Will they find the right porridge?

The spot rate is the primary way the Reserve Bank affects the Australian economy. It works by means of interest rates set by banks for loans and savings that flow to consumers and businesses.

Prices of assets – such as houses or stocks – are strongly influenced by the spot price. Low interest rates allow people to borrow more and also encourage investors to look for products that offer better returns.

It is known that the RBA raised the spot interest rate to nearly 17.5 percent in early 1990 to quell inflation, which was approaching 9 percent. Since then, interest rates here and around the world have been on a downward trend, as has inflation.

Between 1995 and 1999, the cash rate averaged 5.95 percent. Between 2000 and 2004 this was an average of 4.6 percent.

Between 2005 and 2009, including the global financial crisis, the average spot interest rate fell to 4.3 percent, ranging between 7.25 percent and a then-record low of just 3 percent.

In the post-GFC period up to 2014, the cash rate averaged 2.8 percent and then came the last five years of the 2010s. The cash rate averages just 1.58 percent.

The average for this decade was only 0.19 percent.

With the global economy recovering and inflation picking up, financial markets expect central banks like the RBA to raise interest rates. By the end of next year, those markets expect the spot rate to be around 1.25 percent and 2.5 percent by December 2023.

But by how much can the RBA raise the spot rate without sending the economy into recession?

The respected independent economist Saul Eslake notes that the household debt service ratio peaked in the June quarter of 2008. At the time, the official cash interest rate was 7.25 percent.

The average mortgage is up more than 120 percent in Sydney and Melbourne since the June quarter of 2008. Wages have increased by 55 percent.Credit:Peter Rae

In NSW, the average mortgage for an established home was $333,500. In Victoria it was $286,400.

Eslake estimates that, given the massive increase in household debt, achieving the same debt-to-debt ratio would require a cash interest rate of only 3 percent.

NSW’s average mortgage is now $762,200, while in Victoria it has reached $633,200.

Average wages – both in NSW and Victoria – have increased by 55 percent. But the size of the average mortgage has increased by 128 percent and 121 percent, respectively.

This is where the monetary policy rubber comes in. With households so indebted, even a small increase in official interest rates will have a major economic impact. Lowe admits it.

“The fact that debt is quite high right now means that rate hikes will be quite effective because people have more debt,” he said in early November.

“So the cash flow channel is more effective when people have more debt.”

RBA Assistant Governor Luci Ellis spoke this month about the economic future as the world recovered from two years lost in a maze of masks and ivermectin conspiracies.

“Whether the global economy is on a path to a Roaring Twenties or a post-pandemic slump depends on the choices many of us make,” she said.

RBA Assistant Governor Luci Ellis says Australia is on the cusp of a replay of the Roaring Twenties.

RBA Assistant Governor Luci Ellis says Australia is on the cusp of a replay of the Roaring Twenties.Credit:Central press photos

“These, in turn, will depend in part on the stories we tell ourselves about the experience and the lessons we have learned. And one of the stories we can tell and the lessons we have to learn is that people and businesses can actually adapt and they have.”

One of the reasons for Ellis’s confidence is that there is a lot of cheap money and demand is bouncing back.

That doesn’t necessarily mean the economy is in poor health. It is supported by historically low interest rates, central bank money pressure and massive budget deficits.

In the longer term, the problem is increasing productivity throughout the economy.

Had it been up to English textile makers in the early 1800s, the Industrial Revolution would have ended with small workshops still making a small number of expensive garments.

Recessions traditionally destroy less productive companies. Not the pandemic recession.

Recessions can 'clean' an economy of low-productivity firms, but at the expense of employment.

Recessions can ‘clean’ an economy of low-productivity firms, but at the expense of employment.Credit:Jason South

Michael Brennan, chairman of the Productivity Commission, noted earlier this year that the bankruptcy rate in 2020 was a third lower than in 2019.

Every recession is painful, but some have the consolation of a cleansing effect — with low-productivity firms leaving and high-productivity firms remaining — that can prepare the economy for faster productivity growth during the recovery, as in the recession. nineties (for various reasons),” he said.

“Therefore, we will undoubtedly see a redistribution of resources across the economy. Whether we see a productivity recovery as a result of a significant exit of low-productivity companies is less clear.”

Low interest rates do encourage people with money to look for new investments that offer them better returns.

Throughout history, people have sunk money into ‘assets’, absolutely convinced that there was a future in them.


From the Dutch tulip mania of the 1630s and the South Sea Company disaster a century later to the Japanese land bubble in the 1980s, there is no shortage of examples from investors and their money is separated by reality.

Across countries, cheap money has been funneled into housing, stocks and increasingly cryptocurrencies such as Bitcoin and Ethereum.

Those who bought cryptocurrency early on can rightly say that they have made millions of dollars. So were those who bought at the start of the tulip mania or those who bought and sold stock in a 2000 dotcom start-up.

Carolyn Wilkins, who sits on the Bank of England’s financial policy committee, noted this week that the rise of cryptocurrencies was closely linked to interest rate settings.

“Bitcoin serves as a speculative asset rather than money, and is at least partly a symptom of the prevailing low interest rate environment and the quest for yield,” she said.

“That is why, in many jurisdictions, individual holdings are considered investments and are subject to capital gains tax that is made available.”

Blockchain technology that enables cryptocurrencies could bring economic progress. But proponents of synthetic collateral-backed debt obligations made the same claims before the global financial crisis revealed they were little better than legalized betting.

Cryptocurrencies like Bitcoin have been helped by record low interest rates.

Cryptocurrencies like Bitcoin have been helped by record low interest rates.Credit:AP

World-renowned American economist Robert Gordon has argued for some time that the slowdown in productive progress in recent decades is the result of something no central bank can change.

Gordon says the modern world was created between the end of the American Civil War and about 1970. Electricity, the internal combustion engine, the light bulb, antibiotics, motorized flights, the telephone, the television, the computer – they were all invented in that century .


Of course today we have a television and a computer in our pocket, but it is a continuation of a revolution that started in the 1930s.

According to Gordon, the period 1870-1970 is unparalleled in world history. As a globe, we became much more productive and wealthy. But unless Elon Musk settles on Mars and discovers a new life form that changes our understanding of physics and biology, the best days of life-changing innovation are behind us.

Even those who now glorify the virtues of green hydrogen as some sort of miracle have to admit that in the end they can only think of a better way to channel electricity to our businesses and homes (and perhaps vehicles). The real breakthroughs came from Bell, Edison, Westinghouse, Siemens and Tesla.

It may seem like a long bow to draw between the invention of electric light bulbs and monetary policy institutions.

But the Reserve Bank, along with every other central bank, is in a new world. Never before have they had to think about how to ‘normalize’ interest rates from historically low levels at a time of high household and government debt. Often central banks own much of that government debt – the RBA holds more than $300 billion, while the US Federal Reserve holds $5.6 trillion.

According to EY chief economist Jo Masters, it is feasible to raise interest rates to a more normal level. But it will require an increase in productivity that could then pave the way for higher wages, allowing households to pay off their debt.

The US Federal Reserve has $5.6 trillion in US government debt.

The US Federal Reserve has $5.6 trillion in US government debt.Credit:AFP

That would be the productivity gains that Gordon and others say won’t come anytime soon.

Former Governor of the Reserve Bank of India, Raghuram Rajan, this week used an essay on monetary policy to highlight the dangers ahead for the US Federal Reserve and the US economy.

“In anticipation of accommodative monetary policy and financial conditions for the indefinite future, asset markets have collapsed, supported by heavy borrowing. Market participants believe, rightly or wrongly, that the Fed is behind them and will pull out of a path of rate hikes if asset prices fall,” he wrote.

Central banks, starting with the RBA, must find a way to raise interest rates so that they have the ammunition they need to deal with future economic problems. And they have to make do with economies addicted to cheap money while in debt.

Goldilocks found it easier to find a comfortable bed and chair plus porridge at the bear house.

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