So, the Reserve Bank of Australia resisted growing calls to cut interest rates. They were right to do so.
I seemed to be in a minority who believed that rates should be kept on hold for at least the next few months as more data emerges.
There are compelling reasons for the RBA to stay its hand with respect to further easing of monetary policy in the immediate future.
Firstly, the latest CPI data shows headline inflation was flat in the first quarter of 2018, and on an annualised basis it is now running below the RBA target band of 2 percent to 3 percent. The single biggest driver of low inflation in Q1 2019 was the price of oil, which declined during Q4 2018, dropping from around US$75 per barrel to a Christmas Day low of US$42/bbl. Since then it has steadily risen and is now back up to US$65 per barrel.
Given that the cost of oil impacts every part of the Australian economy – road transport is the only sector that touches all others in the national accounts input-output table – inflation will rebound in this current quarter simply because the cost of oil is higher today than it was at the start of the year. To reduce the cash rate because of a transitory effect on inflation cannot be justified.
Secondly, monetary policy becomes less stimulatory the lower the cash rate, and is more stimulatory to business investment than household expenditure. KPMG’s analysis shows there is a fixed and variable effect to monetary policy changes, and the fixed effect varies depending on the level of the cash rate is. For business investment, the fixed stimulatory effect is nearly 30 percent lower when the cash rate is 0 percent-2 percent compared to when the cash rate is above 2 percent; for household consumption, it is about 10 percent less when the official interest rate is below 2 percent compared to when it is above that level.
This is for several reasons, including the fact that for the cash rate to be at levels of around 2 percent – when the long run average is around 5 percent – the economy must be operating sub-optimally. At such low cash rate levels investors and consumers are more likely to be cautious regarding their economic futures than when the economy is running at full capacity and monetary policy settings are seeking to moderate the economy so it doesn’t overheat.
Thirdly, and following on from the above argument, there is something to be said about keeping your powder dry until you really need to use it. At 1.50 percent the cash rate still has some bang left in it should it be dropped to the lower bound of 0 percent – albeit those 150 basis points are less stimulatory than the previous 150bp’s.
So the question to ask is whether some of that bang should be detonated now to deal with domestic concerns – which are likely to be transitory anyway if you are arguing about inflation – or whether the RBA should hold it back in case an external ‘black swan’ event occurs.
If black swans represent the unknown, there are plenty of grey swans already circling. This week we have seen President Trump threatening to reignite the trade war by slapping additional tariffs on $750bn of Chinese goods. There is also a backdrop of increased trade protectionism more broadly, debt shocks in countries like Italy and China, the implementation of Brexit, and Middle East conflicts.
It is true the Australian economy is weaker today than it has been in the last few years. Employment growth is slowing, private sector investment is weak, and real wages growth is non-existent. All valid reasons to look for some form of stimulation to help pump the economy back into life. But cutting interest rates is not the only way for the economy to get a kick along.
With monetary policy already highly accommodative, stimulatory fiscal policy is arguably a better bullet to shoot at this point. Personal income tax cuts and tax offsets are locked and loaded and ready to impact the economy from 1 July 2019. Government spending on infrastructure is strong and growing; and with 10-year bond yields at record lows, there has never been a more favourable time to deliver Infrastructure Australia’s long-list of priority projects.
Fiscal policy boosts, combined with export-led growth in output, and steady (albeit slow) uptick in wages, will collectively result in a strengthening in the domestic economy. Using our monetary policy fire power for transitory falls in inflation would have been overkill.
We look forward now to Friday when the RBA will release its quarterly statement on monetary policy, where it will expand on its forecasts out to 2021.
An earlier version of this article first appears in the The Australian