Former Reserve Bank of Australia (RBA) board member, Professor Warwick McKibbin, has launched a stinging attack on Australia’s low interest rate settings in The AFR:
Professor McKibbin believes interest rates have been kept too low for too long in a misguided effort to lower the dollar and drive housing construction…
The commodity price surge of the past decade had been spent on new mines and ports, which were generating steady revenue, he said.
“That’s why our reaction shouldn’t have been to try to replace the investment boom with a housing boom – we should have done structural change.”
I have sympathy for McKibbin’s view that cratering interest rates is somewhat self-defeating and merely a ‘can kicking’ exercise. Dropping interest rates to record low levels does punish savers and encourage excessive speculative activity, particularly in the housing market.
However, like it or not, Australia is party to the global currency war, and faces an escalating currency if the interest rate differential becomes too wide, potentially choking-off the non-mining tradable economy.
The underlying problem is that the federal government has effectively out-sourced economic management to the RBA. Rather than actually doing its job and engaging in wide-ranging structural and taxation reforms, targeted at boosting productivity and encouraging productive investment (rather than just housing speculation), the Government expects the RBA to manage the economy via one blunt tool: interest rates. And while interest rates are an effective short-run cyclical measure, they are next to useless for reforming the economy’s underlying structure, which in Australia’s case is becoming increasingly unbalanced ans unsustainable.
Of course, intransigence on the part of the RBA is also an issue. Rather than following the lead of other central banks and the IMF, and implementing macro-prudential curbs on mortgage lending, the RBA has shunned such measures. And the end result is low interest rates spilling over primarily into housing speculation, rather than assisting the productive economy, as well as additional upward pressure on the currency (via the banks’ heavy offshore borrowings, used of course to pump housing).
It’s a conundrum that can ultimately only be fixed through government policy. That is, a wide-ranging program of structural (micro-economic) reforms aimed at boosting competition and productivity; a comprehensive program of tax reform, aimed at broadening the tax base, ensuring a higher proportion of tax is raised from the most efficient sources (e.g. resources, land and consumption), and rewarding productive effort over speculation; as well as macro-prudential controls to prevent excessive mortgage lending.
Until the authorities embark on such a program, the Australian economy will continue to whither, with the RBA continually attempting to engineer a cyclical housing/credit boom in a forlorn bid to overcome the economy’s structural shortcomings.
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