The financial markets and financial press may have convinced themselves we have a serious inflation problem and must hit the interest-rate brakes early and often, but the clear message from our top econocrats is that they aren’t in such a hurry. Their eyes haven’t moved from the prize: seizing this chance to achieve genuine full employment.
Nothing in Treasury secretary Dr Steven Kennedy’s remarks to a Senate committee this week suggested he was anxious about our recent rise in prices, nor hinted that a rise in the official interest rate was imminent.
Indeed, “interest rates are still close to zero and expected to remain historically low for some time,” he said.
What little he said about inflation was that “the effects of COVID on inflation, often characterised as a combination of increased demand for goods [at the expense of demand for services] and supply-side shocks, are still passing through the economy.
“Fortunately, these impacts have been much less pronounced in Australia than in other countries. Nevertheless, the impacts have been felt and headline inflation is currently at an 11-year high.” (Not hard when inflation has been so low for so long.)
It’s true Kennedy also said that “it will not be until we see interest rates rise back to more usual levels that the risks associated with very low interest rates abate”.
But it’s clear he meant it would take years before the Reserve had rates back up to “more usual levels” - such as an official rate of 3, 4 or 5 per cent – not to give a big hint that Commonwealth Bank economists were right in predicting this week that the Reserve would start whacking up the official rate at its first board meeting after the May election.
And he was also making a quite different point. Settle back. Usually, he said, monetary policy (the manipulation of interest rates) is the primary tool with which to manage economic cycles, with fiscal policy (the manipulation of government spending and taxes in the budget) focusing on economic growth and budget stability.
Of course, in this conventional approach fiscal was complementary to monetary policy primarily through the workings of the budget’s “automatic stabilisers” (which cut tax collections and increase the number of dole payments when private sector demand is weak, but do the reverse when private demand is strong).
However, when major shocks to the economy come along, fiscal policy plays a more active role. And shocks to the economy don’t come bigger than the pandemic.
In any case, lockdowns cut the supply of goods and services, whereas monetary policy works to encourage demand – provided there’s plenty of scope to cut interest rates, which there wasn’t because rates were already close to zero.
So fiscal became the dominant policy instrument, with huge increases in government spending – including on the JobKeeper wage subsidy scheme – leading to huge increases in the budget deficit and public debt.
Got that? Now for Kennedy’s big announcement: “This unusual episode of macro-economic policy is now coming to an end.”
From here on, the dominant role will revert to monetary policy, with fiscal policy taking a step back.
Why? Well, partly because monetary policy will be busy for years getting interest rates back to “more usual levels”.
In which case, Kennedy says, “it is important that the withdrawal of fiscal policy support is tapered, as it currently is, to ensure that monetary policy has an opportunity to normalise”. (In the lingo of econocrats, “tapered” means something reduces slowly and steadily, not sharply and suddenly.)
As Kennedy says, the tapered withdrawal of fiscal policy support has already been arranged. That’s because all the government’s stimulus measures were designed to be temporary. So, as those programs wind up, the level of government spending – and the size of the budget deficit – will fall noticeably over the next few financial years.
Which means that what he’s really saying is there should be no additional, discretionary moves to hasten the return to a lower budget deficit. Why not? So monetary policy has an opportunity to “normalise”.
Get it? Over coming years, the Reserve will have to move interest rates up a long way to get them back where they should be – that is, to a level where borrowers have to compensate savers both for the loss of their money’s purchasing-power (that is, for inflation) and for being given the (temporary) use of the savers’ money.
But the Reserve’s scope to do this will be constrained if, while it’s trying to tighten monetary policy, the government’s rapidly tightening fiscal policy.
And Kennedy says there’s “an even more compelling reason” for fiscal policy support for demand not to be withdrawn too abruptly. Which is? “The opportunity to achieve full employment”. The “important opportunity to achieve and sustain full employment.”
No one knows how far unemployment can fall before shortages of labour cause wages to grow at rates that worsen inflation. Which, Kennedy says, suggests we need to exercise “a degree of caution” in tightening both fiscal policy and monetary policy.
All this fits with the remarks Reserve Bank governor Dr Philip Lowe made to a House of Reps committee the week before.
Lowe made it clear most of our inflation problem was temporary, not lasting. Although underlying inflation was 2.6 per cent, for the first time in years, “it is too early to conclude that inflation is sustainably in the target range”.
The Reserve has “scope to wait and see how the data develop and how some of the uncertainties are resolved” – one of which is whether “the stronger labour market [is] going to translate to higher wages”.
“I think it’s worth taking the time to have the uncertainties resolved and trying to secure this low rate of unemployment, which we have not had for 50 years.”
The financial types may be in panic mode over inflation, but it doesn’t sound to me like our top econocrats are in any mood to join them.
