Outgoing Reserve Bank governor Glenn Stevens has warned that if the economy needs a big boost it might have to come from government spending rather than interest rates.
In his final speech as governor, Mr Stevens said he had serious reservations about the reliance on monetary policy around the world.
All the major developed economies have interest rates set close to zero in an attempt to lift economic growth but with only modest results.
Actions by central banks have not been enough, and could not be enough, to restore demand fully after a recession and a big build-up in debt, he said.
“It isn’t that the central banks were wrong to do what they could, it is that what they could do was not enough, and never could be enough, fully to restore demand after a period of recession associated with a very substantial debt build-up,” he said.
For Australia, where the trend in economic growth has slowed, the path back to budget balance is proving to be a long one.
But Mr Stevens said the most powerful expansionary push from low interest rates comes when “someone, somewhere” has the capacity and willingness to take on more debt and to spend.
“So for policymakers looking to use low interest rates to boost growth, the question is: which entities, if any, in the economy can accept higher leverage (borrowing) safely?”
And he pointed out that household debt in Australia is currently about 125 per cent of gross domestic product, while public sector debt is only about 40 per cent.
“It’s an interesting question which sector would have the greater capacity to take on more debt, in the event that we were to need a big demand stimulus,” he said.
He made it clear he was not advocating government borrowing to fund routine spending on pensions, welfare and the like.
“The point I am trying to inject here is simply that popular debate in Australia about government debt and how we limit or reduce it seems so often to be conducted while largely ignoring the size of private debt.”
Mr Stevens also used his speech in Sydney to defend the RBA’s performance over his decade at the helm.
He said Australia over time “has achieved the inflation target, avoided a major economic downturn, seen remarkably little variability in real economic activity in the face of enormous shocks, experienced a fairly low average rate of unemployment, and had a stable financial system as well”.