RBA grapples with 'dilemmas, ordinary Australians suffer'

The RBA governor has said he cannot deal with the excessively strong exchange rate, but that eventually falling commodity prices will do the job for him.

With his fellow senior officers, Mr Stevens has has dismissed thoughts of a bubble in housing, but at the top end of some markets, especially Sydney's rich belt, bubble-like signs are evident to rich people, or ordinary people who read newspapers.

Journalists are at last (at last!) discussing the dilemmas that are worrying our friends in the bunker at the top of Martin Place.

With appropriate modesty we point out that our regular column has used the words 'dilemma' or similar quite often in the past year, and also that we have articulated an appropriate way for Glenn Stevens to approach these dilemmas. Here is the evidence.

Our tagline is that 'monetary policy cannot serve two masters', appropriated with attribution from the master monetary economist of the twentieth century, Milton Friedman.

His point is that monetary policy must focus on restraining goods and services inflation and guarding the economy from the ravages of financial instability.

Other objectives need actions other than the subtle movement of interest rates which takes most of the time of central bankers. (What they do after their morning tea is mysterious to most people, which is why central banker do not often invite critics, or even old friends who occasionally offer advice, into the bunker.)

Here is Australia's current position.

The economy is sluggish, though the latest job ads (a highly reliable indicator that has been falling for some time now) may finally be stabilising. Jobs are hard to get and an oversupply of university graduates, and of older, highly experienced workers, is making jobs even harder to get for ordinary Australians.

Inflation is low but may be rising. If there is a big and sudden fall in the value of the Australian dollar, inflation will quickly exceed the RBA's target zone. If our centraql bankers think things are difficult now, imagine double digit inflation with double digit unemployment to follow.

Interest rates may already have gone a bit lower than is wise, partly in the hope of reducing the Australian dollar, which seemed to be working for a time but the RBA has now thrown in the towel.

The trouble is, we have been told, the pesky American central bankers keep deciding not to begin to restore a sensible monetary policy, and the resulting global boom in asset prices is holding the Australian dollar up and may drive it higher again.

The RBA needs help. Australian monetary policy alone cannot solve the problems posed by global asset inflation.

As our better economists have said, one approach to an overvalued exchange rate is to introduce new economic policy reforms to help companies to cope with a high dollar that is greatly hindering efforts to export and to compete with imports.

Here is the rub. No practical and feasable program of economic reform could do more than raise Australia's productivity by a few percent each year. The Abbott government has at least stopped the productivity reducing policies of the late, unlamented Labor govenment but will hasten methodically with its reform program. Labor is committed to doing its best to prevent the axing of the carbon tax and would certainly scream with rage if the Abbott government tried to improve the working of the labor market or attacked fiscal spending sufficiently to create the real hardship in Canberra.

It is a sad fact that it is only an actual economic crisis, or plausible fear of a real crisis, that gets big reforms done quickly. Crises also focus business leaders and ordinary workers on the main game of improving productivity, but this is almost always accompanied by a powerful and damaging increase in unemployment.

This is why I believe we need to fix the currency problem by imposing a modest across-the-board tax on capital inflow. The skeptics point out that Australia is a capital importing nation and cowardly skeptics imagine that global investors would cross Australia off their investment lists if we imposed such a tax. 'Rubbish' is the correct answer to such arguments.

Taxing capital inflow will help to discourage the buying of expensive houses by wealthy people from overseas and rich Australians who play asset booms bravely and well. But, in the next decade or so, house price inflation will only be controlled if there is sensible reform by state and local governments, reforms that allow more people to live in the inner city areas, with higher density housing, faster releases of land for suburban housing and junking of near-useless regulatory blockages by local governments. Governments also need to find ways to encourage people to live and work in rural towns and cities. Like economic reform in general, this process will be at best slow and will not be sufficient to solve the problem of house price inflation. The people who oversee Australia's financial system need to introduce some new policies under the heading of 'macroprudential policy'.

Required asset ratios for financial institutions are part of the solution, ratios that flex up when asset booms gather strength and flex down when the booms decline or when overheated bubbles burst.

When the RBA meets in that large, quiet, board room that seems such a suitable place for quite contemplation or even religious observation (if only a pipe organ with a competent organist were installed), one sincerely hopes that the governor leads his board members in prayer for the wisdom to face their problems (which are the problems of ordinary Australians) honestly and with clarity of vision.

The RBA cannot do more to achieve general reform than to advise quietly and speak generally and not often on the subject.

But the RBA can advise government and should do so in the strongest terms about the urgent need to reform the state of Australia's asset markets by giving it the tools it needs to keep the economy on an even keel while methodical general reforms are planned and carried out.