Taken in isolation, the decision last week by the Reserve Bank’s new interest-rate setting committee to defy all expectations and delay a cut in the official interest rate of a mere quarter of a percentage point, by a mere five weeks, is neither here nor there. Even so, the fuss it has caused damages the Reserve’s credibility – “do these guys know what they’re doing?” – and thereby its ability to manage the economy successfully.
And the coincidental timing with the first application of the new rule that the Reserve publish the numbers of committee members voting for and against – a supposed reform intended to encourage greater debate before such decisions are made – won’t help the Reserve convey confidence that it’s charting a steady course to peace and prosperity.
It was obliged to reveal that while six board members wanted to delay a rate cut, the other three wanted to get on with it. I don’t have any doubt that the six included governor Michele Bullock and her deputy, Andrew Hauser.
And, though I have no inside information, it wouldn’t surprise me if the new Treasury secretary, Jenny Wilkinson, was among the dissenters. Why? Because her predecessor, Dr Steven Kennedy, quietly made it clear in a succession of speeches that Treasury saw no reason for the Reserve’s great fear that wage growth could explode at any moment. (In passing, note that the recent changes to the Reserve’s Act make it clear that, while the Treasury secretary’s seat on the board is “ex officio”, he or she acts in their individual capacity, and cannot be directed by the Treasurer.)
The Reserve’s insistence on delaying the next rate cut – based, apparently, on the flimsy argument that the inflation figures for the month of May may have somewhat overstated its rate of fall – came at a most inauspicious time.
While Trump’s erratic pronouncements are adding greatly to uncertainty – prompting consumers and businesses to delay making big new spending commitments – the last thing the authorities should be doing is adding to it. By this silly decision, the Reserve has shaken the faith of the financial markets, businesses and households in its predictability and desire to steer a steady course to low inflation and higher growth.
Not that this means I have much sympathy for the red-faced participants in the financial markets and the media. They’re just playing their own games for their own commercial reasons. The reason the financial markets are so obsessed by predicting whether the Reserve will or won’t jump at its next rate-setting meeting is that they place bets on the outcome.
So a different headline for stories about the unpredictable decision is: 100-to-1 outsider wins the Reserve Bank Stakes at Martin Place on Tuesday.
As for the media, we have no shame. We use the financial markets’ placement of bets, plus the business economists’ opinions, to pander our customers’ insatiable desire to know what the future holds. Psychologists explain our addiction to forecasts as part of humans’ delusion that, if only we can know the future, we can control it.
When the media’s prediction that the Reserve is almost certain to cut interest rates on Tuesday proves to be dead wrong, the media’s not embarrassed, it’s excited. The routine rates story has suddenly got a lot more interesting. Two stories for the price of one.
It doesn’t do a lot for the media’s credibility, of course, just as the Reserve’s needless unpredictability is ill-judged at a time when the greatest threat to the economy is uncertainty and the suspension of spending intentions, particularly by business.
The fact is that our economy’s recent growth is weak. Hesitant. The risk that the economy will wallow, far exceeds the risk that inflation will take off. The message the Reserve needs to be getting through is: “Good news. Inflation’s coming down and so are interest rates, so now’s the time to look to the future with confidence. Don’t be the last to clamber onto the expansion train”.
Part of the economy’s hesitance is explained by the news that people with mortgages aren’t using the fall in interest rates to reduce their mortgage payments. In which case, the fall in interest rates isn’t strengthening consumer spending as much as could have been expected.
Particularly because of Australia’s unusual prevalence of variable-rate mortgages, the use of higher interest rates to fight inflation puts most of the burden on people with big mortgages. This is not only unfair, it’s inefficient: the two-thirds of households without mortgages are under little pressure to reduce their spending. So those with mortgages have to be hit all the harder to achieve the desired reduction in overall demand for goods and services.
It may be that people with mortgages have been hit so hard in recent years that, rather than using the lower interest rates to increase their spending, they’ve decided to leave their mortgage payments unchanged to reduce their exposure to those unfeeling blighters in Martin Place. If so, that’s a strike against our use of the manipulation of interest rate to smooth the growth in demand.
Readers’ letters to the editor of this august publication strongly supported the Reserve’s decision not cut rates. Huh? It’s easily explained. People with their homes paid off, and their savings held in fixed-interest bank deposits, gain when rates rise and lose when they fall.
This is another strike against the use of interest rates to fight inflation and smooth demand. When rates rise to discourage people with mortgages from spending on other goods and services, they actually encourage the retired to spend more. So the negative effect on the spending of people with mortgages is partly offset by its positive effect on the spending of the retired.
Maybe one day we’ll wake up and find a better way to manage the strength of demand. Meanwhile, we’ll suffer from the Reserve’s reluctance to stop fighting the last war against inflation and start fighting the next war against uncertainty and weak growth in the economy.
