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Interest Rates And If The Dead Horse Doesn’t Move, Flog It Harder!

“The Australian Financial Review” made an interesting statement in its editorial. Apart from that being unusual in itself, I thought it interesting because of what I inferred from it. When talking about the Reserve Bank’s desire to get inflation back to within the 2-3% range, the paper asserted.

“To make sure this happens, the central bank has one single lever to pull: lifting the overnight cash rate to push up the structure of interest rates and to crimp household spending.”

In other words, there is only one thing that the Reserve Bank can do to get inflation back to within its target range and that’s to raise interest rates and so, logically, it’s going to keep raising interest rates.

This might sound reasonable in the same way that someone could argue that whipping a horse makes it go faster because whipping horses makes them run faster. Of course, in the case of the horse, if the poor animal is just lying there without moving, one would reconsider one’s strategy and check that the animal is not, in fact, dead.

While the increase in interest rates isn’t killing the proverbial horse and – much to the Reserve Bank’s horror – Australians are continuing to spend, the fact remains that the strategy doesn’t seem to be working but, as the Financial Review tells us, it’s the only thing that they can do, so they should do it.

This rather like a dentist saying that removing your tooth won’t fix your acute appendicitis but it’s the only comparable procedure that he’s allowed to perform, so he’s going to do it. And, when it doesn’t work, next month he’s going to remove another one. (Yes, I am aware of the inherent sexism in referring to the dentist as a “he” but I didn’t think making the dentist female when they were doing something absurd was really a triumph in the removal of sexist assumptions.)

The simple fact is that inflation is a complicated beast and, while rising interest rates will suppress demand (at least in theory), and this should take pressure of prices, it’s more complicated than that.

For a start, the rise in interest rates mainly affects people who have money borrowed. This means that some of them are struggling to make ends meet already and further rises will just mean that they find it harder to pay for essentials. Of course, it’s harder to cut back on essentials which means that this will may do little to suppress demand because those struggling have already cut back on their discretionary spending. It simply means that one group of people will just be finding it harder and harder, but this will have limited success in fighting inflation.

Not everyone who’s borrowed money is struggling, of course. Some people will have borrowed money to invest and, if you’ve invested in real estate, you may need to put up rents in order to ensure that your negative gearing isn’t losing so much money that you actually feel it. Again, this will mainly reduce the discretionary spending by the renters, who will often be people who’ve already cut back because of rise in energy costs.

Now the next point is the elephant in the room which is that it’s not the demand from everyday Australians that’s fuelling inflation anyway. It’s coming from the increase in energy prices and disruptions to supply chains.

I’m pretty much going to ignore the energy prices, because I don’t think that even Matt Canavan would argue that interest rate increases in Australia will lead to Putin ending the war, so we’re left with disruptions to the supply chains. These are caused partly by Covid and partly by natural disasters such as the once in a hundred-year floods that are taking place in various locations. Whatever, I can’t see another increase in rates improving the supply chain or doing much to stop weather events. I suppose that if you’re not Matt Canavan and you accept the prevailing wisdom on climate change, a recession may do something to reduce our emissions, ultimately leading to improvements in food production but that does seem like a long bow to draw.

The Reserve Bank seems to be going down a path of: We need to do something, and this is something, so we’ve done what we can.

Whatever, it’s worth noting that Philip Lowe was too busy to give his usual public address after the first RBA meeting of the year, but he did have time to brief traders from the major banks at a private lunch. There is no information about whether he included his CV in the briefing, it seems clear that his desire for another term at the RBA is looking as likely as Josh Frydenberg being the next AFL head, so I guess he shouldn’t be wasting his time with public addresses when there’s a lunch to go to.

 

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12 comments

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  1. Florence

    Something most ignore. They want us to think all have taken loans out recently instead of years ago. The majority were near the rate when they took the loan out thanks to low interest rates, had the chance to pay much of the loan.

    The inflation a unique set of causes this time. Not a wage spiral, the majority chasing few goods. It is because of expensive oil, gas & coal, thanks to Putin. It was assisted by food prices through the roof because of climate disasters of fire & floods.

    Raising interest rates across the board cut spending power of the majority who are already reduced to expenditure on essentials. Those at the top with unlimited spending power are a little affected.

    IMHO, reducing the need for fossil fuel and moving to renewals quickly is the best action to take. Tax the windfall profits made from windfall record profits, returning the money to those in need,

    If the reserve bank is unable to identify the reason for present inflation, how can we have faith in what they are doing.

    I hope I make sense, but at eighty-one, this is what I feel in my bones.

  2. Terence Mills

    In his private luncheon with the bankers did Philip Lowe point to the nine consecutive interest rate increases that he has delivered for them and that these go straight to the bottom line of bank profits when passed on to the punters ?

    As he will probably get the flick when his contract comes up in September he will be looking for a comfortable sinecure on a bank board which I’m sure they will deliver as gratitude for the windfall profits he has generated for them and their shareholders.

  3. leefe

    I have never understood why we have variable rates on loans, especially for major purchases such as housing. Once the loan is made, the money has been spent, so increasing interest rates on those loans does nothing more than make life harder for the borrowers and, while I do think life should be made as hard as possible for speculators on the housing market, they are not the people who are really hurt. It’s those buying their homes or renting. Sure, it reduces the amount of money available for discretionary spending, but most renters and home-buyers (especially first home buyers) have, as Rossleigh pointed out, alrready cut back as much as possible.

    It’s really nothing more than another layer of neoliberal capitalism robbing the poorest and most vulnerable to increase (or at least maintain) profits.
    The whole system is rotten from the foundations up.

  4. Terence Mills

    leefe

    It’s a rort !

    In the US The traditional prime mortgage product is a fixed-rate 30-year amortizing loan, which allows the borrower to budget that interest repayments will remain unaltered throughout the term of the loan. It is also possible, without penalty, for a borrower to refinance a loan in circumstances where interest rates are falling.

    There is no reason why the banks should pass on RBA interest increases to borrowers on existing loans. It is solely at the discretion of the banks who invariably will choose to increase repayments for borrowers rather than just apply the increased rates to new loans.

    Banks in Australia are very reluctant to offer fixed-rate loans and when they do it is normally for no more than five years max.

  5. Stephen S

    The border closure led to a 50-year unemployment low. Not what Treasury wants at all. Treasurer Jim Chalmers has hiked migration to 300,000. To flatten wages, boost unemployment, and maintain severe housing un-affordability.

    Governor Phil Lowe is doing his part, with relentless interest rate rises. It won’t be enough to save his job. Chalmers will replace him with someone more compliant. Treasury will become even more dominant, just what Australia doesn’t need.

  6. andy56

    its a ponzi scheme, the whole housing market. The economy is a slave to housing, no other way to put it. If you were to design an economy, you wouldn’t do half the shit our governments have done. Howard was a fuckwit first order. We had a bonanza of money and instead of setting us up for prosperity, he hyper inflated the housing bubble. Humpty dumpty had a great fall alright. At some stage , we will bight the bullet and let housing free fall. thats the only way to get it under control. Then governments will be forced to look at the economy as it really is, a basket case. The RBA should be lined up against the wall for not having any foresight. They are paid big bucks and do SFA. Its 2023, why cant they run interest rates weekly instead of every 3 months when things are then out of hand. In the age of computers , are they still using an abacus? As a small business owner i knew everyday what i owed and was owed. Why dont they reign in bank housing lending? Do anything to decouple housing from the real economy? Fuckwits, the lot of them

  7. Bobbie

    In 1999, the LNP decided to turn the housing market into a casino for speculators. They halved Capital Gains Tax to 50% and let Principal-Only loans rip. That encouraged investors to pile on keen to get their share of gambler-friendly tax advantages. The banks fanned the flames of avarice with ‘all you can grab’ lending. 23 years down the line and inflated land-house values are a powder keg waiting to go off. Govt socialism, in the form of hand-outs and special tax treatment of home-owners and investors, is keeping an economic implosion at bay, atm. Labor, like the LNP, will do everything in their power to prop up prices, because selfish wants dictate, alright? The Reserve Bank takes its marching orders on interest rates from offshore, think BIS. Getting rid of Governor Lowe will change nothing.
    In summary and in the words of US comedian George Carlin: ‘It’s a big club and you ain’t in it.’

  8. GL

    Is anyone going to be surprised when I say that the LNP opposes the government social housing plan?

  9. andy56

    What was Lowe doing? Playing good cop bad cop with a devil’s grin? He took no responsibility but tried to make out he has our interests at heart. What a performance. As if he is paid a lot of money to act dumb. At anytime he could have called the governments bluff and forced any of those weak liberal PMs to actually do their fucking jobs. He went along with the myopic view that capitalism works this way.
    My issue is that in playing with “purity” of purpose, he is a henchman to our economic woes. At no time does he think, this is a bubble that we need to deflate. At no time do we hear him put the government to the torch. He is just a fucking YES MAN.
    The whole RBA board needs to go. We need people of real intellect leading us out of this fucking mess. If the system is fucked, you dont keep digging.

  10. Clakka

    Crazy anglophones. Post-cold war cold war, neo-colonialism, anti-globalisation, sucking fiscal fear and ineptitude, profit, profit, profit, profit ……. da da de da daaah …. hungrier than a plague of locusts; bring on RBA Man! Watch in awe as he pulls his lever! As he provides the excuse for THE BIG PRICE GOUGE and the beating of the little people.

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