Not quite Armageddon, but ugly enough

Published in Insights, The New Zealand Initiative’s newsletter, 7 December 2012

According to the Mayan calendar, the world will end on 21 December this year. It’s not clear, though, whether this was the motivation for the Reserve Bank of Australia (RBA) to cut interest rates to 3% doomsday levels.

Hopefully it is not – because it is uncertain whether such a cut will be able to save Australia at least.

What is unsettling is that the RBA has returned to interest levels not seen since the peak of the global financial crisis.

During the crisis, after the collapse of Lehman Brothers, and with multiple financial institutions wobbling, the concerted policy of global central banks was to flood markets with liquidity aimed at saving the world’s financial system from collapse.

So are we back at comparable danger levels? Not quite.

What we are witnessing instead, is the RBA’s response to a less catastrophic but more structural problem in the Australian economy.

For a decade, the Australian economy has been riding on historically high commodity prices, enjoying unprecedented terms-of-trade as a result. As this boom weakens, inherent flaws in the rest of the Australian economy are being revealed.

Australia’s productivity performance has long been abysmal. The Australian welfare state is bloated and growing. Economic activity is extremely unevenly distributed across the continent – a growth rate gap of up to 15 percentage point between Western Australia and Tasmania.

The RBA is obviously trying to revive a lacklustre economy with its monetary stimulus. It is doubtful such a strategy will work. If it could work, the stimulus would have supported the economy over the past year, during which the RBA had lowered rates from a post-crisis peak of 4.75%. Instead, Australia’s economic performance has deteriorated over this period.

As The Australian’s economics editor Judith Sloan says, “The promise of an on-going boost from mining investment is rapidly fading and there is nothing much in the wings to act as a driver of economic growth.” Which is precisely why this, and potential future interest rate cuts, will do little to revive the Australian economy.

What Australia would need instead are the kinds of structural reforms that have been neglected for years. But unlike an interest rate cut, they cannot be delivered with the stroke of a pen.

No, the world is not coming to an end in Australia. But let there be no doubt, the outlook for our Aussie neighbours is far from lucky.