In response to the continuing economic stagnation, the RBA has refrained from further cuts to the cash rate in August, leaving it at 0.25%. The RBA’s governor, Phillip Lowe, has also hinted that the RBA is unlikely to cut the cash rate to the “zero lower bound” – a point in time where the cash rate is zero and any further cuts will result in a negative cash rate. In effect, monetary policy in Australia will not become any more expansionary.
This low cash rate is expected to remain for quite a while – projections indicate until at least the end of 2022 and most likely further. The Reserve Bank board insists it will not increase the cash rate until unemployment begins to fall and is closer to full employment, and inflation is closer to the two to three percent target band.
By holding the cash rate constant, the RBA has effectively exhausted the capacity of monetary policy to provide any further expansionary effects on the economy. However, under consideration are possible cuts to the cash rate of 10 basis points rather than 25 basis points – this will allow further cuts whilst maintaining a positive cash rate.
Nonetheless, the main stimulatory policy for the economy right now is left to fiscal policy.
This ponders the question of whether monetary policy can play a more proactive role in stimulating economic activity. Possibly, possibly not. Let’s consider some of the RBA’s justifications for not cutting the cash rate further and potentially entering the territory of negative interest rates.
· Negative interest rates promote risk taking. Because individuals and businesses actually receive a positive interest return from borrowing (rather than having to pay interest), there may be growth of “zombie” companies that would otherwise or in the future not survive increases in interest rates. These companies are uncompetitive, and if there are many of these companies in the economy, productivity growth will be hindered. This will limit future economic growth.
· Some businesses may be enticed to take out loans in order to buy back their own capital (i.e. a repurchase of equity or shares) rather than using these loans to invest in productive assets such as machinery. Share repurchases are not a productive activity and do not contribute to GDP.
· A negative cash rate will weaken the exchange rate and thus improve net exports. This may have a positive effect on GDP, but it does not work if many other countries are pursuing similar negative cash rates. Indeed, “competitive devaluations” simply cancel out the increases in competitiveness of one country because the value of currency in many countries decreases.
Bonds and Jawboning
The RBA has signalled that it wishes to maintain the yield on 3-year government bonds at 0.25%. This signals that the RBA expects the cash rate to remain at this low level for 3 years – a prediction of the expectations hypothesis.
However, the RBA also announced that it would engage in bond-buying in order to reduce the yield on these bonds, which had slightly increased above the 25 basis point target due to supply and demand. The idea behind this is quite similar to how domestic market operations can be used to influence the cash rate.
By announcing that it would undertake bond purchases, the RBA signals to bondholders of an expected fall to bond yields. This would hopefully encourage bondholders to reduce the yield that they demand and limit the need for further action. This is a form of jawboning.