Wednesday, February 24, 2021

Ross Garnaut's new plan to lift us out of mediocrity

If your greatest wish is for the virus to go away as we all get vaccinated, and then for everything to get back to normal, I have bad news. You’ve been beaten into submission – forced to lower your expectations of what life should be bringing us, and our nation’s leaders should be leading us to.

Without us noticing, we’ve learnt to live in a world where both sides of politics can field only their B teams. Where our politicians are good at dividing us and making us fearful of change, but no good at uniting us, inspiring us and taking us somewhere better for ourselves and our kids.

Scott Morrison hopes that if he can get us vaccinated without major mishap and get the economy almost back to where it was at the end of 2019, that should be enough to get him re-elected. He’s probably right. Even his Labor opponents fear he is.

Fortunately, whenever our elected leaders’ ambition extends little further than to their own survival for another three years, there’s often someone volunteering to fill the vision vacuum, to supply the aspiration the pollies so conspicuously lack. Among the nation’s economists, that person is Professor Ross Garnaut, of the University of Melbourne.

In a book published on Monday, Reset: Restoring Australia after the pandemic recession, Garnaut argues we need to aim much higher than getting back to the “normal” that existed in the seven years between the end of the China resource boom in 2012 and the arrival of the virus early last year.

For a start, that period wasn’t nearly good enough to be accepted as normal. Unemployment and underemployment remained stubbornly high – in the latter years, well above the rates in developed countries that suffered greater damage from the global financial crisis in 2008-09 than us, he says.

“Wages stagnated. Productivity and output per person grew more slowly than in the United States, or Japan, or the developed world as a whole,” he says. (If that weakness comes as a surprise to you, it’s because our population grew much faster than in other rich countries, making it look like we were growing faster than them. We got bigger without living standards getting better.)

So that wasn’t too wonderful, but Garnaut argues if that’s what we go back to, it will be worse this time. Living standards would remain lower, and unemployment and underemployment would linger above the too-high levels of 2019.

We’d have a lot more public debt, business investment would be lower and we’d gain less from our international trade, partly because of slower world growth, partly because of problems in our relations with China.

Continuing high unemployment would devalue the skills of many workers, particularly the young. Many of our most important economic institutions – starting with the universities – have been diminished.

The new normal would be more disrupted than the old one by the accumulating effects of climate change and continuing disputes about how to respond to this.

So Garnaut proposes radical changes to existing economic policies to make the economy stronger, fairer, and to treat climate change as an opportunity to gain rather than a cause of loss.

At the centre of his plan is returning the economy to full employment by 2025. That is, get the rate of unemployment down from 6.5 per cent to 3.5 per cent or lower – the lowest it’s been since the early 1970s.

This would make the economy both richer and fairer, since it’s the jobless who’d benefit most. Returning to full employment would take us back to the old days when wages rose much faster than prices and living standards kept improving.

Returning to full employment, he says, would require a radical change to the way businesses pay company tax and the introduction of a guaranteed minimum income, paid to almost all adults at the present rate of the dole, tax-free and indexed to inflation.

It would involve rolling the present income tax and social security benefits into one system. This would benefit people working in the gig economy and other low-paid and insecure jobs, and greatly reduce the effective tax rates that discourage women and some men from moving from part-time to full-time work.

Changing the basis of company tax would cost the budget a lot in the early years but then raise a lot more in the later years. The guaranteed minimum income would cost a lot but would become more affordable as more people were in jobs and paying tax.

Much of the economic growth Garnaut seeks would come from greater exports. Australia’s natural strengths in renewable energy and our role as the world’s main source of minerals requiring large amounts of energy for processing into metals creates the opportunity for large-scale investment in new export industries. We could produce large exports of zero-emissions chemical manufactures based on biomass, and also sell carbon credits to foreigners.

Of recent years, Australia has fallen into the hands of mediocrities telling us how well they – and we – are doing. Surely we can do better.

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Monday, February 22, 2021

Here's the unspeakable truth about the fall in interest rates

In these unprecedented times, Reserve Bank governor Dr Philip Lowe is having trouble explaining his actions and motivations because there are various things someone with his degree of influence feels he can’t admit. But I’m under no such constraint. So let me have a go at giving you the message he won’t.

Despite Lowe’s reticence, he’s a fundamentally honest person and if you study what he’s saying – and avoiding saying – you can join the dots.

Long before the coronavirus appeared on the horizon early last year, the rich economies had been caught in a low-growth trap caused by a global imbalance between how much people wanted to borrow and invest, and how much other people wanted to save and lend. Around the world, interest rates were heading close to zero.

With our economy growing at a rate well below its “potential” to produce more goods and services, Lowe slowly and reluctantly cut our official interest rate. He was reluctant because he knew that, with rates already so low and households already so much in debt, cutting rates further would do little to help.

But also because, with the official rate already down to 0.75 per cent, he was perilously close to running out of ammunition, while the Morrison government was totally focused on getting the budget back to surplus and so reluctant to use the budget to stimulate growth.

He didn’t want to follow the other, bigger central banks into the unconventional, uncharted and unhinged territory of “quantitative easing” (QE) – central banks buying second-hand government bonds and paying for them merely by creating money, so as to lower longer-term public and private sector interest rates – much less engineer “negative” interest rates (where the lender pays the borrower to borrow).

By the Reserve’s board meeting early last March, it was clear the virus would slow the economy a bit, so Lowe cut the official rate to 0.5 per cent. Within a fortnight it had become clear the pandemic was a much bigger deal.

So, after an emergency meeting, Lowe announced another cut, taking the official rate down to 0.25 per cent, the level he’d long told us was its “effective lower bound”. He also embarked on various forms of QE, including guaranteeing to buy sufficient second-hand Commonwealth bonds to keep the “yield” (interest rate) on three-year bonds at about 0.25 per cent.

The next big move came last November, when Lowe lowered the official rate’s effective lower bound to 0.1 per cent, lowered the target for the yield on three-year bonds similarly, and decided to buy $100 billion-worth of second-hand bonds with maturities of five to 10 years, so as to force their yields down, too.

Then, earlier this month, Lowe announced a decision to spend a further $100 billion buying longer-dated bonds once the first $100 billion had gone. But, he insisted, the board had “no appetite” to push interest rates “into negative territory”.

So what do all these moves prove?

It’s understandable that Lowe should want to maintain public confidence that the independent authority which has had most influence over the day-to-day management of the economy for the past three decades, the Reserve, is at the helm, actively wielding an instrument that’s still highly effective in keeping us on course.

To this end, he has denied that monetary policy (the manipulation of interest rates) has run out of fire power. As he’s stepped further and further into unconventional measures, he’s suppressed his former reservations about their effectiveness and possible adverse side-effects, and striven to give the impression that everything’s under control and going fine. Monetary policy is playing an important part in getting the jobless back to work.

The reality is different. Movements in interest rates – whether achieved by conventional or unconventional means – affect different aspects of the economy via different mechanisms, or “channels”.

The most front-of-mind channel – “intertemporal substitution” – tells us a cut in the cost of credit encourages households to borrow more and spend it on consumption, while encouraging businesses to borrow more for investment in expansion. But if you read his words carefully, Lowe never claims his measures are causing this to happen – because it’s unlikely much of it is.

Rather, he alludes to the “cash flow” channel, saying lower rates are lowering the interest bills of households and businesses with existing debts, thereby leaving them with more money to spend on other things. True – but not terribly powerful, particularly since most people with home loans leave their monthly payments unchanged and thus pay off their mortgage a bit faster, a form of saving.

In his evidence to a parliamentary committee earlier this month, Lowe vigorously denied that the Reserve was “targeting the dollar” or that he saw signs of “currency manipulation” by other central banks (also known as “competitive devaluations”). Strictly true – but misleading.

Lowe isn’t “targeting the dollar” at a particular level or as a goal in its own right. But he cares deeply about the level of our currency’s rate of exchange against the currencies of our trading partners because this greatly affects the international price competitiveness of our export and import-competing industries, and thus how much they produce and how many people they employ.

When discussing the benefits his recent interest-rate moves have brought us, Lowe never fails to mention that they’ve caused our exchange rate to be “lower than otherwise”. That’s true – but it’s not a lot to show for all the Reserve’s lever-pulling. Lowe isn’t actually denying that monetary policy is much less effective in boosting demand than it used to be.

There’s little evidence that QE does much to increase demand for goods and services – as opposed to demand for assets such as shares and houses (probably with adverse consequences for the distribution of income and wealth). But it does seem clear that QE gives you a lower exchange rate.

Trouble is, when the Americans use QE to make their exchange rate more competitive, this makes other countries’ exchange rates less competitive. So the Europeans and Japanese defend themselves and start doing it too.

Get it? Now all the big boys are doing it – and keep doing more – Lowe’s had little choice but to do it too. Had he resisted getting into the unknown waters of unconventional measures, our dollar would be a lot higher and hugely uncompetitive.

Which means almost everything he’s done over the past year hasn’t been making things better for the economy so much as stopping things getting worse. And it also suggests that, however much Lowe lacks an “appetite” for moving to negative interest rates, if the big boys choose to go further down that path, he’ll have little choice but to join them.

There are other issues on which Lowe has felt the need to be less than frank, but they’re for another day.

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Saturday, February 20, 2021

One problem at a time: jobs first, inflation much later

It had to happen: at a time when inflation is the least of our problems, some have had to start worrying that prices could take off. Funny thing is, it’s not the usual suspects who are concerned.

As so often happens, the new concern is starting in America. But since so many people imagine globalisation means our economy is a carbon copy of America’s, don’t be surprised if some people here take up those concerns.

The new Biden administration is about to put to Congress a recovery support package of budget measures – a key election promise – worth a mind-boggling $US1.9 trillion ($2.5 trillion).

Particularly when you remember that, after the US election but before President Biden’s inauguration, Congress stopped stalling and put through another, smaller but still huge, package of spending measures, it’s not surprising that some people are saying it’s all too much and will lead to problems with inflation.

What’s surprising is that the worries have come not from Republican-supporting and other conservative economists, but from an academic economist who’s been prominent on the Democrat side, Professor Larry Summers, of Harvard.

Summers, a former secretary of the Treasury in the Clinton administration, has been supported – on Twitter, naturally – by Professor Olivier Blanchard, of the Massachusetts Institute of Technology, a former chief economist at the International Monetary Fund.

The Biden package has been vigorously defended by the new Treasury secretary and former US Federal Reserve chair Professor Janet Yellen, supported by Professor Paul Krugman, a Nobel prize-winning economist and columnist for the New York Times.

All four of these luminaries have long been advocates of vigorous use of fiscal policy (budget spending and tax cuts) whenever the economy is recessed.

As well, Summers is the leading exponent of the view that America and the other rich economies (including ours) have, at least since the global financial crisis in 2008, been caught in a low-growth trap he calls “secular stagnation”, because investment spending (on new housing, business equipment and structures, and public infrastructure) has fallen well short of the money being saved by households, businesses and governments.

This imbalance, Summers argues, explains why interest rates have fallen so close to zero. He’s long advocated that governments spend on big programs of infrastructure renewal and expansion (including on the cost of fighting climate change by moving from fossil fuels to renewables) to “absorb” much of the excess savings and, at the same time, lift the economy’s productivity.

All four of these economists would fear (as I do) that the structural problems that kept the economy stuck in a low-growth trap for years before the pandemic came along will reassert themselves once the world gets on top of the virus and we recover from the coronacession.

So why would Summers, of all people, fear that Joe Biden’s massive support package could lead to the return of something that hasn’t been a problem for several decades, rapidly rising prices of goods and services?

Because he fears the package’s spending is three times or more the size of the hole in demand that needs to be filled to get the US economy back to “full employment” – low unemployment and underemployment, and factories and offices operating at close to full capacity.

When the demand for goods and services exceeds the economy’s capacity to produce goods and services, what you get - apart from a surge in imports – is rising prices.

Economists believe that an economy’s “potential” rate of growth is set by the rate at which its population, workforce and physical capital investment are growing, plus its rate of improvement in productivity – the efficiency with which those “factors of production” are being combined.

For as long as an economy has idle production capacity – unemployed and underemployed workers, and offices, factories, farms and mines that aren’t flat-chat – its demand can safely grow at a rate that exceeds its potential annual rate of growth.

But once that idle production capacity – known as the “output gap” – has been eliminated and demand’s still growing faster than supply, the excess demand shows up as higher inflation.

Summers’ concern comes because the Congressional Budget Office’s estimate of the US economy’s output gap is several times less than $US1.9 trillion.

Roughly half of the package’s cost is accounted for by spending on virus testing, the vaccine and other health costs, spending to get schools open again, and income-support for victims of the coronacession, including a temporary increase in unemployment benefits.

Summers has no objection to any of that. But much of the rest of the proposed spending is the cost of cash payments of $US1400 ($1800) a pop to most adults, regardless of their income. This is pure “stimulus” spending, and Summers worries that it may crowd out Biden’s plans for subsequent spending on infrastructure, to be spread over several years.

But calculations of the size of an economy’s output gap are rough and ready. Who’s to say the assumptions on which the budget office’s estimates are based are unaffected by the causes of secular stagnation, or by the unique nature of the coronacession?

And even if the spending of those cheques (much of which is more likely to be saved) did lead to price rises, this doesn’t mean we’d be straight back to the bad old days of spiralling wages and prices. (If we were, it would be a sign the era of secular stagnation had mysteriously disappeared.)

Remember, the Americans’ inflation rate (like ours) has long been below their target. Getting up to, or even a bit above, the target would be a good thing, not a bad one.

And, in any case, a good reason we shouldn’t worry about inflation at a time like this is that, should it become a problem, we know exactly how to fix it: put interest rates up. Australia’s households are so heavily indebted that, in our case, just a tiny increase would do the trick.

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Wednesday, February 17, 2021

Water reform report’s big smile hides its big teeth: much more to do

A quick look at the Productivity Commission’s draft report on national water reform reminds me of the repeated judgment from old Mr Grace, the doddering owner of the department store in Are You Being Served? as he headed for the door: “You’ve all done very well!”

Its review of the progress of the National Water Initiative signed by the federal and state governments in 2004 – encompassing agreements on the Murray-Darling Basin – is terribly polite, understated and relentlessly upbeat.

Apparently, governments have made “good progress” in having “largely achieved” their reform commitments. All that remains is just the need for a teensy-weensy bit of “policy renewal”.

This mild-mannered stuff and congratulatory tone bear no resemblance to my memories of meetings of angry farmers railing against stupid greenies and other city slickers; of their insistence that the immediate needs of irrigators and irrigation towns along the river take priority over the river system’s ultimate survival; of each state government’s insistence on favouring their own irrigators over those in states further down the river; of federal and state National Party ministers happy to slip farmers a quiet favour, avoid enforcing the rules and turn a blind eye to blatant infringements; of federal Labor ministers who, even with no seats to lose in the region, were unwilling to make themselves unpopular by standing up for the rivers’ future.

I remember that the Howard government spent billions of city slickers’ money helping individual farmers make their irrigation systems more resistant to evaporation and seepage when all the benefits went to the farmer and none to the river system.

I remember all the infighting between government water agencies, and the mass fish kills during the recent drought in NSW and Queensland, for which the managers of the system accepted no responsibility.

Fortunately, reporters are adept at ignoring all the happy flannel up the front of government reports and finding the carefully hidden bad bits. And fortunately, we have the assistance of long-standing water experts, including the economist Professor Quentin Grafton, of the Australian National University, whose summary of the report on The Conversation website is headed: “Our national water policy is outdated, unfair and not fit for climate challenges.”

“The report’s findings matter to all Australians, whether you live in a city or a drought-ravaged town. If governments don’t manage water better, on our behalf, then entire communities may disappear. Agriculture will suffer and nature will continue to degrade,” he says.

The report’s proposal to make “water infrastructure developments” a much larger part of the National Water Initiative is a critical way to keep governments honest. For years, state and federal governments have used taxpayers’ dollars to pay for farming water infrastructure that largely benefits big corporate irrigators, Grafton says.

Last year the Morrison government announced a further $2 billion for its Building 21st Century Water Infrastructure project. Such megaprojects, he says, perpetuate the simplistic myths of the early 20th century that Australia – the driest inhabited continent on Earth – can be “drought-proofed”.

When governments signed the original initiative in 2004, they agreed to ensure investments in infrastructure would be both economically viable and ecologically sustainable. But many projects appear to be neither.

The report notes, for example, that the construction of Dungowan Dam in NSW means “any infrastructure that improves reliability for one user will affect water availability for others”. The “prospect of ‘new’ water is illusory”.

The report warns that projects that aren’t economically viable or ecologically sustainable can “burden taxpayers with ongoing costs, discourage efficient water use and result in long-lived impacts on communities and the environment”.

Equally disturbing is that billions of dollars for water infrastructure are presently targeted primarily at the agriculture and mining industries, while communities in desperate need of drinking water that meets water quality guidelines miss out, Grafton says.

Fortunately, the report isn’t so house trained as to avoid mentioning the gorilla the Morrison government prefers not to notice. There’s a lot about the consequences of climate change. It says droughts will likely become more intense and frequent and, in many places, water will become scarce.

In Grafton’s summary, the report says planning provisions were inadequate to deal with both the millennium drought and the recent drought in Eastern Australia. The 2012 Murray-Darling Basin Plan, for instance, took no account of climate change when determining how much water to take from rivers and streams.

The present federal government actually dismantled the National Water Commission in 2015, meaning we no longer have a resourced, well-informed agency to “mark the homework” and make sure the reforms were being implemented as agreed, Grafton says.

In 2007, the worst year of the millennium drought – and the year John Howard feared he’d lose the election if he didn’t match Labor’s promise to introduce an emissions trading scheme – Howard remarked that “in a protracted drought, and with the prospect of long-term climate change, we need radical and permanent change”.

Grafton says we’re still waiting for that change. “If Australia is to be prosperous and liveable into the future, governments must urgently implement water reform.”

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Monday, February 15, 2021

Flogging the monetary-policy horse harder won't help

It didn’t quite hit the headlines, but when Reserve Bank governor Dr Philip Lowe appeared before the House of Reps economics committee a week or so ago, he came under intense questioning from the Parliament’s most highly qualified economist, Labor’s Dr Andrew Leigh.

In my never-humble opinion, Leigh had the wrong end of the stick.

One criticism was that the board of the Reserve Bank is dominated by “amateurs” – business men and women appointed by successive federal governments. According to Leigh, pretty much every other central bank has its decisions on monetary policy (whether to raise or lower interest rates) made by committees of outside monetary experts, who are well equipped to challenge the bank’s own technical analysis.

This is a chestnut I’ve been hearing for decades. It smacks of the old cultural cringe: Australia is out of line with the big boys in America and Europe, therefore we’re doing it wrong. The people in our financial markets spend so much time studying the mighty US economy that their line’s always the same: whatever the Yanks are doing we should be doing.

Sorry, not convinced. It sounds to me like a commercial message from the economists’ union. Why give those plum appointments to businesspeople when you could be giving them to us? When you leave the “technical analysis” just to the hundreds of economists working in the Reserve, you risk them suffering from “group think”, we’re told.

And you’d escape group think by having a committee dominated by professional economists? Economics is the only profession that doesn’t suffer from “model blindness” – the inability to see factors that have been assumed away in the way of thinking about issues that’s been drummed into them since first year uni?

I don’t think so. It’s inter-disciplinary analysis that might improve the decisions, but that’s something most economists hate. After reading Kay and King’s Radical Uncertainty, I’m happier than ever with the idea that the governor and his minions should be put through their paces by people chosen for their real-world experience, not their membership of the economists’ club.

Leigh was on stronger ground when he asked why governments had stopped including a union boss along with all the businesspeople.

But Leigh’s main criticism was that the Reserve had been “too timid in focusing on getting inflation up into the target band”. For the “amateurs” reading this, he meant why hadn’t the Reserve cut the official interest rate earlier and harder since the global financial crisis, so as to get demand growing faster, creating more employment, lifting real wages and the inflation rate in the process.

After his board’s February meeting, Lowe announced that it would be doing $100 billion more “quantitative easing” (buying second-hand government bonds with created money, so as to lower longer-term public and private interest rates). Leigh asked why he hadn’t been more purposeful and announced $200 billion in purchases.

When you’re looking for things to criticise, saying that whatever’s just been done should have been done earlier or bigger is the easiest one in the book. Various other dissident economists are saying what Leigh’s saying.

But, as so often with economists, they’re not drawing attention to the assumptions – explicit and implicit – that lie behind their policy recommendations. Their key assumption here is that cutting interest rates is still as effective in encouraging borrowing and spending as the textbooks say it is.

If households are saving more than we’d like, the reason is that interest rates are too high; if businesses aren’t investing enough, the reason is that rates are too high. So, although interest rates have been at record lows for years, just a couple more cuts (achieved by conventional or unconventional means) would do the trick and get the economy growing strongly.

And although household debt is at record highs, this wouldn’t inhibit people’s willingness to load themselves up with more. Leigh and his mates seem to be having trouble with the concept of “diminishing returns” – that the third ice cream you eat never tastes as good as the first.

Though Lowe can’t or won’t admit it, the obvious truth is that, in the world economy’s present circumstances – “secular stagnation” and all that - monetary policy has pretty much run out of puff. Which explains why he’s been moving into unconventional monetary policy so reluctantly and why, for the whole of his term, he’s been pressing the government to make more use of its budget (fiscal policy) to get the economy moving.

Some of Lowe’s critics, being monetary specialists, have (like the Reserve itself) a vested interest in continuing to flog the monetary policy horse. Other’s deny the effectiveness and legitimacy of using fiscal policy to manage demand, as part of their commitment to Smaller Government.

But perhaps the most revealing exchange came when Leigh accused the Reserve of failing to act on what its own econometric model of the Australian economy, MARTIN, (as in Martin Place) would be telling it. The reply from Lowe’s deputy, Dr Guy Debelle (whose PhD from the Massachusetts Institute of Technology is a match for Leigh’s from Harvard) was dismissive.

“I would just note that macro models don’t do a very good job of modelling the financial sector [of the economy]. They failed pretty poorly in 2007 [the global financial crisis] when macro discovered finance. I think there’s an issue around transmission [the paths through which a change in interest rates leads to changes in other economic variables] which these models don’t take into account,” Debelle said.

“They’re linear. Actually, they assume that financial markets don’t exist, broadly speaking.”

I find it reassuring that our econocrats understand how primitive econometric models of the economy are, and don’t take their results too seriously.

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Saturday, February 13, 2021

Why we're stuck with low interest rates for a long time

When it comes to interest rates, we’re living in the strangest of times, with rates lower than ever.

Savers are getting next to no reward for lending their money. Does this make sense? Not really. But we’re moving through uncharted waters and aren’t sure how we’ll get out of them, nor what happens next.

When Reserve Bank governor Dr Philip Lowe appeared before Parliament’s economics committee last Friday, he was asked whether we get the interest rates the world forces on us, or whether our authorities are free to set the rates they want.

Lowe’s answer was “we have the freedom, but we don’t”. Huh? “It’s complicated,” he explained.

Sure is. What he could have said is that we have some freedom, but not much. Were we to set our interest rates at a very different level to those in the rest of the world, there’d be a price for us to pay.

His own explanation was as clear as mud: we don’t have freedom in a structural sense, but we still have freedom in a cyclical sense.

Let me have a go. Remember that, as part of the process of globalisation over the past 40 years, the rich countries’ national financial markets are now so closely integrated with each other that each country exists in what’s pretty much a single global market, producing a single long-term real interest rate.

Purely by virtue of its big share of the global market, the things an economy as big as the US does can influence the level of the global interest rate. But nothing a middle-size economy like ours does is big enough to move the world rate. We are, as economists say, a “price taker”. We’re free only to take it or leave it.

The market price of something (including the price of borrowing money – the rate of interest) is set by the interaction of demand and supply: how much of it the buyers want to buy, relative to how much the sellers want to sell.

Lowe explained that the reason the “world equilibrium interest rate” has fallen so close to zero since the global financial crisis of 2008 is that, around the world, there’s been an increased desire by people to save, but a reduced desire to invest. That is, savers want to lend a lot more money than investors want to borrow, so interest rates have fallen sharply.

I think by now most economists accept this as the best explanation for the amazing low to which interest rates have fallen. It’s what Lowe means by “structural”. Just why saving is so much greater and investment so much smaller are questions economists are still debating.

Note that this explanation laughs at the standard view in neo-classical economics that saving increases when interest rates are higher, while investment increases when interest rates are lower.

Nor does it fit with the view that the “natural” rate of interest should reflect the rate of business profitability. Although the profits of some businesses have been hard hit by the pandemic, before it arrived – and even since, for most businesses – profitability has been high.

An alternative, minority view – pushed by economists at the Bank for International Settlements in Basel, the central bankers’ central bank – is that world interest rates have fallen so low because of the Americans’ excessive use of “quantitative easing” (central banks buying second-hand bonds and paying for them with money they’ve just created) after the global financial crisis and then, once the US economy had recovered, their failure to sell those bonds back to the market and so push interest rates back up.

An economy where households are saving too much of their incomes, and businesses don’t want to invest in expansion, is an economy that’s growing too slowly and not creating many new jobs. The solution, Lowe said, was to give people confidence to spend (and so get their rate of saving down) and give firms the confidence to invest.

How is he doing this? By cutting the official interest rate as close to zero as possible, and using quantitative easing to lower longer-term government and private sector interest rates. Really? Sounds to me like hoping to recover from a hangover by having another drink.

But back to the point. If interest rates ought to be higher to give savers a decent reward on the money they lend, why can’t our central bank set our interest rates higher than those being paid in other parts of the world?

Well, it can. We do retain that freedom. But because our financial markets are just part of the global market, what that would do is push up our exchange rate.

Why? Because financial institutions around the world would shift money into Australian dollars so as to get into our market and take advantage of our higher interest rates. When the demand for “the Aussie” exceeds the supply, the price goes up.

Such a rise in our currency’s rate of exchange against other currencies would reduce the international price competitiveness of our export and import-competing industries, thus reducing our economy’s growth and job opportunities.

That’s the price we’d pay for stepping out of line.

Lowe told the committee that the two main factors that drive the value of our dollar are world commodity prices and relative interest rates – that is, the level of our interest rates relative to other countries’ rates.

The prices we receive for the commodities we export (particularly iron ore) are up but, he said, the Aussie hadn’t appreciated (risen) by as much as you’d expect from past relationships. Why not? Because our lower official interest rates and quantitative easing have narrowed the interest rate “differential” between our rates and the rest of the world.

So, although rising commodity prices have caused our exchange rate to go higher, our quantitative easing has nevertheless caused the dollar to be “lower than it otherwise would be”. Ah. That’s the game he’s playing.

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Wednesday, February 10, 2021

Canberra's latest innovation: politics without policy

The most remarkable development since we returned to work this month is Scott Morrison’s barefaced announcement that the government has enough on its plate rolling out the virus vaccine and getting unemployment down, and so there’ll be no attempt to deal with any of our many other problems before the election late this year or early next.

There could be no franker admission that we live in an era of leaders who lack the ambition and courage to lead. Only on those problems so acute the mob is baying for the government to “Do Something!” will something be done – or grand announcements made that give the appearance it’s being done.

It’s Prime Minister as odd-job person. You don’t look for ways to secure our future, you sit there waiting for pressing matters to turn up: a light bulb that must be changed, a dripping tap that needs a new washer. Acute problems, yes; chronic problems, through to the keeper.

It’s the confirmation of what all but the rusted-on voters have long suspected: that our politicians are motivated far more by the desire to attain and retain office than by any great desire to make the world a better place for us to live and bring up our kids.

The opposing political parties continuously accuse each other of being “ideological” – of being mad free-marketeers or tax-and-spend socialists – but this serves mainly to con along their side’s true believers and conceal from the rest of us the political class’s overriding objective: to win the next election by fair means or foul.

It’s not hard to decipher Morrison’s thinking. Like the premiers, his popularity has soared following our successful containment of the pandemic, so his prospects of re-election are high – provided nothing goes wrong between now and then.

That does mean he must ensure there are no major glitches in the rollout of the vaccine – to which he will have to pay much attention – but he needs no further achievements to improve his chances of winning.

Indeed, anything else he attempts to fix offers more chance of losing the votes of the disaffected than of adding votes to his existing pile. According to informed sources (aka well-briefed gallery journalists), there’s little enthusiasm for “reform” of taxation, religious freedom, industrial relations or superannuation.

The government’s existing proposals for modest changes to industrial relations rules – about which the unions are making such fuss at present – will be put to the Senate next month but, should they fail to pass, will be dropped.

Some Liberal backbenchers’ urgings that the legislated phased increase in compulsory employer super contributions from 9.5 per cent of wages to 12 per cent be reversed (which I support) and the success of the non-profit industry super funds be sabotaged in other ways (which I don’t), have yet to be decided on, but will probably be rejected.

We’re told that Morrison’s thinking in turning away from any further policy improvement is that, after all the upheavals of 2020, the voters just want everything to calm down for a while. But that’s probably always true of many politician-weary voters. Sounds to me like a convenient rationalisation for a deeply cynical and self-serving political calculation.

You might expect this to hugely disappoint a policy wonk like me, but I confess my feelings are divided.

Morrison’s decision strike cuts both ways. He won’t be doing many things he should, but he won’t be doing many things he shouldn’t. The need for tax reform, for instance, is always with us – and urgent only in the minds of tax economists, who think of little else, and those well-to-do urgers hoping it will involve them paying less while others pay more.

There are, of course, many big problems he’ll be doing nothing to improve: the misregulation of aged care, the need for better-considered mental healthcare, the way the universities have been hung out to dry during the pandemic, the neglect and destruction of technical and further education, the many respects in which governments help oldies (including their parents) screw the younger generation.

The most urgent and important area of neglect is, of course, our response to climate change. But the federal Coalition is so deeply divided on the issue – and Morrison so hog-tied by loudmouth Liberal backbenchers and the Neanderthal Nationals – that it’s a delusion to expect genuine progress without a change of government.

And maybe not much then. As we speak, Labor is working on how many of its own policies to throw overboard. As Labor was reminded by its shock defeat in 2019, the trouble with policies is that they’re much harder for you to sell than for your opponents to misrepresent.

A big part of the reason politicians have become so lacking in policy courage is the way election campaigning has become so negative. After last time, the coming election is shaping as the battle of the scare campaigns.

Bulldust will fly on both sides. Both sides are readying themselves by having as few policies as possible. An unthinking electorate is being rewarded with policy-free elections. How edifying.

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Monday, February 8, 2021

The official forecasters’ latest guess is whistling in the dark

Although everyone knows it’s impossible to know what the future holds, everyone – from prime ministers to punters – asks economists to forecast what will happen to the economy. The economists always oblige. The latest set of official forecasts for our economy were laid before us by the Reserve Bank on Friday. You beaut. Now all is known.

Though economists have an appalling forecasting record, we are undeterred in asking for more, and the economists are undeterred in providing them.

Psychologists tell us people suffer from “the illusion of control” – the tendency to overestimate their ability to control events. Once we know what’s going to happen, we can duck and weave accordingly.

Maybe economists keep producing their forecasts merely to be obliging, but I suspect they suffer their own illusion: that having a dodgy forecast is better than not having any.

Particularly at times when we’re trying to recover from a recession – recessions the economists rarely if ever saw coming – Reserve Bank governors produce optimistic forecasts, or try to sound upbeat about a not-so-wonderful forecast, for the justifiable reason that what actually happens can, to some extent, be influenced by what enough people expect to happen. People tend to act on their expectations, as part of their illusion of control.

Reserve governor Dr Philip Lowe sounded very upbeat about his latest forecasts but, when you examine them closely, they’re not all that wonderful. Funny thing is, most of his optimism was based on the recession being not nearly as bad as he was forecasting throughout most of last year.

If he was conscious of the irony of sounding confident about this year’s forecast because last year’s had been so wrong, he did a good job of concealing it.

He’s certainly right in saying the economy bounced back after the easing of the initial lockdown far earlier and more strongly than anyone expected – with the possible exception of Scott Morrison, who was no doubt praying for another miracle.

If ever there was proof that we live in an age of “radical uncertainty” – where we must make decisions (or forecasts) on utterly insufficient information – the past year must surely be it.

The three after-the-fact reasons Lowe gave for being so wrong – we did a better job of suppressing the virus than expected; the government applied a lot more budgetary stimulus than expected; and businesses and households adapted their behaviour in unexpected ways to minimise the economic cost of the lockdown – are a useful checklist of what could go wrong with this year’s forecast of above-trend growth in real gross domestic product of 3.5 per cent in calendar 2021 and a further 3.5 per cent in 2022.

Such a seemingly optimistic prediction could prove just as wrong as last year’s – though in the opposite direction – if something goes wrong with the rollout of the vaccines or our containment of the virus, if the government’s imminent termination of its main stimulus measures proves premature, or if the behaviour of businesses and households is less helpful than the forecasters have assumed.

I suspect that most of the improvement in the economy’s rate of growth is improvement that’s already happened. It’s the bounce-back from the lifting of the lockdown, not the start of a sustainably strong recovery.

By about the middle of this year, the rapid bounce-back will have run its course, and the recovery proper will begin at a much weaker rate. If so, those two years of seemingly way-above-trend annual growth will look better than they really are, being partly an arithmetic illusion caused by our obsession with rates of change rather than the levels of GDP. The arithmetic catching up with the reality.

What forces will be driving the economy onward and upward? Not population growth, not a lower dollar, not a roaring world economy, not healthy business investment. Consumer spending is forecast to be strong, but it won’t get that strength from the forecast growth in real wages of a mere 0.25 per cent a year for the next two and a half years.

Nor will spending be powered by further budgetary stimulus. With the end of the JobKeeper wage subsidy and maybe the JobSeeker supplement in March, stimulus is being cut. No, if consumer spending stays strong it will be because stimulus payments made but not spent last year will be spent this year. Maybe. Maybe not.

But the ultimate proof that Lowe is not as optimistic as he appears is in his confident prediction that the Reserve won’t need to consider raising interest rates until 2024 at the earliest. Why? Because “wages growth and inflation are both forecast to remain subdued”. If so, the future won’t be all that wonderful.

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Sunday, February 7, 2021

RBA governor abounds in optimism about the economy’s prospects

If you think the coronacession made last year a stinker for the economy, Reserve Bank governor Dr Philip Lowe has good news: this year pretty much everything will be on the up except unemployment.

All Reserve governors see it as their duty to err on the optimistic side, and Lowe is no slouch in that department. In his speech this week foreshadowing Friday’s release of the Reserve’s revised economic forecasts for the next two years, Lowe was surprisingly upbeat on what we can expect in “the year ahead”.

His first reason for optimism is that, though last year saw the economy plunge into severe recession for the first time in almost 30 years, it didn’t go as badly as initially feared.

For one thing, he says, Australians did what they usually do: respond well in a crisis. As a community, we have pulled together in the common good and been prepared to do what’s been necessary to contain the virus.

“Because of these collective efforts, Australia is in a much better place than most other countries. This is true for both the economy and the health situation,” he says.

The downturn in the economy was not as deep as the authorities had feared and the recovery has started earlier and has been stronger than expected. “Employment growth has been strong, as have retail sales and new house building. Across many indicators, including gross domestic product, the outcomes have been better than our central forecasts and often better than our upside scenarios as well,” he says.

As recently as August, the Reserve forecast that the rate of unemployment would be close to 10 per cent by the end of last year, and still be above 7 per cent by the end of next year. Its latest forecast is that unemployment peaked at 7.5 per cent in July and – having fallen to 6.6 per cent in December - will be down to 6 per cent by the end of this year.

Why hasn’t the recession been as bad as expected? Lowe offers three reasons. First, our greater success in containing the virus.

“That success has meant that the restrictions on activity have been less disruptive than we feared. It has allowed more of us to get back to work sooner and it has reduced some [note that word] of the economic scarring from the pandemic.”

The second reason the recession hasn’t been as bad as expected is that governments’ fiscal policy (budgetary) “support” has been bigger than expected, even in August. Most of this support has come from the federal government, but the states have also played a role.

Measuring this “support” the simple way the Reserve always does, by the size of the change in the overall budget balance (this time combining federal and state budgets), he puts it at almost 15 per cent of GDP.

Note that this way of doing it adds together two elements economists often separate: the deterioration in budget balances caused by budgets’ “automatic stabilisers” – that is, the move into deficit that would have happened even had governments not lifted a finger, coming from the fall in tax collections and the rise in dole payments – and, on the other hand, the cost of governments’ explicit decisions to stimulate the economy with extra government spending (the JobKeeper wage subsidy and the temporary supplement to JobSeeker dole payments, for instance) or tax cuts.

This greater-than-expected support has made a real difference, Lowe says. “It has provided a welcome boost to incomes and jobs and helped front-load the recovery by creating incentives for people to bring forward spending.

“There has also been a positive interaction with the better health outcomes, which have allowed the policy support to gain more traction than would otherwise have been the case.”

The third reason the bounce-back has been stronger than expected is that Australians have adapted and innovated. “Many firms changed their business models, moved online, used new technologies and reconfigured their supply lines,” Lowe says.

“Households adjusted too, with spending patterns changing very significantly. Some of the spending that would normally have been done on travel and entertainment has been redirected to other areas, including electrical goods, homewares and home renovations. Online spending also surged, increasing by 70 per cent over the past year” to about 11 per cent of total retail sales.

All this suggests a stronger economy in the coming calendar year. With the key assumption that the rollout of the coronavirus vaccines in Australia goes according to Scott Morrison’s plan, but that international travel remains highly restricted for the rest of this year, real GDP is now forecast to grow at the above-trend rate of 3.5 per cent over this year, and at the same rate again over next year.

In consequence, the level of real GDP will be back to where it was at the end of 2019, before the Black Summer bushfires and the arrival of the virus. Over that 18 months we’ll have had net economic growth of zero.

As we’ve seen, the forecast rate of GDP growth is expected to get the rate of unemployment down to 6 per cent by the end of this year. But then it will take a further 18 months to fall to 5.25 per cent.

As measured by the wage price index, wages grew by just 1.4 per cent over the past year, their lowest in decades. The underlying rate of inflation also grew by 1.4 per cent over the year, way below the Reserve’s target rate of 2 to 3 per cent.

“Given the spare capacity that currently exists [seen in the high unemployment and underemployment of labour, and in unused production capacity in factories and offices], these low rates of inflation and wage increases are likely to be with us for some time,” Lowe concludes.

If so, I’m not sure I’m as upbeat about the future as the Reserve Bank governor is.

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Wednesday, February 3, 2021

Whatever our other problems, there’s much less crime to fear

When I went to Sunday school we used to sing “count your many blessings, name them one by one”. It’s good advice, enthusiastically endorsed in recent times by the practitioners of “positive psychology”. But it’s not something the media do much to help us with. So you may not have noticed that we see far fewer stories about the rising crime rate and shocking descriptions of particular crimes.

That’s because, after rising for about three decades, Australia’s crime rate has fallen sharply since 2001. When the dog doesn’t bark, the media rarely notice. But this is a blessing we should be more aware of. Not everything about the world is going to the dogs.

In a book published this week, The Vanishing Criminal, Dr Don Weatherburn and Sara Rahman seek to answer the obvious question: why something that just kept getting worse has now been getting better for a decade or two. Weatherburn, formerly director of the NSW Bureau of Crime Statistics and Research, is now an adjunct professor at the University of NSW. Rahman is a researcher working in the NSW government.

First, the back story. The figures show that during the 1970s, ’80s and ’90s, Australia faced rapidly rising rates of break-and-enter, motor vehicle theft, robbery, stealing, assault and fraud.

The international crime survey of 2000, covering 25 countries, showed us having the second-highest rate of car theft, the highest rate of burglary, the highest rate of contact crime – covering robbery, sexual assault and assault with force – and the highest overall level of crime victimisation, the authors say.

At that stage, one in 20 Australian households was falling victim to burglary every year, one in 60 was losing a car to theft, and one in 20 people over the age of 15 was being assaulted, according to the Australian Bureau of Statistics.

Although the rates of particular crimes varied widely between suburbs and towns, no state or territory escaped the rise. “The spread of lawbreaking into the suburbs led to rapidly rising public concern, fuelled by an insatiable media and political appetite for stories about rising crime,” the authors say.

At the time, the country was in the grip of a heroin epidemic, which many believed to be responsible for the rise in theft and robbery.

But then, for no obvious reason, crime rates turned from going up to going down. This, too, occurred across all states and territories.

The authors say national recorded rates of property crimes fell precipitously after 2001. By 2017, break-and-enter had fallen by 68 per cent, car theft by 70 per cent, robbery by 71 per cent and other theft by 43 per cent.

The rates for murder fell by 50 per cent, attempted murder by 70 per cent and the overall rate of homicide (including manslaughter) by 59 per cent.

Rates of assault and sexual assault continued to increase, but since 2008, the annual prevalence of actual assault fell by a third, and threatened assault by almost a quarter.

The big exception is recorded rates of (adult) sexual assault, which were higher in 2017 than in 2001, which were higher than in 1993. This is probably due to increased willingness to report offences to police.

Internet fraud has increased, of course. So has use of methamphetamine – “ice”. But unlike heroin, the authors say, ice has so far not made any measurable impression on rates of theft and robbery. It’s probably affecting violent behaviour, of course.

So why the marked decline in so many forms of crime?

The authors note that crime rates have fallen in the United States, Canada, Britain, New Zealand and many European countries. But the decline has differed in its timing and degree in those countries, suggesting there is no single cause.

Rather, in explaining Australia’s decline, they see a coincidence of various factors. With homicide, they find that all the decline has been in gun deaths, rather than the more common knife attacks. So John Howard’s gun buy-back scheme may get some credit, but they think the best explanation is the steady improvement in emergency medical treatment.

Their best explanation for the fall in assaults is the decline in alcohol abuse among young people, in response to rising alcohol prices. Changes in some factors – such as the fall in heroin dependence – have had knock-on effects.

A reduction in the number of offenders relative to the number of police, and a decline in the size of the market for stolen goods, have allowed other factors – such as the risk of getting caught – to exert a greater influence.

Fortuitously, public pressure for the police to get better results reached its peak just as knowledge about what works in policing began to affect police strategy and deployment.

And all this occurred against a backdrop of low inflation, rising real wages and falling unemployment. Crime rates and unemployment do tend to rise together – something for Scott Morrison to remember as he contemplates putting out his Mission Accomplished banner.

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Monday, February 1, 2021

How economics could get better at solving real world problems

The study of economics has lost its way because economists have laboured for decades to make their social science more mathematical and thus more like a physical science. They’ve failed to see that what they should have been doing is deepening their understanding of how the behaviour of “economic agents” (aka humans) is driven by them being social animals.

In short, to be of more use to humanity, economics should have become more of a social science, not less.

This is the conclusion I draw from the sweeping criticism of modern economics made by two leading British economics professors, John Kay and Mervyn King, in their book, Radical Uncertainty: Decision-making for an unknowable future.

But don’t hold your breath waiting for economists to see the error of their ways. There are two kinds of economist: academic economists and practising economists, who work for banks, businesses and particularly governments or, these days, are self-employed as “economic consultants”.

Whenever I criticise “economists” – which I see as part of the service I provide to readers – the academics always assume I’m talking about them. It rarely occurs to them that I’m usually talking about their former students, economic practitioners – the ones who matter more to readers because they have far more direct influence over the policies governments and businesses pursue.

You see from this just how inward-looking, self-referential and self-sustaining academic economics has become. The discipline’s almost impervious to criticism. Criticism from outside the profession (including “the popular press”) can usually be dismissed as coming from fools who know no economics. If you’re not an economist, how could anything you say have merit?

But Kay and King are insiders. As governor of the Bank of England, King was highly regarded internationally. Kay has had a long career as an academic, author, management consultant, Financial Times columnist and head of government inquiries.

So their criticism will just be ignored, as has been most of the informed criticism that came before them. Their arguments will be misrepresented – such as that they seem opposed to all use of maths and statistics in economics. They’re not. But there’ll be little face-to-face debate. Too discomforting.

Trouble is, the push to increase the “mathiness” of economics has gone for so long that all the people at the top of the world’s economics faculties got there by being better mathematicians than their rivals.

They don’t want to be told their greatest area of expertise was a wrong turn. Similarly, all the people at the bottom of the academic tree know promotion will come mainly by demonstrating how good they are at maths.

Kay and King complain that economics has become more about technique – how you do it – than about the importance of the problems it is (or isn’t) helping people grapple with in the real world. (This may help explain why, in many universities, economics is losing out to business faculties.)

In support of their case for economics needing to be more of a social science, Kay and King note there are three styles of reasoning: deductive, inductive and “abductive”. Deductive reasoning reaches logical conclusions from stated premises.

Inductive reasoning seeks to generalise from observations, and may be supported or refuted by later experience. Abductive reasoning seeks to provide the best explanation for a particular event. We do this all the time. When we say, for instance, “I think the bus is late because of congestion in Collins Street”.

Kay and King say all three forms of reasoning have a role to play in our efforts to understand the world. Physical scientists (and mathy economists) prefer to stick to deductive reasoning. But this is possible only when we study the “small world” where all the facts and probabilities are known – the world of the laws of physics and games of chance.

In the “large world”, where we must make decisions with far from complete knowledge, we have to rely more on inductive and abductive reasoning. “When events are essentially one-of-a-kind, which is often the case in the world of radical uncertainty, abductive reasoning is indispensable,” they say.

And, so far from thinking “as if” we were human calculating machines, “humans are social animals and communication plays an important role in decision-making. We frame our thinking in terms of narratives.”

Able leaders – whether in business, politics or everyday life – make decisions, both personal and collective, by talking with others and being open to challenge from them.

The Nobel prize-winning economist Professor Robert Schiller, of Yale, has cottoned on to the importance of narratives in explaining the behaviour of financial markets, but few others have seen it. Most academic economists just want to be left alone to play the mathematical games they find so fascinating.

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