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Saturday, July 2, 2022

The failure of the RBA to cut interest rates before COVID-19 could cost 270,000 jobs.

The Reserve Bank of Australia is about to be under the microscope in the first major review of its performance in at least 30 years, and possibly forever.

In a study published this month in the Economic Record, Australian Labor MP Andrew Lee and I analyze how the bank has set interest rates over the past two decades and evaluate its results.

To do this, we use RBA’s proprietary model (called MARTIN) to assess how well it has achieved its two key goals of full employment and price stability.

We analyze bank performance over three periods:

  1. The global recession that began in 2001

  2. The global financial crisis that began in 2008

  3. Four pre-pandemic years from 2016 to 2019 when inflation was below the bank’s target range of 2-3%.

Top scores for the first two crises

We find that in each of the first two crises the bank did a good job. In the face of major economic shocks, he cut interest rates to keep jobs.

Low interest rates make it easier for businesses and households to borrow and spend. Since 2001, rate cuts have reduced unemployment from 7% to less than 6%.

During the global financial crisis, the bank again aggressively cut interest rates.

The bank’s model suggests that if it weren’t for the rate cut, unemployment would rise to nearly 8%. Instead, it fell to 5% without even rising to 6%.

The score that we assign to the bank for each of these two periods is a solid “five”.

The pre-COVID failure that cost people their jobs

But we find that between 2016 and 2019, the bank lagged significantly.

During this period, the economy began to decline. Economic growth slowed, wage growth was sluggish, and inflation hovered below the bank’s target range.

The bank lowered the interest rate, but not much, from 1.75% to 0.75%.

This relative inactivity meant that the unemployment rate remained above what was needed.

With respect to the optimal path determined by the RBA model, we find that these costs are equivalent to the unemployment of 270,000 people for one year.

The high cost of high interest rates

270,000 jobs is a big deal. By comparison, Melbourne’s commuter rail loop is estimated to create only 8,000 jobs when construction begins in Phase 1, while the national inland rail project is estimated to create around 20,000 jobs. It is estimated that closing the border with Australia cost 72,000 jobs.

Each represents a massive public project or decision, but they pale in comparison to the bank’s decision to slow the economy over this four-year period.

The position taken by the bank under Philip Lowe in charge during these four years represents a fundamental error. Such an error warrants a C- grade at best.

Too Much Concern About Housing Prices?

One explanation for this error could be that the bank did not want to raise housing prices.

Governor Lowe told a business audience in 2017 that while he would like the economy to grow a little more,

if we tried to achieve this through monetary policy, it would encourage people to borrow more and would likely put upward pressure on house prices. At the moment I don’t think these two things are in the national interest.

More recently, he dropped the idea, telling the National Press Club in 2022 that he doesn’t think the idea of ​​holding the bank responsible for house prices makes sense.

Using interest rates to keep house prices down is known as “leaning against the wind.” The Reserve Bank’s own researchers found that the cost of weathering the wind was three to eight times the benefit of avoiding financial crises.

Read more: The RBA is largely right, but there is still room for investigation

Since then we have been in a very different situation. During COVID, the bank cut rates further than thought possible and helped drive unemployment to a 48-year low of 3.9%. And now he’s started pushing the bets back.

But the best way to avoid repeating mistakes is to recognize them and diagnose them. We hope that the review will help to identify where such errors occurred so that the bank can perform better in the future.

World Nation News Desk
World Nation News Deskhttps://worldnationnews.com/
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