Dr Jonathan Reeves
It has become very clear this year that the Australian economy is slowing, despite today’s unexpected fall in unemployment from 5.6% to 5.5%. The telling  figure is that full-time jobs shrunk by 5300. The RBA this month held interest rates at record low levels, with a further rate cut likely this year. In addition, the government is continuing to run budget deficits. And it looks as if we are not creating enough jobs to stop unemployment from rising in the future.
These are policies of monetary and fiscal stimulus that have been widely employed globally since 2008. Australia’s approach to fiscal stimulus has been relatively conventional for an economy with low to moderate government debt.

However, Australia’s approach to monetary policy has not been as standard, when compared to many other countries. Since 2008, many economists and central banks have modified their views on what is an acceptable level of inflation.

Sound arguments can be made to justify an inflation rate of 4 per cent. Whereas, the RBA post 2008 has instead increased interest rates when needed to keep the inflation rate averaging within the 2 to 3 per cent band.

This policy resulted in Australia having very high interest rates, relative to other countries, which pushed the Australian dollar to extreme levels, damaging many sectors of the Australian economy over the last three years.

The RBA currently has the official cash rate at 2.75 per cent, however, there is a strong argument that this could have been done much sooner. It may have resulted in inflation averaging around 4 per cent for a period, though in the current economic environment, this would have been beneficial.

Private sector debt levels and house prices are at excessive levels and moderate inflation over a number of years is one way for adjustment to occur to more sustainable levels of real (inflation adjusted) debt and house prices.

Given the volatility in the mining sector, for a strong Australian economy, we also need other sectors of the economy to be strong. Over recent years, monetary policy has provided insufficient support for these other sectors.

The impact of monetary policy on the unemployment rate can often be delayed. For example, the relatively high interest rates and resulting high exchange rate in recent years, is only now showing up in a rising unemployment rate.

Due to this delayed reaction, current expansionary monetary policy is unlikely to prevent the unemployment rate from rising over 6 per cent. If the goal is to keep the unemployment rate from rising too much, more fiscal stimulus will probably be required.

The recent New Zealand experience provides lessons to be learned. New Zealand’s response to the global economic crisis was unconventional and focused on monetary stimulus with little fiscal stimulus (despite moderate levels of government debt) which resulted in the NZ unemployment rate sharply rising to over 7 per cent.  

However, the rebuild due to the Christchurch earthquakes, provided a major stimulus to the economy (similar to a very large fiscal stimulus) which resulted in a substantial reduction in the unemployment rate. The unemployment rate in Christchurch (NZ’s second largest city) is now below 5 per cent.

Australia still has moderate government debt levels which allows the government the ability to provide further fiscal stimulus.  In addition, to the obvious benefits of keeping people employed, government spending on projects such as infrastructure spending, can provide great long term benefits for the economy.

Dr Jonathan Reeves is a financial economist at the Australian School of Business, UNSW Australia.