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Will they find the right porridge?

Cash rates are an important way for reserve banks to influence the Australian economy. It works by borrowing and saving interest rates set by banks flowing to consumers and businesses.

The price of assets such as homes and stocks is greatly affected by the cash rate. Low interest rates allow people to borrow more and also encourage investors to look for products that offer better returns.

Notably, the RBA raised its cash rate to almost 17.5% in the early 1990s, eliminating inflation, which was approaching 9%. Since then, interest rates here and around the world have been on a downward trend as well as inflation.

Between 1995 and 1999, the average cash rate was 5.95%. Between 2000 and 2004, they averaged 4.6 percent.

Between 2005 and 2009, including the global financial crisis, the average cash rate fell to 4.3%, ranging from 7.25% to a record low of only 3%.

In the post-GFC period up to 2014, the average cash rate was 2.8%, but then in the last five years of the 2010s. The average cash rate is only 1.58 percent.

The average for the last 10 years was only 0.19 percent.

Now, with the recovery of the global economy and the recovery of inflation, financial markets are expecting central banks like RBA to start raising interest rates. By the end of next year, we believe these markets will have a cash rate of around 1.25% and by December 2023 it will be 2.5%.

But how much can the RBA raise its cash rate without a recession?

Respected independent economist Saul Eslake states that household debt repayment ratios peaked in the June 2008 quarter. At that time, the official discount rate was 7.25%.

Since the June 2008 quarter, average mortgages in Sydney and Melbourne have skyrocketed by more than 120%. Wages have risen 55%.credit:Peter lay

In New South Wales, the average mortgage for an established home was $ 333,500. It was $ 286,400 in Victoria.

Eslake estimates that a cash rate of only 3 percent would be required to reach the same debt repayment ratio, given the significant increase in household debt today.

The average mortgage in New South Wales is currently $ 762,200, while in Victoria it has reached $ 633,200.

Average wages increased 55 percent in both New South Wales and Victoria. However, the average mortgage size has increased by 128 percent and 121 percent, respectively.

This is where monetary policy rubber paves the way. Due to the large debt of households, even a slight rise in public interest rates can have a significant economic impact. Rowe admits it.

“The fact that debt levels are very high at this point means that raising interest rates is very effective because people have more debt,” he said in early November. rice field.

“Therefore, the cash flow channel is more effective when people have more debt.”

This month, RBA Vice President Luci Ellis talked about the future of the economy as the world recovered from the two years lost in the maze of masks and ivermectin plots.

“Whether the global economy is on the road to the Roaring Twenties or feeling tired after a pandemic depends on the choices many of us make,” she said.

RBA Assistant Governor Lucieris said Australia could be at the pinnacle of the roaring Twenties.

RBA Assistant Governor Lucieris said Australia could be at the pinnacle of the roaring Twenties.credit:Central Press Photo

“These depend in part on the stories we tell ourselves about our experiences and lessons learned. And one of the lessons we can tell and learn is, in fact, people and It means that companies have adapted and have done so. “

One of the reasons Ellis is confident is that she has a lot of cheap money and demand is returning.

That does not necessarily mean that the economy is in rude health. It is underpinned by record low interest rates, central bank money printing, and huge budget deficits.

In the long run, the problem is the productivity gains of the economy as a whole.

If a British textile maker in the early 19th century had given way, the Industrial Revolution would have ended in a small workshop, still producing a small number of expensive clothing.

The recession has traditionally wiped out unproductive businesses. It’s not a pandemic recession.

A recession can

A recession can “clean up” the economy of unproductive businesses, but at the expense of employment.credit:Jason South

Productivity Commission Chairman Michael Brennan said earlier this year that business failures in 2020 were one-third of 2019.

“Every recession is painful, but some, as it happened in the 1990s, comfort the cleansing effect of low-productivity companies withdrawing and high-productivity companies continuing to do business (for a variety of reasons). ) “He said.

“Therefore, there is no doubt that we will see a reallocation of resources across the economy. It is not clear whether productivity will recover with the significant withdrawal of unproductive companies.”

Low interest rates encourage people with money to look for new investments that offer better rates of return.

Throughout history, people have sunk money into “assets” with absolute conviction that they have a future.

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From the Dutch Tulip Mania in the 1630s and the South Sea Company disaster a century later to the Japanese land bubble in the 1980s, there are many examples of investors and their money being separated by reality.

In every country, cheap money is being poured into housing, stocks, and increasingly cryptocurrencies such as Bitcoin and Ethereum.

Those who bought cryptocurrencies early can, of course, make millions of dollars. The same was true of those who bought at the beginning of Tulip Mania and those who bought and sold stock at the 2000 dot-com startup.

Carolyn Wilkins, a member of the Bank of England’s Monetary Policy Committee, said this week that the rise in cryptocurrencies is closely linked to interest rate setting.

“Bitcoin acts as a speculative asset rather than money, at least in part, a sign of the general low interest rate environment and the pursuit of yields,” she said.

“Therefore, in many jurisdictions, personal holdings are considered an investment and are free to impose capital gains tax.”

Blockchain technology that enables cryptocurrencies has the potential to bring economic progress. But proponents of comprehensive secured debt made the same claim before revealing that the global financial crisis was a bit better than legitimate betting.

Cryptocurrencies such as Bitcoin have been supported by record low interest rates.

Cryptocurrencies such as Bitcoin have been supported by record low interest rates.credit:AP

World-renowned American economist Robert Gordon has long argued that the slowdown in productivity progress in recent decades is the result of something that central banks cannot change.

According to Gordon, the modern world was created between the end of the Civil War and around 1970. Electricity, internal combustion engines, light bulbs, antibiotics, powered flight, telephones, televisions, computers, etc. were all invented in that century.

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Sure, we have TVs and computers in our pockets today, a continuation of the revolution that began in the 1930s.

According to Gordon, the period from 1870 to 1970 is unparalleled in world history. As the Earth, we have become much more productive and wealthy. But unless Elon Musk dwells on Mars and discovers new lifestyles that change the understanding of physics and biology, the best days of life-changing innovation are behind us.

Even those who admire the virtues of green hydrogen as a miracle of some sort ultimately what they are doing is a better way to send electricity to our business and home (and perhaps cars). You have to admit that it’s about coming up. A true breakthrough was brought about by Bell, Edison, Westinghouse, Siemens and Tesla.

It may seem like a long bow to draw between the invention of the light bulb and the setting of monetary policy.

But reserve banks, along with all other central banks, are in a new world. Never before has it been necessary to consider ways to “normalize” interest rate settings from record lows during periods of high household and government debt. Central banks often own much of their government debt. The RBA holds over $ 300 billion and the US Federal Reserve holds $ 5.6 trillion.

Jo Masters, EY’s Chief Economist, states that raising interest rates to more normal levels is achievable. But it requires increased productivity, which can then pave the way for higher wages, which gives households the ability to repay their debt.

The US Federal Reserve holds $ 5.6 trillion in US Government debt.

The US Federal Reserve holds $ 5.6 trillion in US Government debt.credit:AFP

These are productivity gains that Gordon et al. Will not come soon.

Used by former Reserve Bank of India Governor Raghuram Rajan this week Essay on the current state of monetary policy Be aware of the future dangers of the US Federal Reserve and the US economy.

“Asset markets are weeping, backed by heavy borrowing, in anticipation of indefinite monetary policy and loose fiscal conditions. Market participants, right or wrong, the FRB is backtracking. We believe that if asset prices fall, we will withdraw from the path of rate hikes, “he wrote.

Central banks need to find a way to start raising interest rates, providing the ammunition they need to address future economic problems, including the RBA. And they have to do it in an economy that is crazy about cheap cash while having huge debt.

Goldilocks found it easy to find comfortable beds, chairs and porridge in the bear’s house.

Will they find the right porridge?

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