Calm down, this is no rates emergency

Anyone who reckons interest rates are at emergency levels has a poor understanding of economics, economic policy and economic history.

To be sure, the Reserve Bank interest rate cut yesterday has the official cash rate at 2.75 per cent which is, of course, below the 3 per cent low point that prevailed during the depths of the global banking and economic crisis.  But the other policy levers are so vastly different that all talk of ‘emergency monetary policy’ is economic clap trap. 

In the first instance, the 3 per cent cash rate was set during the GFC as the threat of global depression loomed, but it was accompanied by one of the biggest fiscal stimulus settings Australia has seen.

In terms of the size of that fiscal stimulus, real growth in government spending totalled 17 per cent in the two years to 2009-10. This saw government spending rise from 23.1 per cent of GDP to 26 per cent, a rise of 2.9 percentage points in just two years.

In the current environment, while the numbers await confirmation in next Tuesday’s budget, government spending has recorded approximately zero real growth in total over the last three years (to 2012-13) which has meant that the ratio of government sending to GDP has fallen to 23.8 per cent, a drop of around 2.2 percentage points. 

In other words, there is a difference of more than 5 per cent of GDP in government spending between now and the emergency action of Australian policy makers during the GFC. In today’s dollar terms, 5 per cent of GDP is over $75 billion in a single year.

The change in the bottom line of the budget was even more extreme as revenue to the government fell during the GFC. From a surplus of 1.7 per cent of GDP in 2007-08, the budget went into deficit of 4.2 per cent of GDP, a change of 6 per cent of GDP. Assuming a deficit of 1 per cent of GDP for 2012-13 when the budget numbers are updated next week, there has been a contraction in the budget bottom line of around 3 per cent of GDP over the last three years.

In other words, the bottom line change in the budget is a tub-thumping 9 per cent of GDP from the GFC stimulus measures a few years ago to the fiscal contraction now. And 9 per cent of GDP now is around $135 billion in a single year.

Does anyone still think that the low interest rates now bare any resemblance to the emergency levels that prevailed during the GFC?

The other massive difference was the level of the Australian dollar. In March 2008, the Australian dollar was trading around 95 US cents. As the crisis hit and emergency settings were in place, the dollar collapsed to below 65 US cents in late 2008 and early 2009, a fall of over 30 per cent. This helped the export sector keep its head above water at the time of global recession.

Even after yesterday’s rate cut, the Australian dollar is still around U$S1.02, down a few cents from the level prevailing earlier in the year, but whichever way one cares to cut it, the Australian dollar is still strong. It is acting a severe handbrake on economic growth right now as opposed to the stimulus it delivered in 2008 and 2009.

On the basis of the stance of fiscal policy and the level of the Australian dollar, low interest rates are being implemented by the Reserve Bank right now as it works to offset what in the current climate are factors restricting economic growth, not supporting it as was the case during the GFC.

Anyone who makes the comparison of today’s cash rate with the emergency level during the GFC has no idea about the mix of policies and is unaware of the linkages between policy settings and their impact on the economy.

If real government spending was growing by 3 or 4 per cent, it is obvious that the central bank would not have the current cash rate in place. But spending is flat to down so it does!

It would be a similar story, if the Australian dollar was 15 to 25 per cent lower than it is now. In this example, there would be a stimulus to the export sector and those firms competing with imports would also be faring much better. 

While the dollar may fall at some stage, the tight fiscal settings won’t.

This alone should be enough to see the Reserve Bank cut interest rates some more, to new fresh record lows, in the months ahead.

The futures market is pricing in a 2.25 per cent cash rate for early 2014 and on current trends, it just might be right. It is not an emergency, it is a reaction to low inflation and policy restrictiveness elsewhere.

More from Business Spectator

Comments on this article

Comments Policy
Anonymous,

OK. For the record what level of the cash rate do you agree is a "rates emergency"?

0.5%?
1.0%?
1.5%?
2.0%?
2.5%?

Take your pick, but this time lets get the hard number. Otherwise your just another marketeer for the ALP.

Anonymous,

When it is much lower than the rest of the world

Anonymous,

The only option we have is when everyone else drops their rate to ZIRP we refinance all our government loans for 30 years at the ZIRP rate. That way cash flow in government improves at the expense of foreign lenders. Then we can look at infrastructure projects to stimulate.

Dropping our cash rate to ZIRP will not affect the value of the $A. Everyone else has ZIRP and the PRINTER. Free money always wins over ZIRP money.

Anonymous,

The RBA will be forced to print eventually also.

Anonymous,

The Kouk - I respectfully advocate it is yourself who doesn't understand the current policy settings. Having witnessed the policy settings of UK Labour for 10 years - that is over spending on black hole socialist programs and the necessary central bank acccomodation - continual cuts in interest rates - I advocate it is the interest rate cut bloggers who do not understand what is going on.

Over the next 5-10 years Australia is going to suffer because the govt overspent on programs which do not provide an ROI. Now the RBA is going to over-lever the property bubble to compensate for mining slow down. The same dangerous behaviour that required banks to be rescued overseas.

The end game is that you keep cutting - so people's houses increase in value - the problem of which is eventually you hit zero and you've got nothing left. You buy temporary hapiness especially for those with vested interests. But as in the UK the end game is high inflation and a decade of pain.

Its very simple mate - govt overspends on rubbish - RBA cuts to compensate - we all end up poorer because its inflationary.
They should shelve the current spending programs in support of company tax rate cuts to ensure full employment. Playing around with monetary policy is a waste of time in this environment.

Anonymous,

At the end of the day - people will interpret what they interpret - and your articles will never changed that fact.

There's no point sitting here telling people that they're interpreting stuff wrong. Markets work on fear and greed and anticipating things before other people. This is one of the reasons the rate cut was a bad call - it ensues worry.

Anonymous,

Company tax cuts? Wrong, as usual.

Now that the good times are over, the aim of the transnational ruling class is to protect the loot their class made from thirty years of plunder on a scale that exceeded the Spanish conquest of the Americas. Moneybags, rent-seekers and profit-seekers are combining powerful but subtle media campaigns with pressure on the governments that they own to manufacture consent to ensure that the cost and risk can continue to be offloaded onto the 99%. In the Eurozone, these measures to protect their wealth are most obvious as the mindless austerity measures.

Offloading taxation from the rich to the struggling is one of the number of means of protecting the plunder gouged by the filthy rich from the three-decade asset-bubble. As with the GST from Day 1, moves to further reduce a low corporate tax rate is simply the latest con trick to keep us paying for the filthy rich to continue in the fabulous lifestyle to which they've long been accustomed! It is consumers, not companies, who pay the GST. It is companies, not consumers, who benefit from lower company tax; their local shareholders even get a tax credit.

Or, the gougers offer extensive tax breaks to business; in Britain's case, including cuts in corporation tax and the small business rate, reducing employers’ national insurance and creating enterprise zones. It is also planning to slash business regulation and protection for workers to further remove the ‘burdens on business’. Another means is to moving from taxing company profits to taxing consumer transactions.

Or, the gougers sell reductions in corporate tax as being to attract investment, hopefully to increase tax revenues. Of necessity, according to KPMG, governments are acting to stabilise tax revenues using reduced corporate tax relief, strengthened transfer pricing regulations, plus a shift to indirect taxes.

Or, the gougers spin tax cuts and deregulation as good for investment and growth, most well-known as Reagan's "trickle-down". They omit to mention that "trickle-down" was often tried but rarely worked. While the tax-to-GDP in most developed countries is around 30%, that of the US (around 18%) is even lower than that of Greece (around 20%).

In the U.S., millionaire Presidential campaigner Mitt Romney’s decided to stand by his public contempt for the 47% of Americans who pay no federal income tax. His 2011 tax return showed that he pays a lower overall rate than the poorest fifth of Americans.

Compared to the previous three decades of higher taxes and stronger regulation, investment (as a proportion of GDP) and economic growth fell in the "trickle-down" countries. Also, despite having much lower taxes (often not even income tax) and less regulation the 19th century world grew much more slowly than in the high-tax, high-regulation era of 1945-80.

Anonymous,

Alan,

The next four months is going to see the net debt jump $50B. No-one is going to make any big financial decisions during the longest 9 month election campaign Australia has ever experienced. If we have to have a lawyer run the country we should have an option to at least get a bright one.

Anonymous,

Stephen you also forgot to mention the $200 Billion of Debt the government has taken on and spent. Where did that stimulus go? 3% was an "Emergency" level described by your Wayne Swann back in 2008. That is the irony or your article.

Two days ago you practically begged Stevens to lower interest rates reciting a long list of reasons why the economy was in need of a boost. Today you are apologising for the "not so bad" interest rate. Have you thought of seeing a shrink. There seems to be two of you in there.

Anonymous,

I have to say, I am bemused by Swans Cheerleaders who are now saying these rates cuts are not a sign of a poor economy. How about getting out of your ivory towers and checking out the real world of business and consumers. Soaring energy costs, high and inflexible labour costs, very low consumer and business confidence, increased taxation on entities such as the small business favourite - Family Trusts (oh yeah Swanny, only rich investors have Family Trusts). Not to mention a government that is in disarray internally and intent on creating anxiety by spinning their woes away. With all due respect Mr Koukoulas, I appreciate that you must be friendly with the Labor Leadership team, but why not spend some time in a small business and face the harsh reality of the current environment.

Anonymous,

And one more thing, before Stephen writes another article on low government debt I would like him to consider State and Federal debt combined PLUS private debt and then ARGHHH you will realise we are one of the most indebted nations in the world!!! (He can also add the Superannuation liabilities of all levels of government also which are not currently included in Gross and Net debt calculations...then we can have a real debate).

Anonymous,

Good stuff Julian. And well put.

2: 1 (two: one) sacred cows working for State and Federal Governments vs best practice Germany; PLUS we are probably paying ours more than Germany whose cost of living is far higher. Those multipliers are huge on Public Purse. eg. Labor under Beattie and Bligh were running the Government on stats i.e. no best practice; on auto-pilot; funded on credit card; indebted State Governments are taking a cash grab on disability and education. And then you have many many SME issues.

I could write a book on the latter!

Here endeth the Lesson!

Anonymous,

Australia has a huge land mass of course; so add in +15.0% say for Australia.

Anonymous,

Thanks Julian.

Anonymous,

A 25 basis point reduction in rates at 3% is twice as large as a 25 basis point reduction when rates are at 6% - and so on.... The outcomes of these rate reductions as we approach zero become greater and greater yet the standard run-of-the-mill economist seems oblivious to this. Do the simple calcs and draw a chart - its non-linear - so therefore are the inpacts to the wider economy incl both savers and borrowers. To argue that current rates aren't at emergency levels is simply displaying the mother of all blindspots. The RBS is trying to goose the economy by blowing a bubble - in anything - just to get Joe Sixpack down to the bank and borrowing with his ears pinned back. Why dont we simply let nature take its cause - wear the pain - flush the system and then start again in a few years time?

Anonymous,

Proportions are not absolutes. Debt as a ratio to GDP is only a benchmark. To use it as an absolute measure is a gross misrepresentation by Mr kouk.. Who has a nasty habit of frequently doing such (grossly misrepresenting things).

We are in the midst of the biggest terms of trade boom in history, and have enjoyed very strong GDP growth between 2000 to now.

We now enjoy (or suffer depending on your bank balance) negative real interest rates on cash (reported inflation is not actual inflation as people in the real world know).

From a central banking point of view, this most certainly IS an emergency.

Demand can't be stimulated by cheap cash. Tomorrow has already been brought forward to today. Central bankers are now trying to bring the day after tomorrow, after the next day.. Into today.. It can't work. It won't work.

Anonymous,

"Tomorrow has already been brought forward to today. Central bankers are now trying to bring the day after tomorrow, after the next day.. Into today.. It can't work. It won't work."

Hit the nail straight on the head with that comment. The beast isn't reacting the way they want. So what do you do? run with the beast? or jump through the hoops put up by the RBA?

The beast is not spending, and the game is up. Underconsumption is every economy's achilles heel.

So I'm running with the beast.

Anonymous,

I'm with you George. 'Don't fight the Fed' as they say over in the USA...

I'm borrowing as much as I can and sending it out of the country...

Anonymous,

"Anyone who reckons interest rates are at emergency levels has a poor understanding of economics, economic policy and economic history" errrrr wasn't it swan that said 3% was emergency level?
But you are right Stephen, he does have a poor understanding of economics, economic policy and economic history. :o)

Anonymous,

Exporting holes to China skewes the GDP, compared to countries who export products made by people, so lets forget the ratio to GDP spend.
Lets on the other hand look at the spend to income. The average of the last 5 years of the Howard government is they spent 91% of their income over those years. The last 5 years of the Rudd/Gillard government ( not including 2012-2013 ) is they spent 112% of what they received from income ( information from RBA )
We all know about the GFC and frankly if stimulus was what was needed for the period, 08/09 then, we all, are not quibling, but here is the thing, it is now 2013 and we have not seen a return to any rational use of our money, we are not seeing any quality ifrostructure projects that will give future Australians an economic benefit ( NBN excluded because it is not included in government the spend ,and if included would increase the 112% to 115% )
The GDP ratio is just a convenient smoke screen you use when you are trying to show how dedicated to your Labor masters you are, because it always comes down to income in, income out, that is the true mark of a responsible government.

Anonymous,

Spot on Rod.

Anonymous,

Falling interest rates, sliding government revenues, budget deficits forecast for years to come, job losses now being announced almost on a daily basis but hey be calm.

Unfortunately Stephen for you and many of the economists many people do not believe you guys anymore you all have cried wolf one to many times.

The future is not as bright as you make it out to be and I am preparing for that future by further increasing my savings and cuts in expenditure to even higher levels. Nobody is a fool anymore as many in the government and business sector would like to belive, I simpy don't trust them anymore..

Anonymous,

Stephen, Stephen, Stephen... you should stick to more civil past times than heaping aspersions on the straw men Cassandras you dream up concerning interest rates and financial emergencies. Few historians of economics and money can identify a time with more extraordinary monetary measures than are being implemented than now. Any economist who claims as you do that "Anyone who reckons interest rates are at emergency levels has a poor understanding of economics, economic policy and economic history." is just showing their own lack of true understanding of the financial markets and their relationship to the real economy. Our financial system (and the institutions that comprise it) is subject to a long term credit cycle that is currently turning down and is also being fought by the institutions whose existence is threatened by the continued decline in that cycle. Such an environment is an emergency by anyone's metric - admittedly not domestically at present but globally, we can not deny our inclusion in the global set up.

Anonymous,

"Does anyone still think that the low interest rates now bare any resemblance to the emergency levels that prevailed during the GFC?"
Yes,they are 0.25% lower.

Anonymous,

Stephen N. I would take it that you are where the rubber meets the road and are asking this question rhetorically, because you already, from personal experience, know that not only does the interest rate look like a duck, it also quacks like a duck, so you guessed it, it is a duck. And if you want an answer, you are absolutley right, and Steve K should hold his head in shame. ( and he should go back and re read his own past works )
Does anybody want to put any betts on how Steve K will interpret the same economic circumstances next year under a Tony Abbott government. ---------------------------- What, no takers, because we all agree the opposite interpretation will be made of the same information.

Anonymous,

The main reason for the central banks of the US,UK,Japan and Europe having Zero Interest Rate Policy is to enable their governments to employ huge deficit spending at affordable interest rates...that's it.
For the RBA to join the race to the bottom for interest rates when our government has not had to bail out an insolvent banking system through a 40% housing price crash,is puzzling to say the least.
However,Australians have to take this very seriously,because the RBA would not bring us to an emergency interest rate regime unless there was an emergency.
For those who are retired or are about to retire...this for us is an emergency because we have to reign in our spending or hollow out our savings.So for us it would be sensible to employ self-imposed austerity,because this could be some years on very low interest rates...not a few months.

Anonymous,

I'm trying to be disciplined and hold out for capitulation in the sharemarket before re-entering... when you're retired you quite rightly don't like to risk your capital.

Anonymous,

I may have a poor understanding of economics, economic policy and economic history but when the RBA reduces interest rates to the lowest level in over 50 years and hints at more cuts then something is unusual is happening.

And it may not be good.

Anonymous,

It seems we swapped the Dutch disease for the Aussie moron disease. Federal Government in utter disarray, a rogue RBA supremo hinting at even lower rates after cutting them to the bone, but we calmly accept the punishment. The Euro zone, in particular, Cyprus electorates must think , we are nuts.

Anonymous,

The AUD going down to US$0.65 cents in late 08/early 09 had absolutely nothing to do with policy settings by the Australian Government,nor by the RBA.
The AUD dived because the sharemarket crashed : about 46% of our sharemarket is owned by non-residents,mainly the US.When their market crashes,they sell out of our market,exchange our dollars
for theirs and repatriate the money.This happens every single time we have a crash.

Anonymous,

Sorry Vasso,sometimes I get excited and hit the reply button instead of going to the comment section.

Anonymous,

"Now that I am out of government I can tell you what I really believe. Central banks are now so heavily influencing asset prices that investors are unable to ascertain market values".
--- Kevin M Warsh : former Federal Reserve Governor, from comments made to the Stanford
University Institute for Economic Policy Research, 25th Jan 2012

Anonymous,

At the RBA site the cash rate is 2.75% and the inflation rate is 2.5% : looks like we've nearly hit zero interest rates already.

Anonymous,

Stephen...not meaning to be offensive ( and hopefully not a smart arse), but in all honesty, if your postings of late, are an indication of the advice you previously gave the Labour Government, no wonder they are sending us down the drain.
Not only is your content very loosely based on fact, your opinion seems to change, from one week to the next.

Anonymous,

I will supply a few facts .
Once upon a time i paid an interest rate of 19% on my home loan.
Now they have dropped to under 5 % variable.
I worked hard ,saved hard prepared well for my retirement,all for nothing.

Anonymous,

Yes bernard, and interest on my savings from going without are below inflation.

Anonymous,

Yes bernard, and interest on my savings from going without are below inflation.

Anonymous,

Good story Mr Koukoulas
I think a lot of the reply's on this story are wrong the Labor Party after the GFC did the correct thing Keynesian spending was needed it worked job's were saved and working people did not lose there Homes.
I want to know when the Lunacy of Negative gearing is going to stop and why is it that a person on the top rate of tax only gets taxed at 15% when he put's money into super but a low income worker paying 15% tax gets no tax break.
A mining tax like Norway would help with the Finances

Anonymous,

Think you're on the money Paul..as regards the Labour involvement on the weekend when Lehman Bros fell over. That was some of the best ( on the run) government we've had.
Problem has been since that weekend.

Anonymous,

There's is a interesting video on Lehman Bros and the finance pirates called
The Inside Job at the local video store well worth a look.

Anonymous,

Economics is a fools game. So called 'experts' would be more adept at reading dried out tea leaves lying at the bottom of a cup than have the ability to foretell what is in store tomorrow. I take their advice with a strong measure of 'reality pills', always !