The remarkably simple case for an RBA rate cut

The 3.1 per cent growth also needs context. It followed a very ordinary growth rate of 2.4 per cent in the prior quarter, and in the last 5 years, GDP growth has averaged a mediocre 2.4 per cent.

Think of a football team in the bottom half of the competition that has a one off win again the league leaders, and that sums up the GDP result.

Context is important.

It remains a mystery why there has been a near universal lowering in expectations on what makes the Australian economy strong.

A few years ago, most pragmatic economists would judge a ‘strong’ economy to be one that is delivering a tighter labour market, in particular lower rates of unemployment and underemployment, a pick up in wages growth, higher rates of capacity utilisation and inflation bouncing around 2.5 per cent, the middle of the RBA target.

The opposite is happening in Australia right now. Around much of the industrialised world, unemployment rates of 4.5 per cent and lower are the norm.

In the US, the unemployment rate is 3.8 per cent; in the UK, it is 4.2 per cent, Germany 3.4 per cent, Japan 2.5 per cent, New Zealand 4.4 per cent.
Australia’s unemployment rate, at 5.6 per cent, is ugly in comparison, particularly given underemployment is simultaneously close to a record high 8.4 per cent. And unlike these countries where unemployment is falling, over the past six months, the unemployment rate in Australia has been increasing.

The questions about lifting growth and reducing the unemployment rate are not all that complex, but they are shunned and avoided because of a misguided economic theory linked to perceptions of financial instability and responses to deal with a rise in asset prices.

Easier economic policy stimulates economic growth, lowers unemployment and underpins higher wages.
It is simple. Remarkably simple.

With fiscal policy at least partly constrained by the objective of returning to budget balance and then surplus, the other arm of policy open to kick start growth is monetary policy.

Interest rate cuts would have multiple effects. It would free up cash flow for the business sector and households with debt, cash flow that can be allocated to investment and spending.

Lower interest rates are also likely to lower the threshold at which investments are viable and as a result would underpin stronger business investment.
It is also likely that lower interest rates would mean, at the margin, a lower level for the Australian dollar which would support exports and domestic import competing firms.

It seems a no brainer for anyone interested to lowering unemployment and boosting wages.

“Housing” I hear you shout. Wouldn’t lower interest rates spark a resurgence in the house price boom?

The short and categorical answer is no.

This is because any move to lower interest rates could be and should be accompanied by further regulatory restrictions on mortgage lending – perhaps an extension of existing rules on loans.

Ending negative gearing and building more dwellings would also work to dampen house prices. And it is interesting to note that in some parts of Australia – Perth and Darwin in particular – house prices have slumped in recent years despite lower interest rates.
There is much, much more to house prices than just interest rates.

If the RBA was to cut interest rates to 1.0 per cent or less over the next few months, the risk that inflation would exceed its target remain remote. Nor would it fuel a rebound in house prices, if the other regulates kept a firm hand on lending rules.

It would, importantly, help to lift economic growth, lower unemployment and help kick start a much needed lift in wages.

And guess what? If I am wrong and it did unexpectedly underpin an surge in inflation and lead to an overheated economy, the RBA could remove the monetary policy stimulus and hike rates.

Monetary policy is a lever that can be pushed and pulled to fine tune part of the economy. It should be used more often.