Thursday, April 2, 2009

A time to hold.

Earlier this week, I found myself contemplating what decision the RBA will make at its’ next board meeting. In theory there are three options, increase, decrease or hold. After considering the issue carefully I find myself concluding that the cash rate should remain unchanged. I have four reasons why I believe this would be the most appropriate decision.

First, on balance, recent economic news has been relatively good. Second, the full impact of recent rate cuts have still to take effect. Third, the effects of recent fiscal incentives (cash bonuses) have yet to be fully ascertained. Four, I believe it would have a positive effect on confidence.

Some may find my first reason puzzling, perhaps even crazy. However, I believe careful consideration of recent economic data suggests Australia is in a relatively favourable position. This is particularly true when compared to some of our major trading partners and past experiences. For example, Australia’s unemployment rate is no where near the heights of the 1990s recession, nor is it experiencing the gains of the UK or USA.

Sadly, many people appear to be unaware of how much time it takes for a change in the official cash rate to impact on the economy. Research suggests a lag in excess of 12 months. Importantly, much of this research was conducted using data corresponding to economic times. Arguably, cash rate changes have an even less effect in times of hardship. All this suggests that recent changes in the official cash rate have yet to filter through.

The Rudd-Labour Government has placed a big emphasis on cash bonuses. The most recent cash bonus was administered less than a month ago. Not enough time has passed to see whether these incentives have had their desired effect.

Lastly, I believe a decrease in the cash rate would send the wrong signal. Over the last year I have observed that the Australian economy as a whole has been less volatile. In particular, not characterised by the hysteria we see off shore. I think a decision to hold the cash rate would reinforce consumer and producer sentiment.

In conclusion, I confess that I also believe there are harder times ahead. It is my expectation that we will not bottom out for sometime yet. Therefore, I also suggest that it would be wise to preserve some arsenal, even if only for a precautionary measure.


  1. you say 'I believe a decrease in the cash rate would send the wrong signal'
    and then 'I also suggest that it would be wise to preserve some arsenal'

    what good is it to have something in your "arsenal" that would send the wrong signal?

    seeing as how 'there are harder times ahead' and 'cash rate changes have an even less effect in times of hardship', do you think that this 'precautionary measure' could have any significant effect in the future?

  2. This part of the argument I presented is based on managing expectations. It is my belief that consumer/business sentiment at the moment is predisposed to doom and gloom to a degree that is unjustified.
    One way to address this is to show the differences between Australia and the rest of world. This will reinforce confidence in the domestic market.
    If this can be done, then I believe a rate cut in the future can have a positive effect. Especially as Australia is one for the few countries left with room to move (again demonstrating Australia’s economic robustness).