ABC.net.au – 11 March 2015
By Greg Jericho
The RBA has revealed low interest rates aren’t having the impact they used to, and yet the Government isn’t willing to push the fiscal stimulus accelerator. This should make for an interesting May budget, writes Greg Jericho.
For more than a decade now we have had the call of “keeping interest rates at record lows” as an article of faith and goodness of economic management – that low interest rates are a sign that the government is running the economy well and should be trusted.
But what do you do when that mantra hits a wall and even the central bank charged with lowering interest rates tells you the party is over?
Last week the deputy governor of the Reserve Bank, Philip Lowe, gave a speech entitled, “low inflation in a world of monetary stimulus”. The less than attention grabbing title betrayed the fact that this speech contained a very big announcement – cutting interest rates doesn’t help the economy like it used to.
Over the past few weeks I have been noting that the RBA has put out a few noises about the inability of cutting interest rates to stimulate the economy. The speech by Dr Lowe took it up a notch and made sure everyone was paying attention.
The mantra that low interest rates is good has been around for many years, but John Howard really gave it a kick in 2004 with his “who do you trust to keep interest rates low” line.
Even in the run-up to the 2013 election campaign both sides were still talking about low interest rates. Joe Hockey even fact checked the ALP by suggesting the average standard variable mortgage rate under the Howard government was lower than under the Rudd-Gillard government.
In the end he was right – under Howard it averaged 7.28 per cent from March 1996 through November 2007; compared to 7.29 per cent from December 2007 through September 2013:
But since then it has averaged 5.93 per cent, highlighting that we are in a very different interest rate world.
How different? We haven’t seen a cash rate as high as Howard’s “record low” 5.25 per cent for 76 months. November 2008 was the last time the RBA had rates that high.
The standard mortgage rate has averaged 6.3 per cent over the past three years – the lowest three-year average since May 1971.
But in actual fact since Howard talked of low interest rates, we have seen historically low rates:
So what’s the problem?
The problem is when Howard was bragging about low interest rates the unemployment rate was 5.2 per cent and had fallen by half a percentage point in the previous year, and by a full percentage point in the previous two years.
By contrast our record low rates come at a time when the unemployment rate is 6.3 per cent and has risen 0.4 percentage points in the past year, and nearly a full percentage point in the past two.
So we are in a position where low interest rates is no longer a sign of health – it is a sign of a desperate central bank trying to resuscitate demand.
It’s a problem banks around the world are facing.
In his speech Dr Lowe noted that interest rates have fallen so low around the world that in some cases “investors are prepared to actually pay governments to look after their money”.
The US and even Australia are in a similar boat. The 10-year bond yield for Australian government bonds in February averaged 2.5 per cent – the lowest nominal yield ever recorded:
Given the RBA’s target rate is effectively 2.5 per cent (mid-point between 2-3 per cent), buying a bond at that rate is effectively being prepared to accept a 0 per cent real return over 10 years:
Dr Lowe notes that this highly unusual situation remains the aftershock of the GFC, in which central banks here and abroad cut rates to stimulate economic growth, but the growth has not occurred commensurate with the level of stimulus provided. And even more oddly, with lower interest rates have come even lower expectations for inflation.
He argues that a major factor is the level of household debt both around the world and in Australia.
The 1990s and the period in the 2000s up to the GFC saw household debt take off.
When Howard asked who could you trust on interest rates, he could have noted that in the previous three years the level of indebtedness of Australian households had increased from 100 per cent of household disposable income to 139.7 per cent – the fastest three-year rise in Australian history:
Not surprisingly, low interest rates and all, we haven’t had a huge desire to get into more debt. As Dr Lowe notes, since the GFC and during this period of extraordinary low rates, households have “focused on paying down their debts, rather than borrowing more”.
But while this is a healthy thing for households to do – and is good for the long run health of our economy – it means the lower rates are not leading to increased spending that sends money round the economy.
And yet Dr Lowe notes that low interest rates have spurred residential housing construction – up 12.4 per cent in the 12 months to September 2014 – and they have assisted in a drop in the exchange rate.
But despite this GDP growth in 2014 was just 2.3 per cent in trend terms.
So if monetary stimulus isn’t working, how about some help from the fiscal side?
The problem is Joe Hockey has made a mantra out of the need for spending restraint.
His Intergenerational Report released last week continued the debt and deficit disaster theme so beloved of governments since the mid 1980s.
The report even included a graph so keen to scare voters about our debt trajectory that it compared various “estimated” levels of Australia’s net debt in 2055 with current levels of debt in countries like Greece, Italy and Spain. It was a graph so fantastical it really should have included predictions of net debt in Narnia and Westeros.
Fortunately, Hockey’s words haven’t been backed up with a massive contraction in the budget deficit. His current budget settings for the next three years are for a gradual tightening of the fiscal strings, rather than a headlong rush back to surplus done without heed for the fragility of the economy:
But while he might not be slamming on the austerity breaks, he is not pushing the fiscal accelerator either. Last year’s May budget predicted public demand out to 2015-16 would be among the lowest observed for more than 20 years. This is at a time when private demand is also weak:
Since 2011-12, governments have contributed historically low levels towards overall growth in the economy. In that period we have also seen interest rates fall.
But we have also seen economy growth fall below trend and unemployment rise.
And now the Reserve Bank has let us know that low interest rates aren’t having the impact they used to, at the same time we have a government not willing to push the fiscal stimulus accelerator.
It make for a pretty interesting period ahead for Joe Hockey as he starts to frame the May budget.