When the banks began moving their mortgage and other lending rates at variance with the Reserve Bank's changes in its official interest rate, many people took this as a sign the Reserve had lost its ability to control market interest rates, making its monetary policy ineffective.
Fortunately for all of us, this impression was wrong. That so many people came to this conclusion showed their grasp on the mechanics of monetary policy (the central bank's manipulation of interest rates to influence the strength of demand in the economy) was shaky.
But this week one of the Reserve's assistant governors, Dr Guy Debelle, gave us all a little tutorial in a speech to a business school breakfast.
On Tuesday (and on the first Tuesday of every month bar January), the board of the Reserve meets to determine the appropriate "stance" (setting) of monetary policy. The decision takes the form of a target for the official rate (known in the trade as the "cash" rate). Sometimes the target is moved down a little, sometimes up a little, but mainly it's left where it is.
How does the Reserve unfailingly achieve the target? Settle back. The cash rate is the interest rate the banks charge each other to borrow and lend funds overnight.
Every bank has an account with the Reserve called its "exchange settlement account". Just about every monetary transaction in the economy goes through these accounts. As Debelle explains, when you pay your electricity bill by direct debit, the funds are effectively transferred from your bank account, across the exchange settlement account of your bank to that of your electricity company's bank and into the electricity company's account.
All these transactions mean the balance in each bank's exchange settlement account goes up and down throughout the day. But the Reserve requires each bank to ensure its account always has a positive balance. Banks that leave funds in their account overnight are paid interest at a rate 0.25 percentage points below the cash rate, whereas banks that look like having a negative balance may borrow the difference from the Reserve overnight at a rate 0.25 percentage points above the cash rate.
Get it? These penalties are designed to encourage the banks to borrow and lend to each other overnight at the (more attractive) cash rate.
The Reserve's ability to control the cash rate arises because it has complete control over the supply of funds in this market. It ensures there is just sufficient supply to meet the demand for funds at the interest rate it is targeting.
Where an increase in demand threatens to push the interest rate up, it will use its "open market operations" to increase the supply of funds just sufficiently to keep the rate where it wants it. Where a fall in demand for funds threatens to push the rate down, the Reserve will reduce the supply to ensure the rate doesn't change.
Historically, the Reserve would increase the supply of cash by buying second-hand government bonds from the banks and paying for them with cash. (Note that in this context, "cash" doesn't mean notes and coins, it's a nickname for the funds in exchange settlement accounts.)
Conversely, it would reduce the supply of funds by selling bonds to the banks, which they had to pay for from their exchange settlement accounts. These days, however, the Reserve achieves the same effect using repurchase agreements ("repos").
The main reason for fluctuations in the overall daily demand for exchange settlement funds is transactions involving the Reserve's one big banking customer, the federal government. Demand will rise on days when the government's receipts from taxation exceed its payments of pensions and all the rest. Demand for cash will fall on days when the government's payments exceed its receipts.
All this ensures the Reserve has a vicelike grip on the cash rate. And this gives it the ability to influence all the other interest rates in the economy. Why? Because the cash rate is, in effect, the anchor point for all other rates.
Banks fund only a very small part of their operations in the cash market, Debelle explains, but all their funding could be done from that market if they wanted to. The rate at which they're prepared to borrow for periods longer than overnight is the averaged expected path of the cash rate over the life of the loan plus various margins for risk.
If this were not the case, a bank would be better off borrowing all the funds it needed in the overnight cash market and rolling them over every day.
The reason banks borrow and lend at rates higher or lower than the average expected cash rate over the life of the loan is the need to allow for the various risks involved (the risk of not being repaid, the risk in agreeing to lend your money for a longer time, and so forth) and, of course, profit margins along the way.
For several years leading up to the global financial crisis, these various margins (known as "spreads" or "premia") didn't change much, meaning a change in the cash rate brought about an identical change in mortgage and other bank lending rates.
Since the crisis, however, margins have been changing a lot, as a result of people realising they weren't charging enough to cover the risks they were running, and our banks realising they needed more domestic, retail and longer-term funding to protect them against future crises, leading to intense competition between them to attract term deposits.
The net effect has been that the banks' borrowing costs have risen more (or fallen less) than the cash rate has, causing changes in, say, the mortgage rate, to be less generous than changes in the cash rate and thus widening the margin between the cash rate and the mortgage rate.
The Reserve has allowed for this shift in margins, cutting the cash rate by more than it would have so as to ensure market interest rates - the rates people actually pay - are where it wants them to be.
Its influence over market rates thus remains undiminished. And that's because the cash rate remains by far the most powerful influence over other interest rates - though, as we've seen, not the only influence.
Until last week, the financial markets and most business economists thought the Reserve Bank had several rate cuts up its sleeve and would start doling them out this month. The smarter ones don't think that any more.
When the Reserve failed to cut the official interest rate last week, some observers swung to the opposite view of expecting no further cuts for the foreseeable. And with all the fuss about the banks' small "unofficial" increases in mortgage rates, you can bet the punters are now convinced rates are heading back up.
Needless to say, the official rate is unlikely to rise. With luck, it won't need to be cut further. But if the outlook for the economy deteriorates, it will be.
Since the Reserve cares most about the rates households and businesses actually pay, and has no desire to tighten the interest-rate screws, the tiny unofficial increase will be one factor - but only one - favouring another cut in the official rate sooner rather than later.
Why didn't the Reserve cut last week? Because you may have convinced yourself the economy's in trouble, but the Reserve hasn't.
For the markets and business economists to have been so sure the Reserve would cut, it was necessary for them to be convinced of the truth of one or both of two propositions.
First, that the outlook for the world economy is now worse than it was late last year. It's true that, in recent times, the Reserve has judged the state of the rest of the world to be the greatest single threat to the continuing growth of our economy.
But almost all the news we've received from abroad so far this year has been reassuring. Things have calmed down a lot in the euro zone, with the actions of the European Central Bank making people a lot less worried about the European banks than they were, with sovereign bond yields falling back to more sensible levels, with banks able to raise funds with new bond issues, with Greece looking like it may reach a deal with its saviours, and with world sharemarkets looking up.
None of this implies the Europeans don't have a lot more to do, nor that there's little chance of something somewhere suddenly going badly wrong. The continuing risk that things could deteriorate in Europe remains the greatest single reason the Reserve could cut rates again this year.
But you do have to say the improvement in conditions in Europe so far this year makes it easier to believe the Europeans will muddle through.
As for the United States, its economy isn't roaring, but it is doing better than it was, growing fast enough to slowly reduce unemployment. For China, it's slowed a bit, but is still growing strongly.
The second proposition you'd need to believe to have been so confident the Reserve would cut last week is that the domestic economy is clearly slowing.
The tribulations of particular parts of the economy - notably manufacturing and retailing - have generated so many negative headlines I've no doubt many people are convinced the economy's in trouble.
Certainly, the belief the economy is slowing is widely held. But that's what happens when the news is mixed, with the bad bits trumpeted and the good bits played down. Just why the commercial media regard misinforming the public in this way as good for business I'm blowed if I know.
Do they imagine only the Labor government will suffer if they succeed in talking the economy down? Do they think it's like "a Martian ate my baby"? It's just entertainment and no one actually believes them?
The unrecognised truth is, the economy's speeding up a little, not slowing down. That's because we're recovering from the effects of the bad weather this time last year. Abstract from the weather effect and the economy's been travelling at about its medium-term trend annual rate of 3.25 per cent for the past two years or so, and is expected to grow at that rate this year.
With the unemployment rate steady at just 5.2 per cent and underlying inflation in the centre of the target range and expected to stay there for the next two years, you'd have to conclude the economy is right on normal.
In which case, the present level of interest rates - close to their own trend rate - must surely be pretty right. But it's clear from the Reserve's rhetoric that it retains a weak "bias to ease" (cut rates further): "the current [favourable] inflation outlook would, however, provide scope for easier monetary policy should demand conditions weaken materially".
How would such a weakening be manifest? Well, obviously by a deterioration in the world economy. Were Europe to implode, the flow-on to the rest of the world would be considerable - even for us. In this case we know how the Reserve would react: by slashing interest rates in a few big, bold steps.
But the requisite material weakening could also be brought about by a deterioration in essentially domestic factors.
The way the Reserve sees it, the economy is being hit by two powerful but opposing shocks: the expansionary effect of the once-in-a-century mining construction boom and, against that, the contractionary effect of the high exchange rate, which has reduced the international price competitiveness of our export and import-competing industries.
At present, the two conflicting forces are roughly offsetting each other, leaving the economy travelling at its trend rate. Should it become clear the high exchange rate is doing more restricting than the construction boom is doing expanding, which would show itself in slowly but steadily rising unemployment, the Reserve will cut rates further.
Talk to Australian Business Economists Annual Forecasting Conference
Sydney, November 24, 2011
Taken as a whole, the first full year of the Gillard government has been terrible. Julia Gillard has hardly taken a trick all year and her present standing in the polls is worse - much worse, consistently worse - than it was at last year’s election, when she failed to attract enough votes to form government in her own right. Her present primary vote in the low 30s would give her zero hope of winning an election. Only if she could get it up to at least 40 per cent would she be in the hunt. This time last year - three years out from the next election, assuming the government runs full term - I fearlessly predicted Labor would lose it, because ‘this generation of Labor is terminally incompetent’.
Having made that call, I’m sticking to it. I’m doing so even though I know full well how easily the political outlook can change over a period as long as a year, let alone two years. After all, who would have predicted in October 2009 that the election would be months early and fought not between Kevin Rudd and Malcolm Turnbull, but between Gillard and Tony Abbott, that Abbott would come within a whisker of winning and that Labor would be forced into an alliance with the Greens and rag-tag independents?
But I have to add that, at the end of her first year, Gillard and her government are looking in better shape than they did half way through it. The first point to acknowledge is that she’s held her minority government and its alliances together for a year - longer than many people expected - and it’s never seriously looked in trouble. The second is that it’s been a year of great achievement. The opposition has frequently criticised Labor for being unable to actually do anything but, as was always Gillard’s intention, this has been a year of ticking off items on the to-do list - in particular, the various items inherited from Rudd. Of the three big problems he left her, the carbon tax has been put to bed, the mining tax is well on the way and only the asylum-seeker issue remains chronically unresolved. Along with Gillard’s opportunity to be seen looking like a leader on the international stage with other leaders, these runs on the board do much to explain her recent slow improvement in the polls, in the two-party preferred and, particularly, as preferred prime minister.
While the polls continue moving in the right direction - however slowly and with however far to go - Rudd is unlikely to mount a challenge. There’s no reason to doubt his desire to return, and should the poll recovery falter, we’re likely to hear from him. Would the caucus ever turn back to him? There is so much continuing dislike of him they’d have to be terribly desperate, but it’s not impossible. Would it help? No. His grass-is-greener popularity in the polls would soon evaporate as voters were repulsed by this ultimate proof of Labor’s disloyalty, ruthlessness and lack of principle.
Next year should be a year of consolidation and less frenetic policy making, with the government needing to be sure the introduction of the carbon price arrangements goes smoothly. Should the world economy stay on track, the government will press on with its priority of returning the budget to surplus - as, in all the circumstances, it should. Should things go really bad in Europe, the primary response will be from the Reserve Bank, but the government will at least have to reverse its rhetoric and allow the budget’s automatic stabilisers to widen the budget deficit, and may need to consider a new round of fiscal stimulus. For Abbott and the opposition it will need to be a year where, finally, they make their contribution more constructive, outlining their own plans for improvement - even if, as ever, they leave the revelation of their detailed policies until much closer to the election. The longer Abbott continues with his relentless negativity, the more he risks trying the patience of voters.
Can we be sure the minority government arrangement will hold together for another year? No. But the grubby deal to install the former-Liberal Peter Slipper as speaker means it now would take two by-election losses to bring Labor undone. It also reduces Labor’s dependence on any particular independent. And by now it ought to be clear to all that the independents on whose votes Gillard relies have much to gain by continuing to prop her up and much to lose by deserting her. It should also be clear that achieving continued co-operation from the people whose votes she needs is one of the things Gillard is good at.
Why Labor is so bad at it
I have no problem putting the boot into politicians who are flying high, but I don’t enjoy kicking people when they’re down. If for no other reason than that I prefer to be ahead of the conventional wisdom. But I can’t take a look at the political scene and not address the obvious challenge for political analysts: why exactly is this version of Labor so bad at governing?
A host of explanations has been offered, many of which have only some degree of truth and some of which are more in the nature of excuses. One we can dispense with is that it’s all down to the personal failings of Rudd. He had many failings and he left Gillard with a terrible inheritance of a far too long agenda of half-finished policy projects, but we’ve seen enough to know things didn’t immediately look up after his departure.
A favourite excuse of Labor and its supporters is that it’s been turned on by the Murdoch press. It’s true The Australian has turned from being a newspaper to a product aimed at gratifying the prejudices of a particular segment of the audience, but it is - by commercial design - preaching to the already converted. Its influence is limited to those silly people in Canberra who continue to take it seriously, imagining it still to be a newspaper. As for the depredations of Sydney’s Daily Telegraph, it was ever thus. That organ has been a vehicle for foisting the bosses’ views on workers since it was owned by Frank Packer. It’s true the radio shock jocks often take their line from those two outlets, but were they not available the jocks would just have to work harder to find their sources of daily indignation. So, sorry, but I think the Murdoch excuse is greatly overdone. It falls into a class of argument politicians trot out to sustain the faith of the party faithful, not because they believe it or expect the uncommitted to believe it.
I think part of the problem attaches to Gillard herself. The brutal circumstances in which she came to power count against her in the mind of many voters. I don’t doubt there’s an element of misogyny in the electorate’s failure to warm to her and that many people find her voice grates. But her deeper problem is her inability to come over on television as a warm and likable person. Some pollies have that ability, others don’t. Other politicians manage to substitute an air of paternal authority - don’t worry, father is in charge - for likeability (eg Malcolm Fraser, Maggie Thatcher), but Gillard can’t manage that, either.
Lack of an air of authority - leaders who look like leaders and hence command respect and compliance; leaders who seem legitimate - has plagued the Rudd-Gillard government. I’ve come to the conclusion that - at the federal level, at least - the Liberals really are the natural party of government. That’s what the electorate thinks, what business thinks, what the media think, what the Libs themselves think and what, deep down, even Labor thinks. On the central polling question of which party is best to handle the economy, the Libs always win. The Hawke-Keating government managed to out-poll the Libs for a while, but Rudd and Gillard never have. This is not a question of track record, but of long-held and deeply held stereotypes. The party of the bosses will always be better at managing the economy than the party of the workers.
This is what allows Abbott to turn opposition to outright obstruction without attracting criticism. It’s what allows Abbott to take the support of business for granted, while Labor knows it must always be seeking business’s approval. It’s what has allowed business to conclude Labor is anti-business even while Labor modifies its policies - including Fair Work - to avoid offending business. It’s what, in the battle over the mining tax before Rudd’s overthrow, allowed the public to believe the foreign mining giants’ ads claiming the tax would destroy the economy over their own government’s ads assuring them the tax wouldn’t be a problem.
It’s what explains the Libs’ ability to wind up the electorate over Labor’s mountainous deficits and debt and why few economists intervened to dispel the nonsense. It explains why the opposition has had an excessive influence over the government’s fiscal policy and why Labor is obsessed by returning the budget to surplus in 2012-13. It also explains why only at this point have economists entered the debate to attack the government’s deficit mania.
Labor’s universally assumed inferiority - combined with journalism’s highly selective approach to quoting evidence - explains the success of The Australian in convincing almost everyone - punters, gallery journalists and even Labor politicians - that most of the money spent on Building the Education Revolution was wasted.
Associated with Labor’s lack of apparent authority is the phenomenon of the slippery slope. When you’re in power and on top you get a lot of co-operation, compliance and tacit support from interest groups and the public generally - all of which help you stay on top. These benefits of incumbency give you the strength to stand up to particular vested interests and tide you through the ups and downs of the polls. But when your weakness in the polls becomes sustained, you hit the slippery-slope part of the curve where it becomes a lot easier to fall further than to claw your way back up. Where things start to unravel as people who formerly accepted the reality of your continuing authority begin to wonder how long you’ll survive, whether they should give you a push on your way and whether they should start cosying up to your likely vanquisher.
Though she seems to have made a little progress back up the greasy pole in recent days, Gillard has spent most of her time as PM sliding down the slippery slope. It’s a situation that emboldens your critics and opponents while making your supporters more cautious. So things have been unravelling. The denizens of the House with the Flag on Top - pollies on both sides, staffers and journalists - revere success, fear the successful and despise failure. Lindsay Tanner says the press gallery is either at your feet or at your throat. It shifts when it sees you languishing in the polls, emboldened to be a lot more probing and critical and take a lot less on trust. The denizens take the polls so seriously that everyone starts expecting anything you do will fail, and their expectations tend to be self-fulfilling.
One interest group that’s particularly susceptible to this behaviour is business. Business will live with a housetrained Labor government with a steady grip on power. But it does so against its natural preferences. Big business people expect Labor to court them, while quietly accepting it when the Libs choose to ignore or pressure them. Business is very unhappy with Labor and I have no doubt its disenchantment and its increasing willingness to make its unhappiness known is magnified by its perception the Gillard government is not long for this world. It’s willingness to accept the carbon tax has been diminished by Abbott’s success in turning public opinion against the tax. Its complaints against Fair Work - which don’t seem to have great substance - are directed mainly at persuading the next government to shift the balance back in favour of employers. If this does collateral damage to Labor between now and the election, so much the better.
Both the Rudd and Gillard governments seem remarkably inexperienced. This shouldn’t be an excuse because it’s unusual for incoming federal cabinets to have many members with previous ministerial experience. Labor doesn’t seem to realise that maintaining good relations with business isn’t just a matter of senior ministers trying to fit in as many boardroom lunches as possible, or even keeping in touch with the business lobby groups. It means having big business chiefs feel they can ring the PM about a problem and their being on the receiving end of calls from the PM to inquire about their views on relevant matters. The main union leaders would have such a relationship with the PM, but I doubt the business chiefs do. They’d know this and would feel alienated from Labor, especially because Howard was such a great private phoner of power-holders.
Similarly, Labor’s failure to make sure the big miners knew what to expect well before the unveiling of the resource super profits tax is a sign of inexperience. The name of that tax - chosen by Labor’s spin doctors - did much to convince the rest of the business community Labor was anti-profit and anti-business, without doing much to arouse the punters’ resentment of foreign mining giants. Labor’s PR people have been far too young, lacking much journalistic experience, let alone political experience. It should have recruited some old hands. Rudd treated his staff so badly he burnt through a generation of good advisers.
But Labor’s chronic inability to sell its policies to the electorate can’t be explained simply in terms of the inexperience of its spin doctors. It isn’t primarily about spin doctors. I think the root of this generation of Labor politicians’ problem - the key reason they’re so bad at governing - is their background. Unlike earlier generations, almost all of them are apparatchiks; they come from Labor’s professional political class: people who start working for ministers or unions straight from university and climb the Labor career path, never making a success of a career in the outside world or even spending a lot of time as an on-the-ground union official dealing with ordinary workers and disparate employers.
The trouble with this system is that it seems to be breeding a generation of politicians who don’t have a good feel for human nature and, above all, don’t give up their profession and enter parliament with a burning desire to make the world a better place. Their burning desire is to make cabinet minister. Their entry to parliament is a promotion and a pay rise, not any sacrifice. These guys don’t have deeply held values and convictions they’re prepared to fight for and run risks for. Their lack of conviction robs them of the ability to explain policies that arise from their framework of belief. They can’t fashion a compelling narrative of what drives them and where the government wants to take us. They lack the missionary zeal of someone like Paul Keating; they have no desire to convert. They think ‘selling’ policies is a matter for spin doctors and advertising agencies, not of working tirelessly to help people understand the vision and see why it’s so important. When you’re not passionate about explaining your policies, when you’re just a political player, you do what Labor has done from the moment it took office: focus on attacking your opponents, thus conferring them and their criticisms a status they wouldn’t otherwise have. When you’re not a passionate explainer, you avoid answering questions and merely repeat prepared lines.
The problem with all this isn’t just that you fail win public support for your policies, it’s also that the public can sense your lack of commitment and conviction, your preference for self-preservation over leadership, your interests over theirs. You lose authority and respect in the eyes of voters. Courage comes from convictions; public confidence in governments comes from people’s perceptions of your courage and conviction. As John Howard demonstrated with the GST, voters are perfectly capable of giving you grudging respect for pursuing a policy they don’t like the sound of.
Minority government may be the making of Gillard
But having said all that, I now have to highlight a qualification. At the end of its fourth year, Labor has now amassed an impressive list of achievements. Leaving aside its remarkably effective response to the global financial crisis, we have: paid parental leave, equal pay for community workers, plain packaging for cigarettes, the foundations for a national disability insurance scheme, a price on carbon, the likely passage of the minerals resource rent tax, and the continuing pursuit of compulsory pre-commitment on poker machines. (Admittedly, the mining tax was butchered and Labor’s health and hospital changes fell far short of their billing.)
Some of the items on that list may not greatly appeal to you, but they would to the Labor heartland. And it’s noteworthy that some of the items wouldn’t have been there had it not been for the insistence of those whose votes Labor has depended on to stay in government. On the carbon price, in particularly, Gillard had no choice but to press on with its early introduction. See what’s happened? The circumstances of minority government and the ferocious opposition of Abbott have left Gillard with no option but to take principled positions and stick to them through thick and thin. If her improvement in the polls proves lasting, it will be because her failure to win a majority has forced her to exhibit all the impressive qualities she seemed not to possess. Her steadfastness and ultimate achievement may be winning her the grudging respect of the electorate.
Provided she can hold the numbers in the House for another two years, Gillard should benefit from the effluxion of time. It will give people more time to get used to her idiosyncrasies and more time to tire of Abbott’s. And there’d be something very wrong if more than a year of living under the carbon tax didn’t cause people to lose their fear of it.
It’s interesting to observe the way conservatives have transferred the mantle of bogyman from the ALP to the Greens. Labor’s greatest crime is not being typically wrongheaded Labor, but falling under the spell of the demonic Greens. Exhibit A would have to be the carbon scheme. But, apart from its higher levels of compensation to industry, it was little different from Rudd’s carbon pollution reduction scheme, which the Greens rejected out of hand. It’s not politic to say so but, in the end, it was the Greens who changed their tune, much more than Labor did.
The prospect of Abbott
Abbott has been far more effective as opposition leader than I and other smarties expected. He quickly learnt to keep disciplined and avoid putting his foot in his mouth, and quickly displayed his greatest, most enviable strength as a politician: an ability to ‘cut through’ - to have the things he says noticed and broadcast by the media.
His policy of blanket opposition to all the government’s policies has served him well. Many expected the electorate to tire of his relentless negativity, but it hasn’t happened yet. Even so, some strains are beginning to show. His autocratic style has put noses out of joint within the party and, should his standing in the polls ever slip, we will hear from his detractors. There is much discontent within the party and in business over his refusal to criticise Fair Work and propose any changes that could reawaken the spectre of Work Choices.
Despite the opposition’s remarkably strong standing in the polls, Abbott is not personally popular. He has a 55 per cent disapproval rating for his job as opposition leader. And the authoritative Australian Election Study, in which ANU political scientists surveyed voters soon after the last election, found that Abbott’s unpopularity was the main reason he failed to win enough seats. Though Gillard’s popularity rating was low, Abbott’s was a lot lower - lower even than Keating’s in the 1996 election.
Abbott has little interest in economics and no commitment to economic rationalism. His policy positions reek of populism, protection and direct controls. His solemn promises to roll back the carbon and mining taxes, but not reverse the goodies they will be paying for, leave him with a funding gap of many tens of billions he has, as yet, made no attempt to fill. How such a man could bring himself to outline the sweeping spending cuts needed to make good his promise to return the budget to surplus without delay is hard to imagine. He has, however, taken the precaution of refusing to use the services of the new Parliamentary Budget Office to cost his promises. There is no precedent for parties promising to abolish major new taxes already in operation, nor for governments actually doing it. I find it very hard to believe it would happen.
Should Abbott be elected, we face either a monumental breaking of promises or a government totally consumed by the effort needed to turn back the clock. Why the part of the electorate that cares most about good macro management and micro reform has had so little to say about Abbott’s incredible performance I don’t know. Perhaps they’ll have more to say as the reality of an Abbott-led government draws closer.
Observations on monetary policy
I normally begin this section by observing that the market and the business economists have had another bad year in their efforts the second-guess the Reserve Bank’s moves in the cash rate, but this year I have to declare the second-guessers to be ahead on points. The notion that the Reserve might cut rates entered the futures market’s head a lot earlier than it entered the Reserve’s head, so the market has to get credit for that. I’m not sure the market was particularly prescient on size and timing - suggesting it might have been right for the wrong reason. I suspect the market was dominated by foreign players who merely projected North Atlantic conditions onto the Antipodes, making insufficient allowance for local conditions. But, as all of us in the prediction business know full well, a win’s a win. I wouldn’t make those criticisms of the other great hero of this episode, Bill Evans. He stuck his neck out ahead of all of us, we marvelled at his folly, but he turned out to be right and he deserves all the accolades he got.
From where I sit it’s clear to me that to make a legendary call like Bill’s you have to get well ahead of the game, well ahead of the data - and you have to be right. When I saw Bill make his call I thought, that’s not in the Reserve’s plan, so he’ll only be right if he foresees developments the Reserve doesn’t foresee and those developments are big enough to change the plan. He did and they were.
The Reserve begins each year with a view of how the year’s going to pan out and a rough idea of the policy adjustments the outworking of that view will necessitate. It must have such a view because it has an on-the-record forecast, and that forecast is its view. The trick for you guys is to work out what its forecast tells you about the policy adjustments needed to bring the inflation forecast about, given the growth forecast.
This year the Reserve was expecting growth to accelerate as the effects of the resources boom spread through the economy, adding to inflation pressures at a time when we were already close to full employment. It was therefore expecting to have to tighten a few times as the year progressed. But here’s the point: it’s continuously testing its forecasts and its expectations against the data as they roll in. And it makes its judgments about whether policy needs to be adjusted one board meeting at a time. As events unfolded, the economy didn’t accelerate in the way it had been expecting, and so the Reserve never reached a point where it saw the need to act on its ‘bias to tighten’. At first there was the temporary setback of the Queensland floods - which proved less temporary than first thought - and then there was the backwash from the growing sovereign debt problems in Europe, mainly on business and consumer confidence. By November it was clear the economy wasn’t taking off the way the Reserve had expected - mainly because of the confidence backwash from Europe - so the Reserve wasn’t going to have the trouble keeping inflation within the target range it had expected to have, thus allowing it to make what it expects to be a once-off reduction in the cash rate to get it back to neutral. It’s worth noting that part of the scope for this move came not from the effects of Europe but from the past and future revisions to the underlying inflation figures arising from the Bureau’s reweighting of the index.
I don’t think the Reserve has very firm ideas about where the stance of policy goes from here. The economy is pretty much in equilibrium, policy is set at neutral, so the rate will stay where it is until developments occur that knock the economy off its equilibrium path - and off the Reserve’s forecast - in one direction or the other and require a policy response. Clearly, the balance of risks is very much to the downside.
But Bill has made another call and, as I understand it, is predicting another three cuts -presumably 25-basis-point cuts - next year. Here again you see him getting well ahead of the game; well ahead of the Reserve’s thinking, as expressed in its forecast. He can see something coming down the pike the econocrats can’t, and he may again prove himself to be more prescient than them. What would fit Bill’s call of three further cuts over the course of 2012 would be for the economy to slow down rather than speed up as forecast - for it to run out of gas, presumably because of growing caution and uncertainty on the part of business and consumers in response to continued turmoil in Europe. This would be manifest in a continuing rise in unemployment and an inflation outlook that was even more benign, thus allowing the rate to be lowered another click. Of course, were Europe to turn into the full catastrophe, we all know from the events of late 2008 how the Reserve would react. In that case I wouldn’t be surprised to see three cuts next year, but they’d probably come thick and fast, and each be nearer 100 points than 25.
I remarked in my column last Saturday that when the news is full of stories about some economic issue and the authorities pop with a policy change, all the instincts of the media and the punters are to assume that A caused B. In this case, we hear all this bad stuff from Europe, which makes us think the European economy is stuffed, therefore we must be stuffed and that must be what caused the Reserve to slash its forecast and cut the rate. I think all humans have a tendency to string together chains of cause and effect in this way and for our thinking to be unduly influenced by those events that have ‘salience’ (prominence in our consciousness) because they are so dramatic, so highly publicised or so recent.
My point is that this defective reasoning may be very human, but economists need to do better. Because the markets and business economists spend so much time studying developments overseas - usually the US, but these days, Europe - and they do that because national financial markets are so highly integrated - these developments have great salience in their minds, which can tempt business economists to over-weight them when forming views about likely developments in our economy - our real economy.
We need to remember that overseas events may be very exciting and very important, but they’re only relevant to us, our forecasts and our policy stance to the extent that, by some clearly identified channel, they have an effect on our real economy. They may be big in Europe, but are they still big by the time they reach us? Our real economy isn’t nearly as well integrated with the world as our financial markets are. Our domestic demand (GNE) accounts for almost all of our aggregate demand, sometimes more than all. As I keep reminding my readers, roughly 80 per cent of what Australians produce they sell to other Australians and roughly 80 per cent of what they purchase they buy from other Australians. Of course, the sharemarket is a more important channel than it used to be, and so - thanks to an ever-more globally integrated media - are confidence effects. I say all this simply because I keep hearing business economists making predictions about what the Reserve will do, and explaining why it’s done what it’s done, much more in terms of overseas development than I see in all the Reserve’s detailed exposition of why it did what it did. You’ve got to get your direction of causation right. The Reserve is managing our economy, it’s responsible for our inflation rate. Its highest consideration will be what’s happening in our economy and its interest in what’s happening in other people’s economies is limited to assessing the extent to which those events impinge on our economy. That’s obvious, but people who know a lot about what’s happening in other economies seem to keep forgetting it. Sometimes I think the traditional order in which the econocrats set out their analysis - start with the world, then move on to the domestic - may confuse people as to which is the more important.
Last year I advanced my theory that the timing of rate changes is influenced by ‘bureaucratic neatness’. At the time I said:
"Over the past five years the Reserve has changed rates 20 times. Since there are 11 meetings a year, if decisions to change rates occurred at random, each month would have a 9 per cent chance of being chosen for a rate change. The four meetings a year that are preceded by the release of the CPI and followed immediately by the release of the statement on monetary policy, would account for just over 36 per cent of random chances. But, in fact, the SoMP months - February, May, August and November - accounted for 65 per cent of rate changes, with November alone accounting for 25 per cent. The point is that the Reserve has set up a pattern in which the SoMPs come soon after the meeting that comes soon after the CPI release, and two of the SoMPs come not long before the Reserve’s twice-yearly appearance before the parliamentary committee. Remember, too, that the release of the CPI is a key influence on the revision of the Reserve’s inflation forecasts, which are published in the SoMP and which heavily influence decisions about rate changes. The SoMP serves as the main vehicle the Reserve uses to explain and defend its rate decisions. Is it surprising that, having carefully set up the timing of its key publication and parliamentary appearances, the Reserve is more inclined to fit its decisions into that timetable? But why in the past five years has the November pre-SoMP meeting had more than twice the hits that the other three pre-SoMP meetings have had? Perhaps because of an unconscious desire to get the books straight before the end of the year and the knowledge that what you’ve done has to tide the economy over until February."
That was a year ago. What’s happened since then? We’ve had just one rate move and it happened on . . . Melbourne Cup Day, making it the sixth cup day move in a row. Still think it’s mere coincidence? Last year when I advanced my crazy, utterly economics-free theory, my mate Rory Robertson was the first to express his scepticism. So I asked some relevant econocrats what they thought of it. They thought it had some validity. Provided the Reserve hasn’t got behind the curve, and thus needs to catch up ASAP, it will be more inclined to move in those months that fit its carefully constructed reporting cycle.
If the Reserve Bank ends up cutting the official interest rate by 0.25 percentage points on Melbourne Cup Day, it won't be because the economy has weakened so much as because it's not looking as strong - and thus, inflationary - as the Reserve had earlier expected.
The air is full of uncertainty and fear about the fate of the European and American economies, with one excitable pundit even predicting a ''world recession''. But, short of a major meltdown, the North Atlantic countries' troubles won't be a big part of the Reserve's reasons for fine-tuning the stance of its monetary (interest rate) policy.
No one knows what the future holds, and there's a ''non-trivial probability'', as the economists say, that the US economy will start contracting again and, more significantly, the problems in Greece will be so badly handled that the European economies implode.
Were that to happen, be in no doubt: the Reserve wouldn't just be lowering rates by one or two clicks, it would be slashing rates in much the way it did in the global financial crisis of 2008-09. But that's far from the authorities' ''central forecast''. They expect the US to grow by a bit under 2 per cent next year, while the euro area achieves no growth.
What would plunge Europe and the world back into crisis - with Europe entering a period of severe contraction - would be for Greece to leave the euro. That's because of the panic this would cause to euro depositors in many other member-countries.
It's likely the Europeans well understand what they need to do to avoid a conflagration: first, restructure the Greek government's debt (which means bond holders accepting big write-downs); second, recapitalise those European banks hard-hit by the write-down; third, have the European Central Bank purchase large quantities of European governments' bonds so as to lower bond yields and, hence, commercial interest rates.
So the Europeans' problem isn't knowing what to do, it's achieving the agreement of 17 squabbling member-countries to do it. The likeliest outcome is that they do enough to avert catastrophe, but not enough to prevent recurring episodes of financial-market jitters.
Our authorities' forecasts for 2012 aren't far from those the International Monetary Fund published last month. These have the US growing by 1.8 per cent and the euro area by 1.1 per cent. If so, that leaves the world economy growing by, what - 1.5 per cent? No, by 4 per cent - which is about the trend rate of growth. Huh?
What's missing from the sum is China's growth, expected to slow to a mere 9 per cent, and India's, to a paltry 7.5 per cent. Even Latin America is expected to grow by 4 per cent and sub-Saharan Africa by 5.8 per cent.
So much for a world recession.
Weakness in the North Atlantic doesn't equal weakness in Australia by a process of magic. You have to trace linkages between them and us. An important one is psychological: the effect of a sliding sharemarket, worrying news from the North Atlantic and over-excited talk of world recessions on the confidence of Australian consumers and business people.
As for ''real'' (tangible) linkages, these days the US and Europe aren't big export customers of ours. So the key question is the extent to which weakness in the North Atlantic leads to weakness in China, India and the rest of developing Asia.
These days, China is a lot less dependent on exports to the North Atlantic than it used to be. And the Chinese authorities have both the political imperative and the economic instruments needed to keep domestic demand growing fast enough to prevent much of a slowdown in production and employment growth.
So, barring a European implosion, the North Atlantic troubles' effect on us is likely to be limited mainly to their effect on confidence. If so, what are the domestic factors that could lead the Reserve to lower interest rates a little?
In May the Reserve was forecasting growth in 2011 of 4.25 per cent. In August it cut that to 3.25 per cent. Today it would probably say 3 per cent.
But get this: the overwhelming reason for these revisions is the temporary effect of the Queensland floods, in particular the loss of output from coalmines that are taking far longer than expected to resume production.
There have been various highly publicised areas of weakness in the domestic economy - the troubles our manufacturers are having coping with a high exchange rate, very weak department store sales and weak housing starts - but overall (and excluding extreme weather events), there's little sign of weakness.
Despite the much-publicised fall in
consumer confidence, consumer spending grew by 3.2 per cent over the year to June, bang on trend. Business investment has been strong and is sure to get stronger. And earlier figures showed worsening inflation and worryingly strong growth in labour costs per unit of production.
Indicators released this week show strong growth in exports and strengthening retail sales, home building approvals and non-residential building approvals.
The strongest evidence of weakening is in the labour market, with employment growth clearly slowing from its earlier fast past, and the unemployment rate jumping 0.4 percentage points to 5.3 per cent in just two months.
But this is a puzzle because, though growth in employment is weak, growth in hours worked isn't. And though surveyed unemployment is supposed to have jumped, the number of people on the dole is steady.
So how does the Reserve come to be contemplating lowering the official interest rate a little? Because its job is to keep interest rates at a level sufficient to keep inflation travelling within its 2 to 3 per cent target range, and the outlook for inflation has become less threatening.
For a start, the Bureau of Statistics has revised the underlying inflation rate over the year to June from 2.75 per cent to 2.5 per cent. Second, the outlook for economic growth isn't quite as strong as it had been. And third, the atmospherics of the labour market have improved, with more consumers worried about losing their jobs and employers less worried about the emergence of excessive wage demands.
The present stance of monetary policy is ''mildly restrictive''. But if the risk of inflation rising above the target range is now much reduced, the stance of policy should be returned to neutral. That would require a fall in the official rate of just one click - two at most.
The lessons from BlueScope Steel's decision to sack 1000 workers in Port Kembla and Western Port are that, in the economy, benefits always come with costs: we can't have everything and one country can't do everything well.
Leaving aside the continuing fallout from the global financial crisis, the most momentous, long-term development in the global economy is the rapid industrialisation and urbanisation of the developing countries, with Asia as the epicentre of this trend.
For the economic emergence of the developing countries to be occurring at a time when the major advanced economies of the North Atlantic have made such a hash of their affairs is a great blessing to all of us. Whereas we're used to America and Europe providing the motivating force to the world economy, now it's the strong growth in the developing countries that will keep the world growing.
Among the developed economies, Australia is almost uniquely placed to benefit from the emergence of the poor countries. That's because we're located so close to the epicentre, but also because the main thing we sell the world is raw materials, and raw materials are the main thing the developing countries need to import: energy, food and fibre and, above all, the chief ingredients of steel - iron ore and coking coal.
The world prices of all these things have shot up in recent years and all Australians - not just the miners and farmers - have benefited from them. Although these prices are sure to fall back soon enough, they're still likely to stay much higher than they were. That's because the process of economic development in Asia has so much further to run. As people in poor countries get richer and seek more protein, agricultural prices will probably go a lot higher.
But as well as higher prices, our resources boom has entered a second phase of massive investment in expanding our capacity to supply coal, iron ore and natural gas to the rest of the world. This hugely increased investment spending is set to run for years. It will underpin our economy, protecting us against recession.
That's the good news and, overwhelmingly, this is a good-news story - even though, remarkably, we seem to be in the process of convincing ourselves times are tough and that no one who's not a miner has benefited from the boom: we didn't really have eight income tax cuts in a row; the NSW and Victorian governments aren't really getting bigger shares of the revenue from the goods and services tax at the expense of Queensland and Western Australia; none of us has benefited from the high dollar; we're not taking more overseas trips; not buying cheaper electronic gear and not paying less than we would have for our petrol.
And now, just while we're feeling so uncertain and sorry for ourselves in our immense good fortune, we're reminded that with all the benefits of the resources boom also come costs. Who'd have thought it? Quick, double the gloom.
For decades we thought we were losers, being a country obliged by its history and natural endowment to earn most of its export income from raw materials. Now we discover we're winners. But world trade works by each country specialising in what it's good at. You can't specialise in everything and the truth is we've never been good at manufacturing.
Our domestic market has been too small to give us economies of scale and we've been too far away from
the developed countries that buy manufactures.
The flipside of our increasing specialisation in the export of raw materials is our Asian trading partners' increasing specialisation in what they're best at: using their abundant but mainly unskilled and thus cheap labour to produce manufactures, including steel.
Increasing their exports of manufactures is the way they pay for our raw material exports to them, including the chief ingredients of steel.
Our manufacturers are copping it two ways: increased competition with the growing supply of cheaper manufactures from the developing countries, and our high dollar, which makes our manufacturers' prices high relative to those of other countries' manufacturers.
There are limits to the resources of labour and capital available to us in Australia, so the expansion of mining will tend to pull resources away from other Australian industries, particularly those we're not relatively good at, such as manufacturing. Our high exchange rate - which always rises when commodity prices are high - is part of the market mechanism that helps shift workers and capital around the economy.
There are bound to be a lot more job losses in manufacturing. And a lot of those displaced workers are likely to end up in mining or mining construction. Some, of course, will take the places of other workers who've been attracted into high-paying mining and construction jobs. Others will fill vacancies that have no obvious links to the resources boom.
It will be tough for those workers obliged to make this transition and even tougher for those who don't make it. Fortunately, it's happening at a time when unemployment is low. Even so, governments
need to do all they can to help displaced manufacturing workers find jobs elsewhere.
What governments shouldn't do is increase protection and other assistance to manufacturing industry itself in an attempt to stave off change. It needs to adjust to the reality of a significantly changed world economy.
Efforts to help manufacturing resist change can come only at the expense of all other industries. There are no free lunches in industry assistance.
It would be a good way to fritter away the proceeds from what the governor of the Reserve Bank has called "potentially the biggest gift the global economy has handed Australia since the gold rush of the 1850s".
So you like the sound of a cut in interest rates? Don't get your hopes up. It's possible, but not probable. And remember, rates go down only when times get tougher. Is that what you want?
Though the likelihood is that hysteria over the imminent devastation to be wrought by the carbon tax accounts for the greatest part of the present caution among consumers, vague anxiety over the incomprehensible goings on in Greece is probably also contributing.
I don't believe in troubling trouble until trouble troubles me - especially when there's nothing you can do about it. But it seems I'm in a minority. Scare yourself over some event that with any luck won't happen? Yeah, why not? Got to get some excitement in your life.
The surest way for us to get a cut in interest rates would be for some major disaster in Europe - say, a disorderly debt default by Greece that caused the flighty financial markets to spread contagion to other highly indebted members of the euro area - to bring about another global financial crisis.
Should it happen, it would be similar to what we experienced after the collapse of Lehman Brothers in September 2008, with one exception: the financial markets are less likely to freeze up the way they did then. This time, no bank, central bank or government could say they had no inkling it was coming - which is what reduces the likelihood of a disaster being allowed to happen.
What we would get is the same wave of fear and uncertainty among consumers and businesses sweeping instantaneously around the world to every country that has television news - even those with little direct connection to the debt problems, including China (as happened last time) and us (ditto). We wouldn't be human if we didn't act like sheep.
We now know what happens when consumers and businesses around the globe become uncertain about the future and so suspend any plans they may have had for new spending until the outlook becomes clearer: international trade plummets, industrial production dives and world commodity prices crash.
The first time that happened it didn't take the Reserve Bank long to figure out what it needed to do: slash interest rates. It cut the official interest rate by 4 percentage points in five months. It would take it even less time to come to a similar conclusion this time.
If you could enjoy some such huge cut in your mortgage rate while being completely sure you and yours would keep their jobs, what a wonderful world this would be for those schooled by politicians and the media to take an utterly self-centred view of the economy. Trouble is, with everyone around you panicking, you couldn't be at all sure of keeping your job.
But let's step back from the worst-case scenario to something more probable. The truth is that despite all the self-pitying, over-hyped gloom, the Reserve retains a ''bias to tighten'' - its expectation that sooner or later it will need to raise interest rates, not cut them.
Why? Because we're in the middle of the biggest commodity boom, and the early stages of the biggest mining construction boom, we've experienced in 140 years. And because it's delusional to imagine all the benefit from that boom is penned up in Western Australia.
To be more specific, it's because the Reserve's first responsibility is to keep inflation in check and inflation is showing signs of breaking out. In particular, wages are growing at the relatively fast rate of 4 per cent.
Were labour productivity improving at the 2 per cent or even 1.5 per cent rate we've enjoyed in the past, that would be nothing to worry about. But productivity improvement has been particularly limited for some years, meaning ''unit labour costs'' (the average cost of labour per unit of production) are rising at a rate that will add to employers' price pressure.
How do you slow down wages growth? By using an increase in interest rates to slow the growth in borrowing and spending - demand - and, hence, the derived demand for labour.
All this says the Reserve will be scrutinising the consumer price index figures we get on Wednesday with particular concern.
It's true, however, that significant parts of the economy are doing it tough at present. Some of this is the unavoidable and actually helpful consequence of the resources boom's effect on the dollar, but in the case of retailing it's a self-inflicted bout of caution.
So, despite its worries about inflation, the Reserve will be reluctant to raise interest rates while the weakness in retail sales and other parts of the economy raise a question about the ongoing strength of demand. If underlying inflation in the June quarter comes in at about 0.7 per cent, it will be happy to stay its hand and await a clearer picture. Were the underlying increase to be as high as 1 per cent, it would probably still avoid raising rates at its board meeting the following Tuesday, but would be most uncomfortable about it.
When will it raise rates? When it sees signs consumers are losing their caution, or if the unemployment rate were to keep falling.
But what would prompt it to cut rates in the absence of global catastrophe? A lower than expected rise in underlying inflation next week plus, over the next few months, continuing consumer caution leading to further weakness in economic activity and a significant rise in unemployment.
You may wish for a rise in joblessness to bring about a cut in your mortgage rate, but that would be selfish and quite possibly foolhardy.
One reason governments aren't nearly as "tough" as economists and others urge them to be is their knowledge that when the going gets rough - when the losers from that toughness start vigorously objecting - the urgers will be missing in action.
The reaction to last week's budget offers a good example. On budget night every petshop galah was complaining it wasn't tough enough - a "missed opportunity", the last Julia Gillard will get before the next election.
What they were on about was the need to roll back all the middle-class welfare John Howard inserted into the budget.
But there was a fair bit of rolling back in the budget and, on day two, when battlers on more than $150,000 a year (egged on by the media) were screaming blue murder, claiming to be on middle incomes and insisting "$150,000 a year isn't rich", almost all the previous day's urgers were out to lunch. (The media are always accusing the pollies of spin, but the media often put their own spin on the pollies' words. Neither Labor nor any politician would be stupid enough to claim people on more than $150,000 a year were "rich" rather than just comfortable, but the media happily put that emotive word into the pollies' mouths.)
Our small army of taxpayer-subsidised commentators from the libertarian think tanks - the Institute of Public Affairs in Melbourne and the Centre for Independent Studies in Sydney - had surprisingly little to say (with the honourable exception of the centre's Jessica Brown). Presumably, they were too busy preparing another jihad against "churning". You get the feeling Labor cops more criticism for its slowness to roll back middle-class welfare than Howard got for putting it there (here the economist Saul Eslake is the honourable exception). Certainly, the smaller-government brigade is a lot tougher on the government for its timidity than it is on the opposition for its blatant populism and inconsistency.
And if some of the measures proposed in the budget fail to get through the Senate, just watch as economists and media commentators blame it all on the Greens, not the Libs.
But I'm fairly confident most of the measures will get through. I have a feeling they were selected to be acceptable to the Greens and lower-house independents.
Against that, however, the failure of the pure at heart to offer the government any support in its battle with rent-seeking punters, an increasingly partisan media and an unprincipled opposition is a good way to increase the likelihood that those with the balance of power will decide the issue has become too hot so they dare not risk supporting the reforms.
It's funny commentators who last year were claiming Gillard's minority government would be incapable of achieving any reform are now berating it for this "missed opportunity". What were they hoping for: a truckload of tough measures that didn't stand a chance of getting through?
What the two attitudes have in common is they both frame Gillard as a loser. We know about Aussies' love of cutting down tall poppies, but here we're seeing something darker: if someone's down, why not join all those who are kicking them.
It's surprising how those who profess to care so deeply about the good government of the country see so little need to help a weak government be stronger. With our reform advocates it's all care but no responsibility.
As for the notion that governments can only do unpopular things in their first budget after an election, I don't think it applies to minority governments.
In any case, a look at the budget figures makes it clear Gillard is sailing close to the wind in being sure of achieving a small budget surplus in 2012-13 and keeping that surplus in the following few years.
There's a high likelihood that, to increase her margin of safety (and meet her pledge to limit real spending growth to 2 per cent a year), Gillard will need to achieve further spending cuts in her next two budgets - whether she fancies the idea or not.
Last Monday I wrote that the Reserve Bank governor's pay (I should have called it his total remuneration package) of $1.05 million a year had jumped 85 per cent in the past five years. This calculation was based on information in the Reserve's annual reports.
Now the chairman of the Reserve's remuneration committee writes that the figures used in this calculation are not comparable because of the changed accounting treatment of non-cash benefits. He says the cumulative pay rise over the period was in fact 34 per cent.
I have been unable to confirm his calculation from publicly available information. I am puzzled by it because the figure used as the base for my calculation, $570,000, was described in the Reserve's 2005 annual report as the governor's "remuneration package", which included "cash salary, the Reserve's contribution to superannuation, housing assistance, motor vehicles, car parking and health insurance and the fringe benefits tax paid or payable on these benefits".
The letter the previous chairman of the remuneration committee wrote to the Treasurer in September 2009 (made public because of a freedom-of-information request) advised that the value of the governor's total remuneration package had risen by 33 per cent just between 2008 and 2009.
I note that the incorporation into the governor's base salary of "other allowances (including motor vehicle)" worth $44,600 a year - which also included an unused entitlement to spouse travel, valued at $25,800 a year - led to a commensurate increase in his employer's superannuation contribution, which is made at the rate of 21.3 per cent.
Everyone who's seen The Godfather knows how the Mafia works: it's more than happy to do you a favour, but once it has it owns you forever. Our coterie of grossly overpaid chief executives and directors operates much the same way.
They're a mutual pay-raising society - you raise my pay and I'll raise yours - and more than a year ago they induced the governor of the Reserve Bank, Glenn Stevens (a most estimable fellow in every other respect), to join their club.
Stevens accepted the recommendation of the Reserve board's "remuneration committee" that his salary be raised to $1.05 million a year. This is at least double what the heads of federal departments get, and far more than almost all other central bank chiefs get.
It's about five times what the US Federal Reserve chairman, Ben Bernanke, gets. Stevens's pay has jumped 85 per cent in five years, equivalent to annual rises of 13 per cent.
This compares with a former governor's "line in the sand" many years ago setting 4.5 per cent a year as the maximum non-inflationary pay rise for ordinary mortals (a limit that these days would be too high because of our weaker productivity growth).
The price of Stevens's admission to the lowest rung of the indefensible-salaries club is the loss of his - and the Reserve's - moral authority on the question of excessive pay rises for punters. (He also forfeits the ability to be at all critical of the example set by his fellow club members.)
The chances of skilled-labour shortages turning into a general round of excessive wage increases in the next few years are high. If that happens, Stevens has lost the ability to fight it with "open-mouth operations" in the way his predecessor, Ian Macfarlane, sought to talk down the housing boom in 2003 - with some success. No, Stevens will be left with only one instrument: higher interest rates. And consciousness of his self-inflicted impotence in the moral suasion department may lead him to raise rates just that little bit higher than otherwise.
If so, he will have added injury to his insult to wage slaves. The more some workers seek a fraction of the percentage wage settlements Stevens has been accepting, the more others of them will be priced out of a job.
But how does it come about that Stevens is now paid so much more than other central bank bosses? The rest have boards composed largely of economists and public servants. Pretty much only in Australia is the board composed largely of business people.
So what more is natural than this group of chief executives and professional board members seeking to run chief-executive remuneration at the Reserve the way they run it on money-obsessed private-sector boards? And what is more natural than them cutting a nice guy like Stevens in on the easy dosh?
Studies by psychologists show that people engaged in ethically dubious practices are commonly anxious to convince others - and themselves - that "everyone's doing it". And now the governor's just as morally compromised as I am. Told you.
The Reserve's delay in making Stevens's pay rise public - or even privately informing the Treasurer - for almost a year suggests it knew full well it was out of line with "community expectations" and had done something to be ashamed of.
The arguments members of the Reserve's "remuneration committee" have offered in defence of their actions are characteristically weak. The Reserve has to compete with "lucrative offers in the financial sector" to retain staff, we're told.
At the level we're talking about, that's rubbish. These guys aren't real bankers, they're economist bureaucrats who know a lot about monetary policy, but not much else. They could never run a real bank; some could run a dealing room or be a chief economist.
If any of the Reserve's top people have had "lucrative offers" lately it would be nice hear about them. I'll bet they haven't. Even if they had, they wouldn't be tempted.
Anyone who hangs in at the Reserve long term, and thinks they have a shot at being governor, is motivated by something no private-sector job can offer: the knowledge you're playing a significant role in steering the Australian economy. As a bonus, you get to sign banknotes.
It's true salaries need to be reasonably competitive with the financial sector much lower down in the Reserve hierarchy. That's where good young people are often tempted away - especially since the intellectual firepower needed to progress up the Reserve's ranks is formidable.
But that's the joke. In line with the ethic of the indefensible-salaries club, lower salaries aren't increased commensurately. It's demigods only. Little trickles down.
Asked how the yawning gap between Stevens's and Bernanke's salaries could be justified, one genius on the "remuneration committee" argued it was all about how much you could earn after you ceased being governor. Bernanke would command $250,000 a speech. That's a market-forces argument?
In truth, retiring Reserve governors - who have excellent superannuation - can earn vastly higher incomes by accepting all the positions on boards they're offered. Their inside knowledge allows them to become professional directors overnight - and help jack up other top people's salaries. The only constraint is their personal ethics.
It seems clear the Remuneration Tribunal intends to raise the salaries of federal department heads to reduce the gap with Stevens's $1.05 million, on the grounds of comparable responsibilities.
So we start with a bulldust market-forces argument and progress to fairness arguments. When workers argued this way in the old days it was called "comparative wage justice" and every economist condemned it as economically irresponsible. The demigods live by different rules.
I write as chairman of the Reserve Bank Board's Remuneration Committee to correct a misinterpretation in a recent article by Ross Gittins (BusinessDay, 9/5) that claims there had been an 85 per cent increase in the remuneration of governor of the Reserve Bank Glenn Stevens between 2005 and 2010.
The cumulative pay rise over that five-year period was, in fact, 34 per cent. The numbers used by Gittins are not comparable owing to the changed accounting treatment of non-cash benefits between 2005 and 2010.
Roger Corbett, chairman, Remuneration Committee, Reserve Bank Board
Last Monday I wrote that the Reserve Bank governor's pay (I should have called it his total remuneration package) of $1.05 million a year had jumped 85 per cent in the past five years. This calculation was based on information in the Reserve's annual reports.
Now the chairman of the Reserve's remuneration committee writes that the figures used in this calculation are not comparable because of the changed accounting treatment of non-cash benefits. He says the cumulative pay rise over the period was in fact 34 per cent.
I have been unable to confirm his calculation from publicly available information. I am puzzled by it because the figure used as the base for my calculation, $570,000, was described in the Reserve's 2005 annual report as the governor's "remuneration package", which included "cash salary, the Reserve's contribution to superannuation, housing assistance, motor vehicles, car parking and health insurance and the fringe benefits tax paid or payable on these benefits".
The letter the previous chairman of the remuneration committee wrote to the Treasurer in September 2009 (made public because of a freedom-of-information request) advised that the value of the governor's total remuneration package had risen by 33 per cent just between 2008 and 2009.
I note that the incorporation into the governor's base salary of "other allowances (including motor vehicle)" worth $44,600 a year - which also included an unused entitlement to spouse travel, valued at $25,800 a year - led to a commensurate increase in his employer's superannuation contribution, which is made at the rate of 21.3 per cent.
The big divide in economists' views on the outlook for the economy - and hence, for interest rates - is whether they regard the present weakness in consumer spending as worrying or welcome. And that turns on how forward-looking they are.
I suspect it's also affected by what psychologists call "salience" - the tendency for our judgments to be most affected by those events that are highly visible and memorable, those that make the biggest impression on us. Looking at the economy now, what stands out is the weakness of consumer spending, including quite anaemic growth in retail sales. Tourism - whether inbound or domestic - is another area of weakness, badly affected by the high dollar.
So weak is consumer spending that it's putting downward pressure on a lot of retail prices. As Dr Philip Lowe, of the Reserve Bank, pointed out last week, over the past year the Bureau of Statistics' price index for clothing has fallen by 6 per cent (assisted by a fall in import duty on footwear, clothing and textiles at the beginning of last year).
The various indexes have fallen by 4 per cent for major household appliances, 1.5 per cent for furniture and furnishings and by 18 per cent for audio, visual and computing equipment. Indeed, apart from processed food, the prices of very few manufactured goods rose during the past year.
Lowe suspects the weak consumer spending has led to a faster than usual pass-through to retail prices of the substantial appreciation of the dollar, which has lowered the cost of imported goods and services (and also put downward pressure on the prices of locally made goods and services that compete against imports in the domestic market). His suspicions are confirmed by the research of Kieran Davies, of Royal Bank of Scotland, who found the weakness of retail prices was more likely to be the result of pass-through of the higher exchange rate than the compression of retailers' margins.
Davies notes that, unless the dollar appreciates further (not something I'd wish for), the exchange rate's dampening effect on inflation will soon start to wane.
All this spells tough times for the retailers, and their lamentations have had much publicity. So it's easy to see the economy as going through quite a weak patch. This impression will be compounded when we see the way the Queensland floods and cyclone Yasi have taken a bite out of the growth in gross domestic product in the December and, more particularly, March quarters.
Little wonder the financial markets aren't expecting any further increases in the official interest rate until quite late this year, and the governor of the Reserve Bank, Glenn Stevens, thinks rates are "about right for the medium-term outlook". But I think there's a lot more strength behind the economy than all the surface noise would suggest. If I'm right, the rate rises will resume earlier than the markets presently expect.
For a start, the blow from the extreme weather events largely represents the displacement of activity from the March quarter to the June and later quarters. The Reserve is expecting the level of GDP to be no lower by the end of this year than was expected before the floods happened.
For another thing, the weakness in consumer spending is occurring because of a reversion to our earlier saving habits and a (presumably temporary) bout of caution. In other words, consumers aren't short of a bob, they're choosing not to spend.
It's not the sort of thing the media shout about, but household disposable income grew by 6.4 per cent over the year to September in nominal terms. It's being boosted by two major sources of present and future growth: our most favourable terms of trade in 140 years and strong growth in employment. The Reserve's index of commodity prices has risen by almost half over the past year. This doesn't add to GDP directly, but it does add to the nation's real income which, when spent, becomes more visible.
Another less salient factor is the strength of the labour market. Over the year to January, total employment grew by 3 per cent. Within that, full-time employment grew by 3.4 per cent. The unemployment rate is down to 5 per cent, while the rate of participation in the labour force is at a near record high of 65.9 per cent.
This is not the hallmark of a weak economy - quite the reverse. It also gives the lie to the silly talk of a two-speed economy. You may object that the labour market's yet to register the effect of the weak retail sector but, in fact, the various forward indicators suggest employment will continue growing strongly.
And to top off all that there's the least salient factor of all: the looming wall of mining construction spending. Consider this quote from the latest statement on monetary policy: "For some time, the [Reserve] has been expecting very strong growth in resources sector investment.
"The information received over recent months has provided greater confidence in this forecast, with announced plans to date at least as strong as had been expected."
All this is what you see when you lift your eyes from hard-pressed retailers and look at what's in the pipeline. When you do you see that, from a wider perspective, the fact we're not yet adding a consumption boom to a business investment boom is more welcome than worrying.
The economy's potential rate of economic growth is only about 3.25 per cent a year and, with unemployment already down to 5 per cent, we have little spare production capacity.
Even so, the Reserve is forecasting growth of about 4.25 per cent over this year, with growth of 3.75 to 4 per cent in the following years.
Sounds like a recipe for higher interest rates to me.
Talk to Australian Business Economists Annual Forecasting Conference Sydney, December 8, 2010
Just as Glenn Stevens starts each appearance before the House economics committee by reviewing the fate of the forecasts he made at his previous appearance, so I have to start by reviewing the fearless forecasts I made this time last year. Usually Stevens can say his forecasts turned out pretty well, but I can’t. Since I know you guys like people to make a clear ‘call’, I gave one. And as a well-trained journo I put it in the lead: ‘it now seems clear the next federal election will be a double dissolution held not much earlier than normal - late September - with climate change and Work Choices as its main issues. It also seems likely that Kevin Rudd will win in a landslide’. Later, I referred to Tony Abbott, elected to be opposition leader just the previous week, as ‘unelectable’.
Whoops. Every one of those judgments proved wrong. My key miscalculation was in assuming Rudd couldn’t and wouldn’t abandon his commitment to achieving his emissions trading scheme. The other errors I made flowed from that. Labor insiders tell me I was among the first outsiders to detect Rudd’s feet of clay, but as it turned out even I overrated him. Had Rudd not lost his nerve on the ETS he would have had to hold a double dissolution, but the one he considered and eventually decided against would have been held early in the year, not later as I predicted. His about-face on the ETS started his precipitous decline in the polls which, combined with his difficulties over the mining tax, prompted his overthrow. But his brutal replacement by Julia Gillard did little to revive Labor’s electoral standing. Clearly, I and other smarties greatly underestimated Abbott’s powers as a politician, including his ability to largely defuse Work Choices as an election issue.
I’ve known for many years how foolhardy it is to make long-term political predictions - that is, predictions of events more than a year away - because events and attitudes can change so easily between now and then. But, for the sake of a fearless call (and also because the earlier you make your forecast the more time there is for people to have forgotten it), let me break my rule: I predict the Gillard government will run full term but, though that ought to give it plenty of time to lift its game, will lose the next election. I’ve come to the conclusion this generation of Labor is terminally incompetent.
Federal Labor’s achievement this year has been nothing short of extraordinary. To quote Wayne Swan: ‘We came within a whisker of losing government despite the best performing advanced economy in the world, despite substantially increasing the pension, despite fairer workplace laws, despite record investments in human capital, and despite cutting income taxes three times.’
I’m going to devote a fait bit of this talk to trying to explain why Labor stuffed up so badly, before looking to the future for politics and government.
The Demise of Rudd
The man who emerged from relative obscurity to become Labor’s saviour in 2007 turned out to be deeply flawed. Matched against the ageing John Howard, he looked appealing - young, good looking, well spoken, well educated and articulate - and unthreatening. At the same time, he promised to end the unfairness of Work Choices and was judged the more credible of the two in his promise to take decisive action on climate change. But he didn’t look particularly ‘Labor’.
He didn’t look it because he wasn’t. He hadn’t had to fight his way up through the party or the union structure, even though he - like almost everyone at the top of modern Labor - had cut his teeth working for state Labor, in his case as a politically appointed senior bureaucrat working for the Goss government. Labor’s egalitarian ethos hadn’t rubbed off on him, he held the unions in disdain, he was in a faction but not of one, he had little personal support within the parliamentary party and no mates. The main things that got him into the opposition leader’s job were his sponsorship by the NSW Right and his deal with Gillard of the Left. He did deals with many party people, most of whom he stopped talking to after he’d attained the exalted heights of prime minister. He burnt up much goodwill by giving jobs for the boys to boys from the other side - something Howard would never have dreamt of doing. He failed my acid test for Labor ministers: his staff didn’t love him (as most do).
He turned out to be all ambition and little principle. His overriding goal was to maintain his own popularity. He had little courage and was part of a cabinet that almost universally lacked courage. Everything started falling apart when he, after a long period of indecision, took the fatal decision to abandon the ETS because it had become too hard. To be fair, he took a lot of persuading to give up the ETS, but eventually those urging him to stick with it - Lindsay Tanner, Penny Wong and John Faulkner - were overwhelmed by those urging him to drop it: initially, Sussex Street (Mark Arbib and Karl Bitar) and then Gillard and Swan - the two whose careers benefited most from that fatal miscalculation, which in one blow destroyed the credibility of both Rudd and his government.
Despite his reputation as a policy wonk, Rudd turned out to be a hopeless administrator. He couldn’t set priorities or delegate (meaning he had no intrinsic feel for opportunity cost). He moved from one enthusiasm to the next, wanting everything he touched to be the biggest and best ever (he was addicted to superlatives), but had great trouble making up his mind and would delay a decision by demanding more options and the answers to more and more questions. His personal staff and senior bureaucrats were treated very badly. People would work all night to have a response to his queries on his desk next morning, only to discover he hadn’t found time to read it. They’d be summoned to a meeting with him several days later, where he’d flick through their paper, asking questions to which the answer was often ‘on the next page, prime minister’. Papers piled up in his in-tray, everything ran late and often had to be thrown together at the last minute to meet some deadline. Bureaucrats who needed something ticked by the PM would save it till he was out of the country and then submit it to Gillard, who would turn it around in no time. Government decision-making became chaotic.
Rudd was also an autocrat. He didn’t consult - not the unions, business, the backbench, the outer ministry or even the cabinet. Key decisions were made by the kitchen cabinet or Gang of Four, the strategic priorities and budget committee - Rudd, Gillard, Swan and Tanner - and even then there’ve been suggestions the other three were consulted rather than allowed to decide. After Rudd was deposed because the government had ‘lost its way’, Gillard and others were often asked whether they’d done anything to warn or remonstrate with Rudd. The honest answer is: No, not really. People were afraid to speak frankly to Rudd for fear of incurring his (frequently displayed) displeasure and being cut out of the loop. Rudd lacked the courage to sack people, but would just stop talking to those - even those within his office - who’d lost his confidence. By the end, pretty much his only confidants were a couple of inexperienced 30-year-olds in his office. His fatal mistake was to stop talking to Mark Arbib.
Rudd returned from his failed attempt to broker an agreement at Copenhagen exhausted and dispirited. He seems to have gone into a funk of indecision. He baulked at calling a double dissolution, then sought to distract himself with health reform, visiting about 40 hospitals around the country to ‘consult’. Senior bureaucrats and ministers followed him around, hoping he’d make decisions and reach their agenda item.
Rudd’s obsession with always trying to dominate the daily news cycle proved a snare and a delusion. His insistence on having ministers and departments come up with an unending stream of minor ‘announceables’ wasted their time and annoyed them while distracting them from more important matters. Worse, it deluded the government into imagining it was communicating effectively with the electorate. Labor’s small army of young PR punks manhandled the press gallery more than it was used to, meaning the media were ready to turn on Rudd as soon as his dominance slipped. The notion that if you could dominate the news cycle every day for three years the election would be a pushover proved to be wrong. As soon as the decision to drop the ETS destroyed Rudd’s credibility - among people who didn’t fancy the idea, as much as those who did - all those days of media dominance counted for nought.
Rudd’s backdown on the ETS weakened him for the next big battle, over the resource super profits tax. It emboldened the big three miners to seek to destroy the government rather than bargain with it, while reducing the government’s creditability in defending the tax to the public and making the notion of reaching a significant compromise with the miners unthinkable. (What isn’t widely known is that the big three’s resistance was heightened because the tax would have cost them more than twice what Treasury had estimated it would.)
Rudd’s losing fight over the RSPT proved the last straw for the spurned Sussex Street, which patched up its relations with the parliamentary Right in other states, gathered the numbers in caucus and made a last-minute offer to Gillard she couldn’t resist. The former Hawke minister Neal Blewett has expressed surprise at how quickly the party panicked. All successful governments go through periods of being behind in the polls. The explanation is partly that modern Labor is more committed to power than principle, but also that, by then, the entire party was so fed up with the chaotic, authoritarian Rudd. The night the bureaucrats learnt Rudd was being replaced by Gillard there would have been dancing in the streets.
The unlosable election (just)
It’s remarkable that a first-term federal government - particularly one that had performed so well in managing the economy - failed to win the election and went so close to losing it. We’ll never know whether Labor would have done better at the election had Rudd been allowed to stay on. We do know the election would have been held in October rather than brought forward to August. It’s clear the brutality of Rudd’s overthrow would have cost Labor votes - more than the conspirators ever bothered to imagine it might. But it’s doubtful Rudd would have been able to reach a compromise with the big miners over the resource tax, so one imponderable is how well he would have withstood the continued onslaught, including a massive ad campaign and funding of the Liberals.
On the other hand, Rudd’s overthrow robbed Labor of the ability to boast about its various achievements (paid parental leave is one Swan didn’t mention in that earlier quote). How could you justify Rudd’s ousting as necessary because the government had ‘lost its way’ and then praise his performance? Thus did Labor forfeit much of the benefits of incumbency - another price I doubt the conspirators thought about before they acted. But most Labor insiders are saved from worrying about what might have been by their conviction that, one way or another, Rudd had to go.
I think it’s now clear Gillard’s strategy of reaching a quick fix on the government’s three most pressing problems - reaching a compromise on the mining tax, doing something about asylum seekers and filling the vacuum on climate change - then rushing to an early poll while Gillard was still enjoying her honeymoon with the electorate was a costly miscalculation. The honeymoon quickly evaporated, leaving a woman with blood on her hands rushing to the polls before the dust had settled and people had got a chance to get to know her. Unsurprisingly, they weren’t greatly impressed.
The campaign was surprisingly badly run, and was marred by several damaging leaks, which party insiders are convinced came from Rudd. Before the election we were told a uniform swing of just 1.7 per cent against Labor would be sufficient to tip it out, but it actually suffered a two-party preferred swing of 2.6 per cent and still ended level pegging with the coalition on the number of seats. Why? Because the swing was far from uniform, varying greatly between states: down 5.6 per cent in Queensland, 4.8 per cent in NSW and 3.2 per cent in Western Australia, but up 4.4 per cent in Tasmania, 1 per cent in Victoria and 0.8 per cent in South Australia. And because swings aren’t uniform even within states, they don’t translate evenly to seats. In net terms, Labor loss seven seats in Queensland and one each in NSW, WA, Tasmania and the Northern Territory, gaining a net one seat in Victoria, to lose 10 seats in total, eight to the coalition, one to the Greens and one to an independent in Tassie.
On first preference votes, Labor lost 5.4 percentage points, though only 1.5 percentage points of this went to the coalition, leaving almost 4 percentage points going to the Greens. The Greens’ two-party preferred vote in the Reps rose to 11.8 per cent (with 79 per cent of their preferences going to Labor). This was Labor’s fourth lowest primary vote since the beginning of the two-party system in 1910.
Breaking up Labor’s vote by region, its two-party preferred vote fell by 3.3 percentage points in inner metropolitan seats, by 3.1 points in rural seats, but by only 1.8 per cent in outer metropolitan and provincial seats.
On a depressing note, both sides judged it easier to scare people into rejecting the other side than to inspire people to support them. On an encouraging and remarkable note, because both sides were so anxious to claim they’d be better at eliminating budget deficits and debt, both felt they had no choice but to nominate offsetting savings to cover the cost of their election promises (although the Liberals’ costings were deceptive).
Gillard’s strengths and weaknesses
As Peter Hartcher has pointed out, Gillard has one thing in common with Abbott: both seized their party leadership as part of a reform panic. Abbott: the coalition’s panic over Malcolm Turnbull’s commitment to the ETS; Gillard: Labor’s panic over the opposition to the mining tax. Not an auspicious beginning for either of them. I don’t believe Gillard undermined or plotted against Rudd but, even if she didn’t, it looked bad and she has had no honeymoon with the electorate.
She isn’t able to appear warm and likable on television, which means she lacks charisma. She isn’t disliked, but she isn’t liked either. A substitute for likeability (eg Bob Hawke) is being respected - seen as a strong and capable leader (eg Howard, Malcolm Fraser), but she doesn’t have that either. Since the election she and Labor have been flat-lining in the polls, making no progress from their perilous position at that time. You can see this as a sign she’s failed to impress the electorate or that it’s suspending judgment - both, probably.
One of her strengths is she’s a highly capable administrator (notwithstanding the exaggerated problems with the schools halls building program). She’s smart, she works hard, turns the paper around and chairs a very disciplined meeting. Another great strength - much in evidence in the 17-day period between the election and Labor’s confirmation it had the number to continue in government - is her ability as a negotiator and deal-maker. She can give you little, but send you away happy. A third great strength is her willingness to listen, consult and include. All leaders learn from the mistakes of their predecessor, but she would have been inclusive anyway. Cabinet is back to functioning normally. Even if her polling doesn’t improve, it will be a long time before the caucus can be roused against her. And she has had the sense to abandon Rudd’s obsession with dominating the daily news cycle.
Her great weakness is her lack of belief. She’s hugely ambitious, but doesn’t seem to have a deep commitment to Labor’s traditional preoccupation with fairness and redistribution, equality of opportunity, social justice and compassion. She came to power via the Left faction, but shows no sign of having left-wing values. Indeed, I suspect she’s trying to live down her left-wing label by erring on the conservative side. She does keep saying what her values are: she believes in hard work, a fair go through education, and that we’re all equally worthy of respect. That’s fine, but it doesn’t get us far. And though she and her cabinet colleagues keep stressing their belief in ‘a strong economy’, that doesn’t mean she’s an economic rationalist - just a politician who’s concluded a growing economy is essential to staying in office.
Laurie Oakes says Howard made every mistake in the book in his first term, but he only made them once. My big question about Gillard is the steepness of her learning curve. If you learn from your stuff-ups, your chances of survival and success are greatly improved. I concluded Rudd didn’t have a learning curve, so wasn’t sorry to see Labor bundle him out. Gillard was at the fore in persuading Rudd to abandon the ETS, which proved a disastrous mistake, but her decision to fill the vacuum with a citizen’s assembly suggests she was very slow to see the error and start getting back into the carbon-price game.
One of Rudd’s failings was his hankering after the biggest and best in everything, regardless of whether all his grand projects were consistent with his (utterly genuine) commitment to returning the budget to surplus ASAP. This says Gillard should have seen the gold-plated national broadband network coming and taken quite steps to tone it down, but she didn’t.
Tony Abbott and the Libs
Abbott has proved a far more disciplined and successful politician than I ever imagined he could be. He got the job because of his willingness to switch to implacable opposition to a price on carbon (that is, to a policy on climate change that’s less rational that the Greens’), but also because the Libs, expecting a drubbing in the election, wanted him to minimise the loss of their base vote. He not only held the base, he gained almost enough of the middle ground to win. He just kept punching away during the election campaign, kept his foot out of his mouth, and did far better than anyone expected.
Abbott is a contradiction: intensely personable in the flesh, but capable of coming across as a crazed zealot in the media. But after a rocky start he kept all his zealotry well controlled. He can say stupid things (eg that this was the worst Labor government ever) but also things that are charming and disarming (eg that Gillard’s success with the independents showed her to be a talented negotiator).
The Libs are the natural home of economic rationalism, starting with Bert Kelly, The Modest Member, John Hyde and the Dries, and the pre-PM Howard, who once fairly dubbed himself the father of economic rationalism. But rationalism is out of fashion today; Abbott’s not interested in economics and is happy to argue that putting a price on carbon is crazy and pretend that ‘direct action’ will fix climate charge rather than just waste money. There are no rationalists left in the party bar Turnbull (and maybe Joe Hockey), though Hockey is regarded as lazy and has two people after his job (Andrew Robb and Turnbull). But Robb’s credibility has been damaged greatly by the disclosure after the election that his policy costings - which he refused to submit to Treasury and Finance - were flawed to the point of fraudulence.
It took Abbott too long to realise he’d lost the election and that the government was unlikely to fall any time soon. He should assume the election will be in three years’ time. If so, it doesn’t follow that just because he almost won this time he’s sure to win whenever the next election’s held. As I’ve been reminded to my cost, the political world can change dramatically within a year, let alone three. One thing that could change is that three years of Abbott’s unrelenting opposition to everything - punch, punch, punch - could wear very thin with an electorate that gets terribly tired of seeing politicians perpetually arguing with each other. You get the feeling Abbott would oppose the Second Coming if it was Labor policy. Smart oppositions avoid appearing excessively negative by being more selective in what they oppose and drawing attention to the things they support. Abbott has indicated he understands the Libs’ need to do more to articulate their own positive policies, but whether he can force himself to be more positive and less relentlessly negative remains to be seen.
Labor and the economy
The more loudly Labor proclaims its fealty to ‘a strong economy’ the more you realise there’s something amiss. These days, it’s virtually compulsory for governments to claim to be committed to economic reform, though they have considerable latitude in what they define as reform. With the retirement of Tanner, Labor’s down to just one avowed economic rationalist, Craig Emerson, who’s sidelined in Trade. It will take some time for Labor’s new economics professor, Andrew Leigh, to progress from the backbench to the front. I don’t regard Swan as a true believer, though I have hopes for Wong. She did, after all, spend Labor’s first three years trying to introduce market pricing to carbon emissions and water. No, these guys are just politicians, first and foremost, who realise the political importance of good economic performance, but don’t have a deep understanding of, respect for and belief in the power of market forces. They are dogged by an inferiority complex in the economic area, born of their knowledge that they’re only faking it as economic rationalists and of Peter Costello’s decade-long success in reinforcing the electorate’s instinctive belief that the party of the workers couldn’t be any good at managing the economy, whereas the part of the bosses obviously would be.
Rudd and Gillard happen to have done particularly well at macro management, as well as it’s reasonable to expect flesh-and-blood politicians to do. They’ve left the Reserve Bank alone and uncriticised as it’s done its job; they stimulated the economy vigorously at just the right moment, they managed business and consumer expectations brilliantly, and they’ve imposed budgetary strictures on themselves from the off (starting with the requirement that all stimulus spending be temporary and moving to the restrictions on tax cuts and real spending growth till the surplus is back to 1 per cent of GDP). I have no doubt they’ll do ‘whatever it takes’ to get the budget back to surplus in 2012-13. I don’t regard this performance as having been seriously marred by the problems with insulation and school building. It has suited the opposition and sections of the media to leave us with a greatly exaggerated impression of the extent of waste, and to deny the very real trade-off between macro-economic timeliness and value-for-money.
It’s on the micro side that Labor’s performance has been weak, with its wasteful spending on industry assistance, cash-for-clunkers and the like, its inadequate rollback of Howard’s extensive middle-class welfare, its excessive compensation to polluters under its ETS and then its abandonment of that scheme when the going got tough, and finally its mishandling and ultimate butchering of the minerals resource rent tax.
Throughout its life the government has exhibited three related deficiencies: a lack of values, a lack of courage and a lack of skill in managing its relations with the electorate. It’s mainly because of Labor’s lack of deep belief in rational policies that it lacks the courage to fight for them when an unprincipled opposition exaggerates their cost to the electorate. And it’s the same lack of genuine belief and understanding that leaves ministers unwilling or unable to explain and defend policies whose short-term costs will be outweighed by longer-term benefits.
Labor’s explanatory powers and its belief in its own ability to exercise those powers have atrophied through lack of use. It’s relied too long on spin doctors, whose stock in trade is to conceal, confuse and distract rather than explain. People who should be being paid to find effective ways to explain complex and unfamiliar concepts put their effort into trickery, such as announcing backdowns late on Friday afternoons, or bullying journalists. Ministers agree to the public’s self-pitying misconceptions rather than explain complex truths. We didn’t have a recession because we didn’t have two successive quarters of negative growth - what a way to denigrate your own success! Any change in mortgage interest rates not in lock step with changes in the cash rate is profiteering. If power prices have risen a lot the cost of living has gone through the roof and you’re right to feel impoverished.
Why do ministers perpetually attack the opposition rather than explain and defend their policies? Because they’re politicians doing what politicians do, not economic believers doing what believers do. You’ve got to build support for reform - even if only among opinion leaders - but you don’t do it by attacking your political opponents, you do it by unceasing explanation and persuasion.
Why Labor’s so bad at it
In watching the government’s performance over the past three years - but particularly over the past year - I’ve come to the startling conclusion that federal Labor has lost its race memory of how to govern. The Hawke/Keating government knew how to do it, but after 11 years in the wilderness Labor has lost the knack. These guys are amateurs. Many of the ministers and their advisers had experience in government at the state level, but it hasn’t successfully translated to the federal level.
One sign of amateurism is that Labor is still talking and acting like an opposition. Not being in power, oppositions do little other than criticise the other side, leaving it until close to the election to produce positive policies. Sensible governments ignore their opponents as much as possible, exploiting the advantage of incumbency to deny them air. Responding to opposition criticism gives that criticism legitimacy in the eyes of the media and the public. Labor spends all its time attacking its opponents. The electorate finds this far more alienating and confusing than convincing. Those who aren’t one-eyed for one side or the other don’t feel equipped to adjudicate the debate and so are likely to conclude ‘they’re all liars’. In other words, attacking the opposition isn’t persuasive. It’s a sign Labor is confusing scoring points inside parliament house with scoring in the electorate. But the other disadvantage of perpetually disagreeing with the opposition is that it crowds out what the government should be doing: explaining its policies and expounding on their many virtues.
Another sign of opposition thinking is the way Labor keeps expressing sympathy for punters’ complaints that it picks up from its focus groups eg the cost of living, the greedy banks, executive salaries. Oppositions can get away with this, but governments can’t because they’re expected to act on their expressed concern. Governments are unable to do much to fix most of these complaints, many of which are ill-founded. By sympathising with these whinges rather than making the counter points, governments foster the belief that they can and should solve all the problems of individuals, a recipe for voter disenchantment.
If there’s one thing you’d expect Labor politicians to understand it’s the need to ‘do the numbers’ - make sure you have enough support for a proposal before you make it public and risk losing face if you then have to seriously modify or even abandon it in the face of vigorous opposition. Partly this is about pre-marketing controversial ideas to find small modifications that could significantly reduce opposition, without any loss of face. Partly it’s about conditioning people’s expectations and also allowing the leaders of key interest groups to condition their supporters’ expectations. Everyone appreciates a heads-up; no on enjoys being caught by surprise. Consulting before announcement rewards and encourages loyalty among natural supporters eg the unions, and builds trust with non-supporters eg business.
The sad story of the resource super profits tax is a case study. The tax was intended to be no more burdensome than the miners would reluctantly accept, but in the event the big three objected so strongly they declined the opportunity for post-announcement consultation and set out to bring about the government’s electoral defeat. The miners had signalled their willingness to accept a profits-based tax, but seem to have been expecting an extension of existing petroleum resource rent tax (which is roughly what they ended up with). The only warning the miners had was being told of the government’s plan the day before it was announced. The proposed tax was in a highly sophisticated form unfamiliar to the miners (and their financiers), but the bigger problem was Treasury’s gross underestimate of the revenue the tax would raise. When, after weeks of public battling, the government finally realised the extent of this miscalculation, it soon agreed to change the tax in ways that reduced its revenue-raising potential to about what had been originally intended. This was seen by the public as a huge backdown in the face of opposition from a powerful foreign interest group. But worse, in the process the tax was butchered, greatly reducing its intended efficiency benefits. Had the government known the tax’s true revenue-raising power beforehand, it would merely have halved the rate at which it was imposed, from 40 per cent to 20 per cent. Had that happened, the miners’ opposition would have been greatly reduced and no one would have thought any the worse of the government. And the government would have been much better informed in advance of any announcement had it released the Henry report for public comment soon after receiving it, rather than releasing it simultaneously with the announcement of its response. The miners would have known what was being proposed, could have done their sums as to its effect on them and privately warned the government about their misgivings. Taking another example, I believe the controversy over the government’s reservations about the budgetary cost of equal pay is another case where pre-consultation could have saved the government a lot of skin.
This government lacks the confidence that should come from incumbency, that should embolden it to take calculated risks in support of good policy and should, in turn, foster the electorate’s confidence that the country is in safe and competent hands. This is a circular process: acting confident makes the electorate confident in you, which justifies and reinforces your own confidence. Instead we find a government with an economic inferiority complex, always trying to hide behind the authority of others: the allegedly ‘independent’ Treasury, the Henry report, the Murray-Darling Basin Authority, the NBN business case etc. Rudd would also have co-opted the Reserve Bank to his management team had the (genuinely independent) Reserve not politely declined.
Because of the human fallibility of the electorate, politics abounds in paradoxes. But Labor has no instinctive understanding of paradox. When you’re not conscious of paradox - when you don’t realise the public is perfectly capable of holding logically inconsistent attitudes - you’re easily misled by focus groups. One paradox is that though voters don’t welcome hip-pocket pain, they want to be led by someone with the strength and confidence to inflict pain when he or she believes it to be in the nation’s best interests. This explains why even those who feared the hip-pocket cost of the ETS reacted with disillusionment to Rudd’s decision to ditch it. From all he’d said, we really needed it, but he was willing to shirk his leadership responsibility to avoid unpleasantness. What’s particularly worrying is that none of those still at the helm of the post-Rudd Labor Party foresaw the price this expediency would extract. By contrast, Howard pressed on with his far more unpopular ‘great big new tax on everything’, the GST, and (narrowly) survived. What got him over the line was the public’s grudging confidence that he must be doing this unpleasant thing because the country really need it to be done.
Another paradox is that the more concessions you make to interest groups, the more you stimulate rather than satiate the demand for concessions. Show me you’re a soft touch, and I come back for more. Let me see rival interest groups getting in for their cut and I’ll hasten to join the queue. But let me see that nobody else is getting much and I won’t feel bad about getting little myself. The Hawke-Keating government had an objective of trying to stamp out the rent-seeking culture. It wasn’t always honoured, but it served the government - and good policy - better than what we have now.
Another paradox is that the public will overlook individual bad practices for a long time, but eventually the smell will reach a point that registers with the electorate and causes it to turn away in disgust. Individual controversies over conflicts of interest - failure to declare interests; politicians taking jobs with interest groups soon after leaving parliament - don’t excite much interest in the electorate, but if there’s sufficient controversy over time to convince people a government is merely feathering its own nest, it’s in trouble. Politicians devote much time to crafting arguments - often using statistics - designed to mislead without actually lying. People haven’t the knowledge, time or interest to get to the bottom of arguments of this type. They just conclude both sides are lying. It took a long time for politicians to break sufficient promises for the public to conclude that all politicians break almost all promises. I doubt it’s possible for governments to keep a high enough proportion of their promises for sufficient years as to turn that perception around.
One paradox most politicians do understand is that, in this big and complex world where no one has the time to pay the attention they should, voters’ perceptions about things are more important than the reality of those things. Indeed, as the pollies say, ‘the perception is the reality’. There’s much truth to this. But you can push it too far. Neglect the underlying reality of effective service delivery badly enough for long enough and no amount of effort to manipulate perceptions will hide the unacceptable reality. Once you reach that point, nothing you say will be listened to and nothing you do to remedy the situation will help you. This is the story of the long demise of the NSW Labor government.
A final paradox is that when you’re surrounded by risks whichever way you turn - when you’re a minority government, for instance - and are most inclined to proceed cautiously, that just when you need to be bold. Why? Because the public’s reaction to leaders is instinctive and unconscious. They’re impressed by confidence and courage and unimpressed by uncertainty and timidity. They can tell when you’re faking it.
Gillard says she must ‘govern from the centre’ if she’s to win sufficient votes to hold government. This attitude is based on the notion that each side has core support of about 40 per cent, leaving them battling to attract a majority of the remaining 20 per cent of uncommitted, swinging voters in the middle. Market research reveals the uncommitted middle to be social conservative, uninterested in politics and very hip-pocket in its attitude to economics.
But in this, too, Labor is showing signs of amateurism - and being a slow learner. It’s true you can’t get too far from the centre, but it’s not true you should be right in the centre. If you’re Labor you have to govern from left of centre just as, if you’re Liberal, you have to govern from right of centre (as Howard did). You can’t get too far from the Left (or, for the Libs, the Right) or you’ll lose too much of your base, your core support. If you’re right in the centre - neither Left nor Right - you lose your identity, your defining characteristics. Apart from your party name, you don’t look like anything in particular and who wants to vote for you? Not a lot of your base vote and not a lot of the swinging middle.
This, of course, is the story of Labor at this year’s election. It lost a lot of its base to the Greens, but at the same time failed to attract many in the middle, meaning its primary vote fell 5.4 percentage points to 38 per cent - as we’ve seen, federal Labor’s fourth lowest primary vote since the beginning of the two-party system in 1910. In Western Australia its primary vote got down to 31 per cent, in Queensland, 34 per cent. NSW was a fraction below the national average. Humans are meaning-seeking animals. They want to know what leaders and their parties stand for and be able to put them in one box or another. Particularly because of its inferiority complex on economic management, Labor tried to turn itself into a pale imitation of the Liberals and, unsurprisingly, not enough people wanted to vote for it. If that short of thing appeals, why not vote for the real thing?
Particularly because of its decision to abandon the ETS, Labor lost a lot of its primary vote to the Greens, and also Tanner’s seat of Melbourne. Does this matter if it all comes back in preferences? Yes. Not all of it comes back and, in the Senate, it doesn’t come back. In those state elections with optional preferential voting it may not come back. In a growing number of inner-city seats it doesn’t come back if the Greens come second, the Libs come last and the Libs preference the Greens. The Libs didn’t do that in the recent Victorian election, but this just puts Labor at the mercy of the Liberals’ goodwill. It’s clear that, had the Libs preferenced the Greens, Labor would have lost three seats in Victoria. It may well lose some at the coming NSW election.
Experienced politicians know that first you hold your base vote, then you attract enough of the middle. Howard was always rewarding the Liberal heartland with baubles: a tax rebate for private health insurance, a school grants formula biased in favour of elite private schools, concessions for self-funded retirees and so forth. As Costello has said of Labor, ‘a party that can’t hold its base is heading for long-term decline’. One of the great lessons of economics is that we rarely face either/or choices. Rather, the trick is to find the best trade-off between conflicting objectives. To say Labor has no choice but to govern from the centre is to pick one extreme over the other. Labor needs to look like Labor and do enough to satisfy its base while also finding policies that will attract sufficient of the swingers.
Howard has said, ‘you have to spend political capital on reforms’. Labor ministers often decline to adopt worthwhile but difficult policies, privately telling supporters ‘we can’t sell that’. My response is: Then when are you moving to a profession to which you might be more suited? Politicians who can’t sell good policy can’t do their job.
The year ahead
Right now, five out of nine parliaments in Australia are hung. Someone has calculated that 15 of the 16 minority (state) governments in Australia since 1989 ran their full term. The reason for that isn’t hard to discover: the independents who prop up those governments have no desire to risk bringing their positions of prominence and power to an early end. So I think it’s reasonable to assume there’ll be no federal election in 2011.
Gillard would no doubt like to be able to put her own stamp on the government’s agenda, but she’ll have quite a wait before she can because Rudd left her with a long list of unfinished business. She says 2011 will be ‘a year of delivery’ and ‘a year of decision’. Anything she wants to put through the Senate before July 1 will need the support of Fielding and Xenophon and the Greens if it’s opposed by the opposition; anything after then will just need the support of the Greens.
Gillard needs to resolve the ambiguity in her deal with the big three miners on the minerals resource rent tax concerning whether the feds will cover the miners for future increases in state royalties (which would be equivalent to writing the states an open cheque) and also decide on any modifications to accommodate the smaller miners excluded from the election-eve deal. Enacting the mining tax will allow the government to legislate for the rest of the tax package: the phasing up of compulsory super contributions to 12 per cent by 2019, cutting the company tax rate by 1 percentage point to 29 per cent, and so forth.
The tax summit will be held in the middle of the year, but I’ll be surprised if much comes of it. The Henry report was commissioned before the global financial crisis, when the government believed it would have a big budget surplus and plenty of spare revenue to compensate the losers from reforms to be announced before the 2010 election. The budget deficit has put paid to all that, with the government committed to bank all revenue growth and avoid tax cuts until the budget surplus is back to 1 per cent of the GDP. If the economy is booming at that time it will be under pressure to continue avoiding measures that could make fiscal policy pro-cyclical. This greatly reduces its scope for significant reforms.
The more health economists and others have studied Rudd’s reforms to health and hospital funding the less enthusiastic they are. The growing number of Liberal premiers is also unenthusiastic about giving up 30 per cent of their GST revenue, but Gillard will have to get on with legislating the deal that the feds take over 60 per cent of hospital funding, which is supposed to start in July.
The government will keep working on its decision about the plan for the Murray-Darling Basin. The early signs are that it won’t have the courage to adequately increase environmental flows. It will also keep working on the search for a regional solution to its asylum-seeker problem.
Ross Garnaut will release his updated report on climate change in May and the Productivity Commission will publish its advice on the measures being taken by our trading partners and on the impacts of a carbon price on our international competitiveness. Gillard announced recently that the government will decide by the end of the year on the way it will price carbon. This is likely to be a carbon tax - at least initially - rather than an ETS.
Looking further into the future, if the Gillard government runs full term she’s likely to find that, by 2013, the present coalition governments in Western Australia and Victoria will have been joined by coalition governments in NSW and Queensland. This may make COAG meetings more difficult, but it’s likely to improve federal Labor’s chances of re-election. Many voters like the idea of an each-way vote between federal and state, just as many like the idea of federal governments not having a majority in the Senate. Even so, Labor will need to become a lot cannier and a lot more courageous if it’s to win re-election. From her performance so far, I’m not confident Gillard will pull it off.
Observations on monetary policy
It’s been another bad year for business economists and markets in their attempts to second-guess the Reserve Bank’s rate adjustments. I said that last year but - though I haven’t counted up - this year has been a lot worse, with the ratio of misses to hits way up. It’s become a lot harder for you guys to predict now the nation’s economics editors have retired from the prediction game. But that’s the way the more loud-mouthed of your brethren seem to have wanted it.
I should say, however, that market economists’ predictions have been closer to the mark - or less far off the mark - than market pricing. Why? Because the markets are still too focused on what’s happening in the US, whereas the economists have twigged to how heavily the Reserve’s thinking is influenced by developments in the Chinese economy.
I’ve said many times that monetary policy is as much an art as a science and that it’s set in the governor’s gut. All I’d add this year is that this governor’s gut decides which way it’s jumping at the last possible moment. So if he has so much trouble making up his mind, it’s hardly surprising you guys have trouble second-guessing him.
You guys generally get the direction of changes right, and you seem to have figured out that, in all but exceptional circumstances, the size of moves is 25 basis points, but you have a lot of trouble picking at which meeting the change will be made. I guess because you rely on fundamentals rather than chartism, you don’t seem to have explored one potential guide to the timing of moves: bureaucratic neatness. This idea occurred to me when I realised we’d had a Melbourne Cup day rate change for five years in a row. Could this be purely by chance? I decided to do some arithmetic. Over the past five years the Reserve has changed rates 20 times. Since there are 11 meetings a year, if decisions to change rates occurred at random, each month would have a 9 per cent chance of being chosen for a rate change. The four meetings a year that are preceded by the release of the CPI and followed immediately by the release of the statement on monetary policy, would account for just over 36 per cent of random chances. But, in fact, the SoMP months - February, May, August and November - accounted for 65 per cent of rate changes, with November alone accounting for 25 per cent. The point is that the Reserve has set up a pattern in which the SoMPs come soon after the meeting that comes soon after the CPI release, and two of the SoMPs come not long before the Reserve’s twice-yearly appearance before the parliamentary committee. Remember, too, that the release of the CPI is a key influence on the revision of the Reserve’s inflation forecasts, which are published in the SoMP and which heavily influence decisions about rate changes. The SoMP serves as the main vehicle the Reserve uses to explain and defend its rate decisions. Is it surprising that, having carefully set up the timing of its key publication and parliamentary appearances, the Reserve is more inclined to fit its decisions into that timetable?
But why in the past five years has the November pre-SoMP meeting had more than twice the hits that the other three pre-SoMP meetings have had? Perhaps because of an unconscious desire to get the books straight before the end of the year and the knowledge that what you’ve done has to tide the economy over until February.
Glenn Stevens offered some cryptic clues to his thinking and behaviour in his recent parliamentary testimony. He noted that decisions at particular meetings are often finely balanced. When you’re moving in baby steps of 25 points, it’s hard to believe that going now or waiting a month for more data will make much difference to ultimate macro outcomes. If the decision isn’t finely balanced - if it’s quite clear what you need to do - it’s a sign you’ve got behind the curve.
Stevens tacitly admitted that monetary policy isn’t as forward-looking and pre-emptive as it should be. He couldn’t think of any time when it later became clear the Reserve had tightened too soon, but he could think of ‘several times’ when it should have tightened earlier. This is a reference to the first half of 2007, when the Reserve should have tightened further but didn’t because of two successive CPI results that were falsely reassuring, and ended up having to tighten before and during the election campaign. The proposition is that the more timely your tightening, the less you end up having to do. The lesson from this episode is that you have to trust to your judgement of the big picture - which embodies your core beliefs about how economies behave - and not be too swayed by bits of data than don’t fit.
I think Stevens’ remarks alluded to two different circumstances: when you know you’re behind the curve and when you know you’re not. When you’re not behind the game - which should be most of the time - increases are likely to be ‘only fairly gradual and not very close together’. (Say, before each quarterly SoMP?) When you believe you are behind the game, however: ‘I think it is better really to move in a reasonably timely fashion to a point where you might be able to rest for a while. That is a better position to be in.’ I think this explains Stevens’s behaviour between October last year and May this year. He kept saying he was going to move ‘gradually’ towards ‘normal’ (neutral), but in fact he moved at six meetings out of seven (with only two of them SoMP meetings). Why? Because he knew he was behind the game: he’d cut like mad fearing a severe recession but the recession was proving to the remarkably mild so he was anxious to get back to neutral without delay. He eventually decided the banks’ extra rate rises had shifted neutral down from 5.5 per cent to 4.5 per cent, and once he reached that point in May this year, he rested for six months before deciding it was time to start gradually tightening into the restrictive range.
Looking to the monetary policy outlook for 2011, at the parliamentary hearing Stevens gave a lot of hints about the timing of his next move. Quote: ‘What it means is that for the period we are going into in the near term I think this is about the right level. At the moment most commentators do not anticipate and market pricing does not anticipate any further near-term change by us for quite some time. I think that is probably a reasonable position for them to have based on the information we have now.’
But exactly how long is ‘in the near term . . . for quite some time’? I think it’s a guarantee that’s already expired: it applied only to the December meeting - and so, of course, will carry us through to the February meeting. But it leaves the February decision an open question. So if you rule out a February rise you’re doing so on the basis of your own judgment, not a clear indication from the boss.
My call for next year is that, assuming the economy continues to strengthen as forecast but there’s no rapid build-up of inflation pressure, we’ll see another two or three tightenings, well spaced over the course of the year.
