This post was motivated by Scott Sumner´s musings about Australia: Australia´s Great Stagnation:
It looks like the Great Stagnation has hit even Australia. In an earlier post I pointed out that Australian NGDP rose at a 6.5% rate from 1996:2 to 2006:2. Then we had the Global Financial Crisis, and Australian NGDP growth slowed to . . . er . . . it stayed at 6.5% from 2006:2 to 2012:2. No tight money and no recession in Australia.
Some important facts about Australia:
1 NGDP and Trend
2 RGDP & Trend
Notice that when NGDP climbs above trend, RGDP falls below trend!
Zooming in (circles explained later)
What explains the counterintuitive fact that RGDP falls below trend at the same time commodity prices take off?
The rise in NGDP translates into a rise above target in core inflation.
The 200 basis points increase in the cash rate (equivalent to the Fed´s FF rate) just goes to show that interest rates are bad definers of the stance of monetary policy. Despite the increase in the cash rate, inflation and NGDP were moving up, indicating monetary policy was “too easy”!
With Australia being a commodity exporter, another way to gauge the stance of monetary policy is by comparing the move in the exchange rate to the dollar and commodity prices. Monetary policy is “just right” if a rise in commodity prices is accompanied by an appreciation of the Aussie Dollar (USD/A$) and a fall in commodity prices goes hand in hand with a depreciation of the exchange rate.
The chart below shows that in 2004-07 monetary policy was too loose, consistent with NGDP climbing above trend (and inflation increasing). Monetary policy was tightened in 2011-13, consistent with NGDP converging to trend and inflation decreasing (see circles in NGDP & Trend chart above).
At present, NGDP is back on trend (actually just a “whisker” below it). What happens next? Will Australia go the way of Sweden, Israel and Poland, or will it get “smart”?
In the case of Sweden things started unraveling when the Riksbank decided to “prick” a housing “bubble”. According to the FT:
Sweden’s central bank has been lambasted by critics for trying to use interest rates to combat signs of a housing bubble. It lifted rates in 2010 and 2011 as it publicly worried about what it saw as high household debt levels.
In the case of Israel, it may not be coincidence that NGDP began a systematic deviation from trend when Ms Flug took over at the Bank of Israel. Maybe she prefers the role of Finance Minister:
Speaking at a Calcalist conference, Governor of the Bank of Israel said today, “Exceeding the 3% fiscal deficit target will expose the Israeli economy to significant risk and will be liable to harm us citizens. We must show responsibility and take into account the consequences of our decisions over time. Israel’s structural deficit, the deficit not subject to one-time shocks, is already one of the highest in the western world.”
This is what happened:
In the case of Poland, it took three years, but in late 2011 Poland finally botched up and went the way of the majority of countries, letting NGDP fall way below trend. They didn´t (correctly) react to the 2007-08 oil price rise, like the US, UK, EZ, etc. and fared well, but didn´t resist when oil prices picked up again in 2010-11, when, among the initial group, only the ECB was dumb enough to react.
By talking about house prices, the RBA is tempting the “fate” that hit Sweden and Israel. Scott links to an article in a subsequent post:
The Reserve Bank of Australia’s surprise decision to defer its widely anticipated April rate cut for at least another month might have been influenced by the increasingly pricey housing market, which it regards as posing a real “dilemma”.
This, unfortunately, has been going on for some time. Last September, RBA Governor Glenn Stevens was warning of bubble risk in the current low interest rate environment:
Addressing members of the Committee for Economic Development of Australia (CEDA) lunch in Adelaide, he said monetary policy aimed at encouraging business investment and generating employment amid global economic weakness was in danger of creating a housing bubble in Australia.
And the next chart compares two “bubbles”.
Please, Governor Stevens, start thinking smart!