Crazy few days sees rates down, debt up

What a crazy few days.

The RBA delivered an interest rate cut that only the perpetual pessimists were predicting and we saw the pre-election budget handed down in which the government planned to keep the deficit high, set a new peace-time record for government debt and push the delivery of a budget surplus so far into the future that it did not even make it into the four years of so-called forward estimates in the budget papers.

To the RBA first. The simple explanation for record low interest rates is a near record low inflation rate.

When inflation is outside the 2 to 3 per cent target range, the RBA has effectively made a mistake with earlier policy settings.

Also read: Big banks cut home loan rates after RBA

When inflation is above 3 per cent, it means interest rates were held too low for too long and that higher interest rates are needed to cool the economy down and with that, inflation pressures will ease and inflation will return to target.

The March quarter inflation data released last week showed the annual rise in headline inflation at 1.3 per cent, with the underlying measures at a record low of 1.5 per cent.

Both, clearly, are well below the bottom of the target range which means the RBA got it wrong and with a bit of benefit of hindsight to be fair to the RBA, that interest rates were held too high for too long.

All was not lost and this realisation that inflation was too low lead to Tuesday’s decision by the RBA to cut interest rates.

The RBA is trying to give the economy a bit of a kick along in an effort to lift the economy which if successful, would see inflation tick a little higher and hopefully settle back in to the 2 to 3 per cent range.

The interest rate cut this week was the 11^th in the current cycle. Since the first cut in this cycle in November 2011, there have been 11 interest rate reductions that have taken the official cash rate down from 4.75 per cent to just 1.75 per cent.

Interestingly, over this time the underlying inflation rate has gone from close 3 per cent in 2012 down to the current reading of 1.5 per cent which shows that much of the rate cutting cycle to date have only matched the deceleration in inflation.

On the budget, Treasurer Scott Morrison has ensured that Australia will have 12 straight budget deficits including seven delivered by the Coalition government.

Also read: BUDGET 2016: Winners and losers

Net government debt will hit a peace-time high of 19.2 per cent of GDP and gross government debt, the nation’s credit card as the Liberal Party used to refer to will increase from the $273 billion inherited by the Coalition in 2013 to close to $500 billion in June 2017 and $629 billion in 2025-26.

The attitude of the Coalition on debt and deficit has gone from panic about a disaster and an emergency to utter complacency.

Also in the budget was a clear trend to higher tax. The tax to GDP ratio will rise from a recent low of 20.0 per cent in 2010-11 (under Labor) to 23.5 per cent in 2019-20 (under Morrison’s own policies).

Which side of politics is addicted to tax?

Strange days indeed.

 

Stephen Koukoulas is a Yahoo7 Finance expert with 

more than 25 years experience as an economist in government, as Global Head of economic and market research, as Chief Economist for two major banks, and as economic advisor to the Prime Minister of Australia.