Monetary policy in Australia is no longer effective and the task of stimulating the economy should be taken up by a more active fiscal policy, shows new research by The Australia Institute.

The report, Monetary Policy is Spent: It’s Fiscal Policy or Bust by David Richardson senior research fellow at The Australia Institute, shows that in the current economic environment, monetary policy (reducing the official interest rate by the RBA) is ineffective, as interest rate reductions are increasingly nullified by the banks.

Key findings:

• Monetary policy becomes less effective as official interest rates approach zero, for two main reasons:
  1. Spending in Australia on investment is not very responsive to reductions in interest rates.
  2. Any reduction in official interest rates is mediated by the banks and other financial institutions. Deposit rates in Australia cannot go below zero so in order to maintain profit margins the banks resist reductions in lending rates which nullifies any impact of reductions in official interest rates.
• A more active fiscal policy from government would mean more public spending, such as through increases in Newstart, spending more on health, education, and other public infrastructure.

“When even the Governor of the Reserve Bank of Australia is saying that monetary policy is becoming ineffective, you know it is time to rethink how Australia’s economy is being managed,” says David Richardson, senior research fellow at The Australia Institute.

“Private banks control most of the lending in Australia, in this environment and in order to maintain their interest margins, banks are going to resist reducing lending rates.

“Australia saw official interest rates fall in 2016 and mortgage rates followed automatically, as has generally been the case in the interest rate cycles in Australia. But soon after the banks acted to restore their profit margins—three years on, rate reductions were almost completely offset with out-of-cycle lending rate increases by the banks—one could expect those blowbacks to be quicker in the future.

“The effectiveness of using fiscal policy to stimulate a sluggish economy is proven, it’s how Australia stayed out of recession during the Global Financial Crisis.

“Australia’s economy is slowing and official interest rates are nearing zero, now is the exact time to be putting strong fiscal policies in place.”