Why I Would Have Raised the Interest Rates

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The rate increase this week in Australia may have been presented as evidence that the Australian economy is picking up but for me it was anything but.

I am not normally a fan of using rates to control economic activity but on this occasion it was only partly about the economics narrowly defined and a good deal more about providing a warning to the loose fiscal cannons in charge of managing our economy. The rate increase could not have come soon enough to suit me.

Do I know why the RBA raised rates? No. Am I privy to the discussions of the RBA Board? No again. But I do know this. I do know why I would have raised rates, and would keep on raising them until the Government gets the message. That I do know.

The data below are from the most recent set of National Accounts. The data, which I discussed in my previous posting, show the level of National Net Saving and the Saving Ratio. Both are at extraordinarily low levels.

The figures make it unmistakeable that there has been a collapse in the level of national savings available to all users across the economy. These are investable funds that are potentially available for those who would wish to increase our capital base by borrowing the incomes earned by others for use in projects of their own. The funds available have not only cascaded downwards, falling by half over the past year, but the rate of decline has even been accelerating.

This is an outcome that would worry any central banker worth his salt. Depleting our savings in such a savage way will have left us even less able to regenerate growth than we were twelve months before when the stimulus spending began.

Parenthetically, it might be noted that the only justification for a Keynesian stimulus – at least if there were any consistency between the Keynesian models that are taught and the policies everyone is attempting to pursue – is that there are unused saving that need to be soaked up in higher levels of public spending.

Saving in a Keynesian model creates damage because it reduces the level of spending. Since in a Keynesian model we can’t count on investment rising to fill the expenditure void created by our savings, it is the government which must come to the rescue to spend our way to prosperity. It is increased public expenditure and higher deficits that move the economy out of recession.

Well, how much nonsense is that! The government, rather than deploying savings no one else is willing to spend, is spending our savings before anyone else has a chance to get at these savings themselves.

There is then the savings ratio, which the ABS defines as “the ratio of national net saving to national net disposable income.” The data show that in the latest quarter, the ratio has not just fallen, it has become negative. Individuals in aggregate are taking money from their savings and using it to pay the bills. Expenditures are rising faster than disposable incomes.

That interest rates must rise in such circumstances is beyond question. They will rise with or without the RBA, and in fact, aside from mortgage rates, already have. Partly the interest rate number has gone up, and partly there has been a restriction on the availability of credit. But up interest rates have gone and for good reason. The RBA is mostly just catching up with the market.

There are then the data from the RBA showing the growth rate in Business Credit between March and August this year. No economy entering a serious growth phase has numbers anything like that.

In the last month for which there are data, in August 2009, there was again a fall in business credit and over the year the level of business credit has fallen by 2.2%.

This is almost the classic case of crowding out. Others are getting to these funds sooner and more cheaply than business. Government spending has replaced business spending. The government stimulus is thus not only wasteful almost down to the last dollar spent, but is preventing the private sector from having access to the funds it needs to invest and employ.

The political side to the rise in interest rates therefore strikes me as a warning shot across the bow of the government. It is a statement from someone worried about the way in which we are ploughing our productive potential into the ground with the certainty that in a year or two we will have an immense debt and nothing to show for it.

Raising rates may begin the process of sobering up those who have been wasting our resources hand over fist and remind them that there is a price to pay and the debt is starting to be called in now.

And let me add one last point. It is said that the rise in interest rates is working in the opposite direction from the increases in public spending. Higher rates will slow the economy while higher public spending will increase it. There is therefore an inconsistency and contradiction in public policy.

This would be true only if there actually were some kind of stimulating effect of higher public spending. Since such spending is a negative, since it only acts to weaken an economy and slow it down, there is nothing whatsoever contradictory about using higher rates of interest as public spending goes up.

I am, in fact, inferring the highest motives to the Governor of the RBA who may himself actually see only negative implications in the stimulus and is trying to get the government firstly to stop spending, and then, if possible, to roll back what planned levels of spending has not yet taken place.

But as for this rise in rates being a contradiction, there is none at all. Savings are being plundered by the government, and if we are going to find our way to a genuine recovery, the government’s hands must first be pried off the savings of the nation. A really sharp rap on the knuckles may be the only way.

Dr. Steven Kates
for The Daily Reckoning Australia

Dr. Steven Kates

Dr. Steven Kates

Dr. Steve Kates is a Senior Lecturer at the School of Economics, Finance and Marketing, RMIT University. Dr. Kates spent a quarter century as the Chief Economist for the Australian Chamber of Commerce and Industry. Most of his research has been into macroeconomic policy, industrial relations and the history of economic thought. His most extensive area of expertise is in the classical propositions surrounding Say’s Law, on which he has written many papers as well as two books: Say’s Law and the Keynesian Revolution (1998) and Two Hundred Years of Say’s Law (2003) and, with John Cunningham Wood as the general editor, put together a five volume set, Critical Readings on Jean-Baptiste Say. The lead article in the March 2009 issue of Quadrant dealt with “The Dangerous Return of Keynesian Economics” which looks at the importance of Say’s Law in the development of coherent macroeconomic policies.
Dr. Steven Kates

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16 Comments on "Why I Would Have Raised the Interest Rates"

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Justin
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On the RBA’s website http://www.rba.gov.au the stated objectives of the bank are a) The stability of the currency of Australia & b) The maintenance of full employment in Australia. As I think that a) is a pre-requisite for b), so any actions by the RBA should be seen as affecting a). I also think at the same time that a) would be best served by stable money and capital markets, in other words interest rates. So while I agree that ‘Raising rates may begin the process of sobering up those who have been wasting our resources hand over fist’, the… Read more »
GaryB
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Whatever the motives of the RBA in increasing the cash rate, the table from the ABS showing the Aus 08/09 savings stats can’t be interpreted as anything but a collapse in savings in Aus. What a shocker. It contradicts the “urban myth” that savings rates were on the increase here over the last 12-18 months.

Graeme Simpson
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Isn’t it bloody typical, the author of this happens to have a doctorate, he can’t understand why all of us don’t bank a thousand dollars a week, he probably also thinks pensioners are on a few grand a month, higher rates flows onto everything eventually. There should only be emergency reseting of rates, not these idiots at the RBA trying to justify their positions & vast retainers, it reminds me of kids playing with dials, the last time I researched it the lowest paid person who was also on the RBA board earned $450,000 p.a. they wouldn’t know what a… Read more »
Bargeass
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These super low gambler rewarding and encouraging interest rates are the cause not the problem.

Biker Pete, Vancouver Island, Canada
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Biker Pete, Vancouver Island, Canada
Graeme Simpson, 10/10/09: “… everything … goes up, eg: recently cheese, cream, yogurt etc skyrocketed some nearly doubling…” . Agree Graeme, but our recent experience travelling through four countries in four months (so far, this year) indicates there’s little difference in supermarket prices across Australia, England, Scotland, the US and Canada, in the day-to-day necessities, except where a particular product is harvested locally/seasonally. Perhaps the UK has slightly lower supermarket costs for some items, but fuel costs there were double; along with very high parking costs. And wages are far, _far_ lower in some countries and/or provinces. As for greed… Read more »
Ned S
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I’m curious as to how much of that apparent decline in “savings” might actually be money that had been stashed in nice safe cash flowing back into stocks – Maybe? Maybe not? More info required perhaps.

The RBA putting up rates – The media probably tends to play up to the public’s feelings on the issue in some regards – Right now higher interest rates are “bad”! Whereas in 10 years time when lots more retirees are relying on income from bank interest, it could be that higher interest rates will be seen as “good”? :)

JAMES EXPO
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Its about time interst rates went up and the higher the better. Just take a look at the median house price in Melbourne 12 mths ago it was approx 430,000 today it is 520,000.This has been caused no doubt by the panic policy of the RBA influenced by a reckless spending govt.It has done absolutely nothing to help in buying a house it has just eroded the value of your hard earned money as the increase in asset prices will just cost you more in council rates stamp duty land tax etc.These policies have in effect shored up state and… Read more »
Pete
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“Just take a look at the median house price in Melbourne 12 mths ago it was approx 430,000 today it is 520,000.” Just proves Keen was right, doesn’t it?

Pete
Guest

Well…that certainly wasn’t the regular Pete to post that. A misunderstanding?

Greg Atkinson
Guest

Pete how does that prove Keen was right? Actually for Keen to be correct he needs property prices to first fall by the amount they have risen since he made his prediction, and then fall by the amount he originally suggested they would drop (40%) Or perhaps Keen has a moving price baseline that keeps heading up?

Pete
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Wasn’t my post Greg… some other Pete was posting.

Greg Atkinson
Guest

Oh two “Pete’s” this is messing with my brain :) Anyway I am not saying that rising home prices are nothing to worry about, just that Keen’s prediction is looking more shaky by the day. Actually from what I can tell the property market seems to have been correcting in phases.

First the GFC took down the high end market and now I suspect homes up to the 400-600K mark will soften since rates are heading up and the grant is tweaked back.

Anyway know how the Gold Coast real estate market is tracking?

So maybe any bubble is being deflated slowly?

Pete
Guest

Maybe the Gov can buy these and use them for public housing:
http://www.smh.com.au/national/empty-nests-too-high-for-the-empty-nesters-20091101-hrld.html

Lachlan Scanlan
Guest

Maybe a biker variety of Pete?

Ned S
Guest

All is not lost for Steve Keen – Chrissy is coming up – So maybe his mum will pop a new pair of walkers in his stocking.

Ned S
Guest
And I still come back to a comment I made a while back about Keen being a greedy old man – He sold his home that he had bought earlier when he presumably reckoned it was reasonable value for money – Because he reckoned prices were going to crash and he’d make a killing. Hey, I know nothing – House prices may go down. Or not. But either way Keen is a somewhat older chap who doesn’t own a house in what I assume is his country of citizenship … Bugger that! (Or it was just a stunt to increase… Read more »
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