- The federal government may force the Reserve Bank of Australia (RBA) to front up and explain why it’s failed to keep the Australian economy growing strongly.
- With the RBA having consistently missed its target of 2-3% growth, the move would heap more pressure on the central bank to cut interest rates further.
- More rate cuts will reduce the costs of borrowing, potentially flooding the property market with cheap money and inflating a housing bubble.
The Australian economy is in a rut and the Reserve Bank of Australia (RBA) needs to lift its game.
At least that’s the message from the Coalition government, as it intends to make the RBA explain why it’s failed to keep the economy growing above 2% every year.
Speaking to the media this week after the worst year-on-year growth since the global financial crisis (GFC), Treasurer Josh Frydenberg confirmed that he wants the central bank to pull its socks up.
“I am looking to have such an agreement and Treasury are currently engaged in a discussion with the Reserve Bank about that inflation target which is 2 to 3%. I think it has served Australia well,” he said.
“We’re in a new world with low interest rates, relatively low unemployment and low inflation. And if we’re going to have a 2 to 3% band, then we want to hit that target. And as you know, inflation is currently 1.6%.”
Frydenberg’s suggestion that the RBA would be under increased pressure to hit that target under a new agreement is a big departure from the previous one the RBA was operating under.
Both sides have previously watered down the need for strict inflation targets, and instead emphasised the broader objective of “welfare maximisation” — the importance of which Governor Philip Lowe lauded just weeks ago.
“It is worth remembering that inflation control is not the ultimate objective. Rather, it is a means to an end. And that end is the welfare of the society that we serve,” he said, addressing economists at a charity lunch in July.
In other words, the RBA has in recent years aimed to keep the economy delivering as best it can for the Australian people given the circumstances, rather than only trying to kick growth between the 2-3% goal posts.
Historically that rate growth had been considered the optimal rate at which to grow the economy — quick enough to keep increasing wealth but slow enough so as not to lose control of the economy. However, with a global slowdown threatening, many developed economies have struggled to grow at that rate.
In this brave new world, central banks like the RBA have had to adapt, hence trying to keep the economy growing but with a focus on other objectives such as maintaining a strong labour force. This has kept Lowe from simply slashing interest rates — the RBA’s most powerful tool — to 0% to hit the target.
It hints at a divide amongst economists. Critics of Lowe say he has no choice but to cut so shouldn’t bide his time. Others have blamed persistently weak wage growth on his lack of focus on inflation.
If a new agreement is reached however, the RBA will have to answer to the government for low growth which is forecast to continue. That could renergise the RBA to cut again which will do more than increase inflation, Lowe has warned.
“[Our] decisions affect borrowing and asset prices and thus financial stability too. Central banks have to determine how to balance these considerations when making monetary policy decisions,” he said.
Lower rates make borrowing cheaper, which in turn tends to flood the property market with cheap credit, driving prices up. Lowe has flagged this risk before, insisting he wants to grow the economy without creating a property bubble — another way of saying he wants to maximise the welfare of the country.
Given the recent surge in national house prices suggest that the last two cuts have already helped prop up prices, further cuts could simply add fuel to the fire.
“I sometimes feel that as some central banks sought to establish their credentials as inflation fighters they over-emphasised the importance of short-run inflation outcomes. And this has been difficult to walk back from,” Lowe said.
While some economists have criticised Lowe for dragging his feet on cutting rates, he has been trying to walk a fine line. A new agreement threatens to throw that out the window and force his hand.
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