Overton Window – Overton Juggernaut: Part Three

Warning, this diagram came up in a Google image search and is not to be taken too seriously. It’s a jungle out there!

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.

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19 Responses to Overton Window – Overton Juggernaut: Part Three

  1. Patrick says:

    OK I will comment just because I think I like these posts even if that is based mainly on the degree to which they are concordant with my priors.

    But I’m not entirely sure where you are going. Are you arguing for better journalists? Or is this really about your pet institutions idea (which I like even if I’m not sure I agree with it)?

    Or more minimalist, do you just want better decision making frameworks for public agencies (which might just happen to mean the pet idea about institutional independence)?

  2. Nicholas Gruen says:

    If you’re after a governing theme it’s a complaint about the quality of our discourse.

    God knows there’s enough money going to fund public interest discussion of the issues. Apart from the net effect of privately funded interest groups and privately funded commentators who are mainly just barracking for ‘the economy’ – like bank economists – you’ve got the RBA and Treasury with their research departments – Treasury’s a lot smaller than the RBA. You’ve got universities and think tanks.

    Yet VerySeriousPersonOnomics breaks out at every opportunity. All fair enough but there’s no ballast to the conversation, no mainstream challenge to what are essentially unorthodox positions which are forever blossoming. Like I said in the piece, I am not arguing particularly that my own views on monetary policy are right here – though I think they are. It’s just that they are thoroughly orthodox but get virtually no airplay.

    And that’s in areas that are well developed. Now try coming up with an original idea and see how easy that is to get on the agenda!

    • Nicholas Gruen says:

      So it’s not really about my pet institutions idea. Indeed it’s a bit of a counterargument to my pet institutions idea because my idea is that institutions have room to have rational discussions and come up with reasoned positions. The rule is groupthink. But I still go for institutions because I think it would be worse without them. The conduct of fiscal policy in this and other countries is a classic case. How are people supposed to figure out when it makes sense to have budget deficits and who’s responsible for them and all that kind of stuff? Martin Wolf commented that, on what they say neither of the aspiring PMs of the UK going to the polls today deserve to govern the country judging by what they’ve said about the economy. And they’ve said what they’ve said about the economy because they’ve got to appeal to people’s prejudices about it.

      Krugman had a post on this recently – on the way in which consensus emerges about past events which is quite inconsistent with the facts of the time. I can understand how people in the street can be so easily swayed, especially when commentators and propagandists play to their prejudices, but I have this fond notion that the whole role of ‘experts’ is to resist that and try and figure out stuff for themselves, on the merits.

      Yes, I know, naïve isn’t it?

  3. Count me as another who doesn’t quite get where you’re going with this, Nicholas. Early on in the triptych you complain about not being able to get any traction for your independent fiscal policy project, with politicians too focused on Overtonian overtones to give up democratic control over budgeting to faceless wonks. But at the end of this piece, you criticise the Riksbank for not taking their policy to the people and fitting it inside the window of Swedish public discourse. Which is it: do you want democratic accountability for public policy, or do you want the wonks to run the show?

    Of course, you want both: “rational” policy development, and love from the masses. I would contend that you can’t always have both, and that’s why the Independent Fiscal Authority, or whatever you’d call it, is a non-starter. Monetary policy is one thing, but fiscal policy is too sensitive for the people to give up control over.

    Do you not see how the VSPs would come to control your supposedly independent authority as well? It is only because of the threat of democracy that the elites don’t implement full austerity in Western countries. You only have to look at the UK today, where the Tories pulled back on austerity for electoral reasons for the last two years or so to let their economy recover, and have been delivered a comfortable re-election as a result.

  4. Nicholas Gruen says:

    Thanks for your comment Paul,

    I think whenever you read me you think I’m spruiking independent fiscal policy. If you read the post carefully, you’ll see I used it in one paragraph as an example of a broader phenomenon. That phenomenon is not about the need to insulate policy from populism. I’m not talking about that at all in these posts. I’m talking about the failure of opinion leaders to actually lead opinion, to properly address and discuss even mainstream ideas if the VSP juggernaut has got going sufficiently that ‘everyone knows’ the smart money is on some other idea, much less new ideas.

    • I’m talking about the failure of opinion leaders to actually lead opinion, to properly address and discuss even mainstream ideas if the VSP juggernaut has got going sufficiently that ‘everyone knows’ the smart money is on some other idea, much less new ideas.

      We were spoiled by Keating. Political leaders don’t handle economics very well as a rule. Even Keating was a failure as a communicator, eventually, in that he couldn’t take the public with him.

      The reason I read you as having an agenda for an Independent Fiscal Authority is because this agenda is in a lot of what you write, including this extended piece. The overall premise is that politicians are inadequate for the task of educating the public about economics, and in fact some politicians have perverse incentives to defy conventional econ such that they set out to make us dumber by opening their yaps. You bring up this problem repeatedly, and fair enough because it’s a legitimate problem – every economist with balls from Krugman down would agree with you. The fact that you also advocate for one particular answer to this problem, however, means that it is difficult not to connect the dots in the reader’s mind between the problem and your solution.

      Like you, I believe in an institutional solution to this, as with many other problems. Rather than seeking to formally take over authority from politicians, you could talk about reforming Treasury to make it less beholden to government whim and employ their fine minds on things other than justifying political trial balloons, or establishing a new quango to provide apolitical modelling, or starting a new publication a la The Conversation to steer the economic discussion towards the reality-based community. Maybe you’ve grown tired of those options, and fair enough if you have, but I don’t hear much of any other solution from you other than the IFA.

      • Nicholas Gruen says:

        Thanks Paul,

        It’s a big surprise to me that it’s in a lot of what I write. Let me try to clarify this for you from my point of view. A while back I put quite a bit of effort into articulating the case for more independent monetary policy. (As an aside, though it wasn’t reported this way, I did not argue in favour of ‘fully’ independent fiscal policy in which an authority would have power to adjust tax rates without the involvement of governments and parliaments. I offered that as one end of a spectrum the other end of which would be more open independent fiscal advice to governments a la the PC.) However I have not put any serious effort into developing further the case for independent fiscal policy.

        I developed it, became associated with it publicly and because it comes up in various guises publicly, when it does I’m happy to comment on it to the media, and I might even write the odd column referencing it to keep the ball rolling – though I can’t recall having done this on its own for over a decade. In my memory at least when I’ve referenced it, it’s been as a kind of afterthought explaining how we could build institutions to allow more sensible ‘orthodox textbook’ use of budget deficits (on a cash basis) to fund investment and to balance countercyclical deficits with countercyclical surpluses.

        It certainly doesn’t seem to me that I go on about it a lot, but I accept that that’s the impression you have. I was recently asked to write 250 words supporting the abolition of dividend imputation which I did. But I’m not on a crusade for that either. Because I developed the case for that about a decade ago, I occasionally get asked for material on it and, since I still think it’s a no-brainer, I oblige with alacrity. I might even keep the pot boiling in a column if I see the opportunity, as I did with the Henry Review but I haven’t for a good while.

        If you think the independent fiscal policy is in a lot of what I write now, I’d be genuinely interested if you wanted to go back over my blog posts and columns for the last few years. It certainly hasn’t seemed to me that it’s in a lot of what I’ve written. Nor to the best of my knowledge is the more general idea of delegating policy decisions to expert bodies.

        What I can say is that the last time I tried to give a column length summary of where my head was at – a list of things that I think would be worth developing as a reform agenda, I produced a long list of dot points. And now I think about it, I kind of forgot to put in more independent fiscal policy. D’oh!

  5. So these posts are a call for a reinvention of the economic discourse, but not just in a superficial way…

  6. Nicholas Gruen says:

    Nicely put Steve. In for a penny, in for a pound. I’m going the full Nicole!

  7. I am and will always be Not Trampis says:

    Yes nick,

    I have always thought the RBA was way too conservative in cutting rates but I think we need to think just how effective is monetary policy once you get to these levels.

    Fiscal policy hasn’t done any heavy lifting even light lifting. Swan’s last budget was so austere it cut nominal spending and reduced GDP by 0.7 percentage points. This is unheard of and not was needed when the terms of trade induced much lower than normal trend nominal GDP. We have yet to recover it seems to me.
    Certainly no signs of stagflation. ( laughs uproariously) .

    There must be by no now infrastructure projects ready to go. Make the Pacific highway dual carriage way from Melbourne to Brisbane for petes sake.
    That is a no-brainer. John Cox where for art thou?

  8. The thing that amazes me about current budget policy is that there are so many billions being spent in red ink but so little of it seems to be actually stimulatory. ZLB, here we come.

  9. Paul frijters says:

    US inflation is about 0%, with US interest rates for banks 0.25%, so a real interest rate very close to 0%. Same in many other Western countries: real interest rates pretty close to 0 if not negative, such as in Japan where the banks can lend at 0% and inflation appears to be around 2%, making real interest rates for banks -2%.

    In which economic textbook is this orthodoxy? In the ones I know, a zero or negative interest rate is nuts: whoever can borrow at that rate can own the world and make a profit as soon as there is some growth (which there is). Indeed, I have advocated something like 3 years ago that the central banks of the Northern European countries could make a killing by massively borrowing at the 1% rate they can borrow, and then invest in the East. Had they followed that advice and hence profited from the boom in the Indian stockmarket, they wouldn’t have had to worry about government debt for the next few generations.

    Interest rate policy and central bank policy hence doesn’t follow the textbook. We are in wishy-washy land. It is a false dichotomy to say that country X is stupid for not following the textbooks. The Swedes were arguably following the textbook and abandoned that when it seemed to blow up in their face, after which they went with the flow.

    • Nicholas Gruen says:

      Thx Paul,

      I too have advocated something a bit similar – but less adventurous – than your arbitrage scheme and it’s certainly an interesting thing to throw into the mix. But I was talking about the setting of the cash rate as part of Australian macro-economic policy.

      The RBA forecast a situation in which unemployment would continue to rise and, by cutting rates further, it could reverse that reduction, or at the very least moderate it, whilst meeting its inflation target.

      So what’s the argument against doing so?

  10. Nicholas Gruen says:

    Here’s the latest hand-wringing from the RBA. Could we have some clear elaboration of costs and benefits please?

    “It is unlikely to be in Australia’s long-term interests to engineer a consumption boom by encouraging people to borrow large amounts against future income,” Philip Lowe, deputy governor of the RBA, told the Corporate Finance Forum in Sydney yesterday.

    “Debt levels are already high and prospects for future income growth are not as positive as they once were,” Lowe said.

    “So, there is a fairly fine line to tread here. The RBA’s recent decisions have sought to strike a prudent balance ? to help encourage consumption growth and thus business investment, but avoid the type of imbalances that could cause problems later on. We will continue to assess that balance carefully.”

    Low interest rates were “helping to boost household consumption ? by improving the aggregate cash flow of the household sector and boosting household wealth. However, as I have spoken about previously, the overall effect on consumption is probably smaller, or at least slower, than it was in the past,” Lowe said.

    “This is because high debt levels mean that households are less inclined than they once were to respond to low interest rates by borrowing to increase their spending.

    “Notwithstanding this, there is still a spending response to low interest rates and household consumption rose by nearly three per cent in 2014.

    “This is slower growth than in the period from the mid 1990s to the mid 2000s, but it is faster than current growth in real household income.”

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  13. Nicholas Gruen says:

    This suggestion from the Pagan/Wilcox review of forecasting at the RBA is relevant.

    Extend the horizon of the forecast. Under current procedure, the forecast ends before the complete monetary policy story has been told. Although the forecasted inflation rate remains squarely within the target band, the unemployment rate is still about a percentage point above the staff’s central estimate of its sustainable level, and the cash rate remains 300 basis points or more below its presumed neutral level. At least for purposes of discussion within the RBA, it would be useful to map out a plausible path that would take the macroeconomy back to full employment, keep inflation within the target range, and return the cash rate to its neutral level. Policymakers will then be better positioned to ask questions like “am I satisfied that the path described in the forecast represents the best available trajectory towards attainment of the policy objectives?” “Are we striking the best available trade-off between inflation and resource utilization?” “Are we striking the best available trade-off between our macroeconomic objectives and financial stability—including the house-price situation?”

  14. Nicholas Gruen says:

    Two more examples of the Overton Juggernaut for future reference.

    1) Bill Gates warned about a pandemic again and again with little response from the policy class.

    2) Philip Tetlock showed how point forecasts are a hopeless way of eliciting information about what forecasters know and don’t know about the future of the economy in both Expert Political Judgement and Superforecasters. The points he makes are elementary and were explained by me here. Makes no difference. We’re just doing what we’re doing. About a year ago I ran into a good guy who’s a middle ranking bureaucrat in Treasury. He was in forecasting. He’d not heard of Tetlock. My ghast continued to flabber its way through it’s short life.

  15. Nicholas Gruen says:

    Another example – Shiller’s stuff on setting up new insurance markets and new kinds of bons. He’s been on about this for at least a decade.

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