It seems the Reserve Bank is stuck in a constant Groundhog Day, living one intractable interest rate dilemma to another, month by month.
It must be getting a little tedious to say the least, and really quite stressful. Because if it wasn’t already a case of ‘damned if you do and damned if you don’t’ when it comes to interest rate movements in Australia for the past two plus years, it most certainly is now.
What would the US do?
Whatever method America happens to be using to extrapolate future forecasts around inflation, dollar values, consumer sentiment, employment and general economic wellbeing, versus interest rates, at any given time; is largely the path our own policymakers have followed throughout history.
There’s an undeniable pattern to the decisions that have always been made around the raising and lowering of rates in a bid to keep the economy anywhere close to that delicate balance, between too much inflation too soon, and an all out recession.
Essentially, the approach has long been a cautiously bullish one when it comes to anticipating inflation, both here and in other developed economies like the UK and the US.
I know that sounds like a contradiction, but it essentially means regulators don’t necessarily wait until they see evident signs of rampant inflation taking hold before upping interest rates, because by then it could be too late to pull back on the reins and things could get our of control.
So what do you do instead? You predict the rate of inflation based on its relationship to unemployment figures. Because logically, when more people are gainfully employed, they have more money to spend and will in turn; start to make the economic wheels turn faster. Right?
Well, according to the so-called Phillips Curve, that’s exactly how it should work. Some contrary economic boffins from high up in the annals of the good ol’ US of A disagree with such a simplistic notion of measuring inflation in the modern world however.
Mistakes…I’ve made a few
Of course, America still seems to be following the Phillips Curve theory, with three interest rate hikes in the last six months to, “…reflect the progress the economy has made and is expected to make,” according to Fed Chair Janet Yellen.
Recently though, former US Treasury Secretary Larry Summers articulated why this might not be such a crash hot idea, in a piece imaginatively entitled 5 Reasons Why The Fed May Be Making A Mistake.
Summers believes that interest rates should only be lifted when those in power are absolutely certain inflation is going to happen because, well, it’s already happening. He calls this the “shoot only when you see the whites of the eyes of inflation” paradigm.
Summers contends that the old way of thinking is obsolete. He says even if the Phillips Curve was once reliable – which in itself is a hotly contested debate – it’s extremely difficult to statistically estimate the point where unemployment and inflation are in perfect harmony – the Non-Accelerating Inflation Rate of Unemployment (NAIRU) as it’s called. Or my personal favourite – the Goldilocks Effect.
A major issue with this method of forecasting inflation against employment figures to determine whether or not you’ll raise interest rates, is that not everyone who’s ‘gainfully employed’ is making enough money to participate in driving inflation.
The wage growth gripe
Summers has suggested that advanced economies like the US and Australia are suffering from “secular stagnation”, whereby the economic speed limit has almost halved due to an overabundance of savings versus too few productive investment opportunities.
He goes on to point out that timing an interest rate rise incorrectly at this stage of the game could be extremely detrimental to the US economy.
“And I am confident that if the Fed errs and tips the economy into recession the consequences will be very serious given that the zero lower bound on interest rates or perhaps a slightly negative rate will not allow the normal countercyclical response,” says Summers.
Here in Australia we’re also enjoying relatively low levels of unemployment right now, with the ABS announcing a drop in May to 5.5 per cent. On its own, this figure is potentially compelling enough by traditional forecasting standards to suggest an interest rate rise might be well timed right about now.
But when you hold this figure up to the incredibly low wage growth we’ve experienced since before the turn of this century, the reason for our remarkably low rate of inflation becomes more apparent, along with the RBA’s reluctance to raise interest rates. Particularly when you consider the alarming rate of (growing) national household debt we seem to be in.
If Summers’ argument is as watertight as it appears on the surface, the implication is clearly that the RBA will be forced to, at the very least, remain firmly seated on its hands when it comes to making a move on interest rates.
Or, conversely, the only way Governor Lowe could possibly go is further down, by perhaps as many as two further cuts, before the year is out.
Of course that brings us to the other inescapable dilemma faced by the Reserve…the perpetual brink of an alleged ‘bubble’ that our key property markets are perched on, due to a flurry of investor activity driven by…you guessed it…low interest rates.
See…damned if you do…damned if you don’t…these are the dilemmas of deciding our nation’s fiscal fate. Glad it’s not me!
About the Author
Since 2008, David Thomas has built a business aimed at servicing the needs of property investors, owner occupiers and small business owners. David is recognised as one of the top 10 independent mortgage brokerages in the country, David and his team have settled almost billions of dollars worth of residential and investment loans over the last decade.
Known for his straightforward, relatable style, David believes by educating people about property funding; they fare better in the market. By sharing his expertise openly, some of the people he educates will likely become his clients. It's a win-win approach.
David Thomas is a credit representative (Representative Number 506153) of BLSSA Pty Ltd, ACN 117 651 760 (Australian Credit Licence 391237).