Rate Reduction As Reserve Bank Shadows Fiscal Policy

Sydney Morning Herald

Wednesday November 5, 2008

Phillip Coorey

IT TOOK just two months for the Reserve Bank to reduce interest rates by 2 percentage points and thus undo the eight increases of the previous 31/2 years.

Yesterday's 0.75 percentage point reduction took the cash rate to 5.25 per cent, its lowest level since December 2003.

The severity of the economic situation is reinforced when you consider the bank's monetary policy is acting in tandem with Government fiscal policy, of which the most spectacular measure has been spending almost half this financial year's forecast budget surplus on stimulating the economy.

On October 14, a week after the Reserve Bank cut rates by a full percentage point, the Government announced the $10.4 billion economic stimulus package. At the time, the Opposition Leader, Malcolm Turnbull, complained the stimulus package might be too excessive. He said $5 billion would have been adequate.

"We trust that the Government has taken into account advice from Treasury and considered the impact that this stimulus may have on the Reserve Bank's ability to continue reducing interest rates," he warned.

Far from it.

The spending measures announced by the Government do not begin until December 8 but the Reserve signalled yesterday it could ill afford to wait to gauge the effect of the adrenalin hit the spending package would provide.

The Reserve said yesterday deteriorating international conditions and falling commodity prices would dampen growth expected from the spending package, the low dollar and reduced bank borrowing rates.

Today or tomorrow the Government will release the mid-year review of the budget. It will be an unrecognisable document compared to what was released in May. Revenue for this financial year will be $10 billion less than forecast in May. Even before the Government spent $10.4 billion, the forecast surplus of $22.7 billion was always going to be much less.

If the growth forecasts are positive, which is what has been suggested, then that in itself will be a small victory for now.