Zero interest rates are inevitable as household savings fall, debt builds


Chris Bedingfield

Households are facing significant pressure on their balance sheets, however this is not a function of ‘the cost-of-living pressures’ or interest rates.

The squeeze on households is coming from deliberate government fiscal policy in Canberra according to Chris Bedingfield, principal and portfolio manager of Quay Global Investors.

“One of the biggest macroeconomic lessons learned from the Global Financial Crisis (GFC) is investors tend to overestimate the impact of monetary policy and underestimate fiscal policy. Even today, the amount of time dedicated to the impact of fiscal balances pales in comparison to the scrutiny dedicated to central bank actions.

“Yet the evidence suggests this focus is misdirected.

“Following the global financial crisis (GFC), the response was largely based on monetary policy to stimulate the economy. As we now know, the economic recovery after the GFC was very slow and inflation consistently remained below target, despite zero interest rate policy in the US and Europe.

“During the COVID-19 pandemic, however, the policy approach reflected a significant shift toward greater fiscal support (via deficits). The massive fiscal response during the pandemic resulted in a speedier recovery compared to the post-GFC era in terms of jobs and overall economic growth. The aggressive fiscal policy was mirrored in other developed economies, including Australia, with similar results,” he said.

However, Mr Bedingfield now expects the Australian economy to continue to slow – largely due to the current tight fiscal policy from Canberra.

In recognising the accounting identity that requires one entity’s savings is derived from another’s deficit, Bedingfield points out the pursuit of a fiscal surplus will continue to harm the local economy.

“By law, the federal government requires employees and households to save while simultaneously depriving these households of the net financial assets required to support such savings.

“If households are required to run a fiscal surplus (save) equal to roughly 10 per cent of income, and the federal government refuses to run a fiscal deficit, one of two scenarios play out:

  1. The household sector borrows the 10 per cent difference to maintain consumption, or
  2. Households can only spend 90 per cent of income in any one period resulting in a decline in economic activity from one period to the next.

“The first option can sustain economic growth for a while, but at the cost of rising household debt. This is something that occurred during the Budget surplus years of the Howard Costello government (which required households to run large deficits). However, at some point, as debt balances swell, the appetite for additional household credit wanes, spending will slow and the economy sheds jobs,” Mr Bedingfield said.

As they did prior to the pandemic, households will turn to credit to maintain consumption. And like they did prior to the pandemic, the RBA will accommodate this need via monetary policy. In the absence of a change in fiscal policy, this consumer and policy cycle will repeat until we approach zero (again). The only uncertainty is the timing.

“Recent data suggests the RBA may soon change tack and cut interest rates, beginning the march towards zero interest rate – not because of high inflation, but due to a weakening Australian economy.

“In our view, the industry most vulnerable to a sharp rise in near-term unemployment is the construction sector. New dwelling starts are at or near 2013 levels, and the construction industry currently employs 350,000 more workers today compared to what was required to meet the 2013 construction cycle. This means the construction industry has significant excess capacity relative to forward workflow. This is meaningful, as one in 10 Australians are directly employed in construction so the job cuts could be significant,” said Mr Bedingfield.

You must be logged in to post or view comments.