When a country’s central bank increases interest rates, it creates a ripple effect that impacts the entire economy. Even with a 0.25% increase, you have to adjust your marketing strategy to respond to the drop in discretionary income as well as the currency’s relative increased strength.
We don’t have to go into the details of a macroeconomics model, but we should at least mention why interest rates change in the first place.
Interest rates have been historically low following the 2009 recession, not just in Australia, but around the whole world. This was due to central banks increasing the supply of money and thus decreasing their respective interest rates.
Now we’re seeing some countries change to contractionary monetary policy to have the opposite effect. In his book The Macroeconomy: Private Choices, Public Actions, and Aggregate Outcomes, author Michael B. McElroy explains the consequences of expansionary and contractionary monetary policy.
Expansionary monetary policy (accomplished through open market purchases by the Fed) reduces the real rate of interest, just as a contractionary policy (open market sales) would raise it. This change in the interest rate is then transmitted via the multiplier process to investment, net exports, income, consumption, and, ultimately, total output.
When the RBA drove interest rates down as much as possible as a response to the 2009 recession, their intention was to increase investment by businesses and the discretionary income of consumers.
An interest rates increase, on the other hand, typically leads to less discretionary income. Higher credit card rates are less attractive for consumption, and consumers have more incentive to save their money and collect interest. Also, in Australia, mortgage repayments make up the bulk of people’s spending. This means that as well as higher credit card repayments, people will have a larger set of mortgage repayments. A 0.5% increase on a $500K mortgage is about $150 less per month to spend.
A decrease in discretionary income spells trouble for retail businesses. If you’re not selling essential goods, then consumers will have less disposable income to spend on products. In this case, you’d have to rethink your marketing strategy due to the drop in demand.
If you are importing goods from overseas, a strong dollar may mean that you are buying at a better rate, but the reduced spending will reduce your market value for discretionary products. The first thing to look at is your pricing strategy, and are their lower value goods you can market instead?
When interest rates are high, businesses have less incentive to invest as loans become more expensive. In a B2B environment, you might see businesses scale back on orders and refrain from undergoing new projects. They might also take longer to pay as it makes more financial sense for them to hold on to the money.
Although a change in interest rates affects multiple facets of the economy, there are a few factors that get hit harder than the rest. One is non-essential goods since people have more incentive to save money and less incentive to spend it.
The other major factor is net exports. There is a positive relationship between a currency’s relative strength and the country’s interest rate. When a country’s currency strengthens, its businesses have a harder time exporting their goods since they become more expensive to foreign buyers. Likewise, imports become cheaper. In total, there is a noticeable decrease in net exports (exports minus imports).
So Australia is looking at a period of an interest rate increase a reduction of the cost of importing.
You can’t control what the RBA does to interest rates, but you can control your business strategy and response to the change. If you’re selling non-essential goods, then you will have to look out for a decrease in demand for your product. Also, you should take the drop in discretionary income into account regarding your marketing strategy.
The good news is that there may be the opportunity to buy cheap imported products to the lower the cost of your own. You may also find new ways to take advantage of the increased rates when investing your business’s capital.
Despite the likely drops in discretionary income and investment, a central bank may feel the pressure to increase interest rates if it predicts a rise in inflation. Recently, the US Federal Reserve raised interest rates for that exact reason, according to this Forbes article:
The two pieces of economic news that were released today (June 14, 2017) seemingly contradict each other: the Federal Reserve raised interest rates a quarter point, and the Consumer Price Index rose by less than two percent over the past 12 months. The Fed raised interest rates not because of the current inflation rate, but because of their expectations for the inflation rate in...2019.
The situation is a bit different in Australia, however. RBA Governor Philip Lowe’s recently dropped strong hints that Australian interest rates would neither rise nor fall soon. The RBA is currently concerned with the relative strength of the Australian dollar, and an increase in interest rates would exacerbate the associated effects, such as making Australian goods even more expensive for foreign buyers.
If the RBA were to raise interest rates, then discretionary income would fall, business investment would fall, the Australian dollar would strengthen, net exports would fall, and businesses selling non-essential goods would have to rethink their marketing strategies. Even if we don’t expect the RBA to practise contractionary monetary policy anytime soon, it’s always good to know how newspaper headlines and economic storylines would affect your business.
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McElroy, Michael B. “Chapter 6.” The Macroeconomy: Private Choices, Public Actions, and Aggregate Outcomes, Prentice Hall, 1996, www4.ncsu.edu/~mcelroy/302/H_Chpt6.pdf.
Conerly, Bill. “Why The Fed Is Raising Interest Rates When Inflation Remains Low.” Forbes. Forbes Magazine, 14 June 2017. Web. 02 Aug. 2017.
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