The case for a cut in the Reserve Bank’s cash rate is compelling. At 2.5 per cent, Australia’s official interest rate is among the highest in the developed world. Though low by historical Australian standards, our cash rate is well above the negligible rates of the US, the Eurozone, Japan and now Canada. Inflation is under control, further assisted by the recent slide in world oil prices. Wages have been growing at their slowest pace on record. And yet the Reserve Bank has kept interest rates unchanged for almost a year and a half. For what benefit? And more importantly, at what cost?
If Australia is to make a successful transition from the end of the mining boom to a competitive, more diversified economy it needs a lower exchange rate without an accompanying lift in wage inflation and consumer prices. For a time, as mineral prices fell sharply, the Australian dollar remained stubbornly high against the US dollar. But from well above parity in early 2013, our dollar has fallen below 80 US cents. Yet there is no evidence of renewed interest in investing in Australian manufacturing. Prospects for three sectors in which Australia could be highly competitive – tourism, agribusiness and education – are improving, but increased activity and investment are nowhere near sufficient to fill the hole left by the end of the mining boom.
One reason for this lethargy is that, while our dollar has depreciated against the greenback, quantitative easing in Europe and Japan, together with an interest rate cut in Canada, is ensuring their currencies remain low against America’s and ours. These countries are among our strongest competitors in trade of non-mining goods and services.
In these currency wars, the Australian dollar will need to fall substantially further if we are to be competitive. But the large interest rate differential between Australia and the major developed economies is holding it up.
What does the Reserve Bank have to fear from lowering the cash rate? Not wage inflation. Not consumer price inflation. Is it asset price inflation?
House and apartment apartment prices rose sharply during 2014, especially in Sydney and Melbourne. They may now be easing. If not, the Reserve Bank has at its disposal a recommendation of the Murray inquiry to increase the amount of capital the banks are required to hold in respect of home lending. This would slow the flow of lending for housing, reducing any risk of a housing price bubble.
A year ago, most market economists were forecasting the next interest rate movement would be up. Not any more. Others, led by Professor Ross Garnaut and including this columnist, have long been arguing for further reductions in the cash rate at the same time as other measures are introduced, if necessary, to head off any housing bubble.
Any lingering hope at the Reserve Bank that something will turn up to obviate the need for a further cut in the cash rate should now be extinguished. Enormous global surplus capacity in iron ore and coal capacity has been installed. China’s demand for coal might have already peaked. The government’s much-anticipated revival in mining investment in response to the repeal of the mining tax will not materialise.
An alternative explanation for the Reserve Bank’s conservatism on the cash rate is a judgement that this, as Jack Nicholson famously said, is as good as it gets. By this reasoning, in managing the end of Australia’s biggest mining boom in 140 years, unemployment, though a little on the high side, will decline as real wages continue to fall. House and apartment construction is rising. In time, the lower real exchange rate will induce investment outside of housing.
This analysis accepts falling measured living standards as a fact of life. It is, for a time. But whether the burden is widely shared or concentrated on the shoulders of unemployed workers depends on the speed of the transition to a more competitive economy. A reduction in the cash rate would accelerate this transition with no obvious downside risks. The jobs of hundreds of thousands of Australians might depend on it.
Craig Emerson is managing director of Craig Emerson Economics and adjunct professor at Victoria University’s School of Business.