Rising Interest Rates

[Rixter]

An interesting newsletter point of view.

Raising rates is demonstrably a failed gamble to contain inflation. It has no record of success. It is a failed policy pursued only by, in my opinion, a discredited central bank in Australia and New Zealand. What happened after they constantly raised rates? Has it been successful? Has inflation come down?

No, it has gone up! They have raised rates 47% since 2002. Yet since 1997, when the Reserve Bank was formed, wages have only gone up 52%.This is a huge attack on the living standards of Australians. This contradicts the charter of the Reserve Bank.

While I am writing this, the Reserve Bank is deciding on an August rate rise and surprise, surprise, the media is screaming that rates must go up to contain inflation. Why? This year petrol has gone up 30%. Will raising the repayments on every mortgage and every business overdraft across Australia reduce the cost of petrol? No.

We need realistic people on the Reserve Bank board. The only other item to go up in the inflation spike was rents and as we know, rents went up 20% in the last 12 months. That has been caused by the Reserve Bank’s ineptitude which strangles the supply of properties coming onto the market as a deliberate high rate policy and decision from 2002.

The only other bad spots were bread which was up 8.8% for the year and vegetables 6.6%*. Will raising rates lower these prices? Will raising rates cure the drought? Will raising rates bring rain that will increase the supply of these products?

We need more commonsense people on the Reserve Bank board to balance the people who operate from an ivory tower and believe that raising rates solves every single problem.There is a solution. There is a silver bullet. Why isn’t the media suggesting we match Canada’s rate of 4.25%? This would be a huge 2.25% reduction in the impost on everyone in Australia. Would it reduce inflation? Well, yes: it has in Canada.

Would we reduce our balance of payments problems? Yes: it has in Canada. Will consumers win? You bet. Will the banks lose? You bet. Oh … so that is why it is not being canvassed in the media ... the banks have those people in their pocket.
Our central bank, I believe, is not working for us—it is hurting us. Since its inception, there has been a steady decline in our ability to save. There has only been a 10% increase in the gross domestic product per capita over that time.

Over ten years, the Reserve Bank has consistently pushed a high rate policy as normal and yet this flies in the face of the facts. The rest of the world has not seen this as normal at all; and citizens of those countries have been able to enjoy low mortgages and low overdrafts leading into low production costs, leading into exports which we then happily import at the expense of jobs in Australia.

To me, mathematically, it is stupid to have inflation at 2.5% and have a high rate policy which is nearly three times the amount regarded here as ‘normal’. If we ignore the high rate policies of the 70s and 80s and go to the first 70 years of last century, the normal rate was about 0.4% over the inflation rate. This appears sensible and not inflationary. With our current inflation rate of 2.5% it means the Reserve Bank would be sitting on 2.9% and yet, this would still not be the lowest rate in the world.

All companies on the stock exchange, last financial year, returned an average 13% increase on profits while the Australian banks were nearly double this—the forecast for the current financial year profit for all companies is 11% and again, our banks will come in with double this. This shows the banks’ greed is being satisfied only at the expense of every Australian through their voracious appetite for fees and charges.

When can we take the stranglehold off the banks and media comment about economics? It is in the banks’ interest to have high rates; they get money from you for nothing through your cheque account and savings accounts.They have invented new fees on this free money which has given banks a ‘new’ profit of $1.6 billion a year, yet of course they want to lend it out at the highest rate. Are the media commentators employed by the banks? What can we do about it?

 

[Kennethkohsg]

Dear Rixter,

1. If RBA is indeed only formed in 1997, post-Keating ALP Govnernment time, and not earlier, then to me, the Liberal Coalition Govt under John Howard and with Peter Costello as its Treasurer has done well for its excellent economic management of Australia, through their introduction of an independant RBA under the able leadership of Ian MacFarlance.

2. I wonder beside being allowed to tinker with the interest rate mechanism to manage the inflation within the Australian Economy, what other legal powers have the RBA presently has and been empowered, in order the influence the fiscal, or the financial and monetary policies in Australia?

3. Any way, which is the official dividng line between the Australian Treasury and its RBA?

4. To me, I see the following challenges facing the Australian Economy:

a. the fast growing housing and other core types of inflation emeriging within the Australian Economy.

b. the need to review and properly manage the level of money in circulation as well as to ensure that existing easy money and lending for personal and housing consumption in Australia are not excessive and perhaps being properly diverted away for the proper infrastructural development to further expanding the capapcity of the Australian Economy.

c. the pace at which the Australian Dollar Currency is allowed to increase its value vis-a-vis the rest of the World and its attendant adverse impact on its external exports and fast-growing trading deficit related problems

d. the need for prudency and to promote more savings among Australian households instead of trying to further stimulate the personal and housing consumption within Australia.

5. Consequently, I believe if Australia seeks to rein the easy monies flow and divert it away for proper infrastructural development and to exercise its own financial and fiscal discipline where neccessary, (even to the extent of allowing its people to suffer some short term pains at this point in time), a healthier Australian Economy is lilke to emerge and sustain itself longer, together with the continued economic prosperity presently enjoyed by the Australian people.

6. For your kind update and further comments/discussion, please.

7. Thank you.

regards,
Kenneth KOH

 

[duncan_m]

Hi Rixter.. who is the Author?

 

[Rixter]

Dunc,

Was emailed to me by a friend. But views are very thought provolking and may lift the wool in a few areas.

 

[MadMax2]

I am not a professional economist, but for me it looks very fishy, when complex economy is managed by tweaking the interest rates. Sounds very simplistic: CPI is up, consume spending is up, lets increase the interest rates to cool down the economy.

I afraid that such a method of controlling is a result of misunderstanding and underestimating the complexity of the economy. By increasing the rates, the burden of inflation simply is redirected onto middle class, who is already struggling with getting more wages to cope with spending. Some of us will get more wage, but many of us simply will have to sacrifice or sell something in order to sustain living.

 

[topcropper]

Double post..............

 

[topcropper]

The only other bad spots were bread which was up 8.8% for the year and vegetables 6.6%*. Will raising rates lower these prices? Will raising rates cure the drought? Will raising rates bring rain that will increase the supply of these products?

?

Of course raising interest rates will help control inflation. What was the alternative? Leave them at super low rates of a few years ago??? Imagine house prices and consumer spending without the rises?


As for the drought and food prices? The drought is coping more than it's fair amount of blame. I think the drought is not the main reason for rising food prices, if at all. Australia exports just about every food type. So the drought is reducing our capacity to export, not the ability to provide food for Australia. Food prices are determined by export parity. The drought is not the real blame.

Food prices are rising all around the world, and in my opinion, it is the start of an agricultural commodities boom, or the end of ridiculously cheap food. Food was grown a few years ago from fertilizer made with $12 barrel oil and 50 cent per litre diesel. Farmers had no pricing power as food was in oversupply so they were screwed hard. Now farmers are getting a fair price for what they produce in a lot of stuff, and it's about time.

Just like the energy and minerals boom, agriculture is following. Get used to it.

See ya's.

 

[Rixter]

As for the drought and food prices?

Just like the energy and minerals boom, agriculture is following. Get used to it.

Exactly, thats one of points the article is making.

 

[sailor]

The Reserve Bank of Australia came into being on 14 January 1960 to operate as Australia's central bank and banknote issuing authority.
The predecessor to the Reserve Bank, the Commonwealth Bank of Australia, was established in 1911. It was initially just a commercial and savings bank. The Department of Treasury issued notes until 1924, when this responsibility was transferred to the Commonwealth Bank.
The Commonwealth Bank gradually gained more central banking activities until 1945, when new laws formalised its central banking powers. In 1960 the central banking functions of the Commonwealth Bank were transferred to the new Reserve Bank of Australia.
The 1980s saw the abolition of Exchange Control as a result of the float of the Australian dollar and the creation of a banking supervision function for the Reserve Bank. This banking supervision function was then transferred to the newly created Australian Prudential Regulation Authority in 1998.
Ref: http://en.wikipedia.org/wiki/Reserve_Bank_of_Australia

The RBA is supposed to be entirely separate from our political system. Yet last night on tv I saw a Labour Ad stating that John Howard was responsible for rising interest rates. Go figure! Labour should know better.

 

[Rixter]

The RBA is supposed to be entirely separate from our political system. Yet last night on tv I saw a Labour Ad stating that John Howard was responsible for rising interest rates. Go figure! Labour should know better.

My observations as well Sailor. Just goes to show the scare mongering tactics of political parties on all sides aimed at the masses who dont know any better.

In the words of a past media commentator -

" Shame Shame 'Same'!"

 

[outbackjack]

I think we are at the end of the error of low cost for everything and abundance a plenty.

I think things are going to get tougher from now on.

Less fuel, less food , more people etc.


Maybe we have reached the peak of what the earth can supply??

 

[Tim]

Rixter,

interesting post. I listed to the "Boyer Lectures" (which had a series of economic lectures by previous RBA Ian McFarlane) and the impression I got was that indeed, using monetary policy (which has more or less replaced fiscal policy in attempts to regulate inflation) stemmed from NZ & US policy and is basically unproven - it is unproven in that there is an argument of what happens if raising interest rates DOESN'T contain inflation. If in fact raising interest rates does not abate inflation then there does not appear to be a readily available solution from what I understand.

I don't know if this would lead to stagflation but possibly.....

If you look at what is happening in OZ today, M3 circulation is large in comparison to other OECD. I find it hard to imaging prices not increasing constantly in this environment and if that happens my guess is a recession or otherwise unbelievably fantastic growth for anyone holding assets and an increasingly polarisation of wealth for the 'have nots'.

Tim

 

[Kennethkohsg]

Dear Sailor,

1. Thank you for pointing us to the write up on the RBA history.

2. It is interesting to note that Ken Henry, who is the secretary to the Treasury, also sits in as a member of the RBA Board, headed by Glenn Stevens.

3. Thus, I am wondering what Ken Henry's thoughts were this month, as one of the key member in policy making teams in both the Treasury and the in the RBA;- when on one hand, the Australian Treasury releases more money to the Australian public through repeated tax cuts and thereby directly stoking inflationary pressures further and with the RBA having to keep increasing the interest rate in its attempts to bring down the inflations within its targeted 2%-3% level?

Cheers,
Kenneth KOH

 

[alexlee]

Government policy is usually based on its most recent successes. Monetary policy (high rates) is usually credited for breaking the back of inflation in the 80s. It also caused a rather nasty recession, but you have to admit we've had relatively low inflation since then.

As a result, world governments look to that as proof that monetary policy works.

Does it? Who knows. But if enough people believe it, it will work.

As for the RBA target rate, you do have to ask: does 2-3% inflation actually make sense when food and oil prices are rising a lot faster, and arguably can't be controlled even with higher rates? Again, you can't prove it either way.

I think we've had a great run for the last 10+ years, that means a lot of excesses have built up in the system. House prices are high relative to rents. A lot of people are getting arguably excessive pay. A recession would shake things up and even things out a little bit (you don't need as many bankers in a recession, for example). As investors, a shakeout isn't bad, since it drives out the 'me too' investors and leaves a more subdued market with more opportunities for true investors.

As for who bid up prices and made price 'unaffordable' to first home buyers, the problem is twofold: one, people expect too much. Maybe first home buyers can't expect a house on a quarter acre block like the last generation: they may have to 'make do' with a 2 bed unit. Second, it's actually the first time, me too investors who drove up the price, because they had no idea how much they should be paying. I mean, would an investor buy something yielding 3%? It just isn't sustainable if you have multiple IPs. Only people who own ONE IP, think it's going to go up in the short term no matter what their purchase price is, and are paid relatively too much can afford the shortfall.
Alex

 

[buzzlightyear]

I am not a professional economist, but for me it looks very fishy, when complex economy is managed by tweaking the interest rates. Sounds very simplistic: CPI is up, consume spending is up, lets increase the interest rates to cool down the economy.

I afraid that such a method of controlling is a result of misunderstanding and underestimating the complexity of the economy. By increasing the rates, the burden of inflation simply is redirected onto middle class, who is already struggling with getting more wages to cope with spending. Some of us will get more wage, but many of us simply will have to sacrifice or sell something in order to sustain living.

MM2, well said. Interest rates have always been a blunt and somewhat ineffective tool in slowing an economy. They generally take at least 12 months to flow through the whole economy and invariably hit the most marginal in the community who are least able to protect themselves.

The RBA is supposed to be entirely separate from our political system. Yet last night on tv I saw a Labour Ad stating that John Howard was responsible for rising interest rates. Go figure! Labour should know better.

The circular arguments from both the Libs & the ALP around interest rates in this election astound me. In the last election, the ALP was arguing that low interest rates were not as a result of the Government, as the RBA is independent and sets the interest rate policy without reference to the wishes of the gvernment. This election, they argue that opposite. The Libs argued in 2004, vote for us because it is our policy that will keep interest rates low. Now they argue it is other external factors that is driving inflation.

Latham comments were exactly correct. This is the Seinfeld election

Government policy is usually based on its most recent successes. Monetary policy (high rates) is usually credited for breaking the back of inflation in the 80s. It also caused a rather nasty recession, but you have to admit we've had relatively low inflation since then.

The RBA's charter is;
(a) the stability of the currency of Australia;
(b) the maintenance of full employment in Australia; and
(c) the economic prosperity and welfare of the people of Australia."

Source RBA Website

To drivie the economy into a recession or downturn and achieiving a low inflation result only addresses (a) above and maybe (c) in the long-term

 

[sailor]

when on one hand, the Australian Treasury releases more money to the Australian public through repeated tax cuts and thereby directly stoking inflationary pressures further and with the RBA having to keep increasing the interest rate in its attempts to bring down the inflations within its targeted 2%-3% level?
Cheers,
Kenneth KOH

Seems as though the government of the day and the RBA are on different teams, and don't know how to work and play nice together, eh!

 

[ermen]

rates

i wouldn't pay too much attention to the comments that the article has said... it smacks of intellectual bankrupcy and sensationalism. the spread between the nominal rate and the inflation rate is known as the real rate. now why do countries have different real rates? very complex and i'm not qualified to answer that. but to simply say that australia should have the same real rate was canada is totally wrong.

the only good point the article does raise is questioning the efficacy of monetary policy. is it good? i don't know. maybe it was deficient like keynesian economics and will die a natural death soon.

also politics aside, i don't see how the government can be blamed for causing inflationary pressures as well. Their mandate should be to run a balanced budget and to return any surplus to the community. As long as they're not borrowing, the net effects on the economy is deflationary.

maybe the late friedman was right then by saying that monetary policy was too important to be left to discretion (ala the Fed). He was advocating a policy where the bank just pursued a steady growth of money (which M i can't remember).

lastly on the rba policy. i think that it is one of the few institutions where their sole mandate is the maintenance of price stability in australia. i remember comparing that with the US Fed which is the maintenance of full employment or something along those lines.

 

[yieldmatters]

i wouldn't pay too much attention to the comments that the article has said... it smacks of intellectual bankrupcy and sensationalism. the spread between the nominal rate and the inflation rate is known as the real rate. now why do countries have different real rates? very complex and i'm not qualified to answer that. but to simply say that australia should have the same real rate was canada is totally wrong.

Australia and Canada are both open economies, floating currency etc so should have real rates of interest that are in the same ballpark. In a global financial system the real rates of interest tend to converge. Not exactly the same because of other risks and complications but they tend to converge. If they didn't you would have a risk free money making machine - for example if the $AUD real interest rate was higher than Canada you could borrow in $CAD and invest in $AUD while hedging your exchange and pocket the difference (covered interest arbitrage). This would occur until the real interest rates began to converge again.

 

[Kennethkohsg]

i don't see how the government can be blamed for causing inflationary pressures as well. Their mandate should be to run a balanced budget and to return any surplus to the community. As long as they're not borrowing, the net effects on the economy is deflationary.

.

*****************************
Dear Ermen,

1. Isn't the ruling Govt's responsibility to ensure the sound economic management of Australia?

2. Who then decides and plans for the appropiate capacity and size of the Australian Economy that will best serve Australia's long term interests?

3. Instead of returning the money to the people through future tax cuts, why can't the Govt collect less taxes in the first place, like reducing the GST etc or/and divert these budget surplus to improve/expand on the some of the more urgently required infrastructural and social, education, health related projects, so as to pro-actively further expand and strengthen the Australian Economy to meet its new challenges i the near future?

4. For your further comments and discussion, please.

5. Thank you

Cheers.
Kenneth KOH

 

[Kennethkohsg]

lastly on the rba policy. i think that it is one of the few institutions where their sole mandate is the maintenance of price stability in australia. i remember comparing that with the US Fed which is the maintenance of full employment or something along those lines.

&&&&&&&&&&&&&&&&&&&&&&&
Dear Ermen,

1. However, according to its existing Charter, the RBA is supposed to be responsible for overseeing and ensuring:
(a) the stability of the currency of Australia;
(b) the maintenance of full employment in Australia; and
(c) the economic prosperity and welfare of the people of Australia.

http://www.rba.gov.au/AboutTheRBA/History/history_of_the_rba.htm

2. Consequently, has the RBA over-emphasised its role in trying to achieve the 2%-3% inflationary targets and has neglected its other statutory roles to a certain extent, at this point in time?

3. To me, RBA has failed in the past few years, and it is still continue to fail to curb the underlying inflationary pressures within the Australian Economy at large, through the latest interest rate increase, by failing to effectively promote/improve on the Australians' overall savings rate as wwell as to encourage them to effectively reduce their debts/borrowings for personal/housing consumption purposes.

4. To allow the present scenario to continue further by "having too much monies chasing after too little goods within the Australian Economy in general", in essence, the RBA has not been effectively addressing the root cause of the present core inflationary pressures within Australia, through its simple single interest rate increase policy.

5. Consequently, prevailing housing inflation has indirectly caused the local housing to become highly expensive and "unaffordable" across many Australian States, such that many first-time homebuyers are being locked out from the existing housing markets at this point in time. To this extent, the RBA would have failed to properly ensure the welfare of the Australian people, and thereby it is now failing in one of its statutory roles as officially defined in its present Charter. Do you not think so?

6. For your comments and further discussion, please.

7. Thank you.

Cheers,
Kenneth KOH