If the RBA is muddled on interest rates, we'll suffer from its fumbling

Taken in isolation, the decision last week by the Reserve Bank’s new interest-rate setting committee to defy all expectations and delay a cut in the official interest rate of a mere quarter of a percentage point, by a mere five weeks, is neither here nor there. Even so, the fuss it has caused damages the Reserve’s credibility – “do these guys know what they’re doing?” – and thereby its ability to manage the economy successfully.

And the coincidental timing with the first application of the new rule that the Reserve publish the numbers of committee members voting for and against – a supposed reform intended to encourage greater debate before such decisions are made – won’t help the Reserve convey confidence that it’s charting a steady course to peace and prosperity.

It was obliged to reveal that while six board members wanted to delay a rate cut, the other three wanted to get on with it. I don’t have any doubt that the six included governor Michele Bullock and her deputy, Andrew Hauser.

And, though I have no inside information, it wouldn’t surprise me if the new Treasury secretary, Jenny Wilkinson, was among the dissenters. Why? Because her predecessor, Dr Steven Kennedy, quietly made it clear in a succession of speeches that Treasury saw no reason for the Reserve’s great fear that wage growth could explode at any moment. (In passing, note that the recent changes to the Reserve’s Act make it clear that, while the Treasury secretary’s seat on the board is “ex officio”, he or she acts in their individual capacity, and cannot be directed by the Treasurer.)

The Reserve’s insistence on delaying the next rate cut – based, apparently, on the flimsy argument that the inflation figures for the month of May may have somewhat overstated its rate of fall – came at a most inauspicious time.

While Trump’s erratic pronouncements are adding greatly to uncertainty – prompting consumers and businesses to delay making big new spending commitments – the last thing the authorities should be doing is adding to it. By this silly decision, the Reserve has shaken the faith of the financial markets, businesses and households in its predictability and desire to steer a steady course to low inflation and higher growth.

Not that this means I have much sympathy for the red-faced participants in the financial markets and the media. They’re just playing their own games for their own commercial reasons. The reason the financial markets are so obsessed by predicting whether the Reserve will or won’t jump at its next rate-setting meeting is that they place bets on the outcome.

So a different headline for stories about the unpredictable decision is: 100-to-1 outsider wins the Reserve Bank Stakes at Martin Place on Tuesday.

As for the media, we have no shame. We use the financial markets’ placement of bets, plus the business economists’ opinions, to pander our customers’ insatiable desire to know what the future holds. Psychologists explain our addiction to forecasts as part of humans’ delusion that, if only we can know the future, we can control it.

When the media’s prediction that the Reserve is almost certain to cut interest rates on Tuesday proves to be dead wrong, the media’s not embarrassed, it’s excited. The routine rates story has suddenly got a lot more interesting. Two stories for the price of one.

It doesn’t do a lot for the media’s credibility, of course, just as the Reserve’s needless unpredictability is ill-judged at a time when the greatest threat to the economy is uncertainty and the suspension of spending intentions, particularly by business.

The fact is that our economy’s recent growth is weak. Hesitant. The risk that the economy will wallow, far exceeds the risk that inflation will take off. The message the Reserve needs to be getting through is: “Good news. Inflation’s coming down and so are interest rates, so now’s the time to look to the future with confidence. Don’t be the last to clamber onto the expansion train”.

Part of the economy’s hesitance is explained by the news that people with mortgages aren’t using the fall in interest rates to reduce their mortgage payments. In which case, the fall in interest rates isn’t strengthening consumer spending as much as could have been expected.

Particularly because of Australia’s unusual prevalence of variable-rate mortgages, the use of higher interest rates to fight inflation puts most of the burden on people with big mortgages. This is not only unfair, it’s inefficient: the two-thirds of households without mortgages are under little pressure to reduce their spending. So those with mortgages have to be hit all the harder to achieve the desired reduction in overall demand for goods and services.

It may be that people with mortgages have been hit so hard in recent years that, rather than using the lower interest rates to increase their spending, they’ve decided to leave their mortgage payments unchanged to reduce their exposure to those unfeeling blighters in Martin Place. If so, that’s a strike against our use of the manipulation of interest rate to smooth the growth in demand.

Readers’ letters to the editor of this august publication strongly supported the Reserve’s decision not cut rates. Huh? It’s easily explained. People with their homes paid off, and their savings held in fixed-interest bank deposits, gain when rates rise and lose when they fall.

This is another strike against the use of interest rates to fight inflation and smooth demand. When rates rise to discourage people with mortgages from spending on other goods and services, they actually encourage the retired to spend more. So the negative effect on the spending of people with mortgages is partly offset by its positive effect on the spending of the retired.

Maybe one day we’ll wake up and find a better way to manage the strength of demand. Meanwhile, we’ll suffer from the Reserve’s reluctance to stop fighting the last war against inflation and start fighting the next war against uncertainty and weak growth in the economy.

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Our leaders would do better if their followers were thinking harder

Much has been said about the failures of Scott Morrison, Daniel Andrews and Gladys Berejiklian in our never-ending struggle to keep on top of the coronavirus. But just this once, let’s shift the spotlight from our fallible leaders to the performance of those they lead. I think we ourselves could be doing a better job of it.

There is, after all, much truth in the saying that we get the politicians we deserve. When we think we’re entitled to have good government served up to us on a plate, we’ve lost sight of the truth that well-functioning democracies require diligent citizens, not just honest and smart politicians.

Perhaps our biggest complaint has been that our leaders and experts keep changing their tune. Why can’t we be told simply and clearly what’s required of us? Why can’t the pollies decide what they want and stick to it?

It’s as though they’re making it up as they go along, chopping and changing when they realise they’ve taken another wrong turn. Hopeless.

Let me tell you the shocking truth: they are making it up. But if you were thinking harder you’d realise that’s all they can do. As Morrison rightly says, a new virus doesn’t come with an instruction manual.

Our political leaders are relying heavily on epidemiologists and other medical experts because pollies have so little knowledge and experience of pandemics. The medicos know a lot about viruses, epidemics, vaccination and immunology, but at the start they knew little about the characteristics of this particular virus.

They were forced to make assumptions about those characteristics but, as they’ve realised those assumptions were wrong, they’ve changed them.

At the start they thought the virus was spread in big droplets landing on surfaces within one or two metres, whereas now they think it’s more like smoke. Without strong ventilation, it builds up in the air. This explains much of the early uncertainty about whether masks were a good idea.

The medicos have relied on the findings of the limited studies available, but when bigger and better studies have come along with different findings, they’ve updated their views.

As I don’t think Keynes actually said, “When the facts change, I change my mind. What do you do, sir?” Or, as he did say, “It is better to be roughly right than precisely wrong.”

Those people carrying on about how confusing it all is and how incompetent our leaders are reveal their own intellectual laziness: their reluctance to think through complex, nuanced, ever-changing problems when they’d prefer to be back watching carefully choreographed “reality” television. And their ignorance of how science works, slowly groping towards an ever-changing best guess at the truth.

The media’s new-found interest in public health means formerly obscure academics have become TV stars and any boffin who disagrees with what the government’s doing about X gets an op-ed article to air their dissent.

You could say this is adding to the confusion, but it’s science proceeding the way science does. It’s academics doing what academics do – eternally arguing among themselves.

It’s tempting to tell them “not in front of the children”, but when you remember how lacking our leaders are in competence, openness and accountability, the last thing our democracy needs is for experts to keep their critique of government policies to themselves.

You might have thought that a bunch of media-innocent scientists and a news media devoted to highlighting the exceptional over the typical, seeking out controversy and not always untempted by the sensational, would make an explosive combination.

But for the most part, the media have been on their best behaviour, favouring their audience’s need for accurate, trustworthy information. That brings us to the Australian Technical Advisory Group on Immunisation, and its ever-changing recommendation on who should be receiving the AstraZeneca vaccine now it’s been found to carry a very rare risk of blood clotting.

The advice has changed partly because circumstances have changed, but mainly because the original advice led to considerable vaccine hesitancy at a time when the vaccine rollout is way behind, we have Greater Sydney in lockdown and loads of AstraZeneca is going begging while little of the alternative Pfizer vaccine is available.

The advisory group has been criticised, but I think it was a narrowly constituted group, which gave narrow advice when what the government needed – and should have sought from elsewhere – was advice taking account of a broader range of factors.

The public’s huge reaction against the vaccine is unwarranted and unfortunate at such a time. AstraZeneca is less risky than taking aspirin. But when the media gave such attention to the clotting risk, the overreaction wasn’t surprising.

Responsible reporters can say “very rare” as many times as they like but, as our science reporter Liam Mannix has explained, humans are notoriously bad at giving minuscule probabilities the weight they deserve.

The saver may be that, as highly social animals, when people see so many of their friends lining up to “bare their arms”, their hesitancy may evaporate. It’s a strange, messy world we live in.

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Why economists get so many of their predictions wrong

Sometimes the study of economics – which has gone on for at least 250 years – can take a wrong turn. Many economists would like to believe their disciple is more advanced than ever, but in the most important economics book of 2020 two leading British economists argue that, in its efforts to become more “rigorous”, it’s gone seriously astray.

The book is Radical Uncertainty: Decision-making for an unknowable future, by Professor John Kay of Oxford University and Professor Mervyn King, a former governor of the Bank of England.

The great push in economics since World War II has been to make the subject more rigorous and scientific by expressing its arguments and reasoning in mathematical equations rather than words and diagrams.

The physical sciences have long been highly mathematical. Economists are sometimes accused of trying to distinguish their discipline from the other social sciences by making it more like physics.

Economics is now so dominated by maths it’s almost become a branch of applied mathematics. Sometimes I think that newly minted economics lecturers know more about maths than they do about the economy.

Kay and King don’t object to the greater use of maths (and I think economists have done well in using advanced statistical techniques to go beyond finding mere correlations to identifying causal relationships).

But the authors do argue that, in their efforts to make conventional economic theory more amenable to mathematical reasoning, economists have added some further simplifying assumptions about the way people and businesses and economic policymakers are assumed to behave which take economic theory even further away from reality.

They note that when, in 2004, the scientists at NASA launched a rocket to orbit around Mercury, they calculated that it would travel 4.9 billion miles and enter the orbit in March 2011. They got it exactly right.

Why? Because the equations of planetary motion have been well understood since the 17th century. Because those equations describing the way the planets move are “stationary” – meaning they haven’t changed in millions of years. And because nothing that humans do or believe has any effect on the way the planets move.

Then there’s probability theory. You know that, in games of chance, the probability of throwing five heads in a row with an unbiased coin, or the probability that the next card you’re dealt is the ace of spades can be exactly calculated.

In 1921, Professor Frank Knight of Chicago University famously argued that a distinction should be drawn between “risk” and “uncertainty”. Risk applied to cases where the probability of something happening could be calculated with precision. Uncertainty applied to the far more common cases where no one could say with any certainty what would happen.

Kay and King argue that economics took a wrong turn when Knight’s successor at Chicago, a chap called Milton Friedman, announced this was a false distinction. As far as he was concerned, it could safely be assumed that you could attach a probability to each possible outcome and then multiply these together to get the “expected outcome”.

So economists were able to get on with reducing everything to equations and using them to make their predictions about what would happen in the economy.

The authors charge that, rather than facing up to all the uncertainty surrounding the economic decisions humans make, economics has fallen into the trap of using a couple of convenient but unwarranted assumptions to make economics more like a physical science and like a game of chance where the probability of things happening can be calculated accurately.

There’s a big element of self-delusion in this. If you accuse an economist of thinking they know what the future holds, they’ll vehemently deny it. No one could be so silly. But the truth is they go on analysing economic behaviour and making predictions in ways that implicitly assume it is possible to know the future.

Kay and King make three points in their book. First, the world of economics, business and finance is “non-stationary” – it’s not governed by unchanging scientific laws. “Different individuals and groups will make different assessments and arrive at different decisions, and often there will be no objectively right answer, either before or after the event,” they say.

Why not? Because we so often have to make decisions while not knowing all there is to know about the choices and consequences we face in the world right now, let alone what will happen in the future.

Second, the uncertainty that surrounds us means people cannot and do not “optimise”. Economics assumes that individuals seek to maximise their satisfaction or “utility”, businesses maximise shareholder value and public policymakers maximise social welfare – each within the various “constraints” they face.

But, in reality, no one makes decisions the way economic textbooks say they do. Economists know this, but have convinced themselves they can still make accurate predictions by assuming people behave “as if” they were following the textbook. That is, people do it unconsciously and so behave “rationally”.

Kay and King argue that people don’t behave rationally in the narrow way economists use that word to mean, but neither do they behave irrationally. Rather, people behave rationally in the common meaning of the word: they do the best they can with the limited information available.

Third, the authors say humans are social animals, which means communication with other people plays an important role in the way people make decisions. We develop our thinking by forming stories (“narratives”) which we use to convince others and to debate which way we should jump. We’ve built a market economy of extraordinary complexity by developing networks of trust, cooperation and coordination.

We live in a world that abounds in “radical” uncertainty – having to make decisions without all the information we need. Rather than imagining they can understand and predict how people behave by doing mathematical calculations, economists need to understand how humans press on with life and business despite the uncertainty - and usually don’t do too badly.

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