With the official cash dropping to historic lows, what options are on the table for the Reserve Bank of Australia (RBA) to stimulate the economy?
The national economy is sluggish on some key growth metrics, and there are a range of measures the RBA could implement, which have been used in the US and Europe in modern history.
A likely option: further cash rate cuts
My feeling is that the RBA will exhaust cash rate cuts before looking at alternative monetary policy measures. With the official cash rate now at one per cent following cuts in June and July, we think there will be two more cuts to come. This would take the official cash rate down to 0.5 per cent.
Any further cuts are tough for the banks to pass on to their customers, for the simple reason that they won’t want to cut their deposit rates below zero. With that in mind, there’s not much point the RBA going beyond 0.5 or 0.25 per cent with the official cash rate.
What else can the RBA do?
One option available to the central bank could be to undertake quantitative easing. This involves using printed money to buy up securities, government bonds, highly-rated mortgaged-backed securities and highly-rated corporate debt.
The aim of quantitative easing is to inject cash into the economy, in the hope that some of it will be lent out, that people will take on more risk and that long-term interest rates will remain low.
This measure would provide some help. However, if you look at other countries that have employed quantitative easing, there hasn’t been a big increase in lending. Our bond and interest rates are already low, and most Australians borrow over the short-term and not the long-term.
Negative interest rates
The RBA could take interest rates negative, cutting them below zero in the hope that it would force the banks to lend more money out. However, the evidence in Europe is that while it can provide a bit of a boost to lending, it’s not dramatic.
It can also put a lot of pressure on the banks, because it cuts into their interest rate margins which would create its own drag, reducing their profitability and making it harder for the banks to lend.
In reality, I think negative interest rates is probably something the RBA would prefer to avoid.
A more radical option would be where the RBA uses printed money to directly finance government spending. That would probably be a better option, but there are concerns around this measure. Historically, for example in Germany in the 1920s, it has been associated with causing hyper-inflation. So there are some constraints around deploying it.
However, this measure can be done fairly, by targeting government spending to help lower and middle income earners, as opposed to higher income earners. It can also be done in a way that has a guaranteed impact on the economy.
While there are other things that the RBA can do to help the economy, at the end of the day I think we probably will need some more help from Canberra in the form of more fiscal stimulus from the Federal Government to ensure a boost to the Australian economy.
Subscribe to Oliver's Insights to receive my latest articlesShane Oliver, Head of Investment Strategy & Economic and Chief Economist
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