Title of the extract “RBA cuts interest rates to a fresh record low” Source of the extract ABC News Date of the extract 4 June 2019 Date of the commentary 16 June 2019 Word count 749 words Section of the syllabus Macroeconomics RBA cuts interest rates to a fresh record low By business reporter Stephen Letts and Michael Janda Updated Tue at 3:41pm The Reserve Bank has cut its official interest rate by 0.25 percentage points to a new record low of 1.25 per cent. While it is the first change in the RBA's policy setting since August 2016, it was a widely expected result. The RBA governor Philip Lowe effectively flagged a rate cut in a speech last month. The futures market had priced in a 100 per cent likelihood of a cut at the June meeting, with another cut expected by October. All 43 economists surveyed by Refinitiv had also pencilled in a rate cut this month, while 80 per cent of them also expect a follow-up move in August. The RBA has been under mounting pressure to stimulate a clearly faltering domestic economy, with retail sales figures out this morning showing consumers had cut back their spending. While it had been loathe to cut rates in previous months for fear of further ratcheting up risky household debt, the bank felt it had to move given inflation has been marooned under its 2-to-3 per cent target band for the best part of three years and unemployment is starting rise. In seasonally adjusted terms, the unemployment rate ticked up to a high 5.2 per cent in April, from an upwardly revised 5.1 per cent the month before. It was 4.9 per cent in February. In the more stable trend terms, unemployment was steady at 5.1 per cent. The increase was in line with softer leading indicators reported in job ads and business surveys, but higher than the consensus forecast and considerably higher than the RBA's hopes for an improved outlook. The weaker than expected number briefly drove the Australian dollar below 69 US cents — its lowest level in more than three years — on increased anticipation of a rate cut. 'ANZ has let down its customers' ANZ was the first major lender to move, cutting its variable interest rate loan by 0.18 percentage points 10 minutes after the RBA published its decision. "In making this decision we have weighed up a number of factors, such as business performance, market conditions and the impact on our customers, including our depositors," ANZ's head of Australian retail and commercial banking Mark Hand said. However, the decision to pass on just 70 per cent of the cut may not go down well with Treasurer Josh Frydenberg, who urged the banks to pass on the benefits of the cut. "I think the ANZ has let down its customers. This is deeply disappointing from the ANZ," Mr Frydenberg said after the RBA decision and ANZ's response. "This rate cut will be welcome news for Australian households and businesses and it will mean lower mortgage costs and lower interest payments." "It is the Government's expectation, indeed it is the public's expectation, that banks should pass on, in full, to consumers, the benefits of reduced funding costs as a result of the Reserve Bank's decision." The RBA also noted that bank funding costs have fully reversed the increases that took place last year. The Commonwealth Bank has announced that it will pass on the rate cut in full to all of its standard variable home loans. National Australia Bank has followed suit and also announced that it will cut its standard variable rate home loans by 25 basis points. Westpac has tried to tread a middle ground by passing on only 20 basis points in rate cuts for most variable home loans, but 35 basis points for interest-only property investors. The bank is also offering a 3.49 per cent five-year fixed rate for new first home buyer customers. Some smaller lenders have also announced that they will pass on the rate cut in full, including Athena, RACQ and Reduce Home Loans. RateCity said the lowest ongoing variable rate now stands at just 3.19 per cent. Unemployment remains key "The board took this decision to support employment growth and provide greater confidence that inflation will be consistent with the medium-term target," RBA governor Philip Lowe said in the regular post-meeting statement. "The main domestic uncertainty continues to be the outlook for household consumption, which is being affected by a protracted period of low income growth and declining housing prices. "[Tuesday's] decision to lower the cash rate will help make further inroads into the spare capacity in the economy. It will assist with faster progress in reducing unemployment and achieve more assured progress towards the inflation target." While not committing to another move, Dr Lowe's statement will do little to change perceptions the RBA has not finished lowering rates yet. "The board will continue to monitor developments in the labour market closely and adjust monetary policy to support sustainable growth in the economy and the achievement of the inflation target over time," Dr Lowe concluded. The Reserve Bank governor was speaking on Tuesday night in Sydney, where also took questions about the bank's first move in nearly three years and the likely future direction of monetary policy. RBA glass still 'half-full' RBC's Su-Lin Ong said, despite the RBA's still largely optimistic outlook, it is highly likely it will have to cut deeper. "A further weakening in the labour market and core inflation that fails to lift will likely trigger further easing. To our mind, both pre-requisites are likely to be met in the coming months," Ms Ong said. "Despite this, today's statement was balanced and erred somewhat glass half-full." Ms Ong added the extent to which the major banks pass on the full cut to deliver maximum policy traction will be a key determinant for RBA decisions in coming months. Commentary: This article comments on the Reserve Bank of Australia (RBA) lowering its official interest rate “by 0.25% to a record low of 1.25%” to decrease unemployment - a macroeconomic objective. An interest rate is a payment, per unit time, for the use of borrowed money that’s expressed as a percentage of a borrowed loan1. A person is unemployed if they are of working age and actively seeking a job yet are unable to find one. The unemployment rate in Australia rose “to 5.2% in April of 2019, increasing from 5.1% the month before”, an issue which the RBA has tackled by decreasing interest rates. This is an example of an expansionary monetary policy: a policy implemented by the central bank in order to increase aggregate demand. Aggregate demand (AD) is the total demand for final goods and services in an economy at a given time period2. Three of its components, consumer expenditure (C), investment (I), and net exports (X-M), are affected by a decrease in interest rates. This is highlighted in Diagram 1 below: 1 Banton, Caroline. “Interest Rate.” Investopedia. Investopedia, May 28, 2019. https://www.investopedia.com/terms/i/interestrate.asp. 2 Kenton, Will. “Aggregate Demand Definition.” Investopedia. Investopedia, October 15, 2019. https://www.investopedia.com/terms/a/aggregatedemand.asp. As is illustrated, a decrease in the interest rate will increase AD, shifting the AD curve from AD1 to AD2 and the equilibrium point from E1 to point E2. This results in an increase in real GDP from Y1 to Y2 and an increase in the average price level from APL1 to APL2. AD increases due to the decreased cost of borrowing money. This increases both household spending, such as spending on durable goods, as well as investment by firms that is financed by borrowing. Furthermore, a decreased interest rate will decrease the demand for the Australian dollar, causing a depreciation in its exchange rate. This was highlighted in the article as the Australian dollar’s value “dropped to 69 US cents”. This depreciation will make Australian exports more competitive and imports more expensive, thus increasing net exports and AD3. Ultimately, an increase in AD will lead to a decrease in demand-deficient unemployment as the aggregate demand for labour increases from ADL1 to ADL2, as seen in Diagram 2. Therefore, the quantity of labour demanded increases from Q1 to Q2. Due to price-stickiness, demand-deficient unemployment will decrease from a-c to a-b, reducing the disequilibrium in the labour market. Alongside its ability to decrease demand-deficient unemployment, another benefit of the decreased interest rates is the independence of the central bank. Fiscal policies are often hard to 3 Pettinger, Tejvan. “Effect of Lower Interest Rates.” Economics Help, August 3, 2019. https://www.economicshelp.org/blog/3417/interest-rates/effect-of-lower-interest-rates/. implement due to the political nature of the government. On the contrary, central bankers rarely face any political pressure and implement policies which are in the best long-term interests of the economy. The decreased interest rates also have further, positive impacts like “lowering mortgage payments” as outlined in the article, benefiting homeowners by increasing their disposable income as mortgage payments are often the biggest component of homeowner spending4. This monetary policy also has some disadvantages. Firstly, the decrease in unemployment is at the expense of demand-pull inflation. Although this might help in making progress towards the RBA’s “2-to-3 percent inflation target”, concerns still rise in the ineffectiveness of the monetary policy against cost-push inflation - a type of inflation that may arise due to the increased import costs as a result of the Australian dollar’s depreciation. If the interest rates are lowered when cost-push inflation is present it may result in an inflationary spiral occurring, presenting further limitations such as slower economic growth and decreased quality of life. Furthermore, decreased interest rates are ineffective in decreasing other forms of unemployment which make up Australia’s natural unemployment rate; structural, frictional and seasonal unemployment. For instance, structural unemployment is caused by geographical and occupational immobilities, not by insufficient AD, and therefore its level will not be affected by the decreased interest rates. Finally, decreased interest rates may be ineffective if the levels of consumer and business confidence in an economy are low. Consumer and business confidence are measures of the optimism which consumers/producers have about their economic future. If confidence is low, decreased interest rates may be unable to encourage consumer and investment spending, thus not increasing AD and not reducing unemployment. Evidently, decreased interest rates have limitations which other policies may not have. Therefore, a possible solution to the increased unemployment rates in Australia is the implementation of further policies, such as supply side-policies, alongside the monetary policy currently in place. Despite their time-lags, market-based supply side-policies, such as decreasing unemployment benefits, will help deal with structural, frictional and seasonal unemployment, thus further decreasing unemployment in the Australian economy. 4 Pettinger, Tejvan. “Who Benefits from Low Interest Rates?” Economics Help, January 9, 2018. https://www.economicshelp.org/blog/14553/interest-rates/who-benefits-from-low-interest-rates/. Bibliography: Banton, Caroline. “Interest Rate.” Investopedia. Investopedia, May 28, 2019. https://www.investopedia.com/terms/i/interestrate.asp. Kenton, Will. “Aggregate Demand Definition.” Investopedia. Investopedia, October 15, 2019. https://www.investopedia.com/terms/a/aggregatedemand.asp. Letts, Stephen, and Michael Janda. “'ANZ Has Let down Its Customers': Frydenberg Hits out over Rate Cut.” ABC News, June 4, 2019. https://www.abc.net.au/news/2019-06-04/rba-cuts-interest-rates-to-a-fresh-record-low/11176306. Pettinger, Tejvan. “Who Benefits from Low Interest Rates?” Economics Help, January 9, 2018. https://www.economicshelp.org/blog/14553/interest-rates/who-benefits-from-low-interest-rates/. Pettinger, Tejvan. “Effect of Lower Interest Rates.” Economics Help, August 3, 2019. https://www.economicshelp.org/blog/3417/interest-rates/effect-of-lower-interest-rates/.
