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Rising interest rates point to a larger problem

  • 28 June 2022
The recent rise in the official interest rate by the Reserve Bank signals the end of a decade-long fall that has profoundly distorted the Australian economy and produced rampant asset inflation. 

It is worth looking at how the Reserve Bank has sought to manipulate the economy over the last 20 years. From the late 1990s up to the Global Financial Crisis (GFC) in 2007-08 the cash rate roughly moved in the range of five to seven per cent. The Bank then dropped the cash rate down to three per cent to cope with the after shocks of the GFC, then pushed rates back up to almost five per cent in 2012, a return to the previous range. Since then, however, the rate has steadily fallen, down to almost zero. It is now back up to 0.85 per cent, the first rise in 10 years.

The question that should be posed is how effective has the Reserve Bank been at ‘managing’ the economy and financial system? ‘Not very’, has to be the answer. Not that the RBA is alone. The same pattern has been seen across the developed world. Central banks have one weapon at their disposal, the cost of money (the interest rate), and there is not much evidence they have used this tool to make their systems sustainable. Mostly, they have made matters worse. 

The canary in the coal mine was Japan’s central bank in the 1990s. In the 1980s the country was awash with ludicrous levels of debt, a bubble that was pricked early 1990. The Bank of Japan tried to stimulate the economy by reducing interest rates to negligible levels and it also invented quantitative easing (QE), the technique of money printing that central banks, including the RBA, have been using around the world in the last two years to address the damage caused by the Covid-19 lockdowns. 

It did not work. No matter how low the interest rate was sent – at times it was actually negative – the Japanese did not want to borrow. Their economy became moribund for 30 years. 

'None of these initiatives addresses the core problem: how to maintain reasonable controls over the quantity of money while still allowing relatively free markets.'

The central banks in Australia and the United States have recently adopted a similar tactic of lowering rates and introducing QE to recover firstly from the GFC, and then Covid. This had the effect of triggering