With parts one and two here and here . . . in which I conclude the previous two posts with a column for the Guardian which tries to condense the previous two posts as well as deliver on the tantalising ‘to be continued’ of Part Two. The flood of comments on both posts suggests you can hardly wait:
Call me old fashioned but I thought that, since the 1950s, the economic textbook had said that the job of macro-economic policy – broadly the suite of fiscal (the budget) and monetary policy (interest rates) – is to return the economy as rapidly as possible to the path that maximises employment growth without stirring inflation beyond its target band.
With policy rates set by central banks hovering around zero in most of the developed world, and economies depressed, the swing to austerity has been deeply misguided, as some international organisations like the IMF are recognising. At the very least the developed world could be funding a boom in infrastructure investment all financed at Western Governments’ cost of long-term borrowing – which is in many cases down around 2 per cent.
Things are different in Australia. In contrast to other countries, the aggressiveness of our fiscal stimulus, the absence of bank failures and (somewhat later) rising mining investment kept our Reserve Bank’s (RBA’s) cash rates well above zero. Given this, it made sense for Australia to tighten fiscal policy and to gradually return to surplus because interest rates could be lowered further if necessary to support growth.
Then we succumbed to thinking which was both thoughtless but widely shared within the commentariat in which policy was run by the seat of our pants – according to hunches rather than the economic textbook. Amidst gradual fiscal contraction and plunging mining investment, our Reserve Bank (RBA), eased reluctantly and timidly showing little urgency about restoring our economy to its potential growth frontier. Early in 2013 it forecast unemployment “to drift gradually higher” over the next few years. Treasury was predicting something similar. Yet the cash rate was kept steady at 3.0% for February, March and April and then cut by just 0.25% in May 2013. As our economy stagnated, we’ve had just three similar cuts since then – the last one yesterday.
The RBA has indicated that it’s concerned about having interest rates too low for too long, the fear being that it will lead to a bubble. Yet it seems to me that dragging the chain in cutting rates actually reinforces the market’s expectations that interest rate normalisation will be a long time coming. If that’s the case the RBA’s agonised stance could easily be worse for financial stability than cutting more aggressively. I’ve not seen this argument put in public so wonder whether the RBA or its Board have even discussed it, let alone tried to weigh it up.
Of course only a fool would be sure that the official policy is wrong. But such departures from orthodoxy should surely have been the subject of considerable debate – not between left and right, or those who ‘care’ and those who don’t – but between people in a community of largely shared interests aware of their own ignorance and humbly seeking greater insight. The independent RBA’s research department and our universities should be releasing modelling to help us understand the costs, benefits and risks of policy alternatives to allow us to make the difficult and inevitable choices by design rather than default.
Instead we’ve been steering by the seat of our pants as we did when the ‘checklist’ dominated monetary policy as we engineered what turned out to be the recession we had to have. As former RBA governor Ian Macfarlane explained, the vast variety of considerations invited by the checklist “conveyed the idea – sensible as far as it goes – that policy needs to look at all relevant information. What was missing was some framework for evaluating that information and converting it into an operational guide for policy.” The intellectual fog induced by the checklist was a hostile environment for critical debate – in this case marginalising the contributions of eminent academics like Professors John Pitchford on the macro-economic folly of official policy and Bob Gregory on its micro-economic folly both of which rang alarm bells.
In fact some serious research has been done offshore which illuminates the trade-offs we’ve been making. Until recently, Sweden’s Central Bank, the Riksbank, backed its hunch that interest rates should be increased to more ‘normal’ levels, even at the cost of driving inflation well below the middle of its target range. Like us, it did so without serious public discussion of the costs and benefits of so doing. Distinguished Swedish economist and former Riksbank Deputy Governor, Lars Svensson has investigated this episode. He’s compared its costs – increasing unemployment by around 1.2 percentage points – with its benefits – the marginally smaller likelihood and severity of a possible future downturn. The result? Costs have been 200 times the likely benefits! Count one for the textbook and zero for the seat of the pants. The Riksbank has since reversed policy. It’s repo rate now minus 0.25% – the lowest in the world.
The authorities in Australia can rightly argue that, unlike the Riksbank, they’ve not undershot the middle of their inflation target by much if at all. Yet their own forecasts make the case for more vigorous monetary expansion. And the unemployment impact of our timidity on cutting rates looks comparable to the Riksbank’s impact in Sweden. Certainly hindsight suggests that yesterday’s rate cut is too little too late. But hindsight is 20:20. The pity of it is that, as contemporary official forecasts demonstrate, much of this was evident with foresight. We’ve endured unemployment we didn’t have to have, by avoiding the debate we did have to have.
Postscript: The interview of the blogpost.