Low interest rates are supposed to make us borrow and spend. But most of us are saving instead.
I’ve been fielding questions lately about interest rates and the economy.
Such as, with interest rates of 2 per cent being the lowest they’ve been for several generations, why is the economy not growing quicker? Why is government revenue not keeping up with spending? Why is unemployment still over 6 per cent?
The monetary policy – using interest rates to control economic activity – is not stimulating the economy as expected.
Low interest rates have triggered investors to buy established houses and apartments, but there’s been less stimulation in the first-home buyer, or home-building sectors, or in markets outside metropolitan Sydney and Melbourne.
Low interest rates are supposed to make us borrow and spend. But the Reserve Bank said in its March Financial Stability Statement that our household saving rate is higher now than at any time in the decade prior to the GFC.
We’re holding on to our dough – not spending it.
In the latest Budget the government tried to encourage spending by allowing business owners to claim an instant tax deduction on business items up to $20,000, a huge increase on the usual $1000.
So Canberra wants business owners to drive economic growth.
This week we’ll have another interest rate decision but it won’t matter if it drops to 1.75 per cent, or stays the same. You see, we’re at 2 per cent already, which is the lowest cash rate most Australians have seen in their lifetimes. The last time it was this low was before I was born.
Among all the financial data, Australia’s official cash rate is the number that really matters. Two per cent means the economy is in trouble.
Unfortunately for the government, Australians are not dummies – they know what to do with low interest rates. People with home loans are using the low interest rates to get ahead on their repayment schedules and on average, are now two years ahead.
And when Australians are not paying down debt, they’re using low interest rates to fund investment properties that yield better than the 3 per cent yields on cash.
Owner-occupied home loans grew only 5.8 per cent in the year to March, while investment property loans grew by 10.4 per cent.
Of course, all these responses – the savings, the accelerated mortgage repayments, the refinancing and the investment loans – rely on employment.
We’re above 6 per cent unemployment right now – not as bad as the late 1980s when it was mote than 10 per cent, and not as good as 2007 when it got down to 4 per cent.
The best strategy for most Australians is to hang on to their jobs and use cheap debt to do exactly what they’re doing: pay off their home loan and other debts; find the best deal, and fund an investment.
And what about spending as a stimulus? We’ll have to see if business owners are ready to open their wallets.