Uncertainty is poison in an economy.
When uncertainty rises business and consumers worry about the future, they either don’t invest or don’t spend because the outlook is unclear – or at least less clear than the usual ebb and flow of the business cycle.
Deciding what to invest in or whether you will have a job next week or next month, what the price of goods will be in a month or a year, how your family finances will look and how your children will afford university or housing is not only difficult but almost impossible when uncertainty rises.
Sometimes, like the dark days of the GFC, economic activity can grind to a halt.
Uncertainty is the real economy version of market volatility. At times of low volatility things are much easier to forecast than times of high volatility.
So as the RBA meets today and as uncertainty in the Australian economy has risen I believe that it is time for them to cut rates in Australia and cut them hard to 2%.
The Federal Government was handed an economy in transition but an economy that was making that transition.
Business and consumer confidence leapt even though business conditions lagged.
It was a sign of hope in the new government and the behavioural economist in me believed that it was a sign that people were looking for a new style of government.
Whatever the colour of your political affiliations Tony Abbott had convinced enough Australian businesses and the voting public that there would be a new style of Government after Labor’s “lies”. The electorate wanted a break from that, they wanted a fresh start.
But the government doesn’t seem to have appreciated the impact of its sales job on the electorate before the election and, as Malcolm Turnbull noted yesterday, has failed in its sales job of the budget and why its measures are necessary.
This is the key to uncertainty in the Australian economy at the moment.
The electorate – consumers – thought they got a certain style of government with a certain policy agenda. But the budget is very different to what consumers expected. It is littered with broken promises and it seems, if polls and consumer sentiment are to be believed, voters see it as unfair.
It’s the broken promises that are crucial from a behavioural economics angle. The Abbott government has broken promises – just like the last lot!
So it’s not just economic uncertainty it is political uncertainty too.
So with no recovery in consumer sentiment, with manufacturing’s nascent recovery seemingly abandoned and with the Aussie dollar atop 94 cents it is time for the RBA to play the same game the Fed under Bernanke and Yellen is playing. Get the currency down to stimulate growth.
More importantly though the RBA should cut to rebuild confidence – to let consumers and businesses know that like 2008 and 2009 the RBA is going to do its level best to keep this economy moving.
Last time we had the luxury of a China and a mining investment boom to drag the Australian economy out of the doldrums – we don’t have that luxury this time.
It’s time for the RBA to cut rates to 2%.