- The Australian retail sector is experiencing its worst growth since the 1991 recession, according to new figures released by the Australian Bureau of Statistics (ABS).
- If the RBA decide negative interest rates are not the best way to boost consumer spending, they could employ Quantitative Easing (QE).
- QE has previously been implemented by Japan, the US and the UK and could be an option for Australia if spending and wage growth remain stagnant.
According to new figures released by the ABS, the Australian retail sector is experiencing its lowest annual growth since the 1991 recession. This alarming decline in consumer spending, however, is not an issue limited to Australia.
Global financial markets are in an uncertain spot right now and central banks around the world are employing methods previously labelled unconventional, like negative cash rates to boost their economies.
A global trend toward negative interest rates
Already in place in Denmark, Japan and Sweden, negative cash rates – and the consequent release of the first -0.5% ten year fixed rate mortgage – have highlighted a global need to stimulate consumer spending, but is this the right move?
Whilst it’s naïve to assume the Reserve Bank of Australia (RBA) will blindly follow in the footsteps of other central banks, we cannot deny the impact that long-lasting shifts in global interest rates have on Australian policy.
Quantitative Easing: is it time to start printing money?
In parliament last week, the RBA’s Governor Philip Lowe did not rule out Quantitative Easing (QE) — as a second unconventional method that could be applied. Previously executed in the UK, Japan and the US, this tactic could be implemented if negative interest rates are not in Australia’s best interests.
“I think, given the world we’re in, it is prudent to look at these things. As I said, it’s unlikely, but it is possible,” said Lowe.
“The world’s uncertain, and there are scenarios where we might decide that this is warranted. If that’s the case, it’s prudent for us to have done the work in advance to see what we would do. It’s really contingency planning. We’re thinking about what we might do,” he said.
The monetary policy of Quantitative Easing is relatively new to economics, but since its inception has been used across the globe.
Colloquially known as ‘money printing’, QE is a process where a central bank, like the RBA, uses their cash reserves to purchase existing government bonds, in order to pump money directly into the financial system.
These government bonds act as fixed-interest loan securities, to raise asset prices by improving future economic growth expectations and drive up the price of bonds to lower their yield (interest rate).
How low can interest rates go before QE is implemented?
If banks were to reduce their interest rates to below zero, the world of finance as we know it would flip upside down. Savers would pay the banks to hold their money, and borrowers would essentially earn money on the loans they took out.
The RBA cash rate is already at 1%, and home loan rates are the lowest in history, but it’s hard to imagine the big four banks dropping into negative rate territory.
The big banks consistently work to achieve a 10 to 15% return on equity (ROE) and lowering interest rates into negative territory will have a serious impact on that figure. ROE reveals how effectively profit is generated from stakeholder equity, and with a target of 15%, it’s futile to the banks’ bottom line to cut their rates any further, regardless of whether the cash rate moves below zero.
RateCity analysis shows that home loan interest rates are now as low as 2.79%, which begs the question – how much lower can they realistically go?
Lessons from QE in the United States
Dr Stephen Kirchner – Program Director of Trade and Investment at the United States Studies Centre – believes that Australian policymakers can learn from QE programs in the United States.
“The main lesson from this experience for Australia is that the Reserve Bank should transition quickly from the cash rate to QE as its main operating instrument for monetary policy before the level of the nominal cash rate becomes a constraint on the effective stance of monetary policy. The announced program of asset purchases should be open-ended in size and scope and tied explicitly to the achievement of macroeconomic objectives and not an expected future end date,” he said.
“By applying the lessons from the US experience with QE, it is likely Australia could obtain a larger effect from a smaller quantity of asset purchases as a share of GDP.”
What else can be done before resorting to negative interest rates or QE?
The RBA has raised concerns about a dependence upon monetary policy when in principle, fiscal policy – where the government adjusts its spending levels and tax rates to monitor and influence the economy – can create extra demand in the economy by lowering taxes or increasing government spending.
“Spending on infrastructure not only adds to demand in the economy right now … it can also directly improve the quality of people’s lives by reducing congestion and improving services … there’s no shortage of finance to do this … all governments in Australia can borrow for 10 years at less than 2%, and some can borrow at much less than this,” said Lowe in the Standing Committee on Economics last week.
Negative real interest on government loans
As of Wednesday 14th August, the 10-year rate for Australia government bonds was at 0.92%. Given the target for inflation is between two to 3%, this effectively means the government is borrowing at negative real interest.
Negative real interest rates occur when the inflation rate is greater than the nominal interest rate. Taking the example above, if the 10-year rate for Australian government bonds is 0.92% and the inflation rate is 2%, then the borrower gains 1.06% of every dollar borrowed per year.
Is this capacity to earn interest on every dollar borrowed enough to encourage the Federal government to invest in infrastructure, or will it push the RBA to begin the QE process? Only time will tell.