- PD Jonson
The Australian economy - a different view
Updated: May 1, 2020
Different to what? The ideas of the Reserve Bank, as exemplified by governor Philip Lowe's speech on 5 Feb 2020, are good examples of what I regards as 'soft Keynesian' views. The logic is that the economy should be kept running at about its 'natural' rate, real GDP of around 3 % per annum, inflation at 2 % (2 % to 3 % in the RBA's agreement with the Federal government), and unemployment falling to a soft target of 4.5 %. (Compare with President Trump's 3.5 %.)
The implication of all this is that the economy is under control, things will get better and the RBA is steering the ship of state about as well as it could be steered.
This is despite strong growth of debt, with household debt around two times household income, Federal government debt around 20 % of GDP and State debt levels variable but not too different on average. The debt ratio of the Commonwealth is not too bad, unless one needs room to move in a serious economic downturn, and a breakeven budget deficit is predicted. If the outlook is weaker than expected by Mr Lowe, the budget deficit will blow out and Commonwealth debt will resume growth.
Growth of debt is a major problem for Australia, and indeed for most advanced economies. At some stage, growing debt (and excessive asset prices) will produce a massive global recession. Then the soft Keynesian approach will be replaced by a hard traditional depression and we shall all wish we controlled debt before the traditional answer to excess debt.
Apart from excessive, still growing, Australian debt, what are the issues where the economy is not performing as well as governor Lowe implies?
Asset inflation is the issue where the Reserve Bank has no coherent policy. Indeed, I have been told by a highly reliable source that two Reserve Bank governors (Messrs Macfarlane and Stevens) failed to provide any serious answer to the question 'What do you do about asset inflation?' Their answer was 'There is no framework', an answer that I feel is the height of irresponsibility. Two of my attempts to get this issue onto the RBA's radar are linked below.
The great money and credit boom
Monetary policy influences both goods inflation or (more generally) goods and services inflation, which is the focus of the Reserve Bank's target of 2 to 3 % inflation. It also influences - normally in the same direction - asset inflation. A major study almost completed by Dr Clifford Wymer and me says that asset inflation is far more sensitive to monetary policy than goods inflation. It also finds that cash interest rates are not the best measure of the impact of monetary policy. Rather it is 'monetary disequilibrium', a concept originally proposed by the philosopher David Hume in the eighteenth century and rediscovered only in the 1950s and again in the 1970s at the London School of Economics and the Reserve Bank of Australia.
'Monetary disequilibrium' is defined as (M/P - money demand)
This point aside, it should be mentioned that Mr Lowe as a graduate student was an author (with Claudio Borio now of the Bank for International Settlements) of a long paper that suggested that there might be a case to raise interest rates if asset inflation is too strong. This was not the approach of governor Lowe in the face of Australia's ridiculously strong house price inflation, and internationally generated share inflation. But the moment house inflation became negative, he stepped in to reduce interest rates.
The issue of asset inflation requires a massive rethink, even if 'the framework' is not obvious to our central bankers. Ask around, you might find useful leads, Mr Lowe.
Unemployment is another important issue that our central bankers should be allowed to take an interest in. The official measure of unemployment is biased down (to 5 %) by a fake measure of 'employment' defined as one working day per 'reference week'. The official measure of underemployment is around 8.5 %, so adding the official rate of unemployment means unhappy people who can't get work, or enough work, is 13.5 %. Lots of room for more work here.
Low wages growth is another issue that Mr Lowe cannot ignore. His latest speech predicts the wages growth will rise slightly. But what Australia needs is strongly increasing wages, which if inflation is to be restrained needs strong productivity increases. Forecasts that allows that happy outcome should be delivered, even as an example of 'best case' economic outcomes.
Of course, Mr Lowe is well aware that wages growth can only increase (without generating goods inflation) if productivity growth is stronger. He should more often say this, but it is a matter for businesses largely. But there have been times when brave Australian governments - Hawke's government and Howard's government in particular - have made policy changes that raised productivity and allowed non-inflationary wages growth.
The Productivity Commission, as well as Australia's finest economists, have plenty of suggestions about productivity reform, and Mr Lowe should (in my view) become a barracker for productivity. As a start, perhaps he could invite relevant experts in to talk about approaches that might then be turned into useful RBA Economic Papers. Here is an example.
Here is a summary of my views about policy effectiveness in over-borrowed economies.
There are many other issues too far from Mr Lowe's baliwick, such as Australia's excessive numbers of immigrants, reaching agreed policies on 'climate change' and improving education. He has a massive task to sort out on how to handle asset inflation and helping us all in the difficult issue of getting the federal government to handle the productivity issue.
What is my answer? A reader asked.
1. Build productivity as an urgent matter - there is a link above to background, what Hawke and Howard govts did and a list of things to be done.
2. Save real money from the budget and create a real surplus.
3. Tell the RBA to stop reducing interest rates and restore sense by raising them to 3 % as circumstances allow.
4. Cut immigration in half and leave it at that level.
All impossible, you may well say. Certainly whoever is in power would need a good story, which Prime Ministers Hawke and Howard knew and others since then do not seem to know.
If it is not done over some time in the next decade we will be in the midst of an horrendous recession.
Mr Lowe's soft Keynesian speech.
And do not miss Alan Kohler's article in the weekend Australian. Photographs are gut busters.