Hewson's View: It's the economy, stupid

Buying time: Governor of the Reserve Bank of Australia, Philip Lowe, speaking in Canberra on June 24. The RBA, concerned about the country's weak growth rate, cut interest rates to a historic low this week. Photo: Alex Ellinghausen

Buying time: Governor of the Reserve Bank of Australia, Philip Lowe, speaking in Canberra on June 24. The RBA, concerned about the country's weak growth rate, cut interest rates to a historic low this week. Photo: Alex Ellinghausen

What a strange world we live in.

This week our Reserve Bank, that has been characterised, indeed almost totally defined, in the past by its anti-inflation obsession, lowered the official cash rate for the second time in two months, to 1 per cent, a historic low, in part to "provide greater confidence that inflation will be consistent with the medium-term target" of 2-3 per cent.

That is, after a couple of decades of being paranoid about inflation and inflationary expectations, taking every opportunity to keep interest rates as high as possible, for as long as possible, in the emerging market circumstances, they now actually want inflation to increase!

In broad terms, their "theory" as stated is that such cuts in interest rates, in the context of the government's tax cuts, should "support employment growth" and therefore put upward pressure on wages, which have been flat lining, and thereby increase inflation.

It should also be noted that the RBA is now very concerned about our weak growth rate, having roughly halved its growth forecasts during the recent election campaign, and having been constantly "nagging" the government to do more with its budget to support growth.

The current budget is actually quite "deflationary", promising surpluses for the next decade, and to repay net government debt over that period. To achieve their "promised" surpluses for just this and the next three years it is assumed that they can further lower the growth in their spending to about half the rate of what they achieved in their previous six years in office, which was already quite tight, but still saw government debt roughly double.

However, the reality is that the government has made significant, unfunded, expenditure commitments running through the 2020s and beyond, in defence, infrastructure, and the NDIS, on top of health and education, such that these 10-year commitments to surpluses and debt reduction are probably unattainable, and at least the latter part of the tax cuts being approved by Parliament are unaffordable.

It is also noteworthy that although the cost of living was a dominant issue at the last election - especially housing, power, fuel, child and aged care, and medical insurance costs - the RBA's focus on inflation means that they want even more cost-of-living pressures.

Another interpretation of all this is that the RBA is concerned about our household debt "bubble" and is trying to delay a "bust".

Household debt is around 120 per cent of GDP, and nearly twice household disposable income. The recent Banking Royal Commission revealed just how much a culture of "greed" had driven our banks to lend households and investors much more than they could actually afford. Bank lending was heavily on an "interest only" basis such that a significant proportion of their lending was actually "sub prime".

Many borrowers are now increasingly under mortgage stress, even with negative equity, as their house prices (and wealth) have fallen, at a time when their wages have been flat, and their savings mostly exhausted.

In summary, it seems that the RBA, and the Morrison government, are trying to use growth to delay, and hopefully avoid, a major domestic debt crisis. It's certainly just buying time, rather than solving problems.

Clearly both the RBA and the government are constrained in their capacity to respond, with historically low interest rates and the government's commitment to return the budget to surplus. At the time of the GFC, both had considerable capacity to respond with both very high interest rates and the budget in surplus having repaid most of the government debt.

The RBA is clearly asking the government to ease fiscal policy, to delay the return to surplus. Although there are calls for the government to bring forward some of its committed infrastructure spending, this would be unlikely to stimulate early enough.

The RBA is clearly asking the government to ease fiscal policy, to delay the return to surplus.

More direct and immediate stimulation could come from an increase in Newstart, - this should stimulate the spending of the lowest income earners - and, say, a rapid expansion of spending on social housing. Both would also be "good" policy, as these have been seriously neglected policy areas.

In all this the Morrison government has its credibility as an economic manager most at risk, especially given its campaign slogans about a "Strong Economy" and its commitment to "Keep it Strong".

John Hewson is a professor at the Crawford School of Public Policy, ANU, and a former Liberal opposition leader.