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.


susan said...

Hi Lindsay,
Even though I've spent some time every morning for years reading articles about international finance I'm still at a loss when it comes to the details. I think the banks and governments are deliberate in their obfuscation of the essence of what's being done. It's been a long time now since money had anything to do with material wealth and what does happen now is money making more of itself through bonds, buybacks, certificates and whatever else can be used to justify adding zeroes. I've understood for a while now that the financial policies of individual governments have little or nothing to do with their populace. I wonder what you'll think of this article I read a couple of days ago.
All the best

Lindsay Byrnes said...

Hi Susan
Thanks for your interest and the article which I read with interest. I do agree with some of the sentiment expressed in that we are close to a tipping point with debt levels still no better than the position just prior to the GFC.
But in my view this requires governments and their citizens to adjust to a policy predicated on the more realistic anaemic demand that is likely to persist. This arises from the supply side , as a consequence of an excess of commodities/capital to demand, afflicting many developed economies.
You asked my opinion on the article and at the same time bemoaned his lack of detail in relation to international finance.
Let me attempt to outline what I think is the case from my perfective. Firstly I think it is unwise to take a broad brush approach and assume one shoe fits all as for the most part both Australian and Canadian banks and their central bankers have avoided the excesses which are evident elsewhere. Floating exchange rates ensure that prices match supply and demand and there is no need to introduce quantitative easing measures, as last resort-currently being implemented by the EU.
You also can’t simply look at debt levels without examining the underlying assets represented by that debt.
As you would be aware there is nothing wrong with a government issuing bonds to finance future investment in improved facilities and essential infrastructure so long as there are quantifiable benefits which will exceed the interest cost in the future. Just as it is incumbent where there is excessive private capital, for that excess to be returned to the true owners who are of course, the shareholders. In that respect the problem of past and present excesses has more to do with the executive managers of these large corporates, who are, after all, were just employees, with often overly generous share options and who don’t always share equally in the risk. The European Union was a totally flawed concept right from the outset, with the UK wisely electing to stay out of the euro zone. The lack of supervision and governance by some states was nothing short of scandalous.
Best wishes

Rachael said...

That's fantastic that you're still getting letters published in the fin review. Nice one!
Have you heard of They're suggesting "sovereign money creation" as an alternative to existing monetary policies. Obviously the UK and Australia are quite different bit I thought their paper "Sovereign Money" was interesting. How would this apply in Australia?

Rachael said...