In a recent speech, “Low Inflation in a World of Monetary Stimulus” RBA Deputy Governor Philip Lowe highlighted the impact of low interest rates. Significantly he observes that low interest rates are not translating into buoyant consumer spending. As a result, such monetary policy will not necessarily deliver the desired economic outcomes.
One area where low interest rates do appear to be having the broadly expected effect is on asset prices: global equity markets have been strong; property prices are again recording solid gains in some countries; and bond prices have increased substantially. However, for these increases in asset prices to boost the global economy, households and businesses need to respond by increasing their spending. While in the United States there are now some signs that this is happening, on the whole the response of private spending to higher asset prices has been muted.
Overall, looking at this experience, I find it difficult to escape the conclusion that changes in interest rates are not affecting decisions about spending and saving in the way they might once have done. Undoubtedly, low interest rates are helping to repair balance sheets by lowering debt-servicing costs and by pushing up asset prices. In so doing, they are helping lay the foundations for future growth in consumption and investment. But, while this repair process is taking place, consumption is weaker than it otherwise would be. In turn, subdued consumption growth is feeding through to a more subdued business climate and weaker investment.
Arguably, a similar dynamic has been playing out in government finances in a number of countries. After the financial crisis, many governments found themselves with debt levels that were very high. Like many households, they have responded by tightening their belts. Given the high levels of debt and ongoing imbalances between recurrent revenue and expenditure, few governments have seen the very low interest rates as an opportunity to support long-term infrastructure investment at low cost. Rather, much as households have done, governments have taken advantage of the lower debt-servicing costs to help shore up their finances.
He concludes that low interest rate monetary policies are unlikely to succeed.
Finally, stepping back from the short term, the low interest rates we are seeing globally and in Australia are a direct consequence of an elevated appetite for saving and a muted appetite for real investment in many economies. Monetary policy globally has responded to this reality in a way that a decade or so ago would have hardly seemed imaginable. In doing so it has helped the global economy through a very difficult period. But, at the end of the day, the solution to the problems caused by the disconnect between the desire to save and the desire to invest cannot lie with monetary policy. Instead, it lies in measures to improve the investment environment so that once again there is strong productive demand for the use of our societies’ savings.
