Lack of Interest

If interest rates are to be considered a political football, the 2007 Federal election was the Grand Final. They have becomes such a fixture of economic discussion that’s it’s hard to imagine we’ll ever move past it, but I’m hoping this was the last time they will feature so prominently in an election debate. So let’s put the issue to bed.

The Coalition were guilty of misleading the public on nearly all aspects of the way role interest rates play in our economy. In 2004 they made as much hay as they could out of this, and paid a price for it. Why couldn’t they resist the temptation? Well, we all know that Australia is awash in a sea of debt. The numbers certainly attest to the fact that Aussies were sensitive to interest rates in their political leanings.

The following graph (stolen shamelessly from Possum Comitatus) shows how closely the opinion polls tracked interest rates, and shows what would have had to happen for the ALP to lose the election. If there were be any doubts about the potency of interest rates as a political issue, this certainly shakes them. Cause and effect are of course by no means certain in this sort of analysis, but it’s clear the interest rate hikes didn’t help the coalition one iota.

Unfortunately, since Latham’s days, the ALP has implicitly or explicitly bought into the interest-rates-as-an-indicator-of-economic-gravitas line. Now that we are over the line, though, are interest rates neutralized as an issue? Labor has it’s “17% mortgage rate”, the Coalition have their broken promise and six interest rate hikes in a row. Now even the most disinterested amongst us knows that the Liberal party does not, in fact, posesss an interest-rate supressing magic wand. Let’s admit that the Federal Government doesn’t control interest rates. Here are the facts.

1. Despite political campaigns, the government has no control over interest rates. The Reserve bank sets them in accordance with its mandate to keep inflation below 3% (higher interest rates cub spending and so help to lower demand and keep inflation under control).

2. The historical data don’t suggest that Labor has a worse record on interest rates. Under the last Labor government, cash interest rates peaked at 19% under Hawke but only 7.9% under Keating. Under Fraser, interest rates peaked at 21% in April 1982. Mortgage interest rates hit the following highs: Whitlam, 10.38%; Fraser, 13%; Hawke, 17%; Keating, 12%.

3. Despite Howard’s mantra of “17%”, the fact is that mortgage rates were capped by regulation when he was Fraser’s treasurer. It was Labor that derugulated the banking industry.

4. Talk of deficits and surpluses is also misleading. Surpluses are a sign that taxation is outstripping spending, indicating a lack of sufficient investment in infrastructure. Deficits are clearly correct policy when the economy is in recession. Promising to keep interest rates low by running surpluses is not sensible fiscal policy. In this day and age, Government borrowing in any case comes from global financial markets and will have little effect on interest rates domestically.

5. Even for mortgage holders, it’s not the interest rate that matters per se, but the impact interest payments have on their disposable incomes. Australians were paying more interest under Howard than under Keating because debt levels are so high.

Finally, the rhetoric of Howard was often about “wage pressure”. This obviously means keeping your wages low as the economy grows. I don’t know what this can mean except keeping wealth growth as much as possible in the share market and as little as possible amongst wage earners.

The economy is a legitimate political issue, of course. It’s time to put aside this narrow focus on one misleading economic indicator and judge a government’s performance by a more realistic set of metrics: overall growth, environmental responsibility (externalities), standard of living, long term thinking. Under these criteria I have no doubt a Labor government can perform as well as any in the world.

(Andrew Charlton’s Comment in November’s issue of the Monthly is a great and more detailed debunking of the interest rate myths.)

(Originally from http://claytonsouthlabor.blogspot.com/)