This article is from the Australian Property Journal archive
The Reserve Bank governor Ian Macfarlane today defended rate hikes that have brought the Australian property market crashing back to earth.
The RBA chief, speaking before House of Representatives Standing Committee on Economics, Finance and Public Administration in Brisbane, said that the property market has not been singled out for special treatment by the RBA.
Macfarlane said that it is clear that, despite our best endeavours to explain ourselves, a number of people think that the Bank tightened to cool down the property market.
“In fact, I have more than once received unsolicited advice that it would be better for us to explain our action in this way because people could more easily identify with it. The overheated property market is something that people can see around them; it is much more concrete than such concepts as inflation-targeting or returning interest rates to normal.
“However, such an approach would not be consistent with the truth. For a start, signs of overheating in the housing market were clearly evident through the second half of 2002 and all through 2003, yet the Bank did not change monetary policy. It was only when it became clear that good economic growth had returned both globally and domestically that rates were raised.
“I have often stressed that monetary policy has to be set taking into account the average of all the parts of the economy, not to what is happening in one sector. Of course, if a sector is overheated, it may push up the average for the economy, and in that way exert a disproportionate influence. It is also true that, historically, borrowing for housing purposes has been one of the more interest-sensitive sectors, and so it may have been more affected than other sectors by the previous low level of interest rates and it may respond more than other sectors to the recent increases.
“But that does not mean we singled it out.
“We have also been accused of setting monetary policy in relation to the Sydney and Melbourne housing markets, and ignoring the rest of the country. This clearly cannot be true in the case of the recent tightenings, as house prices in Sydney and Melbourne are growing less quickly than in other states; in fact, housing prices in some parts of these cities are already falling.
“In Australia we have conducted monetary policy by using an inflation-targeting regime for about a decade now. It has been a very successful regime in that it has delivered (along with various other reforms) the longest period of uninterrupted good economic growth in the post war period, at a rate exceeding that of all other significant developed economies. It has concentrated our minds at the Reserve Bank in that we have been very conscious of our need to deliver the results to which we have committed. Over the 10-year period, inflation has averaged 2.4%. By acting early on monetary policy to keep inflation in check, we have avoided large swings in interest rates and thereby allowed the economy to prosper.
“As you are aware, our target is a relatively flexible one in that we aim to achieve an average rate of somewhere between 2 and 3%. It is that average by which we should be judged, or made accountable. But there are some observers who think that the system should be more pre scri ptive than this and there should be some strict rule which should determine our actions.
“For example, a few people still think we should aim to keep inflation between 2 and 3% at all times. This is a clear misinterpretation of our system because it fails to realise that it is the average we are interested in. On a number of occasions, inflation has been above 3% and below 2%. In fact, about 45% of the time it has been outside the 2 to 3% range, and we have not regarded this as a failure of policy.
“Since our objective is to achieve an average inflation rate, there are multiple paths for inflation which are consistent with meeting our medium-term objective. We wish to choose the one which best satisfies the other obligations contained in our Act, which I summarise as achieving sustainable growth in income and employment. We are not simplistically committed to achieving the minimum possible variability in the inflation rate, or even hitting the target at some fixed period ahead, such as two years.
“Another approach sometimes put to us is to say that we should raise interest rates if, and only if, our forecast for inflation is above 3%, and lower them if, and only if, it is below 2%. Again, this is a misinterpretation of how the system works. It also ignores the complications and uncertainties involved in economic forecasting. The forecast horizon relevant for policy today is at least two, or even three, years. We can be relatively confident about forecasts for the first half of that horizon, as much of what is going to happen over that period is already set in place. But we can be less confident about the forecasts for the second half. The situation is particularly uncertain when, as is the case at present, the direction of inflation is expected to change during the forecast period.
“Since this type of forecast is so hard to make, we, like a number of other central banks, do not wish to lead the public to believe we can do this with much precision. In fact, we tend to appeal to the balance of risks around the central forecast in order to convey our message. In last month’s quarterly statement we said that the balance of risks was shifting to the upside, which was meant to indicate that inflation was on an upward trajectory through the course of the second year. We also drew attention to the fact that domestic price pressures were increasing, as shown by the fact that the rate of increase in the prices of ‘non-internationally traded goods and services’ had increased from 2% to 4% over the past few years. That does not mean that inflation will rise to 4% once the exchange rate effects have worn off, but at least a significant part of the economy will be influenced by this figure.
“In summary, I want to assure the Committee that the Bank remains committed to the inflation targeting framework and that the decisions taken over the past 18 months have been fully consistent with that framework. It does not seem plausible to us to argue that the Bank could have been confident of meeting its inflation commitments if interest rates had been held at 30-year lows in the face of the pick up in the international and domestic economies that is currently under way.”
