Get ready for a cash rate cut in April

Mon, 25 Mar 2019  |  

This article first appeared on the Yahoo Finance website at this link: https://au.finance.yahoo.com/news/get-ready-cash-rate-cut-april-193244245.html

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Get ready for a cash rate cut in April

The data is in and it is compelling.

The Australian economy is faltering and the risk is that it will weaken further if nothing is done to address this decline.Not only has there been recent confirmation of a per capita GDP recession – that is, on a per person basis the economy has been shrinking for two straight quarters – but inflation is embedded below 2 per cent, wages growth is floundering just above 2 per cent, house prices are dropping at 1 per cent per month and dwelling construction is in free fall.

Add to this cocktail of economic woe an unambiguous slide in global economic conditions, general pessimism for both consumers and business alike and a worrying slide in the number of job advertisements all of which spells economic trouble.Blind Freddie can see that there is an urgent need for some policy action. And the sooner the better.For the Reserve Bank of Australia, there is no need to wait for yet more information on the economy.

It has been hopelessly wrong in its judgment about the economy over the past year, always expecting a growth pick up “soon”. Instead, GDP has all but stalled meaning that inflation, which is already well below the RBA’s target, is likely to fall further.In short, no. It is not like a 25 basis point interest rate cut on 2 April and another 25 in, say, May or June will reignite inflation and pump air into a house price bubble.

Such a claim would be laughable if there are any commentators left suggesting this.

On the contrary, inflation is so low that at best, it might touch 2 or 2.25 per cent in a year or so and the decline in house prices might slow to 0.5 per cent per month even if official interest rates were slashed to 0.5 per cent, some 100 basis points below where they are today. Any interest rate cuts would almost inevitably see the Aussie dollar fall, helping the export sector to grow.

Free money, in other words, to our export sector from easier monetary policy.It would also free up cash flow for the business sector, which has a little under $1 trillion of debt meaning it would be easier to service its collective debt with lower interest rates.

And then there is the ever fragile consumer. With around $1.3 trillion of debt, a 0.5 per cent reduction in interest costs would save around $6.5 billion a year, money that could be used to reduce debt (which is good) or be spend in the economy (also good). The impact is more than the rumoured size of the income tax cuts that Treasurer Josh Frybenberg will announce in the budget, coincidently on the same day the RBA Board next meets.

Unlike the income tax cuts, which either add to the budget deficit or reduce the budget surplus, interest rate cuts are free!The stroke of a pen and the press of a few keys on a key board is all it takes to get this stimulus into the economy. This would see firms making more money, consumers having more cash in their pockets and incentive to hire more workers and pay them more raised.

Interest rates cut would actually improve the budget bottom line because of the stimulus they give to spending, inflation and tax revenue.It is the proverbial no-brainer. So for the RBA Board, there is not that much to think about.

Cut interest rates on 2 April and again quickly thereafter and sit back and watch the positive effects of those moves flow through the economy. Things will not improve overnight.But like the first antibiotic in a 5 day course of medicine, it will start to heal the otherwise sick economy.

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“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.

Wouldn’t it?

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.

The RBA admits it stuffed things up – sort of

Mon, 22 Jul 2019

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The RBA admits it stuffed things up – sort of

The Reserve Bank of Australia needs to be congratulated for publishing research which implicitly confirms that it made a mistake when setting monetary policy in the period mid-2017 to early 2019.

Not that the research explicitly says that, but the RBA Discussion Paper, Cost-benefit Analysis of Leaning Against the Wind, written by Trent Saunders and Peter Tulip, makes the powerful conclusion that by keeping monetary policy tighter in order to “lean against” the risk of a financial crisis, there was a cost to the economy that is three to eight times larger than the benefit of minimising the risk of such a crisis eventuating.

The costs to the economy includes lower GDP growth and higher unemployment, that lasts for at least for several years.

A few terms first.

According to the Saunders/Tulip research, “leaning against the wind”, a term widely used in central banking, is “the policy of setting interest rates higher than a narrow interpretation of a central bank’s macroeconomic objectives would warrant due to concerns about financial instability”. In the RBA’s case, the “narrow interpretation” of the RBA’s objectives are the 2 to 3 per cent inflation target and full employment.

In the context of the period since 2017 and despite the RBA consistently undershooting its inflation target and with labour underutilisation significantly above the level consistent with full employment, the RBA steadfastly refused to ease monetary policy (cut official interest rates) because it considered higher interest rate settings were appropriate to “lean against” house price growth and elevated levels of household debt.