Wednesday, November 19, 2008

But wait there's more - 0.75%, and then more

THE Reserve Bank board will cut Australian interest rates by at least 0.75 percentage points when it next meets in two weeks' time, and may cut by 1.00 points.

The minutes of the board's Melbourne Cup day meeting show that it rejected a recommendation from officials to cut by 0.50 points and instead cut by 0.75 amid alarm about "confidence among consumers and businesses".

Board members including the Governor Glenn Stevens, the Treasury Secretary Ken Henry and ANU economic modeler Warwick McKibbin were especially concerned about the erosion of household wealth.

The rout on share markets and the downwards drift in house prices had cut household wealth by 8 per cent in the 9 months to September. Board members feared that subsequent slides in share prices had made the slide greater.

"Members noted that there were few precedents for the current developments in household wealth," the minutes record...

After presenting the board with the staff recommendation for a cut in the cash rate of 0.50 points the Governor suggested that the members consider a choice between 0.50 points and 0.75.

They opted for the bigger cut in order to bring about "a further meaningful reduction in rates paid by borrowers and assist confidence among consumers and businesses". The aim was to bring rates "quickly to a neutral position".

The Reserve Bank has traditionally regarded the "neutral" cash rate as between 5.50% to 6.00%. This is the rate at which the Bank would be neither stimulating economic activity nor winding it back in. But bank officials believe that the neutral rate is now lower than that as a result of recent decisions by retail banks not to fully pass on cuts in the cash rate.

This would mean that the Melbourne Cup day cut to 5.25% only brought the cash rate back to neutral and perhaps did not quite do that.

Given that there is a clear need for interest rates to stimulate the economy at the moment, it suggests a need for a further big cut in December, with 0.50 points regarded as the bedrock and a cut of 0.75 points regarded as more likely.

Should economic conditions deteriorate further, and especially if the United States is declared in recession during the next fortnight a bigger cut of 1.00 points is likely.

Governor Glenn Stevens will expand on this thinking about rates in a closely watched speech to be delivered to the Committee for the Economic Development of Australia in Melbourne tonight.

A further cut of 1.00 points if fully passed on would cut the standard bank variable mortgage rate from around 7.7% to 6.7%, cutting the repayments on a $300,000 mortgage by an extra $200 per month. Monthly repayments would have dropped $570 from when mortgage rates peaked at 9.6% in August.

Although the Reserve Bank board is not due to meet again after December until February, the Governor Stevens stands ready to call an emergency meeting in January to deliver a further cut if needed. In January the Bank will have an indication of whether the $8.7 billion of stimulus payments due to be deposited into bank accounts from December 8 boosted economic activity or were largely saved.

The Bank has called unscheduled meetings in January twice before; in 1990 and 1992 - in both cases to deliver an emergency rate of 1.00 points.

Late yesterday the futures market was pricing in a cut of 1.00% in December and a further 0.75% in February with further cuts taking the cash rate to a low of 3.25% in May - its lowest level since the 1950s.


Fozzy said...

Peter, One thing I've been wondering. What would have happened if the Commbank hadn't been privatised? My thinking is that they would have had far greater political pressure/intervention to pass on the full interest rate cuts. This in turn was likely to force other banks to do likewise.

Peter said...

You are so right Fozzy.

Privatising the Commonwealth Bank was a HUGE mistake - made by Labor, who began the process.

If the government still controlled the Commonwealth Bank it could make sure banks passed on every rate cut to the maximum extent possible or faced the consequences.

Nick Gruen has suggested re-opening a government bank.

I'll cross-post his idea, but for now, it's here:

Some months ago, one of my children's teachers - I'll call her Tania - sought my advice. Having recently sold her house, she was terrified her life savings would disappear in some bank failure before she'd had a chance to reinvest it in another house. I told her, shamefacedly - three-quarters of a century after the Great Depression - that your money can never be kept completely safe.
The federal government's guarantee should have calmed Tania's nerves (although I hear she's still nervous and authorities report that demand for $100 notes has surged).

When the market calms down and the guarantee is lifted in three years, shouldn't we then have somewhere for people to keep their money safe? I've previously outlined in this column how it could be done.

You already have an account with the Australian Taxation Office.

Since the government helps itself to penalty interest if you're late paying tax, it seems only fair that it pays interest on your surplus.

You can already make internet payments from your bank to your ATO account. The government should commission the software to enable you to use your ATO account to make internet payments enabling you to pay anyone with an ATO account.

Voila! A simple, safe and dirt-cheap savings and payments system. And the system could also interface with the existing bank payments system - the one you use to pay people over the internet.

None of this should be subsidised. Indeed, the government could fund it - including an appropriate return on investment - from interest margins and/or charges, just as banks do.

I reiterate the idea not just for its own sake but also to illustrate a particular approach to that vexed question of the role of government at a time of great questioning. There are two things to note.

First, although the proposal expands government services, it doesn't lurch back to the prereform era. Back then, governments owned banks only to have them operate just like private banks, which eventually made it hard to see the point of public ownership.

So I'm not suggesting having branches around the country, although governments could allow account holders to pay for those services and contract them out to existing public and private retail networks such as banks, post offices, supermarkets and petrol stations.

Instead, existing government infrastructure would be leveraged to create a powerful facility that would cost less and offer more - instantaneous payments without counterparty risk between government guaranteed accounts - than existing arrangements offer.

The second point is that it is cognitively efficient. Rather than send the Tanias of the world on the anxious wild goose chase of assessing banks' respective creditworthiness, we build the simple, safe solution they're seeking while leaving them free to seek more exotic, higher risk and return solutions elsewhere.

Oh, and I'm waiting for Tania to ask me where to invest her super, because while super choice is a great thing for those in the know, for Tania it's another nightmare of cognitive inefficiency. Tania's a great teacher. But since she doesn't fancy her chances of choosing a good fund, what adviser will she consult? How can she tell how knowledgeable they are or if they're mainly motivated by commission payments?

There's one further choice Tania should have. It's already provided to public servants: unless they take charge and put their super elsewhere, there's a large default fund, professionally managed (at arm's length from the government) with scale economies and an absence of commission payments that minimises management fees.

Wouldn't these low-cost government services "crowd out" the private sector?
Australia's pioneering higher education contribution scheme scheme provides the model. HECS crowds out private lending, partly because its interest rate is subsidised (which I don't support). But the main reason is that the government's access to the tax system makes income-contingent loans practicable, where private lenders would shy away from all but the best risks. I'm a big fan of the private sector - I'm in it. But just as more efficient private firms crowd out less efficient firms in markets - providing they're not subsidised - if government services out-compete private firms, so much the better.

It helps us evolve our way towards a more truly complementary relationship between private and public endeavours, as private resources that are crowded out resurface where they're more productive to do things that governments are too big and awkward to do well.

Anonymous said...

Peter, one of the best ideas I have heard in a long while. The idea, a simple, safe and dirt-cheap savings and payments system that could also interface with the existing bank payments system is achievable.

One slight problem: the corporate vulture culture is going to go hard against such a sane solution.

To see what you, and all other sane people in the world are up against (you probably know it already) google - disaster capitalism. For a quick explanation try:

It is why we lost the Commbank in the first place and the same mentality is trying to privatise NSW Electricity and Lottery, etc.


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