If you haven't heard already, the Australian economy is in a bit of a slump with slowing growth and stagnating wages. The Reserve Bank of Australia (RBA) is considering bold strategies to help alleviate the worsening situation - and it might result in Australians getting paid to borrow money via negative interest rates. It's all a bit confusing so here's what we know.
If you've checked property news over the past month, there's a high chance you'll have encountered stories about cash rate changes. Everyone's talking about it, and while the Reserve Bank of Australia has held rates where they've been for almost three years, a change is finally on the horizon.
What has the RBA said?
The RBA is Australia's central bank and is responsible for the country's economic prosperity. It does this by "setting the cash rate to meet an agreed medium-term inflation target" while issuing the nation's banknotes.
RBA governor Dr Philip Lowe recently told the Standing Committee on Economics the RBA was considering a number of possibilities, even "unconventional" ones to get the economy back on track.
"It's possible that we end up at the zero lower bound. I think it's unlikely, but it is possible. We are prepared to do unconventional things if the circumstances warranted it," Dr Lowe told the committee, as reported by Business Insider Australia.
"When we look overseas, we see some central banks have very low-interest rates and some countries have negative interest rates. In Switzerland right now the interest rate is -0.75 per cent, in the euro area it’s -0.40 per cent and in Japan it's -0.10. So some central banks have gone negative. That's one possibility."
Either way, Dr Lowe doubled down he was "expecting interest rates to stay low for a very long period of time."
What does that mean?
Most of us have a vague understanding of how interest rates work. If you have $10 in a bank account, a low interest rate of one per cent, for example, would mean your fortune (assuming you spend none of it) might grow by about 10 cents over the course of a year. For growing your wealth, higher interest rates, say five per cent, are obviously preferable.
On the flipside, if you borrow money from a bank, a lower interest rate means you don't have to pay much extra on top of your debt. Say you took out a $50,000 loan and it had a fixed interest rate of one per cent, you'd pay around $42.47 per month. This is because interest on a loan is usually calculated by multiplying the loan and the interest rate and then dividing by the number of the days in the year. In this example, [(50,000 x 0.01) / 365] would equal $1.37 per day. Multiply that number by the amount of days in a month (let's say, 31) and it equals around $42.47 per month.
But Dr Lowe said the RBA was considering negative interest rates as seen in some central banks in Switzerland and Japan. This is where things get a little unusual.
With a negative interest rate, the opposite occurs. Instead of gaining interest on amounts left in your bank account, you actually lose money. Your $10 in the bank will lose 10 cents over the course of a year with a negative one interest rate. Conversely, you would earn money on any loan you borrow.
That $50,000 loan with a fixed interest rate of minus one per cent (for example's sake) would likely earn you about $42.47 in interest per month. This is what the RBA has suggested it's considering as it would free up disposable income for Australians under financial pressure and give them more purchasing power, subsequently, stimulating the economy.
So, when can I see that money in my account?
Before you'll see any money earned on your home loan, the RBA would first need to decree the negative interest rate policy. Once that happens, commercial banks would then need to update their policies and then apply it to existing customers.
The RBA hasn't specified when it might consider applying this "unconventional" method in order to stimulate the economy but with the way things are heading, it might be trying out a mixture of strategies sooner rather than later.
"We could reduce the cash rate down to a very low level, and it's possible, if the circumstances warrant it, that we could take action to lower the risk-free rates further out along the term spectrum," Dr Lowe said.
"We're not doing this because we think it's likely; we're doing it because it's prudent in the global circumstances we face."
In Japan, the policy of negative interest rates hasn't been all that successful. The Bank of Japan (BOJ) adopted a negative interest rate in 2016 after a lending crisis. Since then, Japanese banks have seen huge losses, causing the BOJ to adjust rates to zero and then 0.2 per cent on 10-year yields. Analysts have said it's not eased the pressure on the economy.
It's for these reasons the RBA isn't ready to jump on putting this policy in place without testing other measures first, given how different the Australian economy is to Japan's.
"The effectiveness of these measures depends upon the specific circumstances the country's in and the nature of its financial markets," Dr Lowe said to the committee.
"There's not a one-size-fits-all here... A package of measures works best—rather than doing just one thing, doing a number of things that reinforce one another."
It's not yet clear what will happen in the immediate future but something's got to budge.
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