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.
|The information in this report was compiled by the staff at City National Bank from data and sources believed to be reliable but City National Bank makes no representation as to the accuracy or completeness of the information. The opinions expressed, together with any estimate or projection given, constitute the judgment of the author as of the date of the report. City National Bank has no obligation to update, modify or amend this report or to otherwise notify a reader in the event any information stated, opinion expressed, matter discussed, estimate or projection changes or is determined to be inaccurate. This report is intended to be a source of general information. It is not to be construed as an offer, or solicitation of an offer, to buy or sell any financial instrument. It should not be relied upon as specific investment advice directed to the reader’s specific investment objectives. Any financial instrument discussed in this report may not be suitable for the reader. Each reader must make his or her own investment decision, using an independent advisor if prudent, based on his or her own investment objective and financial situation. Prices and availability of financial instruments are subject to change without notice. Financial instruments denominated in a foreign currency are subject to exchange rate risk in addition to the risk of the investment. City National Bank (and its clients or associated persons) may, at times, engage in transactions in a manner inconsistent with this report and, with respect to particular securities and financial instruments discussed, may buy from or sell to clients or others on a principal basis. Past performance is not necessarily an indication of future results. This report may not be reproduced, distributed or further published by any person without the written consent of City National Bank. Please cite source when quoting.|