The Reserve Bank’s extended low interest rate policy and consideration of “unconventional monetary policy tools” reveals a lack of self-reflection and a commitment to a model that is unsustainable.
This month the RBA continued its 84-month unprecedented experiment with low interest rates, setting a record low 0.75 per cent. Since October 2012, every interest rate decision has held or set another record low.
With little economic success to show for this experiment, the solution according to the RBA is to go even harder.
“Unconventional monetary policy tools” now are being considered, including negative interest rates and quantitative easing that would result in rapid monetary expansion through the credit market.
This approach relies on expanding a debt-based economy already approaching its limits. Australia has the second highest household debt-to-GDP ratio in the OECD behind Switzerland and, despite recent budget improvements, government debt remains at record highs. The RBA has created its own quagmire. Any tightening of monetary policy risks popping the RBA-induced debt bubble, while additional easing of policy will likely further inflate the bubble and worsen the inevitable economic consequences.
This same predicament was faced earlier this year by the US Federal Reserve when it abandoned an attempt to normalise interest rates. By holding interest rates at zero for seven years the Fed created an economy dependent on high levels of debt with low borrowing rates.
Despite low unemployment numbers, the Fed is clearly concerned by weaker-than-expected growth, a volatile stockmarket and increased government debt. The US economy simply cannot handle a return to normal interest rates, causing the Fed to change course and continue with monetary expansion.
The underlying problem is that the RBA remains committed to a view that boosting consumption spending will ignite the economy. Low interest rate policy promotes consumption by leaving households with more to spend by lowering loan repayments, the single largest expense for many households. Low interest rates and monetary expansion also inflate asset prices, increasing asset owners’ wealth and making them more likely to consume.
But the attempt to expand debt-financed consumption is losing its stimulus effect as it is becoming increasingly inconsistent with individual financial interests.
With high and rising household debt, and an uncertain economic future, it is little wonder households are reluctant to increase spending and instead are taking advantage of low interest payments to pay down their debt.
But according to the Keynesian economic framework that informs RBA decision-making, responsible individual and household behaviour leads to undesirable economic outcomes. Rather than saving for the future, individuals should consume for the present. The Keynesian view is that higher savings at the individual level leads to a reduction in demand through less spending, which reduces economic growth. According to this view, this will lead to reduced income and in turn reduce total savings, often referred to as the “paradox of thrift”.
The problem with this approach is that it reverses the economic fundamentals of growth. Increasing consumer spending at the expense of saving will produce only a short-term boom. No amount of meddling by the central bank can bypass the basic economic reality that economic expansion requires resources to be diverted away from present consumption towards the production of future goods.
Long-term sustainable growth requires savings to invest resources into expanding the nation’s capital stock, which enables productivity and wage growth. And it is precisely the investment, not the consumption, side of the equation that is missing. New private sector business investment is just 11.2 per cent of GDP, lower than the rate during the economically hostile Whitlam years and near the recessionary lows of the early 1990s.
There are several areas governments need to address to boost investment. High and complex taxation discourages domestic and international investment and distorts resources away from their most productive use.
Added to this is a substantial red-tape burden. This week the latest World Economic Forum global competitiveness figures were released. The report provides an comparison of global competitiveness based in part on a worldwide survey of business executives. Australia’s competitiveness is being weighed down by regulation. Australia has dropped from 77th to 80th in the world for the burden of regulation. Red tape is stifling business investment and reducing economic opportunity and growth. Rather than focusing on boosting debt-financed consumption within a highly indebted economy, governments should focus on expanding the ability of the economy to generate long-run prosperity. This means liberating supply rather than artificially and unsustainably stimulating demand.