Why were interest rates so high in the 1980s?

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Why were interest rates so high in the 1980s?

August 16, 2022

If you think interest rates are high in 2022, then let's consider the past, especially the 80s...why were interest rates so high in the 1980s?

As we discussed recently, the past four decades of house prices - including interest rates - reveal an extraordinarily different, and hardly comparable time, to that of 2022. You need only talk to those in their 70s-90s to discover jaw-dropping changes in interest rates, property prices and lending. This blog writer's parents, for example, recently talked of how they struggled to borrow $12,000 in the late 1970s to buy a Melbourne home. "This figure was like $5 million to us - but it was like this for everyone," my parents said. And bear in mind, interest rates soared even further in the late 1980s, hitting a record-high of 17.5% in 1990. But why did this happen? There's no easy answer but one of the best ways to explore this question is to go back to the 1960s to start.

1960s: Golden age not so golden

The 1960s have been described as a golden economic age for Australia. Inflation was beautifully low - around 2.5% - as were interest rates, staying steadily below 5% for the majority of the decade. The Depression and WWII were behind us (although the Vietnam War was too close for total comfort). The Reserve Bank of Australia (RBA) was also established in the '60s and we experienced a highly regulated banking system and overall, our economy ran along fairly smoothly. Indeed, what was once our lowest ever interest rate (2.89% in early 1960) was great news for buyers. But there were plenty of issues still lurking behind scenes.

1970s: "Stagflation"

These issues came to a head in the 1970s, "exploding into a confusing mix of high inflation, low growth and higher unemployment". They also set the stage for the extraordinary interest rates of the early 1990s. One of the key points to note is that a decade of low inflation and interest rates resulted in a complacent attitude when it came to buying property. But in 1974, interest rates spiked to 10.38% for the first time in Australian history - and sat around this figure until 1980 - while inflation jumped to 18%. Investors were left surprised by both the inflation and interest rate hikes, says former RBA governor, Bernie Fraser, who described these buyers as "the victims of an unanticipated rise in inflation (who) ... could not foresee the sharp jump in the early 1970s". Lenders were also allowing loans of "very low and often negative" interest rates, says Mr Fraser. As well, unemployment rose sharply from the mid-late 1970s (from 2% in the early part of the decade and peaking at 5.5% in the mid-1970s) as a recession hit many western countries, including Australia. According to the RBA, this recession was due to a global oil price crisis in which the world price of oil quadrupled. This in turn saw major inflation spikes to 18% along with high pressure on domestic wages, says RBA. This economic combination - falling output, rising unemployment and high rates of inflation – is now commonly known as "stagflation". And our economic situation didn't get better in the 1980s.

Many people often ask...why were interest rates so high in the 1980s. We take a look back at each decade.

1980s: New decade, same economic crises

Why were interest rates so high in the 1980s? Well, 1987 saw global share markets crash, with the ASX waving goodbye to 40% of its value, while unemployment rates still weren't improving. Mr Fraser has described the problems of the '70s being "mirror image(d)" in the 1980s. "The smell of burnt fingers in the 1970s lingered on," he says. "Real" wages also dropped sharply between 1985 and 1988 in a "just about unprecedented (change) in the post-War period," according to the RBA. With the aim of reducing inflation, global central banks aimed to tighten fiscal policies but this only led to yet another recession "we had to have" in many western countries, including Australia - which also had to deal with a drought in 1982-1983. This drought is still considered to be one of the most severe we've experienced in the 20th century.

1990s: Better days - or not

The 1980s recession essentially continued into the 1990s with interest rates spiking to their highest ever figure of 17.5% in January 1990 "because the transmission of tighter monetary policy took longer than expected to put downward pressure on demand and inflation", says the RBA. Unemployment also reached its highest ever figure of 11.2% in December 1992. However, these figures have been steadily falling ever since, as have interest rates, which dropped to 17% in February 1990 and between 1997-1999, remained steady at around 5%. Bar a short time in 2007-2008 when they rose to 7.25%, interest rates have remained around 5% or lower ever since.