• Pete Jonson

Macroeconomic policy ruminations

Updated: Jan 12

In this final chapter I will summarise all the macroeconomic issues. Firstly monetary policy, then briefer: fiscal policy, productivity, climate change and defence.


The great monetary economist, Milton Friedman, said that ‘monetary policy cannot serve two masters’. He was saying this in discussing ‘ordinary inflation’. Once asset inflation is introduced the problems become more difficult.

First, I discuss ordinary inflation. This is usually represented by the single variable of ‘cash rate’. In my opinion this is an overly simplified adjustment. Ordinary inflation is best represented by ‘Monetary disequilibrium’, or in the positive version ‘Excess money’. A well-run central bank should create a measure of ‘Excess money’ and in normal times will aim to aim for zero value for Excess money.

Instead of a simple measure of ‘cash rate’ a near zero value for excess money will be a far more reliable measure for more or less monetary equilibrium.

Excess money, the inverse of monetary disequilibrium, is created by the real money (M/P) – Money demand (^m, a function of money demand, itself real income and a suitable interest rate, perhaps cash rate.). If the economy needs more stimulus, real money can be increased. If the economy needs less stimulus, real money can be cut. In either case, the interest rate can be cut to boost economic demand or raised to reduce activity, but in both cases, altering the real supply of money should be the major weapon.

In my time in the 1980s as chief economist in the Reserve Bank of Australia, our models were simpler, and in any case were not largely used in practical policy matters. At their best, a well based economic model can be simulated for, say, five years ahead. Such a model, with well-defined Excess money and Animal spirits, could raise issues that occasionally caused the policy team to think again.

In the late 1980s, as I have written, the board seemed to endorse my view that higher interest rates were needed but higher authority successfully promoted lower interest rates. This encouraged a stronger economy but with a new team, after my departure and that of Governor Johnston, interest rates were raised. Firstly, this was done too modestly and then too late and too large. Predictably, this helped create the largest recession since the Great Depression. The new Deputy-governor apologised, but the damage was done.

But, to be fair, there was lack of the guidance to monetary policy now proposed. Excess money negative and Animal spirits low. Neutral. Or Excess money positive and Animal spirits positive.

A new approach to Monetary policy

In my opinion, three objectives are needed for the best outcomes for effective monetary policy. The traditional ‘Cash interest rates’ measure needs to be replaced by ‘Excess money’.

Excess money should be the first measure to be the most important variable for monetary policy. Cases of strong asset inflation or strong goods inflation require tightening ‘Money’ and raising cash interest rate. Cases of weak or negative asset inflation and weak economy require increased money supply and reduced cash interest rate.

In cases of severe Boom or Bust or when the nation’s exchange rate is too high or too low, extra response is required to modify the exchange. When the exchange rate is too high, monetary policy should be eased and if too low, monetary policy needs to be tightened

So-called ‘Prudential policy’ needs to be used to limit the build up of asset inflation, currently in Australia house prices and share prices. Such a policy has been attempted by the newly created Australian Prudential Regulated Agency (APRA) from the rib of the Reserve Bank. APRA is famously regarded as lacking teeth, a point hinted at in the finding of the Banking Royal Commission. APRA needs to be restored to the RBA and given a more active role in resisting Asset inflation.

Recent policy in Prudential Policy and other changes to asset inflation have seen increases in monetary policy, but so far asset booms have run free. No wonder that Goods and Services inflation has started to rise again.

Other macroeconomic policies

Fiscal policy also seems to have been more attracted to expansion as has Monetary policy. Monetary policies included large increase in money, as debt was dramatically created. Cash interest rates are almost zero. Both these changes are meant to prevent severe recession and are likely to create dramatic income instead.

The Howard-Costello government created a surplus of fiscal policy. But at the time of the global crisis of 2007-08, budgets again became negative and this took renewed deficits. Then in 2019-202? A massive deficit, due to peak at around one Trillian of deficit has been added. This will add growth to GDP and both sorts of inflation. Likely, kind of economy will as usual include strong inflation (of both kind) and difficult real economic occurrence.

Certainly, there will be difficult work to try to reduce real economic activity and inflations during the period of large and continual government debt.

Productivity policy is relatively weak and the government and Productivity Department need also find fresh sources of productivity. Indeed, our Chapter 11 has a list of a large number of productivity increasing suggestions. Yet despite these proposals, posted in 2014, recent allegedly conservative governments have done little to increase Australian productivity.

Climate change is an area that appears to be under way and aims to achieve Australian net zero global temperature by 2050. If this target is missed in a material way Australia will be criticised greatly if other countries achieve the net zero objective. If most western countries but not Australia achieve the objective, Australia will become much criticised. China and India (two countries with an allowance for a slower time for zero) will need to make a plausible case for achieving zero in 2060 and 2070 respectively, or they too will be greatly criticised.

Of course, if the global temperature by 2050 is well ahead of the zero temperature, the world will be in big trouble with large areas of hot places in the global warm part of the world. All nations will look foolish if they are mostly incapable of meeting an agreed target.

Here is my biggest question. What if it turns out that rising temperature is due to ‘too many people’? It will be far too late by 2050, and in any case, it will be impossible to cut numbers short of draconian action that will just not be possible. In this case, more dramatic solutions will be needed.

Seeding the external air, for example, by putting large amounts of sand in the sky, or building large sheets like massive umbrellas, or other better solutions. Indeed, just in case the world’s nations find it impossible to sort out large changes to existing methods of production, it would be wise to undertake more direct methods.

Defence is blessed by a serious Minister, Peter Dutton. If he has his way, Australia will become far more protected. So far, Mr Dutton looks like a man who gets on with it and has the courage to tell his department to get on with it.


Fiona Prior wonders if the American forefathers got it wrong - 'Hamilton'. More here.

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