“If the Reserve Bank was still retaining its narrow focus on keeping inflation between 2 and 3 per cent per annum, it would be cutting interest rates at its May meeting,” opined the The Sydney Morning Herald a couple of days ago.
Instead, the Reserve Bank of Australia (RBA) opted to do nothing at its May meeting. Although doing nothing for a central bank is sometimes akin to “doing nothing” when you see burglars enter a neighbor’s house.
At any rate, The Sydney Morning Herald added, “The domestic economic is growing, but still weak. And the currency is still high—factors that some say should lead the RBA to cut rates.”
So why the timidity? Why does not the RBA cut rates?
“Financial instability”—that is, soaring house prices, and fear of a bubble-pop.
RBA Governor Phillip Lowe has publicly fretted about “dealing with the mess in five years’ time when the housing market pops,” said the Sydney paper.
It is huge and yet largely un-discussed challenge for many central banks, certainly the Federal Reserve, the RBA and the Bank of England. How to respond to soaring house prices (into which so much bank-lending is poured) but soggy economies?
It is a topic that orthodox macroeconomists revile, but in fact large trade deficits appear to skyrocket housing prices in nation after nation. The New York Fed published a paper to that effect, which was then updated and also published in the prestigious Journal of Money, Credit & Banking.
As embracing “free trade” and even genuflecting to huge trade deficits is required of proper U.S. macroeconomists today, the above papers have been resolutely ignored.
Thus, a policy challenge snarls before central bankers. Property zoning and trade deficits are not likely to change. But to hold interest rates “low” will send housing prices to the moon. The average house in Sydney now retails north of $1 million. In Great Britain, the middle-class can no longer buy housing, a situation mirrored in large parts of the West Coast and Northeast of the U.S.
The Unpopular Solutions
Macroeconomists and central bankers in Australia, Great Britain and the U.S. must come to terms with this new reality of trade deficits, property zoning, soaring house prices and monetary policy. The craft of macroeconomics must be conducted not in theory, but accepting the facts on the ground.
Property zoning has become a macroeconomic issue, certainly of greater importance than the minimum wage, or whether there is a tariff on Canadian lumber. The macroeconomics profession needs to say so, and else offer increasingly worthless advice to policymakers.
Unless trade deficits and property zoning are tackled dead on, vast swathes of the English-speaking publics may come to conclude (and many already have) that “free trade” or worse, even “free enterprise” are but games rigged to benefit a propertied and financial class.
Would they be entirely wrong?
For investors in companies in the English-speaking world, proceed cautiously. The central banks must learn to either live with higher inflation, or suffocate growth. And macroeconomists need to abandon orthodoxy—at least in present-day context—the least likely outcome of all.