Let me count the ways.
- The way already receiving attention is the narrowness of the base of the action of monetary policy. Lots of households don’t get squeezed by monetary policy. A small number with interest income earn more. Lots of families pay more interest but a lot have paid off a fair bit of their mortgage and can extend their term or reduce the rate at which they’re paying off their loan early, so they don’t reduce their consumption. But the main burden is those with high debt. Monetary policy is sometimes called a ‘blunt’ instrument for this reason, but it’s really too sharp an instrument – that is it has too narrow a base. Fiscal contraction (spending cuts or tax increases) can be much more broadly based.
- Monetary policy is a ‘blunt instrument’ in another sense – it has proverbially ‘long and variable lags’. Its effect on firms’ investment takes a good while to come through, is hard to predict and, can come on suddenly.
- Tight monetary policy sees our exchange rate rise. You can argue that that’s pretty healthy in this climate in which we’re busting a gut to push resources into mining. But the risk is that we see disinvestment elsewhere in our traded sector reducing its contribution to export in the future. With current account deficits like ours, that may not be a good thing.
All these problems were with us last time we were in a similar situation – which was the late 1980s. One can add the inflationary pressure and the pressure on wages. It seems to me there’s at least one further problem now.
- High interest rates are depressing construction and, to my amazement, the heady prices being paid for residential property around the country are insufficient to attract sufficient resources into the sector. Rents are rising strongly and will continue to do so – adding to inflation and to interest rates.
We are living in interesting – and tricky times.