A massive housing bubble could form if Australia pulls the trigger on negative interest rates and quantitative easing, analysts warn

The last thing Australia needs. (Photo by Christopher Furlong,Getty Images)

The diagnosis of an ailing Australian economy is widely accepted, but it’s how to treat it that’s increasingly proving contentious.

Despite unconventional methods, like negative interest rates and quantitative easing (QE), receiving the full endorsement of Reserve Bank of Australia (RBA) governor Philip Lowe – the man ultimately responsible for them – others remain highly sceptical.

That’s because having never been tested in Australia, the effect of tools like QE – where a central bank prints more money in order to purchase government bonds and other safe assets – is not entirely known.

“The RBA has stated that it would consider using a QE-style program to inject more money into the economy. Ideally, the recipients of these funds would use them to make greater investments and generate economic activity. However, the effectiveness of this policy in Australia is likely to be limited, given the existing abundance of money supply,” IBISWorld senior analyst Jason Aravanis said in a note issued to Business Insider Australia.

QE and negative interest rates could encourage Australians to make riskier investments and inflate a housing bubble in Australia.

IBISWorld warns a QE program would help push the price of less risky assets up as the RBA buys them, reducing their rate of return, and forcing Australians to take on more risk to get the same results. That could in turn set Australians up for plenty of heartache if the country were to then enter a recession, as the value of riskier assets plummets and their wealth is eroded.

But that’s not all.

“It is also possible that these funds will flow into the property market instead. Consequently, this measure risks only further inflating housing prices rather than stimulating the economy,” Aravanis said.

In other words, QE could more likely create a housing bubble than what the economy really needs: significant growth of jobs, wages, and spending.

The threat of a housing bubble has already been raised by the RBA itself, with Lowe warning falling interest rates could help create one as the cost of borrowing drops. With the official interest rate at 0.75% currently, and with a prevailing consensus that it will be cut to 0.5% early next year, the RBA nonetheless seems to be throwing caution to the wind.

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Further to that, Lowe has also warned QE and other unconventional tools could be used once the rate hits that benchmark. If rates were to then go negative, that could add more fuel to the fire, although Aravanis does believe they will have a net positive impact on the economy as money moves away from banks into the real economy.

The value of the Australian dollar could plunge as a result of unconventional monetary policy

The other major impact of QE is that it would discourage investment in Australia, as investment returns declined. As demand for the Australian dollar decreases – it’s currently at 10-year lows – so too will its value. While that’s bad news for Australians looking to travel or buy imported products, it’s generally considered good for the economy by increasing demand for now-cheaper Australian goods.

In the current economic climate, however, it’s unlikely to help Australia anyway.

“By depreciating the currency, the RBA would potentially improve export competitiveness and deliver an increase in inflation by making imported goods more expensive. However, this strategy’s effectiveness is predicated on other central banks not seeking to devalue their own currencies,” Aravanis said.

Interest rates around the world.

“Given that central banks in most of Australia’s major trading partners have also recently cut their cash rates, it is unlikely that this method would deliver economic stimulus,” he said.

That’s because as countries around the world cut their interest rates, the relative value of their currency is lowered. As each currency depreciates at the same time, the advantage of a weak dollar is lost.

READ MORE: The RBA has admitted further rate cuts will do little to help the economy as global politics takes its toll

The best stimulus right now would be government stimulus

Given these arguments, Aravanis joins other economists – including Lowe himself – in calling for the government, not the RBA, to spearhead stimulus measures.

“As the RBA has cut rates closer to zero, it has become evident that the capacity for monetary policy to meaningfully stimulate the economy is now marginal at best. In contrast, expansionary fiscal policy is likely to be far more effective in the current economic climate,” Aravanis said.

While the government has remained steadfast in its refusal to sacrifice a budget surplus, economists worry that any surplus it achieves could be short-lived – or worse, harmful – to the welfare of the Australian economy.

“It is an optimal time to ramp up fiscal spending on infrastructure, or offer greater tax breaks to Australian households. With a deteriorating economic climate, it is clear that other policy objectives are more important than simply achieving a budget surplus in 2019-20,” Aravanis said.

“If the Federal Government were to conduct fiscal expansion, it would significantly benefit several industries across the economy.”

With no fiscal stimulus in sight, the RBA looks to be getting impatient.

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