p><a href="https://www.propertyobserver.com.au/images/2020/2/5/inflation%20.jpg" target="_blank">Click here</a> to enlarge:  </p>
<p><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2020/2/5/inflation%20.jpg" alt=""></p>
<p><span><strong>CRAIG JAMES</strong><em> is the chief economist at <a href="https://www.comsec.com.au/default.aspx" target="_blank">CommSec</a>.</em></span></p>
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cjames-5S2v74qSNK

The Reserve Bank Governor paints a positive picture: Craig James

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<p>GUEST OBSERVATION</p>
<p>Governor Phillip Lowe has laid out in very clear terms the circumstances in which the bank would resort to quantitative easing and the way in which it would implement it.</p>
<p>Quantitative easing is simply a change in the way it eases monetary policy when the official interest rate approaches zero.</p>
<p>Usually it does it by cutting the so-called <a href="https://www.rba.gov.au/education/resources/explainers/how-rba-implements-monetary-policy" target="_blank">cash rate</a>, which is the rate banks pay each other for money deposited overnight.</p>
<p>Eight years ago the cash rate was 4.5%. Three years ago it was 1.5%. After the most recent three cuts in June, July and October, it is just 0.75%</p>
<hr>
<p><a href="https://images.theconversation.com/files/303837/original/file-20191126-112484-iegrak.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=1000&amp;fit=clip"><img src="https://images.theconversation.com/files/303837/original/file-20191126-112484-iegrak.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" alt=""></a></p>
<p><em><span class="attribution"><a class="source" href="https://www.rba.gov.au/statistics/cash-rate/" target="_blank">Source: RBA</a></span></em></p>
<p>Last night, Governor Lowe said the <a href="https://www.rba.gov.au/speeches/2019/sp-gov-2019-11-26" target="_blank">effective lower bound was 0.25%</a>. Rather than let the cash rate get any lower or negative (an option he explicitly ruled out), the bank will push down other longer-term rates by buying government bonds.</p>
<p>It’s the “quantitative easing” approach adopted by the US Federal Reserve between 2009 and 2014.</p>
<p>Government bonds are sold by governments in return for money, a means of borrowing. The buyer gets guaranteed interest payments and a guarantee that their money will be returned in full after three, five, 10 or even 20 years depending on the length of the bond.</p>
<p>Once issued, bonds can be traded on a market, and the price at which they change hands can be expressed as an implied interest rate, which becomes the risk-free rate against which all other interest rates are benchmarked.</p>
<p><strong>How quantitative easing would work</strong></p>
<p>Buying bonds from investors would push down that risk-free rate, pushing down the entire structure of long-term interest rates.</p>
<p>All other things being equal, this should also push down the exchange rate by reducing the return on Australian dollar denominated financial investments.</p>
<p>Governor Lowe indicated he might buy state government bonds as well as Commonwealth bonds.</p>
<p>Importantly, he argued that although the bank would be mindful of the need to ensure private banks had enough access to the bonds they needed to hold for regulatory purposes, those holdings would not be an impediment to quantitative easing.</p>
<p>He ruled out buying residential mortgage-backed securities and other private assets given that those markets are currently functioning well and Reserve Bank purchases could distort them.</p>
<p>The approach borrows heavily from the US Fed.</p>
<p>As in the US, Lowe says quantitative easing would be complemented by “forward guidance”, where the Reserve Bank would signal early how long-term interest rates would be kept low and the circumstances in which it expected to raise them again.</p>
<p>The guidance is designed to influence market expectations for future interest rates, enhancing the effectiveness of cuts in long term interest rates.</p>
<p><strong>When it would happen</strong></p>
<p>In addition to “how”, Governor Lowe spelled out “when” – the economic circumstances in which the bank would resort to quantitative easing.</p>
<p>It would do it when the cash rate was at 0.25% and inflation and unemployment were moving away from its objectives.</p>
<p>The bank targets 2-3% inflation on average over time and has recently identified 4.5% as the “full employment” unemployment rate.</p>
<p>Importantly, Lowe emphasised that the Australian economy has not yet reached the point where a cash rate as low as 0.25% would be needed and argued quantitative easing was unlikely to be needed in future.</p>
<p>The cash rate is at present 0.75%. Setting 0.25% as the effective lower bound gives the Governor 0.5 percentage points left to cut before implementing quantitative easing.</p>
<p>Implicitly, Governor Lowe is saying that those cuts of 0.5 percentage points will be enough to stabilise the economy.</p>
<p><strong>A pause for a breath at 0.25%</strong></p>
<p>Lowe also indicated the bank would not seamlessly transition to quantitative easing.</p>
<p>He implied there was an additional hurdle or threshold that would need to be crossed, suggesting he would be reluctant to make the transition.</p>
<p>His big problem is that neither inflation nor the unemployment rate are moving in the right direction.</p>
<p>The bank has undershot its inflation target since the end of 2014, giving the economy a weak starting point going into an emerging global downturn.</p>
<p>My <a href="https://www.ussc.edu.au/analysis/lessons-from-quantitative-easing-in-the-united-states-a-guide-for-australian-policymakers" target="_blank">research</a> on the US experience for the United States Studies Centre shows that the main problem with is quantitative easing was that it was not done soon enough or aggressively enough.</p>
<p><strong>It might be better to be bold</strong></p>
<p>While quantitative easing was effective, it could have been made more so had what was going to happen been made clearer.</p>
<p>The Fed went out of its way to limit the transmission of quantitative easing to the rest of the economy, fearful it would be too potent and lead to excessive inflation.</p>
<p>Those concerns proved misplaced. By pulling its punches, the Fed ended up being less effective and having to pursue quantitative easing for longer than if it had used it more aggressively.</p>
<p>Governor Lowe’s very obvious reluctance to go down the quantitative easing route suggests the Reserve Bank is in danger of making the same mistake, but it is not too late to learn from what happened in the US.<img src="https://counter.theconversation.com/content/127697/count.gif?distributor=republish-lightbox-basic" alt="The Conversation" width="1" height="1" style="border: none !important; box-shadow: none !important; margin: 0 !important; max-height: 1px !important; max-width: 1px !important; min-height: 1px !important; min-width: 1px !important; opacity: 0 !important; outline: none !important; padding: 0 !important; text-shadow: none !important;"></p>
<p><em><strong>Stephen Kirchner</strong>, Program Director, Trade and Investment, United States Studies Centre, University of Sydney.</em></p>
<p><em>This article is republished from <a href="http://theconversation.com" target="_blank">The Conversation</a> under a Creative Commons license. Read the <a href="https://theconversation.com/now-we-know-the-reserve-bank-has-spelled-out-what-it-will-do-when-rates-approach-zero-127697" target="_blank">original article</a>.</em></p>
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The Reserve Bank has spelled out what it will do when rates approach zero: Stephen Kirchner

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<p>EXPERT OBSERVER</p>
<p>What has changed since the last meeting?</p>
<p>The CoreLogic national home price index rose by 1.7% in November – the biggest rise in 16 years.</p>
<p>Wages rose 0.5% in the September quarter to be up 2.2% on the year.</p>
<p>Building approvals fell by 8.1% in October.</p>
<p>Business confidence and conditions rose in October.</p>
<p>Job ads fell by 1.7% in November. </p>
<p>Private sector credit annual growth fell from 2.7% to a 9½-year low of 2.5% in October.</p>
<p>Employment fell by 19,000 in October – the first fall in 17 months.</p>
<p>The jobless rate rose from 5.2% to 5.3%.</p>
<p>In the twelve months to October 2019, the Budget deficit stood at just $78 million.</p>
<p>New business investment (spending on buildings and equipment) fell by 0.2% in the September quarter to be down by 1.3% over the year.</p>
<p>The rolling annual trade surplus was a record $63.35 billion in the year to September.</p>
<p>The Australian dollar has generally held around US66-69 cents.</p>
<p>The US and China are still reportedly progressing on a ‘Phase 1’ trade deal.</p>
<p>US and Australian share markets hit record highs in November.</p>
<p>The Reserve Bank Governor spoke on ‘unconventional monetary policies’.</p>
<p><strong>The assessment</strong></p>
<p>The Reserve Bank emphasises that rate cuts are indeed working. “The lower cash rate has put downward pressure on the exchange rate, which is supporting activity across a range of industries. It has also boosted asset prices, which in time should lead to increased spending, including on residential construction. Lower mortgage rates are also boosting aggregate household disposable income, which, in time, will boost household spending.”</p>
<p>The Reserve Bank has left the cash rate at 0.75% after cutting rates in June, July and October, each by 25 basis points. There have now been 15 rate cuts since November 2011 with the cash rate cut from 4.75%.</p>
<p><img src="https://res.cloudinary.com/dz9xllyip/image/fetch/c_scale,w_580,q_auto:good/https://s3-ap-southeast-2.amazonaws.com/po.images/2019/12/3/Rate%20Cuts%20Lower%20AUD%20CommSec.jpg" alt=""></p>
<p>Previously rates rose seven times from October 2009 to November 2010 from 3.00% to 4.75%.</p>
<p>Interest rates are set to stay low for an extended period. The latest monthly reading suggests that inflation remains stuck near 1.5% – well below the Reserve Bank’s 2-3% target zone.</p>
<p>Rates could still go lower but the Reserve Bank seems prepared to play the waiting game. The Reserve Bank has emphasised that the rate cuts are indeed working, suggesting it may allow more time before deciding the next rate move. While rate cuts have caused confidence to weaken, the RBA is asking people to focus on the positives of lower rates like higher home prices and a lower Aussie dollar.</p>
<p>The Commonwealth Bank Group has pencilled in another rate cut in February. But fiscal policy stimulus is preferred. The mid-year budget review is handed down later in December.</p>
<p>The statement from the previous November 2019 meeting is on the left; the statement from today’s December 2019 meeting is on the right. Emphasis has been added to highlight key points in the wording in the statements.</p>
<p>The Reserve Bank emphasises that rate cuts are indeed working. “The lower cash rate has put downward pressure on the exchange rate, which is supporting activity across a range of industries. It has also boosted asset prices, which in time should lead to increased spending, including on residential construction. Lower mortgage rates are also boosting aggregate household disposable income, which, in time, will boost household spending.”</p>
<p><strong>Perspectives on interest rates</strong></p>
<p>The Reserve Bank has left the cash rate at 0.75% after cutting rates in June, July and October, each by 25 basis points. There have now been 15 rate cuts since November 2011 with the cash rate cut from 4.75%.</p>
<p>Previously rates rose seven times from October 2009 to November 2010 from 3.00% to 4.75%.</p>
<p><strong>What are the implications of today’s decision?</strong></p>
<p>Interest rates are set to stay low for an extended period. The latest monthly reading suggests that inflation remains stuck near 1.5% – well below the Reserve Bank’s 2-3% target zone. </p>
<p>Rates could still go lower but the Reserve Bank seems prepared to play the waiting game. The Reserve Bank has emphasised that the rate cuts are indeed working, suggesting it may allow more time before deciding the next rate move. While rate cuts have caused confidence to weaken, the RBA is asking people to focus on the positives of lower rates like higher home prices and a lower Aussie dollar.</p>
<p>The Commonwealth Bank Group has pencilled in another rate cut in February. But fiscal policy stimulus is preferred. The mid-year budget review is handed down later in December.</p>
<p><em><strong>Craig James</strong> is the chief economist at CommSec.</em></p>
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Reserve Bank believes its rate cuts are working: CommSec's Craig James

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<p>EXPERT OBSERVATION</p>
<p>In its quarterly statement on monetary policy, released today, the Reserve Bank of Australia declared its preparedness to “ease monetary policy further if needed”.</p>
<p>This suggests the bank still thinks monetary policy – in this case lowering interest rates to stimulate the economy – could help “support sustainable growth in the economy, full employment and the achievement of the medium-term inflation target”.</p>
<p>But in the wake of the bank last month lowering the official interest rate to a record low and the current somewhat sad state of the Australian economy, <a href="https://www.afr.com/policy/economy/monetary-policy-has-run-its-race-costello-20191015-p530ys" target="_blank">many commentators</a> have speculated that <a href="https://www.rba.gov.au/monetary-policy/" target="_blank">monetary policy</a> doesn’t work any more.</p>
<p><strong>Is that right?</strong></p>
<p>Reserve Bank cash rate</p>
<p><a href="https://images.theconversation.com/files/294952/original/file-20191001-173393-1b2cjw9.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=1000&amp;fit=clip"><img src="https://images.theconversation.com/files/294952/original/file-20191001-173393-1b2cjw9.jpg?ixlib=rb-1.1.0&amp;q=45&amp;auto=format&amp;w=754&amp;fit=clip" alt=""></a></p>
<p><a href="https://www.rba.gov.au/statistics/cash-rate/" target="_blank">Source: RBA</a></p>
<p>There are a number of variants of the “monetary policy doesn’t work” argument. The most basic is that the Reserve Bank has this year cut rates from 1.50% to 0.75% without any improvement to the Australian economy.</p>
<p>This is a textbook example of one of the classic logic fallacies known as “<a href="https://www.britannica.com/topic/fallacy#ref1102390" target="_blank">post hoc ergo propter hoc</a>” (from the Latin, meaning “after this, therefore because of this”).</p>
<p>Put simply, it assumes the rate cuts have had no effect and doesn’t account for the possibility things might have been worse had there been no cuts.</p>
<p>Things might have been even worse. We’ll never know.</p>
<p>It also ignores what might have happened if the RBA had cut sooner. Again, we can’t know for sure. It is possible, though, to make an educated guess.</p>
<p><strong>When to cut rates</strong></p>
<p>Had Reserve Bank governor Philip Lowe acted, say, 18 months earlier to cut rates, he would have signalled that Gross Domestic Product growth was indeed lower than desired, that the sustainable rate of unemployment was more like 4.5% than 5%, and, most importantly, that he understood the need to act decisively.</p>
<p>That would have sent a powerful signal.</p>
<p>It would also have ameliorated the huge decline in housing credit that pushed down housing prices in Sydney and Melbourne by double digits.</p>
<p>That, in turn, would have prevented some of the weakening in the balance sheets of the big four banks that has occurred (witness this annual general meeting season).</p>
<p>All of this would have pumped more liquidity into the economy and put households in a much stronger position, likely leading to stronger consumer spending than we have seen.</p>
<p><strong>Bank pass through</strong></p>
<p>One gripe both the Reserve Bank governor Philip Lowe and federal treasurer Josh Frydenberg have had with the banks is their <a href="https://www.propertyobserver.com.au/https://www.abc.net.au/news/2019-10-14/josh-frydenberg-asks-accc-to-investigate-banking-sector/11598614" target="_blank">failure to fully pass through the RBA cuts</a>.</p>
<p><a href="https://theconversation.com/four-questions-about-mortgages-the-accc-inquiry-should-put-to-the-big-four-banks-125224" target="_blank">It is true there is a problem</a> with banks not being able to cut deposit rates below zero, and as a result having less scope to cut mortgage rates, which are majority funded from deposits.</p>
<p>But there are, of course, other ways monetary policy can work. The leading example is quantitative easing (QE).</p>
<p>This is where the central bank pushes down long-term interest rates by buying government and corporate bonds. At the same time this expands the money supply, thereby adding some upward inflationary pressure.</p>
<p>There is <a href="https://theconversation.com/below-zero-is-reverse-how-the-reserve-bank-would-make-quantitative-easing-work-118843" target="_blank">little reason</a> to think such measures wouldn’t work.</p>
<p><strong>The power of free money</strong></p>
<p>Perhaps paradoxically, the closer interest rates get to zero the more powerful those rates may end up being.</p>
<p>To put it bluntly, if someone shoves a pile of money into your hand and asks almost nothing in return, you’re likely to use it. In fact, you would be pretty silly not to.</p>
<p>Suppose your mortgage rate really goes to zero – as <a href="https://www.propertyobserver.com.au/https://www.abc.net.au/news/2019-09-13/european-central-bank-ecb-cut-rates-negative-record-low/11508704" target="_blank">has happened in Europe</a>.</p>
<p>You might decide to redraw that and spend the money on a home renovation or some other productive purpose. Or you might decide to buy a more expensive house.</p>
<p>Such spending provides an economic boost.</p>
<p>The effect is all the more pronounced if people expect interest rates to be low for a long period of time. Aggressive cutting coupled with quantitative easing – which lowers long-term rates – signal just that.</p>
<p><strong>But not only monetary policy</strong></p>
<p>Just because monetary policy still has some effect at near-zero rates doesn’t mean we should pin all of our economic hopes to it.</p>
<p>A near consensus of economists have argued repeatedly for the use of more aggressive fiscal policy – including more infrastructure spending and more tax cuts.</p>
<p>Indeed, Philip Lowe has raised eyebrows by <a href="https://www.rba.gov.au/speeches/2019/sp-gov-2019-08-09" target="_blank">speaking so forthrightly</a> on this issue. That doesn’t make him wrong, though.</p>
<p>There is little doubt the Reserve Bank should have acted much earlier to cut official interest rates. There is also a very good chance it will need to begin to use other measures such as quantitative easing in the relatively near future.</p>
<p>All of that says the Australian economy, like most advanced economies around the world, is in bad shape.</p>
<p>But it doesn’t mean monetary policy has completely run out of puff.<img src="https://counter.theconversation.com/content/126579/count.gif?distributor=republish-lightbox-basic" alt="The Conversation" width="1" height="1"></p>
<p><a href="https://theconversation.com/profiles/richard-holden-118107" target="_blank">Richard Holden</a>, Professor of Economics, <a href="http://theconversation.com/institutions/unsw-1414" target="_blank">UNSW</a></p>
<p>This article is republished from <a href="http://theconversation.com" target="_blank">The Conversation</a> under a Creative Commons license. Read the <a href="https://theconversation.com/vital-signs-does-monetary-policy-work-any-more-126579" target="_blank">original article</a>.</p>
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rh-YsoTT2xMuQ

Does monetary policy work any more?

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<p>EXPERT OBSERVER</p>
<p>The minutes of the July monetary policy meeting of the Reserve Bank Board confirm that the Board is still open to further monetary easing, although as we had expected, prospects for a third consecutive easing in August have been dampened.</p>
<p>The best way to assess the likelihood of a move in August is to compare the wording in the June minutes with the wording in the July minutes.</p>
<p>In the June minutes, the key “considerations” section noted “members agreed that it was more likely than not that a further easing in monetary policy would be appropriate in the period ahead”. This very strong sentence was not repeated in the July minutes.</p>
<p>Furthermore the minutes do state that “the Board will continue to monitor developments in the labour market closely, and adjust monetary policy if needed”.</p>
<p>In the June minutes, the “if needed” qualification was not used, merely saying instead “members agreed that in assessing whether further monetary easing was appropriate, developments in the labour market would be particularly important”.</p>
<p>Finally, my experience is that when a central bank decides to pause, it often refers back to previous policy decisions.</p>
<p>In the final paragraph of the July minutes, the Board notes “this decision, together with the reduction in the cash rate decided at the previous meeting, would assist in reducing spare capacity in the economy”.</p>
<p>Other points which are worthy of noting are:</p>
<p><strong>&gt; </strong>The Board confirms that it expects that GDP growth will return to trend over coming years. That comment provides a fairly clear indication that the GDP forecasts that will be provided in the August Statement on Monetary Policy will maintain the view that GDP growth in 2020 will reach 2 ¾ per cent.</p>
<p>Westpac expects that following further evidence around the economy’s momentum through 2019, this growth forecast will need to be revised down in the November Statement on Monetary Policy, paving the way for a further rate cut at the November meeting.</p>
<p>In that regard, it is interesting that  in previous communications, the dominant emphasis has been on reducing spare capacity in the labour market, the decision to cut rates was also impacted by the recent disappointing data on output growth, which is described as well below trend over the year to the March quarter.</p>
<p>Despite the prospect of some lift in income growth from the legislated tax cuts, the outlook for consumption growth remains uncertain.</p>
<p><br><strong>&gt;</strong> The description of the housing market continues to be cautious. Conditions in Sydney and Melbourne are noted to have stabilised, although rising auction clearance rates were on low volumes, and more generally, turnover in the housing market had remained low.</p>
<p><br><strong>&gt;</strong>The Board explicitly dismisses any prospect of a further decline in interest rates “encouraging an unwelcome material pick-up in borrowing by households that would add to medium-term risks in the economy”.</p>
<p>This is important, since lower rates are expected to support the economy through a more competitive currency and the freeing up of cash for borrowers, but any spill-over into excessive borrowing would always be seen as a constraint for policy.</p>
<p><br><strong>&gt;</strong> The focus on the labour market remains clear with the unemployment rate, the underemployment rate, and wages growth being the key indicators of spare capacity.</p>
<p>The Board notes that developments in these variables continue to indicate that spare capacity was likely to remain in the labour market for some time. That observation indicates that the Board expects that a further easing in monetary policy will be “needed”.</p>
<p><br><strong>&gt;</strong> Finally, it is worth noting that the Board specifically addresses the recent uplift in the Australian dollar.</p>
<p>It points out that it is important to assess the currency effect on the basis that without the rate cut, the exchange rate would have been higher as other central banks continue to ease policy.</p>
<p><strong>Conclusion</strong></p>
<p>On May 24th, Westpac complemented its February call for two rate cuts in the second half of 2019 with the likelihood of a third cut.</p>
<p>However, we expected that there would be some months break between the second and third cuts.</p>
<p>With the first two cuts now having been delivered, and some clear signals from these minutes that the Board is likely to pause before further adjustments, we remain comfortable with our call that the next move will be in November.</p>
<p>The minutes confirm that the Board is prepared to move and probably expects to move again but prefers to wait a while to assess the impact of the first two cuts.</p>
<p>Our forecasts for growth, inflation and the unemployment rate clearly point to the need for further stimulus, and we expect that the November meeting will provide that timing.</p>
<p>However we do recognise that while growth and inflation remain key policy objectives, the labour market has the most immediate priority.</p>
<p>With updates to conditions in the labour market being provided on a monthly basis, prospects for the next move being as early as September or October cannot be dismissed.</p>
<p><em>BILL EVANS is Chief Economist for Westpac</em></p>
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