RBA cuts interest rates to new record low

The Reserve Bank of Australia (RBA) has cut its cash rate to 1.5%. This means that interest rates charged and paid by banks should drop too.

The rate cut is the latest in a succession of cuts as shown by the chart below.

In the last four years the RBA has now halved its cash rate (3% to 1.5%). The aim of this expansionary monetary policy is to try and stimulate household consumption (C), business investment (I) and to some extent moderate the rise in the Australian dollar (AUD) to help maintain competitiveness in overseas markets. The rate cut will affect these variables via the monetary policy transmissions mechanism, although many doubt they will be that effective.

The reason that the RBA cut rates are given by their statement: extracts below.

"The global economy is continuing to grow, at a lower than average pace."
"Commodity prices are above recent lows, but this follows very substantial declines over the past couple of years. Australia's terms of trade remain much lower than they had been in recent years."
"In Australia, recent data suggest that overall growth is continuing at a moderate pace, despite a very large decline in business investment."
"Recent data confirm that inflation remains quite low. Given very subdued growth in labour costs and very low cost pressures elsewhere in the world, this is expected to remain the case for some time."

However there are some indicators that suggest that rates need not be cut. This is typical in any period and the RBA has to decide on the balance the forces to make its decision. They identify:

"Several advanced economies have recorded improved conditions over the past year..."
"Labour market indicators continue to be somewhat mixed, but are consistent with a modest pace of expansion in employment in the near term. "
"Low interest rates have been supporting domestic demand and the lower exchange rate since 2013 is helping the traded sector."

There are several concerns about monetary policy. These include will cutting rates at such low levels actually promote any change in behaviour, i.e. will cutting rates work? There is concern that the cut in rates simply shows how desperate the economic situation is and so any influence rate cuts have is overwhelmed by lower business and consumer sentiment.

There is also criticism that the RBA have badly mismanaged the situation for years and have failed to learn from other central banks. The Guardian article below explores this.

The ABC looks at the rate cut here

The Guardian discusses RBA policy here

VCE students will be interested in the conduct of monetary policy by the RBA and how this is likely to effect the Australian economy, in particular how it might work through the monetary transmission mechanism. Also the factors that are influencing Aggregate Demand in Australia are highlighted by this decision. IB students should also be interested in the RBA overall policy that is discussed in The Guardian ad how appropriate their actions have been in recent years given the time lags involved in policy and the influence of relative interest rates.