How to get monetary policy completely wrong

There is a difference between the prevailing rates of interest in the money and credit markets and what can be loosely called the natural rate of interest. When the rates diverge, problems emerge.

The central bank in Australia (the RBA) conducts the management of monetary policy, independently of the Government of the day but to a stated aim of constraining inflation between 2% – 3%pa. It has just manipulated down market interest rates twice in two months. Prior to that, the official cash rate (the benchmark the RBA uses to influence all other rates) was held ‘at emergency low levels’ for 3 years. If the old rates were at emergency levels, then what are they now being lower still? The official cash rate is now 1%pa.

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Gathering voices

Some months ago, I posted a piece here saying that the problem with the economy had nothing to do with high interest rates. Cutting interest rates further would not work. Since then, the Reserve Bank of Australia has cut the official cash rate from 2.5%pa to 2.0%pa.

If only a few more economists would make their views known, such as here, and a few more would stand up to the uninformed mainstream economics doctrines* taught mostly everywhere since the death of Keynes, then we would begin to see an improvement in public policy. Let’s hope.

* To help kickstart thinking, how many borrowers pay 2%pa on their borrowings? What is your mortgage rate? What is your credit card rate? What is the cost of capital under a debt finance model for a small business? There are thousands of interest rates in the market, not just one with stepped margins. Why would that be? What does that mean for the IS/LM model and ‘the’ interest rate?

Economists, groupthink and dark clouds

The official cash interest rate in Australia is 2.5%pa. According to business press surveys of “leading economists”, most believe that the Reserve Bank of Australia should cut the official rate very shortly. Weak economic growth and rising unemployment worry the economists and their policy response recommendation is to reduce interest rates. We shall find out soon enough if the RBA takes that approach, but if the business press is correct, what is it about these economists that makes them unable to see that if interest rates are already at low levels and economic growth is insipid, then the problem is not likely to be a high interest rate. Can’t they see what happens in other countries where official interest rates have approached zero and it has not spurred economic activity?

So-called leading economists who argue that more artificial credit expansion, in an environment that has already suffered more artificial credit than is reasonable, are firstly demonstrating that they have no clue as to what has caused the mess nor how to get out of it. Secondly, they cling to each other and reinforce their collective group-think views because they have little else to comfort themselves that they know what is going on. This fear on their part and their response to argue for more policy medicine along the same lines that is making the patient sick is leading to ever increasing dark storm clouds looming on the economic horizon.

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