Economics and Banking – Page 418 – Digital Finance Analytics (DFA) Blog

NSW Investment Property On The Slide

The data from the ABS today, provides a view of all finance for September, and contains a number of significant points. Trend data (which irons out the noise month by month) shows that lending for owner occupied housing was $20.6 bn, up 2% from last month ($20.2 bn). Personal finance was down 1.1% from $7.3 bn to $7.2 bn, whilst commercial finance – which includes investment home lending – was down by 0.4% from $44.4 bn to $44.3 bn.

However, looking in more detail, and separating out investment lending from other commercial lending, we see that investment housing was $12.9 bn, down from $13.2 bn last month. The relative proportion of new loans for investment housing in the month sat at 38.6%, down from 39.6% last month. So owner occupied lending is now dish of the day.

We also see that business lending, net of investment housing, fell from 48.1% to 48%, although the value rose a little from $31.2 bn to $31.3 bn. We continue to see the relative share of lending to the commercial sector falling, which is not healthy for future growth prospects. The banks prefer to lend against residential property as the current capital adequacy ratios still makes this more attractive than commercial lending, and loss rates are lower, so net margins remain strong. Firms are still holding off from investing, and many who would borrow are finding the terms, and costs prohibitive. We will discuss this further in the next report on the business sector, to be released shortly.

The other data point, which is quite stunning, is the fall in investment lending in NSW. Looking at the original data we see that it fell from a peak monthly flow of more than $6 bn in June to $5.5 bn, supported by a relative growth in investment by entities other than individuals, which would include self-managed superannuation funds and other commercial entities. Momentum looks set to fall further, in the investment sector, whilst owner occupied lending is set to grow. Indeed the trend line for owner occupied loans in the graph above, shows a clear movement up, as banks reset their sites on attracting owner occupied business and refinance – this explains all the heavy discounts currently available for owner occupied loans in the market at the moment, funded by hikes in rates to existing borrowers.

Transforming Shadow Banking into Resilient Market-based Finance

The “shadow banking system” worth at least $36 trillion in 2014 globally, can broadly be described as “credit intermediation involving entities and activities (fully or partially) outside the regular banking system” or non-bank credit intermediation in short. Such intermediation, appropriately conducted, provides a valuable alternative to bank funding that supports real economic activity. But experience from the crisis demonstrates the capacity for some non-bank entities and transactions to operate on a large scale in ways that create bank-like risks to financial stability (longer-term credit extension based on short-term funding and leverage). Such risk creation may take place at an entity level but it can also form part of a chain of transactions, in which leverage and maturity transformation occur in stages, and in ways that create multiple forms of feedback into the regular banking system.

The Financial Stability Board has been established to coordinate at the international level the work of national financial authorities and international standard setting bodies and to develop and promote the implementation of effective regulatory, supervisory and other financial sector policies in the interest of financial stability. It brings together national authorities responsible for financial stability in 24 countries and jurisdictions, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts.

The FSB is chaired by Mark Carney, Governor of the Bank of England. Its Secretariat is located in Basel, Switzerland, and hosted by the Bank for International Settlements. Their latest reports address the future regulation of shadow banking.

Progress report on Transforming Shadow Banking into Resilient Market-based Finance: This report sets out actions taken to implement the FSB’s two-pronged strategy to address financial stability concerns associated with shadow banking over the past year, and next steps.
Global Shadow Banking Monitoring Report 2015: This report presents the results of the FSB’s fifth annual monitoring exercise to assess global trends and risks of the shadow banking system, reflecting data as of end-2014. It covers 26 jurisdictions and the euro area, representing about 80% of global GDP and 90% of global financial system assets.
Regulatory framework for haircuts on non-centrally cleared securities financing transactions: This report finalises policy recommendations in the framework for haircuts on certain non-centrally cleared securities financing transactions published in October 2014 to apply numerical haircut floors to non-bank-to-non-bank transactions and update the implementation dates of these recommendations. The framework aims to address financial stability risks in securities financing transactions.

In addition, in the coming days, the FSB will publish Standards and processes for global securities financing data collection and aggregation.

The reports published today mark further progress in the FSB’s two-pronged strategy in the following three ways that are in accordance with the actions and deadlines set out in the updated Roadmap towards strengthened oversight and regulation of shadow banking endorsed by the G20 Leaders at the Brisbane Summit in November 2014.

First, with regard to system-wide monitoring to track developments in the shadow banking system, the FSB has introduced this year a new activity-based “economic function” approach in its annual monitoring (ref. (ii) above). The approach helps narrow the focus to those parts of the non-bank financial sector where shadow banking risks may arise and may need appropriate policy responses to mitigate these risks. The first results of this approach, which will be further refined going forward, suggest:

The new activity-based, narrow measure of shadow banking was $36 trillion in 2014, increasing by $1.1 trillion compared to 2013. This is equivalent to about 30% of the overall non-bank financial sector assets and 60% of the GDP of the 26 participating jurisdictions.
The shadow banking activity based on this narrow-measure largely occurred in advanced economies, although growth is rapid in a number of emerging market economies. Credit intermediation associated with collective investment vehicles comprised 60% of the narrow aggregate and has grown by nearly 10% on average annually over the past four years.
In 2014, the wider aggregate comprising “Other Financial Intermediaries” in 20 jurisdictions and the euro area grew to reach $80 trillion, from $78 trillion in 2013. This wider measure outpaced growth in other categories of financial intermediation and the overall economy.

Second, there has been further progress this year to strengthen oversight and regulation of shadow banking, particularly in the area of securities financing. With the publication of the final standard, the regulatory framework for haircuts on non-centrally cleared securities financing transactions is complete, with the scope extended to cover securities financing between non-banks (ref. (iii) above). The standards and processes for global securities financing data collection will increase the transparency of these important financing markets.

Third, the implementation of previously agreed policies is progressing. It is essential for the agreed policies to be implemented in a timely manner, and the FSB, in coordination with the relevant standard-setting bodies, will continue to monitor the national implementation of agreed policies to ensure they achieve the intended objectives. Since shadow banking activities take a variety of forms and continue to evolve, FSB members are also mindful of the need to periodically review the agreed policies.

Mark Carney, Chair of the FSB said “Non-bank financing is a welcome additional source of credit to the real economy. The FSB’s efforts to transform shadow banking into resilient market-based finance, through enhanced vigilance and mitigating financial stability risks, will help facilitate sustainable economic growth”.

Glenn Stevens, Chair of the FSB Standing Committee on Assessment of Vulnerabilities said “The annual shadow banking monitoring exercise is an important mechanism for identifying potential financial system vulnerabilities in the non-bank sector. The activities-based approach in this year’s report enhances our understanding of the evolving composition of this sector and potential risks”.

Daniel Tarullo, Chair of the FSB Standing Committee on Supervisory and Regulatory Cooperation said “The extension of the scope of the securities financing regulatory haircut floor framework to cover transactions between non-banks will limit regulatory arbitrage and prevent the build-up of excessive leverage and liquidity mismatch in the non-bank financial system”.

AMP Bank Returns to the Investment Mortgage Market

AMP Bank has announced it will accept investor property loan applications effective 16 November following a temporary withdrawal from the market in response to regulatory growth guidelines.

The return to investor property lending is in line with AMP Bank’s commitment to return to the market in 2015.

Investor property lending to SMSFs remains on hold in order to meet AMP Bank’s regulatory commitment for the SMSF portfolio. The bank is expected to return to SMSF lending later this year.

Household Financial Confidence On The Up

The latest edition of the DFA Household Finance Confidence Index for October 2015 is released today, and shows a noticeable uptick compared with last month. The current index stands at 90.7 compared with 87.7 in September, still below the long-term neutral position, but on the improve. Taken with the stronger employment dat a, released today by the ABS, we think there a potential drop in the cash rate is off the table, unless there is an external shock. Should the US lift rates in December this would be another nail in the rate cut coffin.

The results are derived from our household surveys, averaged across Australia. We have 26,000 households in our sample at any one time. We include detailed questions covering various aspects of a household’s financial footprint. The index measures how households are feeling about their financial health.

To calculate the index we ask questions which cover a number of different dimensions. We start by asking households how confident they are feeling about their job security, whether their real income has risen or fallen in the past year, their view on their costs of living over the same period, whether they have increased their loans and other outstanding debts including credit cards and whether they are saving more than last year. Finally we ask about their overall change in net worth over the past 12 months – by net worth we mean net assets less outstanding debts.

Looking at the segmentation of the index, property inactive and owner occupied households improved compared to property investors who were more concerned about rising mortgage rates, and lower property price growth. They are also being hit by lower rental returns. This shows the importance of the property sector on overall confidence.

Overall, at a national level, 61% of households said their net worth had improved, up 1.1% from last month, and still being supported by rising property prices in the eastern states. 13% of households said their net worth was lower, and these were impacted by lower stock market prices, and some property price falls in WA and SA.

Looking at cost of living, there was a fall in those who said their costs were higher at 35%, compared with 40% last month, mainly due to lower prices for some foods, fuel, and low interest rates. 60% said there was no real change.

Looking at real income, 5% said they were better off, a slight rise from last month, whilst 55% said their real incomes had stayed the same over the past year (this is after inflation), very similar to last month. 38.7% said their incomes, in real terms, had fallen.

Next we turn to debt. Here 13% were more comfortable (up 1.8% from last month) with their levels of debt, whilst 26% were less comfortable, and 58% about the same, close to last months results. The small hikes in mortgage rates have yet to hit, so we will see if the score changes next month. However, absolute low rates are helping, and future expectations for interest rises appear more subdued.

The status of savings showed that 15% were more comfortable, up 2.4% on last month, thanks to deposit returns stabilising, and dividends holding up.

Finally, job security improved, with 17% saying they felt more secure (up 0.7%), and 63% saying they felt as secure as last year, similar to last month. However, there was a more negative note in WA, and on an aggregated national basis, 20% of households were less secure, up 1% on last month. Better employment prospects showed through in NSW and VIC.

So, we think there is a change of momentum in the index, and unless there is some external shock, the index is likely to climb as we enter the summer months. One factor which came though in the data was a more positive expectation about our political leaders, and this is flowing though to improved confidence.

ANZ to pay $13 million after failing to accurately apply bonus interest

ASIC says Australia and New Zealand Banking Group (ANZ) is compensating around 200,000 customers approximately $13 million after it failed to accurately apply bonus interest to Progress Saver Accounts (PSA) for a number of years. The refund payment includes an additional amount to recognise the time elapsed since the initial breach. ANZ reported this matter to ASIC under its breach reporting obligations in the Corporations Act.

PSA holders qualify for bonus interest payments in any particular month if they satisfy deposit and withdrawal requirements for that month. ANZ misaligned the monthly cycle it applied to determine whether a PSA holder was eligible for bonus interest payments and the monthly cycle it applied to calculate bonus interest payments. This issue was limited to PSA holders who made qualifying deposits or disqualifying withdrawals near the end of their monthly interest cycle, and did not impact the payment of bonus interest in other circumstances.

As a result, PSA holders may have made a qualifying deposit or disqualifying withdrawal on the last day of the previous monthly cycle while believing that it was the first day of a new monthly cycle.

ANZ discovered the breach following a customer complaint and reported it to ASIC. ANZ advised ASIC of its intention to undertake a thorough account reconstruction exercise to determine the financial impact on all affected PSA holders. The financial impact is dependent on what other transactions occurred in neighbouring monthly cycles.

ASIC Deputy Chairman Peter Kell said, ‘ANZ has taken its breach reporting obligations seriously in this matter. Breach reporting helps ASIC ensure affected consumers are returned to the position they would have held if it were not for the breach occurring at all.’

ASIC acknowledges the cooperative approach taken by ANZ to resolve this matter.

ANZ has issued letters to current PSA holders to clarify and update existing terms and conditions such as requirements and timing to qualify for bonus interest payments.

ANZ is contacting and providing refunds to affected past and present PSA holders, a process that should be completed by the end of this week.

New Total Loss Absorbing Capacity Standard for Global Banks Is Credit Positive – Moody’s

In Moody’s latest Credit Outlook, they discuss the impact of the new Total Loss Absorbing Capacity (TLAC) Standard for Global Banks.

Last Monday, the Financial Stability Board (FSB) published its standard for total loss absorbing capacity (TLAC), which sets forth the amount, composition and location of capital and debt required to meet bank recapitalization needs in a resolution. The standard prompts global systemically important banks (G-SIBs) to increase the resources available to absorb losses beyond the regulatory capital requirements and buffers embedded in the Basel III framework, a credit positive.

The TLAC framework aims to ensure that banks maintain sufficient loss-absorbing instruments (both capital and eligible long-term debt) to absorb losses and recapitalize a bank in a resolution without the use of public funds and to reduce the chance of systemic disruption. The TLAC standard applies to the 30 institutions that the FSB designated as G-SIBs, although national regulators might also require non-G-SIBs to conform with the global standard. Firms will be required to meet TLAC standards alongside regulatory capital requirements and buffers set out in the Basel III framework.

The FSB set an initial level of TLAC at 16% of risk-weighted assets (RWAs) and 6% of the leverage exposure (the denominator of the Basel III leverage ratio) starting 1 January 2019. This will rise to 18% of RWAs and 6.75% of leverage exposure starting 1 January 2022. The 1 January 2019 start date should provide banks with sufficient time to reach the required levels.

Chinese G-SIBs have been exempted from the initial TLAC deadlines given the still-low levels of demand among Chinese non-bank investors for fixed-income assets, which constrains the extent to which banks can issue substantial volumes of capital and debt instruments. Nevertheless, Chinese G-SIBs will be required to meet the first benchmark – 16% of RWAs and 6% of leverage exposure – by 1 January 2025, and the 18% of RWAs and 6.75% of leverage exposure requirement by 1 January 2028.

TLAC can comprise a range of instruments, from equity to long-term senior debt. Senior holding company debt should typically be eligible as TLAC owing to its structural subordination. The guideline contemplates the eligibility of senior unsecured bank debt normally ranking pari passu with excluded liabilities such as derivative liabilities and short-term deposits by allowing senior bank debt of up to 2.5% of RWAs in 2019 and 3.5% in 2022 issued by institutions subject to resolution regimes that provide for partial or complete exclusion of the pari passu liabilities from bail-in. However, it remains unclear how the preconditions for the eligibility of senior bank debt would be fulfilled. In particular, the inclusion of such debt must not give rise to material risk of legal challenge under the no creditor worse off principle.

The Basel Committee on Banking Supervision estimated that for a sample of 29 G-SIBs based on last year’s G-SIB list, the average eligible external TLAC ratio at the end of 2014 was 13.1% of RWAs and 7.2% of the leverage exposure. This estimate assumed no bank-issued senior debt would be eligible as TLAC, and revealed that only six banks met the 16% TLAC requirement. The aggregate shortfall to the 2022 TLAC requirements totals €1.1 trillion for all 30 G-SIBs, or €755 billion when excluding the Chinese G-SIBs. For banks subject to operational resolution regimes, which include all US and European G-SIBs, the introduction of TLAC requirements will benefit depositors and other senior unsecured creditors because of a larger cushion available to absorb losses at failure from the issuance of more subordinated securities.

Additionally, other things being equal, a larger layer of any given class of debt will benefit the ratings of that class, given that potential losses would be spread over a larger pool of investors. This could be somewhat offset by an increased reliance on wholesale funding, and a weakening of profitability should funding costs increase. However, we do not expect a material effect on those metrics.

NZ Housing Risks Rising

New Zealand’s financial system continues to perform well despite a deterioration in the outlook for global financial stability and increased risks related to the dairy and housing sectors, NZ Reserve Bank Governor, Graeme Wheeler, said today when releasing the Bank’s November Financial Stability Report.

“Global economic growth has softened over the past six months, and uncertainty over the path of economic and financial adjustment in China has helped to depress commodity prices and added to financial market uncertainty. Interest rates at historic lows are encouraging higher leverage, leading to a build-up in risk in international asset markets. This environment creates risks for the New Zealand banking system, which remains reliant on the global markets for funding.

“The dairy sector faces a second consecutive season of weak cash flow due to low international dairy commodity prices. Prices have shown some recovery since August, but many indebted farms are coming under increased pressure, which would be exacerbated if low dairy prices are sustained or dairy farm prices fall significantly.

“House price growth in Auckland has increased strongly with house price-to-income ratios in the region now comparable to those seen in some of the world’s most expensive cities. Rising investor activity has been an important driver of price developments, and international evidence suggests that investor loans have a higher tendency to default in the event of a major downturn in the housing market.

“A sharp downturn could challenge financial stability, given the large exposure of the banking system to the Auckland housing market. While it is still too early to judge the effect of recent policy changes, they are expected to help moderate pressure on Auckland house prices, and will improve the resilience of bank balance sheets to a housing downturn.”

Deputy Governor, Grant Spencer, said that “Banks hold strong capital and liquidity buffers and have maintained their profitability with further reductions in cost-to-income ratios. Lending growth to households and businesses has picked up and is being funded mainly through higher domestic deposits.

“The banks are working with dairy farmers experiencing difficulty, and it is important that they continue to take a medium-term view when assessing farm viability. The banks’ losses on dairy exposures are expected to be manageable but banks need to ensure that they set aside realistic provisions for the likely increase in problem loans.

“New rules on Auckland residential investor loans came in to force on 1 November. The bulk of these loans are now required to have a loan-to-value ratio (LVR) of no more than 70 percent. Banks are also now required to put residential property investment loans in a separate asset class and hold more capital against them.

“LVR restrictions have been eased outside of Auckland where housing market activity has been more subdued. However, the Bank is closely monitoring the recent rises in house price inflation in some areas such as Hamilton and Tauranga.

“The Reserve Bank has a number of other regulatory initiatives in train. Public consultation has recently closed on a stocktake of banking regulations and a summary of submissions will be published shortly. We have recently released a consultation paper proposing changes to the outsourcing policy for banks. And we are also well advanced on an improved oversight regime for payment and settlement systems.”

Home Lending Rotation Continued In September

The latest home finance data from the ABS confirm the trend that investor loans are on the slide, and being replaced by growth in owner occupied loans and refinancing. In September, trend, owner occupied housing commitments rose 2.0% to $20.5 bn while investment housing commitments fell 1.9% to $12.9 bn. The number of commitments for owner occupied housing finance rose 0.7% in September whilst the number of commitments for the purchase of new dwellings rose 1.3% the number of commitments for the purchase of established dwellings rose 0.8%. The number of commitments for the construction of dwellings fell 0.1%.

The proportion of investor loans fell back to 48%, whereas a few months back it was well above 50%. Refinance of owner occupied loans continues to rise, to nearly 20% of all loans written, a level not seen since 2012. So the relative shift away from investment loans is confirmed, in response to regulatory intervention.

In stock terms, the mix of investment loans – as reported in original terms, has fallen back to 38%, but is still way higher than when regulators officially started to worry about the systemic risks of investment loans above mid thirties. we can expect to see further data revisions in coming months, as banks continue to reclassify loans.

Turning to first time buyers, the number of first home buyer commitments as a percentage of total owner occupied housing finance commitments fell to 15.4% in September 2015 from 15.8% in August. However, this does not tell the full story.

Looking at DFA adjusted data, to take account of first time buyers going direct to the investment sector, we see a further fall in new FTB investor loans, down more than 2% in the month. The number of FTB loans for owner occupation rose however, by 6%, so the overall volume of loans is up. The average FTB loan was 2% larger this month.

The strategies of the banks are clear, focus on owner occupied loans, and offer deep discounts to wrest refinanced loans from competitors, whilst using back-book repricing to fund it. At what point will the regulators step-up their surveillance of owner occupied lending? We think they should do so now.

Many Eastern States Investment Properties Are Underwater

We have had the opportunity to do a deep dive on investment property loans, using data from our household surveys. We have looked at gross rental returns, net rental returns (after the costs of mortgage servicing are included) and net equity held (current property value minus mortgage outstanding). The results are in, and they make fascinating reading, especially in the context of up to 40% of all residential property loans being for investment purposes, according to the RBA. Whilst we will not be sharing the full results here, one chart tells the story quite well.

We show the average gross rental yield on houses by state, (the blue bar), net rental yields before tax (the orange bar) and the net gross average capital gain (the yellow line). Gross yield is annualised rental over current value, assuming full occupancy; net rental is annual rental less annual mortgage repayments; and capital value is the current marked to market price less current outstanding mortgage. The first two are shown as a percentage, the last as a dollar value. The chart below only covers houses, we have separate data on other property types but won’t show that here.

We found that investment property which were houses in VIC were on average losing money at the net rental level (and this is before any maintenance or other costs on the property). Those in NSW were a little better, but still in negative territory. The other states were in positive ground – some only just – and of course this is at current interest rates, before the latest uplifts were applied by the banks. We accept that the pre-tax position does not tell the full story, but as a stand-alone investment, many property investors are from a cash flow perspective underwater. Indeed, they are banking on prospective capital gains, and at the moment, they do have a cushion, but if prices were to slip, many would find this eroded quickly.

Our take is that the property investment sector contains considerable risks for banks, and investors, and these are not well understood at the moment. The more detailed analysis we did also showed that some specific customer segments, regions and postcodes were more at risk. Running scenarios on small interest rate rises shows that things get worse very quickly, especially for higher LVR loans.

We concur with analysis from Ireland and New Zealand, that the risks in the investment loan portfolios, despite the apparent historic low rates of default, are higher, and under Basel IV we expect investment loans to carry a higher capital rating, meaning that interest rates on investment loans are likely to rise more in the future, relative the the cash rate.

Central banks can deliver on a ‘divine coincidence’ – but…

… Glenn Stevens is a not a miracle worker. From The Conversation.

Inflation-targeting central banks usually benefit from what some economists have labelled a “divine coincidence”.

This is when the best policy response to inflation also turns out to be the best response to unemployment. A central bank should raise its policy rate when inflation is high and the unemployment rate is low — and vice versa. All else equal, the effect of such a policy response is that inflation and unemployment will return to their long-run levels.

An absence of a trade-off in achieving an inflation target and stabilising unemployment makes the lives of central bankers relatively easy — most of the time. But, alas, this divine coincidence doesn’t always hold.

The stagflating ‘70s

In the 1970s, central bankers faced a dilemma due to massive spikes in oil prices that resulted in less-than-divine sounding “stagflation” – that is, simultaneously high inflation and unemployment. If central banks pushed interest rates high enough to put a lid on inflation, they would increase unemployment further. But if they tried to hold interest rates down, they risked inflation spiralling out of control.

Most economists believe that central banks were too timid in the 1970s and inflation targeting was developed in the late 1980s and early 1990s as a way to make sure central bankers would keep their eye on the inflation ball whenever the divine coincidence failed again.

A surprising downside to the divine coincidence

The divine coincidence hasn’t really failed since the 1970s. For example, the recent global financial crisis led to lower inflation and higher unemployment in most countries. In this case, central bankers faced no dilemma in pushing interest rates downwards. Their only dilemma was what to do after their policy rates hit the zero lower bound.

But there is a surprising downside to the divine coincidence holding over the past quarter century. It seems to have lulled most everyone into thinking central bankers are miracle workers who can hit two targets with one arrow.

Worse yet, if central bankers can hit two targets, why not ask for more? Shouldn’t they also keep house prices under control? Stock prices? The exchange rate? Bank lending rates?

This idea of targeting bank lending rates has received much attention over the past few weeks in Australia, where the major banks have raised their mortgage rates, supposedly to cover increased costs related to changing capital requirements from Basel III.

Following this increase in bank lending rates, there were public calls for the Reserve Bank of Australia (RBA) to cut its policy rate to help bring mortgage rates back down. The RBA wisely chose not to listen.

But it is notable how easily the (implicit) idea that the RBA should target mortgage rate spreads could become such a focus of the public discussion surrounding monetary policy.

What’s the problem?

Public officials should want to cool an overheating housing market. They should want to minimise anti-competitive practices in the banking industry. And surely they should want a low and stable rate of inflation.

But they just can’t use one instrument – that is, the policy rate — to achieve all of these wonderful outcomes at the same time.

In the absence of more widespread divine coincidences, different desired outcomes will always require different policy instruments. And most practical tools to achieve outcomes other than just low and stable inflation have big distributional consequences.

For example, if policymakers really want to prevent an overheated housing market, they need to design tax and planning policies that influence demand and supply of housing. These have very different effects on homeowners and renters and are clearly more the domain of governments (national and local), rather than a central bank.

Likewise, if policymakers really want to make the banking system more competitive, they should do so via the regulatory environment. To be sure, any policy changes along these lines ought to involve consultation with the central bank given that there is a likely trade-off between a more competitive banking system and greater systemic risks, at least if the recent experience of the global financial crisis is any indication.

But the point is that such policy should not be conducted by a central bank alone. And it definitely shouldn’t be done by adjustments to the policy rate. This would be a misguided “duct tape” solution to a more serious architectural flaw.

Who is steering the ship?

Inflation targeting central bankers need to focus on their main objective of stabilising inflation and not be sidetracked into trying to correct all other macroeconomic and financial problems. They are not miracle workers — although they have generally delivered on their inflation targets.

To the extent the divine coincidence has held, inflation targeting central bankers have been lucky enough to also help stabilise unemployment. But they should not be expected to offset the effects of an uncompetitive banking system — or ill-conceived fiscal policy, for that matter. Their objective of low and stable inflation should always guide their decisions, not a response to the decisions of others with different objectives.

We should expect central banks to be focused on the inflation horizon, not to be divine.

Author: James Morley, Professor of Economics and Associate Dean (Research), UNSW Australia