This article first appeared on the Yahoo Finance website at this link: https://au.finance.yahoo.com/news/rba-interest-rates-government-can-stimulate-economy-but-wont-210050650.html
“Bitterly disappointing”: We are seeing a once in a generation policy failure
Imagine having the power to promote economic growth, lower the unemployment rate and set in train the conditions to boost real wages growth and inflation?
It would be immensely satisfying to change policies to improve the living standards and quality of life for every day, hard-working Australians and their families.
Next imagine a harsh reality where economic growth is weak and slowing, the unemployment rate is rising and wages growth and inflation well below a satisfactory level, and you choose not to wield the power reverse these uncomfortable circumstances?
Doing nothing, unwilling to pump some much needed cash into the economy because of a political dogma wedded to a notion that budget surpluses are good and that holding interest rates unnecessarily high so you might dampen demand for houses – which is seen as a problem – and household debt overwhelms your power to make things better.
It’s as absurd as a firefighter unwilling to put out a fire because it might waste water. Yet this is the situation that is before the Treasurer, Josh Frydenberg and the Governor of the Reserve Bank of Australia, Philip Lowe.
Mr Frydenberg is in charge of how much spending and tax the government will manage each week and month and year. He can change policies to spend a little more (infrastructure, education and health) or tax a little less, the effect of which would be to support economic activity and jobs.
Dr Lowe controls monetary policy which is a vital determinant of cash flows for consumers and businesses. Interest rates also set a threshold whereby investment, spending and hiring decisions are undertaken. A change in monetary policy is potent and can be delivered for free, with the stroke of a pen or at least the pressing of keys on a keyboard.
“Today I have cut official interest rtes by 75 basis points to 0.25 per cent.”
In the 100 days or so since the election, Mr Frydenberg has made is clear that he is unwilling to countenance any easing of fiscal policy. Sure, the election-promised income tax cuts have been delivered, but their objective was a political one, not economic. Never once before the election did Mr Frydenberg say the income tax cuts were an essential policy action to boost economic activity. Treasurer Frydenberg has made it clear the plans for a budget surplus is superior to policy changes to support the economy, jobs and wages growth.
That’s a pity.
Having held interest rates steady at a high level for two and half years, RBA Governor Lowe was forced to cut interest rates in June and July, having been an advocate of higher interest rates just six months earlier.
I suppose credit is due to Lowe for learning from his mistakes.
At 1.0 per cent, Australian interest rates still remain well above the rates set by most credible central banks during their episodes of disinflationary slow-downs and that is still a problem for the Australian economy. To boost growth, Dr Lowe could (should) cut interest rates to near zero but he has a preference to have higher unemployment and lower living standards than needed as he maintains his crusade against house prices and household debt.
Without policy action by the government and the RBA, the economy is likely to remain a chronic under-performer. That means annual economic growth will be 2.5 per cent or less meaning the unemployment rate will remain above 5 per cent and could even exceed 6 per cent in a worse case.
It will be a tough time for the 710,000 people currently unemployed and additional 1.15 million underemployed. In these circumstances, there is no hope for a meaningful pick up in annual wages growth which will be lucky to hit 2.75 per cent, while inflation will struggle to lift to 2 per cent, let alone get to 2.5 per cent, the mid-point of the RBA target band.
And this is the upside of the outlook. If the US-China trade impasse expands and global economic conditions take a turn for the worse, the Australian economy will be in trouble – severe trouble. By then, it might be too late for policy makers to deliver a quick pick up. Rather they will be obliged to undertake rescue action to limit the damage. Budget deficits, negative interest rates and quantitative easing will be the order of the day.
It is bitterly disappointing to see this policy failure from the RBA and now the government.
A recession, while still unlikely, would see the unemployment rate exceed 6 per cent and destroy wealth and income.
This would be a problem of the government’s and RBA’s own making and if the economy remains weak into 2020, the RBA and government should be condemned for the first major policy stuff up since the lead into the early 1990s recession.