Stevens Seen Taking on Good Cop Role at RBA

For the first time in 7 1/2 years at the helm of Australia’s central bank, Glenn Stevens is playing good cop as the nation’s treasurer turns villain.

Traders are pricing in just a 2 percent chance of an increase in the record-low 2.5 percent cash rate this year, interbank futures show. Joe Hockey will deliver his first budget tomorrow, with spending cuts and new levies to tackle a forecast A$123 billion ($115 billion) shortfall over four years.

“This will be a budget that at the very least prevents the Reserve Bank from raising rates any time soon and eventually may even prompt them into cutting rates if there is a significant tightening of fiscal policy,” said Saul Eslake, chief Australia economist at Bank of America Merrill Lynch in Melbourne and a member of the shadow board of the Reserve Bank of Australia. “Governor Glenn Stevens could be the one playing the role of ‘good cop’ - a relatively unusual one for him.”

Stevens defied the government of the day in 2007 by raising rates during an election campaign and in 2009 was the first Group of 20 central banker to tighten policy as the global credit crunch eased. Faced with surging home prices and signs of a recovery in domestic demand, Stevens this time has flagged a period of rate stability to assist the economy’s transition from resource-investment driven growth.

The RBA is independent of the government, preventing direct fiscal-monetary policy coordination. Still, unlike central banks in other major developed nations, the top bureaucrat in the Treasury Department sits on the board, blurring the boundary between an inflation-targeting bank and growth-oriented governments.

Policy Conflict

There was disagreement between the two drivers of economic policy in 2009, according to a document from U.S. diplomats in Canberra and Sydney released by WikiLeaks, an organization that publishes secret papers on its website. It referred to disagreement between officials within the Treasury Department which wanted the RBA to cut rates more aggressively, and central bank board members who argued any slowdown would be limited, swayed by the assessment of then-member Warwick McKibbin.

A spokesman for the RBA in Sydney declined to comment, while the Treasury Department didn’t immediately reply to e-mails seeking comment on the document.

McKibbin, who declined to comment due to RBA policy that prohibits discussion of board deliberations, was proven right as Chinese demand and government stimulus helped refloat Australia’s economy. Now, he says interest rates are too low.

“A fiscal consolidation that is gradually implemented over decades should lead to lower policy interest rates than otherwise,” said McKibbin, who served on the RBA’s board from 2001-2011 and is professor of economics at Australian National University and a Senior Fellow at the Brookings Institution in Washington. “But if you are starting from a position where rates are already too low, this is less likely.”

Austerity Period

Ken Henry, secretary to the Treasury from 2001-2011, says Australia needs to undertake fiscal tightening. “There will have to be a period of austerity,” he told Bloomberg TV in Hong Kong on April 30.

The RBA cut rates to a record low last year to help smooth the transition from resource investment to domestic drivers of growth such as residential construction. Cutbacks by mining companies and upcoming fiscal consolidation will weigh on growth, the RBA said in Sydney May 9.

“The current accommodative monetary policy setting is likely to be appropriate for some time yet,” it said.

Budget Cuts

An audit of government spending released at the start of this month estimated as much as A$70 billion a year could be saved within the next decade. Hockey is set to announce reductions in welfare, government staffing, an increase in the pension age to 70 and a temporary levy on high income earners, according to local media reports ahead of tomorrow’s budget release.

Hockey will announce a A$30 billion deficit for 2014-15 after recording a A$46 billion shortfall this fiscal year, according to the median estimate of 10 economists surveyed by Bloomberg News.

Australia’s last major fiscal tightening, then-Treasurer Peter Costello’s debut 1996 budget in John Howard’s government, was supported by 2.5 percentage points of rate cuts in 1996-97 and a decline of about 30 percent in the currency from a peak in 1996 to its trough in 1998. That’s unlikely to occur this time, said Eslake, noting the cash rate is already low and the currency resilient, averaging above 90 U.S. cents this year.

“The government needs to be aware that the circumstances in which it’s bringing this budget down are quite different from those which Howard and Costello had 18 years ago,” he said.

Political Capital

Australian governments traditionally cut spending at the start of their first term when they have maximum political capital and can blame predecessors for poor economic management.

Stevens, in his final three years at the helm of the RBA, has faced criticism in the past from playing villain.

After the governor raised borrowing costs even as the global credit squeeze intensified, the Daily Telegraph, the country’s biggest selling newspaper, led its front page on April 5, 2008, with a picture of Stevens and the headline: “Is This The Most Useless Man in Australia.”

Costello was on the wrong end of the RBA’s independence in 2007, when Stevens increased rates during an election campaign the Liberal-National Coalition went on to lose.

McKibbin maintains the potential for a conflict of interest remains due to the Treasury Secretary’s place on the board. He recommends the civil servant or an official could instead brief the RBA board at each month’s meeting on the government’s economic outlook and policy stance.

“Having the Treasury Secretary on the RBA Board is -- and has always been -- a potential conflict of interest,” McKibbin said. “In terms of a voting role it works against the independence of the central bank and adds nothing to coordination.”

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