The Reserve Bank of Australia is playing a dangerous game. First its Governor, Ian Macfarlane, used words at a parliamentary committee hearing last week that could only translate as meaning an increase in interest rates of 2 per cent in the near to medium future. Then this week the bank increased rates by a quarter of one per cent (25 basis points in the jargon) which followed a similar rise a month ago.
It may be that Mr Macfarlane was engaging in some artful scare tactics. By merely warning of such large rises, he will cause consumer sentiment to turn, particularly in the housing market. That might not be such a bad thing. The alacrity with which people put their hands up a real-estate auctions, particularly in Sydney, is alarming. However, the Australian economy is more than the Sydney housing market. And in any event the Sydney housing market will adjust itself without any help from Mr Macfarlane. There comes a time when people in Sydney will question whether they will get a return on capital and whether it is wise to spend so much on housing. It does not matter a great deal whether the Sydney housing boom busts this year, next year or the year after. No the real concern is business investment. If Mr Macfarlane succeeds in scaring the business-investment horses as well as the hapless home-buyers of Sydney, he will not have done the country a service.
He trouble with the second rate rise is that it came so soon after the previous one. What significant trends can possibly emerge in a month? It might have been better to have waited. It takes time for consumer and business sentiment to change and even longer for that to translate into action. And then greater time is needed to see how that flows through with the multiplier effect. It is almost an admission that the bank got it wrong the time before last and should have increased the rate by half a per cent instead of a quarter per cent – and few would argue that.
True, inflation is running uncomfortably close to the top of the 3 per cent target set by the bank and Government, but it is hardly runaway. Inflation must be recognised as a danger and the most important economic indicator to keep under control. But it is debatable whether interest rates on their own can control it. The bank is also worried about wage growth. Once again, though, one must question whether raising interest rates will do anything to stem wage increases. More likely, the higher cost of servicing mortgages will cause employees and unions to press for higher wage increases to maintain their standard of living. If businesses then get hit with higher wage demands at a time of feeling the cost of higher interest rates, it could be very difficult for business investment and the consequent wealth generation.
Maintaining a good climate for business investment should rate more highly in the bank’s considerations. Business investment drives economic growth, wealth generation and higher standards of living. To some extent the bank’s hand has been forced by the government irresponsible boost in fairly unproductive government spending (or at least spending unmatched by productivity) in the lead up to the last election just before the last election. The Government needs to rein in more now.
Mr Macfarlane has been too robust on the interest-rate front. Australia does not have to repeat the mistakes of the early 1990s and have “”a recession we had to have”. That recession was caused by a too severe interest-rate policy. Yes, the bank should tighten a little, but it plays a dangerous game in forecasting high rate increases and then setting down the path to fulfill that forecast.