The interest rate hike – did the Reserve Bank get it right?

Dr Sean Turnell

The recent interest rate rise has prompted varying reactions from economists, politicians and homeowners alike. Former Reserve Bank economist and Macquarie University lecturer, Dr Sean Turnell believes that the Reserve Bank had some difficult decisions to make as statistical evidence is unclear on how our economy is fairing.

“Figures from the Australian Bureau of Statistics (ABS) would suggest that there was probably not a need for the Reserve Bank to jump on the interest rate brake to slow the economy down,” says Turnell. “However, this is where the situation is quite interesting. The Reserve Bank doesn’t believe those numbers and thinks the economy is growing faster.”

According to Turnell, the Reserve Bank has the ‘inside track’ on numbers not available to the ABS, as they spend a great deal of time speaking with lenders, banks and financial markets. “They have a feel – sometimes a gut feeling – as to where the economy is going before the statistics arrive,” explains Turnell. “But it was a pretty big call for them to make to ignore the stats and rely on instinct.”

According to Turnell, Reserve Bank Governor Ian Macfarlane and the Board would have looked at the following issues before deciding to increase rates:

• the troubles that the economy has faced in the past – a boom bust cycle;
• the balance of payments constraint – our economy has been growing much faster than the rest of the world. Incomes are high, people are buying more imported goods, but other economies are not buying our export products in equivalent numbers giving a current account deficit;
• the housing market bubble which eventually will burst. House prices then start to fall, people feel less wealthy, they have problems servicing their mortgages, spend less and the economy tracks downwards. Property developers build less as house prices fall and the economy also sags because there is not enough work for those in the building sector;
• outside factors such as the rising oil price plus the threat of another bird flu epidemic.

The economy could go either way depending on whether the Reserve Bank has got it right says Turnell.

“If they have got it right, a small interest rate change of 0.25 per cent will not have very great implications and they will have managed the cycle very well,” he explains. “If they are wrong, there is a danger there could be a sudden collapse in the housing market and a prolonged downturn, possibly a recession. In the past it has taken ten years for the market to come back to the peak of the bubble after a downturn.”

If the Reserve Bank was right but decided not to increase interest rates, a wages breakout may have led to high inflation according to Turnell. Instead of two small increases there would be much larger increases.

So has the Bank got it right? “We might just muddle through,” Turnell says. “The implications of two minor increases should not be that great.”

For further information contact Turnell via email: sean.turnell@mq.edu.au

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