Australian Business Economists Annual Forecasting Conference, Sydney, December 6, 2001
With the federal election not far behind us, this isn’t a bad time to be examining the
political and policy outlook, though I have to warn you up-front that it’s not a particularly
cheery outlook for people with the policy preferences I suspect you have. The first bad
sign is that this was the first election in many years (since the Vietnam-war election in
1966, I think) where economic issues - the state of the economy and micro reform –
weren’t dominant. Rather, the dominant issues were the boatpeople and ‘security’ –
which suited John Howard down to the ground. He may now be ashamed of the way he
stooped to pressing xenophobic and possibly racist buttons, but there is simply no
denying the overwhelming emphasis on the boatpeople issue in his advertising –
particularly in the final week – and even in the signs his people strung up around polling
places. It suited Howard to promote this mighty distraction from the public’s economic
discontents: the high price of petrol (until the last month or two), all the complaints from
people who perceive themselves to be losers from globalisation or national competition
policy, and, above all, all the lingering whinges about the GST package.
The Labor Party chose not to fight on macro issues, adopting the Government’s policies
on the inflation target and the independence of the Reserve Bank, and on the mediumterm
fiscal strategy. It even matched Howard and Costello’s stupid – but clearly
premeditated – promise to keep the budget in surplus throughout the next term. Both
sides chose not to mention unemployment, even though it’s risen by a percentage point
over the past year. The Government tried to hide its stated intention to sell the rest of
Telstra. In the end the parties were not far apart on Labor’s preferred issues of education
and health (neither side was promising the kind of sweeping changes to funding
arrangements – and funding sources – that are needed to bring genuine improvement to
these areas). And, most surprising of all, in the one policy area where the parties did have
significant, ideologically driven differences – industrial relations – both sides had their
own reasons for not wanting to raise it. The conclusion is inescapable: neither side
wanted to talk about economic issues in this campaign. And that fact does not augur well
for further economic reform in the Government’s third term.
How Howard won
It’s important to understand how Howard won the election and why Labor lost. Early this
year, after the West Australian and Queensland state elections and the Ryan federal byelection,
Howard had been written off by everyone but himself. His back-to-the-wall
survival strategy had two stages. The first stage was to remove all the negatives – all the
reasons people wanted to vote against him; the second stage was to find a positive reason
for them to vote for him. The first stage involved, in particular, doing something to
mollify each of the various interest groups with gripes about the GST. Thus we had: the
changes to the BAS, the cut in petrol excise and the abolition of indexation, the cut in the
beer excise, the temporary increase in the first-home owners grant, the $300 handout to
pensioners, the extra tax rebate for the self-funded retirees and the backdowns on various
unpopular aspects of business tax reform, such as taxing family trusts as companies and
the abuse of personal service income. As you well know, this Rollback and various
spending programs appropriated most of the prospective budget surpluses for this and the
next three financial years. The second stage of Howard’s strategy involved seizing on the
Tampa incident and exploiting it for all it was worth. In that sense, this issue involved
less good luck than ‘good’ political manipulation. Howard well knew how unpopular the
boatpeople were with most Australians, he was on the look out for an issue to use as a
diversion from the public’s economic discontents and he had the quick wittedness to see
the Tampa’s potential and exploit it shamelessly. Howard’s use of the boatpeople was an
example of the timeless effectiveness of the oldest trick in the leaders’ handbook: using a
threat from outside to unite your team. But it also had something else: whereas Howard’s
own version of GST Rollback had been about the removal of negatives, Tampa gave
people a positive reason for voting for him. They’d been reminded of an issue they really
cared about – the need to repel the alien interlopers – and been shown the perfect man for
the job.
What role did September 11 play in the election result? Did it make people feel insecure
and anxious about what the future might hold, and thereby force them back into the arms
of the incumbent? Yes, I guess it did to some extent and Howard was certainly quite
blatant in the way he sought to fan uncertainty. But I don’t think it was nearly as big an
issue as the boatpeople. And, by its depiction of alien and threatening Arabs and
Muslims, it served to reinforce the boatpeople threat. What’s more, first Peter Reith and
then Howard himself sought to link the two issues with the disingenuous statement that
he couldn’t be sure there were no terrorists among the boatpeople.
In their efforts to minimise retrospectively the central role played by the Tampa issue,
Liberal functionaries have argued that the Government’s good economy management and
the good state of the economy were major factors in its win. It’s true the public perceived
the Libs to be much better economic managers than Labor (with a strength of belief few
economists would share) and that Howard and Costello exploited this perception
brilliantly in their strategy of keeping Labor boxed in. But, even so, it’s important that
economists don’t fall for this line. The aphorism to remember is that no-one votes out of
gratitude – as Jeff Kennett, Winston Churchill and many other politicians have
discovered. The politics of economic management isn’t symmetrical: bad management
can get you tossed out, but good management can’t, by itself, get you re-elected. At best,
it’s the removal of a negative. To me, the proof that the state of the economy didn’t figure
largely in Howard’s re-election is that it wasn’t a lot different between March (when
Howard had been written off) and November (when he won). Interest rates were a bit
lower; unemployment was a bit higher. Back in March, the good state of the economy
wasn’t sufficient to outweigh the whole range of people’s economic complaints – about
petrol, globalisation, competition policy and the GST – but by November petrol prices
had fallen, much had been done to mollify the GST whingers and, above all, Howard had
managed to divert everyone’s attention to a (perceived) non-economic issue.
Why Beazley lost
Why did Labor lose? Because, once Howard had played his masterstroke, the whole
emptiness of Labor’s election strategy, its policies and its leadership was revealed. Kim
Beazley tried to get himself elected the same way Howard got elected: by making himself
a small target so that all the focus was on the public’s dissatisfactions with the Prime
Minister as a person and with his policies, notably the GST. Unfortunately for Kimbo,
Howard was no Paul Keating. It was an appropriate strategy for Beazley, a man with no
particularly strong convictions about economics, no personal reform agenda, and no
burning desire run the country much differently from Howard. Labor hit on two
genuinely important issues for the positive centrepiece of its campaign – education and
health – but it revealed little understanding of the structural problems involved, nor any
desire to tackle them. It just wanted to exploit public discontent about education and
health by promising to spend more money on them. But the real rock on which Labor’s
strategy was built was the unpopularity of the GST. It thought it was on to a winner but,
as things turned out, the GST proved a fatal distraction. As we’ve seen, Howard had
mollified much of the unhappiness with the tax package and then powerfully diverted
attention to the treat from terrorist boatpeople. In the process, however, he’d done
something else important in defusing the GST as an election issue: he’d emptied the till.
Labor could have won plenty of votes with a big program of Rollback, but the money just
wasn’t there for anything more than a laughably token effort. So, for Labor, the GST
ended up being a distraction, and the distraction proved fatal. Without the GST issue,
Labor was reveal as having few feathers to fly with. I have to say that, on this, Labor got
its just deserts – from Day 1, its position on the GST was cynical, opportunist and devoid
of principle. It’s also worth noting that it was a good thing for the long-term future of
reform in general, and tax reform in particular, to have the Government comfortably reelected.
Had it lost, tax reform would have got the blame – from both sides. This isn’t a
huge amount of comfort, however, because the Libs’ conclusion from the episode would
be that the GST brought them a mighty lot closer to the abyss than they ever want to be
again, and they’ll make sure they never take on any reform even half so unpopular.
Labor under Crean
Before we move from politics to policy, I should say a little about the new Labor leader,
Simon Crean. Crean is unelectable and everyone knows it – his party knows it and the
talkback callers know it. He got the job because there was no-one remotely better, but this
won’t protect him from recurring leadership rumblings whenever he’s judged to be
faltering. Fortunately, Crean is under no illusion that he’s regarded as unelectable and
that he’ll get only one crack at the prime ministership – if that. This is why he’s trying so
hard to be the new broom and everything that Beazley wasn’t. Labor will have plenty of
well-developed, alternative policies this time around. Like his deputy, Jenny Macklin,
Crean has an economics degree. But he’s no economist. The Canberra press gallery keeps
marvelling at how ‘dry’ he’s become since he became shadow treasurer, but this doesn’t
prove much. The gallery wouldn’t know a genuine dry if it saw one. One thing it means is
that Crean saw no alternative but to wear the fiscal straitjacket that Peter Costello so
cunningly fashioned for him with all his silly talk of perpetual surpluses. But that was
mainly about being seen to have politically correct views on fiscal issues. The other thing
it means is that Crean is what Labor politicians call ‘pro-business’. He wants business –
big as well as small – to see him as pro-business and he really is pro-business in the sense
that, when business lobbyists are on the make for a new tax break or handout, Crean will
be very keen to talk turkey. He was dead keen for Labor to be seen to be co-operating
with Costello to get the Ralph business tax reforms through the Senate. Unlike many of
his colleagues, he had no problem going along with the halving of capital gains tax, only
requiring that the Government ensure the total package was revenue neutral by including
some anti-avoidance measures (most of which it subsequently dropped when the going
got tough). What Crean is and always will be is a full-on believer in industry policy:
special deals for manufacturing, tarted up by reference to the latest fashionable
enthusiasm – R&D, IT, the New Economy, whatever. At the centre of his industry policy
is always a tripartite deal between government, unions and business. And at the centre of
the tripartite deal is always the great deal-maker and ringmaster, Captain Handout
himself, Simon Crean.
Two points about the Government before we leave politics for policy. There will be two
recurring political themes in the Government’s third term. First, after the new Senate is
installed in July and for as long as the Libs look strong in the polls, we’ll have the
Government trying to get its way with a recalcitrant Senate by threatening a double
dissolution – something that would be guaranteed to reduce the Democrats numbers.
Second, Howard is supposed to be retiring two years into this term, but he’s made no firm
promises (public or private) and the ability to quit while you’re ahead seems incompatible
with the ego required to be a successful prime minister. Knowing all this, Costello and,
just as importantly, his parliamentary supporters, will be as twitchy as hell until the
changeover is effected. You may know that there is no love lost between the two men. So
the welling of tensions to the surface will be a recurring theme and the gallery will be on
the lookout for them. Since such reports are usually unsourced and often formally denied
by the parties, there’s a temptation for Liberal sympathisers back in Sydney to see them
as products of the gallery’s overactive imagination. Not so. Stories of leadership tensions
have a high ratio of signal to noise and are often borne out by a subsequent formal
challenge. They’re usually well-founded because the journalists have politicians
whispering in their ears.
Howard’s third-term agenda
As everyone realised as soon as the election was over, John Howard had managed to get
himself re-elected without a third-term agenda of any consequence. This is typical of
politicians. When you’ve got your back to the wall, you fight to preserve your political
life and only once you’ve succeeded do you worry about what you’ll do next. By now,
however, Howard does see the need for an agenda. Quote: ‘It would be a terrible mistake
if in this term we thought everything had been accomplished and no more reform was
necessary because we a need to have an activist reform agenda’. And now his cabinet has
been appointed, he’s told them their first job is to think up a list of things that need doing.
But despite his fine words, I don’t hold much hope for genuine economic reform, for five
reasons. First, campaigning on the slogan ‘Keep Australia in safe hands’ doesn’t get you
off to a very daring start. Second, Howard’s long-held personal ‘conviction’ agenda –
which was set in concrete while he was Treasurer in the Fraser Government – has only
two major items, both of which have been ticked off (even if they haven’t been finished
properly): reform industrial relations and introduce GST. Third, what Howard really
meant by that quote is that governments are expected to keep busy. They can’t be seen to
be resting on their laurels, but must always have some big new projects on the go. It
doesn’t follow, however, that all the big new projects have to be economic. I suspect that,
from now on, a lot more of the Government’s appearance of busyness will come from
non-economic endeavours such as defence and ‘security’ and a federal government’s
version of the law-and-order agenda, such the war on drugs. Fourth, if the economic
downturn proves deeper and longer than all of you guys expect – as I suspect it may – the
public’s economic focus (and, hence, the Government’s focus) will switch back from
micro reform issues to all the old issues of macro stabilisation: what’s the Government
doing about creating jobs to reduce unemployment and, much later, what’s the
Government doing to rein in the Budget deficit?
Fifth, I fear there’s a micro-reform price to be paid for the cleverness of the boatpeople
ploy. John Edwards (in my opinion the only business economist with a good feel for
politics) reminded us during the campaign that no party was running in support of
globalisation. Not a good start towards a courageous third-term agenda, but I fear it’s
worse than that. Part of the cleverness of the boatpeople issue was that it diverted
people’s attention away from their discontents about globalisation, the effects of national
competition policy on the regions, and suchlike. People were so stirred up by the threat
posed by the boatpeople that they forgot their worries about globalisation etc. You could
argue that this is a good thing: the Libs managed to get re-elected without being punished
for the perceived evils of globalisation. But I fear it works the other way. There’d be a
close overlap between the people stirred up about globalisation and the people stirred up
about boatpeople. Why? Because the boatpeople issue is merely a novel dimension of
globalisation. Like the opposition to globalisation, the boatpeople issue is about
resistance to change, fear of foreigners, protectionism (build up border barriers to keep
the threatening world at bay) and about mercantilism (it’s OK for us to plunder other
countries’ skilled workers, but it’s a terrible loss for our brains to go abroad). Shifting the
focus from scientists to ordinary workers, it’s a fair bet that much of the fear of invading
boatpeople arises from a fear they will ‘take our jobs’.
Part of the genius of Howard’s identification of the potency of the boatpeople issue is that
it redefined the globalisation issue in a way that allowed him to get out in front of the
mob as the leading opponent of globalisation – to provide the very kind of leadership that
people in the regions and One Nation voters had been craving – without incurring the ire
of the business and economic supporters of globalisation. He found the one exception to
the globalisers’ rule: countries should be open to the free flow of all goods, services,
ideas, technology, capital and executive and highly skilled labour, but tightly limiting the
inflow of common-or-garden labour is AOK.
But what’s the opportunity cost of this cleverness? Now the Libs have experienced the
huge political benefits of setting themselves at the head of the anti-globalisation crowd,
are they really going to want to alienate that crowd by returning to a pro-globalisation
agenda? What price the business community’s push for a much bigger immigration
program? And what about the remaining islands of tariff protection? In its first term, the
Howard Government reviewed the post-2000 arrangements for the tariffs on motor
vehicles and textiles, clothing and footwear. It decided to freeze the 2000 rates for four
years, but then to catch up with the deferred reductions on the day after the freeze. In this
term, the Government’s challenge is to stick with its rather daring back-end loading,
resisting industry pressure to review the post-2004 arrangements and further postpone the
reduction. What do you reckon are the chances of it going to the barricades in defence of
free trade?
The unfinished agenda
The one area where Howard has made clear his determination to push on with reform is
industrial relations: exempting small business from the unfair dismissal law, further
limiting union access to workplaces, tightening the prohibition on secondary boycotts,
requiring secret ballots before strikes and banning unions from charging non-union
freeriders a fee for negotiating a collective agreement in their workplace. Most of these
measures have been blocked frequently in the Senate by Labor and the Democrats. The
chances of them changing their minds in this term are slim. So what’s Howard on about?
He’s playing politics, trying to knacker Crean from the start in the same way he so
successfully knackered Beazley. Howard and Costello made so much fuss about
Beazley’s $10 billion budget black hole that he was branded for all time as a bad
economic manager. Labor developed an inferiority complex about macro management, it
lived in fear of being asked ‘where’s the money coming from?’ and was never really
game to take the fight up to the Libs on the weaknesses in their economic performance.
This is why, once the Libs had raided the fiscal cookie jar, Labor was snookered. It could
see no alternative to standing up in the campaign and promising to splash out sixpence on
Rollback, sixpence on education and sixpence on health. Howard believes Crean’s
Achilles’ heel is his union background. So he’s bowling up the IR legislation as a (quote)
‘test of whether Mr Crean has really freed himself from union domination’. Crean being
Crean, he will try to find some compromise on which they can do a deal. But Howard
won’t be buying. He’s not on about getting whatever IR reform he can, he’s on about
stigmatising Crean in the eyes of the public and getting the drop over him from the off.
I believe Howard will add few if any new items to the reform agenda. There are many
unfinished items on the agenda, but I fear little progress will be made.
Telstra: has reached stalemate. Much as Howard and Costello would like to complete its
privatisation, this is unlikely. Labor and the Democrats retain control of the Senate and
their opposition is implacable. In any case, even the National Party is unlikely ever to
agree to it; the bush would never understand. For all intents and purposes, the era of
privatisation – federal and state – has come to an end.
Business taxation: many loose ends remain but, after all the angst of the past two years,
there’ll be little enthusiasm for tying them up, either from the Government or business.
Howard has promised to examine company tax arrangements affecting Australian
multinationals and is sure to do something. This could come under the heading of tax
reform, but is more likely to involve a few grudging, piecemeal concessions intended to
shut the Business Council up till next time. On another matter, if you’re still dreaming of
a cut in the top tax rate, dream on.
National competition policy: this is the progressive review of all anti-competitive state
and federal legislation. It’s meant to be micro reform on automatic pilot. But it’s grinding
along very slowly, without that fact disturbing the Howard Government or any other. The
Nats made various promises to throw further sand in the gears.
Review of Trade Practices Act and the ACCC: This election promise was intended to
look anti-Fels, but whether it ends up clipping his wings or adding to his feathers remains
an open question. The Prof gets up a lot earlier than his big-business detractors. Howard
made no bones about the purpose of the review: ‘It’s time we had another look at whether
the competition laws of this country preserve the right balance between large and small
within our community but, equally, allow for the development of sufficient critical mass
amongst our larger corporations that they can fully participate in a globalised economic
environment.’ Doesn’t sound like reform to me – more like special rates for business
mates. We’ll see how much eventuates. But there’s no doubt about the future of the Four
Pillars policy – it will still be standing inviolate in three years time.
Ageing policy: a nice, post-election idea to take this issue more seriously, but unlikely to
lead to any controversial policy measures. Howard may yield to the financial services
lobby’s pressure for a thorough review of superannuation – its adequacy and tax
arrangements – but I doubt it. His election promises on super would actually add to the
mess and amount to little more than the introduction of super tax concessions for rich
single-income families.
Fiscal policy
Turning now to fiscal policy, it won’t surprise you to hear that I’m not much impressed
with the way it’s been conducted in recent years. A key element in the Government’s reelection
strategy was to spend virtually all of the prospective budget surpluses, so as to
win votes by doing so and, just as important, so as to deny Labor the chance to do so.
Particularly in the latter objective, it succeeded brilliantly. Despite all the warning it had,
Labor was totally wrong-footed. With little to spend it had little policy to offer and little
to say about anything economic. If you fear, as I do, that the economy may be a lot
weaker next financial year than the Government’s forecasts imply, then a case can be
made for a discretionary increase in government spending, even to the point where it
takes the budget into deficit. But that case wasn’t made – either by the Government or by
Labor – and the new spending measures weren’t of an appropriately immediate, finite,
pump-priming nature.
We’ve been through five fat years in which the budget outcome has invariably come in
above budget – often well above. But I suspect that, between the raid on the surplus and
the economy’s move into what could be several years of slower growth, we may be
entering a period of lean years where budget outcomes come in below budget. In other
words, the underlying cash balance may well drop into deficit, as the fiscal balance
already has, to the turn this financial year of more than $3 billion.
But both Howard and Costello kept promising to keep the budget in surplus throughout
their new term. So, does this say we’re in for a tough, post-election budget next May to
haul the balance back into surplus? Not a snowball’s chance in hell. There’s a far higher
chance that, by then, the Government will see a need to supplement easy monetary policy
with further discretionary fiscal stimulus. But, even if we don’t reach that point, I reckon
it won’t be long before Costello has to do a lot of climbing down about the importance of
keeping the budget in perpetual surplus.
John Howard is inordinately proud of his achievement in ‘bringing the budget back to
surplus’. But Paul Keating used to be just as proud of his own, similar achievement. What
Keating discovered, however – much to his disillusionment - is that ‘bringing the budget
back to surplus’ isn’t a ‘reform’ – it isn’t something that needs to be fixed and then, once
fixed, stays fixed. It’s a chore to be repeated once-a-cycle. By the time he realised that,
despite his earlier labours, the budget had unfixed itself and needed to be ‘brought back
to surplus’ a second time, Keating had little stomach for the task. His interests had moved
on; been there, done that. It was his failure to re-apply his shoulder to the budgetary
wheel that left such a damaging inheritance for Beazley as Labor’s next leader. The
Beazley black hole crippled Labor for 5 years, robbing it of economic credibility and
budgetary flexibility. But the point is that the ultimate test of fiscal heroism is the second time-around test. We’ve yet to see whether Howard does any better on that test than
Keating did.
We know already, however, that the Government’s fiscal performance isn’t nearly as
impressive as it pretends. It’s much-trumpeted Charter of Budget Honesty has fallen well
short of expectations. It’s a flawed document, open to manipulation for political purposes,
which Costello has not hesitated to do. Despite its efforts to obfuscate the facts, we know
from John Edwards’s calculations that this Government’s levels of spending and taxation
as a proportion of GDP are remarkably high, and give the lie to its small government/low
tax pretensions. Nor does its much-boasted ‘fiscal framework’ live up to its billing. Its
medium-term fiscal strategy (to balance the budget on average over the cycle) is
admirable in principle but, since the Government’s reversal of its decision to publish
estimates of the structural budget balance, is unmeasurable in practice. We now have a
fiscal framework that is honoured by nothing more than bald assertion.
Finally, we have the Government introducing accrual accounting, converting its measures
and targets to an accrual basis (which, it assured us, was the superior measure), then
quietly switching them back to underlying cash when the going got tough. Even more
remarkable, it’s done so virtually without a peep from business economists who, if
they’ve even noticed, don’t seem to care. The fact that this year’s premature MYEFO
revealed a fiscal deficit of $3.1 billion for this financial year and $1.3 billion for next year
prompted no-one to cast aspersions on the whole bipartisan election-campaign farce of
manfully struggling to ensure that promises didn’t push the underlying cash balance into
even a million of deficit. It’s clear that business economists, as well as being weak on
politics, are weak on accounting. Someone in Treasury told them the cash measure is
more apposite for macroeconomic purposes, and they inquired no further. What that
someone didn’t both to tell them is that the cash measure is much easier to falsify than the
accrual measure. Few business economists realise the truth that the budget is already in
deficit.
Monetary policy
The market is still having a fair bit of trouble reading signals from the Reserve Bank. The
reason for that is simple: the Reserve is not very good at signalling. A big part of the
trouble is that the two institutions – the Reserve and the market – have quite different
objectives and don’t make adequate allowance for the other side’s different approach. So
there’s a lot of failed communication and, as every (successful) journalist understands,
that has to be the Reserve’s fault, not the market’s. Why? Because it’s the Reserve that’s
initiating the communication. If I write a column that’s misunderstood by thousands, it’s
idle for me to tell myself I’m surrounded by idiots. I attempted to communicate, but
failed. If I don’t like it, the only alternative is to lift my game.
The market assumes that every formal announcement from the Reserve – every statement
accompanying a policy move, every quarterly statement on monetary policy (SOMP) –
contains a signal about the Reserve’s future intentions. Sorry, it’s not that easy. The
confusing thing is that sometimes SOMPs contain a signal and sometimes they don’t.
Sometimes it suits the Reserve to signal and sometimes it doesn’t. When it doesn’t suit to
signal, the Reserve doesn’t bother. On those occasions, all the signal-like remarks in the
statement are merely backward-looking justifications of past decisions. The market is so
fanatically forward-looking that it’s incapable of recognising a backward-looking
statement when it sees one. What it forgets is that central bankers are bureaucrats, and
bureaucrats are obsessed by justifying their actions. They’re highly defensive animals. So
that’s our first culture clash.
Why would the Reserve not want to signal? Because it’s common for statements to be
issued at times when it doesn’t know what it plans to do at the next meeting. It will be
awaiting developments and reacting to them. When you break down the conduct of
monetary policy to its meeting-to-meeting moves, it’s a highly subjective business; it’s
artistry, not science. Should we go now or wait a month? Should we do 25 or make it 50?
Such decisions are the stuff of the monthly meeting, but they’ll be made on the flimsiest
of grounds. They’re not strategy, merely tactics. Often, the tactical decision will be based
on the question: which alternative would have the more helpful effect on confidence?
Often, the answer to that question will come from the governor’s gut-feel. Certainly, such
decisions will be made very late in the peace. And, without wishing to shock you too
deeply, it’s always possible that such tactical decisions will be finally determined in the
board meeting itself. (Which raises another issue: how would the board feel if the
outcome of its deliberations was regularly and clearly signalled a month before hand?)
So, while the Reserve has no desire to catch the market out, it simply can’t clearly signal
its detailed intentions in every formal statement because it doesn’t know what they are.
And here’s another major culture clash to be aware of. The Reserve is well aware that,
whether it waits a week or a month or even a few months to make its next move –
whether it does two 25s in a row or one 50 up-front – makes no discernable difference to
ultimate macro outcomes. In contrast, those distinctions mean everything to the markets. I
fear this difference of interest means the Reserve will never feel a need to keep the
market as well signalled as it would like to be.
A reality with which the Reserve needs to grapple more successfully, however, is this.
Though the Reserve may have times when it wants to send a signal and times when it
doesn’t, both the media and the markets have vested interests in receiving a signal every
time. So they’ll always find a signal, whether or not one’s been sent. That being the case,
it behoves the Reserve to do more to ensure that at least they don’t walk away with a
wrong signal. When the Reserve has no message to send and is merely boring away
justifying past actions, it should try harder to ensure it doesn’t inadvertently mislead
people as to its future intentions. It should at least leave people with the right impression
as to whether it retains a bias to tighten/loosen.
To get down to practicalities (and at the risk of st
ating the obvious), when you’re
scrutinising a statement in search of signals, there should be two items on your checklist:
one, what does it say about the balance of risks on inflation and, two, what does it say
about the balance of risks on activity? The answers to those two questions should tell you
as much as is being signalled about the Reserve’s intentions.
If we take last month’s SOMP as a case study, it did carry two signals. The first came in
the way the Reserve laid it on so thick about international conditions being ‘at their
weakest for many years’, with synchronicity being ‘all the more cause for concern’ and
how global growth had ‘turned out to be a good deal weaker than previously thought’.
Got that – or would you like some more? The second signal came with the announcement
that, at its November meeting, the board had ‘elected not to change the stance of policy
for the present’. This, I suspect, is the first time the Reserve has announced a nondecision.
What you had to work out was why. Taken a face value (and ignoring the extent
of the carry-on about the world economy), you could conclude that the Reserve was
pretty happy with the stance of policy by November 6, and only if there were more bad
news between then and now would it be likely to cut at its December meeting. But you
had to be able to supply a word that would never cross an independent central banker’s
lips – a word that started with ‘e’ and ended with ‘lection’. You had to know Ian
Macfarlane is too proud to admit that only in the most extreme circumstances would the
Reserve risk getting itself embroiled in the political fray by adjusting rates during an
election campaign. Most market participants knew that, but some – being so weak on
politics – hadn’t followed the logic through properly and wondered if the board had made
a decision at its November meeting and was waiting til after the election to announce it.
As John Edwards pointed out, you only have to think about that proposition for a minute
to realise that such behaviour would get the Reserve into at least as much trouble with the
pollies as changing rates during the campaign. But that was all the Reserve’s second
signal amounted to: if you were one of the mugs expecting a cut a day or two after the
election, forget it. There are some matters so sensitive that they’re written in invisible ink,
and you have write them in yourself. One was the Reserve’s attitude to elections, another
was the role of the GST in the Reserve’s decisions to tighten policy in the run up to July
2000.
Now for my call, which comes in five points. First, the Fed may have further to go than
the markets imagine. It will be prepared to cut further if it’s not confident that recovery is
on the way. It will regard the whole 200 basis points as available to be used and, as we
learnt last week, sees no need to keep its power dry.
Second, if the Fed eases more, the Reserve will ease more – though, as we’ve seen, not to
the same extent.
Third, our economy can’t go into recession unless consumer spending actually falls,
which isn’t likely. The downside risk that could produce such a fall is a savage bout of
cost-cutting and layoffs by big business as propitiation to the god of Shareholder Value.
Fourth, the big test for our economy should come mid-year, when housing has finished its
run. Will the US cavalry have perked up in time to rescue us? That’s the base-case hope,
but I have my doubts. Even if we are left in the lurch, however, that should mean weak
growth rather than negative growth. By the time the non-arrival of the US recovery had
become apparent, the Reserve would presumably have been easing further in anticipation
(as the Fed would have, too). By then there would be more serious consideration of the
need to supplement monetary stimulus with discretionary fiscal action.
Fifth, unless we’re very unlucky, at some point in the first half of next year both the Fed
and the Reserve will reach the end of what they need to do (though uncertainty means
they’re unlikely to signal clearly that this point has been reached). What happens then?
This is where our last culture clash arises. Central banks are perfectly happy to live with
protracted periods of inactivity, but the market (and the media) has a vested interest in
movement. So the easing phase isn’t over for five minutes before markets are bracing
themselves for the tightening phase. To rationalise this compulsive behaviour, the market
has already started telling itself how worried the central bankers will soon be about
rampant inflation. This conveniently overlooks the evident structural change in inflation
and productivity, as well as the central bankers’ track record in the sitting-on-their-hands
department. Consider our Reserve’s record. It held the cash rate steady at 4.75 per cent
for more than a year between July 1993 and August 1994, then held it at 5 per cent for 16
months between July 1997 and December 1998 and at 4.75 per cent for a further 11
months to November 1999.
So here’s my call: most of you guys will spend most of next year anticipating a rise in
rates that never eventuates.
The Political and Policy Outlook in Australia 2002
