Monetary Policy 101 - Interest Rate Rise

Submitted by Craig Strzelecki on 7 May, 2006 - 23:40

The Australian interest rate is much higher than most of our trading partners. The reason is simple: the Australian economy has a nasty Current Account Deficit (CAD). An since the Australian dollar is stronger, imports look to be cheaper while discouraging exports as our products would seem more expensive to their currency.

But there is also the issue of bad credit. The IMF sent out a warning about a month ago about that issue. Recently the Economist magazine reported that more and more big loans for takeovers and leveraged buyouts in the US and Europe are being made without the standard restrictions that were in place previously. Requirements such as keeping certain ratios (debt to assets, cash flow profits etc) or limiting what the money could be used for. There is money flowing in the woodwork, and borrowers can easily shop around, not for the best rates but to find the best deal with the least restrictions.

Recall that it is simply history occurring again, something that the RBA is trying to prevent: the late 90s leading up to the Long Term Credit Collapse in 1998, Russia's default in the same year, Orange County in the US going broke through lax lending controls and Australia's 'Recession We Had To have'.

The Economist also noted that many of these easy loans were not being financed by banks which have a good understanding of lending. The banks are doing the arranging of loans but selling many of the loans off to other investors, such as Hedge Funds and Mutual Funds which have had little experience in credit risk management when lending money.