Showing posts with label macroeconomics. Show all posts
Showing posts with label macroeconomics. Show all posts

Friday, December 15, 2023

Chalmers finds a better way to get inflation down: fix the budget

There’s an important point to learn from this week’s mid-(financial)-year’s budget update: in the economy, as in life, there’s more than one way to skin a cat.

The big news is that, after turning last year’s previously expected budget deficit into a surplus of $22 billion – our first surplus in 15 years – Treasurer Jim Chalmers is now expecting this financial year’s budget deficit to be $1.1 billion, not the $13.9 billion he was expecting at budget time seven months’ ago.

Now, though $1.1 billion is an unimaginably huge sum to you and me, in an economy of our size it’s a drop in the ocean. Compared with gross domestic product – the nominal value of all the goods and services we expect to produce in 2023-24 – it rounds to 0.0 per cent.

So, for practical purposes, it would be a balanced budget. And as Chalmers says, it’s “within striking distance” of another budget surplus.

This means that, compared with the prospects for the budget we were told about before the federal election in May last year, Chalmers and Finance Minister Katy Gallagher have made huge strides in reducing the government’s “debt and deficit”. Yay!

But here’s the point. We live in the age of “central bankism”, where we’ve convinced ourselves that pretty much the only way to steer the economy between the Scylla of high inflation and the Charybdis of high unemployment is to whack interest rates up or down, AKA monetary policy.

It ain’t true. Which means Chalmers may be right to avoid including in the budget update any further measures to relieve cost-of-living pressures and, rather, give top priority to improving the budget balance, thereby increasing the downward pressure on inflation.

The fact is, we’ve always had two tools or instruments the managers of the economy can use to smooth its path through the ups and downs of the business cycle, avoiding both high unemployment and high inflation. One is monetary policy – the manipulation of interest rates – but the other is fiscal policy, the manipulation of government spending and taxation via the budget.

This year we’ve been reminded how unsatisfactory interest rates are as a way of trying to slow inflation. Monetary policy puts people with big mortgages through the wringer, but lets the rest of us off lightly. This is both unfair and inefficient.

Which is why we should make much more use of the budget to fight inflation. That’s what Chalmers is doing. The more we use the budget, the less the Reserve Bank needs to raise interest rates. This spreads the pain more evenly – to the two-thirds of households that don’t have mortgages – which should be both fairer and more effective.

Starting at the beginning, in a market economy prices are set by the interaction of supply and demand: how much producers and distributors want to be paid to sell you their goods and services, versus how much consumers are willing and able to pay for them.

The rapid rise in consumer prices we saw last year came partly from disruptions to supply caused by the pandemic and the Ukraine war. There’s nothing higher interest rates can do to fix supply problems and, in any case, they’re gradually going away.

But another cause of the jump in prices was strong demand for goods and services, arising from all the stimulus the federal and state governments applied during the pandemic, not to mention the Reserve’s near-zero interest rates.

Since few people were out of job for long, this excessive stimulus left many workers and small business people with lots to spend. And when demand exceeded supply, businesses did what came naturally and raised their prices.

How do you counter demand-driven inflation? By making it much harder for people to keep spending so strongly. Greatly increasing how much people have to pay on their mortgages each month leaves them with much less to spend on other things.

Then, as demand for their products falls back, businesses stop increasing their prices and may even start offering discounts.

But governments can achieve the same squeeze on households by stopping their budgets putting more money into the economy than they’re taking out in taxes. When they run budget surpluses by taking more tax out of the economy than they put back in government spending, they squeeze households even tighter.

So that’s the logic Chalmers is following in eliminating the budget deficit and aiming for surpluses to keep downward pressure on prices. This has the secondary benefit of getting the government’s finances back in shape.

But how has the budget balance improved so much while Chalmers has been in charge? Not so much by anything he’s done as by what he hasn’t.

The government’s tax collections have grown much more strongly than anyone expected. Chalmers and his boss, Anthony Albanese, have resisted the temptation to spend much of this extra moolah.

The prices of our commodity exports have stayed high, causing mining companies to pay more tax. And the economy has grown more strongly than expected, allowing other businesses to raise their prices, increase their profits and pay more tax.

More people have got jobs and paid tax on their wages, while higher consumer prices have meant bigger wage rises for existing workers, pushing them into higher tax brackets.

This is the budget’s “automatic stabilisers” responding to strong growth in the economy by increasing tax collections and improving the budget balance, which acts as a brake on strong demand for goods and services.

There’s just one problem. Chalmers has joined the anti-inflation drive very late in the piece. The Reserve has already raised interest rates a long way, with much of the dampening effect still to flow through and weaken demand to the point where inflation pressure falls back to the 2 per cent to 3 per cent target.

We just have to hope that, between Reserve governor Michele Bullock’s monetary tightening and Chalmers’ fiscal tightening, they haven’t hit the economy much harder than they needed to.

Read more >>

Monday, October 16, 2023

Chalmers should give the RBA an employment target

My trouble is I’m too nice. I’m too reluctant to tell people when I think they’re not trying hard enough. If I had time over again, I’d be tougher on nice young Treasurer Jim Chalmers and his white paper on employment.

The Albanese government wants to revitalise our resolve to achieve full employment, but didn’t have the courage to put a number where its mouth is and nominate a numerical target for employment.

I’ve been convinced of this by my former colleague, friend and most worrying competitor, Peter Martin, now of the universities’ The Conversation website.

Chalmers says the white paper is “ambitious”, but Martin isn’t convinced. “A clearly ambitious statement would have specified a target for unemployment, ideally one that was a bit of a stretch,” Martin says.

He notes that the Keating government’s Working Nation statement did that in 1994. Released at a time when unemployment was almost 10 per cent, it specified a target unemployment rate of 5 per cent – an ambition that served as a beacon for decades.

With all the progress we’ve made in recent times, getting unemployment down to about 3.5 per cent for more than a year, Martin proposes setting a stretch target of 3 per cent, or even 4 per cent, as an aspiration.

Essentially, his argument for setting a target is that “what gets measured gets done”. And he’s dead right. This is not about economic theory, it’s about the practicalities of not just having ambitions, but making sure you have your best shot at achieving them.

In an ideal world, it would be enough to merely state your ambitions. But in a world of human fallibility, we need to impose on ourselves rules and targets to help us stick to our guns.

The target we’ve had for the rate of inflation – of 2 to 3 per cent, achieved on average over time – which we’ve had since 1996, has been no magic answer, but has been highly effective in leaving everyone in no doubt about whether we were on track or off track, and by how much.

But, as is widely agreed, in the day-to-day management of the economy, we have two objectives, not one: price stability (as measured by the inflation target) and full employment (as not measured by any target).

This lopsidedness leaves us constantly tempted to err on the side of low inflation at the expense of low unemployment. That’s the unspoken message the lack of a numerical target is sending the economic managers, particularly the Reserve Bank. As I’ve written before, this omission may secretly suit the interests of business.

So if the Albanese government’s professed determination to get full employment back up on its pedestal alongside price stability is to be meaningful, it must involve setting two targets, not one.

Last week, one of the nation’s leading labour market economists, Professor Jeff Borland of Melbourne University, joined this debate. He doesn’t agree that the white paper was the right place for the government to nominate a specific numerical target.

But he does believe the managers of the macroeconomy require a numerical target. To achieve what the white paper calls the “maximum sustainable level of employment”, he says, “you need to know what it is”.

Borland accepts the white paper’s criticism of the present way of estimating full employment, the NAIRU, or non-accelerating-inflation rate of unemployment, which “evolves over time, is difficult to measure, and does not capture the full potential of the workforce” – a reference to underemployment and “potential workers”, who want to work but aren’t actively seeking a job, and so aren’t counted in the labour force.

Borland adds another criticism, that “estimation of the NAIRU has become a ‘black box’, making it almost impossible to understand why it is at a particular level at any time.”

So Borland accepts the government’s argument that, rather than relying solely on estimates of the NAIRU, “policymakers need a broad suite of measures to gauge the extent of current underutilisation [of labour]” and whether the labour market is close to the current maximum sustainable level of employment.

This means Borland rejects Martin’s argument that unemployment can stay the measure of full employment because it moves in line with underemployment (having a part-time job, but not as many hours as you want).

“The rate of unemployment is no longer sufficiently informative about labour underutilisation – and labour underutilisation is what we should care about for policymaking,” Borland says.

However, he dismisses the claims of other critics that the new full-employment objective is bad news for keeping inflation under control.

He quotes what the white paper says on the matter. The objective is to “keep employment as close as possible to the current maximum sustainable level of employment that is consistent with low and stable inflation”.

The plain truth is that there has always been much potential for conflict between the goal of price stability and the goal of full employment. Life is full of such conflicts.

And a key teaching of economics is that when you encounter two conflicting but highly desirable objectives, the answer is never to fly to one extreme or the other, as humans are so often tempted to do.

No, economics teaches that what you should do is seek out the best available “trade-off” (combination) between the two, so you end up with as much of each as the circumstances allow.

The point is that making sure we have explicit targets for both is the best way to motivate the economic managers to find the best trade-off available. Both the white paper and the recent independent review of the Reserve Bank’s performance imply that, in recent years, we haven’t been finding the best trade-off between the two.

But there’s still time for Chalmers to nominate a numerical employment target. Although the Reserve’s act requires it to achieve full employment, the review recommended that, in the setting of interest rates, the full-employment objective be raised to the same status as the inflation target.

The place for this to happen is in the imminent “statement on the conduct of monetary policy”, the agreement between the treasurer of the day and the governor that the treasurer has newly appointed.

It was in the first of these agreements, in 1996, between Peter Costello and Ian Macfarlane, that the Howard government accepted the inflation target the Reserve had formulated as the government’s target.

In the upcoming agreement between Chalmers and new governor Michele Bullock, he could ask the Reserve to go away and come up with its own employment target.

But if he wants to be seen by the public as doing his job with diligence and the courage of his convictions, he will ask the new governor to accept an employment target the government has determined as the embodiment of the fine ambitions expressed in its white paper.

Read more >>

Monday, October 2, 2023

How full employment can coexist with low inflation

Who could be opposed to full employment? No one. Not openly, anyway. But Treasurer Jim Chalmers’ white paper on employment has been badly received by the Business Council and other business lobby groups. And, of course, business’s media cheer squad.

At least since Karl Marx, the left has charged that business likes unemployment to stay high so there’s less upward pressure on wages and workers are more biddable. We know that when, during recessions or lockdowns, bosses announce they’re skipping the annual pay rise, the unions never dare to disagree. Forget the pay rise and keep my job secure.

So you don’t have to swallow all the Marxist claptrap to suspect there may be some truth to the idea that, though businesses hate recessions, they don’t mind a bit of healthy unemployment.

If so, don’t expect them to be greatly enamoured of Labor’s latest resolve to pay more than lip service to the goal of full employment. But, by the same token, don’t be surprised if business happens to find in the full-employment package something they can profess to be terribly worried about.

Talk about speed reading. As is the practice in lobbyist-ridden Canberra, within minutes of the release of the white paper last Monday, the Business Council – like a lot of other business lobby groups – issued a full-page press release singing its agreement with the government’s move. It was all wonderful, and, in fact, just what the council had been calling for in its own recent voluminous report.

Until, suddenly, in the third-last paragraph, we discover the government had got it a bit wrong. Unfortunately, “we believe the federal government’s workplace relations reforms will undermine the objectives set out in the white paper.

“They will return the workplace relations system to an outdated model, unable to meet the expectations of both employees and businesses in the ways they seek to work today. It will risk fossilising industry structures and work practices when we know technology is going to change and people and workplaces need to adapt quickly,” the council says.

“If the government is to achieve the task it has set itself in this white paper, we encourage it to halt the current workplace relations changes and work constructively with business to identify challenges and find solutions that will deliver sustainable real wage increases for Australians.”

Ah, yes. Now we have it. And I’m sure all that would make perfect sense to every chief executive.

No, part of the opposition to the employment white paper comes from paper’s qualification to the definition of full employment as no one being jobless for long: “These should be decent jobs that are secure and fairly paid.”

But another part of the opposition has involved flying to the defence of the NAIRU – the “non-accelerating-inflation rate of unemployment” – which Chalmers now calls the “technical assumption” used by the Reserve Bank and Treasury in their forecasting, as opposed to the broader definition of full employment set out in the white paper.

The Australian Chamber of Commerce and Industry, the biggest employer group, said in its response to the white paper that the government “needs to make it clear that, contrary to trade union understandings, there will be zero impact on the Reserve Bank’s interest rate setting framework, and zero expectation that [it] will be more doveish on inflation”.

Well, not sure about that. Those who take the government’s recommitment to the goal of full employment to be a return to the post-World War II days when full employment was the only goal in the management of the macroeconomy are doomed to disappointment.

But those who happily imagine it will make zero difference are also kidding themselves. As the white paper makes clear, achieving sustained full employment involves “minimising volatility in economic cycles and keeping employment as close as possible to the current maximum level consistent with low and stable inflation”.

It doesn’t mean that, having fallen to about 3.5 per cent, the rate of unemployment must never be allowed to go any higher. No one has abolished the business cycle, nor the need for macro management to smooth the ups and downs in demand as the economy moves through that cycle.

So, the likelihood that, having greatly increased interest rates despite the fall in real wages, we’ll see some rise in unemployment in coming months, won’t prove the white paper was all hot air.

It’s also true, as more sensible business economists have realised, that the improvements in education and training that the white paper envisages could reduce “structural” unemployment, and thus the level of estimates of the NAIRU.

The truth is, economists make lots of calculations and the NAIRU is just one of them. While their calculations can tell them the NAIRU is now higher or lower than it was a few years ago, economists have never been able to tell you just why it’s changed.

The best they’ve ever been able to do is “ex-post” (after the fact) rationalisation. If the NAIRU has fallen, think of something that’s improved. If it’s risen, think of something that’s got worse.

The way the critics have rushed to the defence of the NAIRU, you’d think its magic number was written by God on tablets of stone. It’s just an estimate. And, like all estimates, it can be more reliable or less reliable.

No, what the government’s recommitment to full employment does is put full employment back up there as an economic objective equal in importance to low inflation. There’s always been scope for tension between the two objectives, and this increases that tension.

It says: if you’ve been erring on the side of low inflation, don’t. Try harder to find a better trade-off between the two.

It means the Reserve Bank and Treasury will now be less mindless and more mindful in the way they use the NAIRU to influence forecasts and judgements. But, unlike the critics, I think the Reserve and Treasury have already got that message.

As generator of magic numbers, the NAIRU has two glaring weaknesses. It was designed in an era when most jobs were full-time, so entirely ignores the spare capacity hidden in underemployment.

And, as the Reserve itself has acknowledged, it assumes all price rises are caused by excess demand, when we know that, in recent times, many price rises have come from disruptions to supply. And we know there’ll be more supply-driven pressure on prices from the transition to renewables and other things.

Have you noticed that whenever the Reserve and Treasury tell us their latest estimates of the magic number, they never tell us how much “judgment” they applied to the number that popped out of the model before they announced it?

But if that doesn’t convince you, try this one: the judgements the Reserve Bank makes will be better in future because, for the first time in a quarter of a century, Chalmers has appointed to its board someone who really knows how wages are set in the real world.

Read more >>

Monday, September 25, 2023

What's kept us from full employment is a bad idea that won't die

Lurking behind the employment white paper that Treasurer Jim Chalmers will release today is the ugly and ominous figure of NAIRU – the non-accelerating-inflation rate of unemployment. If the Albanese government can’t free itself and its econocrats from the grip of NAIRU, all its fine words about the joys of full employment won’t count for much.

The NAIRU is an idea whose time has passed. It made sense once, but not anymore. The story of how this conventional wisdom came to dominate the thinking of the rich world’s macroeconomists has been told by Queensland University’s Professor John Quiggin.

In the period after World War II, economists decided that the managers of the economy faced a simple choice between inflation and unemployment. Low unemployment came at the cost of high inflation, and vice versa.

This relationship was plotted on something called the Phillips curve, and the economic managers could choose which combination of inflation and unemployment they wanted.

It seemed to work well enough until the mid-1970s, when the developed economies found themselves with high unemployment and high inflation at the same time – “stagflation” – something the Phillips curve said couldn’t happen.

The economists turned to economist Milton Friedman, who’d been arguing that, if inflation persisted long enough, the expectations of workers and businesses would adjust. The inflation rate would become “baked in” as workers and suppliers increased their wages and prices by enough to compensate for inflation, whatever the unemployment rate.

So, after much debate, the economists moved to doing regular calculations of the NAIRU – the lowest rate to which unemployment could fall before shortages of labour pushed up wages and so caused price inflation to take off.

Since the early 1980s, the economic managers have tried to ensure the rate of unemployment stayed above the estimated NAIRU, so inflation would stay low. Should inflation start worsening, central bankers would jump on it quickly by whacking up interest rates.

Why? So that expectations about inflation would stay "anchored". Should they rise, the spiral of rising wages leading to rising prices would push up actual inflation. Then it would be the devil’s own job to get it back down.

If this sound familiar, it should. It’s what the Reserve Bank has been warning about for months.

Trouble is, the theory no longer fits the facts. Inflation has shot up, but because of supply disruptions, plus the pandemic-related budgetary stimulus, not excessive wage growth. And there’s been no sign of a worsening in inflation expectations.

Wages have risen in response to the higher cost of living, but have failed to rise by anything like the rise in prices. Why? Because, seemingly unnoticed by the econocrats, workers’ bargaining power against employers has declined hugely since the 1970s.

Meanwhile, the stimulus took us down to the lowest rate of unemployment in almost 50 years, where it’s stayed for more than a year. It’s well below estimates of the NAIRU, meaning wages should have taken off, but shortage-driven pay rises have been modest.

All of which suggest that the NAIRU is an artifact of a bygone age. As Quiggin says, the absence of a significant increase in wage growth is inconsistent with the NAIRU, which was built around the idea that inflation was driven by growth in wages, passed on as higher prices.

“As a general model of inflation and unemployment, it is woefully deficient,” Quiggin concludes.

Economists have fallen into the habit of using their calculations of an ever-changing NAIRU as their definition of full employment. But it’s now clear that, particularly in recent years, this has led us to accept a rate of unemployment higher than was needed to keep inflation low, thus tolerating a lot of misery for a lot of people.

So if today’s employment white paper is to be our road map back to continuing full employment – if our 3.5 per cent unemployment rate is to be more than a case of ships passing in the night – we must move on from the NAIRU.

A policy brief from the Australian Council of Social Service makes the case for new measures of full employment and for giving full employment equal status with the inflation target in the Reserve Bank’s policy objectives – as recommended by the Reserve Bank review.

The council quotes with approval new Reserve governor Michele Bullock’s definition that “full employment means that people who want a job can find one without having to search for too long”.

But it says another goal could be added, that “people who seek employment but have been excluded (including those unemployed long-term) have a fair chance of securing a job with the right help”.

And it argues that “since an unemployment rate of 3.5 per cent (and an underemployment rate of 6 per cent) has not triggered strong wages growth, this could be used as a full employment benchmark”.

One of the things wrong with the NAIRU was that it was a calculated measure, and it kept changing. As Quiggin notes, it tends to move in line with the actual rate of unemployment.

“When unemployment was high, estimates of NAIRU were high. As it fell, estimates of NAIRU fell, suggesting that how far unemployment could fall was determined by how far unemployment had fallen,” he says.

Which is why, to the extent that econocrats persist with their NAIRU estimates – or the government sets a more fixed target – the council is smart to suggest a test-and-see approach.

Rather than continuing to treat a fallible estimate as though it’s an electrified fence – to be avoided at all cost – you allow actual unemployment to go below the magic number, and see if wages take off. Only when they do, do you gently apply the brakes.

The council reminds us that it’s not enough to merely aspire to full employment, or even specify a number for it. It’s clear that, apart from the ups and downs of the business cycle, what keeps unemployment higher than it should be is long-term unemployment.

Committing to full employment should involve committing to give people who have “had to search too long” special help just as soon as their difficulties become apparent.

This would be a change from paying for-profit providers of government-funded “employment services” to punish them for their moral failings.

Read more >>

Monday, September 11, 2023

How Philip Lowe was caught on the cusp of history

Outgoing Reserve Bank boss Dr Philip Lowe was our most academically outstanding governor, with the highest ethical standards. And he was a nice person. But if you judge him by his record in keeping inflation within the Reserve’s 2 to 3 per cent target – as some do, but I don’t – he achieved it in just nine of the 84 months he was in charge.

Even so, my guess is that history will be kinder to him than his present critics. I’ve been around long enough to know that, every so often – say, every 30 or 40 years – the economy changes in ways that undermine the economics profession’s conventional wisdom about how the economy works and how it should be managed.

This is what happened in the second half of the 1970s – right at the time I became a journalist – when the advent of “stagflation” caused macroeconomists to switch from a Keynesian preoccupation with full employment and fiscal policy (the budget) to a monetarist preoccupation with inflation and monetary policy (at first, the supply of money; then interest rates).

My point here is that it took economists about a decade of furious debate to complete the shift from the old, failing wisdom to the new, more promising wisdom. I think the ground has shifted again under the economists’ feet, that the macroeconomic fashion is going to swing from monetary policy back to fiscal policy but, as yet, only a few economists have noticed the writing on the wall.

As is his role, Lowe has spent the past 15 months defending the established way of responding to an inflation surge against the criticism of upstarts (including me) refusing to accept the conventional view that TINA prevails – “there is no alternative” way to control inflation than to cut real wages and jack up interest rates.

If I’m right, and economists are in the very early stages of accepting that changes in the structure of the economy have rendered the almost exclusive use of monetary policy for inflation control no longer fit for purpose, then history will look back more sympathetically on Lowe as a man caught by the changing tide, a victim of the economics profession’s then failure to see what everyone these days accepts as obvious.

Final speeches are often occasions when departing leaders feel able to speak more frankly now that they’re free of the responsibilities of office. And Lowe’s “Some Closing Remarks” speech on Thursday made it clear he’d been giving much thought to monetary policy’s continuing fitness for purpose.

His way of putting it in the speech was to say that one of the “fixed points” in his thinking that he had always returned to was that “we are likely to get better outcomes if monetary policy and fiscal policy are well aligned”. Let me give you his elaboration in full.

“My view has long been that if we were designing optimal policy arrangements from scratch, monetary and fiscal policy would both have a role in managing the economic cycle and inflation, and that there would be close coordination,” Lowe said.

“The current global consensus is that monetary policy is the main cyclical policy instrument and should be assigned the job of managing inflation. This is partly because monetary policy is more nimble [it can be changed more quickly and easily than fiscal policy] and is not influenced by political considerations.”

“Raising interest rates and tightening policy can make you very unpopular, as I know all too well. This means that it is easier for an independent central bank to do this than it is for politicians,” he said.

“This assignment of responsibility makes sense and has worked reasonably well. But it doesn’t mean we shouldn’t aspire to something better. Monetary policy is a powerful instrument, but it has its limitations and its effects are felt unevenly across the community.”

“In principle, fiscal policy could provide a stronger helping hand, although this would require some rethinking of the existing policy structure. In particular, it would require making some fiscal instruments more nimble, strengthening the (semi) automatic stabilisers and giving an independent body limited control over some fiscal instruments.”

“Moving in this direction is not straightforward, but some innovative thinking could help us get to a better place,” Lowe said.

“During my term, there have been times where monetary and fiscal policy worked very closely together and, at other times, it would be an exaggeration to say this was the case.”

“The coordination was most effective during the pandemic. During that period, fiscal policy was nimble and the political constraints on its use for stabilisation purposes faded away. And we saw just how powerful it can be when the government and the Reserve Bank work very closely together.”

“There are some broader lessons here and I was disappointed that the recent Reserve Bank Review did not explore them in more depth,” Lowe said.

So was I, especially when two of Australia’s most eminent economists – professors Ross Garnaut and David Vines – made a detailed proposal to the review along the lines Lowe now envisages. (If Vines’ name is unfamiliar, it’s because most of his career was spent at Oxbridge, as the Poms say.)

But no, that would have been far too radical. Much safer to stick to pointing out all the respects in which the Reserve’s way of doing things differed from the practice in other countries – and was therefore wrong.

In question time, Lowe noted that one of the world’s leading macroeconomists, Olivier Blanchard, a former chief economist at the International Monetary Fund (and former teacher of Lowe’s at the Massachusetts Institute of Technology), had proposed that management of the economy be improved by creating new fiscal instruments which would be adjusted semi-automatically, or by a new independent body, within a certain range.

Lowe also acknowledged the way the marked decline over several decades in world real long-term interest rates – the causes of which economists are still debating – had made monetary policy less useful by bringing world nominal interest rates down close to the “zero lower bound”.

How do you cut interest rates to stimulate growth when they’re already close to zero? Short answer: you switch to fiscal policy.

But what other central banks – and, during the pandemic, even our Reserve Bank – have done was resort to unconventional measures, such as reducing longer-term official interest rates by buying up billions of dollars’ worth of second-hand government bonds.

Lowe said he didn’t think this resort to “quantitative easing” was particularly effective, and he’s right. I doubt if history will be kind to QE.

However, there’s one likely respect in which the ground has shifted under the economists’ feet that Lowe – and various academic defenders of the conventional wisdom – has yet to accept: the changed drivers of inflation. It’s not excessive wages any more, it’s excessive profits.

More about all this another day.

Read more >>

Monday, June 5, 2023

Business cries poor on wages, even as profits mount

Don’t believe anyone – not even a governor of the Reserve Bank – trying to tell you the Fair Work Commission’s decision to increase minimum award wages by 5.75 per cent is anything other than good news for the lowest-paid quarter of wage earners.

Because they are so low paid, and mainly part-time, these people account for only about 11 per cent of the nation’s total wage bill. So, as the commission says, the pay rise “will make only a modest contribution to total wages growth in 2023-24 and will consequently not cause or contribute to any wage-spiral”.

But that’s not the impression you’d get from all the wailing and gnashing of teeth by the main employer group, the Australian Chamber of Commerce and Industry. It claims “an arbitrary increase of this magnitude consigns Australia to high inflation, mounting interest rates and fewer jobs”.

These are the sort of dramatics we get from the Canberra-based employers’ lobby before and after every annual wage review. They lay it on so thick I doubt anyone much believes them.

But it’s worse than that. In the age-old struggle between labour and capital – wages and profits – most economists have decided long ago whose side they’re on, and long ago lost sight of how one-eyed they’ve become.

For a start, many of the talking heads you see on telly work for big businesses. They’re never going to be caught saying nice things about pay rises.

Econocrats working for conservative governments have to watch what they say. And parts of the media have business plans that say: pick a lucrative market segment, then tell ’em what they want to hear.

In my experience, there’s never any shortage of experts willing to fly to the defence of the rich and powerful, in the hope that some of the money comes their way.

But I confess to being shocked in recent times by the way the present Reserve Bank governor, Dr Philip Lowe, has been so willing to take sides. The way he preaches restraint to ordinary workers struggling to cope with the cost of living, but never urges businesses to show restraint in the enthusiasm with which they’ve been whacking up their prices.

It’s true that Lowe has a board that’s been stacked with business people, but that’s been true for all his predecessors, and they were never so openly partisan.

When businesses take advantage of the excessively strong demand that Lowe himself helped to create, that’s just business doing what comes naturally, and must never be questioned, even in an economy characterised by so much oligopoly – big companies with the power to influence the prices they charge.

But when employees unite to demand pay rises at least sufficient to cover the rising cost of living, this is quite illegitimate and to be condemned. The more so when a government agency such as the Fair Work Commission acts to protect the incomes of the poorest workers.

On Friday, the commission set out what has long been the rule for fair and efficient division of the spoils of the market system between labour and capital: “In the medium to long term, it is desirable that modern award minimum wages maintain their real value and increase in line with the trend rate of national productivity growth”.

In other words, wage rises don’t add to inflation unless their growth exceeding inflation exceeds the nationwide (not the particular business’) trend (that is, over a run of years, not just the last couple) rate of growth in the productivity of labour (production per hour worked).

But last week, in his appearance before a Senate committee, Lowe was twisting the rule to suit his case, setting nominal (before taking account of inflation) unit labour costs (labour costs adjusted for productivity improvement) not real unit labour costs as the appropriate measure.

He told the senators that growth in labour costs per unit of 3 or 4 per cent a year was adding to inflation because the past few years had seen no growth in the productivity of labour (which, of course, is the fault of the government, not the businesses doing the production).

This is dishonest. What he was implying was that wage growth should not bear any relationship to what’s happening to prices at the time. Wage growth should be capped at 2.5 per cent a year every year, come hell or high water.

Without any productivity improvement, any wage growth exceeding 2.5 per cent was inflationary. Should the nation’s businesses choose to raise their prices by more than 2.5 per cent, what was best for the economy was for the workers’ wages to fall in real terms.

Now, Lowe is a very smart man, and I’m sure he doesn’t actually believe anything so silly. Like the employer groups, he’s cooked up a convenient argument to help him achieve his KPIs. He sees the inflation rate as his key performance indicator.

He’s got to get it down to the 2 to 3 per cent target range, and get it down quick. He ain’t too worried what shortcuts he takes or who gets hurt in the process.

When he claims that, absent productivity improvement, wage rises far lower than the rate of inflation are themselves inflationary, what he really means is that they make it harder for him to achieve his KPIs.

Clearly, the wage rise that would help him get the inflation rate down fastest is a wage rise of zero. It would plunge the economy into recession, and businesses would have a lot more trouble finding customers, but who cares about that?

It’s not true that sub-inflation-rate pay rises add to inflation. What is true is that the bigger the sub-inflation rise, the longer it takes to get inflation down. But he doesn’t like to say that.

Why’s he in such a hurry he’s happy for ordinary workers to suffer? Because he lies awake at night worrying that, if it takes too long to get inflation down, inflation expectations will rise and a price-wage spiral will become entrenched.

Does Treasury secretary Dr Steven Kennedy also lie awake? Doesn’t seem to. He told the senators last week that “there are no signs of a wage-price spiral developing and medium-term inflation expectations remain well anchored”.

If ever there was a general fighting the last war, it’s Lowe.

Meanwhile, please don’t say business profits seem to be going fine. It may be true, but please don’t say it. Business doesn’t like you saying such offensive things, and business’ media cheer squad goes ape.

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Friday, May 26, 2023

What they don't tell you about how the budget works

Now we have some space, there are things I should tell you that there’s never time for on budget night. If you don’t know these things, the media can unwittingly mislead you, and the government spin doctors can knowingly mislead you.

A budget’s just a plan for how much income you’re expecting in the coming period, and what you want to spend it on. Governments have budgets and so do businesses and families.

You may think you know a lot about budgeting and that all you need is common sense, but the federal government’s budget ain’t like any other budget you’ve known.

Where people go wrong is assuming the government’s budget is the same as their own household budget, only much bigger. Families budget so they don’t end up spending more than they earn.

But governments often spend more than they raise in taxes – run at a “deficit” – and only occasionally spend less than they raise – run a “surplus”. When they run deficits, they borrow to cover it; when occasionally they run a surplus, they can pay back a bit of it.

Governments can borrow, and keep borrowing, in a way families can’t. Why? Because they can’t go broke. When they run short of money, they can do what no family can do: order all the other families to give them money. It’s called taxation.

And national governments can go one step further and print their own money. Money is just a piece of plasticky stuff that’s worth, say, $50. Why is it worth $50? For no reason other than that the government says it is, and everyone believes it.

Actually, these days the government doesn’t print money so much as create it out of thin air, by crediting bank accounts. This is done not by the government itself, but by a bank the government owns: the Reserve Bank. It created hundreds of billions during the pandemic (although now the Reserve is making the government gradually pay it back, by actually borrowing the money).

Everyone knows that whatever you borrow has to be paid back. What’s more, you have to keep paying interest on the debt until it is paid back. Parents know they have to get any home loan paid back before they retire.

The trouble with a family is that eventually it dies. The kids grow up and start families of their own, then mum and dad pop off. But governments don’t die. The nation’s government acts on behalf of all the families in the country. There are always some families dying, but always others taking their place.

This is why families have to pay back their debts, but governments don’t – and often choose not to. Because governments go on and on, the main way they get on top of their debts is by waiting for the economy to outgrow them, so the size of their debt declines relative to the size of the economy.

Remember, unless you add to it, a debt is a fixed dollar amount, whereas the size of the economy – gross domestic product – grows with inflation and “real” economic growth.

The final thing making government budgets different from family budgets is that a particular family’s budget is too small to have any noticeable effect on the economy, whereas the federal budget is so big – about a quarter the size of the economy – that changes the government makes in its spending and taxing plans can have a big effect on an individual family’s budget and indeed, many families’ budgets.

But it also works the other way: what happens to one family won’t have a noticeable effect on the budget, but what happens to many families – say, everyone’s getting bigger pay rises, or many families are cutting back because they’re having trouble coping with the cost of living – certainly will affect the budget.

What common sense doesn’t tell you is that there’s a two-way relationship between the budget and the economy. The budget can affect the economy, but the economy can affect the budget.

Whenever a treasurer announces on budget night that he (one day we’ll get a she) is expecting the budget deficit to turn into a surplus, the media usually assume this must be because of something he’s done.

Possibly, but it’s more likely to be because of something the economy did. In this month’s budget, it’s because the economy’s been growing strongly, leading families and companies to earn more income and pay more tax on it.

Because many in the media imagine the government’s budget is the same as a family’s budget, they assume that budget deficits are always a bad thing and surpluses a good thing.

Not necessarily. If the budget was in surplus during a recession, that would be a bad thing because it would mean that, by raising more in taxes than it was spending, the budget would be making life even harder for families.

Only when the economy’s growing too fast and adding to inflation pressure is it good to have the budget in surplus and so helping to slow things down. And deficits are a good thing when the economy’s in recession because this means that, by spending more than it’s raising in taxes, the budget’s helping to prop up the economy.

But not to worry. When the economy goes into recession, the budget tends to go into deficit – or an existing deficit gets bigger – automatically. Why? Because people pay less tax and the government has to pay unemployment benefits to more people. Economists call this the budget’s “automatic stabilisers”.

Hidden away in the budget papers you find Treasurer Jim Chalmers quietly admitting he has no intention of trying to pay off the big public debt he inherited. His “overarching goal” is to “reduce gross debt as a share of the economy over time”.

Finally, for a family, a $4 billion surplus is an unimaginably huge sum of money. But for a federal government, it’s petty cash.

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Friday, May 19, 2023

Chalmers and Lowe: good cop, bad cop on the inflation beat

Have you noticed? There’s a contradiction at the heart of Treasurer Jim Chalmers’ budget. Is it helping or harming inflation?

Both Chalmers and Reserve Bank governor Dr Philip Lowe are agreed that our top priority must be to get the rate of inflation down. That’s fine. Everybody hates the way prices have been shooting up. The cost of living has become impossible. Do something!

But while Lowe seems to be just making it all worse, jacking up mortgage interest rates higher and higher, nice Mr Chalmers is using his budget to take a bit of the pressure off, helping with electricity bills, cutting prescription costs and so on.

It’s as though Lowe is the arsonist, sneaking round the bush to start more fires, while Chalmers is the Salvos, turning up at the scene to give the tired firefighters a kind word, a pie and a cup of tea.

Is that how you see it? That’s the way Chalmers wants you to see it, and Lowe knows full well it’s his job to be Mr Nasty at times like this.

But what on earth’s going on? Has the world gone crazy? No, it’s just the usual dance between brutal economics on one hand, and always-here-to-help politics on the other.

Let’s start from scratch. Why do we have an inflation problem? Because, for the past 18 months or so, the prices of the things we buy have been shooting up, rising much faster than our wages, causing the cost of living to become tough for many people.

Why have prices been rising so rapidly? Partly because the COVID-19 pandemic and Russia’s attack on Ukraine caused international shortages of building materials, cars, computer chips and fossil fuels. But also because the massive increase in our governments’ payments during the pandemic left us cashed up and spending big on locally made goods and services.

When the suppliers of the stuff we buy can’t keep up with our demand for it, they raise their prices. The media may call this “price gouging”, but economists believe it’s what happens naturally in a market economy – and should happen because the higher price gives the suppliers an incentive to produce more. When they do, the price will come down.

When inflation takes off like this, what can the managers of the economy do to stop prices rising so fast? They can do nothing to magically increase supply; that takes time. But what they can do is reduce demand – discourage us from spending so much.

How? This is where it gets nasty. By squeezing households’ finances so hard they have to cut their spending. Once demand for the stuff they’re selling falls back, businesses are much less keen to raise their prices.

At present, households are being squeezed from all directions. The main way is that wages aren’t keeping up with the rise in prices. As well, more of the wage rises people are getting is being eaten up by income tax, thanks to “bracket creep”.

And the fall in house prices means home-owning households aren’t feeling as wealthy as they were.

All that’s before you get to Mr Nasty, raising the interest rates paid by people with mortgages, which is particularly tough on young home owners, with more recent, much bigger mortgages.

(You may wonder if this extra pressure on, say, only about 20 per cent of all households is either fair or the most effective way to get total household spending to slow. And you may be right, but you’d be way ahead of the world’s economists, who think the way they’ve always done it is the only way they could do it.)

But what part is the budget – “fiscal policy” – supposed to play in all this? It should be helping put the squeeze on, not reducing it. Now do you see why some are questioning whether Chalmers’ $14.6 billion “cost-of-living relief package” will help or hinder the cause of lower inflation?

The budget balance shows whether government spending is putting more money into the economy, and its households, than it’s taking out in taxes. If so, the budget’s running a deficit. If it’s taking more money out than it’s put back in, the budget’s running a surplus.

The way the Reserve Bank judges whether the budget is increasing the squeeze on households, or easing it, is to look at the size and direction of the expected change in budget balance from one year to the next.

The budget papers show the budget balance is planned to change from an actual deficit of $32 billion last financial year, 2021-22, to an expected surplus of $4 billion in this financial year, ending next month.

That’s an expected tightening of $36 billion, equivalent to 1.6 per cent of the size of the whole economy, gross domestic product.

No doubt such a change is adding a big squeeze to household incomes. But then the budget balance is expected to worsen in the coming financial year, 2023-24, to a deficit of $14 billion. That’s an easing of pressure on households’ finances equivalent to 0.7 per cent of GDP.

Put the two years together, however, and its clear the budget will still be putting a lot of squeeze on households – on top of all the other squeeze coming from elsewhere.

Somewhere in there is most of Chalmers’ $14.6 billion relief package. As a matter of arithmetic, it’s undeniably true that, had the package – which, by the way, is expected to reduce the consumer price index by 0.75 percentage points – not happened, the squeeze would be, say, $10 billion tighter than it’s now expected to be.

But there’s no way, looking at that – and all the other sources of squeeze – the Reserve will be saying, gosh, Chalmers is adding to inflation pressure, so we’d better raise rates further.

Chalmers has said the “stance” of fiscal policy adopted in the budget is “broadly neutral”. Not quite. So, I’ll say the nasty word Mr Nice Guy doesn’t want to: the stance is “mildly contractionary”.

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Monday, May 8, 2023

How budget spin doctors manipulate our first impressions

These days, federal budgets are just as much marketing and media management exercises as they are financial and economic documents. That’s because the spin doctors’ role has become central to the way Canberra works. This is just as true under Labor as the Coalition. Media management is a characteristic of government by the two-party duopoly.

Budgets are actually the management plan for controling the government’s spending and tax-raising over the coming financial year. Because you can’t do a budget without first making guesses about what will be happening in the economy at the time, the budget documents contain detailed economic forecasts and commentary about what it has supposed will happen.

These forecasts are taken very seriously on budget night, but rarely referred to again. That’s because this era of dominant “monetary policy” (manipulation of interest rates), conducted by an independent central bank, means it’s the Reserve Bank’s forecasts that matter.

We’ve had those already, on Friday. The financial markets care more about the Reserve’s opinions than the government’s because they’re always trying to guess what the central bank will do to interest rates. What’s more, the RBA revises its forecasts quarterly, so the budget forecasts soon become outdated.

All this means the government’s forecasts can’t be very different from the Reserve’s. Differ by more than half a percentage point, and you get headlines about a split between Treasury and the central bank. Nothing the econocrats hate more (even though there’s unceasing rivalry between the two outfits).

A separate question is what effect the budget, and particularly the new measures it contains, will have on the economy: on gross domestic product, inflation and unemployment. Now that the macroeconomic fashion (aka “best practice”) dictates that the management of demand be left to the central bank – except in emergencies, such as the pandemic – the budget papers will contain little discussion of this.

But the inescapable fact remains that, the federal budget being so big relative to the economy, everything it does affects economic growth. That’s true whether the economic effects were intended or are the unintended consequence of politically driven decisions. All budget measures are political but, equally, all have economic consequences.

At this time of year, many people say they don’t know why the government is bothering to hold a budget when it has already announced the changes it’s making. Well, not quite.

What’s true is that, these days, budgets – and the days leading up to them – are highly stage-managed by the spin doctors. These people are based in the PMO – prime minister’s office – with extension into every minister’s office, via the minister’s press secretary. All paid for by the taxpayer, naturally.

The spin doctors’ job is to use the “mainstream media” to convey to voters an unduly favourable view of the government and the things it’s doing. They do this by exploiting the foibles of journalists and their editors.

Hence, the common trick of releasing potentially embarrassing information late on a Friday, when it’s less likely to make the bulletin. The hope is that, by Monday, the under-reported story is passed over as “old”.

The spinners have the great advantage of a near monopoly over news about what the government is doing. Much of this news is put into press releases, but much is held for selective release to journalists and outlets that are in favour with the government. Write a piece like this one and don’t expect to be popular.

In the olden days, many budget “leaks” really were leaks, the product of journalists talking to bureaucrats and putting two and one together to make four. These days, bureaucrats are forbidden to speak to journos, so most budget leaks have come from the spin doctors, intended to soften us up for what’s to come.

Sometimes, something – say, that the government has decided to increase the JobKeeper payment only for the over-55s – is leaked to just one or two news outlets to “run it up the flagpole and see who salutes”. If it goes over well enough, it will happen. If there’s a big adverse reaction it may never be heard of again.

Any bad news is usually officially announced ahead of the budget, so it won’t spoil the budget’s reception on the night. Lots of small but nice decisions will be announced early, so they don’t get overlooked on the night.

But, particularly if there has been a big pre-announced unpopular measure, the spinners will save some nice, un-foreshadowed hip-pocket measure for unveiling on the night. This, being the only major budget measure that’s “new”, will dominate the media’s reporting. I call it the cherry on top.

As a former treasurer, John Kerin, demonstrated in 1991 – much to the disapproval of Paul Keating - there is no genuine need for reporters to be locked up and allowed to see the budget papers well before the treasurer delivers his speech at 7.30pm, immediately after the ABC evening news.

But the budget “lockup” persists to this day because of its great media-management advantages. It’s of much benefit to have the treasurer’s made-for-telly (that is, full of spin) budget speech broadcast in prime time, rather than after lunch. (The smaller disadvantage is that the ABC gives the leader of the opposition – not the shadow treasurer – right of reply, at the same time on Thursday night.)

The other advantage of a lockup is that letting journalists out so late in the day gives them little time to ask independent experts what they thought of the budget. Rather, they’ve spent six hours locked up with Treasury heavies. (I remember one saying to me, long ago: “Not much there to criticise, eh?” )

This media manipulation usually ensures the media’s first impressions are more favourable to the government than they should be, getting the budget off to a good start with the voters. Only on day two do the interest groups finish combing through the fine print and finding the carefully hidden nasties.

All pretty grubby, but true.

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Friday, May 5, 2023

RBA review attacks the groupthink of others, but not its own

With more time to think about it, it’s clear the review of the Reserve Bank is not the sweeping blockbuster shake-up overhaul we were told it was. Even if all its recommendations are accepted, ordinary borrowers and savers won’t discern any difference in the way interest rates go up and down. But to those who work at the Reserve, and the small army of people who make a lucrative living second-guessing its decisions, the proposed “modest improvements” are a big deal.

Ostensibly, they’re aimed at getting the Reserve up to “world best practice”. But that’s just a spin doctor’s term for doing things the same way everyone else does them. Where’s the evidence that the conventional wisdom is sure to be “best practice”?

It’s also a way of concealing the colonial cringe. Because the rich world’s financial markets are now so highly integrated, with the biggest rich country’s Wall Street setting the lead, most people in our financial market think that if we’re not doing it the way the US Federal Reserve does it, we’re obviously doing it wrong.

This inferiority complex is reinforced because, for the past 30 years, most other central banks have conformed to the US Fed’s ways – even the world’s best colony-conscious country, Britain, has switched to the Fed’s way.

So, what is the Fed’s way? To have interest rates set by a special committee of outside experts, meeting eight times a year not monthly, with each member employed part-time and getting lots of research assistance.

The monetary policy committee should hold a press conference after every meeting and each member should give at least one speech a year on the topic.

To be fair, the Reserve’s Americanisation was pre-ordained by Treasurer Jim Chalmers’ terms of reference and his decision to have the inquiry led by Carolyn Wilkins, a former Bank of Canada heavy and now Bank of England heavy.

Of course, just because we do things differently to the others doesn’t guarantee we’re doing it better, any more than it means we’ve been doing it worse. I’d say our performance over the past 30 years – since the introduction of inflation targeting – has seen a few missteps, but been at least as good as any of the others.

And if the American way is “best practice”, how come the Fed’s been so heavily criticised for being slow to respond to the inflation surge?

But let’s be frank. The review’s big criticism of the Reserve is that it’s too insular, too inward looking and inbred. Except when one Treasury man got the job, governors are always promoted internally. The present governor joined the bank from high school. External appointments to senior economic jobs are rare.

As the review’s critique implies, the Reserve is a one-man band. The governor’s word is law, with limited tolerance for debate. He runs as much of the show as he chooses to, leaving the boring bits to his deputy.

It suits the governor to have a board stacked with business people because, not being economists, their doubts are easily dismissed. Employees would never disagree with the boss in front of the board, and any reservations the Treasury secretary may have would be raised in private.

There always used to be a union leader on the board, but he was let go as part of John Howard’s efforts to delegitimise the union movement which, in his eyes, was in league with his Labor opponents.

This does much to explain the present governor’s ignorance of labour-market realities. Dr Philip Lowe bangs on unceasingly about wages, but excludes unions from the Reserve’s extensive consultations with business and even welfare groups. I don’t remember hearing that swearword “union” ever pass his lips.

There’s always been an academic economist on the board, but they’re in no position seriously to take on the establishment. The board rarely if ever votes on anything. Rather, the chairman-governor “sums up the feeling of the meeting”.

Note, the Reserve has worked this way for the four decades I’ve been watching it. But it does seem to have become more insular and, as the review charges, more subject to “groupthink”, under Lowe.

The inquiry heard from young ex-Reserve economists saying they’d been warned that expressing doubt about the house line would harm their promotion prospects. I’ve been hearing that lately, too.

It’s madness for the Reserve to recruit the cream of each year’s graduating economists, then tell ’em not to speak unless spoken to. And what a way to train the next governor but three.

So, bring an end to groupthink inside the Reserve? Of course. Get a more vigorous debate around the board table before deciding on rates? Sure.

But here’s the joke. While rightly criticising the Reserve for encouraging groupthink, the report is itself a giant case of groupthink. It accepts unquestioningly the conventional wisdom of recent decades that there’s really only one way you could possibly manage the economy through the ups and downs of the business cycle, and that’s by manipulating interest rates.

Any role for “fiscal policy” – changing taxes and government spending? Didn’t think of that but, no, not really. Just make sure it doesn’t get in the way of the central bank.

We’ve fiddled with interest rates so much we’ve got them down to zero. Should we stop? Gosh no. Just think of some way to keep going. The review accepts that the central banks’ misadventure into “unconventional monetary policy” – UMP – which it sanctifies as “additional monetary policy tools”, is now part of “best practice”.

Really? Competitive currency devaluations are the way to fix the global economy’s ills? Can you hear yourselves?

Apparently, slowing the growth in spending by directly punishing the small proportion of households young and foolish enough to load themselves up with mortgage debt is “best practice”.

No, it’s not. It’s just a sign that the review committee is so caught up by global groupthink that it has never thought there might be a better way.

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Monday, March 6, 2023

RBA inquiry should propose something much better

The inquiry into the Reserve Bank, due to report this month, will be disappointing if it does no more than suggest modest improvements in the way it does its job. The question it should answer is: should we give so much responsibility to an institution with such a limited instrument – interest rates – and with such a narrow focus?

In Reserve Bank governor Dr Philip Lowe’s lengthy appearance before the House of Representatives Economics Committee last month, he spent much of his time reminding critics that he only has one tool, so he can’t do anything to resolve the problems they were complaining about.

He’s right. But if the problems are real, and he can’t do anything about them, why should the central bank be the top dog when it comes to managing the economy, and Treasury’s job be limited to worrying about debt and deficit?

Shouldn’t the greatest responsibility go to an institution with more instruments, and ones capable of doing more tricks?

By the way, if you’re wondering why I’ve had so much to say recently about the limitations of monetary policy and the questionable convention of making it dominant in the management of the macroeconomy, it’s because it’s the obvious thing to do while we’re holding an inquiry into Reserve Bank’s performance.

Frenchman Olivier Blanchard, one of the world’s top macroeconomists, recently caused a storm when he tweeted about “a point which is often lost in discussions of inflation and central bank policy”.

“Inflation,” he wrote, “is fundamentally the outcome of the distributional conflict between firms, workers and taxpayers. It stops only when the various players are forced to accept the outcome.”

Oh, people cried, that can’t be right. Inflation is caused when the demand for goods and services exceeds the supply of them.

In truth, both propositions are correct. At the top level, inflation is simply about the imbalance between demand and supply. At a deeper level, however, “distributional conflict” between capital and labour can be the cause of that imbalance.

Businesses add to inflation when they seek to increase their profit margins. Workers and their unions add to inflation when they seek to increase their real wages by more than the productivity of labour justifies.

But this way of thinking is disconcerting to central bankers because – though there may well be a way of reducing inflation pressure by reducing the conflict between labour and capital – there’s nothing the Reserve can do about it directly.

Central banks’ interest-rate instrument can fix the problem only indirectly and brutally: by weakening demand (spending) until the warring parties are forced to suspend hostilities. So distributional conflict is the first thing monetary policy (the manipulation of interest rates) can’t really fix.

Then there’s inflation caused by other supply constraints, such as the pandemic or wars. Again, monetary policy can’t fix the constraint, just bash down demand to fit.

The next things monetary policy doesn’t do are fairness and effectiveness. When we’re trying to reduce inflation by reducing people’s ability to consume goods and services, it would be nice to do so with a tool that shared the burden widely and reasonably evenly.

A temporary increase in income tax or GST would do that, but increasing interest rates concentrates the burden on people with big mortgages. This concentration means the increase has to be that much greater to achieve the desired slowing in total consumer spending.

A further dimension of monetary policy’s unfairness is the way it mucks around with the income of savers. Their interest income suddenly dives when the Reserve decides it needs to encourage people to borrow and spend.

In theory, this is made up for when the Reserve decides to discourage people from borrowing and spending, as now. In practice, however, the banks drag their feet in passing higher interest rates on to their depositors. But it’s rare for the Reserve even to chivvy the banks for their tardiness.

Governments need to be free to encourage or discourage consumers from spending. But where’s the justification for doing this by riding on the backs of young people saving for a home and old people depending on interest income to live on?

The next thing monetary policy doesn’t do is competition. What’s supposed to keep prices no higher than they absolutely need to be is the strength of competition between businesses. You’d think this would be a matter of great interest to the Reserve, especially since there are signs that businesses increasing their “markups” are part of the present high inflation.

But only rarely does the Reserve mention the possibility, and only in passing. It gives no support to the Australian Competition and Consumer Commission’s efforts to limit big firms’ pricing power.

The final thing monetary policy doesn’t do is housing. The Reserve is right to insist that its increases in interest rates aren’t the main reason homes have become so hard to afford.

The real reason is the failure of governments to increase the supply of homes in the places people want to live – close to the centre of the city, where the jobs are – exacerbated by their failure to provide decent public transport to outer suburbs.

But the ups and downs of mortgage interest rates must surely be making affordability worse. To this, Lowe’s reply is that, sorry, he’s got a job to do and only one instrument to do it with, so he can’t be worried about the collateral damage he’s doing to would-be young home buyers.

Well, he can’t be worried, but his political masters can. And if they’re not game to fix the fundamental factors driving up house prices, they should be willing to create an instrument for the short-term management of demand that doesn’t cause as many adverse side effects as using interest rates does.

The one big thing going for monetary policy as a way of keeping the economy on track is that the Reserve’s independence of the elected government allows it to put the economy’s needs ahead of the government’s need to sync the economy with the next election.

But, as various respected economists have pointed out, there’s no reason the government can’t design a fiscal instrument, giving another body the ability to raise or lower it within a specified range, and making that body independent, too.

It’s the Reserve Bank inquiry’s job to give the government some advice on why and how it should make a change for the better.

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Friday, March 3, 2023

Now the hard part for the RBA: when to stop braking

In economics, almost everything that happens has both an upside and a downside. The bad news this week is that the economy’s growth is slowing rapidly. The good news – particularly for people with mortgages and people hoping to keep their job for the next year or two – is that the slowdown is happening by design, as the Reserve Bank struggles to slow inflation, and this sign that its efforts are working may lead it to go easier on its intended further rises in interest rates.

But though it’s now clear the economy has begun a sharp slowdown, what’s not yet clear is whether the slowdown will keep going until it turns into a recession, with sharply rising unemployment.

As the Commonwealth Bank’s Gareth Aird has said, since the Reserve Bank board’s meeting early last month, when it suddenly signalled more rate rises to come, all the numbers we’ve seen – on economic growth, wages, employment, unemployment and the consumer price index – have all come in weaker than the money market was expecting.

What’s more, he says, only part of the Reserve’s 3.25 percentage-point rate increase so far had hit the cash flow of households with mortgages by the end of last year.

“There is a key risk now that the Reserve Bank will continue to tighten policy into an economy that is already showing sufficient signs of softening,” Aird said.

That’s no certainty, just a big risk of overdoing it. So while everyone’s making the Reserve’s governor, Dr Philip Lowe, Public Enemy No. 1, let me say that the strongest emotion I have about him is: I’m glad it’s you having to make the call, not me.

Don’t let all the jargon, statistics and mathematical models fool you. At times like this, managing the economy involves highly subjective judgments – having a good “feel” for what’s actually happening in the economy and about to happen. And it always helps to be lucky.

This week, the Australian Bureau of Statistics’ “national accounts” for the three months to the end of December showed real gross domestic product – the economy’s production of goods and services – growing by 0.5 per cent during the quarter, and by 2.7 per cent over the calendar year.

If you think 2.7 per cent doesn’t sound too bad, you’re right. But look at the run of quarterly growth: 0.9 per cent in the June quarter of last year, then 0.7 per cent, and now 0.5 per cent. See any pattern?

Let’s take a closer look at what produced that 0.5 per cent. For a start, the public sector’s spending on consumption (mainly the wage costs of public sector workers) and capital works made a negative contribution to real GDP growth during the quarter, thanks to a fall in spending on new infrastructure.

Home building activity fell by 0.9 per cent because a fall in renovations more than countered a rise in new home building.

Business investment spending fell by 1.4 per cent, pulled down by reduced non-residential construction and engineering construction. A slower rate of growth in business inventories subtracted 0.5 percentage points from overall growth in GDP.

So, what was left to make a positive contribution to growth in the quarter? Well, the volume (quantity) of our exports contributed 0.2 percentage points. Mining was up and so were our “exports” of services to visiting tourists and overseas students.

But get this: a 4.3 per cent fall in the volume of our imports of goods and services made a positive contribution to overall growth of 0.9 percentage points.

Huh? That’s because our imports make a negative contribution to GDP, since we didn’t make them. (And, in case you’ve forgotten, two negatives make a positive – a negative contribution was reduced.)

So, the amazing news is that the main thing causing the economy to grow in the December quarter was a big fall in imports – which is just what you’d expect to see in an economy in which spending was slowing.

I’ve left the most important to last: what happened to consumer spending by the nation’s 10 million-odd households? It’s the most important because it accounts for about half of total spending, because it’s consumer spending that the Reserve Bank most wants to slow – and also because the economy exists to serve the needs of people, almost all of whom live in households.

So, what happened? Consumer spending grew by a super-weak 0.3 per cent, despite growing by 1 per cent in the previous quarter. But what happened to households and their income that prompted them to slow their spending to a trickle?

Household disposable income – which is income from wages and all other sources, less interest paid and income tax paid by households – fell 0.7 per cent, despite a solid 2.1 per cent increase in wage income – which reflected pay rises, higher employment, higher hours worked, bonuses and retention payments.

But that was more than countered by higher income tax payments (as wages rose, with some workers pushed into higher tax brackets) and, of course, higher interest payments.

All that’s before you allow for inflation. Real household disposable income fell by 2.4 per cent in the quarter – the fifth consecutive quarterly decline.

That’s mainly because consumer prices have been rising a lot faster than wages. So, falling real wages are a big reason real household disposable income has been falling, not just rising interest rates.

Real disposable income has now fallen by 5.4 per cent since its peak in September quarter, 2021.

But hang on. If real income fell in the latest quarter, how were households able to increase their consumption spending, even by as little as 0.3 per cent? They cut the proportion of household income they saved rather than spent from 7.1 per cent to an unusually low 4.5 per cent.

If I were running the Reserve, I wouldn’t be too worried about strong consumer spending stopping inflation from coming down.

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Monday, February 27, 2023

The rich world should think twice about 'central bankism'

For the best part of 30 years, the governments of the advanced countries have outsourced the management of their economies to independent central banks. For many of those years, this change looked to have been a smart one. Now, not so much.

If the central banks’ efforts to get on top of the huge and quite unexpected surge in inflation that followed the pandemic go too far, and the rich countries end up in a severe recession, the inevitable search for someone to blame will lead straight to the door of the central bank.

After all, it was the central bank that, ignoring all the cries of pain, insisted on raising interest rates as far and fast as it did. And, as would by then be obvious, it misjudged and went too far.

It ignored the first rule for econocrats using a policy tool notorious for its “long and variable lags”: if you keep tightening until you’re sure you’ve got inflation beat, you’re sure to have gone too far.

You kept telling us it wasn’t your intention to cause a recession, but we got one anyway. So, were you lying to us, or just incompetent?

That’s my first point: if we do end up in recession, the independent central banks will get the blame, and there’ll be a posse of angry voters around the world demanding they be stripped of their independence.

But even if – as we hope - the worst doesn’t come to the worst, there’ll still be a strong case for our politicians to ask the obvious question: surely there must be a better way to run a railroad?

The rich world moved to central bank independence in the 1990s for strictly pragmatic reasons: because governments couldn’t be trusted to move the interest rate lever up and down to fit the economic cycle, not the political cycle.

Fine. But this is a democracy. How come a bunch of unelected bureaucrats have been given so much power? The fact is, independent central banking’s legitimacy comes solely because a duly elected government saw fit to grant it that freedom, and the present government hasn’t seen fit to take it away. Yet.

The trick is, if a central bank really stuffs up, voters will be furious, and they’ll turn on the only people they can turn on: the government of the day. You may think that, should a government of one colour be tossed out because of the central bank’s almighty stuff-up, the incoming government of the other colour would be mighty pleased with the central bank.

No way. What it would think is: if those bastards could do it to the others, they could just as easily do it to us. The new government’s first act would be to clip the central bankers’ wings.

The broader point is that independent central banking was not ordained by God. It’s just a policy choice we made at a time when it seemed like a good idea. When circumstances change, and we realise it wasn’t such a good idea, we’ll be perfectly equipped and entitled to change to a different policy arrangement we hope will work better.

Of course, moving away from economic management by interest-rate manipulation wouldn’t please everyone. It wouldn’t please academic economists who’d devoted their lives to the study of monetary economics (and right now, are hoping for a well-paid spot on the Reserve Bank board).

Nor would it suit the industry that, over the past 30 years, has grown up on the pavement outside the central bank’s building, so to speak. All the money market dealers who make their living betting on whether the central bank will change rates this month and by how much. Nor the economists who write the professional punters’ tip sheets.

And it’s a safe bet it wouldn’t suit the big banks, who’d much prefer the economy to be run by their mates down the road in Martin Place, rather than all those unknown bureaucrats and politicians in Canberra.

When you let one institution run the economy day to day for so long, it starts to get proprietorial. It’s in change of the economy and, when problems arise, it must be the outfit that takes charge and does what’s necessary to fix things.

There’s never a time when you admit that some other institution – the government and its Treasury advisers, for instance – should take the running because their instrument, the budget, is more multifaceted and suited to the problem than is your one-trick-pony instrument, interest rates.

And you do this even when the official interest rate is not far above zero. You tell everyone who thinks you’re out of ammo and should leave the running to Treasury and fiscal policy, they’re wrong, and resort to quantitative easing and other “unconventional measures”.

I reckon a big part of the reason what we thought was a problem of holding the economy together while we dealt with the pandemic turned into the worst inflationary episode in 30 years was the uncalled-for intervention of central banks, pushing themselves to the front of the fiscal parade.

And this from the institution that’s spend decades telling us it knows more about inflation than everyone else, cares more about inflation than anything else, and accepts ultimate responsibility to protect us from the supreme evil of inflation.

Today’s conventional wisdom says the present inflation surge was caused by big pandemic and war-caused supply shortages coming at a time when demand had been overstimulated. But a big part of that overstimulation occurred because central banks insisted on coming in over the top of those who were better equipped to respond to the pandemic and, indeed, were responsible for ordering and policing the lockdowns: the federal and state governments.

In Australia, nowhere was this overkill more apparent than in housing. While both federal and state governments were instituting temporary incentives to encourage home building, the central bank was not only slashing the official interest rate to near zero, it was lending to the banks at a hugely concessional rate, and buying second-hand government bonds, so the banks could offer home buyers two and three-year fixed-interest loans.

Throw in a temporary, pandemic-caused shortage of imported building materials, and you have much of our inflation surge being explained by an astonishing 27 per cent leap in the cost of a newly built home.

Why wasn’t there any co-ordination between the three arms of government that caused this avoidable inflationary disaster? Because the central bank is independent. It acts on its own volition.

But also because, when your only tool is a one-trick pony, you end up wearing blinkers. When you can only join the game by putting rates up or putting them down, you just can’t afford to worry about anyone who may be sideswiped in the process.

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Friday, February 24, 2023

How about sharing the economic pain arround?

If you don’t like what’s happening to interest rates, remember that although the managers of the economy have to do something to reduce inflation, it’s not a case of what former British prime minister Maggie Thatcher called TINA – there is no alternative.

As Reserve Bank governor Dr Philip Lowe acknowledged during his appearance before the House of Representatives Standing Committee on Economics last week, there are other ways of stabilising the strength of demand (spending) and avoiding either high inflation or high unemployment, which are worth considering for next time.

So, relying primarily on “monetary policy” – manipulating interest rates – is just a policy choice we and the other advanced economies made in the late 1970s and early 1980s, after the arrival of “stagflation” – high unemployment and high inflation at the same time – caused economists to lose faith in the old way of smoothing demand, which was to rely primarily on “fiscal policy” – manipulation of taxation and government spending in the budget.

The economic managers have a choice between those two “instruments” or tools with which smooth demand. The different policy tools have differing sets of strengths and weaknesses.

Whereas back then we were very aware of the weaknesses of fiscal policy, today we’re aware of the weaknesses of monetary policy, particularly the way it puts a lot more pain on people with home loans than on the rest of us. How’s that fair?

Lowe says the conventional wisdom is to use monetary policy for “cyclical” (short-term) problems and fiscal policy for “structural” (lasting) problems, such as limiting government debt.

But it’s time to review what economists call “the assignment of instruments” – which tool is better for which job. The more so because the government has commissioned a review of the Reserve Bank’s performance for the first time since we moved to monetary policy dominance.

It’s worth remembering that the change of regime was made at a time when Thatcher and other rich-country leaders were under the influence of the US economist Milton Friedman and his “monetarism”, which held that inflation was “always and everywhere a monetary phenomenon” and could be controlled by limiting the growth in the supply of money.

It took some years of failure before governments and central banks realised both ideas were wrong. They switched back to the older and less exciting notion that increasing interest rates, by reducing demand, would eventually reduce inflation. There was no magic, painless way to do it.

Macroeconomists long ago recognised that using policy tools to manage demand was subject to three significant delays (“lags”). First there’s the “recognition lag” – the time it takes the econocrats and their bosses to realise there’s a problem and decide to act.

Then there’s the “implementation lag” – the delay while the policy change is put into effect. Lowe described the cumbersome process of cabinet deciding what changes to make to what taxes or spending programs. Then getting them passed by both houses, then waiting a few weeks or months for the bureaucrats to get organised before start day.

He compared this unfavourably with monetary policy’s super-short implementation delay: the Reserve Bank board meets every month and decides what change to make to the official interest rate, which takes immediate effect.

He’s right. While the two policy tools would have the same recognition lag, monetary policy wins hands down on implementation lag.

But on the third delay, the “response lag” – the time it takes for the measure, once begun, to work its way through the economy and have the desired effect on demand – monetary policy is subject to “long and variable lags”.

Lowe said it took interest rate changes 18 months to two years to have their full effect. But I say most budgetary changes – particularly tax changes – wouldn’t take nearly that long. So, that’s a win for fiscal.

The sad truth is that measures to strengthen demand by cutting interest rates, or cutting taxes and increasing government spending, are always popular with voters, whereas measures to weaken demand by raising interest rates, or raising taxes and cutting government spending, are always unpopular.

This meant politicians were always reluctant to increase interest rates when they needed to, Lowe said. This is a good argument for giving the job to the econocrats at the central bank and making them independent of the elected government.

This became standard practice in the rich economies, although we didn’t formalise it until the arrival of the Howard government in 1996. Lowe advanced this as a good reason to stick with monetary policy as the dominant tool for short-term stabilisation of demand.

Against that, using monetary policy to get to the rest of us indirectly via enormous pressure on the third of households with mortgages shares the burden in a way that’s arbitrary and unfair.

What’s more, it’s not very effective. Because such a small proportion of the population is directly affected, the increase in interest rates has to be that much bigger to achieve the desired restraint in overall consumer spending.

But if the economic managers used a temporary percentage increase in income tax, or the GST, to discourage spending, this would directly affect almost all households. It would be fairer and more effective because the increase could be much smaller.

Various more thoughtful economists – including Dr Nicholas Gruen and Professor Ross Garnaut – have proposed such a tool, which could be established by legislation and thus be quickly activated whenever needed.

A special body could be set up to make these decisions independent of the elected government. Ideally, it would also have control over interest rates, so one institution was making sure the two instruments were working together, not at cross purposes.

Another possibility is Keynes’ idea of using a temporary rate of compulsory saving – collected by the tax office – to reduce spending when required, without imposing any lasting cost on households.

They say if it ain’t broke, don’t fix it. It’s obvious now that macroeconomic management needs a lot of fixing.


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Monday, October 31, 2022

Memo RBA board: Time to stop digging in deeper on interest rates

If, as seems likely, the combined might of the advanced economies’ central banks pushes the world into recession, the biggest risk isn’t that they’ll drag us down too, but that our Reserve Bank will raise our own interest rates too far.

That’s the message to us – and everyone else – from the International Monetary Fund’s repeated warnings about the unexpected consequences of “synchronised tighten” by the big economies – America, Europe and, in its own way, China, all jamming on the brakes at the same time.

Synchronised macro-policy shifts are a relatively new problem in our more globalised world economy. Until the global financial crisis of 2008, world recessions tended to roll from one country to the next. Since then, everyone tends to start contracting – or stimulating – at the same time.

When you were stimulating while your trading partners weren’t, much of your stimulus would “leak” to their economies, via your higher imports. But, as we learnt in the fight to counter the Great Recession, when everyone’s stimulating together, your leakage to them is offset by their leakage to you, thus making your stimulus stronger than you were expecting.

The fund’s warning is that we’re now about to learn that the same thing happens in reverse when everyone’s hitting the brakes – budgetary as well as monetary – together. Synchronisation will make your efforts to restrain demand (spending on goods and services) more potent than you were expecting.

So the fund’s message to us is: when you’re judging how high interest rates have to go to get inflation heading back down to the target, err on of side to doing too little.

But there are four other factors saying the Reserve should be wary of pushing rates higher. The first is Treasurer Jim Chalmers’ confirmation in last week’s budget that the “stance” of his fiscal policy has also switched from expansionary to restrictive, and so is now adding to the restraint coming from tighter monetary policy.

Chalmers has cut back the Coalition’s spending programs to make room for Labor’s new spending plans, while “banking” the temporary surge in tax revenue arising from the war-caused jump in world energy prices, and the success of the Coalition’s efforts to return us to full employment.

As a result, the budget deficit has fallen from a peak of $134 billion (equivalent to 6.5 per cent of gross domestic product) in 2020-21, to $32 billion (1.4 per cent) in the year to this June. The present financial year should see that progress largely retained, with the deficit rising only a little.

What’s more, the government’s already acting on its intention to force our greedy gas producers to raise their prices by a lot less than has been assumed in the budget’s inflation forecasts.

Second, the Reserve’s efforts to reduce aggregate (total) demand by using the higher cost of borrowing to reduce domestic demand, will be added to by the other central banks’ efforts to reduce our “net external demand” (exports minus imports).

What’s more, the expected further big fall in house prices will help reduce domestic demand by making home owners feel a lot less well-off than they were (the “wealth effect”).

Third – and this is a big point – the restrictive effect of the Reserve’s higher interest rates will be massively reinforced by the “cost-of-living squeeze” (aka the huge fall in real wages). Comparing the wage price index with the consumer price index, real wages fell by 2 per cent over the year to June 2021, and by an unbelievable 3.5 per cent to June this year.

Now the budget’s predicting a further fall of 2 per cent to June next year, with only the tiniest gain by June 2024.

This is an unprecedented blow to households’ income. It just about guarantees an imminent return to weak consumer spending. And it’s a much bigger blow than the big advanced economies have suffered, suggesting our central bank should be going easier on rate rises than theirs.

The final factor saying the Reserve should be wary of pushing rates higher is “lags”. As top international economist Olivier Blanchard reminded us in a recent Twitter thread, monetary policy affects the inflation rate with a variable delay of maybe six to 18 months.

This says you should stop tightening about a year before you see any hard evidence that inflation has peaked and started falling. Wait for that evidence, and you’re certain to have hit the economy too hard, causing the recession we didn’t have to have.

But to stop tightening before the money market know-alls think you should takes great courage.

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Monday, September 26, 2022

Monetary policy is no longer fit for purpose

It’s an outstanding feature of the modern economy: the multitude of people who could do a far better job of running interest rates than the fool they’ve got doing it at the moment. Welcome to the inquiry into the performance of the Reserve Bank.

One small problem. About half governor Dr Philip Lowe’s critics complain he was too slow putting rates down, while the other half say he was too slow putting them up. Since interest rates are a cost to borrowers but income to savers, it’s hardly surprising that, whichever way the Reserve jumps, many will be complaining.

To be clear, it’s always a good idea to review regularly the performance of an institution with as much power over our lives as the central bank.

But equally, the inquiry needs to focus on the right question. Some critics just want someone to agree with them that the Reserve could have done a better job in recent years. Others – particularly academics specialising in monetary economics – want to argue about the mechanics.

Should we change the monetary target? Since the Reserve’s procedures aren’t identical to the US Federal Reserve’s, doesn’t that mean we’re doing it wrong? Why stack the Reserve’s board with business worthies when it would make much better decisions if you stacked it with academic experts like me and my mates?

Leaving aside those who just care about how much interest they’re paying or receiving, most of those who were pushing for the inquiry have a vested interest in monetary policy continuing to be the dominant instrument used in the year-to-year management of demand. They need monetary policy to stay dominant because their living depends on it.

But monetary policy’s role in the “policy mix” is the most important question. Just as much of the pomp and pageantry we’ve been watching isn’t as ancient as many monarchists imagine, monetary policy has been the main instrument used to manage demand only since the late 1970s.

Before then, fiscal (budgetary) policy was dominant, with monetary policy an afterthought, and the central bank a vassal of Treasury. The switch made sense then, but does it still?

And even then, we got off on the wrong foot, starting by trying to control the supply of money, which didn’t work. We didn’t switch the focus to controlling interest rates until the early ’80s. The inflation target came in the mid-90s, and it wasn’t until 1997 that the Reserve’s independence from the elected government was formalised.

It would be nice to imagine we’re gradually closing in on the one right way to manage the economy, but this would be a delusion. History tells us we keep changing the way we do it to better fit the particular problems of the era. Indeed, it wasn’t until the late 1940s that everyone agreed there was a macroeconomy that needed managing.

The two main “arms” of macro management (we abandoned the third arm, exchange rate policy, in 1983 when maintaining a fixed exchange rate became impossible) have different strengths and weakness.

The great advantage of monetary policy is that the econocrats who run it can ignore the electoral cycle. It can also be adjusted quickly and easily. But after acknowledging that, it’s otherwise inferior to fiscal policy. It can’t be targeted at particular regions or industries, and it takes longer to do what you need it to – with the notable exception of house prices.

Our present problem of sudden, high inflation – caused by disruptions to the supply (production) side of the economy being exacerbated by an overstimulated demand (spending) side – well demonstrates the bluntness, crudeness and unfairness of monetary policy.

This raises two questions. Did we need to use both arms of policy to respond to the pandemic? And how much of our present excess demand can be attributed to monetary policy?

The econocrats defend what, with hindsight, was clearly too much stimulus, by saying they didn’t know how much economic disruption the pandemic would cause, the medicos initially led them to believe it could be much worse than it turned out to be and, anyway, it’s better to err on the side of doing too much than too little.

But none of that says we had to overdo it on both barrels. With the official interest rate already down to 0.75 per cent before the virus arrived, it was clear the Reserve was almost out of ammo. I imagined it would have little more to contribute, leaving fiscal policy to do all the heavy lifting. As it did.

But no, the Reserve rode to the rescue as though it was the only knight that could find a horse. It slashed rates to near zero, offered cheap loans to the banks and, before long, joined the bigger central banks in buying government bonds with created money, to lower longer-term interest rates.

At the time, I wondered whether this was just institutional turf protection. It was the Reserve’s job to be the chief demand manager, and it wasn’t going to sit out the biggest crisis in ages just because it had run out of ammo. We’ll find something we can make into bullets.

Looking back, I suspect the Reserve’s determination not to be left out of the party has added greatly to our new problem and to the pain it’s inflicting on us to fix the problem. When you boil it down, one of the main “channels” through which monetary policy influences demand is by interfering in the cost of housing.

The Reserve is right to say interest rates aren’t the primary cause of high house prices, but because monetary policy is such a one-trick pony, it can only ignore all the pain it inflicts by causing prices to soar when it cuts rates and fall when it raises them.

Between the two arms, they’ve revved up the housing industry, only now to be hitting the brakes. They’ve caused surprisingly few extra homes to be built, but pushed up the price of new homes by 20 per cent, adding 1.8 percentage points to the 6.1 per cent inflation rate.

According to Professor Simon Wren-Lewis, of Oxford, the old consensus among academics that monetary policy should take the lead in demand management, has been replaced by one where interest rates are the favoured instrument to deal with inflation – as now – but fiscal policy should be the main weapon used to fight recessions. Or lockdowns.

Point is, had we followed that rule during the pandemic, we’d now have a much smaller inflation problem. Something the inquiry should ponder. And whether resorting to “unconventional measures” was ever a smart idea.

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