Nov 082006

The Prime Minister, John Howard, says he does not like the interest rate rise any more than any borrower.

ABC News.

I am always amused when the Prime Minstrel makes any attempt to draw himself alongside the ordinary ‘battler’ in Australian society. The man doesn’t even have a home mortgage, let alone a job which pays a pittance and falls subject to punative industrial relations legislation. Yet he sings as if he does, and is.

My one great doubt in this economic management saga on behalf of the board of the RBA – not government, please note – is whether twenty-five basis points is sufficient to reign in a growing inflation rate and stem fiscal demand. The borrower marketplace has been well prepared for this rate rise. Indeed, many lending institutions have already factored the rise into their product ranges and marketing strategies. The average borrower or intending borrower – the smart ones – have already likewise factored at least 0.25% into their servicing calculations. In short, I don’t believe twenty-five basis points is enough. There is no ‘fright’ factor in these rate rises any longer.

Economic pundits are now muttering the word, ‘recession’. A recession, according to the ANZ Bank’s financial dictionary, is clarified as being

A drastic slowing of the economy. The Americans, who are good at making precise definitions, often apply the term to a situation where gross national or domestic product has fallen in two consecutive quarters. A recession would be indicated by a slowing of a nation’s production, rising unemployment and falling interest rates, usually following a decline in the demand for money. A popular distinction between recession and depression is: ‘Recession is when your neighbour loses his job; depression is when you lose yours.’

Recession in this country is not normally chacterised by falling interest rates, due to the penchant of the board of the RBA to employ monetary policy, which is the use of domestic interest rates to stymie unfettered demand for money which feeds an inordinate growth in industry sectors which are not balanced by equivilent demand. Evidence the last recession in this country, the one we ‘had to have’ according to history and the Prime Minister of the day, Paul Keating. An excellent explanation of that recession exists here. Suffice to say, that recession was brought about by urgent and dramatic over-application of fiscal policy by the RBA, influenced by government. It is fair to say, however, that recession in Australia is characterised primarily by two consecutive quarters of negative growth in GDP.

Recession is now, due to the unforeseen impact of the current drought which is recognised as far worse than initially thought, almost a given insofar as the Australian economy is concerned. An excellent article, again courtesy of the ANZ Bank, make the point that today’s rate rise, supposed at the time of writing, will assist to create an economic environment which is

more balanced between higher inflation and lower growth (as opposed to being skewed in the direction of higher inflation previously), implying that the bar for rate rises post November will be set higher.

Recession may well have been avoided, as the ANZ implies, however that assessment is based on the application of monetary policy to an appropriate level. I have doubts that today’s twenty-five basis points is sufficient.