On the AM radio program today Samatha Hawley, the interviewer, asked Andrew Robb, the Opposition Finance Spoken, whether ANZ’s 6 basis point increase in its standard variable rate mortgage is “justified”.  The “just” price for money — that is so medieval.  Should we have “usury” laws to go with “just” prices.  Later in the interview Ms Hawley emphasised the questionable justice of the ANZ’s price rise by noting that ANZ had raised its prices despite making a profit last year.  Profits and price rises — how dreadful.

The medieval notion of “just” prices — where just means that the price is righteous in the sight of God — has been replaced in the modern world by “competitive” prices.  The medieval notion of the economy, and all of society, is that each person and each enterprise is part of single community of the faithful acting by God’s law and facing final judgement for their actions on Earth.  In that context a “just” price makes sense — just prices are the result of righteous behaviour by producers and consumers.

The modern notion of prices is that prices are set within an institutional framework.  altruistic behaviour by individuals is not uncommon, but it is much less common than self-interested behaviour, and the equilibrium of prices and quantities in the market, as the determined at margin, arise from self-interested behaviour.  Socially optimal prices arise if the institutional framework of the market is optimal.  Design and control of the market is at the institutional level, not the individual level.  In the interview today, Ms Hawley should be asking “has the banking system in Australia become non-competitive”.  She should be taking a modern, institutional perspective.

The answer would be that the Australian mortgage market has certainly become less competitive since the beginning of the GFC.  The competition that was provided by the securitisation channel and the foreign banks is much diminished.  Most of this reduced competition is beyond the control of the Federal Government, but some of it has been caused by the Government.  For instance, the Government gave Australian commercial banks the right to issue covered bonds that are senior to Government’s claim on the assets of the bank.  This subordination of the Government’s claim has reduced the yields on the bonds of the large banks by 30 or 40 basis points, or more, but the Government asked for nothing in return.  The Government might have insisted that either the banks increase their capital (to reduce the cost to the Government of providing deposit insurance) or, even better, the Government might have asked the banks to reduce the cost to households of switching mortgages, which would lead to a direct improvement in competition in the market.

The hand wringing and moralising that goes on after the banks change their prices is so silly and medieval and doesn’t get us anywhere.  It leads us away from the modern view of institutional arrangements in markets which ultimately determines how socially optimal market outcomes are.

2 Responses to The just price of money

  1. Paul Frijters says:

    Hi Sam,
     
    nicely argued, but there is a twist: the population indirectly motivates the institution builders and regulators by their judgment of whether the actual outcomes seem ‘right’ in their own moral reckoning. Hence, indirectly, the question of whether the prices and the profits are ‘right’ is a crucial question for politicians. If the majority of the populations thinks it isn’t right, politicians will promise to tweak the institutions such that it becomes ‘right’.
    It is a crucial step in democracy that those not experts at something nevertheless judge what has been done in specific expert realm by means of applying their own moral compass to a perceived outcome. They might not be able to judge the process via the pie is baked or even know how it can be baked better, but they can tell if the pie tastes good or bad. The alternative is to have experts judge the outcomes for all of us as well, which is a far scarier prospect than radio-presenters not being quite ‘au fait’ with how prices come about.

  2. Sam Wylie says:

    Hi Paul
    Yes, I agree.  Sometimes expression of moral outrage by the public galvanises politicians into action in a way that any amount of discussion of institutions does not.  An example is public reaction to the footage of how Australian cattle are being slaughtered in some overseas abbotoirs.  The public reaction was immediate and visceral and government action was correspondingly swift and decisive.
    The problem with expressions of moral outrage towards the banks is that they attend every increase in bank rates above the cash rate, but nothing else ever happens.  In case I think we need more discussion of how to increase competition and more questioning of the Government about why it doesn’t do anything to increase competition.  
    Cheers
    Sam  

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