Interest Rates and Inflation

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It was four years ago that the first house on my street sold for over a million dollars. It was a stunning moment but also a stunning house. It sold for $1.2 million and in the context of the times was pretty well worth what it cost to buy.

That same house sold again this April. Once again the entire neighbourhood went through the house to have a look and while it had been kept up, nothing extra had been added. It was the same, except that this time the property sold for $1.7 million. In four years property prices, at least so far as this particular property was concerned, had risen by forty percent.

There has subsequently been quite a bit of action in selling houses on our street but the most astonishing moment was last week. This was a house that had not been touched for fifty years. To say that it had “original features” only underscores what a derelict mess it was.

And the price: it went for over $1.4 million with four bidders going beyond the $1.2 million level and two going above 1.4.

That this totally astonished all of us in the street is to put our reaction as mildly as possible. That it depressed my son who was trying to think how he would ever be able to buy a house for himself was perfectly understandable. This is an economy with property prices gone mad.

The man who bought the house had just sold up in a more expensive suburb and was locating down, pocketing a net million along the way, although probably half of that will be sunk into renovations. The seller has netted for himself more than a million relative to the price he paid, and was for him on a property he had rented out and not lived in himself. This is, for him, all money in the bank.

And that’s the point. It is all money in the bank. There is, according to the press, a difference of opinion between Treasury and the Reserve Bank over interest rates and their proper direction. Treasury cannot see what the rush to raise rates is all about. The economy has barely touched bottom, assuming that it even has. So far as Treasury is concerned, it is madness to be raising rates already when recovery has not truly even begun.

But then there’s the RBA. What it sees are house prices rising again and an inflation already becoming entrenched. While the “headline” movement in the CPI was a quite moderate 1.3% across the year, the “underlying” rate the Bank relies on rose by 3.8%, well outside its band of 2-3% per annum over the course of the cycle. And even the headline measure showed an increase of 1.0% for the quarter which of itself is worry enough.

Inflation and What to Do About It

That the economy, particularly the private sector, is still generally moribund is likely. That there is a long way to go before we return to the kinds of momentum we would prefer seems about right. That raising rates right now will slow the economy and delay a return to stronger levels of private sector activity seems almost unanswerable. Yet, with all this liquidity sloshing around, what is a central bank to do?

What makes it worse is that the very aim of the government seems to be to push the private sector out of the way. This is not like an inadvertent error by the Prime Minister to have raised the level of public spending in a panic and therefore to have crowded the private sector out. This seems more deliberate than that, and is in keeping with the notions put forward by the PM in his economically challenged article published in The Monthly at the start of the year in February. At the time, he wrote:

“The magnitude of the crisis and its impact across the world means that minor tweakings of long-established orthodoxies will not do. Two unassailable truths have already been established: that financial markets are not always self-correcting or self-regulating, and that government (nationally and internationally) can never abdicate responsibility for maintaining economic stability. These two truths in themselves destroy new-liberalism’s claims to any continuing ideological legitimacy, because they remove the foundations on which the entire neo-liberal system is constructed.”

Neo-liberalism, you see, means leaving production decisions to the market to be made by profit-making firms which are trying to work out what consumers would like to buy. This the Prime Minister will not permit given these apparently “unassailable truths”. It is his judgement that is going to matter and come what may, he is determined to have the government absorb our national savings for his own purposes rather than for our own.

In a depressing assessment reported in The Australian this week we were told that “the nation’s key economic advisory body [the Productivity Commission] says the government has not ‘universally applied’ its own promise to subject all major infrastructure spending to detailed and transparent cost-benefit analysis.” Listed were $66 billion worth of projects that the government does not know, and apparently does not care, whether the money being spent will be repaid in revenues ultimately earned.

I therefore want the RBA to raise rates and keep on raising rates because that may be the only way we are finally going to convince the Prime Minister there are costs to the approach he is taking. Whether raising rates will prevent inflation from taking off is hard to say. It might put a brake on wage movements which are the main feedstock of the inflation process, but governments are the worst industrial relations negotiators so I wouldn’t count on them.

But what I am looking for is recognition within the government that they cannot keep pushing their own expenditures upward, crowd out the private sector, and hope to generate real growth. Is there no one within the Government who actually does understand how prosperity comes about? From how they have so far behaved, it really doesn’t look that way from here.

The Government is counting on your ignorance to get away with literally destroying billions of dollars of our wealth. If these projects do not repay their costs, they will just make us poorer.

But they will create jobs. And they will lead to a rise in the recorded level of GDP. That other jobs in the private sector will not be created, and that we will actually end up with a lower standard of living because of this tremendous level of public waste, is just how it is.

I now meet people all the time who tell me we had to do something about the Global Financial Crisis. OK I say. Pay the higher interest rates and taxes and be done with it. Such nobility I think! Such self sacrifice! Such idiocy!

These latest expenditures are not being done in the heat of a crisis. They are a matter of deliberate policy. That we let governments direct so much of our resource base to ends of their own choosing is unfortunate. But if we as a community do not know any better, that is just how it is going to be.

Dr. Steven Kates
for The Daily Reckoning Australia

Dr. Steven Kates

Dr. Steven Kates

Dr. Steve Kates is a Senior Lecturer at the School of Economics, Finance and Marketing, RMIT University. Dr. Kates spent a quarter century as the Chief Economist for the Australian Chamber of Commerce and Industry. Most of his research has been into macroeconomic policy, industrial relations and the history of economic thought. His most extensive area of expertise is in the classical propositions surrounding Say’s Law, on which he has written many papers as well as two books: Say’s Law and the Keynesian Revolution (1998) and Two Hundred Years of Say’s Law (2003) and, with John Cunningham Wood as the general editor, put together a five volume set, Critical Readings on Jean-Baptiste Say. The lead article in the March 2009 issue of Quadrant dealt with “The Dangerous Return of Keynesian Economics” which looks at the importance of Say’s Law in the development of coherent macroeconomic policies.
Dr. Steven Kates

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79 Comments on "Interest Rates and Inflation"

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Tom
Guest
All true words and observations from my viewpoint in the economy (BEcon). I happen to live in the treasurers electorate and have emailed him a number of times to let him know, not everyone agrees with using taxpayers funds to support the broken status quo. All I have received is policy statements and opinion. Unfortunately as the government in power dealing with an issue too complex for most people to understand, (let alone want to understand), they can get away with pretty much anything. The newspapers are too busy keeping their property and finance advertising revenue streams happy (their last… Read more »
Dan
Guest
One possible future scenario is that house prices will never correct downwards, but that the shortage of houses for _sale_ will become such that people are forced to rent for longer and longer periods before being able to buy. The reason for this would be because of financial institutions entering the housing market and not leaving it. They are already deeply in it, of course, through mortgages, but they may decide to collect rent forever and never hand over title – in a more formal sense. There is an opportunity for them to muscle in and charge any rip off… Read more »
Paul
Guest
Nice comment, Dan. I’ve watched the price of Australian housing rise and rise since the middle of the 1990s. I’ve seen – as I’m sure you have – housing prices increase by 600% in 12 years in some Melburnian suburbs. And I’ve looked at all the logical economic explanations for this momentous and protracted economic aberration. Every single piece of knowledge – logic – I have tells me that there will be a crash. ‘There simply has to be a fundamental correction’, my internal monologue exclaims. But you know what, my intuition – that pulsating rhythm of truth that never… Read more »
Annie
Guest
Feel a bit the same way Paul. Logically house prices should fall, but the penchant Australians have for endenturing themselves to banks is limitless it seems. All logic points to a decline in prices; stagnant wages, tax increases, interest rate rises, decrease in the first home owners grant etc. But will it happen? There’s still some crap to flow through the system and I think things are still pretty shaky. This recovery could be based on false premises and the whole lot could fall like a house of cards. Don’t know if it will…….wish I did. I am going country.… Read more »
Pete
Guest
Wow. You can tell a market is going to turn when even the bears are giving up reasonable logic for the flawed logic of the mainstream. Dan: (not Denning) I very much appreciate your capacity for thinking laterally. However, banks aren’t in the real-estate business. But, I take your point that they could reconsider this position. Let’s think about it from their perspective – what would they get from it? Banks need to make profits. How much of a rental yield would be a profit? Assuming that most of a bank’s money is in fact sourced elsewhere/borrowed, that means they… Read more »
Dan
Guest
Not flawed, Pete – and yes it’s a brainstorm type idea. But consider a housing crash – a proper one – in Australia. Foreclosures galore and house after house falling into the banking sector’s hands with no prospect for resale in the immediate term. Banks do manage real estate on a smaller scale. Usually houses they repossessed and then rent on to employees who move around. I was just thinking they could be left holding the baby, and it might be better to lose a percent or so per annum (though not necessarily so) for one of the Big Four… Read more »
Dan
Guest

Err.. flawed logic of mainstream is indeed flawed logic. But your maths seems about right.

Richo
Guest

In this scenario, the bank hasn’t paid $400,000 to acquire the house.
It has cost them the outstanding amount of the loan.
That could be $200,000 or $300,000 or less. That should give a fatter profit margin

Also the house is would no longer worth $400,000 if the property market has crashed so bad that its not worthwhile to sell the house. Best to calculate from the cost of acquiring it.

Pete
Guest
You are right Richo. Conversely, banks could also be left with even more owing on them. Also, perhaps some houses will not be able to be rented without work done on them (for safety purposes?) Other properties may not yield the such high rents. I take yours and Dan’s point that realising a loss of say $100K is excessive compared to realising a loss of maybe $10K per annum on rent. However, what is not guaranteed is that prices will significantly recover (in real terms at least). Perhaps the bank would never be able to sell the house at a… Read more »
David (Brisvegas)
Guest
The issues that seem to be missed in my humble opinion on Australian real estate are, firstly, it’s not 1 market, but thousands, and prices rise and fall in varying degrees, based largely on what’s available to buy. Jump on realestate.com.au and the difference between suburbs of available houses for sale will show this quite clearly, particularly suburbs within 10kms of the city vs 20 kms and more out from CBD. Secondly, unless Aussie unemployment goes through the roof, or interest rates go through the roof, why would people need to sell and create a price crash scenario. Unemployment would… Read more »
Pete
Guest

Ralph said: “The consequence is that the government has now designated an asset class that is a rolled gold protected species…” You mean the Big Four banks, Ralph?

Ned S
Guest

Couldn’t really expect much else if one had really exercised their grey matter a bit more I guess eh? So I am feeling a bit silly for not having placed nearly as much weight on it as I should have – Sheepish grin. Nevermind – I hedged my bets and the game goes on!

Martin
Guest
David, I’d like to respond to your post by saying that I think your perspective on the whole situation (housing prices) is naive, simplistic and, sadly, entrenched in the generalised myopic stupor that caused – and continues to propel – the housing (un)affordability crisis. First of all, of course prices differ from one suburb to the other – that kind of price differential is natural and quite typical in all economic markets. But it doesn’t mean that the Australian market is not one single market – milk prices differ significantly, but it doesn’t mean that milk, is milk, is milk.… Read more »
Dan
Guest
Indeed, Martin. It was the foreign investors buying into Australian housing (not necessarily ageing dog-boxes in industrial suburbia, but apartments and whatever else is generic and has a predictable maintenance cycle) that made me think that if housing turns to having faceless owners in far away places, then it might represent a shift from occupiers owning their dwellings to being forever renters and not even having access to credit any more. See, it doesn’t matter how you pay someone, as long as you pay them. It can be $2000 a month in house repayments (for an ordinary house), or $500… Read more »
Pete
Guest

Ralph said? Who the hell is Ralph? I don’t see a Ralph.

Biker, stop playing silly buggers and using my name. You just seem more and more like a child every day.

(this is regular Pete speaking about the last ‘Pete’ comment)

Ned S
Guest
Dan – Hallucinating is allowed. There isn’t much that could be said about Oz property I haven’t heard said I think – So a new thought that hovers within the bounds of rationality is extremely welcome. The thing I keep banging my forehead against the post with the nail in it with the Steve Keen brigade is that they seem fixated on the facts that house prices are high and it is a bubble and bubbles crash so they’ll get cheap houses one day – To which I say Yeh it could pan out that way but I can see… Read more »
Regular Pete
Guest
I like your response Martin. Dan, I also like your response. You make a good point about mortgagee’s then becoming home ‘renters’ from the bank. It would save the bank some hassle. But, it is essentially the same as those mortgage ‘holidays’ that people are taking from the banks right now. The banks seem quite unwilling to forego long-term profits, but rather letting people off the hook for paying in the short-term. The interest still adds on to the principle. I do think you are onto something, and perhaps this could be an extension or modification of these mortgage holidays.… Read more »
Greg Atkinson
Guest

Hi Ned as I commented elsewhere Steve Keen has conceded he was wrong. So I suspect the Steve Keen fan club will need to regroup.

But Keen did manage to make himself fairly well known and set up a website to sell his wares, perhaps this might help ease the pain of selling his home too early :)

Pete
Guest
I like your response Martin. Dan, I also like your response. You make a good point about mortgagee’s then becoming home ‘renters’ from the bank. It would save the bank some hassle. But, it is essentially the same as those mortgage ‘holidays’ that people are taking from the banks right now. The banks seem quite unwilling to forego long-term profits, but rather letting people off the hook for paying in the short-term. The interest still adds on to the principle. I do think you are onto something, and perhaps this could be an extension or modification of these mortgage holidays.… Read more »
Ned S
Guest

Thanks Greg – Full credit to Keen then. At least he can take it on the chin when he is wrong. As most of us were to one degree or another – Good for you Biker!!!

Pete
Guest
Nothing wrong with Steve Keen except that he was naive enough to put a specific time limit on his prediction. He didn’t give himself much room on that one. But that is because he believed in markets. The Gov. is distorting markets. Think that’s not a bad thing? High house prices causes pain to some groups, but also takes capital (credit) away from other areas of the economy. Like small business. Like corporate real estate. Like entrepreneurs. Like innovators. Like education. Like anything that is actually ‘productive’ in the economy. And it encourages rampant (and blind) speculation. For those of… Read more »
Dan
Guest
I think the big danger is debt, not owning a house, Ned. So I agree with you there. People owning their house(s) with no debts needn’t worry, in my opinion – it’s a bit like gold – a long term play, except you can actually pay your bills from rental income. What I foresee is a transfer of wealth away from people with big mortgages and unreliable employment (that’s obvious), as per your usual economic downturn (except I think it’ll be bigger and longer than most people like to imagine). That might make for ripe pickings for house-vultures, but that… Read more »
Ned S
Guest

Hey Pete – You’ve got trading skills … Capitalize on those I reckon. I don’t … Some day maybe? [But probably not.] To be dead honest I’m not as motivated as I was a couple of decades back. So I’m sitting back waiting to see just how much effort Ken Henry reckons I’m going to have to exert to make things happen for me in Oz. And if he dishes out any little pointers as to other investments government might like to see us in – I’m not the fighter I once was I guess?

Dan
Guest

Definitely, Pete. Philosophically/ideologically I don’t hide the fact that I hate usury, usurers, the defrauding of workers of their wages, the murder of innocents, the neglect of social obligations towards the poor, sick and dying, and the blatant lies, damned lies and statistics coming from government and the media. This is what’s wrong with the way the government manages our economy, allows banks to go rampant, fights unjust wars and over-taxes unwitting workers.

Some call it Karma, but I call it the Universal Justice System. They can’t get away with it forever.

Greg Atkinson
Guest

Pete “the markets” are influenced by government actions and Keen should have factored that into his thinking. The biggest error he made was confusing theory with reality. He simply isn’t what I would call streetwise. There are some things you only learn by getting your hands dirty and you just don’t get that experience crunching numbers at a university all day.

Ned S
Guest

And “wise old mamma” would have never recommended selling one’s home because house prices might go down one day Greg. But such is life said my namesake before they hanged him … ! :)

David (Brisvegas)
Guest
We’ll see who is right or wrong in time, but the one certainty is that nobody really knows. No, I don’t watch Today Tonight or any of those shows, as Bloomberg is my preferred viewing. Sensationalist “economists” like Steve Keen should be held truly accountable for their self serving rantings, designed to give him some notoriety, make him money so maybe he can now afford a penthouse unit on Australia’s highest peak. Let’s hope he stays there. An unemployment rate of 6% means 94% with a job, who can continue to fund their way into the various levels of the… Read more »
Pete
Guest
David: “Sensationalist “economists” like Steve Keen should be held truly accountable for their self serving rantings, designed to give him some notoriety, make him money so maybe he can now afford a penthouse unit on Australia’s highest peak.” What the? I am open-mouth-gaping surprised at that comment. Shouldn’t this instead be said of Mr Joye, all of the banks, and perhaps half of the worlds economists? Steve isn’t raking in the dough like they are. Steve’s bias sits with his logic, not his income stream or mainstream pandering. My main point isn’t so much to defend Steve but to wonder… Read more »
Greg Atkinson
Guest

Where is Biker Pete in his moment of glory? Biker Pete 1- Steve Keen 0.

Pete
Guest
Biker should wish he had half the brains that Steve Keen has. In fact I think most of us should. He made a bet that was wrong, but he made it for the right reasons. Many people like Biker have made the right bet for all the wrong reasons. If this is what people have become – people who praise speculation and good fortune, whilst deriding reasoning and moral accountability – then a Depression is exactly what we need. Unfortunately there are plenty of people who are not like that. And in a Depression they will suffer too. Hopefully not… Read more »
Greg Atkinson
Guest

Pete – Steve Keen was “speculating” about a 40% drop in house prices. Not sure how that makes him any different from those who speculate about prices going the other way.

Anyway, let’s be honest, if Keen had won the bet you would be amongst the first to give Biker Pete a hard time. So let’s not rain on Biker Pete’s parade where ever he is.

Ned S
Guest
I wish I had half the commonsense that Biker has. And in amongst it all, who actually noticed under what circumstances and when he reckoned that Oz house prices were liable to take a whack? (I sure did and concur fully!) Speculation – For mine Buffet is a predatory “old” speculator – From whom most people who’ve ever heard the word “investing” have hoped to learn something – Then there is Mr G Soros of course. Plus Yeh, the love of money is firmly entrenched in “civilized” humanity – When such “civilized” governments want to effect societal change they do… Read more »
Pete
Guest

Greg:
“…if Keen had won the bet you would be amongst the first to give Biker Pete a hard time. So let’s not rain on Biker Pete’s parade where ever he is.”

Why would I give him a hard time? I wouldn’t need to.

He’d still be out there saying that property is the best asset anyway. Confidence and stubborness don’t equal intelligence.

Ned:
I know you might choose to not notice Biker dishing out his insults instead of debating the point, but it certainly wasn’t a one-way street. He has insulted more people on this site that anyone has since I have been here.

Pete
Guest

And why he keeps being brought up anymore is beyond me.

Dan
Guest

It can only be love, Pete, pure and simple.

Greg Atkinson
Guest

Actually Dan it is because I know I would get a bite by mentioning B.P ;) BTW if he ever finds his way back online it will kill him that he missed all this! Anyway my constant theme about economic forecasts is that they are simply well thought out guesses at best, so you are a bit of a mug making a bet over one.

prozak
Guest

Ned,
you are full of yourself.

“With some (NOT Pete!) feeling the need to tell a bloke he’s got a small whanger and his missus is a slut when house prices go up….”

Is that really how you remember it? Better go see a doctor. Alzheimers has finally taken hold.

If you weren’t s far up BP’s arse you might have noticed why everyone else took an instant disliking to him.

Dan
Guest

prozak, didn’t your mother teach you any manners as a child?

prozak
Guest

Dan,
wow you got me.
So Clever. So witty.
Spend less time getting involved in arguments that are not yours and you might for once make a useful comment on here.

Ned S
Guest

I don’t think I have anything to say that you’d find useful either Sir. So I’ll allow your remark “If you weren’t s far up BP’s …”, speak for itself.

prozak
Guest

Ned,

What a weak character you must be. Your digger and aussie battler forebears would be ashamed.

Making comments laced with lies just to get a reaction and then not having any sort of character to either argue your case or back down from your lies.

Regular Pete
Guest

Sensationalist “economists” like Steve Keen should be held truly accountable for their self serving rantings, designed to give him some notoriety, make him money so maybe he can now afford a penthouse unit on Australia’s highest peak. Yep! Suck it up, son…

Lachlan Scanlan
Guest

Yep.High fibre diets’l do dat for ya. Good stuff Pete.

Pete
Guest

It’s obviously Biker saying that stuff.

Shows how pathetic he is that he needs to impersonate others.

Pete
Guest
Ha,Ha, Regular Pete! We’re both ‘regular’ blokes, mate. The difference is I don’t air my bowel movements online. Remember, you fellas started the tag theft… and, it ‘backfired’, literally on you. So I’ll post as Pete whenever I want, mate. Try to be a good loser. Some suggestions for a new tag: Special K Pete; Hi-Fibber Pete; Renter Pete…. (?) Loved Kates’ piece, BTW. The icing-on-the-gingerbread… Gotta go and remind Sixty Minutes about the sequel to their first King of the Property Bears’ show. Think I’ll fly over for the Big Walk. (I’m the Kiwi bloke in the cowboy hat…… Read more »
Pete
Guest

So typical of you to stoop this low to steal someone else’s name Biker.

For others it is a pretty obvious difference between when I am saying something and when you are anyway. Because you can’t comment on the topics, only your pathetic opinions of people.

Leeches like yourself don’t even deserve responses.

Pete
Guest

But you responded. ;) Get over your disappointment at losing the opportunity to steal another man’s home, son. Remember, just because you backed a loser, it doesn’t mean you must remain one. Find a large Sydney icon… and get over it… . :)

Ned S
Guest
Welcome back Biker. Uncle Dan reckons stay out of debt. Cousin Greg’s staked out a Yammy shop for when you pop in. Cousin Ross reckons deflation is the go. But CA doesn’t sound convinced? I hear on the grapevine Pete’s still a bit miffed at you – Something about something of his you borrowed? That bloke who’ll be visiting from the big smoke – You know, the one with all the learning? – He asked if you could recommend a comfy brand of walkers. And whether you know if hats with corks really do keep the drop bears away? Oh,… Read more »
Anthony
Guest
Yah know fellas………….I feel whacked as a guy who thought that a look at this column might yield some intellect. And…….indeed it did! But as usual…..fleetingly and sure to end within a brief time. As with most of my 45yrs of experience in Aust, since exiting the UK in search of wider fields (but ending up listening to what I can only describe as Ozzie “pretenders to intellectual capacity”.) I can truthfully say that none of you can hold on to intelligent conversation long enough to even qualify as an entrant into what I used to enjoy(in 1960’s London)that we… Read more »
Pete
Guest
G’day mate! Yes, Regular Pete is a little miffed, but I bet you ten bucks he will get over it _really_ soon. An apology would clear the air of course, but you know how some of these bears are, Ned. That young bloke got over his overdose, did he? Dangerous stuff, that fluoxetine. After I read one of his recent posts, I looked it up… and sure enough: diarrhea; talking, feeling, and acting with excitement and activity you cannot control; confusion and difficulty concentrating. Walkers? You can’t beat Merrells. Keen to pass on the tip to Sixty Minutes. Deflation, I… Read more »
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