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Monetary overreach: Why another interest rate cut won’t solve our problems

One of the nation's leading economists has likened interest rate cuts to putting a bandaid on the economy. Photo: The New Daily
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Most economists believe the Reserve Bank will cut interest rates to just 0.1 per cent on Tuesday.

Two-thirds of the 43 experts surveyed this week by comparison site Finder said it would, and markets put the chance of another rate cut at 84 per cent.

But is taking rates even lower a good idea?

One of the nation’s leading economists says no.

In an analysis paper published by the Centre for Independent Studies, UTS industry professor Warren Hogan argues that further cuts to interest rates would cause more harm than good as “monetary policy has virtually no positive impact on long-term economic outcomes”.

Its only role is to bring forward or delay spending in the economy by changing the price of money, Professor Hogan told The New Daily.

But over the past two decades central banks have been expected to fix structural issues in the economy by simply cutting rates.

Which has had three “hidden costs”:

  • Asset price inflation and excessive debt accumulation
  • The creation of zombie firms
  • Greater risk taking as yield-seeking savers move into riskier and often unregulated financial products.

Reserve Bank governor Philip Lowe has himself acknowledged the link between interest rate cuts and asset-price inflation over the years.

In an address to central bankers in August 2019, Dr Lowe said “monetary policy can’t drive long-term growth” and relying on it risked “further increases in asset prices in a slowing economy, which is an uncomfortable combination”.

The Reserve Bank has also cited the risk of reflating Australia’s housing bubble as a reason not to cut interest rates at past meetings.

In fact, so great has the run-up in house prices been over the past few decades that academics at the University of Sydney described it as the basis of a new class system.

Meanwhile, so-called ‘zombie firms’ have been a major problem since the global financial crisis.

These are essentially bad businesses that would have gone bankrupt in a more competitive environment, but have been kept alive by repeated cuts to interest rates that have lowered their operating costs.

Deutsche Bank Securities estimates that the zombies’ share of publicly traded US companies has doubled, to 20 per cent, in just seven years.

Which is a major issue for households and businesses, as zombie firms weigh on investment spending and productivity growth – the main driver of improving living standards – by keeping labour and capital from flowing to more productive uses.

A 2018 paper by the Bank for International Settlements, for example, found that a 1 per cent increase in the share of zombie firms in an industry lowers the capital expenditure rate of other firms in that industry by 1 per cent.

And if firms are investing less, then our economy will grow much more slowly than it otherwise would – eating into jobs and wages growth.

Professor Hogan concedes it’s a sensitive argument to advocate, as it essentially means accepting a rise in bankruptcies in the pursuit of a more productive economy down the track.

“It’s the same public policy problem that we have with climate change,” he said.

“It’s really hard for a policymaker to go, ‘Look, over the next 5 to 10 years, this is going to cost us big time if we don’t do something now, but to do something now is going to cost us a little bit’.

“Basically, the costs have to be really clear and really large in the long-term in order to [convince people to] pay the price now.”

The third downside of easy monetary policy that Professor Hogan highlights is the risk associated with yield-seeking savers moving into unregulated financial products.

“You’ve got all these ads in the paper for debentures and [dodgy] finance companies – and this is because they’re offering an interest rate of 4 per cent when all you can get from your bank is 1 per cent,” he said.

“I’d argue that people who are putting their money in those finance companies – I mean, do they understand the credit risk they’re taking?”

And then there’s the sharp rise in people stuffing $100 bills under the mattress.

Taken together, the hidden costs warrant a fundamental rethink of the role of central banks, Professor Hogan said.

“For a number of years, the RBA has been resisting calls for a review of the conduct of monetary policy and its inflation target,” he concludes in his paper.

“Few question the objectives of monetary policy as set out in law as the stability of the currency (low inflation), full employment and the welfare of all Australians.

“The question is whether inflation targeting is still the right framework to deliver on those objectives.”