Recently the Sydney Morning Herald’s Economics Editor Ross Gittens wrote an explaining why the economic doomsayers are wrong.
He used the frequently quoted recent speech of RBA Governor Glenn Stevens to provide some cogent arguments why Australia shouldn’t be so gloomy.
In the long boom before the global financial crisis, when economists convinced themselves they’d achieved the Great Moderation and everyone was confident the good times would roll on forever, anyone who thought they saw a problem looming was either ignored or dismissed as a fool.
In the North Atlantic economies’ continuing agonies since the crisis, it’s been roughly the reverse. Excessive optimism has swung to excessive pessimism and anyone who thinks they see a problem looming gets a microphone and loud speaker stuck in front of their face.
Now it’s the people who don’t think the end is nigh who tend to be ignored.
One person who thinks things aren’t as bad as they’re being painted is Glenn Stevens, governor of the Reserve Bank. He gave a speech this week in which he begged to differ with the doomsayers. The cogent arguments he advanced deserve more attention than they’ve been given.
When it comes to dark forebodings, first prize goes to fears of a break-up of the euro. But worries about a hard landing in China are now coming second. Stevens examines the figures and concludes China is still likely to grow by 7 or 8 per cent a year.
Next he responds to the pessimists’ greatest fear of disaster in the domestic economy: a collapse in house prices. He’s not convinced they’re overvalued by our historical standards. And while, expressed as a multiple of annual household disposable income, they seem very high compared with American prices, they are within the pack of other developed countries. It’s the US that seems out of line.
But, he concedes, ”even though we don’t face immediate problems, we should ask: what if something went wrong?”
OK, so let’s look at some worst-case scenarios. If the thing that goes wrong is a ”major financial event” emanating from Europe, he says, the most damaging potential transmission channel would be if there were a complete retreat from risk, capital market closure and funding shortfalls for financial institutions.
This would be a problem for many countries, of course, not just us. But in that event the Aussie dollar might decline, perhaps significantly.
”We might find that, in an extreme case, the Reserve Bank – along with other central banks – would need to step in with domestic currency liquidity, in lieu of market funding. The vulnerability to this possibility is less than it was four years ago; our capacity to respond is undiminished and, if not actually unlimited, is not subject to any limit that seems likely to bind.”
An alternative version of this scenario, if it involved the sort of euro break-up about which some people speculate, could be a flow of funds into Australian assets. In that case our problem might be not being able to absorb that capital. But that means the banks would be unlikely to have serious funding problems.
If the thing that went wrong was a serious slump in China’s economy, the Aussie would probably fall, Stevens says, which would provide expansionary impetus to the Australian economy. But more importantly, we could expect the Chinese authorities to respond with stimulatory measures.
”Even if one is concerned about the extent of problems that may lurk beneath the surface in China – say in the financial sector – it is not clear why we should assume that the capacity of the Chinese authorities to respond to them is seriously impaired.
”And in the final analysis, a serious deterioration in international economic conditions would still see Australia with scope to use macro-economic policy, if needed, as long as inflation did not become a concern, which would be unlikely in the scenario in question.”
Next, what if house prices did slump after all? In such a scenario people typically worry about two consequences. The first is a long period of very weak construction activity, usually because an excess of housing stock resulting from previous overconstruction needs to be worked off. But we’ve already had a long period of weak residential construction and it’s hard to believe it could get much weaker at the national level.
The second common worry is about what a slump in house prices would do to the balance sheets of the banks and other lenders.
But this scenario is regularly covered by the Australian Prudential Regulation Authority in its ”stress-testing” of the banks.
”The results of such exercises always show that even with substantial falls in dwelling prices, much higher unemployment and associated higher levels of defaults, key financial institutions remain well and truly solvent.”
Stevens points out that a lot of the adjustments we’re complaining about at present – including households’ higher and more normal rates of saving, a more sober attitude towards debt, the reorientation of the banks’ funding away from short-term foreign borrowing, and weak house prices – are strengthening our resilience to possible future shocks.
”The years ahead will no doubt challenge us in various ways, including in ways we cannot predict. But what’s new about that? Even if the pessimists turn out to be right on one or more counts, it doesn’t follow that we would be unable to cope.
”Acting sensibly, with a long-term focus, has as good a chance as ever of seeing us through,” Stevens concludes.
Source: The Age
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