Monday, February 2

Rate cuts are bad policy

My letter headed “Rate cuts are bad policy” as per below appeared in the AFR today captioned to a humorous cartoon depicting a RBA official holding up cut out paper stars and stating “ a new way of cutting rates" : with curious commentators replying “Hey, it stimulated you ………briefly" .

In “Cut rates to ease the shift away from mining” (AFR29th January 2015) Craig Emerson argues for RBA cuts to facilitate a falling currency and ensure a more rapid transition to investment in the non-mining sector of the economy. 
But Warwick Mckibbin concludes a rate of three per cent is more appropriate, since Australia does not need to follow in the footsteps of European economies, who have exhausted fiscal alternatives and must rely on monetary policy to stimulate anaemic economies. Rather, he posits a more efficient taxation reform can restore business confidence, inclusive of a widening of the GST, but using the transfer system for more equitable outcomes. 

Furthermore, recent sharp falls in the currency are yet to have an impact and will start to also impact inflation, with the core rate (minus oil etc.) up .7% for the previous quarter. The idea the added risk of a housing bubble can be mitigated by the Murray inquiry recommendation to increase a bank’s capital in relation to their lending for housing is and admission of the risk. It's never has been a good idea to embrace one loose policy on the basis another will  curtail its excesses.     

But the likely excesses of low rates don’t just effect housing, but instead encourage people to take on undesirable risk because of the paltry returns, to create bubbles elsewhere. Eventually , returning to future normality then becomes a nightmare.  

Post script ..........the RBA to day reduced the rate by  .25% or 25 basic points to add to the risks as I have mentioned. The decision means the RBA has less confidence in the future and is targeting a lower exchange rate to engender a more competitive position. To my way of thinking  it was not necessary , but time will tell.