The dollar is stuck in Hockey's house of horrors

If Treasurer Joe Hockey is angered by the Reserve Bank of Australia’s shift towards a neutral stance on policy his solution should be obvious: do something about housing.

Reports yesterday suggest that the RBA’s push for a period of cash rate stability has angered the Abbott government. It fears that a higher dollar will make the Coalition’s economic management more difficult over the next two or three years.

Recent decisions by the RBA have reflected three competing interests: a high dollar, rising house prices and the impending collapse of business investment. The RBA has struggled to find the right balance, with policy considered too high to lower the dollar and too low to slow the housing market (The RBA’s caution is an economic hazard, April 15).

While I am deeply concerned by Hockey’s casual contempt of RBA independence and the politicising of monetary policy, it is true that the dollar is too high and does pose an immediate threat to the Australian economy. Every passing month with an elevated dollar is putting pressure on Australia’s vulnerable tradables sector; it’s reducing business investment and jobs and compromising the necessary rebalancing of the Australian economy.

Nevertheless, there are two fundamental problems with Hockey’s position. First, cutting rates is unlikely to lower the exchange rate significantly; and second, government housing policy – supported by both political parties – is largely to blame for the predicament the RBA finds itself in.

On a day-to-day basis, variation in the Australian dollar is often driven by expectations for the cash rate, however, over the medium- to long-term the exchange rate is largely driven by a single factor: the terms of trade. The RBA can lower rates all it likes but until the terms of trade begins to drop the dollar will remain at a stubbornly high level.

Consequently, the cash rate doesn’t matter nearly as much as the price of iron ore or growth in China. When either of those two factors begin to slide, the terms of trade and the Australian dollar will inevitably follow suit. By comparison, a cut of 25 to 50 basis points is unlikely to make much difference.

Nevertheless, cutting rates can do more to boost growth than simply lowering the Australian dollar and there are segments of the economy that could certainly benefit from lower borrowing costs.

Unfortunately poor housing policy – supported by successive governments at all levels and of both political persuasions – has created the predicament that the RBA finds itself in.

Government housing policy largely encourages housing speculation and during periods of low rates those incentives can create reckless behaviour. Both negative gearing and capital gains tax concessions cost the taxpayer billions, do not increase home ownership rates, and artificially boost house prices.

Indeed without either of those two policies, and more flexible state and local government planning schemes, both house prices and house price growth would be considerably lower – providing the RBA with ample room to lower rates if it saw fit.

If the government was serious about lower rates it should address housing policy immediately. The removal of negative gearing, for example, would save the budget $4 billion annually, boost home ownership among young people, slow price growth and allow the RBA to lower rates to support the non-mining economy. It’s a classic win-win for the government and taxpayers.

In recent months I have said that the RBA should do more to rein in house prices by introducing macroprudential policies designed to slow lending – I stand by that call (A housing policy lesson from New Zealand, February 19). But those policies are only necessary because of government housing policy that encourages reckless speculation. The best long-term solution is to address the cause, not scramble to fix the problem after it occurs.

Hockey’s displeasure will not concern anyone at the RBA. The central bank doesn’t play politics and governor Glenn Stevens has proven time and time again that the board will pursue the course of action it sees fit regardless of political implications – just ask John Howard.

However, the Coalition’s views are not without merit and Australia may need lower rates to support the rebalancing process – though I question whether a rate cut will have a significant effect on the dollar.

The Coalition must recognise that monetary policy doesn’t operate in a vacuum; rates will only decline if house price growth slows. Unfortunately the biggest impediment to that occurring is the government itself – if the Coalition is serious about the need for lower rates then the next step is clear: do something about housing.