Interest Rate Increases Are Ineffective

I’ve recently replaced a lot of fences at my place. As I’m not a fencer I employed a guy to do the job. To save him some time and effort I decided that I would pull down the fences around our front paddock. Not using the right tools meant that it took me a lot longer than necessary – the truth is I wasn’t effective because I was using the wrong tools for the job.

Last week the Reserve Bank increased the official Cash Rate which is the current method they use for attempting to control inflation. I’m stepping out here in on a limb to say that I think it’s an absolute wasted effort, for quite a few reasons. Here are two:

The first reason that interest rate increases are not a good solution is because in the short term they only impact the floating rate. Last week the OCR increased, so the banks increased their floating mortgage rates. But financial experts across most newspapers advise us that approximately 70% of home owners have their mortgages on fixed interest rates. That means that their interest won’t be affected until that term expires. So the interest rate hike last week will have very little impact on people’s spending and therefore will have very little impact on inflation.

Sounds a bit like me using the wrong tools for fencing.

But there’s another reason that makes interest rate increases less effective. Employment. We are currently enjoying a very tight labour market. What this means is that there are more jobs than there are employees. Therefore wages are secure and people can afford to pay more for their mortgage. And because employers do not want to lose their employees they are more open to provide wage increases to match interest rate rises.

Once again this reduces the concern of the home owners and does not have very much impact on their spending or borrowing and therefore has little impact on inflation.

This “love affair” that kiwis have with bricks and mortar and borrowing mortgage funds means that the Reserve Bank is fighting a very hard battle. They have indicated in their report that they are considering other means of controlling inflation. There is capital gains tax, changing the tax laws relating to negatively geared properties, and restricting the funds that banks have available for lending.

Whatever your view on this I find the commentary as helpful as a wet paper bag. There is very little constructive discussion that provides home owners with help and motivation to increase their savings, accelerate debt repayments and decrease their spending (or over spending).

My hope is that people take responsibility to make wise choices about their mortgages and their spending. Despite the ineffective Government Policy I think we all need to do what’s right for our families: pay off debt as fast as possible, have a long term savings/investment plan and spend less than we earn.

Phil Strong
CEO Wisemoney