The office of Treasurer Peter Costello has taken up the role of consumer advocate by ringing the major banks asking them (read, pressuring them) when they would be passing on to consumers the cut in interest rates announced by the Reserve Bank on Wednesday. Mr Costello then chided the National Australia Bank for being the most tardy in passing on the cut, even suggesting that consumers take it into account when choosing which bank to go to when taking out a new loan. He praised Westpac for being the first off the mark.
The tactic of getting down to that level of details carries a certain amount of risk. The NAB is waiting a whole 12 days to pass on the cut. That equals $8.22 on a $100,000 loan. It is trivial, given that the difference in bank fees and value of other services could be many times that, particularly for people taking out new loans. In a competitive environment, banks present a variety of products with different interest rates and different fees for different services with varying flexibility and varying ranges of quality and flexibility of services. There is more to choosing a bank than judging them on the speed of passing on interest-rate cuts. Governments should not be in the business of advertising the wares of one bank over another. That is a matter for consumers and the market.
With an election just around the corner, the Treasurer clearly wants to be seen as the good guy – the man who delivered interest rate cuts right now. There was really no need to get down to that level. Despite its recent profligacy, the Government can still take a lot of credit for its economic management. It has delivered four surplus Budgets. It has repaid some $60 billion in government debt. It has created a much better climate for the Reserve Bank to contemplate interest rate cuts.
Perhaps of more import is the question of how effective are interest rates as a tool of economic policy. It was fairly apparent in the 1990s that raising interest rates in an attempt to put a brake on rising imports and a deteriorating balance of trade position was a flawed policy. The rising rates put a brake on everything and plunged Australia in the recession we did not really need to have. A floating exchange rate seems to do the trick quite satisfactorily, especially combined with tax reform, as we are now seeing. Exports have improved as has the balance of trade. It is too bad for a few overseas travellers, but again their reluctance to travel will only help the balance of trade.
The question now is whether cutting interest rates will do the job expected. In theory people will be attracted into the housing market with lower rates. However, housing has already had a major boost with the first-home-buyers scheme, and probably does not need further boosting. In any event, the general low-interest environment has put many more people in reach of their first home that it is difficult to see whether any further cuts will have much effect, especially as people will not stretch themselves too much in a low interest rate environment out of a fear that rates might go back up again.
Lower interest rates are also regarded as a stimulant to consumer spending because people have more money in their pockets. That is fine in theory, but in practice most borrowers tend to reduce the term of their loan rather than reduce the amount of the repayment. This is especially true in uncertain economic times – the very times that economic policy advisers urge lower rates.
Raising rates will damp consumer confidence and capacity, but it does not follow that lower rates will improve consumer confidence.
Lowering rates might take a lot longer than imagined to flow through to consumer confidence. Borrowers will first use the rate cut to reduce their loans and to get a bit of a buffer in uncertain times before going on a spree.