The Reserve Bank’s decision to leave official interest rates unchanged may not have been predicted by the markets, which were tipping a 25 to 50 basis point cut, but it was predictable. It makes no sense to use up precious stimulatory firepower until the effects of past cuts and the Federal Government’s massive stimulus package become clearer.
There are leads and lags in monetary policy. It takes anywhere from six months to 18 months for the full impact of a shift in monetary policy to become apparent. This cycle started last September and while the cumulative impact of 400 basis points of rate cuts could be expected to have an earlier and more pronounced effect than the bank’s more usual gradualism, it makes sense to have a pause in the cycle while the bank sits back for a while and considers how effective the rapid rate reduction strategy has been.
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That is particularly the case with the first phase of the Rudd Government’s second stimulus package about to get underway next month, when another deluge of cash will hit lower-income households, to be followed by the even bigger insulation and school building, and the public and defence housing programs as the year progresses.
The $52 billion of fiscal stimulus ($10.2 billion of it before Christmas) and 400 basis points of rate cuts equates to a massive injection of adrenaline into a faltering economy.
With most of the second Rudd package not flowing until the second half of this year, and with the lag in the impact of monetary policy, it simply isn’t possible to determine how much stimulus is enough. The data so far is ambiguous.
The RBA had been indicating in its more recent statements that it might sit back for a while and see how events unfolded
In his statement, the bank’s Glenn Stevens referred to the “major change” in both monetary and fiscal policies. Market and mortgage rates were at very low levels by historical standards, business loan rates were below recent averages and debt-servicing burdens had been reduced considerably.
The cumulative decline in rates and the fiscal stimuli would provide “significant support” for domestic demand over the period ahead, which was why, “notwithstanding evident economic weakness at present,” the bank decided that monetary settings were “appropriate for the moment”.
What the Governor didn’t say was that with the cash rate target now at 3.25%, the bank has diminishing flexibility.
It still has a lot more scope for further rate cuts than most of its international peers, who have exhausted their conventional monetary policy armouries and are now considering unconventional methods of intervention in markets. The RBA’s capacity is, in the circumstances, probably better kept in reserve in case the economy needs another round of boosting later in the year.
The Australian economy, even before the full impact of the measures taken by the Government and the RBA kick in, is holding up better than most of the world economy, where the economic downturn has generally been severe and continuing and banking systems are teetering. The Australian banking system is also intact and functioning reasonably – if not perfectly – normally.
Stevens acknowledged that economic conditions were weak and likely to remain so in the near term.
With the global conditions worsening and the full force of the bank’s and the Government’s response to it yet to flow, we are in something of a twilight zone.
The effects of the actions so far may insulate the Australian economy from the full brunt of the global economic meltdown. If they don’t, at least the Government and the central bank still have some ammunition left.
This article first appeared on Business Spectator.