Last night, in a much anticipated speech broadcast live on the Reserve Bank’s website, Governor Phil Lowe laid out in very clear terms the circumstances in which the bank would resort to quantitative easing and the way in which it would implement it. Via The Conversation.
Quantitative easing is simply a change in the way it eases monetary policy when the official interest rate approaches zero.
Usually it does it by cutting the so-called cash rate, which is the rate banks pay each other for money deposited overnight.
Eight years ago the cash rate was 4.5%. Three years ago it was 1.5%.
After the most recent three cuts in June, July and October, it is just
0.75%
Last night, Governor Lowe said the effective lower bound was 0.25%.
Rather than let the cash rate get any lower or negative (an option he
explicitly ruled out), the bank will push down other longer-term rates
by buying government bonds.
It’s the “quantitative easing” approach adopted by the US Federal Reserve between 2009 and 2014.
Government bonds are sold by governments in return for money, a means
of borrowing. The buyer gets guaranteed interest payments and a
guarantee that their money will be returned in full after three, five,
ten or even 20 years depending on the length of the bond.
Once issued, bonds can be traded on a market, and the price at which
they change hands can be expressed as an implied interest rate, which
becomes the risk-free rate against which all other interest rates are
benchmarked.
How quantitative easing would work
Buying bonds from investors would push down that risk-free rate, pushing down the entire structure of long-term interest rates.
All other things being equal, this should also push down the exchange
rate by reducing the return on Australian dollar denominated financial
investments.
Governor Lowe indicated he might buy state government bonds as well as Commonwealth bonds.
Importantly, he argued that although the bank would be mindful of the
need to ensure private banks had enough access to the bonds they needed
to hold for regulatory purposes, those holdings would not be an
impediment to quantitative easing.
He ruled out buying residential mortgage-backed securities and other
private assets given that those markets are currently functioning well
and Reserve Bank purchases could distort them.
The approach borrows heavily from the US Fed.
As in the US, Lowe says quantitative easing would be complemented by
“forward guidance,” where the Reserve Bank would signal early how
long-term interest rates would be kept low and the circumstances in
which it expected to raise them again.
The guidance is designed to influence market expectations for future
interest rates, enhancing the effectiveness of cuts in long term
interest rates.
When it would happen
In addition to “how,” Governor Lowe spelled out “when” – the economic
circumstances in which the bank would resort to quantitative easing.
It would do it when the cash rate was at 0.25% and inflation and unemployment were moving away from its objectives.
The bank targets 2-3% inflation on average over time and has recently
identified 4.5% as the “full employment” unemployment rate.
Importantly, Lowe emphasised that the Australian economy has not yet
reached the point where a cash rate as low as 0.25% would be needed and
argued quantitative easing was unlikely to be needed in future.
The cash rate is at present 0.75%. Setting 0.25% as the effective
lower bound gives the Governor 0.5 percentage points left to cut before
implementing quantitative easing.
Implicitly, Governor Lowe is saying that those cuts of 0.5 percentage points will be enough to stabilise the economy.
A pause for a breath at 0.25%
Lowe also indicated the bank would not seamlessly transition to quantitative easing.
He implied there was an additional hurdle or threshold that would
need to be crossed, suggesting he would be reluctant to make the
transition.
His big problem is that neither inflation nor the unemployment rate are moving in the right direction.
The bank has undershot its inflation target since the end of 2014,
giving the economy a weak starting point going into an emerging global
downturn.
My research
on the US experience for the United States Studies Centre shows that
the main problem with is quantitative easing was that it was not done
soon enough or aggressively enough.
It might be better to be bold
While quantitative easing was effective, it could have been made more so had what was going to happen been made clearer.
The Fed went out of its way to limit the transmission of quantitative
easing to the rest of the economy, fearful it would be too potent and
lead to excessive inflation.
Those concerns proved misplaced. By pulling its punches, the Fed
ended up being less effective and having to pursue quantitative easing
for longer than if it had used it more aggressively.
Governor Lowe’s very obvious reluctance to go down the quantitative easing route suggests the Reserve Bank is in danger of making the same mistake, but it is not too late to learn from what happened in the US.
Author: Stephen Kirchner Program Director, Trade and Investment, United States Studies Centre, University of Sydney
Financial system vulnerabilities remain elevated and more effort is required to ensure that the system remains resilient over the longer-term, Reserve Bank Governor Adrian Orr says in releasing the November Financial Stability Report.
International risks to the
financial system have increased. Global growth has slowed amid continued
uncertainty about the outlook for world trade. This has resulted in reductions
in long-term interest rates to historic lows, including in New Zealand. While
necessary to maintain near-term inflation and employment objectives, prolonged
low interest rates can promote excess debt and investment risk-taking, and
overheat asset prices, Mr Orr says.
Mr Orr noted that the Reserve Bank’s Loan-to-Value Ratio (LVR) restrictions have been successful in reducing the more excessive household mortgage lending, thereby improving the resilience of banks to a significant deterioration in economic conditions.
But, there remains the risk that prolonged low interest rates could lead to a resurgence in higher-risk lending. As such, we have decided to leave the LVR restrictions at current levels at this point in time.
Mr Orr says the Reserve Bank
is committed to bolstering the long-term resilience of the financial system.
“Strong bank capital buffers are key to enabling banks to absorb losses and
continue operating when faced with unexpected developments. The Reserve Bank
has proposed increasing these buffers further with final decisions on the
Capital Review proposals to be announced on 5 December.”
Deputy Governor Geoff
Bascand says good governance and robust risk management processes within
financial institutions are important to maintain long term resilience. Our
recent reviews of banks and life insurers, and the number of recent breaches in
key regulatory requirements, reinforces the need for financial institutions to
improve their behaviour.
“We are engaging with
industry to ensure that they strengthen their own assurance processes and
controls. We have also reviewed our own supervisory strategy and will be taking
a more intensive approach, which will involve greater scrutiny of institutions’
compliance,” Mr Bascand says.
“Some life insurers have low
solvency buffers over minimum requirements. Recent falls in long-term interest
rates are putting further pressure on solvency ratios for some of these
insurers. Affected insurers are preparing plans to increase solvency ratios and
are subject to enhanced supervisory engagement. This highlights the need for
insurers to maintain strong buffers, and insurer solvency requirements will be
reviewed alongside an upcoming review of the Insurance (Prudential Supervision)
Act.”
Governor Philip Lowe spoke at the Australian Economists Dinner last night. In many ways, little new here, but the RBA thinks the zero bounds cash rate is 0.25%, and QE is an option, but only in a crisis. “There may come a point where QE could help promote our collective welfare, but we are not at that point and I don’t expect us to get there”.
He said: As I discussed in the Sir Leslie Melville lecture at the ANU a month ago, low interest rates are not a temporary phenomenon. Rather, they are likely to be with us for some time and are the result of some powerful global factors that are affecting interest rates everywhere.[1]
Given this assessment, it is not surprising that there is a lot of discussion internationally about the
use of so-called ‘unconventional’ monetary policies. People are rightly asking: if
interest rates are going to stay low and be constrained by a lower bound, what other monetary policy
options are there?
I have been part of these international discussions through chairing the Committee on the Global
Financial System (CGFS) at the Bank for International Settlements in Basel. Last month, the Committee
published a report titled: ‘Unconventional Monetary Policy Tools: a Cross-country
Analysis’.[2] The report reviews the experience with the use of unconventional policy tools and
discusses how these tools can be used by central banks to achieve their objectives. If you are
interested in these issues and have not looked at the report, I encourage you to do so.
This evening I would like to summarise some key observations of the report and then explore how those
observations might be applied to Australia.
The CGFS Report – the ‘Unconventional’ Policy Tools
The report discusses four unconventional policy tools.
The term ‘unconventional’ monetary policy has now become the conventional shorthand for a
wide range of policies, although I am not sure it is the best terminology. I say this because most of
these tools have always been in the toolkit of central banks and have been used in one way or another in
the past. What has been unconventional over recent times is the way these tools have been
used.
Negative interest rates
The first of the four tools discussed in the report is negative policy rates.
This is one tool that is truly unconventional.
Prior to the financial crisis, it was widely thought that zero was the lower bound for the policy
interest rate – so it was common to talk about the ‘ZLB’, or the zero lower bound.
It was thought that if interest rates went below zero, people would hold their savings in banknotes
rather than be charged by their bank to deposit their money.
But zero has not turned out to be the constraint that it was once thought to be. So we now talk about
the ELB – the effective lower bound – not the ZLB. While countries with negative interest
rates have seen some shift to banknotes, it has been on a limited scale only. This reflects the use of
bank deposits for making transactions and the fact that most banks in countries with negative interest
rates have set a floor of zero on retail deposit rates. These banks have judged that it doesn’t
make sense, either commercially or politically, to charge households and small businesses negative
interest rates on their deposits.
It is worth pointing out that negative policy interest rates have largely been a European phenomenon.
Policy interest rates have been negative in the euro area, Denmark, Sweden and Switzerland. Rates have
been lowest in Switzerland, at minus ¾ per cent (Graph 1). The only country outside
of Europe that has had negative policy interest rates is Japan, but even there it is only a very small
share of bank reserves at the Bank of Japan that earns a negative rate, at
minus 0.1 per cent.
Graph 1
Extended liquidity operations
The second unconventional policy discussed in the report is the extended use of central bank liquidity
operations.
In response to the financial crisis, many central banks made significant changes to their normal market
operations to deal with strains in financial markets that were impairing the supply of credit to the
economy.
While the specifics differ across countries, the changes to market operations included: expanding the
range of collateral accepted; providing much larger amounts of liquidity; extending the maturity of
liquidity operations; increasing the range of eligible counterparties; and providing funding to banks at
below the cost that was then prevailing in highly stressed markets, sometimes on the condition that the
banks provide credit to businesses and households.
This graph shows the size of the extended liquidity operations of the major central banks
(Graph 2). The biggest operations were during the crisis period of 2008 and 2009, with significant
liquidity support also being provided in 2011 and 2012 to support bank lending during the European
sovereign debt crisis.
Graph 2
It is worth recalling that during these periods of stress, banks had become very nervous about their
access to liquidity. This, in turn, made them nervous about lending to others, making the possibility of
a severe credit crunch very real. By providing financial institutions with greater confidence about
their own access to liquidity, central banks were able to support the supply of credit to the economy.
The CGFS report recognises that there were some side-effects of doing this, but the strong conclusion of
the report is that these measures eased liquidity strains in highly stressed bank funding markets and
helped restore monetary transmission channels to the broader economy.
Asset purchases – quantitative easing
The third policy tool discussed in the report is the outright purchase of assets from the private
sector, paying for those assets by creating central bank reserves – also known as quantitative
easing or QE.
These asset purchases were on an unprecedented scale and led to very large expansions of central bank
balance sheets (Graph 3). Before the financial crisis, the major central banks owned securities
equivalent to around 5 per cent of GDP. In recent years, this has risen to nearly
30 per cent. This is a very large change.
Graph 3
As part of their QE programs, central banks bought a wide range of assets, but the main asset purchased
was government securities. Central banks now hold nearly 30 per cent of government securities
on issue, which is equivalent to around 20 per cent of GDP. The largest purchases have been
made by the Bank of Japan, which holds almost 50 per cent of Japanese government bonds on
issue.
In the United States, the Federal Reserve also bought large quantities of agency securities backed by
the US government. Elsewhere, central banks bought private securities such as covered bank bonds,
corporate bonds and commercial paper. And the Bank of Japan bought equities via exchange traded funds
(ETFs) and real estate investment trusts.
The precise motivations for these asset purchase programs varied across countries, but a common
motivation was to lower risk-free interest rates out along the term spectrum, well beyond the short-term
policy rate. Buying government bonds was seen as reinforcing policy rate cuts and/or acting as a
substitute for further reductions in the policy rate once it was at its lower bound. The expectation was
that lower risk-free rates would flow through to most interest rates in the economy, boost asset prices
and push down the exchange rate.
A related motivation for buying government securities was to reinforce market expectations that policy
rates were going to stay low for a long time. This ‘signalling channel’ added to the
downward pressure on long-term bond yields.
Another motivation in some countries was addressing problems in specific markets. In the United States,
for example, the Federal Reserve purchased government-backed agency securities to support mortgage
markets. And the Bank of England purchased commercial paper to ease highly stressed conditions in
corporate credit markets.
Finally, the expansion of the central bank’s balance sheet through money creation should, in
theory, have stimulatory effects through the so-called ‘portfolio balance channel’. The
idea here is that as the central bank purchases securities with bank reserves, investors seek to
rebalance their portfolios, and in so doing push up other asset prices and lower risk premiums for
borrowers. It is difficult, though, to isolate this effect from the other channels I just spoke
about.
Forward guidance
The fourth policy response was forward guidance.
This took two forms: calendar based and state based. Under calendar-based guidance, the central bank
makes an explicit commitment not to increase interest rates until a certain point in time. Under
state-based guidance, the central bank says it will not increase rates until specific economic
conditions are met. We have seen examples of both in practice. Some central banks also have provided
forward guidance regarding their asset purchase programs.
A primary motivation of forward guidance is to reinforce the central bank’s commitment to low
interest rates. A related motivation is to provide greater clarity about the central bank’s
reaction function and strategy in unusual times. The experience has mainly been positive, with the
guidance helping to reduce uncertainty. There are, however, some examples where a change in guidance
caused market volatility. The ‘taper tantrum’ in the United States in 2013 is an example
of this.
Some Observations
Before I discuss the relevance of all this to Australia, I would like to make three broad observations,
drawing on the report as well as my own reading of the evidence.
The first is that there is strong evidence that the various liquidity support measures and targeted
interventions in stressed markets were successful in calming things down and supporting the
economy.
When markets broke down and became dysfunctional, the actions of central banks helped stabilise the
situation and helped avoid a damaging gridlock in the financial system. They also helped contain risk
premiums in highly stressed markets. It is also worth pointing out that many of the measures to support
liquidity were successfully unwound once the job was done – so they proved to be temporary,
rather than a permanent intervention.
The CGFS report also documents the positive effects of some of the other unconventional measures. In
general, though, I find this evidence less compelling. These various measures certainly pushed down
long-term yields and provided monetary stimulus in the depths of the crisis when it was needed. But
these extraordinary measures have continued way past the crisis period. In some countries, asset
purchases have yet to be unwound and it remains unclear when, and even if, this will happen. So a full
evaluation is not yet possible.
This brings me to my second general observation. And that is that there have been some side-effects of
the various unconventional measures. I will touch on a few of these that the CGFS report discusses.
The first is that the extensive use of unconventional monetary tools can change the incentives of
others in the system, perhaps in an unhelpful way.
It is possible that the willingness of a central bank to provide liquidity reduces the incentive for
financial institutions to hold their own adequate buffers, making episodes of stress more likely in the
future.[3]
It is also possible that the willingness of a central bank to use its full range of policy instruments
might create an inaction bias by other policymakers, either the prudential regulators or the fiscal
authorities. If this were the case, it could lead to an over-reliance on monetary policy.
A second side-effect is the impact on bank lending and the efficient allocation of resources.
Persistently low or negative interest rates and a flattening of the yield curve can damage bank
profitability, leading to less capacity to lend. In some countries, there are concerns that low interest
rates allow less-productive (zombie) firms to survive. There are also financial stability risks that can
come from low interest rates boosting asset prices (and perhaps borrowing) at a time of weak economic
growth.
A third side-effect is a possible blurring of the lines between monetary and fiscal policy. If the
central bank is buying large amounts of government debt at zero interest rates, this could be seen as
money-financed government spending. In some circumstances, this could damage the credibility of a
country’s institutional arrangements and create political tensions. Political tensions can also
arise if the central bank’s asset purchases are seen to disproportionality benefit banks and
wealthy people, at the expense of the person in the street. This perception has arisen in some countries
despite the strong evidence that the various monetary measures supported both jobs and income growth and
thereby helped the entire community.
These are all side-effects we need to take seriously.
The third general observation is that experience suggests that a package of measures works best, with
clear communication that enhances credibility. Exactly what that package looks like varies from country
to country and depends upon the specific circumstances. But clear communication from the central bank
about its objectives and its approach is always important.
The report also notes that there may be better solutions than monetary policy to solving the problems
of the day. It reminds us that when there are problems on the supply-side of the economy, the use of
structural and fiscal policies will sometimes be the better approach. We need to remember that monetary
policy cannot drive longer-term growth, but that there are other arms of public policy than can
sustainably promote both investment and growth.
Application to Australia
I would now like to turn to what this all implies for us in Australia.
I will make five sets of observations.
The first is that the Reserve Bank has long had flexible market operations that allow us to ensure
adequate liquidity in Australian financial markets. We have used this flexibility in the past,
particularly during the global financial crisis, and we are prepared to use it again in periods of
stress if necessary.[4]
At the moment, though, Australia’s financial markets are operating normally and our financial
institutions are able to access funding on reasonable terms. In any given currency, the Australian banks
can raise funds at the same price as other similarly rated financial institutions around the world, and
markets are not stressed. So there is no need to change our normal market operations to do anything
unconventional here. Having said that, if markets were to become dysfunctional, you can be reassured by
the fact that we have both the capacity and willingness to respond. But this is not the situation we are
currently in. Things are operating normally.
The second observation is that negative interest rates in Australia are extraordinarily unlikely.
We are not in the same situation that has been faced in Europe and Japan. Our growth prospects are
stronger, our banking system is in much better shape, our demographic profile is better and we have not
had a period of deflation. So we are in a much stronger position.
More broadly, though, having examined the international evidence, it is not clear that the experience
with negative interest rates has been a success. While negative rates have put downward pressure on
exchange rates and long-term bond yields, they have come with other effects too. It has become
increasingly apparent that negative rates create strains in parts of the banking system that can impair
the ability of some banks to provide credit. Negative interest rates also create problems for pension
funds that need to fund long-term liabilities. In addition, there is evidence that they can encourage
households to save more and spend less, especially when people are concerned about the possibility of
lower income in retirement. A move to negative interest rates can also damage confidence in the general
economic outlook and make people more cautious.
Given these considerations, it is not surprising that some analysts now talk about the ‘reversal
interest rate’ – that is, the interest rate at which lower rates become contractionary,
rather than expansionary.[5] While we take the possibility of a reversal rate seriously, I am confident that
here, in Australia, we are still a fair way from it. Conventional monetary policy is still working in
Australia and we see the evidence of this in the exchange rate, in asset prices and in the boost to
aggregate household disposable income.
My third observation is that we have no appetite to undertake outright purchases of private sector
assets as part of a QE program.
There are two reasons for this. The first is that there is no sign of dysfunction in our capital
markets that would warrant the Reserve Bank stepping in. The second is that the purchase of private
assets by the central bank, financed through money creation, represents a significant intervention by a
public sector entity into private markets. It comes with a whole range of complicated governance issues
and would insert the Reserve Bank very directly into decisions about resource allocation in the economy.
While there are some scenarios where such intervention might be considered, those scenarios are not on
our radar screen.
My fourth point is that if – and it is important to emphasise the word
if – the Reserve Bank were to undertake a program of quantitative easing, we would
purchase government bonds, and we would do so in the secondary market. An important advantage in buying
government bonds over other assets is that the risk-free interest rate affects all asset prices and
interest rates in the economy. So it gets into all the corners of the financial system, unlike
interventions in just one specific private asset market.
If we were to move in this direction, it would be with the intention of lowering risk-free interest
rates along the yield curve. As with the international experience, this would work through two channels.
The first is the direct price impact of buying government bonds, which lowers their yields. And the
second is through market expectations or a signalling effect, with the bond purchases reinforcing the
credibility of the Reserve Bank’s commitment to keep the cash rate low for an extended period.
Currently, the government bond yield curve sits around 20 basis points above the overnight indexed
swaps (OIS) curve, which represents the market’s average expectation of the future monetary policy
rate (Graph 4). Purchasing government securities could compress this differential and could also
flatten the OIS curve through the expectations effect I just mentioned. A lower term premium would lower
borrowing costs for both governments and private borrowers, and would bring the benefits that come with
that. An exchange rate effect could also be expected.
Graph 4
Our current thinking is that QE becomes an option to be considered at a cash rate of
0.25 per cent, but not before that. At a cash rate of 0.25 per cent, the interest
rate paid on surplus balances at the Reserve Bank would already be at zero given the corridor system we
operate. So from that perspective, we would, at that point, be dealing with zero interest rates.[6]
My fifth, and final, point is that the threshold for undertaking QE in Australia has not been reached,
and I don’t expect it to be reached in the near future.
In my view, there is not a smooth continuum running from interest rate reductions to quantitative
easing. It is a bigger step to engage in money-financed asset purchases by the central bank than it is
to cut interest rates.
There are, however, circumstances where QE could help. The international experience is that in stressed
market conditions, the central bank can help stabilise the situation by buying government securities.
That experience also suggests that QE does put additional downward pressure on both interest rates and
the exchange rate. In considering the case for QE, we would need to balance these positive effects with
possible side-effects.
We would also need to consider the effects on market functioning. We are conscious that government
securities play a crucial role as collateral in some of our financial markets. Given the limited supply
of government debt on issue, the Reserve Bank and APRA have already had to put in place special
liquidity arrangements for the banking system. We are also conscious that the Australian
government’s fiscal position means that the gross stock of government debt is projected to decline
relative to the size of the economy over the years ahead. These considerations are not impediments to
undertaking QE, but we would need to take them into account.
It is a reasonable question to ask what might be the threshold to undertake QE in Australia.
It is difficult to be precise, but QE would be considered if there were an accumulation of evidence
that, over the medium term, we were unlikely to achieve our objectives. In particular, if we were moving
away from, rather than towards, our goals for both full employment and inflation, the purchase of
government securities would be on the agenda of the Board. In this world, I would hope other public
policy options were also on the country’s agenda.
At the moment, though, we are expecting progress towards our goals over the next couple of years and
the cash rate is still above the level at which we would consider buying government securities. So QE is
not on our agenda at this point in time.
It is important to remember that the economy is benefiting from the already low level of interest
rates, recent tax cuts, ongoing spending on infrastructure, the upswing in housing prices in some
markets and a brighter outlook for the resources sector. Given the significant reductions in interest
rates over the past six months and the long and variable lags, the Board has seen it as appropriate to
hold the cash rate steady as it assesses the growth momentum both here and elsewhere around the world.
The Board is also committed to maintaining interest rates at low levels until it is confident that
inflation is sustainably within the 2 to 3 per cent target range.
The central scenario for the Australian economy remains for economic growth to pick up from here, to
reach around 3 per cent in 2021. This pick-up in growth should see a reduction in the
unemployment rate and a lift in inflation. So we are expecting things to be moving in the right
direction, although only gradually.
The Board continues to discuss what role it can play in ensuring that this progress takes place and how
it might be accelerated. It recognises the benefits that would come from faster progress, but it also
recognises the limitations of monetary policy and the importance of keeping a medium-term perspective
squarely focused on maximising the economic welfare of the people of Australia. There may come a point
where QE could help promote our collective welfare, but we are not at that point and I don’t expect
us to get there.
It’s the bank’s new computer model of the Australian economy, made up
of 147 equations working in concert. Some are quite simple, such as how
global oil prices affect domestic petrol prices, whereas others are
more complex, such as how a rise in the unemployment rate affects
household spending.
Unveiled in August in a discussion paper entitled “MARTIN has its place”,
the model is available for use by analysts outside the bank for whom it
can serve as something of a guide as to what the bank might be
thinking.
It provides useful insights into what the bank will do next, after it
has cut its cash rate as close to zero as possible and needs to
stimulate the economy further.
Economists use models like drivers use maps – to take a large and
complicated country and simplify it to its essential ingredients in the
hopes of providing a useful guide to navigating it.
A map doesn’t tell you everything about a route – that would be hard
to come to grips with – but it highlights important features or paths
you should watch for. Models do the same – simplifying the complex
Australian economy into the paths that matter.
But instead of breaking Australia down into rivers and roads, or
cities and states like a map might do, MARTIN divides the Australian
economy into different sectors such as households, firms and the
government with the 147 equations describing the ways they interlink
with each other.
This map is principally designed for two purposes.
The first is forecasting. Every three months the bank looks
inside its crystal ball to try and divine how the economy will evolve in
the years to come. MARTIN has become a key input into that process.
The second use is the ability to run “what if” simulations to see
how the economy would react in different scenarios. For example, what
would happen if the price of iron ore crashed tomorrow, or what would be
the impact if the government ramped up its spending on infrastructure?
What does MARTIN say about quantitative easing?
MARTIN will have been put to work pondering the implications of
deploying so-called “quantitative easing” after the Reserve Bank’s cash
rate gets too low to cut.
Quantitative easing involves the Reserve Bank buying financial
assets, such as government or mortgage bonds, in order to continue to
supply money to the economy after its cash rate has fallen to zero.
I have used MARTIN to model three different scenarios for quantitative easing in the Australian economy.
The first is what would happen if quantitative easing isn’t used at all.
The second is what would happen if the bank started a modest quantitative easing program in early 2020 lasting around a year.
The third is what would happen if the bank commenced an aggressive
quantitative easing program to simulate the economy for 18 months.
I assume the bank would purchase assets in a similar manner to how
the US conducted quantitative easing after the global financial crisis,
buying bonds to lower interest rates on two year and ten year government
securities.
MARTIN says quantitative easing would have two major effects on the
economy. First, it would lower the cost of borrowing for Australian
businesses. They would be expected to increase investment as more
projects become viable as the interest rates they were charged fell.
Second, the lower rate structure would weaken the Australian dollar
by as much as 5 US cents. A cheaper dollar would make our exports more
competitive and make foreign imports more expensive.
MARTIN thinks it could work
MARTIN predicts quantitative easing would boost manufacturing,
agriculture and mining exports relative to where they would be without
it.
The depreciation would also encourage Australian households to spend
more on local goods and less on what would be dearer imports. This
should lead to higher wages, increased household incomes and spending,
and improved economic growth.
In fact, MARTIN predicts that, by boosting economic growth,
quantitative easing would actually lead to higher interest rates as
inflation returns to the Reserve Bank’s target, allowing interest rates
to return to more normal levels.
Combining these two effects, MARTIN suggests a large quantitative
easing program would reduce unemployment by 0.3 percentage points,
equivalent to 40,000 extra jobs, and boost wages across the economy.
The output of any model is only as good as the information and data that are fed into it, but the output of MARTIN is why more and more economists expect the bank to quantitatively ease in the new year. Its brain says it should work.
This suggests the bank still thinks monetary policy – in this case
lowering interest rates to stimulate the economy – could help “support
sustainable growth in the economy, full employment and the achievement
of the medium-term inflation target”.
But in the wake of the bank last month lowering the official interest
rate to a record low and the current somewhat sad state of the
Australian economy, many commentators have speculated that monetary policy doesn’t work any more.
There are a number of variants of the “monetary policy doesn’t work”
argument. The most basic is that the Reserve Bank has this year cut
rates from 1.50% to 0.75% without any improvement to the Australian
economy.
This is a textbook example of one of the classic logic fallacies known as “post hoc ergo propter hoc” (from the Latin, meaning “after this, therefore because of this”).
Put simply, it assumes the rate cuts have had no effect and doesn’t
account for the possibility things might have been worse had there been
no cuts.
Things might have been even worse. We’ll never know.
It also ignores what might have happened if the RBA had cut sooner.
Again, we can’t know for sure. It is possible, though, to make an
educated guess.
When to cut rates
Had Reserve Bank governor Philip Lowe acted, say, 18 months earlier
to cut rates, he would have signalled that Gross Domestic Product growth
was indeed lower than desired, that the sustainable rate of
unemployment was more like 4.5% than 5%, and, most importantly, that he
understood the need to act decisively.
That would have sent a powerful signal.
It would also have ameliorated the huge decline in housing credit
that pushed down housing prices in Sydney and Melbourne by double
digits.
That, in turn, would have prevented some of the weakening in the
balance sheets of the big four banks that has occurred (witness this
annual general meeting season).
All of this would have pumped more liquidity into the economy and put
households in a much stronger position, likely leading to stronger
consumer spending than we have seen.
It is true there is a problem
with banks not being able to cut deposit rates below zero, and as a
result having less scope to cut mortgage rates, which are majority
funded from deposits.
But there are, of course, other ways monetary policy can work. The leading example is quantitative easing (QE).
This is where the central bank pushes down long-term interest rates
by buying government and corporate bonds. At the same time this expands
the money supply, thereby adding some upward inflationary pressure.
There is little reason to think such measures wouldn’t work.
The power of free money
Perhaps paradoxically, the closer interest rates get to zero the more powerful those rates may end up being.
To put it bluntly, if someone shoves a pile of money into your hand
and asks almost nothing in return, you’re likely to use it. In fact, you
would be pretty silly not to.
You might decide to redraw that and spend the money on a home
renovation or some other productive purpose. Or you might decide to buy a
more expensive house.
Such spending provides an economic boost.
The effect is all the more pronounced if people expect interest rates
to be low for a long period of time. Aggressive cutting coupled with
quantitative easing – which lowers long-term rates – signal just that.
But not only monetary policy
Just because monetary policy still has some effect at near-zero rates
doesn’t mean we should pin all of our economic hopes to it.
A near consensus of economists have argued repeatedly for the use of
more aggressive fiscal policy – including more infrastructure spending
and more tax cuts.
Indeed, Philip Lowe has raised eyebrows by speaking so forthrightly on this issue. That doesn’t make him wrong, though.
There is little doubt the Reserve Bank should have acted much earlier
to cut official interest rates. There is also a very good chance it
will need to begin to use other measures such as quantitative easing in
the relatively near future.
All of that says the Australian economy, like most advanced economies around the world, is in bad shape.
But it doesn’t mean monetary policy has completely run out of puff.
Author: Richard Holden, Professor of Economics, UNSW
The RBA held rates today, as expected, but their explanation is turning pretty sour as reality bites. Expect more downgrades and rate cuts ahead, just a matter of time.
I also find it amazing that unlike UK, USA, and NZ there is no streamed press conference nor questions from the media after the announcement. The RBA continues to be more covert than its peers and less exposed to questions about its policy.
At its meeting today, the Board decided to leave the cash rate unchanged at 0.75 per cent.
While the outlook for the global economy remains reasonable, the risks are tilted to the downside. The
US–China trade and technology disputes continue to affect international trade flows and
investment as businesses scale back spending plans because of the uncertainty. At the same time, in most
advanced economies, unemployment rates are low and wages growth has picked up, although inflation
remains low. In China, the authorities have taken steps to support the economy while continuing to
address risks in the financial system.
Interest rates are very low around the world and a number of central banks have eased monetary policy
in response to the persistent downside risks and subdued inflation. Expectations of further monetary
easing have generally been scaled back over the past month and financial market sentiment has improved a
little. Even so, long-term government bond yields are around record lows in many countries, including
Australia. Borrowing rates for both businesses and households are also at historically low levels. The
Australian dollar is at the lower end of its range over recent times.
The outlook for the Australian economy is little changed from three months ago. After a soft patch in
the second half of last year, a gentle turning point appears to have been reached. The central scenario
is for the Australian economy to grow by around 2¼ per cent this year and then for growth
gradually to pick up to around 3 per cent in 2021. The low level of interest rates, recent tax
cuts, ongoing spending on infrastructure, the upswing in housing prices in some markets and a brighter
outlook for the resources sector should all support growth. The main domestic uncertainty continues to
be the outlook for consumption, with the sustained period of only modest increases in household
disposable income continuing to weigh on consumer spending. Other sources of uncertainty include the
effects of the drought and the evolution of the housing construction cycle.
Employment has continued to grow strongly and has been matched by strong growth in labour supply, with
labour force participation at a record high. The unemployment rate has remained steady at around
5¼ per cent over recent months. It is expected to remain around this level for some time,
before gradually declining to a little below 5 per cent in 2021. Wages growth remains subdued
and is expected to remain at around its current rate for some time yet. A further gradual lift in wages
growth would be a welcome development and is needed for inflation to be sustainably within the
2–3 per cent target range. Taken together, recent outcomes suggest that the Australian
economy can sustain lower rates of unemployment and underemployment.
The recent inflation data were broadly as expected, with headline inflation at 1.7 per cent
over the year to the September quarter. The central scenario remains for inflation to pick up, but to do
so only gradually. In both headline and underlying terms, inflation is expected to be close to
2 per cent in 2020 and 2021.
There are further signs of a turnaround in established housing markets, especially in Sydney and
Melbourne. In contrast, new dwelling activity is still declining and growth in housing credit remains
low. Demand for credit by investors is subdued and credit conditions, especially for small and
medium-sized businesses, remain tight. Mortgage rates are at record lows and there is strong competition
for borrowers of high credit quality.
The easing of monetary policy since June is supporting employment and income growth in Australia and a
return of inflation to the medium-term target range. Given global developments and the evidence of the
spare capacity in the Australian economy, it is reasonable to expect that an extended period of low
interest rates will be required in Australia to reach full employment and achieve the inflation target.
The Board will continue to monitor developments, including in the labour market, and is prepared to ease
monetary policy further if needed to support sustainable growth in the economy, full employment and the
achievement of the inflation target over time.
The RBA minutes for October are decidedly bearish, clearly the battery in their rose-tinted specs as run down, revealing the mounting risks in the economy. Probably more risks ahead, more cuts and the proverbial QE in some form…
International Economic Conditions
Members commenced their discussion of global economic conditions by noting that heightened policy
uncertainty was affecting international trade and business investment. This had continued to be
apparent
in a range of indicators, including new export orders and investment intentions. Conditions in
the
manufacturing sector had remained subdued, partly because of ongoing US–China trade
tensions.
These tensions had led to a contraction in bilateral trade between the United States and China,
which
was resulting in the diversion of some activity to other economies. Members noted that the trade
and
technology disputes continued to pose significant downside risks to the global economic outlook.
In general, conditions in the services sector had been relatively resilient in most advanced
economies,
supported by strong labour market conditions. Employment growth had continued to outpace growth
in
working-age populations, unemployment rates had remained at low levels and wages growth had
risen.
Nevertheless, inflation had remained low, although core inflation had picked up in the United
States in
recent months.
In the United States, GDP growth appeared to have slowed a little further in the September
quarter.
Growth in core capital goods orders and investment intentions had declined, whereas growth in
consumption had remained robust. In the euro area, the weakness in output growth in the June
quarter had
been broadly based. Industrial production had fallen, particularly in Germany, and investment
intentions
had remained below average. In Japan, exports had declined further, although output growth in
the
September quarter had been supported by above-average household spending ahead of an increase in
the
consumption tax in October.
In east Asia, export volumes had been flat for several months. Other indicators of activity, such
as
industrial production and surveys of manufacturing conditions, had shown tentative signs of
stabilising.
Growth in output had also slowed in India, driven by weakness in consumption. Members noted that
the
political unrest in Hong Kong had affected economic activity there to a significant extent.
In China, a range of indicators suggested that the pace of economic activity had slowed since the
start
of the year. Economic indicators remained subdued in August, although they had recovered a
little from
broad-based weakness in July. Growth in industrial production and retail sales had edged higher
in
August, and fixed asset investment growth had been broadly unchanged. Conditions in housing
markets also
appeared to have softened. In response to the slowing in activity, the authorities had announced
further
measures to ease policy in September. Chinese demand for imported iron ore and coal had
increased,
supported by ongoing investment in infrastructure.
The iron ore benchmark price had continued to be volatile since the previous meeting. Members
noted
that supply concerns in the iron ore market had eased somewhat, and ongoing strength in Chinese
steel
demand had been met by an increase in iron ore imports. Oil prices had also been volatile, with
the
attacks on oil infrastructure in Saudi Arabia having disrupted oil supply and exacerbated
uncertainty in
the region.
Domestic Economic Conditions
Members noted that the main domestic economic news over the previous month had been the release
of the
national accounts data for the June quarter and updates on the labour and housing markets. On
balance,
the data had pointed to a continuation of recent trends.
The national accounts reported that the Australian economy had grown by 0.5 per cent in the June quarter. Year-ended growth had slowed to 1.4 per cent, the lowest outcome in a decade. Nevertheless, there had been a pick-up in quarterly GDP growth over the first half of 2019 compared with the second half of 2018. The pick-up had been driven by stronger growth in exports, led by exports of resources and manufacturing goods. Members noted that export demand was being supported by the lower level of the Australian dollar. Public demand had also been growing strongly, partly because of spending on the National Disability Insurance Scheme. Members observed that the drought had continued to affect the rural sector to a significant extent and that, as a result, farm output was expected to remain weak over the following year.
Growth in household disposable income had been subdued. Strong growth in income tax paid by households had been a contributing factor, as had been low growth in non-labour income, partly reflecting the effects of the drought on the farm sector. By contrast, strong employment growth had boosted growth in labour income.
Consistent with the ongoing low growth in household disposable income, household consumption had increased by only 1.4 per cent over the year to the end of June. Members noted that there had not yet been evidence of a pick-up in household spending following the recent reductions in the cash rate and receipt of the tax offset payments, although they acknowledged that it may be too early to expect any signs of a pick-up. Retail sales had remained subdued in July and car sales had decreased in August. Despite weak reported retail sales conditions generally, on a slightly more positive note some contacts in the Bank’s liaison program had reported a mild pick-up in retail sales since July. Responses to consumer surveys in September had suggested that, on average, households planned to spend around half of their lump-sum tax payments, broadly in line with what had been assumed in the Bank’s most recent forecasts.
The residential construction sector had contracted further and this was expected to continue for some time. The decline in dwelling investment in the June quarter was greater than had been expected a few months earlier. Higher-density approvals had declined in July, to be at their lowest level in seven years; detached approvals had also declined in July. The Bank’s liaison program had continued to report weak pre-sales for higher-density developments. Taken together, this information implied that dwelling investment would decline further over coming quarters.
The turnaround in the established housing market had continued in September. Housing prices had increased further in Sydney and Melbourne, and auction clearance rates had remained high in both cities. The pace of growth in housing prices had also picked up in some other capital cities in recent months. However, housing turnover had remained low.
Business investment had decreased a little in the June quarter, driven by a decline in non-residential construction outside the mining sector. Nevertheless, the outlook for non-mining business investment remained favourable, supported by investment in infrastructure. Mining investment had picked up largely as expected. Members noted that mining investment was expected to continue to increase gradually, supported by projects both to sustain and to expand production. Survey measures of business conditions had remained around average in August; members noted that conditions in retailing were reported to have been very weak, while conditions in the mining industry had remained well above average.
Conditions in the labour market had continued to be mixed. Employment growth in August had remained stronger than growth in the working-age population, and the employment-to-population ratio had reached its highest level since late 2008. Employment had increased by 2½ per cent over the preceding year, the third successive year of strong employment growth. The participation rate had also increased to another record high. Members noted that the strong demand for labour had been met by an equally strong increase in supply. The unemployment rate had been around 5¼ per cent since April and the underemployment rate had remained above its recent low point. Looking ahead, job vacancies and advertisements had declined, suggesting that employment growth would probably moderate over the subsequent few quarters. Members noted that the ongoing subdued growth in wages implied that there continued to be spare capacity in the labour market.
Financial Markets
Members noted that financial conditions remained accommodative internationally and in Australia.
Several major central banks had eased policy in September and market pricing implied that market
participants expected the global economic expansion to be sustained by an extended period of
policy
stimulus. Expectations of further monetary easing had been partially scaled back in response to
tentative signs of progress in the trade and technology negotiations between the United States
and China
and some better-than-expected US economic data. These developments had also supported the prices
of
equities and corporate bonds.
As expected, the US Federal Reserve had reduced its policy rate again by 25 basis points in
September. The Federal Reserve had noted that, although the US economy had remained strong,
easier
policy was warranted given muted domestic inflation pressures, a weakening in global activity
and
persistent downside risks. Members of the Federal Open Market Committee did not anticipate a
prolonged
easing cycle, but continued to signal that they were willing to ease policy further if needed to
sustain
growth and meet the Federal Reserve’s inflation objective. Market pricing suggested that
the
federal funds rate was expected to decline by a further 50 basis points or so by mid 2020,
which was a little less than had previously been anticipated.
The European Central Bank (ECB) had delivered a package of stimulus measures in response to
inflation
being persistently below the ECB’s target, protracted weakness in economic growth and
continued
downside risks. The package included cutting the ECB’s policy rate by 10 basis points
to
–0.5 per cent, exempting a portion of banks’ excess reserves from negative
deposit
rates, committing to not lifting rates until inflation returned sustainably to target, renewing
purchases of government and private sector securities, and easing the conditions of the targeted
long-term refinancing operations designed to encourage banks to lend to the private sector.
The People’s Bank of China had provided additional but targeted monetary stimulus, further
cutting
its reserve requirements, with larger adjustments for some smaller banks that are important
providers of
finance to small businesses. Chinese banks had also lowered the benchmark lending rate for
corporate
borrowers slightly.
Government bond yields in major markets had risen a little, with yields in Australia following suit. Nonetheless, bond yields remained very low, with a large portion of bonds in Europe and Japan trading at negative yields. Members noted that a sizeable proportion of the investors holding these negative-yielding bonds were constrained by their mandates or regulatory requirements, including asset managers, banks, insurance companies and pension funds.
Members noted that financing conditions for corporations remained favourable globally. Equity
prices
had remained close to recent peaks, spreads on corporate bonds were low and issuance volumes had
been
strong. In Australia, the cost of capital for corporations had been quite stable for some years,
although more recently it had declined a little. Members also discussed hurdle rates for
business
investment, which had not changed much over recent times.
Major exchange rates had generally been little changed over September, with the US dollar
having
appreciated over the preceding two years or so on a trade-weighted basis. The Chinese renminbi
had
stabilised after its earlier depreciation, while the Japanese yen had depreciated, consistent
with some
easing of concerns about global risks. The Australian dollar had been little changed and
remained around
its lowest level in recent years.
In Australia, borrowing rates for households and businesses, as well as banks’ funding costs, were at historically low levels. Housing loan approvals to both owner-occupiers and investors had increased in the three months to August, consistent with stronger conditions in some established housing markets. However, members noted that this increase in approvals had not yet translated into faster growth in housing credit. The pace of growth in housing credit for owner-occupiers had been fairly steady since the beginning of the year and the stock of housing credit for investors had continued to decline a little.
Financial market pricing indicated that a 25 basis points reduction in the cash rate was
largely
priced in for the October meeting, with a further reduction expected by mid 2020.
Financial Stability
Members were briefed on the Bank’s regular half-yearly assessment of the financial system.
Globally, investors were accepting low rates of compensation for bearing risk, despite the increased chance of significantly weaker economic growth. Members noted that a sharp slowdown in global growth could result from an escalation of the US–China trade and technology disputes or geopolitical tensions in the Middle East, Hong Kong or the Korean peninsula. Central banks had eased monetary policy in response to the potential for weaker growth, and additional easing was expected by markets, leading to falls in long-term government bond yields. Despite the increased uncertainty, risk premiums were low and in some cases had fallen further. The lower risk-free interest rates and low term, credit and liquidity risk premiums had seen many asset prices increase further. Any shock that caused markets to increase risk premiums or revise upwards expectations of future policy rates, such as a pick-up in inflation without accompanying stronger growth, could see a broad range of asset prices fall. Given debt levels were high in some non-financial sectors in some economies, a fall in asset prices could result in financial stress for some businesses and households, which could spill over to financial institutions.
Members observed that there had been strong growth in corporate debt in the United States, France
and
Canada, particularly lower-quality debt. Members noted that borrowers whose credit ratings fell
below
investment grade, and who relied on market-based finance, could face difficulty accessing
funding, given
many investors’ mandates were constrained by credit ratings. The interaction of high
sovereign debt
and less resilient banks in Japan and some European economies was also seen as a risk. However,
in the
United States and the United Kingdom, the resilience of the banking system had increased as
profitability had improved.
Corporate debt in China had increased sharply over the previous decade, although in relation to
GDP it
had declined recently in response to policy measures to promote deleveraging. These measures
included
closing some unprofitable state-owned firms, restructuring some debt, reducing the size of
non-bank
financing and reducing non-banks’ interactions with banks.
In Australia, near-term risks related to the housing market had eased in the preceding few months with a turnaround in housing prices in Sydney and Melbourne. Prices in those cities had fallen by a little under 10 per cent over the preceding 18 months, reducing the housing equity of households and resulting in a small share with negative equity. The recent increase in housing prices in those cities had reduced the risk of large increases in negative equity, which could result in losses for lenders if declines in income reduced households’ ability to meet debt repayments. Half of all loans in negative equity were in Western Australia and the Northern Territory, where housing price declines had persisted over the previous few years. Members noted that the rate of mortgage arrears in Western Australia had increased by more for riskier types of lending, including lending with smaller deposits, higher repayments relative to income, and loans to investors and self-employed borrowers.
Despite the high level of household debt in Australia relative to other countries, the risks from household debt appeared to be mostly contained. While the share of mortgages in arrears had continued to rise, it remained at a low rate relative to many other countries and in absolute terms. In addition, the quality of new lending had increased in recent years. The shares of loans with high loan-to-valuation ratios and with interest-only repayment terms had declined following a focus by regulators on this higher-risk lending. Further, members noted that households continued to have large prepayments on their housing debt. In aggregate, mortgage prepayments were equal to two-and-a-half years of repayments. However, while one-third of borrowers had prepayments exceeding two years of mortgage repayments, a slightly lower share had very little or no buffers. Of these, a little less than half appeared more likely to be vulnerable to shocks to their ability to meet their mortgage payments.
The resilience of Australian banks had increased since the financial crisis. Banks had largely
completed their transition to their higher ‘unquestionably strong’ capital ratios.
Banks’ resilience would increase further with the introduction by the Australian Prudential
Regulation Authority of a Loss Absorbing Capacity (LAC) regime, which will require banks to
raise an
additional 3 percentage points of capital by 2024. Members observed that banks were already
issuing
new Tier 2 securities to meet their LAC requirements. Banks’ profitability had
declined a
little over the prior year or two, although banks remained highly profitable. The increase in
housing
arrears had resulted in a small decline in banks’ overall asset quality, although asset
quality
remained high. Rates of non-performing business loans were a little below rates for housing
loans.
Members also discussed non-financial risks facing the financial system. Members noted that cyber
risks,
and IT risks more broadly, were increasing as technology systems become more complex and
embedded in all
operations. Members also noted that climate change presented a risk to financial institutions.
While
extreme weather events were thought unlikely to produce large losses for the financial system as
a
whole, at least at present, losses could be larger in future if financial institutions do not
manage the
risks carefully.
Considerations for Monetary Policy
In considering the policy decision, members observed that the risks to the global growth outlook remained tilted to the downside. The trade and technology disputes between the United States and China were affecting international trade and investment, as businesses scaled back their spending plans in response to increased uncertainty. In China, the authorities had taken further steps to support the economy, while continuing to address risks in the financial system. In most advanced economies, inflation remained subdued despite low unemployment rates and rising wages growth.
In this context, global interest rates had continued to decline, with the central banks in the
United
States and Europe reducing interest rates in the previous month. Further monetary easing was
widely
expected, as central banks continued to respond to the downside risks to the global economy and
subdued
inflation. Long-term government bond yields were close to record lows in many countries,
including in
Australia. Borrowing rates for both businesses and households were at historically low levels,
and the
Australian dollar was at its lowest level in recent years.
Members considered the case for a further easing in monetary policy at the present meeting, to support employment and income growth and to provide greater confidence that inflation would be consistent with the medium-term target. Members noted that the Bank’s most recent forecasts suggested that the unemployment and inflation outcomes over the following couple of years were likely to be short of the Bank’s goals. The most recent run of data had not materially altered this assessment and, on balance, had been on the softer side. The ongoing subdued rate of wages growth also suggested that the economy still had spare capacity. There was therefore a case to respond to the general outlook with a further easing of monetary policy.
Members were mindful, however, that monetary policy was already expansionary and that the lower
exchange rate was also supporting growth. They acknowledged that these factors and the recent
tax cuts
could combine to boost growth by more than their individual effects would imply, especially
given the
context of the mining and established housing sectors seeming to have reached turning points. At
the
same time, members recognised that it was possible that the effects may be smaller than expected
and the
global risks were to the downside.
Members also considered the argument that some monetary stimulus should be kept in reserve to address any future negative shocks. However, that argument requires changes in interest rates to be the key driver of demand, rather than the level of interest rates, which experience has shown to be the more important determinant. Members concluded that the Board could reduce the likelihood of a negative shock leading to outcomes that materially undershot the Bank’s goals by strengthening the starting point for the economy.
The Board’s discussions also focused on the ongoing strength in employment growth. The
period of
strong employment growth had not reduced spare capacity in the labour market significantly.
Almost all
of the strength in employment growth over the preceding three years had been matched by higher
participation, so there had been little progress on reducing unemployment and underemployment.
It was
also possible that participation was rising partly in response to weak growth in incomes.
Moreover,
employment growth was forecast to slow over the period ahead.
Members also discussed the possibility that policy stimulus might be less effective than past experience suggests. They recognised that some transmission channels, such as a pick-up in borrowing or the effect on the home-building sector, may not be operating in the same way as in the past, and that the negative effect of low interest rates on the income and confidence of savers might be more significant. Notwithstanding this, transmission through the exchange rate channel was still considered likely to work effectively, and evidence suggested that the positive effects of lower interest rates on aggregate household cash flows via lower debt repayments was likely to support household spending, given that household interest payments exceed receipts by more than two to one.
Members also noted that the housing market and other asset prices might be overly inflated by lower interest rates. Members acknowledged that asset prices were part of the transmission mechanism of policy, including by encouraging home building. By themselves, higher asset prices were considered unlikely to present a risk to macroeconomic and financial stability. This assessment would need to be reviewed if rapidly increasing asset prices were accompanied by materially faster credit growth, weak lending standards and rising leverage. Although household debt was still considered high, members saw only a limited risk of excessive borrowing at the current juncture: household disposable income growth (and thus borrowing capacity) is weak; the memory of recent housing price falls is still fresh; and banks are still quite cautious in their appetite to lend. Nonetheless, members assessed that close monitoring of this risk was warranted.
Members concluded that these various factors did not outweigh the case for a further easing of
monetary
policy at the present meeting. Taking into account all the available information, including the
reductions in interest rates since the middle of the year, the Board decided to lower the cash
rate by a
further 25 basis points. Members judged that lower interest rates would help reduce spare
capacity
in the economy by supporting employment and income growth and providing greater confidence that
inflation would be consistent with the medium-term target. Members also noted the trend to lower
interest rates globally and the effect this was having on the Australian economy and inflation
outcomes.
Members judged it reasonable to expect that an extended period of low interest rates would be required in Australia to reach full employment and achieve the inflation target. The Board would continue to monitor developments, including in the labour market, and was prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.
The Decision
The Board decided to lower the cash rate by 25 basis points to 0.75 per cent.
