The Fed cut interest rates by 50 basis points maybe not in regular meetings but not cyclical in reaction to the COVID-19 disaster, which is likely to turn into a worldwide pandemic.
In fact, lenders continually tend to reduce interest rates sooner than later. Australia’s economic growth remains slow on a per capita basis, wage growth remains hovering around 2 percent, unemployment is 5.3 percent and inflation is below the target group of 2-3% for the whole period of Philip Lowe as governor (due September 2016).
The US market, by contrast, performs better at these steps. Unemployment is at its lowest speed in decades. Wage growth is more than 3.6 percent every year.
What makes US interest rates cut more reveals about the Fed’s perspective on the financial consequences of COVID-19. The US stock market reacted to the statement by falling around 3 percent, before regaining the next moment.
One Instrument In The Box
There is a story among small Australian businesses, one of the special commentators and voiced by former treasurer Peter Costello that the Reserve Bank’s interest rate reduction no longer does anything to spur growth and investment because prices are so low.
In addition, the argument goes, by cutting interest rates that the central bank is sending a negative message about the condition of the Australian market.
The difficult fact is that the market is in a bad condition.
Cutting interest rates alone wont solve this problem. Nevertheless, it is an instrument owned by the Reserve Bank.
As every major economist stated, prior to the COVID-19 epidemic, the Australian market had a fiscal stimulus that was significantly different from the budget-balanced fetishism of their current Coalition government (and, to be honest, also Labor resistance at this time).
We are now likely to find some targeted stimulation due to COVID-19, however, which will not deal with pre existing Australian market issues.
Sending A Message
Curiously, this review of the Reserve Bank of Australia only applies very well to the US Federal Reserve’s decision to reduce prices radically and to do this outside the cycle. Doing so eats up monetary policy ammunition.
Along with the virus crisis is not only a demand side problem where consumers are not spending. In addition, this is a supply-side problem where the company cannot produce what the customer is ready to buy.
There is no reduction in interest rates that can improve the global supply chain which is disrupted by the closure of bulk factories in China.
Exactly what the Fed is doing is sending a message that a catastrophic virus will be of prime importance.
This will help produce a savage cycle of faith about requirements because customers respond to fast cuts by increasing prudent savings and reducing expenses.
Therefore the Fed uses some of its limited ammunition in ways that appear to be ineffective, and contain fearful consumers and markets.
Time To Spend And Borrow
Returning to Australia, it will be very important to unpack the Reserve Bank’s financial answers along with the national government’s financial reaction. How big is the response to COVID-19 and how much is it about the inherent weaknesses of the Australian market.
The real fear is that too little will be achieved, especially with financial policy, to overcome the underlying economic weaknesses.
There is some hope, today the possibility of a budget surplus has basically disappeared, the coalition government will soon be free to do what it should have done so far creating lasting investment in the Australian market.
The debt market will basically protect us from borrowing. That is a rare opportunity to make wise investments that will pay big dividends in the coming years.