I’m going to ask you to forget what you think you know.
This time about interest rates.
And only for the next few minutes.
See, rates are used, very reasonably and appropriately, to either stimulate the economy or to remove stimulus from the economy.
When interest rates rise, we have less money to spend elsewhere, and businesses will be less likely to take on riskier projects (only those with higher rates of return will go ahead).
When they fall, we can spend the savings, and businesses will invest in more projects.
It is, though imperfect, a very clever, useful and appropriate tool to stop economic troughs from being too deep and too long, and to avoid the worst of the irrational exuberance that tends to tip economies over the edge.
Yes, we can argue about the size and timing of interest rate changes.
I’ve argued that rates were too low, for too long, both post GFC and post-COVID-crash (it’s too early to say post-COVID, unfortunately).
I’ve also argued that central banks, globally, including our own RBA, were essentially asleep at the wheel as inflation roared back to life, waiting too long to raise rates.
But overall, these are smart, sensible, sober men and women doing their best to moderate the excesses of the economic cycle.
Perhaps my biggest criticism about using rates as an economic tool is that the burden – and reward – falls unfairly on some, leaving others largely unaffected.
Rate increases hurt borrowers, likely to be younger and with (relatively) lower incomes, because they’re earlier in their careers.
Higher income earners can more easily (if not happily!) absorb higher rates, while retirees and savers actually benefit.
Similarly, when rates fall, borrowers benefit (they can spend up big or, hopefully, pay off the mortgage quicker – the latter doesn’t help economic activity, though!), but savers get whacked.
To be clear, I have no dog in the fight, nor am I saying one group is more deserving than another – just that the good and bad effects of rate changes are far from universal or even one-directional!
It’s worth asking – as one of my podcast correspondents, Joe, did this week – whether we can find a better way.
And I think Joe might just be onto something.
Hear me (and him) out:
What if, rather than (only) using rates, we used the Superannuation Guarantee Levy, instead?
(For those playing at home, the SG contribution is the amount your employer legally has to contribute to your Super, currently 10.5% of wages or salary)
Now, let’s say we start when rates are back at a relatively neutral level.
And with the SG levy at its final legislated level of 12% of your pay.
Now, let’s say the economy starts to overheat. The RBA decides it needs to take some demand out.
It can raise interest rates, with the impact I described earlier.
But what if, instead, it raised the SG to 13%.
The government wouldn’t get any more money.
You wouldn’t lose any money.
You’d have less take-home pay, cooling the economy, but that reduction would be offset by being set aside for retirement.
Interesting idea, huh?
And of course, when the economy was weak, and more stimulus was needed, the RBA would drop the SG to, say, 11%, putting more money in your pocket. You could still save and invest the extra if you wanted to, but many people would happily spend the difference, boosting the economy.
Now, it’d be politically difficult. The usual suspects would bleat about it being ‘your money’ etc etc.
(But then, your take home pay is ‘your money’ and they don’t complain when interest rates go up, so we can put that in the ‘blind ideology’ basket where it belongs.)
Why do it?
Well, first, the money raised from higher rates wouldn’t go into the financial system, benefitting the rich few, but would go into your Super, benefitting ‘Future You’.
Second, the impact would be broader than just the roughly one-third of us who have a mortgage (and the 10-15% of us who most feel the pain, assuming many with a mortgage can more easily absorb the impact).
Yes, yes… there are a lot of reasons not to do it.
But most of those reasons might come down to versions of the ‘status quo’ bias.
Or, as my podcast co-host Andrew Page might put it, the lack of starting from first principles.
And yes, it isn’t perfect.
It wouldn’t impact the cost of business borrowing (for good and for ill). It wouldn’t address the level of relative interest rates, compared to our international trading partners, impacting the currency and foreign investment, among other things.
First, we shouldn’t do things just because it’s the way we’ve always done them, as Andrew would say.
And second, there are drawbacks in the current system, and there would be (different) drawbacks if we changed to a different approach.
But, of all of the options that bear considering, this one makes some sense, doesn’t it?
And should be thrown into the mix?
I think so.
It may not be the perfect solution. It may not even be better than the structures and levers we have now.
But I reckon it’s worth thinking it through, and comparing the risks and opportunities with other potential (and current) policy tools.
And a quick aside: if we are going to stick with using rates as the primary tool to influence the economic cycle, at the very bare minimum we should be tasking the banking regulator to offset the influence of rates on house prices (I’ll tell you how in a sec).
Rate movements are supposed to impact the level of spending and investment in the economy, not asset prices themselves.
The impact on asset values – in particular housing – is an unwelcome side effect which, ‘til now, has been tolerated.
But we needn’t accept or tolerate it, particularly on house prices.
And we have the – very simple – tool we need to stop it making housing a whipsawed plaything.
All the banking regulator, APRA, would need to do is increase the ‘lending buffer’ as rates fall, and raise it as they come down.
The buffer is what the banks use to tell us how much we can borrow. They’re obliged to use the current interest rate, then add a couple of percentage points to allow for rate rises. But the buffer could – should – be raised and lowered as circumstances require it.
Our repayments would fall as rates drop, but banks would be forced to use a higher buffer, meaning the amount we could borrow would be essentially unchanged.
And our repayments would rise, as rates go up – but lowering the buffer at the same time would mean house prices wouldn’t be compressed artificially.
Housing prices would be more stable, befitting their role as, well, shelter, rather than financial playthings.
Which I reckon would be good for society.
So, there you have it: two ways governments and regulators could (potentially) improve the way our economy is run.
Worth due consideration, don’t you think?
Have a great weekend.
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