Editorial: Pessimism not healthy for our economy

Economics, the dismal science, was at its worst on Wednesday when the Reserve Bank moved to quash rises in interest rates and the dollar. The bank was unhappy that mortgaged households have been putting their loans on fixed rates for three to five years, taking advantage of today's low interest rates while they can. These people were acting in the belief that the recession will soon relent and mortgage rates will start rising again. Can optimism be unwelcome?

The lending banks must share some of that optimism because they have been hedging their risk that the fixed rates they are giving for three to five years will turn out to be too low. Their hedging arrangements have raised wholesale interest rates at a time when the Reserve Bank is intent on lowering rates still further as an antidote to the recession. But how much does this matter?

New Zealand's official cash rate is at a record low point of 3 per cent and the bank has indicated that it expects to lower the rate to 2.5 per cent within a month or two. At these levels, it is questionable whether interest rates are having much effect on the economy. In places where the recession is deeper, central banks already have base rates near zero and they are starting to buy their own Governments' securities - printing money in effect - to try to prevent deflation.

Deflation, a condition in which the general level of prices is falling, discourages immediate spending, destroys business and jobs and can turn a recession into depression. That is what the Reserve Bank Governor, Alan Bollard, gently calls "downside risk".

On Wednesday, he reminded the markets that his last monetary policy statement on March 12 had said "the risks around the outlook continue to be weighted on the downside", and he warned that the rise in longer-term interest rates since then was "unwarranted" and "inconsistent with the monetary policy outlook".

Optimism, it seems, can be self-defeating if it is premature. Dr Bollard said "this apparent distortion" in interest rates "could put unnecessary pressure on the cost of borrowing by firms and households". But it is households that are generating this demand for fixed rates. Dr Bollard may be right that they could enjoy lower floating rates for a bit longer than they think, but the optimism expressed by their behaviour is surely better for the economy at present.

This is a time to keep a sense of proportion about monetary policy. Like the brakes on a moving vehicle, monetary settings are very useful to keep the economy from going too fast for its capacity or the inflationary hazards on the road ahead. The world is in this predicament in part because the United States' monetary manager did not apply the brakes against the housing bubble, as New Zealand's and others' did.

Now that the vehicle has spun out and stalled, the brakes are of little use. It needs accelerant. Government spending can send new fuel through the system. All that the brakes can do is ensure they do not impede the recovery. With the base interest rate at 3 per cent, they hardly represent an impediment. Even the five-year fixed-mortgage rates of 6 per cent that worry Dr Bollard are hardly a discouragement to recovery. It is not borrowing rates that are inhibiting business expansion at the moment, it is the climate of pessimism.

That climate owes more to economists and market commentators than the mood of the people, which appears to be one of patience rather than despondency. Dr Bollard has done nothing to assist that mood with his strictures on interest rates this week. It is hard to see how higher long-term rates would inhibit a recovery later this year. A little less monetary fuss for the moment might do us the world of good.