Saturday, October 11, 2008

RBA got it wrong on rates

If anything, the 1 percentage-point drop in interest rates must shatter the myth of infallibility that has come to surround the Reserve Bank.  It is now clear it got monetary policy very wrong.  The RBA was not just caught on the wrong side of the market with high interest rates -- it was deliberately raising rates as the global credit crisis unfolded.

Raising interest rates during the last federal election may well have been a courageous decision -- in every sense -- but in retrospect, the RBA displayed very poor judgement.  It is now apparent to everyone it had no crystal ball.

Many politicians, however, are wary of criticising the RBA, and warn each other against making such criticism.  Being above criticism is a privilege not usually reserved for just another arm of government.

Accountability standards at the RBA are unusually lax.  The RBA governor and his senior staff testify to the Parliament before the very same politicians who are in the RBA's thrall.  There are, however, excellent arguments for maintaining the independence of the RBA and Australia does have the balance correct on that issue.  However, there needs to be some improvement in the accountability of the central bank.  Rather than just releasing the minutes of RBA meetings, the RBA should consider releasing transcripts.

Unfortunately the Government has yet to wake up to the causes and full implications of the current crisis.  Kevin Rudd is blaming it all on "free-market ideologues" and a "lack of regulation".  Similarly the US Congress is blaming excessive executive compensation.  In other words, it is business as usual.

It is true that the private sector mispriced risk, but the issue of importance is where that risk originated.  It is here that we see how government failures lead to the crisis.  Attempts by the Bush Administration to toughen up regulation of Fannie Mae and Freddie Mac were stymied by Democrats -- hardly known to be free-market fundamentalists.  The US Community Reinvestment Act and the Boston Federal Reserve acted to make US bank lending less conservative, and indeed somewhat irresponsible.  Apparently rigorous regulations based on so-called black box risk assessment models lead to regulatory complacency.  Finally, US interest rates were too low after 2003.

It is simply not true to say that a lack of regulation, or executive compensation, or free-market ideologues caused the crisis.  Governments and government intervention were at every step along the way.  In Australia our banks are in good shape, yet the international impact of the crisis on our economy will be exacerbated by the RBA's policy errors.

More importantly, the notion that government can easily and successfully mould markets for its own purposes has also been shown up.  This crisis highlights the collapse of regulatory capitalism.  The market cannot accommodate any number of regulatory interventions, even assuming that the government gets it right.  At some point the system fails and the market clears away the failed business and regulatory models.  That is what is happening now.


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