Interest Rates: How High Will They Go?
Interest Rates: How High Will They Go?
An estimated $150 million was bet on the 2009 Melbourne Cup. The well-backed Shocking winning the race wasn’t the best result for bookies but, roughly, punters probably lost something in the order of $15 million. That’s big money for a horse race, but small change when compared with the damage RBA Governor Glenn Stevens did on the same day.
The latest RBA statistics show $865 billion of homes loans outstanding in Australia. An estimated 85% of those are variable rate. So, when the Governor puts interest rates up 0.25%, the cost to Australia’s homeowners is $1.8 billion a year.
Now that’s big bikkies. Still, the cup day rate rise shouldn’t have come as a surprise. It had been well flagged by the RBA and expected by financial markets. The big question now is: how high will they go?
All the official talk is about keeping inflation under wraps. But, for a guy who has sensed the need to start applying the monetary brakes before any other central bank around the world, Stevens seems remarkably sanguine about the risk of inflation: ‘Both CPI and underlying inflation are expected to be consistent with the target in 2010.’
Of course, he may be worried about beyond 2010. The economy is, Stevens pointed out in a recent speech to The Melbourne Institute, coming out of this recession with less ‘spare capacity’ than previous recessions. That’s good news if you’re looking for a job, but also means inflation could rare its ugly head much sooner than we all would like.
But I think the RBA is also pursuing a different agenda. Stevens has been at pains to point out that the 3% benchmark rate we’ve seen over the past 6 months was an ‘emergency’ rate. Now that we’ve seen off the emergency, the RBA wants to get back to a level that it considers ‘normal’ sooner rather than later.
Official interest rates are a tool that the RBA uses to regulate the economy. When things get a bit heated, they put rates up, which reduces the demand for loans and takes a bit of cash out of people’s pockets. When the economy hits the skids, like it has during the past year or so, the RBA can slash rates, making it easier for people to borrow and giving them more cash so that demand can be maintained.
The problem is that you can’t have rates less than zero (Well, that’s not quite true. Sweden’s Riksbank did make its deposit rates negative at one point. Generally, though, this rule holds. Why would you put your money in the bank if you get less back once you take it out?). Japan has been hard up against this limit for more than a decade. Interest rates are zero, the economy remains moribund and there’s nothing the central bank can do about it. The US is also at zero, has been there for almost a year and shows no signs of raising rates soon. So what happens the next time a recession rolls around? Ben Bernanke, Chairman of the US’s Federal Reserve, will have nothing to play with.
That and not inflation is, I believe, why Glenn Stevens is so keen to get interest rates back up before Australia gets used to 3%. He’s trying to rebuild his ammunition pile so that, next time trouble rolls around, he has plenty to play with again. I’d guess his target is somewhere between 5% and 6%. Whether our highly leveraged economy can handle it or not is another question, but that’s where Stevens would like to be.
Custom Search 2
Comments
And this seems to be prudent monetary policy. It seems a logical approach to move to have monetary tools available in a time of crisis (severe inflation or slump in demand) vs risking inflation as well as blunting this key tool.
The only thing that worries me about raising rates while the rest of the developed world has them camped at zero is the effect it is having on the $AU. There must be a point where this really becomes crippling for our exporters. Our sharemarket is allready one big carry trade for US institutions. So I don't think the RBA should go too hard to soon.
Is it really possible for any central bank to know what interest rates should be? Can the GFC caused by too much debt/leverage be solved by more of the same and by the people who never saw it coming? Alan Greenspan famously commented that he could never recognize a 'bubble' until after it had popped. How about allowing the free market to determine interest rates?
Re your into- I thought I read that the TAB hold alone was $167m. Add that to the bookies, sports betters, Betfair, sweeps, calcuttas, etc and you could go close to $225m or so- $10 for each Aussie.
Which is exactly Governor Glenns'problem- we like a punt, like to take too much risk, like to take the (perceived) easy option by buying a lazy investment property or three, max the credit cards, etc, etc. So Glenn has to keep us real by continually reminding us he will jack up interest rates, basically to protect us from ourselves
I have wondered why the RBA only has one tool at hand (interest rate adjustment) to adjust 'things' in the economy.
Put interest rates down and the borrowers are pleased and the lenders are not, put interest rates up the borrowers are impacted and the lenders are pleased. In both cases a different part of the community affected.
However if he could get to play with the GST rate all the community are affected beneficially I suppose if it goes down - everything is cheaper (equivalent to a stimulus?) and if they go up everything is dearer and so we are all affected.
Mixing the two of interest rates and GST rate might allow better tuning than the bluntness of just interest rate adjustment.
cheers
The problem with that is it would make it enormously complicated for businesses to calculate what GST they owe if they rate can change every month - as well as the amount charged for all goods and services. Everyone would have to run around changing the prices of things every other month. It sounds like a good idea in principle, but the application just wouldn't be possible.
Yes indeed. We all keep subscribing to this notion central bankers have the wisdom to guide and direct our economy. Even if central banks were trully independent of political pressures, which they're not, I don't believe they are trully independent - at the end of the day, they have demonstrated themselves not to be independent thinkers. Central bankers, treasurers and mainstream economists - don't they all speak the same mindless babble as the mainstream financial media? And what's their track record? Unsustainable 'Growth' creating massive asset bubbles, followed by crashes that "they never saw coming because they don't have a crystal ball". Meanwhile they continue to punish savers, because consumption is our saviour. Hello? By investing less and spending more we are laying the foundations of our economic nirvana? And these are the wise monkeys that are supposed to direct our economy?
The 'Taylor Rule' may provide a clue as to the RBA's interest rate target.
It uses a neutral rate, expected GDP relative to long-term trends and expected inflation relative to a central bank’s targeted amount to work out a target interest rate.
The equation is TARGET RATE = NEUTRAL RATE + (.5X(GDP EXPECTED - GDP TREND) + .5X(INFLATION EXPECTED - INFLATION TARGET)). It is a simple tool but effective.
Assuming a neutral interest rate of 5.0%, 2010 GDP of 3.5%, L-T trend GDP of 3.5%, 2010 expected inflation of 3.5% and target inflation of 2.5% the RBA target rate is 5.5%, which is the middle of Steve's guess.
Steve
The interest rate issue is highly pertinent, and your well positioned post has elicited some thoughtful responses.
It would be nice to think that the market could give us appropriate rates, but our interest rates are artificially low and it appears that they need to be artificially raised, (we have seen what greed and speculation can do in a low interest rate environment).
Unfortunately the RBA also has to act as a foil for the politically inept stimulous. I note that low interest rates coupled with the outrageous first home assistance package, at a time of excessive population growth are reeking havoc in the Melbourne residential real estate market - with this level of political ineptitude, thanks be that we have an RBA with one foot on the ground.
It's also fiscal policy, controlled by the government, and not monetary policy. All you are doing by raising the GST rate is taking money out of the hands of consumers and putting it in the hands of the government. It's much simpler to do this by fiddling with the amount of government expenditure than fiddling with the GST rate (although there doesn't seem any other long term solution to the US's problems than to raise tax rates).
Central banks do have other tools (witness the 'quantitatvie easing' taking place around the world) but controlling the overnight money market rate has been deemed the most effective and transparent.
Did Stevens really cause that much damage? Is it true that only 30% of home owners have a mortgage?
As a self funded retiree I am delighted to see interest rates going up.
If the RBA thinks that raising interest rates can solve economic ills, they are kidding themselves. Take this for example, my parents bought their house for $70000 when interest rates were between 10-13% in the late 80's. Now their house is valued over $250000. So much for contolling inflation? The average house loan now is $300000. Think about the cost of repayments now. Yes, raising interest rates might bring down inflation but what happens when people are unable to pay their mortgages when interest rates continue to rise? People declare bankrupt and they can't pay a cent back. Raising interest rates might benefit the lender but at the end it will be detrimental to them, The big banks owe money to other lenders and then they become backrupt. The RBA are short thinkers; and those people who work for them are on high wages so they are not sympathetic to the working class (just like politicians). We will eventually see an american style housing crisis. And then we will have the ETS coming in by Rudd. Electricity goes up, food and other supplies go up. Maybe it is time for the RBA to think that government policies are the cause to inflation. Wake up, it is not too hard.
Matt, I don't think it's a case of 'raising interest rates will solve economic ills', but rather having artificially low interest rates over extended periods has caused severe financial & economic distortions. The reason house prices (and other asset prices) have gone up so dramatically since the 80's, I would suggest, has more to do with the fact that interest rates dropped dramatically, and then were held at very low levels for a sustained period. Governments trumpet low interest rates on the basis that mortgages will be more afforable - and yet affordability has gone down! This is typical of distortions created by regulators who are short term focused. Perhaps as Robert H says, having rates set by the market is the only solution? Also, on the subject of low interest rates, why should we keep punishing people like Brian S? Why shouldn't we get a decent return for our savings? Why shouldn't people have to pay a reasonable interest rate to borrow? Any incentive to be prudent with ones borrowings would have to be a good thing.
Absolutely right James ... and with the USD at 0-0.25% it's basically a new global carry trade (replacing the Yen carry trade), with the hot money flowing from Wall St in to Oz in search of yield.
Stevens may want to put the cat back into the bag, but he will be severely constrained by the actions of his fellow central bankers in this regard.
Central bankers don't have a damn clue. Anyone who thinks that an inflationary "helicopter drop" represents good monetary policy (like Bernanke) needs their head read.
Unfortunately most bankers and economists have their chains of causation completely wrong; they believe in a fiat-currency world where fractional reserves and money printing can keep the party raging forever, and where credit simply doesn't exist (and debt doesn't matter) because it doesn't fit their Chicago-school model.
No doubt the next time the global economy falls into a (predictably larger) heap, they will be left scratching their heads and wondering where it all went wrong. The UKis one more QE session away from a run on the pound, and I wonder whether the de-facto reserve (the USD) is that much further behind.
Central bankers who seem to think that "temporary" 8% GDP deficits can be sustained on the back of >100% debt-to-GDP ratios need a beating. When the revolution comes it will be their backs against the wall, to be sure.
On confused chains of causation, this piece is well worth a read:
http://www.nakedcapitalism.com/2009/09/guest-post-if-credit-is-not-creat...
So we have to ask ourselves, how are our regulators any better than those of Zimbabwe or Bolivia? We are all very smug (perhaps even subconsciously) in the belief that our leaders and regulators are so mutch more prudent, wise and sophisticated than in these banana republics. But is this really so? We are simply supported by a much more robust economy that can sustain, to higher degree, the beating of the economic witch doctors.
Post new comment