Reserve bank maintains the rate of interest at a record low

By Joe Montero

Something is going on. The Reserve Bank has just kept the official rate of interest at a low 1.5 percent for the thirteenth time in a row.

This is often seen as a good thing. But only from the standpoint of ignorance of that the rate of interest really is.

It exists, because money is an intermediary that exists for the transfer of goods and services form one human being to another. This means that money holds an equivalent value of what is really being exchanged between individuals.

Serving this function requires that in the aggregate, there must be a certain quantity of money circulating that is equivalent to the total of what is being exchanged. If there is too much money, it is devalued, because more is servicing the same quantity and value of what of what is being exchanged. If there is not enough, there is less money servicing the same, it is value moves upwards.

These movements  are measured by changes in the natural rate of interest. The official rate is a means to artificially affect the quantity of money, by raising it when there is not enough and lowering when there is too much. The limitation is that the official rate cannot vary too much from the natural rate, without causing serious problems for the economy, by creating exaggerated imbalances.

Australia’s current experience can only come about through one of two reasons. The total value of what is being exchanged is not growing sufficiently or there is too much money in circulation. It can be both and this is exactly what is happening.

For some time, the total of what Australia produces as a nation has been stagnant and declining overall in terms of quantity, relative to rising population and in the absolute. The main exception has been natural resources. The big tell-tale has been the decline of manufacturing.

The big growth areas have been in financial services firstly, and secondly,  the hospitality industry. They have one characteristic in common and it is that they are about servicing the exchange of what already exists, rather than adding to its total.

Unbalanced growth favouring these sectors has channelled a bigger proportion of the money supply towards them, and this creates a relative oversupply of money, in the absence of an equivalent growth in the real economy.

Computerisation of the economy has exaggerated the problem by speeding up transactions enormously, which is equivalent to increasing the quantity of money in circulation and  it pushes the rate of interest down still further.

There are counter pressures. There is not enough space here to go into these. In any case, they have not been enough to push interest rates upwards.

Consequences of this transformation in favour of financial services, have been that it has played an important role in an enormous increase in prices and fuelled speculative investment.

Another is that it is a factor behind the redistribution of income in Australia, through the destruction of jobs and the channelling of profit towards those gaining a dividend from the financial sector. This is the main reason why the banks and other financial institutions have been doing so well lately.

Together, these effects are restricting the capacity of average households to spend and increasing reliance on debt, which in themselves have a further negative impact on the real economy on the one hand and extend the oversupply of money in circulation on the other.

Reserve Bank governor Philip Lowe may be upbeat about the Australian economy and put a positive spin on maintaining the low official rate of interest.

He refers to the impact of the lowering of the exchange rate of the US dollar. It does effect Australia, but not exactly in the way he implies. Again, this is another story. In any case, this is secondary to what is going on here in Australia.

He does admit however that there is a worry in terms of output, employment and inflation. It’s just that he doesn’t tell the whole story.

Failure to recognise the real problems and admit them get in the way of putting into place an alternative economic strategy to guarantee balanced economic growth that focuses on restoring the real economy and bringing financial services into line with what is appropriate for ta healthy Australian economy.