From the AFR:
Former federal opposition leader John Hewson says the Reserve Bank of Australia should continue slashing interest rates so they are in line with other developed economies.
A day after the RBA cut the cash rate by 0.5 of a percentage point, to 3.75 per cent, Dr Hewson said it would be better for Australia if it was as low as 2 per cent.
While in the 1980s he supported an independent central bank to control inflation through interest rates, it had not worked. “They didn’t change the [inflation] target, they kept it at 2 per cent and they used any opportunity to crank interest rates up and hold it there as long as they can,” he told a business lunch in Sydney yesterday.
“They’ve kept the interest rate way out of line to where it ought to be. Travel anywhere in the world and you see that we could be operating on a 2 per cent cash rate.
“But how you get from 3.75 [per cent] to 2 [per cent] is near impossible.”
Let’s make one thing clear. I would love to see the cash rate at 2% and the dollar at 90 cents. I think my record of writing on Dutch disease makes that obvious. But, it matters a great deal how that is achieved (I say this with the caveat that I can’t find the full text of Dr Hewson’s speech, so his comments may be out of context).
Let’s say the RBA had actually cut rates from 2010, down from the GFC low of 3% to 2%. What would have happened? We can’t be sure, of course, but my guess is the following:
- the First Home Buyer Bubble created by GFC uber-stimulus would have run for longer and house prices would have peaked later, if they peaked at all
- aggregate demand would have been stronger
- the dollar would have been lower, perhaps somewhere in the 90 cent range
- capital spending for the old services economy would have been higher
- corporate profits would have been higher
- the stock market would be perhaps 1,000 points higher
- the Budget would be stronger, without so much austerity
- unemployment would be 4.5% and inflation would be 4%+
- the household savings rate would be maybe half what it is today
- the current account deficit would be wider by a couple of percentage points
- deposit flows into banks would be much lower and they would be borrowing money offshore hand over fist
- the same widening spread to the cash rate would be obvious
- ratings agencies would be delivering downgrades to the banks and their cost of funds would be rising further than today
In short, we’d be growing faster, global markets would be charging us more for the privilege and we’d be headed straight into an historic bust that would likely result in a housing crash and zombie banks to rival the 1890s, as well as a gaping liquidity trap that rendered monetary policy completely useless. Is that preferable to today’s managed deflation of the unsustainable dimensions of our economy?
Of course, there are other ways to get he cash rate to 2% that may also manage a slow deflation. But each of these involves changes to fiscal and tax settings not monetary policy. Either you would need to:
- remove or adjust negative gearing and/or capital gains concessions for housing which would dampen demand, lower prices and suppress bank lending
- have a big, fat mining tax and SWF which would slow mining investment at the margins, lower the dollar, and increase growth in other tradeable sectors
- have a big fat surplus and SWF which would shift the source of pressure on the services economy from monetary to fiscal tightness. But if you did this without addressing the tax code, the easing in interest rates may still cause a blowoff in household debt and house prices
Dr Hewson instead describes the need for fiscal largesse:
The stimulus you would have expected in difficult global and domestic circumstances just isn’t going to be there. . .” he said. “I don’t think we should be going into surplus with a passion next year and I think the interest rate structure is about double what it ought to be.
Dr Hewson’s comments as described (which may be wrong given our lovely media) advocate that the RBA pursue the very boom and bust policies it was designed to avert and that the government do nothing to help out beyond spending like a drunken sailor.
