The protracted delay on the part of three of the major banks in deciding whether, and by how much, to follow the Commonwealth Bank in raising their lending rates by more than the 25 basis point increase in the Reserve Bank's official cash rate on Melbourne Cup day, meant that monetary policy continued to dominate the national economic conversation for a second consecutive week. By the end of last week, the major banks had raised their standard variable mortgage rates by an (unweighted) average of 41 basis points, 16 basis points more than the increase in the cash rate.
As I observed in these pages a fortnight ago, for all of the (often confected) outrage expressed by politicians of all stripes in reaction to the banks' decisions, those decisions will make very little difference (other than in the short term) to the interest rates actually paid by borrowers. That's because the Reserve Bank will take account of the banks' pricing decisions in their own deliberations about the future course of monetary policy, which since the onset of the global financial crisis (when banks began departing from slavish adherence to movements in the cash rate) have been explicitly couched in terms of the interest rates paid by households and business borrowers.
Almost certainly, when making its decision earlier this month, the Reserve Bank Board would have had in its mind the likelihood that further increases in interest rates would be needed in order to ensure that (in the language of Statement on Monetary Policy released a few days after the meeting) "inflation remains consistent with the [2-3% per annum] target over the medium term". The Bank's staff may even have had some idea of the level to which the rates paid by borrowers would eventually need to rise, given their forecasts for growth and inflation, in order to ensure that inflation remains within the target range. Whatever that level is, the official cash rate now needs to rise by less than it would have done otherwise in order for the rates paid by borrowers to reach it.
Thus, if the Reserve Bank had been thinking that it would need to raise the official cash rate, say, three or four times next year in order to keep inflation within the target range, after the major banks' decisions to raise their lending rates by an average of 41 basis points, they will now only need to raise the official rate two or three times to achieve the same outcome.
In other words, the interest rates paid by household and business borrowers on their loans are, other than in the very short term, the rates which the Reserve Bank thinks they should be paying so as to achieve its monetary policy objectives. The argument about whether the banks should be confined to moving their rates in line with the official cash rate is really one about how the stream of additional interest payments made by household and business borrowers should be carved up between bank shareholders (and bank executives), bank depositors (who are now getting a reasonable deal from banks for the first time in two decades) and others who provide funds to banks (including superannuation funds).
One unfortunate consequence of the continuing focus on bank interest rates is that rather less attention was paid to last Tuesday's release of the Government's Mid-Year Economic and Fiscal Outlook.
This showed that the budget outlook had deteriorated since the Pre-Election Economic and Fiscal Outlook by an average of about $1bn over each of the four years of the forward estimates period (2010-11 through 2013-14). The Government attributes this largely to the impact of a stronger Australian dollar and earlier-than-expected utilization of tax losses on revenue from company tax, though these were partly offset by upward revisions to personal income tax revenues and downward revisions to expenditure projections.
Despite new spending totalling over $3½bn to meet Labor's election commitments and its subsequent deals with the Greens and independents, the Government still expects to meet its promise to return the budget to surplus by 2012-13. That's largely because the new spending commitments have been offset by a combination of deferring the proposed reduction in tax on interest income by a year, pushing out a number of expenditure commitments beyond the end of the current forward estimates period, and pulling $¼bn out of the contingency reserve. For the most part, these amount to "fiddling" rather than genuine structural improvements in the budget.
That's a pity, because the Government has missed an early opportunity to have fiscal policy make a larger contribution to the task of managing what Glenn Stevens has previously described as a "fairly robust recovery". As he noted at the time, "part of that task will inevitably fall to monetary policy". But now that both the Reserve Bank and the Treasury seem confident that Australia is looking at a period of "above trend" economic growth over the next few years, fiscal policy could and should be shouldering a larger share of that task.
It's true, as Treasurer Wayne Swan has pointed out, that Australia's fiscal position is vastly superior to that of most other advanced economies. But that's of limited relevance given the vastly different economic outlook for Australia compared with most other advanced economies.
It's also true that at least fiscal policy isn't working in the opposite direction to monetary policy, as it was under the Howard Government and the first year of the Rudd Government when any additional revenues that would have produced a budget surplus in excess of 1% of GDP was instead "given away" in the form of tax cuts or cash handouts, adding to spending pressures in the economy at a time when the Reserve Bank was trying to restrain them. But that doesn't mean that the Gillard Government couldn't be doing better.
In Opposition, Labor was (rightly) critical of the erosion of fiscal discipline under the Howard Government (as Peter Costello has been subsequently). Labor now has an opportunity to wind back some of this profligacy, as well as its own. And if it is serious about shielding homebuyers from higher interest rates, it should pursue that opportunity with gusto.
This article was first published in The Age on November 17, 2010.
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