Rate Cut Based on Flawed Reasoning – 2 Nov 2011


Bearish economist Steve Keen says there are a few flawed reasons for the Reserve Bank interest rate cut.

“They have cut rates this time around not because they are proactive, but because they are reactive to their own flawed modelling.

“The only economic models that the RBA use are neoclassical, so by definition they have deficiencies in their modelling,” Keen wrote on The Conversation academic website.

“They’re about as relevant to the Australian economy or global economy as the weather conditions on Mars are to those on Earth.

“The RBA’s models previously told them that we could expect to see rising inflation and falling unemployment, so that’s why they expected they would need to continue keeping rates up.

“Now what has happened is that inflation is falling when the recent revision of the Australian Bureau of Statistics figures drastically reduced the recorded level of inflation.”

Keen wrote that this should be a surprise to the RBA, because its models would say that with the level of capital utilisation right now we should have rising inflation.

He notes unemployment is rising, which goes against the RBA expectations.

“If it hadn’t been for the redefinition of the consumer price index that led to the ABS revisions, the RBA would have held the line this time around,” Keen says.

“This is because it generally tends to respond too slowly when it needs to move in the opposite direction.

“The RBA probably would have held off to see what this Thursday’s unemployment figures showed.

“But with the CPI revision, the RBA board has a reason that appears consistent with its philosophy about how inflation is caused.

“They can adjust the rate and attribute it to a flaw in the data, which led to the ABS revision. But I think that the inflation figure has come as a surprise to them.

“The RBA is still expecting a booming economy, when in fact what we are experiencing is a debt deflation.

“I’ve had personal experience in talking with deputy RBA governors on this – they do not see the importance of the ratio of private debt to gross domestic product.

“Yet that is what is driving the entire global economy at the moment, because you have unprecedented levels of private debt that were accumulated during asset bubbles, which banks studiously ignored.

“When those asset bubbles reached their peaks and burst, then the debt levels came down as well. That reduction in debt is what drove the global financial crisis,” Keen says.

“The RBA continues to ignore the role of private debt in aggregate demand and economic performance in general, so they will continue to be wrong about this for a substantial amount of time.

“They have cut rates this time around not because they are pro-active, but because they are reactive to their own flawed modelling.

“We can expect more cuts to come,” he predicts.

Source: Property Observer – 2nd November 2011

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