RBA out of rate cut power, says ex-governor Ian Macfarlane

Ex-governor Ian Macfarlane has warned that the RBA has reached the limits of its ability to boost the economy through rate cuts.

Former RBA governor Ian Macfarlane at his Sydney home. Picture: Milan Scepanovic.

Former Reserve Bank governor Ian Macfarlane has warned that the central bank has reached the limits of its ability to boost the economy through interest rate cuts and further reductions will have “very little power to do anything useful’’.

After the RBA cut official interest rates to a record 0.75 per cent this week, Mr Macfarlane said central banks were facing the “most perplexing and difficult ­period for monetary policy ever’’.

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“Too much faith is being placed in the expectation that monetary policy can do things that it can’t do,” Mr Macfarlane said in an interview.

“It’s done everything it can do. Once interest rates are negligible, further cuts would seem to have very little power to do anything useful — although there are some theoreticians in the Reserve Bank and in some other places who have more faith in a purely ­monetary theory of inflation than I have.”

The comments by Mr Macfarlane, whose 10-year tenure as RBA governor expired in 2006, will fire debate about whether the federal government should boost spending to underpin growth.

Until now, Mr Macfarlane has not spoken publicly about the conduct of monetary policy without clearing the comments with the incumbent chief. He did so once in 2016 with Glenn Stevens.

Mr Macfarlane’s comments came as retail sales figures for ­August, released on Friday, failed to meet analysts’ expectations, ­rising by only 0.4 per cent, despite a surge in tax refunds and interest rate cuts in June and July.

Consumer spending, which makes up 60 per cent of GDP, is the weak link in economic revival.

The central bank noted that the latest cut in official interest rates was aimed at lifting household ­incomes.

The RBA said on Friday that global and Australian financial systems were “vulnerable to a destabilising correction” as ultra-low interest rates reignited a price bubble in every asset class from stocks to commercial property.

In its latest financial stability report, the central bank said downside risks to growth — including from a disruptive Brexit, tensions in the Middle East and the US-China trade war — had ­increased markedly.

After a tumble on Wall Street this week, the Australian sharemarket lost $80bn in value on Wednesday and Thursday. A late surge on Friday saw the ASX benchmark S&P/ASX 200 up 0.37 per cent, closing at 6517.

The local market was down 2.9 per cent over the week, the worst performance since November, while the Australian dollar hit a 10-year low below US67c after the RBA cut.

Mr Macfarlane said the current era was “the most perplexing and difficult period for monetary policy ever”. “At least during the GFC, you knew what had to be done,” he said of the period the RBA was helmed by Mr Stevens, when ­official interest rates were slashed to “emergency levels” of 3 per cent. Another easing cycle pushed the cash rate down to 1.5 per cent in August 2016, where it remained for almost three years.

“Too much weight is being placed on monetary policy at a time when its power to do anything useful is severely limited,” Mr Macfarlane said.

On Tuesday, RBA governor Philip Lowe said the bank had more firepower in its policy ­armoury, and was prepared to cut further “to support sustainable growth in the economy, full ­employment and the achievement of the inflation target”.

Market watchers interpreted this as a signal that “quantitative easing” was on the way, which could see mass printing of money to buy government bonds.

There is a rift in policy emphasis between the Morrison government and the independent RBA, with Josh Frydenberg seeking a new deal on inflation targeting with the central bank.

Mr Macfarlane’s intervention comes as a growing number of economists question the efficacy of interest rate cuts to stimulate consumption, given high levels of household debt and low levels of confidence. Some observers are raising doubts about the wisdom of the government’s contractionary fiscal policy, with a budget in “balance” and on track for its first surplus in more than a decade because of surging company tax ­collections.

In a broad sense, Canberra is hitting the brakes while the RBA is pushing on the accelerator, calling for an end to public sector wage caps, more infrastructure spending and structural reforms to lift productivity and make the business sector more dynamic.

Since the May 18 election, the central bank has cut official interest rates three times by 25 basis points — in June, July and this month — in the hope of reducing the unemployment rate to 4.5 per cent and stoking inflation to get growth in consumer prices within its medium-term target band of 2-3 per cent.

After Tuesday’s rate cut, Dr Lowe conceded progress to those goals was “slower than we would like”. “In reaching that decision, the board recognises that the impact of monetary policy on the economy has changed over time, and that there can be some undesirable side effects from low interest rates,” Dr Lowe said.

He noted the fall in incomes for those who rely on deposits, such as retirees. “Importantly, the board recognises that monetary policy still works. It works to support employment, jobs and income growth across the economy.”

Although annualised GDP of 1.4 per cent in the June quarter was the weakest result in a decade and inflation was at 1.6 per cent, Dr Lowe said the economy appeared to have reached “a gentle turning point”.

In mid-2016, Mr Macfarlane chastised financial markets for bullying the RBA into kneejerk interest rate cuts during a currency war. A month earlier, after a budget day rate cut, his predecessor, Bernie Fraser, said too much was being expected of monetary policy. At the time of his exit, Mr Stevens said there were limits to the effectiveness of monetary policy, given high levels of household indebtedness.