This week the Reserve Bank of Australia (RBA) announced a surprise key interest rate cut of 25 basis points to a record low of 1.75 percent. Shortly after that the country’s Treasury came up with unexpected fiscal easing measures, including tax cuts to boost job and economic growth.  

The combined moves were a way to fight disinflationary pressure, while transitioning from a commodity-driven economy to a more diversified one.

The market welcomed these moves, as this is one of the rare occasions when we have seen coordinated monetary and fiscal stimuli announced together on the same day.

The Australian dollar (AUD) had appreciated by 15 percent from the beginning of this year, but after this double-dose announcement, the currency immediately weakened by 3 percent, making Australian goods look more attractive to foreign markets. 

It was quite a relief to see the market respond the way it should. In this instance, the AUD could keep weakening a bit further.

The big disillusionment and fear this year is that monetary policy alone will no longer be able to conquer disinflationary pressures in advanced economies. This concern increased especially after the market saw the Japanese yen and the euro surge to 12-month highs even after both the Bank of Japan and the European Central Bank took dramatic measures, such as introducing negative interest rates.

While these bold measures by central banks were necessary to keep their economies running, the lesson we have learned is that monetary policy is just the adrenaline shot and only works temporarily. The true change needs to happen with structural changes through fiscal policy.

When central banks have to take dramatic steps such as quantitative easing and negative interest rates, there are unintended consequences. Quantitative easing results in a bigger income gap and negative interest rates result in reverse market psychology where people hoard cash away from banks. These side effects are signs that central bankers have already done their job and now it’s time for the politicians to do theirs.

My view is that by making coordinated moves on fiscal policy and monetary policy together, market economics will work more effectively. As free-market believers, we don’t want market economics to fail – but there were signs that it was starting to do so. This move by Australia may be a positive example to encourage other countries, including our own, to take bolder fiscal stimulus measures in conjunction with monetary policy. This one-two punch seems to prove more effective than either one alone. 

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