Zeroing in on monetary impotence

The politicians have tried to frame this eighth cut in the cycle for their own electoral ends. But post-crisis monetary policy is a difficult beast to pin down, and increasingly feeble anyway.

Joe Hockey was stating the obvious when he made his "appalling" statement earlier this week that another Reserve Bank cut to the cash rate would be a sign that the economy was performing below expectations. The Reserve Bank, of course, cut official rates to their lowest point on record today.

While Kevin Rudd might have thought the comment appalling, it is difficult to spin the latest 25 basis point cut as an indicator that the economy is performing well.

Labor’s own economic statement last week showed collapsing revenues – the forecast budget deficit for this year blowing out by $12 billion to $30 billion in 2½ months, projected economic growth revised down and projected unemployment revised up.

The Reserve Bank has now cut the cash rate by 225 basis points since the cycle of rate reductions started on November 2011. It now sits at 2.5 per cent.

The latest cut comes despite a fall of more than 15 per cent in the value of the Australian dollar since mid-April, a fall that ought to be supportive of domestic economic activity as the resources boom and the associated investment boom wanes, and against the backdrop this week of weak retail sales numbers and an ANZ job advertisement survey that shows the number of job ads is nearly 19 per cent lower than a year ago.

Reserve Bank Governor Glenn Stevens referred to the "below trend" growth in the economy again today and said this was expected to continue in the near term as the economy adjusted to lower levels of mining investment. He also said the easing of monetary policy over the past 18 months had supported interest-sensitive spending and asset values and that further effects can be expected over time.

What it hasn’t done, in an environment of weak business and consumer confidence and political instability, is generate any investment and growth in the non-resource sectors.

It might have put a floor under house prices, which are rising, and pushed rate-sensitive investors toward high-risk sources of yield, but it questionable whether those are particularly productive outcomes.

It is also the case that, while households are saving more and borrowing less, savers are being punished for their prudence with the benefits of lower rates flowing to borrowers. National Australia Bank and Bank of Queensland passed on the latest cut immediately.

For those households struggling with the cost-of-living pressures which Kevin Rudd was referring to when he criticised Hockey this week there are others, particularly retirees, who are seeing their incomes dwindling.

Former Reserve Bank board member Warwick McKibbin has said that trying to raise demand by a sole reliance on cutting interest rates wouldn’t induce investment in the current environment of weak confidence and that further reductions would do more to misallocate capital than stimulate demand.

One of the interesting aspects of this post-crisis era and its reliance on monetary policy, conventional and otherwise, is that the more central banks try to do the less effect it appears to have.

That’s a major topic of debate in the US and elsewhere, as is the potential (which may be the existing reality) that over-reliance on monetary policies could create ultimately destructive risk-taking and pricing distortions. There’s a lot of speculative activity occurring globally that has been predicated on access to near-limitless flows of ultra-cheap funding.

It is noteworthy that while, as usual, the statement from Stevens was very, very similar to last month’s, there was a material omission.

Last month he said the board had judged that the easier financial conditions that were in place would contribute to a strengthening of growth over time. That sliver of optimism disappeared from today’s statement.

The Reserve Bank's decision does have some political implications given that it has occurred at the outset of the formal election campaign, which is why it was characterised so differently by the major parties ahead of the actual event.

The response to the electorate to the cut – whether they embrace Rudd’s view of it as good news, or Hockey’s that it reflects a worsening economy – could be a factor in the election outcome. It would be more of a factor if the central bank was to cut again next month, with another board meeting scheduled in the week leading up to the election.

Of longer term consequence, of course, is whether it is any more effective than the previous seven rate cuts (including one of 50 basis points), or the dive in the dollar, in igniting some level of growth in demand and economic growth.