Has monetary policy lost its steam?

by Julia Corderoy09 Mar 2015
As the market bets on a further cut to the cash rate next month, the Reserve Bank of Australia has said monetary policy isn’t stimulating the economy the way it has in the past.

Speaking to the Goldman Sachs Annual Global Macro Economic Conference, RBA deputy governor Philip Lowe said the global economy is in “very unusual times”.

“In earlier eras, one could have predicted with some confidence that this type of monetary stimulus would have created a boom in economic activity and subsequently a substantial lift in inflation,” he said.

“Yet, today, many parts of the world continue to operate with considerable spare capacity, inflation rates are low almost everywhere and inflation expectations have generally declined, not increased.”

According to Lowe, the global economy is still suffering a hangover from the Global Financial Crisis, on top of handling “very high levels of debt” that exist in many advanced economies – a combination that is causing consumers to be cautious of spending, despite the historically low rates.

“In the years leading up to the crisis, a reduction in interest rates could be reliably predicted to encourage such a response [an increase in spending]. Credit was easily accessible, economic volatility in many economies was low and people were prepared to borrow,” he told the conference.

“In today’s world, things look quite different. After a steady increase in debt levels over the previous two decades, many people do not want more debt. They do not want to – or they do not have the confidence to – bring forward future spending to today. As a result, household indebtedness in many countries has declined even though interest rates are the lowest on record.”

As the limits of monetary policy are becoming more visible in our current environment, Lowe said the economy needs to stop relying on monetary policy as the fundamental driver of growth. 

“But, at the end of the day, the solution to the problems caused by the disconnect between the desire to save and the desire to invest cannot lie with monetary policy. Instead, it lies in measures to improve the investment environment so that once again there is strong productive demand for the use of our societies’ savings.”

However, despite the effects of monetary policy being different today than they were in the past, Lowe said it hasn’t been exhausted in Australia just yet – there has been a lift in housing construction, a decrease in the Australian dollar and a boost in asset prices. 

As such, Lowe said further easing may be appropriate over the period ahead, echoing governor Glenn Stevens’ comments in the monetary policy decision statement released last week.