On 23 September 2004, three days before the launch of his re-election campaign, John Howard visited the marginal seat of Deakin in the north-eastern suburbs of Melbourne. He wandered up and down a busy shopping strip, chatting to residents and looking as casual as a politician can when encircled by a phalanx of minders. He popped in and out of businesses, including the local branch of the Bendigo Bank where, in a not-so-subtle symbolic act, he accepted the gift of a piggy bank from one of the tellers.
The backdrop for the delivery of the day's message was a small business owned by a local resident, Bill Sutherland. A bank manager turned newsagent, Sutherland had been well prepared by an advance party: he quickly volunteered to the attendant press that he had borrowed around half-a-million dollars to set up his business and was worried about interest rates. "We're hoping you're going to do the right thing by us, and keep interest rates down and the cost of business down," he said to the prime minister. "Well, the interest rates are the most critical cost of the lot," Howard responded. Sutherland nodded furiously: "Well, it is to us. We certainly don't want to go back to the '80s or '90s, when the interest rate was up around 20% or so!" Howard, warmed up by now, belted this one out of the park: "Yeah, the small-business rates were murderous then, weren't they?"
Addressing the media, Howard summed it all up: "This election, more than anything, is an opportunity for people to make a judgement about whether they want to have higher interest rates under Labor or re-elect a government that will always deliver lower interest rates than the Labor Party."
Interest rates were not only central to the 2004 election. They have been a recurring theme of the past 11 years of Coalition government. Even more importantly, it is almost certain that interest rates will be a major theme, perhaps the major theme, of the next federal election campaign. The story Howard and Costello will tell the Australian people will go, roughly speaking, like this. Under Labor interest rates are always unacceptably high. Under the Coalition they have been and will remain low. They will suggest to the Australian people that interest rates are controlled by governments and directly linked to federal budget deficits and surpluses. As no part of this story is actually true, the next election campaign will be conducted on the basis of a series of seriously misleading or straightforwardly false Howard-Costello claims.
Are interest rates higher under Labor? The highest interest rate during the Hawke years was 19%; the highest under Keating was 7.9%. But when Howard was treasurer in the Fraser government, interest rates peaked at 21.4% in April 1982. (He defended the rate by arguing that it was necessary to prevent an "economic crisis".) The situation was not dissimilar for housing rates, which are different to the government rates - the benchmark for the economy - but nevertheless important: these are the ones that affect the average mortgagee. A Liberal Party television advertisement screened before the 2004 election showed that rates were 10.38% under Whitlam, 17% under Hawke and 12% under Keating. What was conveniently omitted was Howard's own unimpressive record as treasurer in the early '80s, when housing rates hit 13%. So much for the notion that interest rates are always higher under Labor governments.
Do governments, anyhow, have much control over interest rates? As John Howard pointed out in his own defence in 1982, it is doubtful that they do. More importantly, whether they are higher or lower under one party or the other is of much less consequence than the government of the day understanding both the real determinants of interest rates and their place in the economy. On this score, Howard and Costello have spent many productive hours assiduously establishing in the minds of voters a false association between Labor, budget deficits and high interest rates.
Peter Costello has never tired of pointing to the "budget black hole" presided over by the Keating government as evidence of Labor's profligacy. Yet the deficits of the early '90s were not the result of bad management, but rather of an appropriate economic policy in the aftermath of a recession. In a recession, the budget will automatically go into deficit because tax intakes fall (as profits go down) and government outlays go up (unemployment benefits, for example). Should the government slash unemployment benefits and other government programs for the sake of the budget balance? Most economists would say no, because reducing the deficit would compound the recession by further reducing demand in the economy. Far from being irresponsible, deficit spending in a recession is widely accepted to be sound economic policy.
The second aspect of the government's economic spin is that budget deficits cause high interest rates. Howard and Costello know this to be untrue, and they are too clever to guarantee a direct link between the two, so the stock phrase they employ is that budget deficits ‘put pressure' on interest rates. At the launch of his 2004 election campaign, Howard said, "Nothing is more certain than if economic policy is allowed to slip into the hands of those who, when they last had control of it, delivered five budget deficits in a row, that there will be massive upward pressure on interest rates."
There is, in theory, a relationship here. It is as follows: if the budget is in deficit, then the government's tax intake is less than its spending. To pay the bills, it must borrow the shortfall. And when the government goes to the money markets to borrow, it increases the demand for the pool of available funds for loan. By increasing the demand for funds, it raises the price of funds: that is, the interest rate. If the government adds itself to the queue of people wanting money, it makes it harder and more expensive for the private-sector borrowers to get cash, meaning that they are less likely to borrow and less likely to invest and spend.
This sounds logical, and indeed it is. It's logical, but it is not significant. Australia is, of course, part of a global economy: neither the nation's government nor its businesses are constrained to borrowing in the domestic economy. They meet their financing needs not just in the lap pool of Australian savings but in the ocean of world savings; and the impact of the government's borrowing on global debt markets is near negligible. This is a principle well known in the United States, which has long since lost the fiscal fetishism that still holds Australians in the thrall of budget surpluses. Says the American journalist James Ledbetter: "Today the thesis that such measly sums [moderate budget deficits] could control or even significantly influence the overall economy will produce, at best, polite throat-clearing from the average American banker or businessperson."
The US started running a mammoth budget deficit in 2001, one that grew to $400 billion by 2003. Yet during this time the country's interest rates did not rise, but instead slumped to just 1%, the lowest level in 45 years. How could the US have such low interest rates while the deficit was so large? It certainly wasn't because there was excess American saving. It was because the deficit wasn't being financed by domestic funds: China, Taiwan and South Korea were buying up trillions of dollars of American government bonds. It was their saving that financed the fiscal profligacy of the US. George W Bush's chief economic advisor, Glenn Hubbard, said, "I don't buy that there's a link between swings in the budget deficit of the size we see in the United States and interest rates ... there's just no evidence."
Is that an isolated example, an aberration from Howard's law of rate-boosting deficits? No. On the contrary, it's often the norm. When governments face recessions and crises of confidence, they try to prime the pump by spending and going into debt, to get shoppers back in the malls and CEOs back in the investing game. At the same time, the central bank pitches in by cutting interest rates to defibrillate the economy with a shock of cheap credit. In recessions, low rates and high deficits go hand in hand. Even in a boom, where excessive government spending can over-stimulate the economy, the relationship between rates and deficits is weak. Ian Macfarlane, the previous governor of Australia's Reserve Bank, noted that attempts to make links "directly from budgets to monetary policy [involve] an almighty leap", and this is because monetary policy is based on the level of activity in the entire economy, of which stimulus from the government is just one small part.
Economic policy has been one of the Coalition's key electoral strengths. The great triumph of Howard and Costello has been to convince Australians of a spurious link between his government's fiscal conservatism and low interest rates. It is a story that may play well in the marginal electorates, but is also one that doesn't make economic sense. Interest rates have been flat since 1996, when Howard and Costello came to power. Interest rates have enjoyed consistently low inflation, and the nation has enjoyed a benign economic climate and a new monetary policy which has been implemented competently by the Reserve Bank.
Furthermore, and despite appearances, interest rates are not what really matters to Australian families. It is not the level of interest rates that we should worry about, but rather the amount of interest we pay: that is, the interest rate multiplied by our level of debt. As we have seen, interest rates have stayed low under Howard and Costello, but since debt levels have been heading into the stratosphere over the same period, the amount of interest that Australian families have been paying has actually increased. This, and not the mere fact of interest rates staying low, is the real story for the nation's mortgagees, but it is not one that John Howard or Peter Costello ever recount.
Interest rates peaked at 18% in June 1989. To today's mortgagees and credit-card users, this seems a devastatingly high figure and it is unsurprising that the Coalition uses it to incite fear. But at that time, high interest rates were much less significant; indeed, they were not enough to stop Labor being re-elected in 1990 and again in 1993. The difference between then and now is that we have accumulated so much debt in the past decade that even minor increases in interest rates have a terrible effect on household budgets. This is the dark side of the prime minister's low-interest-rate ‘success'. He has benefited politically from low interest rates, but he has done nothing to stop Australians' accumulation of record debt.
In 2004, the then Opposition leader, Mark Latham, had the opportunity to call Howard's bluff, to point out the errors in the prime minister's claims about interest rates and trust that an honest argument, backed by economists and the Reserve Bank, would cut through to the electorate. Instead, Latham proffered a marker pen and an over-sized sheet of cardboard inscribed with three promises which made up what he called the "Labor Low Interest Rate Guarantee". Sheepishly, Latham signed a commitment to put "downward pressure on interest rates" by, you guessed it, "keeping the budget in surplus ... and bringing down net debt".
With that one gesture Latham told Australians that the bogus link which the Coalition had made between deficits and interest rates was genuine, that Labor had a lot to apologise for from its last time in government, that the only way for the party to be accepted in the political mainstream was to confess its sins and promise never to re-offend. Standing on the podium in front of the cardboard guarantee, Latham looked like a schoolboy blustering his way unprepared through a class presentation. He looked down at the ground as he uttered the phrase "fair dinkum". He knew he was being dishonest, and he knew he was selling out past Labor governments and making it harder for future Labor leaders.
So far Kevin Rudd and Wayne Swan have avoided Latham's mistake. Rather than playing Howard's game, they have wrong-footed him by focusing on the future. Rudd argues that Australia needs to address its future prosperity, rather than coasting on the resources boom: "The time to mend the roof is when the sun is still shining," he told an audience of small-business people in July. The strategy has gone some way to denying Howard the chance to run a scare campaign about the big-spending, high-interest-rate Labor governments of the '80s and '90s.
Nevertheless, polling shows that the economy remains the Coalition's strongest electoral asset, and its best chance of avoiding defeat in the forthcoming election. Howard and Costello have carefully crafted an image of themselves as Australia's economic saviours. They claim, in speech after speech, that the Labor era was marked by needlessly high interest rates and inappropriate overspending, that the Coalition inherited a basket-case economy. They claim that only their government has the winning formula: cutting the budget, reducing debt and getting interest rates down. They claim, again and again, that a change in government will necessarily cause economic disaster. These are not only myths. They are distractions from what actually matters: economic policies which deliver long-term prosperity to the nation, rather than short-term political advantage to those who cling so desperately to power.