The Case for Negative Interest Rates in Australia

Ignore Bill Evans at your peril

Westpac’s Bill Evans made the case for negative interest rates in Australia in this piece, which nicely debunked many of the fears and objections that have been raised against them. You can also see Bill make his case in this video:

The most significant part of Bill’s remarks is his observation that it is only Governor Phil Lowe’s insistence that Australia will not adopt a negative cash rate that precludes Bill from forecasting one. As Bill suggests, it is difficult to make negative rates your forecast when the RBA explicitly rules it out.

The problem for the RBA is that the data are unlikely to move their way any time soon, not least because Australian monetary policy is too tight. The RBA effectively conceded as much when Phil Lowe told the House Economics Committee even before the pandemic that it would take a deeply negative cash rate to get inflation back to target in the short-term. If that’s true, then it begs the question why the RBA hasn’t already taken rates into negative territory. As Miles Kimball has argued, a short period of negative interest rates that drives a recovery and a quick return to positive interest rates is surely preferable to a decade of zero or low rates as a result of keeping monetary policy too tight for too long.

Neither the leadership of Westpac, nor the Reserve Bank, will be thanking Bill for his analysis, but his comments should be viewed as an effort to educate them both. Bill is probably the only market economist with sufficient standing to make that case (and the implied criticism of monetary policy) without being told to clear out their desks the next day. There have been times when Bill has done more to ease the effective stance of monetary policy than the Bank itself, simply by calling out the disconnect between the what the RBA says and what the flow of data imply about the stance of monetary policy. This is another one of those calls. Listen up!

My own preference would be for the RBA to engage in massive outright bond and other asset purchases instead, but there is no reason why negative rates could not also be employed. Even a positive official cash rate with a negative floor for the cash rate corridor would be preferable to the current asymmetrically positive floor that serves the banks more than the objectives of monetary policy.

As noted in this space previously, the big challenge for the RBA will come when the market takes cash rate expectations and the 3-year bond yield negative. The RBA could just let the peg go, which would be the appropriate response. But it’s not impossible to imagine a situation in which it tries to defend the 3-year bond peg as a floor (in yield terms) rather than a ceiling.

As the ECB showed this week, the trend for other central banks is to do more, not less and it will be hard for the RBA to exempt itself from this trend. Its attempt to do so is already being reflected in the exchange rate, contributing to a further tightening in monetary conditions. The Governor would no doubt like fiscal policy to bail him out, but the government’s willingness to do the heavy-lifting while the RBA sits on its hands is likely to wear increasingly thin. The St Louis Fed’s deflation probability indicator is ringing the bell on the Fed’s monetary policy. The deflation bell tolls for Phil too.


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