Government needs to pick up the slack BEFORE an emergency not after

There is increasing commentary recently about what it would look like if the RBA engaged in quantitative easing (QE) if it runs out of traditional interest rate ammunition.

I am pleased that the RBA is lowering interest rates, making it cheaper for people, households, businesses and governments to borrow. And yet, the talk of QE makes me nervous.

QE essentially involves the RBA entering the market and buying up financial assets. This acts to reduce further the interest rates on more assets across more maturities than could be achieved through the RBA’s usual open market operations with short term securities.

By reducing longer-term interest rates, the RBA will ideally suppress the exchange rate further and stimulate further borrowing and spending by individuals, households, businesses and governments.

Currently borrowers aren’t sufficiently tempted by record low short-term interest rates. Nor are we in the midst of a full-blown financial crisis. Instead it is entirely possible that the biggest obstacle facing them is not the availability of cheap credit but a lack of demand. Individuals aren’t confident about their future wage levels (demand for their labour). Businesses aren’t confident about future sales (demand for their products and services). Governments are also nervous about debt levels.

In such circumstances, ever-cheaper credit won’t necessarily stimulate the real economy. It will more likely over-inflate asset markets, including stocks and housing, as investors become ever more speculative in the face of cheap credit.

This is what makes me nervous. While I'm happy with what the RBA is currently doing, Australia needs a boost that is sustainable, not a speculative one with potentially dangerous fallout.

This is why governments need to step in with fiscal stimulus and structural reform before the RBA runs out of traditional interest rate ammunition. This can include:

-        Progressing with tax cuts and other financial supports for low and middle incomes

-       Bringing forward infrastructure spending, especially the smaller simpler projects that can be started sooner;

-    Reforms such as the replacement of stamp duty, the simplification of building approvals processes and planning frameworks, labour market reforms and incentives for small and medium sizes businesses.

-    APRA also needs to loosen its lending restrictions on banks from a 7 per cent borrower assessment rate to a simple 2.5 per cent buffer above the standard variable rate. This is the main obstacle to access to finance, not the RBA.

Unless governments can’t (or won’t) capitalise on record low interest rates unless the RBA uses QE to reduce them further, QE is likely to distort economic activity with questionable benefits.

Governments need to do this for Australia before the RBA brings out the emergency measures. There is no shortage of worthy recipients for stimulus and the potential consequences of failure are mounting.