Warning sign we’re all ignoring

SOMETHING’S not right in Australia’s economy. The warnings are piling up, and the longer we ignore them, the more trouble we could be in.

Normally, interest rates don’t sit still for long. They usually rise and fall. But ours are frozen rigid. Our interest rate has now been stuck at 1.5 per cent for twenty months. That is quite a low rate and a low rate is supposed to make the economy better.

AN ANALOGY

Imagine you’re in hospital. The doctor puts some bandages on your leg. “This should heal up in no time,” he says.

Every day, he visits and peeps under the bandages. He smiles, says not to worry, and leaves the bandages on. For a week you’d be confident. For a month you’d feel okay. But if he leaves the bandages on for more than a year, you start to get pretty worried you’re not actually healing under there.

Are these bandages working? Do we need a new doctor in the house?

RATES ARE STUCK

The RBA board has a meeting once a month, deciding whether to change interest rates. Sometimes they change rates every time, like in 2008-09, where they cut at six meetings in a row. But recently, the meetings have been non-events. At 18 consecutive get-togethers since August 2016, the board chose to do nothing.

This isn’t a record we should be boasting about.

This isn’t a record we should be boasting about.Source:Supplied

Of course, there were periods in the past where interest rates were stable, but mostly when they were at normal levels, around 5 per cent. This time is a record twice over — not only have interest rates never been so low, they’ve never been so stuck.

It gets even more astonishing when you consider that nobody expects interest rates to change in the next six meetings either. The RBA will most likely hit the two-year mark and continue their strategy of inaction. But will it ever work?

WHY DO WE CARE ABOUT THE RBA?

The answer is: the RBA tries to steer us away from recessions, using interest rates as the steering wheel and inflation as the white lines on the road.

About 30 years ago we discovered that if you can control inflation (growth in prices), you can keep a handle on the economy. When inflation is nice and steady, the economy should keep growing. No recessions, no crises, low unemployment, everybody’s happy.

The RBA’s job is to keep inflation between 2 per cent and 3 per cent, which has been chosen as the sweet spot.

When inflation gets a bit high, the RBA puts up Australian interest rates, and these things happen:

People save more money.

People (and companies) borrow less money to spend on things.

These make the economy slows down, which should make inflation lower.

When inflation gets a bit low the RBA puts down Australian interest rates, and these things happen:

People save less, spend more.

People (and companies) borrow more money to spend on things.

These mean that the economy speeds up, pushing inflation higher. In theory, anyway.

In reality, we’ve had low interest rates for ages. But people are still saving a lot, companies aren’t borrowing much and inflation is looking too low, having been below the target of 2 per cent to 3 per cent almost constantly since 2014, as shown in the next graph.

Low inflation might keep prices low, but your wage is probably feeling like it’s stuck in the past decade.

Low inflation might keep prices low, but your wage is probably feeling like it’s stuck in the past decade.Source:Supplied

The RBA keeps saying it expects inflation to get better, “although this progress is likely to be gradual”. Is that good enough?

WHERE THE RUBBER HITS THE ROAD

A crappy economy is not an abstract issue. It makes a big difference to real lives. Around 700,000 Australians are unemployed. We have a trend unemployment rate of 5.5 per cent and rising.

Underemployment is falling slightly, but still high. There are 1.1 million people who want more hours but can’t get them. That’s a lot of stress and worry in a lot of Australian households.

If the RBA can’t control inflation, and can’t get the economy humming like it should be, the result is human suffering.

IT COMES BACK TO HOUSE PRICES

Australia is stuck. In a perfect world, the RBA would probably have cut interest rates again. Would have tried to get inflation back up, get some heat back into the economy, and fix up unemployment.

The reason we don’t live in a perfect world is that Australia’s house prices are dangerously high — especially in Sydney, where the RBA is — and if they cut interest rates any further, it could make house prices go even crazier.

And here’s the problem with our whole system. Low interest rates are meant to make people spend money on consumable things like food and drink and holidays that make the economy roar. Low interest rates do that — a little bit — but they do far more to make people borrow huge sums of money to buy assets like houses. You get multi-million dollar houses, and that doesn’t really do much for the economy.

So this is the message we should get from this weird long period of low interest rates — interest rates are a blunt tool. We can’t rely on them to solve everything.

If we want economic growth to come back and the unemployment rate to go down, we need to lean less on the RBA’s interest rate policy, and more on the Treasurer’s economic policies. If we want a better economy, it’s time for Treasurer Scott Morrison to stand up.

Jason Murphy is an economist. He publishes the blog Thomas The Think Engine. Follow Jason on Twitter @Jasemurphy

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