The strong likelihood of a further interest rate cut from the Reserve Bank, perhaps as soon as December, has sparked some commentary about monetary policy settings that is lamentable for its shallowness.
On a couple of occasions this week, RBA Governor Glenn Stevens and his board have reiterated the point that a "further easing [in official interest rates] may be appropriate in the period ahead”. This seems a fair assessment given the mix of inflation news, domestic data trends, risks presented from the overvalued Australian dollar and the global economic funk. If a rate cut is delivered, the cash rate will fall to 3 per cent returning to the near 50 year low set by the Reserve Bank during the depths of the global financial crisis in 2009.
This has lead some senior politicians and otherwise serious commentators to suggest official interest rates would be returning to an "emergency” level. This was the term used by both Stevens and Treasurer Wayne Swan when discussing domestic monetary policy at the time the world economy was on the cusp of economic depression three years ago.
The inference from those suggesting interest rates are returning to an "emergency” level is that the economy is just as fragile now as it was during the GFC and as a result there is a material risk of a domestic economic slump into recession. Indeed, Shadow Treasurer Joe Hockey said last month that "we are now only one quarter of one per cent away from what Wayne Swan describes as emergency levels of interest rates … That's not because the Australian economy is doing well, that's because the Australian economy is doing it tough."
For the chicken littles like Hockey, a few home truths need to be laid out.
Any sensible policy observer would know there is a lot more to economic policy than just interest rates. One vitally important influence on the economy is the stance of fiscal policy.
During the GFC, Commonwealth government spending rose 12.7 per cent in real terms in 2008-09 with a further 4.2 per cent rise in 2009-10. Together with the drop in tax revenue as the government allowed the fiscal automatic stabilisers to kick in, the budget balance swung almost 6 per cent of GDP in two years. From a surplus of 1.7 per cent of GDP in 2007-08, the budget moved to a deficit of 4.2 per cent of GDP in 2009-10.
This massive fiscal stimulus was being injected into the economy when the RBA had the 3 per cent emergency interest rates in place.
In the current non-emergency period, the fiscal position shows that real government spending will be cut by a record 4.4 per cent in 2012-13 and that the budget balance will swing from a deficit of 4.2 per cent in 2009-10 to a surplus of 0.1 per cent in 2012-13. This is a swing of 4.3 per cent of GDP in three years.
This means there is a difference of over 10 per cent of GDP in the change in the budget balance between the time of the GFC and now. In 2012-13 dollar terms, this is worth around $155 billion. With private sector debt currently around $2.2 trillion, this $155 billion swing in the budget is the equivalent of a 7 per cent differential in interest rates.
So rather than emergency for interest rates complementing emergency fiscal settings as was the case during the GFC, the current policy mix has easier monetary policy working to offset the restrictive effects of one of the most contractionary fiscal settings ever seen in Australia.
Interestingly, in contrast his comments from last month, Hockey spoke of the fiscal and monetary policy interplay in 2010 when he said, "I have consistently argued that there is a trade-off between fiscal policy and monetary policy. The two arms of policy together determine the total amount of stimulus that the government sector imparts to the economy.” He added, "The trade-off between fiscal and monetary policy has been confirmed by both the Treasury and the Reserve Bank.”
Hockey was absolutely correct with those comments.
There is one other massive difference between policy now and during the GFC which makes a mockery of the "emergency” interest rate chatter – that is, the level of the Australian dollar (Australian dollar). During the GFC, the Australian dollar slumped below 70 cents in late 2008 and early 2009, a level that helped support the export sector and the economy more generally. Now, quite clearly, the Australian dollar is well entrenched above $US1.00 and is over-valued on all measures. The need for lower and not emergency interest rates settings in these circumstances for the Australian dollar seems obvious.
All of which shows that any move from the Reserve Bank to cut the cash rate to 3.0 per cent in the months ahead is no where near an emergency setting. It is part of the overall policy rebalancing in the aftermath of the GFC. The tight budget setting and cuts in government spending are rebuilding government savings and at the same time, giving the bank room to lower interest rates and at the margin, offset the economic dampening effects from the rise of the Australian dollar.