It’s amazing so many people are so sure they can see where the Reserve Bank is headed. Once interest rates are down to zero it will be on to QE - “quantitative easing” – and negative interest rates, they assure us. Don’t you believe it.
What’s surprising is how heavily the self-proclaimed experts are relying on their vivid imaginations. Or maybe lack of imagination, falling back on the lazy market dealer’s assumption that we should do – and will do – whatever the Americans have done.
What few in the financial markets and financial media are doing is their due diligence: carefully examining what the Reserve – particularly its governor, Dr Philip Lowe – has actually said about its attitude towards “unconventional monetary policy tools”.
Lowe had a lot to say when he appeared before the House economics committee in August. And in the Reserve’s written response to the committee’s questions. As well, Lowe had more to say when delivering a report on the topic by a Bank for International Settlements committee (BIS), which he chaired.
People assume the Reserve is hot to trot. It ain’t. It began the written response by saying “while at this point it is unlikely that the Reserve Bank will need to employ unconventional monetary measures, the [board] considered it prudent to understand the issues involved and has studied the experience of other countries”.
Prudence is the word. Since these are times when the unprecedented has become commonplace, Lowe is resolved to “never say never”. But don’t mistake this for enthusiasm. Read what he says -more in his remarks on his own behalf than as chair of the BIS committee – and you see how reluctant he is to start down the unconventional road.
He keeps repeating that the effectiveness of the various unconventional measures “depends upon the specific economic and financial conditions facing each economy at the time, as well as the structure of its financial system”.
That’s his way of saying, just because the Yanks did it, doesn’t mean we will.
His reference to the particular structure of a country’s financial system is especially relevant to the unconventional tool so many people assume is next: “purchasing government securities, so as to lower long-term risk-free interest rates”.
It’s a lot easier to believe this would stimulate private sector borrowing and spending in financial systems where home loans and business borrowing are geared to “the long end” – such as America’s – than in systems like ours, where lending for housing and small business is based on the short term and variable end of the interest-rate yield curve.
And Lowe’s reference to financial conditions at the time is also relevant: long-term interest rates are already at unprecedented lows. What would be gained by making them even lower?
If there’s one thing we ought to have figured out by now it’s that, whatever ails our economy at present, it ain’t that interest rates are too high.
People in the financial markets can fail to see this because, in all the trading of currencies and securities they do (many, many times more than would be necessary just to provide firms in the real economy with “deep” markets), so many of them make their living betting on the central bank’s next move.
When you’ve fallen into the habit of seeing the Reserve’s main role as holding regular race meetings, you see the conventional race days continuing until the official interest rate hits zero, obliging it to move to unconventional race days.
Trouble is, the Reserve thinks monetary policy is about the effect it has on the real economy of households and businesses, not about keeping money-market dealers in the luxury to which they’ve become accustomed.
For instance, it’s not at all clear that it will keep cutting until it hits zero. In its written response, the Reserve says that reducing the long-term bond rate “would involve reducing the cash rate to a very low level [my emphasis] and possibly purchasing government securities”.
Why get off at Redfern? Because there’s little point in cutting the official rate beyond the point where the banks are able to pass it on to their customers in the real economy.
Similarly, why would the Reserve engineer negative interest rates if the banks couldn’t get away with passing them on to their customers?
Lowe says the most clearly successful use of unconventional tools – buying private-sector securities - was at the height of the financial crisis when “the financial sector stalled and stopped doing its job, hamstrung by losses and drained of liquidity”.
However, security-buying policies aimed primarily at providing monetary stimulus were less obviously successful. So, should another financial crisis cause particular markets to freeze then, yes, sure, the Reserve would be in there taking whatever unconventional measures were needed to get them going again.
