What more can Reserve Bank do to revive the economy?

Reserve Bank Governor Philip Lowe. Picture: Kym Smith

The Melbourne Cup day meeting of the Reserve Bank board is likely to pass with less fanfare than in some previous years.

Markets expect no change to the RBA cash rate from its current level of 0.75 per cent, and indeed the probability of a further full 25 basis point rate cut to 0.50 per cent has been scaled back in recent months from a sure bet to around 75 per cent.

However, the discussion around the board table in Martin Place will be anything but laid-back and sedate. The series of recent rate cuts by the bank has attracted a range of criticisms; two former treasurers have stated that monetary policy has run its race, and former RBA governor Ian Macfarlane commented that “once interest rates are negligible, further cuts would seem to have very little power to do anything useful”.

In fact, at least one of the channels through which monetary policy impacts the economy is still working exceptionally well, potentially too well. The RBA rate cuts, along with an easing of lending guidelines by the Australian Prudential Regulation Authority and the removal of uncertainty around the taxation of investors in the housing market, have seen a surprisingly outsized rebound in house prices. This is probably one factor in the RBA’s expected pause.

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In contrast, the hoped for lowering of the Australian dollar has proved more elusive given that a number of central banks overseas have also been easing their monetary policies. And the boost to household cashflows from lower interest rates and tax refunds hasn’t so far seen debt laden consumers materially increase their appetite for spending.

That said, a common element to these criticisms and observations is that monetary policy has been asked to do more than can reasonably be expected of it and that other policies need to play a greater role if the economy is to return to a trajectory that delivers full employment and inflation in line with the 2-3 per cent target.

Ironically, central banks globally are at least partly to blame for how this situation has come about. In seeking independence from their governments to pursue the goals of price stability and full employment, the responsibility for the day-to-day management of the economy has in effect been ceded to central banks.

The end game in this development was former European Central Bank president Mario Draghi’s famous comment in 2012 that he would do “whatever it takes”. The comment marked the turnaround of the euro crisis, but inflation subsequently has remained stubbornly below the ECB’s 2 per cent target, the ECB’s policy rate recently was cut to -0.4 per cent, its bond buying programme is being restarted, and the euro area’s economic growth remains structurally weak.

Even in the US, where growth has been strong and the unemployment rate has fallen to a 50-year low, core inflation is moderately below the 2 per cent target and the Federal Reserve has been lowering its official interest rate to guard against downside risks to the outlook, most notably the trade wars. This is despite Fed chairman Jerome Powell commenting that fitting trade policy uncertainty into the risk management framework of monetary policy “is a new challenge”.

Similarly, RBA Governor Philip Lowe is expected this week to state that the board is prepared to ease monetary policy further if needed to ensure its positive economic forecasts are achieved.

This is even though Dr Lowe has acknowledged that “the focus needs to be on an improvement in the investment environment, so that investors are prepared to … use low funding costs to build new productive assets”.

This, though, is beyond the powers of even central banks.

Paul Brennan is an independent economist based in Sydney and has worked at Citigroup Global Markets as well as the RBA, federal Treasury and OECD.