Why we should have lower rates

Mark Crosby explains – I couldn’t agree more.

The RBA released minutes of their most recent meeting yesterday. Debate in the press today about the merits of the RBA keeping their powder dry, or whether they should have cut further. The minutes end with

The question for policy was whether further stimulus should be added at this meeting, or whether, having reduced rates at each meeting since September, the Board should pause for a further evaluation of the situation. Members could see reasonable cases for both courses of action. On balance, they judged that, having made a major change to monetary policy over the preceding several meetings in anticipation of weak economic conditions, the best course for this meeting was to leave the cash rate unchanged. Members believed this would leave adequate flexibility for policy at future meetings.

Alan Oster likened the argument for holding fire as like waiting for the hole to get deeper before trying to dig yourself out. I agree with him on this. There is no sense waiting for further evidence of deteriorating local and global conditions. Delaying cutting just delays the normal response to monetary loosening – Japan made the mistake of waiting too long to cut real interest rates in the early 1990s – eventually inflation became deflation, and it was not possible in the end to deliver the negative real rates that Japan needed to help stimulate recovery. One issue is why central bank interest rate changes are positively autocorrelated. If a new piece of information about the economy arrives that affects the desired target cash rate there is no theoretical reason not to go straight to the new target cash rate.  The fact that rates were cut for several meetings after September suggests that cuts made late last year should have been larger, particularly after the consistent bad news of Q4 when it became evident how poorly the global economy is travelling. The cash rate should have been 2% or below by January this year.

I liken the argument to the captain of the Titanic seeing the iceberg and saying ‘this ship takes a long time to turn round, so it would be silly to change direction too suddenly. I’ll just turn the rudder a few degrees and review the situation in a few minutes.  Don’t want to give away all my ability to turn – what if I need to turn more in a few minutes.

This entry was posted in Uncategorised. Bookmark the permalink.
Subscribe
Notify of
guest
8 Comments
Oldest
Newest Most Voted
Inline Feedbacks
View all comments
Patrick
Patrick(@patrick)
12 years ago

I agree as well. But these are the same people who raised rates even when it was patently obvious, at least in the finance industry (which they should have a feel for I would have thought), that the shite was hitting the fan.

I expect they will be most influenced by ‘peer pressure’, really.

observa
observa
12 years ago

Well actually the captain of the Titanic believed his ship was unsinkable, because all the engineering expertise told him so and he didn’t have to worry about icebergs anymore so he could keep on travelling full steam ahead. Unfortunately he and the passengers discover to their dismay, this isn’t quite so, but the Reserve Band are still playing on trying to maintain a sense of calm and orderliness in such matters.

Paul Frijters
Paul Frijters(@paul-frijters)
12 years ago

I have not seen any convincing evidence that it is good to have zero percent interest rates for any sustained period of time. Zero interest rates means no return on savings which means the money will flow elsewhere, as indeed happened with Japan. Also, you get the phenomenon of quite extreme leveraging if interest rates are close to zero (borrowing costs nothing), which is one of the things that got us into this mess. Just because the US, with its rather unenviable history of financial controls and outcomes, has near-zero interest rates doesnt mean it is the right thing to do for us. I think the RBA did the right thing.

pedro
pedro
12 years ago

One the subject of using the stairs instead of the elevator for the rate cutting, is there an issue with bank adjustment to the new reality, at least for deposit rates? Dropping 2% in one go could be disruptive on that side of the ledger.

A can see your point on the powder kept dry position, but I wonder whether the RBA does not want to drop to a level it will soon rise from, again because of the disruption. Mind you, I’m waiting for the next drops so I can lock in.

derrida derider
derrida derider
12 years ago

Yes, the “keep you powder dry” argument is as great a nonsense with monetary as with fiscal policy.

As soon as the enemy is in range you should fire with everything you’ve got – and this enemy is in very close range indeed relative to the time it takes such ordnance to have an effect.

If it was because abrupt moves might cause inconvenience to the banks then it’s a scandal – bugger the banks, I say. Anyway such inconvenience mmust pale next to the inconvenience deflation would cause the bastards.

observa
observa
12 years ago

“bugger the banks, I say.” Can I take it then you’re not in favour of that 100% taxpayer deposit guarantee then derrida? As for ‘everything they’ve got’ we’ve seen the results of Keynesian shock and awe. They give AIG an awesome $200 bill and are then shocked that execs continue to pay themselves $160 mill in bonuses. That’s OK they’ll offer to give back $160 mill of the handouts to set it all to rights. And they wonder why there’s an investment strike? Sheesh! As for printing money at near zero rates, these buffoons have no inkling of what happens to bond prices as interest rates rise 0.5 or 1% from near zero. It’s a lot different to rising 0.5-1% from 7 or 8%. All that fiat dough and the world economy still goes backwards.

Paul Frijters
Paul Frijters(@paul-frijters)
12 years ago

nick and all,

we are going through some of the most grand economic experimentation the world has ever seen, where a whole host of market distortions and irrationalities is being countered by a whole host of further market distortions. Zero-percent interest rates in the US; the money press has just been put on maximum; a large number of loans to developing countries is about to expire and seems unlikely to be rolled over; the Chinese are showing signs of being less willing to keep buying US bonds which, if this happens, will put the US dollar in free-fall; asymmetric deposit guarantees; de facto nationalisation of many of the worlds biggest financial institutions; a grandfathered bailout of the mistakes of the past via debts future generations will have to pay off; all against the backdrop of more volatile commodity, food, and oil prices than living memory allows. No one really knows what to do in these circumstances, so who can possibly give simple cut-and-dry answers to any of the associated policy questions?

Let’s think a bit harder about this zero-interest rate thing. If the interest rates differential between us and the US/EU goes down, this will undoubtedly put pressure on our exchange rate. Good or bad, who knows? Probably bad if it falls too fast. Zero-interest rates are a distorion. Yes, they encourage people to put off repaying their mortgage and buy an extra car, but they also encourage irresponsible leveraging, which is particularly dangerous in the face of the bank guarantees.

On balance, I think there is something to be said for having a reasonable long-term interest rate being the rate at this moment.