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The failure of interest rate cuts

The failure of the non-mining parts of the economy to respond to the progressive decline in interest rates has also surprised.
David Bassanese, Australian Financial Review, 7 January 2013

Since 1994, I have argued that the Reserve Bank of Australia (RBA), economists in industry, media commentators do not understand the complexities of how interest rates impact on retail spending and other parts of the economy.  My most recent letter to the RBA, which I also sent to David Bassanese, is reproduced below.


28 December 2012

Dr Christopher Kent
Assistant Governor (Economic)
Reserve Bank of Australia

Dear Christopher

Consumer reactions to lower interest rates

It is good to see increased coverage of the issue as to whether interest rate movements have less influence on consumer spending and investment than in the past.  I refer to the analysis in the December 2012 RBA Bulletin (“Households’ Interest-bearing Assets”) and the Economist article “Savers’ lament” of 2 December 2012.

This is a topic I have been researching for nearly 20 years and I have accumulated quite a bit of evidence – see

My concerns are:

  1. That so-called savers react to interest rate changes faster than borrowers, thus potentially misleading policy makers and retailers with an initial perverse reaction.  Some 50% of households with a mortgage are paying off more than the minimum amount and so may not have their cash flow affected for a long time, if ever.  Savers tend to feel the cash flow impact quickly and adjust their spending quickly.  On average 40% of adults want lower interest rates and 20% want higher interest rates (see chart).  But many of the former will not have their payments adjusted as interest rates rise and fall.
  2. Since 2010, there has been a major increase in the proportion of adults who are determined to build savings (see accompanying article).  Thus, the dynamic will be different to recent experience.  Over 65’s are trying to rebuild their capital after suffering losses in the GFC.  Young adults are building savings to enter the residential property market and have to save a larger deposit than in the past.  This is due to the end of the GFC-related doubling or tripling of the first home owners grant and tighter lending standards.  Thus, two large groups of consumers now have to save at a higher rate – because lower interest rates on savings means that their capital goal would otherwise take longer to achieve than with higher interest rates.
  3. Lower interest rates may now be delaying the much needed housing construction recovery – because young adults are getting less help from interest earnings and so have to save for a longer period to achieve their deposit.


It is important to recognize the different types of savers – for example active savers building their savings and retirees living off the proceeds of savings.

I would be happy to discuss my findings with you, should you be interested.



Charlie Nelson
Managing Director


To my surprise, I received a reply from Christopher Kent.  He said that this is an interesting empirical question deserving further attention.

There does seem to be a perception that savers are not liquidity constrained.  Perhaps we should instead talk about net recipients of interest.  Some of these may well not have a liquidity constraint and so would be unaffected by changes in interest rates.  But there are probably millions of people on government benefits who receive relatively small amounts of interest and who have to cut back on spending when interest rates fall.  In addition, people who are saving for a purpose, whether it be a car; a home; or just for a rainy day, need to save more or for longer when interest rates fall.

As usual, I have had no response from David Bassanese at the Financial Review.

Charlie Nelson
4 March 2013

10 June 2013

Alan Mitchell, Economics Editor of the Australian Financial Review, said of the March quarter national accounts "The most unpleasant surprise in the latest national accounts was the weakness of household consumption,  ...". and "Household spending - on consumption and new housing - has not responded to the 2 percentage point cut in the official rate (and the 1.6 percentage point cut in indicator bank lending rates) over the past year and a half in the way economists had hoped".
AFR 8 June 2013.

His colleague David Bassanese said in the 6 June 2013 issue that "Indeed, perhaps the biggest disappointment in the March quarter national accounts was the sluggishness of consumer spending, ...".

Surprising, disappointing - maybe.  But predictable as long ago as December 2012 as my article shows.

29 July 2013

Westpac chief economist, Bill Evans says that domestic demand for goods and services is currently the worst it has been for many decades, despite a historically low cash rate of 2.75 per cent.

"Normally when you cut rates you stimulate demand but in this cycle the response has been the most modest it has been since the 1970's," he said, adding that he believes the RBA needs to lower rates to 2 per cent in order to boost demand in the face of major domestic and global headwinds.

Australian Financial Review, 25 July 2013, page 31.

"Home Building has been punching below its weight and normally low mortgage rates would be stimulating the sector towards clear recovery by now."  Kim Hawtrey, BIS Shrapnel associate director, Australian Financial Review, 29 July, page 33.

As predicted in my letter to the Reserve Bank of Australia in December 2012!

29 August 2013

Boral, Fletcher Building, CSR and Adelaide Brighton have been forced to cut thousands of jobs, close down plants, write down equipment and lower production in response to a {housing} construction industry in the doldrums despite record low interest rates, a rising population and state government incentives.
Michael Hobbs and Jake Mitchell, Australian Financial Review, 22 August 2013.

Historically low interest rates had so far failed to add any identifiable spark to consumer confidence and the spending that inspires.
Grant O’Brien, Woolworths chief executive, Australian Financial Review, 29 August 2013, page 36.

As predicted in my letter to the Reserve Bank of Australia in December 2012!