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ESSA X CAINZ Debate: Is a zero cash rate necessary for Australia’s recession recovery?

September 29, 2020
Writer(s): Ashlee Stojanovski, Sean Reid, Jason Suhartanto, Anthony Wong

Disclaimer

*The speakers in this article are competitive debaters, and therefore the views expressed may not necessarily represent their beliefs or the beliefs of the organisation they belong to.*

Preamble

Cash rate is the interest rate on unsecured overnight loans between banks.

First Affirmative (Nigel Pereira)

Time is money. An undeniable statement that rings true no matter what time period it is pronounced in. People value their time, and who doesn’t in an increasingly globalized world money is at its most basic form power, a form of truth and more importantly what runs the world. The amount of money you have differentiates your social standing. The champagne glass a lucid image that brings to light the inequality in the world, the global disparity of income. And Australia the ‘Great Southern Nation’ that it is, will crumble if it undervalues the importance of cash.

Quintessential to running an expansive economy Is having a positive cash flow, a freshmen level of economics. The cash rate is the numerical number of an interest rate on unsecured overnight loans between banks, and why is this important to have a zero cash rate during a recession? For the simple answer of expenditure.

With a lower cash rate, a zero cash rate, Australia’s economy will see savings interest rate decline significantly. Take Japan, a country that delves in the black magic of negative interest rates. You pay to hold money in a bank, why then would anyone pay to store. Because of risk, if you kept a large proportion of your money at home, you’d would constantly be concerned about the safety and security of such funds. For the salient point that during uncertain times, marked by recessions, people depict a behavioural pattern of risk averseness. They keep a tight hold on what they derive value from, and thus the cash is stunted by both the system itself and us, the people, inside it.

So, how can we then rise above a recession if the money is halted at the beginning of the cycle. Simply put, we give precedence to the opposition, to expense. Money fixes money. Recessions are economic events, hence you need cash to flow. Thus, the salient point in creating a string of cash flow is to incentivise consumption and what better way to implement a monetary policy to attract money.

Money fixes money, a zero cash rate is essentially in stipulating economic growth. Thus, the motion stands.

First Negative (Sean Reid)

Going to a zero cash rate in Australia would be a move that is unconventional and has been demonstrated not to work. Th RBA governor Phillip Lowe has affirmed in recent times that cutting the rate below the effective zero bound which has been stated to be 0.25% has costs that outweigh the benefits. We have seen the experiment of interest rates being at zero in the US for some time as well as the in the European Union. This has done very little to help simulate the economy in these nations before the conravirus pandemic hit. What it has coincided with is the QE program launched effectively in the United States which may be a better option in Australia.  Further, fiscal policy is going to be far more important going forward to help the economy bounce back to a level where it can actually grow above trend.

The negatives associated with zero interest rates mean that there is no incentive for people to hold money in deposits in banks and this leads many investors to engage in more risk-taking behaviour via the financial markets. We have seen the US stock market grown to unsustainable levels based on money from speculative investors being pumped into financial markets as a result of little to no reward for holding cash in banks. Further to this, many of your ordinary people are more likely to engage in risk-taking behaviours via investment decisions in risky stocks. What we do know about the benefits of having a zero interest rate is that there is the potential for more loans but in the current environment having a zero interest rate is not going to be enough as compared to say a rate of 1% to entice consumer and business confidence to increase to a level where more investment is going to be undertaken.

Therefore, fiscal policy is going to much more effective in helping the economy recover because unlike a zero cash rate, fiscal policy has the ability to not just inflate assets prices further but help boost the supply side of the economy while simultaneously increasing aggregate demand in the short term. Infrastructure spending and tax reforms are likely to prove far more effective than the marginal difference between low and zero interest rates. Phillip Lowe has conceded that the RBA has urged government of all levels in Australia to take on additional fiscal spending.

Second Affirmative (Jonas & Nigel)

The opposition, in their response, makes a firm distinction between monetary and fiscal policy, apparently glorifying fiscal policy as a singular economic policy tool. This neglects the complementary role of fiscal and monetary policy in the economy. It appears that the central argument used by the opposition is that the zero-cash rate, being part of monetary policy, is bad because it is not fiscal policy. 

As written in the opposition’s first sentence, this would indeed be an unconventional move. But during this very unconventional time, an unconventional move is indeed necessary. Of course, for greater monetary flexibility, it would be preferable not being this close to the zero-lower bound; however, this is where we find ourselves. We must look ahead for the best response given the situation. We think the benefits of reduced interest rates outweigh the costs.

To recover from this crisis, lower interest rates are critical to stimulate the economy in tandem with recovery packages and fiscal policy. By reducing the costs to borrow, this would increase the incentive to invest and thus spur spending. For consumers looking to buy homes and cars, such low costs would be a welcome economic benefit. The opposition claims that with interest rates reduced to zero, “ordinary people are more likely to engage in risk-taking behaviour”. We find this a baseless claim which appears to draw a causal claim between zero interest rates and risk-taking behaviour by consumers. The claim continues by asserting that this risk-taking behaviour would manifest in investments in risky stocks. Why, exactly, would the investment necessarily be in risky stocks? Given that only 31% of Australians held shares in 2017, we find this a baseless argument.

The free flow of credit associated with a cash rate of zero further incentivises capital spending by businesses. Not only is this by itself an economic stimulus – it can also increase individual consumption.

Now, with a zero cash rate, the RBA could turn to quantitative easing for further stimulus. Buying financial assets from commercial banks, not only is the monetary supply increased, but this would increase prices and lower the yield on these assets. This can, consequently, lower interest rates associated with different time horizons. 

Due to the importance of economic stimulus right now, we think Australia needs zero cash rates to be used in tandem with fiscal policy. This is needed to get us through the crisis. 

Second Negative (Jason Suhartanto)

While it may be true that lower interest rates are needed for stimulating the economy as reducing borrowing costs will increase incentives to invest and spend, this argument does not take into account that these policies have been biased towards short-term fixes and ignore all the other unintended long-term consequences caused by the temporary economic growth.

The opposition also stated that low interest rates will “further incentivise capital spending by businesses”. However, this does not guarantee economic growth because in practice many companies will use these borrowed funds to buy existing assets instead of expanding their productive capacity.

For a similar case in the United States in 2019, companies are taking advantage of low interest rates to do share buybacks, as seen in the chart above. While there are other factors, economists say that low interest rates play a huge factor in companies doing stock buybacks, and it can be observed that the buybacks and interest rates have a negative correlation. While this will boost their EPS measure in the short term, they would have to use future cashflows to pay down the debt being accumulated today in the long term.

In addition, a zero-interest rate will create unhealthy competitiveness in the corporate sector. By artificially controlling the price of money, companies will not be lacking in funding and can set up in competition with well-funded companies without having a sensible or economic business model. Unsound companies will survive and create competition for healthier companies that do not rely on free funding. This will cause prices to fall and therefore will also cause deflation.

The opposition also stated that savers looking for riskier alternatives is a baseless argument. However, it is important to see that most of the current low-risk assets that non risk takers are investing in will be affected by the low interest rate policies. The data that the opposition showed about the percentage of Australians investing in stocks clearly does not indicate anything. Instead of seeing the proportion of the population investing in shares, we are more interested in seeing more volatility in the shares market, including the non-risk investors who are jumping in the market because of their investments being affected by the low interest rates. There is no denying this fact since the Australian recession on March earlier this year is hugely because the RBA’s decision to cut rates. Therefore, the first negative’s argument is clearly not baseless.

When interest rates are so low and do not serve the normal function to spur economic growth, a liquidity trap might happen. Money does not flow through the economic system but will go into investments that do not produce economic growth, such as the stock market or paying loans. This can branch to other problems such as rising of unemployment as companies lay off workers. When wages decline, people cannot pay for things and prices on goods and services will also be forced down, leading to more unemployment and lower wages. This danger of deflation will be difficult to counter as the economy keeps crashing down.

This zero-interest rate policy will urge spenders to take more debt and companies to take on high leverages with no cost. At some point, the debt will have to be written off in a crisis, with losses inevitably carried by everyone. In conclusion, since the short-term positive effects will be outpaced by the long-term negative effects, the zero cash rate policy would not be sufficient for Australia to recover from recession.

Third Affirmative (Nigel Pereira)

I would like to depart from logical arguments by the affirmative team as the opposition’s inundation of misaligned truths have dug them their grave. As our first speaker highlights cash rate is a ‘freshman level of economics’ however the negative team plays it as synonymous with interest rate!!!Two very distinguished ideas, while correlated, maybe, definitely not interchangeable. Yet, their misrepresentation extends beyond realms of argument into the foundations of their arguments.

The negative team opposes the notion that lower interest rate ‘will not guarantee economic growth’ due to asset management opportunities that it presents various corporations. Whilst this idea does hold some value, one of the few salient points; indeed, the oppositions disregard for foreign capital investments is concerning. Lower cash rates cause lower interest rate which would argue in favour of foreign tycoons to see investment opportunities where others may only see recession. This growth mindset stands to be the case on a macrocosm level. With the wealth distribution (champagne glass) indicating that the top few brackets of income earners not having the value of their wealth as effected, compared to lower income thresholds. Thus, the lack of accountability for foreign injections, which consists of the same amount of GDP as Australia’s entire Agriculture industry, is another failing of the oppositions stance.

Furthermore, the dominant role of the service industry in Australia’s GDP, ~65% of GDP, depicts a clear picture of how in the “long run” business can foster growth during a recession. Lower cash rate will indirectly cause lower prices contributing to lower variable costs for businesses everywhere. This is of particular importance as recessions have uncertainty in regard to its time frame, and having certainty in some facets of life, eg business operations, is essentially to every small business. Thus, it lowered a zero-cash rate would not just be a mere ‘short term fix’ as the negative team would have you believe.

Beyond this, the negative team overstates the importance of “volatility in share markets”, as this volatility only becomes relevant in contexts where there are enough capital investments in the market. A precedence to having markets is the essential criteria of having a demographic with capital to invest. In recessions, highly uncertain times, the willingness of people to expend capital in another highly uncertain medium violates the neoclassical assumption of what a rational behaviour is. We the audience are led to question what rationale, if any, is fostered on the oppositions team, when committing to a fallacious argument such as this. Thus, the motion stands.

Third Negative (Anthony Wong)

What the affirmative team has presented is essentially three round-about ways of stating that a lower cash rate (and hence interest rate) encourages economic growth as per “freshman level of economics.” However, as much as reciting the equation, GDP = C + I + G + X – M, can scrape you a pass in Introductory Macroeconomics, this is fundamentally untrue in the real world.

Let us look to recent history for an example of the perils of a zero (or effectively zero) cash rate in the real world. In the years following the 2008 Great Recession, the European Central Bank had set a near zero deposit rate (zero between 2012-13) in the presence of a high savings rate by the population. Investment, consumption and inflation all remained subdued for long periods of time presenting a liquidity trap, the breakdown of monetary policy.

With the ABC reporting a savings rate in Australia that nears a 50-year high, the opposition is essentially advocating for this liquidity trap to be replicated. Australians are demonstrating low confidence in a prompt economic recovery and saving for their own futures. With cash being kept under beds and the exact opposite of economic stimulus risks occurring with a zero cash rate.

Additionally, the affirmative team has criticised our disregard for foreign capital investment. They have stated that lower cash rates are more appealing for foreign investors. However, in the context of a global pandemic induced recession, a zero cash rate isn’t exactly competitive. Why invest in Australia with a zero cash rate when the rate is -0.75% in Switzerland and -0.5% in Japan? With increasing regulation imposed by the Foreign Investment Review Board and the Foreign Minister set to be given powers to void existing foreign trade agreements, Australia is set to become increasingly protectionist regardless of an attractive cash rate number.

As much as the affirmative team would like to argue that Macroeconomics 101 says cash rate down implies consumption, investment and net exports up. It seems that their rationale stays at this level. The real world is much more complex than what is presented in a textbook. A zero cash rate is not necessary for Australia’s recession recovery, in fact, it may prevent it.

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.

Meet our authors:

Ashlee Stojanovski
Writer
Sean Reid
Writer
Jason Suhartanto
Writer

Jason is a second-year Data Science student of the Bachelor of Science. I hope to deliver insights from the point of view of a different industry. I am particularly interested in algorithmic trading, fintech, and sports bookmaking.

Anthony Wong
Writer