In macroeconomic terms, the RBA decision to keep interest rates unchanged looks like a good call. With the levels of indebtedness we have in Australia, the risk of overkill, as seen in 1990, are greater than the risk of delaying for a while to see what happens. Although the evidence is patchy, the claims that economic activity has peaked look quite plausible. On most reasonable estimates, interest rates are still below their ‘neutral’ level and it looks as if they can’t go significantly above this level without producing substantial damage
In microeconomic terms, the decision looks far less appealing. Interest rates represent the price of current consumption in terms of future consumption. If they are permanently held below their equilibrium (roughly the same as neutral) level, the result must be too much consumption and too little saving and Australia has seen this in spades, with negative rates of household savings for some years. Not surprisingly, this has been accompanied by a boom in asset prices, particularly for residential land. This in turn has been associated with a shift in investment towards housing which, since it produces non-tradable services, is not helpful in addressing a huge current account deficit.
When one set of considerations strongly suggests holding interest rates steady and another suggests they need to rise significantly, the obvious conclusion is that we are trying to do too much with one instrument.