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Can interest rates fall any lower?

August 12, 2019
Writer(s): Manraj Nijjar

With the official interest rate sitting at 1%, interest rates have never been lower in Australian history. While they have been enjoyed by a large part of the population, they also present some difficulties.

Why they have been necessary

Slow wage growth is a persistent problem within the Australian economy. The extent of this issue is evident with an average annual growth in real wages (in the five years to November 2018) sitting at a mere 0.5 per cent per annum. The average recorded in the previous five years prior was a larger 1.8 per cent per annum (Geoff Gillian , Parliament of Australia, 2019).

Another contributing factor is the housing market. Representing a lion’s share of the average household’s wealth, the recent movements in the market have significantly shaped household spending decisions. Since 2017 the market has plateaued and even fallen in many suburbs, with fewer properties being sold at auction and low/negative growth in housing finance. The fall in paper wealth can lead to households spending to drop in order to compensate, and increases levels of saving as a precautionary measure.

This means lower levels of consumer expenditure, lower economic growth and lower levels of inflation presenting all the required conditions for interest rates to stay low.

Implications of low interest rates

While the low rates have been a necessary part of the monetary policy, they do place some unwanted consequences as well.

With the interest rate so low, the benefits of holding money in bank deposits are fewer, and therefore the supply falls. With less deposits on hand, the banks must be stricter in their selection criteria in regard to providing loans. They only loan to borrowers with the highest credit ratings and substantial assets to collateralize those loans. This leads to many candidates with reasonable credit ratings to miss out on loans.

Furthermore, the low rates mean there is a larger opportunity cost in holding back deposits. Other investments seem more desirable now. However, these assets often don’t produce employment, such as the stock market and paying down loans.

The combined effect is that money doesn’t flow through the economic system.

Future

With significantly subdued inflation rates, and low economic growth the low interest rates are here to stay. But they are unlikely to reach negative levels. The impact of falling bank deposits will outweigh any of the benefits (greater household spending).

The RBA governor Lowe agrees with the long term forecast stating:

“It is reasonable to expect that an extended period of low interest rates will be required in Australia to make progress in reducing unemployment and achieve more assured progress towards the inflation target”

The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ, our Partners and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.

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