THE PRESS FRIDAY, DECEMBER 9, 1988. Interest rates climb again

Press, 9 December 1988, Page 12

THE PRESS FRIDAY, DECEMBER 9, 1988. Interest rates climb again

The most ominous of the chinks in the Government’s economic strategy has been persistent high interest rates. In spite of a reining-in of the rate of inflation, and in spite of a marked slowing of increases in the consumers price index, banks and finance houses have been reluctant, or unable, to lower interest rates by anything like the same degree. Now, interest rates seem to be on the rise again. Three of the main trading banks have increased their base lending rate on overdrafts, personal loans, and term loans. A corresponding increase in mortgage rates seems inevitable, and costly money damages hopes for business investment that is needed to set the economy on an upward path. The Governor of the Reserve Bank, Dr Don Brash, attributes the rise in base lending rates to a fear that the Government might abandon, or significantly water down, the economic policy it has been following. The banks themselves have blamed funding costs, in particular the surging cost of five-year Government stock, for the rise. The political uncertainty being generated in the Beehive between the Prime Minister, Mr Lange, and his Minister of Finance, Mr Douglas, has not helped. The possibility of a blow-out in the deficit increases as Mr Lange and Mr Douglas continue to push different barrows: Mr Douglas saying the Government must show genuine restraint in its spending and Mr Lange assuring everyone that social spending will not be cut.

Probably all of these factors have played a part in the increase. They are all facets of the same jigsaw and the increase in the base lending rates is just another piece of the puzzle. Ever since January, when Mr Lange unilaterally overturned the Douglas flat-tax proposal of the previous month, the business community has seemed unsure of just who has been in control of the Government’s economic policy. Mr Lange’s ear is the more attuned to the rustle of General Election ballot papers; political considerations increasingly have forced adjustments, or delays, or reappraisals of aspects of Rogernomics. An interest in reactions in the electorate is not wrong, but these diversions from the Douglas plan are being interpreted — Dr Brash believes incorrectly and unfairly — as a renunciation of policy. Of greater consequence, however, is the implication of these adjustments -for the economic promise Mr Douglas offered when he introduced his period of pain. Clearly the chances of Mr Douglas achieving his budgeted deficit — excluding income from the round of asset sales — have been compromised by the tinkering with his programme. A larger-than-expected deficit next year will further boost interest rates and some of the financial institutions could be acting in anticipation of this. The market will have to be convinced that the Government’s demand for funds can be curbed. Without clear evidence that the Government deficit will be kept under control, it will be hard to persuade financial institutions that interest rates should be reduced, other than by direct intervention, which would be an admission that Rogernomics has not worked as well as it

should. Little scope remains now for resorting to the traditional, first choice for spending cuts, the Government’s wage bill, because big inroads have been made already on State sector employment. The next most logical area of restraint, and the one offering greatest savings, is the one to which Mr Lange refuses to take the pruning knife: social spending. Mr Douglas has not actually argued for cuts; he has pressed to get more value for money through more precise direction of welfare payments. The result might, just possibly, be the same. The Government’s determination not to intervene directly to reduce interest rates — by having the Reserve Bank pump money into the economy, for instance — is sound. This would mean an abdication of monetary policy and would be interpreted, correctly, not only as a defeat for Rogernomics but as evidence that the fight against inflation had been abandoned. Attempts by the Government and its advisers to reduce interest rates indirectly — by talking them down, for instance — clearly are not working in the face of tensions in the Cabinet and ambiguity over economic directions. The Government is left really with only two other options. One is to cut its spending; the other is to increase its revenue.

Various measures have been taken and still are being taken to decrease spending; but the gains available from these have just about been exhausted. Social spending has been declared off-limits by Mr Lange. Application of user-pays policies can be extended only so far, and there are limits to the cuts that can be made in the provision of services by the State beyond which society itself could fall apart. The State never was, and should not be, primarily a dispenser of welfare handouts, and it cannot turn its back altogether on all the other essential, perhaps humdrum, functions that society requires of it. This leaves the possibility of an increase in Government income. Once-only asset sales aside, increasing the Government’s revenue would mean an increase in taxes, either direct or indirect. The prospect is unpleasant; but the dilemma thus described helps to explain the increasing frequency of references in Cabinet Ministers’ speeches to the possibility of a capital gains or assets tax. The Treasury is preparing papers on these options. The likelihood that an assets tax — which Mr Douglas prefers to a capital gains tax — will be introduced next year increases with Government assurances that no increase in the rate of goods and services tax is planned. A new tax will not make the Government popular, any more than will high interest rates. In the end, the Government might be forced to choose between these. Next week’s special, two-day Cabinet meeting is bound to consider the possibilities. The irony is that the Cabinet meeting is an attempt to remove uncertainty, and it is a direct consequence of the political uncertainty that is helping to fuel high interest rates. If nothing comes from the meeting to reassure the nervous money markets, the Government will find it harder than ever to persuade the doubters that its economic policy is still on course.