Grim warning over Australia's 'abnormal' economy

Former Australian Treasurer Peter Costello, pictured in 2007. Photo / File

Australia's longest serving treasurer has issued a warning for the country's economy, which he says is being propped up by emergency-level interest rates.

Peter Costello, who was responsible for the nation's purse for the nine years to 2007, said he was perplexed by the abnormality of the financial situation.

Most indicators suggested the economy was healthy, he said: unemployment is 5.3 per cent, inflation is 1.6 per cent, the budget is "more-or-less balanced", it has a trade surplus and a current account surplus.

Costello told a Yahoo Finance conference in Sydney yesterday these factors would traditionally be partnered with interest rates between 5 and 6 per cent, because "that was the kind of cash rates that we dealt with back in those days" when he served beside then prime minister John Howard.

"If you would have said to me to think of an economy where the cash rate is 1 per cent and the long term bond rate is 1 per cent, what sort of economy is that?" he said.

"I would say it's an economy that's never existed — we've never had 10-year money you can get for 1 per cent or less.

"If I had been forced to make a guess, I probably would have said to you that's got to be a deep recessionary economy.

"Why else would you have interest rates at 1 per cent?"

Costello said this imbalance in the economic narrative had created a conundrum where the nation's financial fortunes were difficult to predict.

He says any increase in interest rates had proven volatile for the share market.

"These are not normal times," he said.

"Every time it looks like they're (interest rates) going to normalise and go up, the markets go haywire and people say 'we don't want that to happen'.

"I don't know how long abnormal conditions last … can they last for 15 years? Can they last for 20 years?

"I think one day conditions will revert to more normal conditions, the kind of conditions we've seen over the last century or so, and then there will be adjustments."

Despite this, Costello said the Reserve Bank cutting rates again on Tuesday, as is widely predicted, would have little effect on the economy.

The now Future Fund chairman said the soft levers of monetary policy in the hands of central bank boss Philip Lowe had "passed their useful life".

He also said the government should resist calls to fall into debt to stimulate the economy.

"I hear the case for infrastructure — most of it is built by state government and in fact they are spending big on big projects,'' Costello said.

"The commonwealth government doesn't really build infrastructure and when the commonwealth government builds infrastructure it builds school halls and puts pink batts into homes. It rarely works … it just can't do it. I would be very, very wary about going back down the path of fiscal stimulus."

Current Treasurer Josh Frydenberg backed Costello's scepticism of the economic benefits in further interest rate cuts.

"Peter Costello is absolutely right that it's a law of diminishing returns once you start to reduce interest rates below a certain amount, the impact on the economy is reduced," Frydenberg told ABC radio today.

Frydenberg also agreed with his mentor's view to resist the urge to ramp up federal infrastructure spending.

"They build a lot of it and they also help fund it, and obviously that is where great care needs to be taken to choose the right projects, but also too to help fund them," the Treasurer said.

In a speech to the Armidale Business Chamber on Tuesday night, Lowe hinted at further rate cuts to be announced at the RBA board meeting next week.

"The board is prepared to ease monetary policy further if needed to support sustainable growth in the economy, make further progress towards full employment, and achieve the inflation target over time," he said.