The Leader of the Opposition Tony Abbott delivered a broad ranging speech to the Sydney Institute last night. It covered many issues, but one issue Mr Abbott noted was:
“Less borrowing means lower interest rates.”
This throw away line is dreadfully wrong.
Let’s start by looking at the last decade of Australia’s economic history. When the Coalition moved to eliminate Commonwealth Government net debt and reduced the amount of borrowing to almost nothing in the five years up to 2007, we witnessed the longest rate hiking cycle ever recorded from the RBA. From a low point of 4.25% at the beginning of 2002, the RBA hiked interest rates on 12 consecutive times through to March 2008, which saw the cash rate peak at 7.25%.
What’s more, as government borrowing increased as the budget slipped into deficit in late 2008, interest rates were slashed to a 50 year low of 3.0%.
And right now, a look overseas sees Japan with massive debt and borrowing, yet interest rates are anchored near zero. The US fiscal position is unsustainable with trillions of dollars borrowed by the government in the last couple of years, yet its borrowing costs, out to 10 years, are under 2%. I could go on.
Without going into the dynamics of the links between borrowing and interest rates, it should be obvious that many factors influence interest rates of which borrowing is of the third or fourth order. Not that that is the perception here in Australia.
Stephen,
ReplyDeleteThe perception in Australia is based on Economics 101, not cherry picked examples that are influenced by a multitude of deeper more complex factors.
Are you telling us that the following simply isn't true?
When the government borrows it competes with the private sector for funding, known as "crowding out". Supply and demand says that the cost of borrowing must increase (i.e. interest rates).
Furthermore, government borrowing represents economic stimulus, contributing to inflation, and therefore places pressure on the RBA to increase interest rates to contain inflation.
I'm not a fan of Tony Abbott, but you can't argue against fundamental economic principles with loose examples to support your argument. As you said, there are many factors that impact interest rates... that doesn't mean that government borrowing doesn't.
Michael
You are partly right. But I would shudder to think what Japanese yields would be in they didn't have any borrowing?
ReplyDeleteCrowding out effect is from the demand for capital side only. Depends on supply - i.e. whether there are sufficient (or excess) savings to fund the borrowing.
Cheers
Michael:
ReplyDelete"When the government borrows it competes with the private sector for funding, known as "crowding out". Supply and demand says that the cost of borrowing must increase (i.e. interest rates)."
This is often untrue. Firstly, demand is currently less than supply - especially when there's a global recession. We're more likely to be crowding in than crowding out. Secondly, different rules apply when you're borrowing in your own currency. Supply is nuanced - the Australian government isn't going to default (notwithstanding Barnaby Joyce's idiosyncratic contributions to the debate) and so suppliers who may not be willing to loan to the private sector (due to risk-aversion) may be willing to loan to a government.