The Reserve Bank is lifting interest rates mainly because China’s stunning economic rebound is set to fuel Australian mining investment and exports. And house prices are bubbling up.
That sits uneasily with official interest rates at 50-year lows designed for the worst of a global financial crisis that has passed.
But the Rudd government’s big budget stimulus could also become a factor behind higher interest rates next year.
Much of the budget stimulus — equal to nearly 5 per cent of gross domestic product in 2009 and 2010 — is yet to come. That will help the economy recover to close to 3 per cent growth by the end of next year, Reserve Bank governor Glenn Stevens said this week.
But it could also prompt the RBA to lift interest rates higher than it otherwise would, according to Stevens’s testimony to the Senate economics committee last week. The link was established by Stevens’s answers to questions from independent senator Steve Fielding and Liberal senator Scott Ryan. The latter asked Stevens whether removing $20 billion to $30bn of remaining stimulus spending between now and the end of 2011-12 would mean interest rates might not have to rise as much.
“If the presumption is an impact on demand that is $20billion or $30billion less, over three years that is a level of demand that is nearly a per cent of GDP a year lower,” Stevens replied.
“So, all other things being equal, the course of the economy would be a bit different. What we are responding to is total demand, more or less, rather than where it comes from.
“It is really the total that counts most. So in that hypothetical scenario, yes, I think that would have some bearing on the future path of interest rates.”
That is, interest rates tend to increase when demand increases, whether it comes from government spending or export demand from China. That’s part of keeping overall spending growth within the economy’s overall productive capacity in order to keep inflation in check.
Importantly, Stevens backed the Rudd government’s fiscal stimulus for helping Australia to keep the global recession at bay. And he rejected two other claimed reasons why the stimulus would push up interest rates.
First, the projected increase in government debt was manageable and was likely to be less than had been forecast.
Second, bigger government borrowing would not push up interest rates by crowding out private borrowers because Australia operated in a much bigger global capital market. But the bigger interest rate issue for the Rudd government next year could be that the economy risks being too stimulated by easy monetary policy, the budget stimulus, a housing construction recovery and export demand from China. Something may have to give.