- Siobhain Ryan
- From: The Australian
- August 31, 2011
LABOR'S handling of the global financial crisis has come under fresh scrutiny, with a leaked diplomatic cable revealing a split with the Reserve Bank on the economy's ability to recover on the back of the China boom.
A 2009 US embassy cable released by WikiLeaks yesterday exposes cracks in Labor's relationship with the bank during the crisis, with the Rudd government angry that the independent central bank had not cut interest rates harder and faster during the downturn.
The cable shows the government considered outspoken Reserve Bank board member Warwick McKibbin as a stumbling block to its aggressive approach because of his conviction - ultimately vindicated - that China would recover in time to save Australia from recession.
And it reveals the government was so fearful of doing too little to stave off recession that it accepted the risk of doing too much.
The Reserve Bank slashed interest rates from 7.25 per cent in September 2008 to 3.25 per cent in February the following year as the global financial crisis threatened to send the economy into recession.
Mr Kennedy suggested that Reserve Bank deputy governor Ric Battellino and others on the board, who included then Treasury secretary Ken Henry, had been swayed by Professor McKibbin's argument that Australia was likely to be spared the worst of the global economic downturn by a recovery in China in the second half of 2009.
"Kennedy argued that McKibbin could be right, but that the preponderance of evidence is that the current downturn will be much worse," the cable said.
It added the government was concerned that there was a risk that by the time the RBA decided to move, the economy would have deteriorated so much that further interest rate cuts might not have much of an impact. "(Mr Kennedy) stressed that the PM would much prefer the Bank and the government to have to take rapid action to compensate for doing to (sic) much than take corrective action after doing too little," it said.
The Reserve Bank ultimately cut rates one more time - by 0.25 percentage points on April 8.
The Australian economy, which was also supported with $42 billion in stimulus spending by the government, managed to avoid a technical recession, contracting 0.9 per cent in the December 2008 quarter but bouncing back with 0.8 per cent growth in the March 2009 quarter and 2.6 per cent for the 2009 year.
A spokesman for Wayne Swan said yesterday Treasury had made it clear that without the government's stimulus measures, Australia would have fallen into recession. "Instead, unlike nearly all other advanced economies, Australia avoided recession, prevented high and prolonged unemployment and kept net debt at less than a tenth of the level across advanced economies, with monetary policy and fiscal policy working hand in glove to achieve these world-beating results," the spokesman said.
But Professor McKibbin - who has argued that the scale of Labor's stimulus had contributed to overheating the economy during its recovery from the GFC - said Australia's performance during and since the crisis vindicated his position at the time.
"That's why you want the Reserve Bank to be independent from both Treasury and government," Professor McKibbin said. "It would have been good if the government had listened to my advice on fiscal policy at the time. We wouldn't be facing what we do now, which is an exacerbation of the two-speed economy.
"Right now we should be running surpluses and extracting demand from the economy to reduce pressures on the non-mining sectors."
Opposition finance spokesman Andrew Robb said last night the latest US cable highlighted the "extent of panic" within the Prime Minister's office during the GFC.
"Warwick McKibbin's reading of unfolding events proved pretty right," Mr Robb said. "The RBA, after cutting rates by 4 [percentage points] in six months quite rightly kept some powder dry as it was mindful of the inevitable overreaction of the Labor government in relation to stimulus spending."
Mr Robb also attacked the "loose lips" within Mr Rudd's office on Reserve Bank interest rate decisions. "It doesn't really come as a great surprise given what we've learnt since about how the office operated," Mr Robb said.
According to the latest cables, Reserve Bank assistant governor for economics Malcolm Edey told US officials on April 2, 2009, that the bank was "truly undecided" on whether to continue to slash rates, potentially as far as zero, or to keep them on hold. But he believed Australia was set for a worse recession than in the early 1990s.
The cable attributed the indecision in part to Reserve Bank board members' differing outlooks for the economy over the following year. Professor McKibbin, who was the only independent academic economist on the RBA board, finished his term last month and has since proposed a more expert board that excludes the Treasury secretary.
The board's composition has also come under fire from unionists for being dominated by big business. One of the Rudd government's first acts on taking office in 2007 was to announce its plans to strengthen the independence of the Reserve Bank, with Mr Swan insisting since then it was inappropriate to comment on or criticise its rate decisions.
Professor McKibbin said he was "stunned" the government discussed board deliberations so freely in 2009. Mr Kennedy told the US embassy at the time that some Reserve Bank board members were "leery of appearing to be too close to the government for fear they will be blamed for turning a blind eye to excessive deficit spending".