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Today, the RBA made another 25 basis point cut to the cash rate, moving from 1.00% to 0.75%. This had been widely flagged prior to the meeting, and Governor Phillip Lowe noted:
“While the outlook for the global economy remains reasonable, the risks are tilted to the downside… It is reasonable to expect that an extended period of low interest rates will be required in Australia to reach full employment and achieve the inflation target.”
After a long period of lying dormant on interest rates, the Reserve Bank kicked into gear in June with the first of now three cuts, in part due to weakening global growth and slower domestic conditions. But rates are falling for two reasons, not one – and the second is the one some people misunderstand. Rates are also falling because these days the world’s economic growth shows up more in jobs than in wages, so inflation is harder to get moving than it used to be. That’s why the RBA is doubling down on the accelerator – cutting for both cyclical (a slower economy) and structural reasons (inflation is harder to get moving).
But how effective will the cuts be? Former Treasurer Peter Costello noted, “All these people who are holding off spending or borrowing or investing are going to say, ‘I wouldn’t have done it at 1 per cent, but I’m going out there now that it’s 0.75 per cent?’ I don’t think that’s going to happen.” (Sydney Morning Herald, 26/09/19).
Lower interest rates should boost economic activity by stimulating aggregate demand, which flows through to more jobs, higher wages and pressure on prices, helping the RBA meet its target for inflation of 2-3%. This transmission occurs through a number of channels, from savings and investment and cash flows, to asset prices and wealth, and exchange rates.
To date, the rate cuts already appear to be feeding through to asset prices, with data suggesting the sharp house price corrections in Sydney and Melbourne have ended (albeit with transaction levels and new housing investment still subdued).
The value of the $A has taken a hit, which is providing support for import competing sectors, and delivering a stronger return in $A terms to commodity exporters (and paying dividends for the Federal Budget along the way).
But the missing link so far is business investment.
The likes of Brexit, the US-China trade-wars, Hong Kong and disruptions in the Middle East, have all contributed to tilting global risks to the downside more so than they have in some time. If businesses aren’t investing because of increased uncertainty, then lowering interest rates may not see significant increases in investment. In the recent Deloitte CFO Sentiment survey, increases in uncertainty corresponded to a fall in investment intentions and risk-taking behaviour. This suggests that even at very low rates, if businesses lack confidence, projects may not proceed, and central bankers lack the capacity to shift this narrative by decisively cutting rates.
What’s more, the continued easing of monetary policy can act as a signal, contributing to weaker consumer confidence, flowing through to already tepid household spending. This is obviously counterproductive to the RBA’s goal. Like any good relationship, communication is key, and it’s up to the RBA to change the community’s understanding of why it’s cutting rates (that it’s as much to push up inflation as it is because of cyclical economic weakness).
Given these challenges, policy makers must also look to other levers. One heavily referenced alternative is for fiscal policy to pick up the slack, investing in long-term infrastructure projects that can support future productivity and absorb spare capacity in the labour market, all while credit is cheap. Reforms to encourage businesses to invest, innovate and expand, changes to immigration policy and human capital investments could also be beneficial. Such efforts could boost productivity and improve expectations about the future economic outlook. But reform is also so often difficult, expensive and politically contested.
So for now, rates are being cut in the hope there is an impact on the economy. But with the cash rate sitting at a record low, there’s less room to move than ever, limiting the RBA’s arsenal to deal with future shocks if things turn sour.
David is a macro economist with extensive experience in applied economic and quantitative analysis of the Australian economy, along with considerable experience in labor market analysis. David is a regular commentator on macroeconomic trends, and prepares a weekly economic briefing newsletter.
Monique is an experienced economist with a background in econometrics and corporate finance. Her key skills and interests include econometric modelling, labour market analysis and public policy advisory. Since joining Deloitte, Monique has developed multiple cross-sectional models isolating the influence of personal characteristics on various economic and social outcomes. She has considerable experience working with statistical software (i.e. STATA) and is confident in managing large datasets. Monique also regularly reports on current macroeconomic trends and outlooks in both domestic and global contexts, and applies her statistical background to provide deeper insights in these areas.