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Policy changes necessary to make interest rate cuts sustainable

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John Hewson Leader of the Opposition M e d i a R e l e a s e

243/91 8 October 1991


Further interest rate cuts are on the way. Probably sooner rather than later and perhaps twice more before Christmas.

But the upcoming easings are going to require a little more effort to justify than the last poorly timed and ill-explained cut.

In particular, it will be necessary to outline what policy changes are being put in place to ensure that the cuts are sustainable.

It is not difficult to persuade Governments to cut interest rates in a period of weakness but the experience of the 1980s is that it is another to persuade them to lift them again when the

economy gets rolling again.

That is what makes the current drive to pull the interest rate lever alone such a dangerous exercise.

Mr Hawke has learnt nothing from past mistakes.

Policy was eased in 1983 and this led to the balance of payments crisis of 1985/86.

And the episode was repeated again in 1987 leading to a painful process of re-tightening in 1988/89 - the more especially so if the same people trying to persuade the Government to pull the trigger on the way down are tardy in changing direction on the way back up as the election cycle turns its circle.

Messrs Hawke and Kerin are again painting themselves into a corner on this time.

Both know that much of the gain in inflation and the current account stems from the depth and intensity of the recession.

Yet both are promising a "robust recovery around the corner".

On the face of it they seem to be making the same mistakes as in 1983 and 1987 by preparing to ease further now.

But this time it can be argued that the mistake may be compounded by the other arms of policy which appear, if one believes the Government's recovery rhetoric, to being set on a pro-cyclical basis.

Thus there are reports that Mr Hawke will provide further funds for infrastructure projects at the next Premiers' Conference. Mrs Kirner has already put an order in for "industry initiatives" are



also likely to get a guernsey to satisfy Bill Kelty and the other interventionists. And the Prime Minister and Treasurer are yet to come clean on the nature of their deal with the ACTU to give them a 5 per cent wage increase this financial year.

Meanwhile structural changes are stuck in a rut, with the

Government unable to make progress even on such obviously essential matters as waterfront reform.

So the danger is that we are building in a repeat of the roller coaster rides of the late 1980s.

Of course, it is possible that the deflationary forces are even stronger than the government has so far admitted.

But if that is the case the Government should come clean and tell us the full story.

Does the Government have evidence that the economy is not

recovering as the Prime Minister has promised?

Does the Reserve Bank have evidence that some financial

institutions and/or some of their customers are in even worse shape than the present bad and doubtful debt figures reveal?

Do they have information indicating that the overseas economic situation is even worse than anticipated and, therefore, that the outlook for our commodity prices is even worse than so far


There does seems to be a prospect now that the deflationary forces are gathering momentum abroad. US money supply is down below 2 per cent and Japanese money supply is running at similar levels (see chart I attached).

The US Fed therefore seems likely to cut interest rates further in the near future to try to keep confidence going as the Dow Jones shows signs of sagging and the Japanese seem likely to follow suit.

Those rate cuts will be passed on round the world either directly or through the intolerable pressures it will put on the exchange rate levels in high real interest rate countries such as


And domestically the collapse in profit margins seems likely to drive inflation to close to the price stability range of zero to 2 per cent by Christmas.

So the bottom line for Mr Kerin is this:

If, as now seems likely, further interest rate increases are on the way, they will either stem from temporary weakness in the economy and can only be sustained therefore while that temporary weakness remains. In this circumstance, policy changes to other policy instruments will be essential to make the cuts


On the other hand, if the next cuts reflect medium-term

deflationary forces of a magnitude not seen in recent history then we have an issue of a very very different magnitude. And one not capable of being dealt with by simply pulling the interest rate lever alone.

The Government cannot have it both ways. It cannot go on claiming recovery is around the corner but refusing to take the policy action to lock in the painfully won gains on inflation and the

current account.

In brief, we must :

- reduce public sector spending;

-reshape the tax system to provide incentives to work, save and invest and support the transfer of resources into our traded goods sector;

- act swiftly to put in place a genuine system of enterprise level negotiation which links pay and performance in the


- move to privatise fully all Commonwealth business enterprises;

- trim the immigration intake to match our economic


- stop talking and actually start implementing the structural reforms identified by the Opposition, the Government's own officials, and others in the community including the business sector and the responsible elements of the union movement.

Interest cuts which flowed from this action would reflect policy strength - not weakness as is now the case - and would open the way for a recovery in business profitability and investment.


money supply M 2 global deflation continues

Per cent change on year earlier 16





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