Pedal to the metal but still no traction

• Steve Pierson
• 15 years ago
• Categories: economy
• Tags: interest rates

Another review of the Official Cash Rate, another record cut. This time, it’s a 1.5% cut bringing the OCR to 3.5%. That’s the lowest rate since the OCR was introduced in 1999.  Good news for those with floating rate mortgages (not so good for the 80% of mortgagees with a fixed rate) and an opportunity for me to feel smug for locking in that money on term deposit back in June. But, more seriously, this is yet more evidence of how serious the economic situation is; the Reserve Bank is throwing everything, including the kitchen sink, at the problem and there is no sign of it making a blind bit of difference. Paradoxically, the scale and swiftness of the reaction by our Reserve Bank and other central banks around the world has been seen as panic by the credit market and further discouraged lending.

Yesterday, the Herald editorial wrote of the Reserve Bank’s use of the OCR: “Brakes are an effective means of control of a vehicle with momentum, they are less effective at restoring momentum when the vehicle has practically stalled.” Now, that of course just shows what a crappy analogy brakes are for monetary policy*. In fact, monetary policy is more like an accelerator. When the economy is going to fast, causing the engine to overheat (inflation), you decrease the money supply, part of the fuel of the economy, by increasing interest rates. When the economy is growing only slowly and overheating isn’t an issue, you increase the money supply by cutting rates, promoting growth.

Problem is, this time our economy is stuck, along with the rest of the world, in a quagmire. More acceleration isn’t doing the trick. Most major economies already have their pedal to the floor and we’re getting close to joining them. To strain the analogy a little further, even if an all out of burst of acceleration does get us moving again, we’re still in a vehicle that is not designed for the new terrain we’re in. Ultimately, we need to re-design the economy into a smarter, greener one that uses energy more efficiently and isn’t so reliant on depleting reserves of fossil fuels – so that it isn’t so vulnerable to future oil shocks like last year’s.

Right now, we’re asking monetary policy to fix a crisis that it wasn’t designed to deal with. Until we adapt to the new economic realities, we’re just going to keep getting stuck.

*[The Herald editorial also said the OCR is reviewed monthly. It’s every six weeks.]