Should the RBA put an end to ultra-low interest rates?

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Is it time for the Reserve Bank to put an end to ultra-low interest rates? Adam Creighton, an award-winning economics journalist, recently posted this question in an article for The Australian.

Australians borrowed $13.2bn to invest in houses and apartments in January (an increase of 27% from more than a year ago). They also borrowed $20bn to live in their own homes, according to the Australian Bureau of Statistics. Many analysts, including Creighton, warn that the country could be on its way to an economic downturn.  

Aside from historically-low interest rates, the speculation is being fuelled by a capital-gains tax system that encourages leveraged property speculation.

“There’s now a stock-market element to the housing market because of the higher share of property investors,” said Bob Gregory, economics professor at Australian National University and a former RBA board member.

The Reserve Bank’s last two interest rate cuts – in May and August last year – were “clearly a mistake,” Gregory said. However, the fallout from reversing them could be more devastating. “If these people jumped, the house-price fall would be much bigger than people have been used to; it could be a major catastrophe for the economic environment.”

To add fuel to the fire, the value of housing credit has edged up 6%, almost triple the pace of wage growth, to $1.56trn.

Organisations such as the International Monetary Fund, the OECD, and various global ratings agencies have repeatedly warned that Australia’s housing market is overheated. In parliament, political pressures to ease the housing affordability crisis have intensified.  

The Reserve Bank’s new governor, Philip Lowe, envisioned Australia’s current predicament in 2004 in a paper he co-authored with Claudio Borio, who has since risen to become head of the Monetary and Economic Department at the Bank for International Settlements (BIS). The paper warned central banks about the dangers of ignoring financial markets and credit when setting interest rates.

“The symptoms of an unsustainable boom would more likely first show up in excessive credit and asset price growth,” Lowe and Borio said. “This in turn would make the economy more vulnerable to the slowdown or contraction that, sooner or later, would follow, whether in response to a central bank tightening to quell eventually rising inflation or in the wake of the spontaneous unwinding of the imbalances.”


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