Record-low interest rates unlikely to fix the economy

14 May 2015

The RBA’s recent bid to liven the economy by slashing official interest rates to a record low would fall short of its aims according to University of Queensland Professor of Economics Dr John Foster.

On 5 May the Reserve Bank of Australia (RBA) cut official interest rates by 25 basis points to a record low of two per cent.

Dr Foster said the move would not solve the economy’s underlying problems of stagnant economic growth, high unemployment and reduced income through the softening of mining activity.

“Up until last year, manufacturing was decimated by a very high exchange rate. The time to lower interest rates and, thus, the exchange rate, was about three to four years ago,” Dr Foster said.

“The RBA did not do this, presumably because of a fear of inflation but, at that time, there was little sign of real inflationary pressure in Australia or any other advanced country.

“The cuts in interest rates we are now seeing are much too late.

“This has been a very significant policy failure which is now difficult to fix because of an emergent negative budgetary position that prevents significant fiscal stimulation of the economy, particularly in new industries that can replace those that have declined, such as car manufacturing.”

Dr Foster said monetary policy changes such as reducing interest rates tended to have a much weaker effect in the short term than fiscal policy such as reducing taxes or increasing government expenditure.

“Inasmuch as it lowers the value of the Australian dollar, interest rate cuts can provide a boost to Australian exports, and thus the economy,” he said.

“However, this is a complicated and uncertain process because there are so many factors involved.”

Dr Foster says household savings from reduced mortgage costs may be balanced out by other losses.

“There will be an average household monthly saving of about fifty to sixty dollars, but offsetting this, will be a loss of income on bank deposits, which will hit the old hardest, as Joe Hockey acknowledged,” he said.

“Perhaps more worrying is that historically very low rates of return on both bank deposits and government bonds is driving savings into the share market and property markets with the risk that they are being overvalued.

“A sharp price correction in one or both of these markets down the track would be both painful and disruptive to ordinary Australians.

“History tells us that the interest rate must rise again, we just don’t know when.”