Back to back rate cuts
July 2019, Sydney: the Reserve Bank of Australia cuts the cash rate for the second consecutive month to 1 per cent.
Just for some context, during the Global Financial Crisis, the lowest the cash rate went was 3 per cent.
Why did the RBA cut rates again? Let’s look at some highlights from the July statement.
Reason number one: Australian economic growth is weak
In terms of economic growth, the goal is around 2.5 to 3 per cent growth in gross domestic product (GDP) annually.
In the year to the March quarter of 2019, the Australian economy grew by only 1.8 per cent. According to RBA Governor Philip Lowe, “consumption growth has been subdued, weighed down by a protracted period of low income growth and declining housing prices.”
Let’s analyse this quote. One, consumption is weak which leads to weak economic growth BECAUSE consumption makes up around 60 per cent of GDP. Two, low income growth and falling house prices reduce consumer confidence and their incomes, leading to more saving and less spending (because they are uncertain of the future).
So: cut rates, encourage spending and borrowing, and accelerate economic growth.
Reason number two: There’s a lot of unused or underused labour in the workforce
Dr Lowe also talked about how Australia has made little progress in reducing the amount of spare capacity in the economy. This particularly refers to unused or underused labour; what economists would call unemployment or underemployment.
As a result of the excess supply of labour, wages growth remains low. By cutting the cash rate, the RBA wants to see a fall in the level of underutilisation in the Australian economy (underutilisation rate = unemployment + underemployment).
Reason number three: Inflation remains below the target band
The RBA’s target band for inflation is 2-3 per cent over the course of the business cycle. Australia’s inflation rate hasn’t been within the target band, consistently for some years now (see graph below).
Inflation hasn’t lived in the target band for some time now.
By cutting the cash rate, the RBA’s trying to boost inflationary pressures in the economy.
Willl this rate cut actually work?
As an economics student, you can question the effectiveness of monetary policy. The RBA’s had an expansionary stance for some years now and there hasn’t been a huge boost to growth or inflation.
Another point to consider is that fiscal policy could do more, right now, to stimulate the economy. Is it appropriate to run contractionary fiscal policy (move to a surplus) when the RBA is trying to increase economic growth? They’re working against each other. This is a question worth asking.