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  • Pete Jonson

Saturday Sanity Break, 13 July 2019 – Economy, mysteries of inflations

Updated: May 2, 2020

The RBA has cut cash interest rates by 50 basis points and more cuts are expected. The government has cut tax rates for low and middle earners. Some more infrastructure is in the pipeline. APRA has softened restrictions on bank lending.

Enough is enough’ stimulus is my view. It is important to protect the budget surplus, and I sincerely hope that most of the tax cuts go toward savings and/or reducing household debt, which is dangerously high. Real estate spruikers say house prices will be rising again soon but I doubt this. In any case, further falls are needed to help first time home owners.

Vast war games in Northern Australia underway are being watched by a Chinese spy ship. I liked the US General who said he didn’t mind the Chinese spying as they would see things that might 'cool their jets'. The potential trade war between USA and China are still the biggest risk to the Australian economy and if it does get much worse the best economic policy for Australia will be ‘reduce rations’. This was the modern Australian approach to recessions or depressions until the recession of 1960-61, when spending replaced ration reductions.

My chapter here about Australia’s hard times will elucidate.

A question to be answered.

  • Q. Since ‘inflation’ is always and everywhere a monetary phenomenon’ (Friedman - bottom left in my painting of ‘Favourite economists‘) what determines whether monetary policy influences asset or goods and services inflation?

Economists have poured massive efforts in attempts to answer this question. Simple econometrics has been unconvincing and theoretical work has also failed.

My work with two colleagues was to extend Friedman and Schwartz’s wonderful analysis of goods and services inflation from 1867 to 1960. We ‘extended Friedman’ in two ways: one was adding data to 2014; two was extending the coverage to include the analysis of a representative of asset inflation, using US share prices.

We examined US data in the same time slices as Friedman and Schwartz. We divided monetary policy into three categories; ‘tight’, ‘neutral’ and ‘easy’. Mostly asset inflation moved in the same direction as goods inflation. However, there were seven episodes of what we called ‘aberrant behaviour’. The most outstanding example was the US economy in the 1920's. Monetary policy was ‘tight/neutral’. Goods inflation was low. Yet share prices went through the roof.

We could only speculate at the cause or causes of this aberrant behaviour. It seemed to us that ‘Animal Spirits’ may have been especially buoyant. Perhaps this was partly due to low goods inflation combined with strong output growth.

One reviewer said: ‘Friedman was not interested in asset inflation’. Another, also rejecting our paper, said: ‘you have no theoretical framework’ – just using Friedman’s theory we assumed.

We temporally gave up after these rejections, partly because post-GFC became complicated. With further time, however, it seems that post GFC represents another aberrant episode. Also now with co-author Clifford Wymer I have built a model of the UK economy, using mainly data supplied by the Bank of England. But I have delved into two books plus the Economist magazine since inception in 1843 to formulate an hypothesis about the nature of Animal Spirits in the UK economy.

In our model ‘Animal Spirits’ influences business investment, share prices and bank lending. Another innovative hypothesis used in separate macromodels from 1976 by Wymer and myself, (subsequently in joint research) is ‘monetary disequilibrium', in my view a better measure of the effects of monetary policy than growth of the money supply. This variable enters both the share price equation and the goods inflation for the UK in our model from 1855 to 2014.

In this model, monetary disequilibrium enters both the share price equation and goods inflation, but with a far larger parameter for share prices. Since Animal Spirits also strongly influences share inflation, but not goods inflation, this is evidence that could support aberrant high share inflation/low goods inflation episodes. We hope soon to build a long-term USA model, and if it has similar parameters in its price equations we may have concrete evidence in favour of our conjectures about the role of Animal Spirits and Monetary Disequilibrium in ‘Extending Friedman’.


If you would like to see a truly original film ‒ that is enjoyable and has a storyline ‒ Fiona Prior recommends going no further than Director Bong Joon-ho’s ‘Parasite’, winner of this years Palm d'Or at Cannes film festival. More here.

Sporting life.

Ash Barty out of Wimbledon but will bounce back for the US open. Australia’s men’s cricket team flogged by England in the second semi-final of the World Cup but will bounce back for the Ashes series. Our women’s cricket team flogged England’s women’s team. Australia’s women’s soccer team saw its coach fired and failed to get through to the business end of its world cup. Rugby Australia fired its best playerfor quoting a Biblical prediction and is likely to do badly in its World cup and then lose a lot of money when the case comes before a serious court.

But at least Caaaaarlton! under its new coach is winning more Australian footy games than losing (3/5), and has just beaten Sydney at home and probably finishing Sydney’s finals hopes. I felt firing coach Bolton was wrong, but I salute the genius whose idea it was. Finally, after dead years we long-suffering supporters have wins to cheer us, and hope for the next few years.

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