International comparisons of monetary policy

Much of the expert commentary on Australia’s monetary policy settings is driven by what’s happening in other countries. But monetary tightening can have markedly different effects in different countries, and while Australia appears to be more cautious, it seems to have handled it well so far.

A brief history of recent monetary policy in the Anglophone countries

At the height of the COVID pandemic in 2021, interest rates charged by central banks fell to extraordinarily low levels. For example, policy rates in Australia, the UK and the US fell to 0.1%. Canada and New Zealand were slightly higher at 0.3% and 0.4% respectively, while the European Central Bank’s policy rate was an extraordinarily low -0.5%.

However, supply constraints resulting in part from the war in Ukraine and a general easing of fiscal and monetary conditions have led to higher inflation, with consumer price increases averaging 6.6% in Australia, 6.8% in Canada, 7.2% in New Zealand, 9.1% in the UK and 8.0% in the US in 2022. Peak inflation rates were even higher; for example, Australia reached 7.8% in the four quarters ending December 2022.

Unsurprisingly, monetary conditions have tightened everywhere and interest rates have risen. However, the Reserve Bank has been criticized for the earlier and higher interest rate hikes in all other comparable countries. For example, in the last quarter of 2023, the Reserve Bank cash rate reached 4.35%, compared to 5.0% in Canada, 5.5% in New Zealand, 5.3% in the UK and 5.4% in the US.

Now all of these countries, except Australia, have started to cut interest rates. However, the RBA governor is warning us not to expect a rate cut before next year, while financial markets and some economists, including me, think there should be a cut in December.

In summary, other countries appear to have tightened and raised interest rates more quickly, and at the same time been quicker to ease monetary policy and lower interest rates.

International comparison of interest rates

But before we conclude that the RBA is being too cautious, we need to acknowledge that, for institutional reasons, the impact of official interest rate changes can vary significantly across countries.

The critical difference is that the proportion of loans with variable and fixed interest rates varies significantly across countries. Where most loans have variable interest rates, monetary policy will have shorter lags and greater impact. Where most loans have fixed interest rates, borrowers are not affected by interest rate changes until the fixed term of the loan matures over several years.

The chart below, by Ian Verrender from the ABC, shows that the policy rate, shown by the blue bar, is lower for Australia than for New Zealand, Canada, the UK, the US and Germany. However, Australia has the highest interest rates for new mortgages, as shown by the yellow bar. Most importantly, however, is the red bar, which shows the interest rate on all past-due mortgages, showing that Australia has the highest interest rates overall, despite the lower official rates.

Results obtained

In short, comparing what is happening with official interest rates in different countries does not tell us much. Instead, we should focus on their impact on the economy – do interest rate changes achieve the desired balance between reducing inflation and maintaining employment?

When comparing Australia’s record to the US, the Australian authorities, both the RBA and the government, appear to have done a pretty good job. True, the US has brought inflation down to 2.5%, while Australia’s inflation rate for the four quarters ending in June was 3.8%. But the monthly CPI forecasts from Commonwealth Bank and Westpac economists are for consumer prices to rise by just 2.7% in the 12 months ending in August, and we are certainly bringing inflation down.

Australia has also been significantly better at maintaining employment than the US. While the proportion of Americans employed is still lower than it was before the pandemic, the proportion of people employed in Australia is at a record high, about 1.4 percentage points higher than before COVID.

Similarly, Australia has done better than other Anglophone countries in keeping unemployment low, with unemployment rising to 6.6% in Canada and 4.4% in the UK, compared to 4.1% in Australia.