by Stephen Koukoulas
13 April 2013
When setting monetary policy, the Reserve Bank of Australia almost always has to deal with conflicting pressures when it decides whether a particular level for the official cash rate is appropriate.
That dilemma has been evident in recent times where the RBA has confronted a generally weak economy with rising unemployment on the one hand, and incredibly strong house price growth on the other.
What to do is the difficult decision for the RBA, as the weakness in the economy would normally mean lower interest rates are necessary while rampagingly strong house prices would normally demand higher interest rates.
So far, the RBA has generally erred on the side of fighting rising house prices first, leaving the sluggish economy and worryingly high level of unemployment largely to run its course. Since late 2013, the RBA has delivered just one cut in official interest rates. This is despite economic growth being locked in below trend for all of that time and the unemployment rate edging up to its highest level in more than a decade. Inflation has, as a result, fallen and in underlying terms is well anchored near the bottom of the 2-3% target. Perhaps of even more concern, wages growth has fallen to levels never before seen in Australia, which is a sure sign that the labour market weakness and structural change in the economy is forcing workers to accept less.
As well as keeping rates higher than they may otherwise be, the RBA has tried to tackle the house price problem with its fellow regulators ostensibly through a softly-softly policy. The macro-prudential initiative is centred on the regulators asking the banks to limit their lending to borrowers who want to buy an investment property.
The RBA was late to adopt this policy (December 2014), particularly when it has been evident for some time that house prices were rising at an uncomfortable pace and Australia’s big-picture outlook was being undermined by a sharp decline in the terms of trade. Even now, it is not clear whether the policy is all that effective with the annual rise in credit for investment purposes rising by 10%, which is a large factor behind house price growth at a solid 7.5% to 8% with Sydney prices up around 14%.
This policy balancing act from the RBA has not been helped by the poorly framed, poorly targeted and hopeless execution of fiscal policy from the Abbott government. In 18 months in office, the fiscal policy narrative has directly undermined business and consumer confidence as it has proposed policy settings that will hinder growth and add layers of complexity to business operations. Such “signature” policies as the paid parental leave scheme and Medicare co-payment, for example, were dropped after the realisation they were unfair and ineffective.
Not only that, but the government has further damaged the budget by adding tens of billions of dollars to the deficit through spending increases and tax changes.
Fiscal policy is neither being aimed at supporting growth and jobs nor fiscal consolidation. This is something that the Reserve Bank governor, Glenn Stevens, has hinted at when analysing business confidence and consumer sentiment and why they are not more upbeat, and not taking advantage of low rates and a falling dollar.
But there is only so much the RBA can do. It can only set a specific level for rates and see how that impacts on the economy.
The government can, via fiscal policy and other economic reforms, do many things. It can change taxes and direct spending to areas that will overcome pockets of weakness, boost inefficiency and promote fairness. It can regulate changes in the labour market, the level of services it provides and all of this with an eye on economic growth, jobs and personal wellbeing. After 19 months in office, the opinion polls and performance of the economy suggest the Abbott government is failing economically and that all the hard work on managing what is a patchwork economy is being left to the RBA.
