The International Monetary Fund is now recommending to central banks, such as the Reserve Bank of Australia to use interest rates to take pre-emptive action to control asset price bubbles such as the bubble in Australian house prices.
The IMF’s senior economist, Alasdair Scott said “There might be times even when inflation is under control, but they should think of what’s happening in asset price markets to see whether these, there are these kind of financial vulnerabilities building up,” he said.
“And if that’s the case, they should strongly consider taking pre-emptive action and not think that we can just pick up the pieces after the crisis has happened should that be the case.”
This advice probably comes a bit late for Australia. It is probably only 12 to 18 months away before Australia starts to pick up the pieces of the biggest House asset bubble in history. At this stage it is far too big to worry about a pre-emptive strike. Yet, this topic has been open to debate for years.
Former Reserve Bank Governor, Ian Macfarlane said in the 2006 Boyer Lectures :
Many people have pointed out that it is difficult to identify a bubble in its early stages, and this is true. But even if we can identify an emerging bubble, it may still be extremely difficult for a central bank to act against it, for two reasons.
First, monetary policy is a very blunt instrument. When interest rates are raised to address an asset price boom in one sector, for example, house prices, the whole economy is affected. If confidence is especially high in the booming sector, it may at first not be much affected by the higher interest rates, but the rest of the economy may be.
Second, there is a bigger issue which concerns the mandate that central banks have been given. There is now widespread acceptance that central banks have been delegated the task of preventing a resurgence of inflation, but nowhere to my knowledge have they been delegated the task of preventing large rises in asset prices which many people would view as rises in the keeping of his wealth. Thus if they were to take on this additional role, they would face a formidable task in convincing the public of the need.
Hind sight is a wonderful thing. In October 2002, in an interview on Inside Business on Australia’s real estate bubble, Reserve Bank Governor, Ian MacFarlane said “This situation is one that we at the Reserve Bank are not entirely comfortable with.”. Later the next year, Ian MacFarlane addressed the Sydney Institute with a speech titled “Do Australian Households Borrow Too Much?”
The RBA had no difficultly identifying the bubble in its early stages. If the Reserve Bank of Australia took pre-emptive action on the housing bubble at the time, Australia could now genuinely be one of the financially strongest countries in the world now, rather than one just because the bubble has been a bit slow to burst here.
» Pop bubbles with rate rises: IMF – The ABC, 23rd September 2009.
» IMF urges more action from central banks – The Age, 22nd September 2009.
» Do Australian Households Borrow Too Much? – Ian Macfarlane, RBA Governor, Talk to The Sydney Institute, Sydney – 3 April 2003.
He’s dead right that interest rates are a blunt instrument. What about preventing domestic banks from borrowing overseas? Some kind of approval process, only borrowing for productive investment. Should result in a lot of competition for domestic deposits, positive real interest rates, expensive credit, rein things in a bit earlier
Interest rates are a blunt instrument, and some argue fail to control inflation correctly. History shows us our economy was more “stable” prior to the introduction of the RBA.
What the underlying cause is, IMHO, is people controlling banks and other lenders who don’t understand asset cycles. These monkeys still don’t believe housing is a poor investments overtime. They see it as a one way price speculative vehicle to loan money by the bucket loads, with the backing/security of an increasing asset.
NO!! Lending to housing should be restricted by the individuals income combined with the projected value of the property being set by inflation, no speculation.