A vastly changed world means consumers won't react the same to higher interest rates
- Written by Katherine Hunt, Lecturer in Accounting, Finance and Economics, Griffith University
The Reserve Bank today kept interest rates at a record low of 1.5%. Such low rates create economic uncertainty – and if Australia’s historical GDP growth is anything to go by, consumers face more uncertainty than the bottoming out of interest rates would usually suggest.
This is because high house prices lead home-owners to feel wealthy, yet the economy as a whole does not convey a message of wealth to all consumers.
Boom and bust come and go, and sometimes you can be forgiven for feeling economic déjà vu. But how might Australians react to record low rates this time around? Business moves in cycles over time, so economists sometimes look to history as a guide to what might happen next.
A flattening out of interest rates can mean many possibilities for consumers and businesses. Historical GDP growth rates would indicate that the business cycle is at the same stage as in 2011. But what this means for consumers depends on how the other economic “stars” align. The indicators from 2011 are able to provide a model of how consumers may react over the coming years.
Does 2011 provide a model?
The relationship between interest rates and unemployment has been of interest since target interest rates were introduced in 1990.
The rise in unemployment from 4% to 6% between July 2008 and May 2009 occurred at the same time as the Reserve Bank rapidly slashed the target interest rates.
However, with the Reserve Bank now unlikely to reduce interest rates any further, the impact on unemployment and other pointers for consumer behaviour may be different this time compared to 2011.
To predict consumer behaviour in the current uncertain conditions, the most appropriate method would be to consider past situations where GDP has gone up, and reflect on changes to key consumer indicators.
Based on Australia’s current GDP growth rates, and those of the last few decades, we are most likely at the “February 2011” stage of the business cycle – when growth was at 1.9%.
Based on the business cycle method of anticipating future consumer indicators, we would expect the trend to continue. Consumers would save the same or less of their income. And consumer sentiment would remain flat.
However, with property prices at all-time highs in capital cities, it is possible this will counteract rising interest rates when it comes to consumer expectations because there are conflicting messages. On the one hand, consumers feel wealthy because of property prices. However, they are expecting their mortgage repayments to increase when interest rates start to tick up.
In this environment it is expected that unemployment remains steady, as it has since 2009, with the sharemarket remaining flat. It is expected that as the sharemarket remains flat (or modestly increases) across developed countries, the price of gold continues to rise.
We can make these sorts of predictions, if 2011 is a guide to what will happen in the coming years.
Authors: Katherine Hunt, Lecturer in Accounting, Finance and Economics, Griffith University