There’s a trick for governments trying to manage their economy. Once in a while – maybe every 30 or 40 years – the rules of the economic game change. What used to be the right thing to do becomes wrong, and now the right thing is something we’ve long believed was not the way to go.
Trouble is, the game change is never announced by thunder and lightning flashes from on high that everybody sees. Those paying close attention soon get the message, but many people – even many economists – don’t.
Some people have invested their careers – and their egos – in the old way of doing things and resist any talk of change. They stick to their ideology when it’s time for pragmatism and re-examination of old ideas to see if they still work.
These rare times of change are dangerous for governments. Those that don’t get the message in time stuff up and get thrown out.
Our last government to badly misread the economy’s changed circumstances was Gough Whitlam’s. And we know what happened to it. But that was more than 40 years ago, and now the sharp-eyed can see the rules have changed again.
If Scott Morrison and Josh Frydenberg can’t see it, the economy’s recovery will peter out and, sooner or later, they’ll be out.
Fortunately, it seems from Frydenberg’s speech on Thursday that they and their Treasury advisers do get it, and are acting accordingly.
For about 30 years after World War II, Australia – and all the developed economies - enjoyed a Golden Age of strong economic growth, full employment, low inflation and a narrowing gap between rich and poor.
The economy pretty much managed itself, leaving governments free to focus on other issues. After 23 years in opposition, Whitlam’s Labor came to power with a long list of economic and social reforms to be made.
It got on with “the Program” – involving massively increased government spending – not realising that inflation had got away, that “stagflation” meant rates of unemployment of less than 2 per cent would never be seen again, and that governments now had to spend most of their time worrying about the economy and making sure their “reforms” didn’t make things worse.
In the years after WWII, the rich economies’ focus was on keeping demand for goods and services growing strongly so the workforce could stay fully employed. It was decided that, of the two main “instruments” available for managing the economy, “fiscal policy” – using the budget to change government spending and taxation – was better.
The other instrument, “monetary policy” – moving interest rates up or down to discourage or encourage borrowing and spending – should play a subsidiary role by keeping rates perpetually low.
But by the late 1970s, the rich economies realised that high inflation – caused by the demand for goods and services running ahead of the economy’s ability to supply them – was the key problem, and the best instrument to control inflation was monetary policy. This would leave fiscal policy free to be used to keep budget deficits down and limit the build-up in government debt.
That’s been the conventional “assignment of instruments” for the many decades since then, the one everyone’s used to and many have come to view as the God-ordained way for the economy to be managed. It fits well with the populist fearmongering about “debt and deficit” that Tony Abbott & Co used to help get the Coalition back to power in 2013.
Trouble is, over the decades, inflation in the prices of goods and services has pretty much gone away. But weak growth in the advanced economies since the global financial crisis means unemployment has remained high – well above anything that could be called full employment.
It’s clear the basic problem we face has switched from excess demand relative to supply to insufficient demand relative to supply. Low inflation means low nominal interest rates, but when rates are already low, cutting them a bit further doesn’t do much to encourage businesses to borrow for expansion or households to borrow more for consumer spending (as opposed to bidding up the price of houses).
That’s been true for some years, but now the coronacession has pushed the official interest rate almost to zero, while “quantitative easing” only seems to push up the prices of houses and other assets.
Get it? With monetary policy having lost its potency, fiscal policy becomes the only game in town. The only policy instrument capable of being used to stimulate growth and keep our economy and everyone else’s recovering and unemployment falling.
But as well as being the only lever left, it’s also the one better suited to boosting demand and taking up idle supply capacity. When the problem is the private sector’s reluctance to expand, and the wages households use to increase their consumer spending have stopped rising, the only way to keep the economy moving until the private sector revives is spending by the public sector.
Frydenberg’s speech makes it clear he gets this and, rather than use the budget to get the deficit down, he’ll focus on continuing to use it to foster growth. In time, this will “repair the budget by repairing the economy”.
I think most voters will happily go along with this policy switch.
But there are still many economists and others who don’t get the need to change tack and will oppose it. Particularly those with a vested interest in active monetary policy – money-market people and economists specialising in monetary economics.
But also, amazingly, Labor’s Shadow Treasurer, Jim Chalmers, who’s calling for an inquiry – a royal commission? - into the Reserve Bank’s alleged mishandling of monetary policy.
He seems to think monetary policy’s steady loss of potency in Australia (and all the rich countries) over a decade or more can be explained by the Reserve Bank governor’s repeated failure to meet his KPIs for inflation.
Sack the governor, change the procedures, problem goes away. Really, Jim?
