Unintended Consequences of Lowering Interest Rates

Wednesday, October 30, 2019

The RBA recently cut Australia’s overnight cash rate to a record low 0.75% with many predicting further interest rate cuts to come. Interest rates in places like Europe and Japan have been at ultra-low levels for many years and have not helped these economies alleviate their stagnant growth. This paper discusses why ultra-low rates are not necessarily working – in fact, how they may actually be counterproductive to the RBA’s objectives.

In its attempts to further prolong Australia’s record-breaking, 28-year economic expansion and because Australian inflation remains below its 2% ‘target’, the RBA is now resorting to cutting interest rates to the bone. Many are even suggesting that the RBA may resort to quantitative easing at some stage to stimulate the Australian economy if the central bank’s continued rate cuts do not lead to a pick-up in economic growth and jobs in Australia.
 
The truth is that the RBA has joined the world’s central banks in conducting an experiment. Their paradigm is that the economy will benefit from policies based on economic theories that, in reality, have previously resulted in major imbalances and have frequently ended in crises: the technology boom and bust, the housing boom and mortgage financing bust in the US followed by a global financial crisis, and several other booms and busts such as those experienced in Iceland, Spain, and Ireland. The common theme in all these events is easy access to very cheap credit.
 

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