Rate cuts failing to bite: RBA

INTEREST rate cuts are losing the ability to stimulate the economy, the Reserve Bank has warned.

INTEREST rate cuts are losing the ability to stimulate the economy, with the Reserve Bank warning that it is up to the government to take measures to help revitalise growth.

In a frank admission of the limits to the influence of central banks, Reserve Bank deputy governor Philip Lowe said consumers, businesses and governments were not responding to the extraord­inarily low interest rates that would once have sparked an inflationary debt boom.

Dr Lowe said rate cuts were having little effect on household consumption because retirees and other savers were being forced to cut back their spending and their income fell in line with rates, while people with debts were using lower rates to accelerate repayments rather than raising their spending.

In a speech in Sydney yesterday, Dr Lowe said monetary policy was becoming less effective worldwide. He said inflation rates were falling and investment and consumption growth remained depressed, despite years of exceptionally low interest rates — including the current record low of 2.25 per cent in Australia — and the extraordinary support provided by the major advanced nations­’ central banks buying their governments’ bonds.

“Economic activity does not appear to have responded to the stimulatory monetary conditions in the way that occurred in the past and inflation rates have been very low,” he said. “I find it difficult to escape the conclusion that changes in interest rates are not ­affecting decisions about spending and saving in the way they might once have done.”

The RBA opted this week to keep rates on hold at 2.25 per cent — less than half their level of 4.75 per cent in late 2011 — but many economists expect a 25-basis-point cut to a new record low of 2 per cent in coming months, with the economy remaining soft.

Dr Lowe said that one of the ways monetary policy worked was by encouraging people to bring forward spending, either by borrowing or drawing on their savings.

“In the years leading up to the (global financial) crisis, a reduction in interest rates could be reliably predicted to encourage such a response,” he said.

“Credit was easily accessible, economic volatility in many economies was low and people were prepared to borrow. In today’s world, things look quite different.”

An interest rate cut puts more money into the aggregate household budget because household borrowing is always much larger than household deposits in savings institutions. However, savers and borrowers respond in different ways. “Many borrowers have responded to the lower interest rates of recent years by paying off their loan a little faster, rather than increasing their spending,” he said.

Since the rate cuts that began with the global financial crisis, repayments on home loans have risen to exceed the scheduled repayments. “Conversely, it seems likely that those relying on interest income have reduced their spending by more than would previously have been the case,” Dr Lowe said. “Certainly, the many letters we have been receiving at the bank recent­ly would suggest this.”

Dr Lowe said the most important single reason for the loss of effectiv­eness in monetary policy around the world was the size of the debts that were built up ahead of the GFC. In the case of Australian households, there was a big rise in mortgage debts in the decade to the mid-2000s as people reac­ted to lower rates and increase­d availability of finance.

“In (this) earlier period, the level of interest rates that we have today would have caused a large boom in borrowing, but this has not occurred,” Dr Lowe said.

The surge in house prices in the early 2000s led households to withdraw equity from their homes, increasing their mortgages, and using the proceeds to fatten the household budget. Despite the recent lift in house prices, households are continuing to inject additional equity into their homes.

Dr Lowe said the same reaction to low interest rates could be seen in governments. “Few governments have seen the very low intere­st rates as an opportunity to support long-term infrastructure investment at low cost,” he said.

“Rather, much as households have done, governments have taken advantage of the lower debt-servicing costs to help shore up their finances.”

Dr Lowe said that although monetary policy was less effective than it once was, it was still helping to support the Australian economy. He said the lift in housing construction was exactly what had been expected by the Reserve Bank when it cut rates in the second half of 2013.

This was boosting employment in the construction industry and bringing added benefits through spending on homewares and relate­d goods.

Lower interest rates have also contributed to the fall in the Australian dollar — from more than $US1 in mid-2013 to about US78c now — making industries exposed to international trade more competitive. An early sign of this was a lift in exports by services sectors such as education and tourism. “I don’t think we’re at the point of concluding that monetary policy is not effective in boosting the economy,” Dr Lowe said.

“We’re some way from that and we do have the scope to lower intere­st rates further if we deem that that’s appropriate.”

Dr Lowe said that, stepping back from the short-term problems, the broader issue for the globa­l economy was that there was a greater appetite for saving than for investment.

“The solution to the problems caused by the disconnect between the desire to save and the desire to invest cannot lie with monetary policy,” he said.

“Instead, it lies in measures to improve the investment environment so that once again there is strong productive demand for the use of our societies’ savings.”