We're at a global debt precipice and our central banks are failing us
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We're at a global debt precipice and our central banks are failing us

As a long-term advocate for independent central banks, and for inflation targeting as their modus operandi, my advocacy for an independent Reserve Bank here in Australia dating back to an academic paper in 1980, I am embarrassed and dismayed as to where we have ended up.

Being entirely objective, you’d have to conclude that the RBA has been asleep at the wheel. Unfortunately, the RBA has been put on a pedestal with our politicians unwilling to criticise – but even though the bank is independent, it should still be held accountable, like any other arm of government.

The debt crisis is growing but the RBA, like central banks globally, is bereft of options to deal with it.

The debt crisis is growing but the RBA, like central banks globally, is bereft of options to deal with it.Credit: Dominic Lorrimer

Inflation targeting has become a bizarre exercise in self-delusion. Our RBA actually believes it  controlled inflation in the 90s and early noughties, and that it was able to fine-tune inflation control, as if it could turn up the interest rate knob by a few basis points, and thereby turn down our inflation rate knob accordingly. A genuine delusion of grandeur.

Sure, while it may have restrained inflationary expectations, most inflation reduction was the result of the world being flooded with cheap Chinese imports, and other structural shifts.

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Unfortunately, the RBA essentially became obsessed with inflation control, always seeking/fearing some evidence of a pick-up in inflation. Recall its response to the GFC. Basically, the RBA was initially forced to lower the cash rate significantly, but clearly, hesitantly, and nowhere near as significantly as other global central banks. Then, somehow, as it soon perceived a risk of renewed inflationary pressure, it quickly raised it again only to finally to have to lower it to the current level, when those feared inflationary pressures didn’t materialise.

Since about August 2016 it has been stuck in the headlights, unable or fearful to move the cash rate either way.

I have also been surprised that the RBA’s target range for inflation of 2 to 3 per cent was never adjusted, as economic and market circumstances changed, and I am disturbed that asset prices were excluded from its working definition of inflation. Imagine how it may have responded differently, indeed should have responded differently, with the explosion of house prices, and household debt in recent years.

The bottom line of the RBA conduct has been to create an economy where growth is actually faltering, perhaps even towards a recession, despite its most recent forecast that it was about to run above trend; household debt is among the highest in the world – approaching 120 per cent of GDP and almost 200 per cent of household disposable income; and where a significant percentage of bank housing loans are actually sub-prime as demonstrated by the banking royal commission; and where the financial system is also heavily exposed to climate risks. The latter two risks are significant for both individual institutions, as well as for the whole financial system.

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With the faltering of our growth recently revealed for the last half of 2018, and obviously having continued, the RBA is now under real pressure to consider, and for increasingly political reasons, a further cut in rates, even though it may compound the housing finance crisis, and do little to stimulate growth.

Globally, having basically created the GFC by the creation of excessive liquidity, central banks responded by again flooding the world with excessive liquidity. However, the feared inflation monster never did materialise, and neither did the hoped-for sustainable growth.

Yet, most central banks have been unable to disengage from the bloated balance sheets that they built pumping excessive liquidity into their economies – indeed, G7 central bank balance sheets are still over three times their size at the time of the GFC – with their official interest rates still stuck at or near historic lows, some still negative, having failed to generate the desired strong and sustained growth, nor the feared run-away inflation.

In recent weeks, there has been a significant shift in central bank thinking now being driven by the fear that global growth is slowing sharply, and may be even fall into recession.

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The US Federal Reserve has recently stopped raising the Federal Funds rate and committed not to do so for some time – indeed, they may have to lower it – and then last week the European Central Bank pledged not to increase Eurozone interest rates until beyond the end of this year, and pre-announced another cheap loan program for European banks starting in September.

The US Federal Reserve went to great lengths over the last couple of years to end "quantitative easing”, indeed went back to the old central bank songbook of trying to “normalise”, that is raise, interest rates, claiming to fear the inflationary consequences of Trump’s corporate tax cuts, and increased spending. But their inflation fears were without foundation, and they simultaneously started to run foul of Trump and his intolerance for an independent Fed.

So, the world economy has been left teetering on the brink of a precipice, with central banks essentially unable to respond. The bottom line of all their liquidity easing has been a significant increase in global debt and inequality, both now serious constraints on our global capacity to move forward.

While central bankers look bad, so do economists. They need plausible explanations as to why the massive liquidity expansions didn’t create runaway inflation? They need to address the likely consequences of sustained periods of negative interest rates? They need to explain why Trump’s tax cuts didn’t actually “trickle down” to significant investment, jobs, wages, and growth, rather than simply create record levels of dividend payouts and share buy-backs? They need to explain why wages have essentially flat-lined through all this.

Central banking is now in crisis, really with no answers. There is a very real risk of another GFC/credit/liquidity crisis, even as global growth slows. Central banks don’t have the policy armoury, nor the capacity, to respond.

John Hewson is a professor at the Crawford School of Public Policy, ANU, and a former Liberal opposition leader.

John Hewson is a professor at the Crawford School of Public Policy, ANU, and a former Liberal opposition leader.

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