RBA cuts leave economy vulnerable

by Madison Utley05 Jun 2019

Yesterday, the RBA cut the official cash rate to a historical low of 1.25%, with at least one more cut widely expected in the coming months. While the move is intended to stimulate the economy, the cuts come at a significant cost.

The lower the cash rate drops, the less of a buffer remains able to be utilised as a tool in the case of a recession – a potentiality that cannot be disregarded in light of the stagnating GDP, creeping unemployment, absence of income growth, and rising cost of living.

Typically, the basic strategy among central banks dealing with a recession is to cut the interest rate in a significant way, often by as much as 500 basis points. The RBA has begun to eat through that room, and is expected to continue to do so.   

Martin North, principal of Digital Finance Analytics, said there are several “unconventional strategies” that may be implemented if a recession were to hit even after several RBA cuts.

There has been some conversation around what is considered the most likely path – quantitative easing, which is essentially if the RBA were to inject new money into the money supply.

“There is no evidence anywhere around the world that these quantitative easing strategies have actually worked. They’ve postponed the inevitable, but the problem is it’s a one-way street and I can’t see how to get back,” explained North.

He continued, “If you look around the world where these unconventional strategies have been used, they’ve taken interest rates lower, they’ve inflated asset, stock and home prices, but they haven’t solved the fundamental economic issues: growth is still weak, debt is still very high.”

North feels confident that the risks outweigh the possible benefits, warning that these strategies have seemed to offer only a temporary solution before plunging the economy into further chaos.  

“The fact that the Reserve Bank is even contemplating it suggests to me that the broader economic management in the country has been pretty weak. I think the rates have already been cut too low, I think the government has been too reliant on the housing sector and housing debt,” said North.

“If Australia goes down this route – which I think is possible – it would be unconventional, it would be untested, it would be an experiment,” he concluded.