Australian politicians from both sides of the political fence are consistent indeed in explaining Australia’s economic fortunes. When growth rates in Australia falter, external factors like events in the US or Asia are pointed to as the key cause for blame by those in Government (whether Coalition or Labor) and those in Opposition blame inept economic management by the Government. When growth and employment are up those in Government put it down to excellent internal economic management, while those in Opposition either deny it is happening or put it down to good luck or flow-ons from external factors. Thus the economic mutterings and explanations on the causes of the current economic must be taken with a grain of salt. Moreover, economic forecasting and explanations by politicians has to be seen in the light of the electoral cycle. The closer the election the more panicked the response.
It is fortunate, indeed, therefore that one of the main levers of economic management – setting official interest rates — is in the hands of the Reserve Bank, more particularly, the monthly meeting of the Reserve Bank Board. It will meet tomorrow.
When it meets it will be bearing in mind that the United States seems set for a slowdown in growth, or maybe a mild recession. A recession in the US will affect our export markets, so Australia will need to boost domestic demand to replace it, if we are to avoid a worse downturn than otherwise in store. It can do that by lowering interest rates. Further, the US has already reduced interest rates by a full percentage point in the past month. This means that Australia can afford to lower interest rates without causing international investors to flee Australia, putting pressure on the currency by lowering the exchange rate.
The Reserve Bank has to perform a delicate balancing act. It must ensure that demand is not boosted to artificially high levels with low interest rates so as to fuel inflation. Conversely, it must not put the breaks too hard on with high interest rates to cause unnecessary business retraction and consequent unemployment.
The bank must also act within the context of the Government’s fiscal position. If government itself has boosted demand by increasing spending, then interest rates would have to stay higher than would otherwise be the case. However, the fiscal position is a slow-moving beast. Interest rates act on the economy more quickly.
The signs are that the Reserve should reduce interest rates, but some caution is warranted. The US economy, coming off a greater high, is slowing more quickly than the Australian economy. The US is going through a dot.com bust after a dot.com boom – a boom Australia never had. Also, retail figures issue last week indicate that the Australian economy is not as weak as commentators had earlier suggested.
Prime Minister John Howard and Treasurer Peter Costello have changed their tune since late last year when they were saying everything was rosy. Now they are warning that Australia is in for a slow-down and only the good economic managers – the Coalition – can be trusted to manage the economy in difficult times. It was self-serving twaddle. Much of it was insurance so that if the economy does slow in this election year, they can say that it was expected and predicted and there is no cause for alarm. The Reserve should to listen to the over-stated case by Mr Howard and Mr Costello. Nor should it get too alarmed at the US position, despite statements by its own deputy governor, Glenn Stevens, that the us slump could have a serious impact on Australia.
Rather it should hark back to the position of its Governor Ian Macfarlane late in 1999. Then he argued that it was better to engage in a constant fine tuning rather than fewer short, sharp shocks. Moreover, Australia has gone through a couple of local one-off events – the GST and the Olympics – the effect of which has not been worked through.
The Reserve should opt for a cautious quarter to half percent reduction, rather than attempt to engage in a big-boosting statement which it might have to partially reverse later. That would have an unnecessarily negative impact on business confidence.