Why Cutting Interest Rates Won't Juice The Economy
The Reserve Bank of Australia issued its latest interest rate decision this week.
Recent economic data has confirmed a serious slowdown in the national economy. GDP growth has fallen close to zero -- and in per capita terms, it’s shrinking. Inflation also fell to zero, heightening the risk Australia could tip into deflation. Property prices continue their plunge, business investment is weak, and consumer spending is also declining.
In short, it’s possible Australia has already entered recession -- its first in 28 years.
Given all that bad news, it would normally be a no-brainer for the RBA to cut the interest rate. It takes several months for rates to affect the broader economy, so if anything they are already late in responding to this slowdown.
However, in the midst of a heated federal election campaign, discretion was the better part of valour for RBA Governor Philip Lowe. He knew a decision to cut rates would become a political football: raising high-profile questions about the government’s economic strategy. So he stayed on the sidelines, for now.
But if the numbers continue to deteriorate, expect an interest rate cut soon after the election.
It’s doubtful how much impact a rate cut would have, in any event. The Bank’s benchmark rate has been at 1.5 percent since August 2016. That is negative in real terms: adjusted for consumer prices, borrowers actually pay back less than they borrowed. (Of course, average consumers don’t get such low rates -- they’re reserved for banks and other large institutions.)
Ultra-low interest rates have not stimulated business investment, still in the doldrums after the collapse of the mining boom. They haven’t prevented the meltdown in property prices -- which were themselves inflated by even lower interest rates in previous years. And they aren’t rescuing consumer spending, either.
Indeed, there’s an obvious explanation for weak consumer demand: Australian wages have been stuck in the mud for several years. Since 2013, wages have been growing at the slowest sustained pace since the Second World War -- about two percent per year, barely matching inflation. With wages going nowhere fast, and consumer debt already equal to 200 percent of disposable income, cutting interest rates is like pushing on a string.
The RBA has repeatedly highlighted the consequences of low wages for overall economic performance. But in announcing the decision to keep rates on hold, Dr Lowe clung to his hope that growing employment would light a fire under Australians’ pay packets. He noted a recent uptick in wage growth: inching up from an annual pace of under two percent in 2016 to 2.2 percent last year. And he expressed faith that more wage acceleration is in store: we just have to be patient.
Dr Lowe’s confidence that market forces will automatically restore normal wage growth is unjustified for two key reasons. First, growth in the number of jobs doesn’t say anything about the quality of those jobs. With almost one in three Australians employed in part-time work, and even more in contract, labour-hire, and ‘gig’ positions, merely having a job no longer guarantees steady, rising wages.
Second, to the extent that wage growth did rebound slightly in 2018, it was an institutional decision, not market forces, that deserves the credit. The Fair Work Commission decreed a big 3.5 percent increase in the national minimum wage, effective 1 July last year -- the biggest hike since 2010. One in four Australian employees receive wages tied to that national minimum, through wage categories specified under the modern awards system. So about a quarter of Aussie workers (mostly lower-wage) got a welcome 3.5 percent raise on July 1.
That proactive decision lifted the average wage paid in the overall labour market by close to a full percentage point. And it single-handedly accounts for all of the improvement in average wage growth recorded in 2018. Based on the size and scope of the minimum wage increase, we can estimate average wage gains flowing to non-award workers: just 1.8 percent in 2018, as bad as ever. And after extracting the impact of the big minimum wage boost, the underlying wage trend was actually slightly worse in 2018 than the year before.
So Governor Lowe is barking up the wrong tree, hoping that market pressures of their own accord, even if lubricated by lower interest rates, will fix the wage problem. Yes, wage growth must be resuscitated to avoid recession and rekindle growth.
But it will take proactive measures, starting with further improvements in the minimum wage, to make that happen.
Wages have been a hot topic in the current federal campaign. Labor leader Bill Shorten declared the campaign would be a “referendum” on wages, and the major parties have made starkly contrasting promises about wage and workplace issues.
Governor Lowe is sitting out the campaign, keeping his hand off the interest rate lever despite the gathering storm clouds. But in any event, there are more powerful remedies available to fix stagnant wages and weak consumer spending.
Voters will decide on May 18 which of those remedies will be put to use.
Main Photo: Working Title Films