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Jumps race beats Cup for importance

By Henry Thornton - posted Tuesday, 3 November 2009

The Reserve Bank will increase cash rates today. The only question is whether this will be by 25 or 50 basis points, with 75 a long priced outsider and zero left at the gate.

The economic news has been mostly good since the board of the RBA last met. Most importantly, US GDP rose for the first time in a year. There are caveats of course – mostly the rise was due to the direct or indirect effects of government activity.  Equally important, the US economy is still shedding jobs, the dark side of what is shaping as a substantial surge in productivity.

Europe is in an equally dire state. France and Germany both showed a small GDP increase on the latest numbers, and Norway raised its cash rates by 25 basis points. However, elsewhere, things are looking far less cheery. The UK reported falling GDP for the sixth quarter in a row, and Spain’s unemployment exceeds 17 per cent. On Henry’s direct observation, there is at least as much underemployment, and this is a feature of all developed nations. Japan is still experiencing deflation, but this does not seem to bother the Japanese.


China, however, is powering on, and carrying the rest of Asia with it. India is said to be considering interest rate hikes, and South Korea also. China’s latest GDP growth was reported at an astounding 8.9 per cent, a gold medal performance if there ever was one.

Everywhere, central bankers are debating three things. The public debate concerns inflation, and when to raise interest rates, and by how much. This discussion is broadly in the public domain, but the other topics are mainly put on the record by central bank watchers like Henry.  Some of these watchers, the ‘trusties’, get private briefings by their central bankers but Henry can say without fear of contradiction this is not his lot in life.

The two issues debated mostly in secret conclave concern why the capitalist system almost imploded in 2008, and what needs to change in the setting of monetary policy, and on the structure of financial regulation.

On the setting of monetary policy, the first issue is the danger of very low interest rates, as created by Alan "Bubbles" Greenspan in the US economy the last time there was a whiff of grapeshot on Wall Street. This is highly relevant as Ben Bernanke and many other central bankers are currently presiding over a monetary regime as unsustainable as that of Bubbles himself, to general applause.

So the question is how soon and how quickly can interest rates be raised from current emergency levels to more normal levels. "Not until employment stops falling" is probably the general view, and Australia’s Glenn Stevens is to be congratulated for going sooner, and from a higher low, than virtually all his colleagues.

The closely related issue is how to avoid asset and lending bubbles and what to do about them when they appear to be in danger of occurring. "Take account of asset prices in your measure of inflation" is Henry’s answer and this seems to have occurred to a number of other central bank watchers such the estimable Andrew Smithies of London, as reported in Henry’s Blog last week. Whether to expand the measure of "Inflation" to include asset prices, or whether to introduce a set of asset prices in a "check list" of inflationary indicators, is what the central bankers will be debating behind closed doors.


Then there is the issue of how to recast financial system supervision. So-called "Macroprudential" supervision is generally agreed to be the central banker’s prime responsibility, and amounts to not letting a lending boom get out of control, and raising interest rates boldly when there is a lending or asset price boom is their relevant responsibility. The feeble objection that "no one can tell if it is a bubble until it has burst" has been swept away by the near meltdown of the world’s banking system.

Whilst acting with interest rates, a prudent central bank will presumably tell the financial regulation authority to do something about it also. One hopes such advice would be put on the record when it is offered.

The financial regulators have a bigger task. Many ideas have been floated. Systematically raising the capital to asset ratios as a boom developed is already agreed, as suggested above. Splitting current financial conglomerates into simple banks, investment banks and in some cases also freeing fund managers is a popular suggestion. Simple banks would be managed by simple souls paid simple amounts, but would be bailed out to the extent of protecting depositors balances if simple management failed.

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First published in The Australian on November 3, 2009 and on Henry Thornton's blog

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About the Author

Henry Thornton (1760-1815) was a banker, M.P., Philanthropist, and a leading figure in the influential group of Evangelicals that was known as the Clapham set. His column is provided by the writers at

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