Boring old monetary policy is currently being given a jolt, as the government and Reserve Bank consider “unconventional” policy measures such as negative interest rates. And while they are extreme responses to a stagnant economy, they are also signs of how unwilling the government is to let go of its budget surplus, even while the economy cries out for stimulus.
Negative interest rates sound like some mad economic science that turns everything we are used to on its head, because they mean the lender pays the interest rather than the borrower.
Essentially, however, it is just an extension of standard monetary policy, where the RBA lowers the cash rate in order to reduce the costs for banks, which then lower their rates and encourage more people and businesses to borrow.
Right now the cash rate is 0.75%. According to standard economic theory the lowest it can go is 0%, but negative interest rates just ignore that and set a rate where the RBA is effectively paying banks to borrow money.
Imagine taking out a mortgage and getting interest payments rather than having to pay them!
First off, I should let you know that it not likely to ever happen.
A number of countries currently have negative interest rates – most notably Japan, which has had negative interest rate for nearly four years now – but even in those countries the mortgage rate is still above zero.
Negative interest rates are generally unadvisable, however, because it makes for a pretty dire situation for both savers and the banks themselves, whose margins get squeezed.
They also have the effect of signalling to everyone that the economy is tanking, which can have a negative effect as people stop spending out of fear that bad times are ahead.
Negative interest rates are not the only unconventional monetary policy that central banks can pursue. The other most-used measure is “quantitative easing” (QE), which is a term so mangled in jargon that it appears mostly used to ensure no one really knows what it means.
Basically it is the central bank increasing the amount of money in the system. It doesn’t do this by printing more money, but by buying a set amount of government bonds or bank-owned mortgage backed securities.
QE has the impact of lowering the yields for these bonds and thus reducing the borrowing costs for companies and households.
The other unconventional option is for the RBA to give forward guidance – such as saying it would not raise interest rates until certain conditions have occurred – such as an unemployment rate below 5% and inflation growth above 2.5%.
Now, as noted you are not likely to be getting a negative mortgage rate, and even a cash rate below zero looks unlikely in the near future.
There has been some movement on the futures market as investors and speculators try to read the RBA tea leaves, but for now the market anticipates another cut in the cash rate to 0.5%, but no real likelihood of a cut further than that.
These things can change fast, however.
At the start of this year the market was expecting the cash rate at this point would still be 1.5%, and even in June the anticipation was that the cash rate would now be 1.0%, as opposed to the actual rate of 0.75%.
Things could be very different to what is anticipated currently – although over the past decade the market has generally been too optimistic about when interest rates will start to rise.
And so even while it may not seem likely, the possibility of the cash rate going below zero is very much in the front of both the RBA’s and the government’s minds.
The governor of the Reserve Bank, Philip Lowe, recently co-authored a paper by the Bank of International Settlements (often called the central banks’ central bank) which discussed the efficacy of unconventional monetary policy.
And over the weekend, the Australian’s Michael Roddan revealed an FOI-obtained Treasury department briefing on “unconventional monetary policy” provided to the cabinet.
The documents are themselves not all that shocking; they are the standard briefing note that the public service produces on all manner of issues every day. The shocking aspect is that the treasurer’s office was actually asking for such a brief.
There really are only two reasons why the Reserve Bank would adopt either negative interest rates or one of the other big “unconventional” policies: that the economy had deteriorated to such a state that the cash rate needed to be cut another three times to 0%, and that the government at the same time had refused to use any fiscal stimulus measures.
The BIS paper on unconventional monetary policy makes this quite clear, noting that one of the problems of such measures is that “it might induce a bias toward inaction among other policy authorities, such as regulatory, prudential and fiscal policymakers, if they believe the burden of policy interventions can be left to the central bank”.
The Treasury’s own briefing supports this, noting that one of the problems of negative interest rates and QE is that they can cause a big increase in asset prices such as housing, while not improving the broader economy. It also noted that they can be difficult to unwind, and “as such, fiscal policy can play a greater role when monetary policy is constrained”.
But there remains no sense of the government wanting to pursue any sort of fiscal stimulus, other than the tax cuts it has already legislated and which are taking some time to flow through into any meaningful pickup in demand.
Certainly the forward-looking measures of inflation expectations show no sign of increased demand, despite the current record low interest rates.
Essentially the government is hoping that while record low interest rates have not yet spurred an increase in demand, even lower record rates will do so.
No one suggests we are at a point where we should be pursuing extreme fiscal stimulus as occurred during the GFC, and yet there appears to be willingness within the government for extreme monetary policy to be pursued.
And extreme measures are only ever a sign that things have not gone to plan. Negative interest rates and quantitative easing are “break glass in case of emergency” measures; a prudent government might instead consider what it can do to ensure that emergency does not occur.
• Greg Jericho writes on economics for Guardian Australia