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  • PD Jonson

Policy breakthrough ...

Updated: May 2, 2020

... financial stability & monetary policy

Readers will be aware of my attempts to persuade the RBA to sort out policies to control asset inflation, so far as this is possible, distinct from monetary policy, which involves keeping the overall economy on an even keel with low goods and services inflation. This week, Janet Yellen, US Fed Chairwomen, joined the crusade, which is all over save the shouting.

Glenda Korporaal yesterday reviewed the RBA's latest comment on monetary policy. She says 'yesterday’s glass-half-empty statement from Martin Place reveals a sense of frustration at the RBA with the stubbornly high dollar.

'A month ago, the bank was hopeful that some easing in the exchange rate could “assist in achieving balanced growth in the economy”, but now it’s not so sure.

“The exchange rate remains high by historical standards, particularly given the declines in key commodity prices” (which is what it said last month) “and hence is offering less assistance than it might in achieving balanced growth in the economy”. (Read: now we are really getting impatient that the dollar isn’t coming down). More here.

I must admit my own frustration. In my case it arises from having proposed a solution eighteen months ago to be met with lofty silence from the RBA. (See Monetary Policy Revamp.)

Since then I have done a lot of work on asset inflation and monetary policy, mostly reflected in the regular articles on monetary policy in 2013 and 2014 posted here.

The rule that 'monetary policy cannot serve two masters' (a much ignored dictum of Milton Friedman) is slowly being taken up in the search for policies to curb housing booms. The traditional approach - and I confess to supporting this until my Pauline insight reported in January 2013 - was to use monetary policy (ie, interest rate policy) to moderate asset inflation. That is, to raise interest rates more than would be required to control the economy in efforts to contain goods and services inflation when assets such as housing are looking dangerously uppity, and prior to that to talk about the dangers of excessive house price increases and threaten to raise interest rates. Or cut rates by more than required for overall stability in an asset crash. This is sometimes called 'leaning into the wind'.

Now good thinkers, including the new governor of the Bank of England, Ben Bernanke himself and (I believe) senior people in the RBA, are considering or (in the UK case implementing) what is called a 'macroprudential' policy to directly curb house price inflation by controlling bank lending for housing.

And, earlier this week, the Fed's new chief, Janet Yellen, changed the goalposts for US policy, supporting the UK, hints from Ben Bernanke and the RBA.

The FT reports: 'Federal Reserve Chair Janet Yellen speaks at the International Monetary Fund in Washington, Wednesday, July 2, 2014. Yellen said she doesn't see a need for the Fed to start raising interest rates to address the risk that extremely low rates could destabilize the financial system. 'Janet Yellen has mounted a forceful defence of the US Federal Reserve’s decision to keep monetary policy loose in the face of soaring asset prices, arguing there was no need to increase interest rates to tackle financial instability because the central bank has other tools at its disposal.

'In a clear signal of how the Fed intends to prevent a repeat of the 2008 crisis, its chairwoman suggested the central bank is more interested in having a resilient financial system that can cope when asset bubbles burst than it is in popping them through rate rises'

But here is the clincher.“I do not presently see a need for monetary policy to deviate from a primary focus on attaining price stability and maximum employment, in order to address financial stability concerns,” said Ms Yellen.

“That said, I do see pockets of increased risk-taking across the financial system, and an acceleration or broadening of these concerns could necessitate a more robust macroprudential approach.”

'A macroprudential approach would involve using non-monetary policy tools designed to manage the safety of the financial system as a whole'. Full report here.

With appropriate modesty, I feel I have been fishing in the right stream. Now, dear RBA, let's discuss the overvalued exchange rate. While the overvalued Australian dollar is not a 'bubble', it is creating general economic instability by distorting asset allocation across the economy.

'Macroprudential policy' will create a lot of debate in coming years, but I feel that policies like those discussed above, distinct from 'monetary policy' are going to be essential. 'Monetary policy cannot serve two masters', in this case control the overall economy sensibly and also 'influence' house prices, share prices or the exchange rate (or other asset prices), in an appropriate way except for short periods when the needs of asset inflation are in accord with the overall need for economic stability with low inflation.

The FT has already added to the debate with its editorial headed 'Caution on rates is wise but Fed could do more on bubbles', a proposition I agree with.

My simple point is this. If respectable central bankers see the necessity of curbing house prices, or excessive financial system risk, with 'macroprudential policy', why not do something about a stubbornly excessive exchange rate? Something other than cutting interest rates, which has been the unstated (in my view) approach in recent times in Australia.


Janet Yellen's speech is linked below, as well as a more recent speech by Vice Chairman, Stanley Fisher.

Janet Yellen, Chair, US Fed, 2 July 2014, including 'Watch live'option.

Stanley Fischer, Vice Chairman, US Fed, 10 July 2014

The conclusion of Janet Yellen's speech is quoted here.

'Conclusion In closing, the policy approach to promoting financial stability has changed dramatically in the wake of the global financial crisis. We have made considerable progress in implementing a macroprudential approach in the United States, and these changes have also had a significant effect on our monetary policy discussions. An important contributor to the progress made in the United States has been the lessons we learned from the experience gained by central banks and regulatory authorities all around the world. The IMF plays an important role in this evolving process as a forum for representatives from the world's economies and as an institution charged with promoting financial and economic stability globally. I expect to both contribute to and learn from ongoing discussions on these issues'.

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