If money is the life-blood of the economy interest rates are its blood pressure. And if the analogy holds, which it does this far, rates can both be too high and too low.
The risks are also similar. Too high and you risk the economic equivalent of stroke. Just right is somewhere between 4 and 6 per cent, just as with blood pressure there is a normal range for rates and this is what it has tended to be over history.
When rates drop below 4 per cent something is wrong and there is a good risk that the patient may be about to faint.
The public knows this, so the posturing of both sides on the issue is bizarre.
John Howard made a comment which, in reasonably foreseeable and campaigning terms, might have been justifiable at the time, that “Interest rates will always be lower under a Liberal government”. The Liberals appear to have felt trapped into supporting this statement even when it had become unjustifiable.
On the other hand Labor doesn’t want to admit that things aren’t travelling that well, so they trumpet lower interest rates as an achievement.
If there really was a new political paradigm, politicians would be straight with the electorate.
Nevertheless, new paradigm or not, I think they would be rewarded if they were honest. And here is what they should say.
Interest rates are only this low because the international economy is sick, and we’re worried that ours might be as well.
They are being lowered because if they stay above the level of the rest of the world overseas speculators will push our dollar to damaging heights by borrowing cheaply in their own currencies to invest not in our productive industries but our financial markets.
They are being lowered because we are worried that the decrease in capital expenditure in the mining industry will leave Australia without an engine of growth.
But do not expect them to stay at these levels forever.
By all means use them to go out and buy houses and expand your businesses, but budget on significantly higher interest rates in the future when you do so.
You see, interest rates represent a bargain between lenders and borrowers. While low interest rates might be good for house buyers and businesses, they put pressure on the retirement incomes of older Australians.
Whatever has happened overseas, that bargain must eventually move back to favour those who have been savers. Make sure that when they do you aren’t stranded.
And that is advice we are going to take ourselves. This election is not about promising yet more renovations of the Australian political economy to increase the number of shiny objects in it. This election is about facing up to the realities of our economy and the world economy and getting Australia back into tip-top shape.
While ordinary Australians have spent the last 5 years since the GFC getting their own finances into shape, Australian governments have been doing the opposite.
Now is the time to acknowledge that the Australian people were right all along and to realign government with you.
When we’ve done that, interest rates will return to normal – hopefully not too high and not too low, but just right.
On an article on interest rates I was surprised that there was no mention that the base interest rate set by the Reserve Bank is the overnight rate charged by the Reserve to the private banks who have become overextended for that night only.
In !957, when unemployment was virtually unknown but many women were still stay at home mums, the Which Bank extended home loans at 5%pa fixed for 25 years. I know because I had one.
There is absolutely no need for a sovereign, currency issuing government, to balance its budget if there are underemployed people and resources in the sovereign area and there are worthwhile infrastructure needs.
The sovereign government can put the unemployed to work and pay them, and the materials suppliers, up to the point where the economy starts to boom. It is only when an economy is booming that a budget surplus can be an acceptable aim as the sovereign government needs to curb the over enthusiasms of the private sector.
Any sovereign government surplus, or austerity aim, when there is significant under employment creates further underemployment. Look at what is happening in Europe and the USA.
The USA should be repairing the 18,000 bridges that need repair, and the sewerage systems etc now in decay, using deficit expenditure to fund those tasks rather than using QE to rescue the causes of the GFC rather than providing jobs, and mortgage relief for the GFC’a victims.
Read New Economic perspectives on this subject or our own Prof Bill Mitchell.
Comment by John Turner — August 7, 2013 @ 12:57 pm
Interest rates are but one of an array of levers that can be pulled by governments/reserve bank in response to changed market conditions. As such there is no “too high” or “too low”. Interest rates are what they are. Full stop. to suggest that there is an “ideal” is as ludicrous as suggesting that there is an ideal tide height.
Comment by barney — August 7, 2013 @ 1:04 pm
Graham
“getting Australia back into tip-top shape.” –When has Australia ever been in “tip top shape”?
Let me guess, during the periods of Conservative government and the definition probably incorporates the idea of low government welfare spending and fiscal surpluses and of course tax cuts with a sprinkling of middle class welfare–the entire austerity package.
The Australian economy has never been in tip top shape, we’ve simply been lucky, so far.
Comment by RussellW — August 7, 2013 @ 3:02 pm
John, your 5% loan bears out that we can expect interest rates to be between 4 and 6 per cent when things are going well. That’s why the Comm Bank gave you the loan for 25 years and fixed it. They couldn’t have known that Gough Whitlam and OPEC were going to ruin the party 17 years later.
Barny, the RBA has only one lever. The government has the other major one – government revenue and expenditure. But there is no logical link between this and your declaration that there is no normal level of interest rates. You’ll find when the economy is well run it is about where I say it is. Try this link if you doubt me http://www.rba.gov.au/statistics/tables/xls/f05hist.xls?accessed=2013-08-07-16-25-56
Russell, Australia was in tip-top shape in the mid-90s through to probably about 2009, before Rudd had done too much damage. Try Peter Hartcher’s The Sweet Spot if you want all of the statistics that show this. Widespread wealth, decreasing inequality, increasing confidence, and moving ahead of most countries in the world on a whole range of economic and non-economic indicators. I’m not sure why you would describe a wealthy and growing wealthier country as being subject to an “austerity package” unless you are using the term pejoratively.
Comment by Graham — August 7, 2013 @ 4:32 pm
Graham,
On Insiders last Sunday Mike Seccombe stated that history will show that the Howard era was one of Australia’s worst. I agree with him.
Deregulation of the financial system went too far by a country mile. In October 1998 the Governor of the Reserve bank, Ian Macfarlane stated, “”More and more people are asking whether the international financial system, as it has operated for most of the 1990s, is basically unstable. By now I think the majority of observers have come to the conclusion that it is…” “The intellectual underpinning of the free market position …The Efficient Markets Hypothesis – is very weak. In all the exchange rate tests of which I am aware, the hypothesis has been contradicted by facts.”
“We need to devise a system for maximizing the benefits to be gained from international capital while limiting the risks.” “It is simplistic to insist on the totally free movement of capital in all countries and in all circumstances.”
On 31 October that year the western leaders after a G& meeting promised to put in place “international principles and codes of best practice in fiscal policy, financial and monetary policy, corporate governance and accounting” to “ensure that private sector institutions comply with new standards of disclosure.”
Failure to live up to their promise led to the GFC.
Howard wasted the early part of the minerals boom. Although government debt was eliminated the common weal had lost a major block of assets and private debt was massive. We do not need a budget surplus while there is a demand gap. That gap is increasing.
In mid September 2008 all of Australia’s banks were in effect bankrupt as a consequence of the Lehman collapse and the consequent GFC.
Comment by John Turner — August 7, 2013 @ 7:44 pm
Should read G7.
Comment by John Turner — August 7, 2013 @ 7:45 pm
Graham,
Thanks for the reference. I have to say I’m rather cautious in assigning blame or praise to any incumbent government for the current state of the nation’s economy. Prevailing economic conditions are often the result of decisions made by long forgotten administrations or foreign bankers. “Sweet spots” come and go, our problem is that the underlying structure of the Australian economy is basically Third World and our external private debt is huge.
John Turner,
Agreed, politicians, particularly conservatives, are keen to “prove” their superior economic management by producing budget surpluses, that’s something they can show to the voters.
I recently read a demolition of the “Efficient Markets Hypothesis” in John Quiggin’s “Zombie Economics”
Comment by RussellW — August 7, 2013 @ 10:26 pm
Russell, I disagree that our underlying structure is “third world”. In what way? We have one of the top economies in the world. Your third world must meet a high hurdle.
John, the reason “conservatives” are keen to prove their superior economic management by producing surpluses is that surpluses are necessary from time to time, and we win votes by managing the economy better than the opposition. Our voters understand that before you can fund aspirations you have to have the money.
Comment by Graham — August 7, 2013 @ 11:20 pm
Graham,
re; “surpluses are necessary from time to time”
That statement requires that you know when surpluses are necessary or are likely to occur.
The budget deficit over the business cycle, from peak to peak, needs to at least match the growth of the economy over that cycle. The money necessary to run a larger economy can only flow from the excess expenditure of the currency issuing government.
Banks do not create money. They create private credits and deficits that are exactly equal in total and as the loans are repaid both are equally extinguished. That is a simple accounting principle.
What banks can do is become less prudential, which they did in the Howard years. The consequential increase in the size of borrowings as citizen borrowed to own homes reduced other demand in the economy. All profit from interest is a drain on other spending capacity.
To maintain demand, citizens increased their credit card debt. Both credit card debt and housing debt became bubbles that had to plateau. Once the plateau occurs people lose their enthusiasm and economy contracts which is just what happened not long after Howard lost power.
Keynes made the situation quite clear in his General Theory at Ch. 10, Section 6.
Anyone who doesn’t understand Keynes should be wary of commenting on economic issues.
A conservative, Nixon, finally accepted Keynes view and took the world’s currencies off the gold standard.
A sovereign government does not need the money before it can spend. If it there are underemployed people and supplies then deficit spending should be used to utilise both on worthwhile projects, Then, when the economy recovers, due to the new incomes and market demand created, tax collections will rise, social security payments will fall and the government’s balance will move towards surplus.
New Economic Perspectives blogs cover all of this succinctly. Neo-liberal main stream economists and politicians are way out of date.
Comment by John Turner — August 8, 2013 @ 8:42 am
Graham,
your statement about well run infers that the economy exists in a vacuum. As keynes said when the facts change i change my mind. A well run economy in a world downturn is far different from a well run economy in a boom. Time and tides Graham.
Comment by barney — August 8, 2013 @ 9:31 am
Graham,
“Third world” is probably an obsolete term, I’m showing my age.
http://en.wikipedia.org/wiki/Economy_of_Australia
Particularly the section-“Australia’s balance of payments”.
“In trade terms, the Australian economy has had persistently large current account deficits (CADs) for more than 50 years.[34] One single factor that undermines balance of payments is Australia’s narrow export base.”
–particularly for an OECD country. Canada, probably the most comparable economy to Australia, exports a much higher proportion of manufactured goods.
As a result, Australia is extremely vulnerable to changes in the terms of trade of our very narrow export base-that’s typical of ” Third world” economies.
We’re still living on luck, which could soon run out, which incidentally, is the real meaning of the term “The Lucky Country”. If our governments were ever serious in regard to “sound economic management”, the first task would be to encourage our capitalists to extract their collective digits and compete internationally.
Comment by RussellW — August 8, 2013 @ 10:31 am
Russell,
The balance of trade has certainly been a worry for a long time. Japan, then Korea and China have followed mercantilist policies and Australia hasn’t been prepared to defend domestic industries, even one that are essential for our long term wellbeing and interests.
The whitegoods, car and construction materials industries are a good example.
We have lost most of the steel consuming industries and unless Australia reverses course there will be no steel industry
There has been some respite from the current account balance as some sixty countries have accumulated reserves of the $A. That in economic effect means that we are getting some of our imports for the cost of key strokes, something that the USA has been doing since the first oil crisis.
The sooner the world get back to the Keynes proposed currency (Bancor or a basket of currencies) for real international trade the better.
Comment by John Turner — August 8, 2013 @ 12:46 pm
Graham. Conservative govts around the world are running a much lower interest rates regime, some in negative territory!
Therefore it follows, ours are not yet too low, but may be just a tad high, particularly for the non-mining economy, which is still contracting. And something we need to increasingly rely on, with the winding down of the mineral boom or extraction.
I agree mostly with John Turner, except that it was ever a good idea to get off the gold standard.
Keynes learned to manage with the gold standard, which served for all practical purposes, as a virtual self adjusting for inflation, basket of currencies?
Not so the virtually worthless USD, which seems to have largely replaced something of genuine intrinsic worth or redeemable value, with virtually worthless paper; gold tends to automatically adjust, with the rise and fall of the overall global economy.
I mean, if I bought a thousand ounces of gold today, and stashed it or $150,000 under the bed.
Which could be exchanged for the greatest amount of goods and services, two or three decades down the track? The gold or the dollar bills?
We need to reinvent currency, so that it actually does represent just so many international units of energy, permanently!
Everything else does! Even matter!
Alan B. Goulding.
Comment by Alan B. Goulding — August 8, 2013 @ 2:43 pm
We do not need gold to back our currencies if there are responsible elected people backing the supply.
Currently in the West private central banks create most of the money to equal increases in our growth + inflation.
They totally control our Govts and have shares in the major corporations around our planet.
Unless we move back to Govt banks and debt free infrastructure ,we are stuffed. China is finding cheaper energy and resources elsewhere.
Comment by Ross — August 8, 2013 @ 8:58 pm