Are Interest Rate Levers too Clumsy for a Teetering Economy?

I’ve been having a think lately about whether the use of Interest Rate movements by the Reserve Bank is actually too clumsy an instrument for effective economic management. The potential weakness has emerged only in recent times as the signs of a world-wide economic melt down have begun to expose one of the limitations of the GST as an interest mechanism that taxes consumption.

When the economy is booming and everyone feels rosy, the key requirement is to reduce paperwork and simplify processes to maximise effectiveness. There is little doubt that the GST method is a far more effective system when things are booming.

But I am starting to think that going for a one size fits all approach through a flat consumption tax may not be as great when the only measure left to slow spending is interest rates. Lifting interest rates invariably hits those who can least afford it the hardest. Already pressed to the wall to pay home loans or rents, there is often little discretionary spending left in poorer income families. Interest rate rises are a heavy punishment that in the end, capture many people who are sensible managers of their limited budgets. And frankly I think it is a clumsy and unfair approach.

Which is where I think there might be some benefit in re-visting the old ‘sales-tax’ model that the GST replaced. Not for the purposes of reinstating it but for the purposes of seeing if there is anything of value in the way it worked that could provide a more precise instrument to manage the economy.

The key attribute was the wild variation in taxation rates. That was also its downfall as things became too onerous for what tax level applied to what aspect of a product or service. But that variation could be something that a revamped approach to a GST ought to be considered. Consider then higher rates of GST applied on certain consumer goods. If a Government could act to decrease the incentive on CERTAIN types of consumer goods (i.e the highly discretionary ones) then an increase in a GST rate for that type of product would be a precise instrument for detering spending, slowing economic activity in that sphere.

Significantly, it means that the ‘treat everything as a nail’ approach that hammer-like Interest rate adjustments are, do not need to penalise those who can least afford it. There are a vast number of people who are going to lose their homes, not because they bought a plasma TV or splashed out on a holiday, but because some decisions made by very wealthy senior bankers elsewhere in the world meant that prudent risk management processes were ignored in the search for higher executive bonuses. Yes there were many executives who were prudent, just as there are some households whose priorities were less than switched on to commercial realities. But unfortunately the heavy handed interest rate rises approach is clumsy and penalises those who can least afford the change.

In the paper ‘A Blueprint to Advance Australia Collectively’ which was sent to all major polticial parties in 2000, I suggested that temporary Superannuation incentives might also be a lever. To some extent that idea was picked up but not as fully as it could have been. So more flexibility is required and the flexibility that might be afforded Governments in considering short term increases in GST on certain consumer goods might be just the lever to help.

Just a thought…