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Are We Ready For The Next Shock?

We need some fresh thinking to protect us from the next economic shock.

The Reserve Bank of Australia (RBA) is running out of ammunition to ward off the evil economic marauders. It’s a worldwide problem. But what can be done?

The RBA’s cut in official interest rates last month to a record low 1.5% means it is running out of ways to stimulate inflation and stop the deflation dragon razing everything in its path.

Australia experienced deflation, or negative inflation, for the first time in seven years in the March quarter. It was a surprise – at least to the general population whose main concern had been property prices and wages.

Consumer price index in the March quarter

consumer-price-index-in-the-march-quarter

Source: ABS

The Australian Bureau of Statistics (ABS) said the consumer price index (CPI) shrank 0.2% in the three months and the annual rate of inflation dipped to 1.3% from 1.7% at the end of December.

Skeletal hand on the lever

The RBA’s aim is to keep inflation in a band between 2% and 3%, but the hand holding the lever is rapidly becoming more skeletal. The fact that inflation is now well below that range was one of the main reasons for the bank’s latest cut to the overnight cash rate.

Australia’s official interest rates

australias-official-interest-rates

Source: RBA

But because interest rates in Australia are still positive – compared with large parts of the world where they are negative – foreign investors are keeping the local dollar inflated and countering the impact of the RBA’s cuts.

At the same time, property prices are maintaining their ridiculous levels as low interest rates encourage more borrowing.

Outgoing RBA Governor Glenn Stevens acknowledged the problem in one of his last speeches when he said foreign investors were looking for infrastructure, commercial property, shares or any kind of Australian asset paying a reasonable return.

Although a 6 per cent return on commercial property was low by Australian historical standards, it was very attractive to investors elsewhere. Even government bonds at 2 per cent were luring foreign investors, he said.

Australian government 10-year bond yield

australian-government-10-year-bond-yield

Source: Tradingeconomics.com, Department of Treasury

Shock tactics

So what happens when the next big economic shock hits? What can the RBA do?

The popular solution to date has been quantitative easing, or what’s now called ‘helicopter money’. Simply, it means printing more money. Europe, Japan and the US have all done it.

Kevin Rudd’s government coped with the global financial crisis by giving out cash payments to households in 2008 but that’s as close as we have come to quantitative easing.

The main issue is that helicopter money doesn’t solve anything, it just pushes the problem onto the next generation.

Adjunct Professor at Victoria University’s College of Business Craig Emerson has a creative solution in the form of an infrastructure-led joining of fiscal and monetary policy.

Key projects with measurable economic returns would be chosen by an autonomous body and a pipeline of assets created for international investors to purchase, he suggests.

That’s simplifying his solution but the basic premise is that it would “result in economic stimulus and productivity-raising infrastructure investment”. That has to be good.

Given a whole generation has grown up without experiencing a recession – the last one in 1990 being the one Paul Keating said we had to have – let’s hope we can keep that good fortune going by trying ideas other than just printing money.

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