Despite any impression you’ve gained, fixing inflation isn’t the end game. It’s getting the economy back to strong, non-inflationary growth. But I’m not sure present policies will get us there.
The financial markets and the news media have one big thing in common: they view the economy and its problems one day at a time, which leaves them terribly short-sighted.
Less than two years ago, they thought we were caught in the deepest recession since the 1930s. By the end of last year, they thought the economy had taken off like a rocket. Now they think inflation will destroy us unless we kill it immediately.
For those of us who like to put developments in context, however, life isn’t that disjointed. The day-at-a-time brigade has long forgotten that, before the pandemic arrived, the big problem was what the Americans called “secular stagnation” and I preferred calling a low-growth trap.
In a recent thoughtful and informative speech, Treasury secretary Dr Steven Kennedy observed that the pandemic “followed a period of lacklustre growth and low inflation”. (It was so low the Reserve Bank spent years trying to get inflation up to the target range, but failing. Businesses didn’t want to raise wages – or prices.)
So, Kennedy said, “when assessing the policy decisions made during the pandemic there was an additional consideration for policymakers in wanting to not just return to the pre-pandemic situation, but to surpass it.”
One economist who shares this longer perspective is ANZ Bank’s Richard Yetsenga. He describes the 2010s as our “horrendum decennium” where unemployment and underemployment were relatively high, consumer spending relatively weak and business had plenty of idle production capacity.
He reminds us that real average earnings per worker in 2020 hadn’t budged since 2012. “The resulting weakness in consumer demand meant that ‘need’ – the most critical ingredient [for] business investment – was missing,” he says. “Excess demand, and the resulting lack of production capacity, is a pre-condition of investment.”
See how we were caught in a low-growth trap? Weak growth leads to low business investment, which leads to little productivity improvement, which leads to more weak growth.
During the Dreadful Decade, the prevailing view among policymakers was that high unemployment was preferable to high inflation, which might become entrenched. So, unemployment was left high, to keep inflation low.
Yetsenga says this decision to entrench relatively high unemployment was a mistake. “Unemployment, underemployment and the inequality they contribute to, all affect macroeconomic outcomes [adversely]“.
“Those on higher incomes tend to save more, reducing consumption, but those on lower incomes tend to borrow more. Inequality, in other words, tends to lower economic growth and exacerbate financial vulnerability.”
Even so, Yetsenga is optimistic. The policy response to the pandemic has “changed the baseline” and we’re in the process of escaping the low-growth trap.
Unemployment is at its lowest in five decades and underemployment has fallen significantly. Real consumer spending is 9 per cent above pre-pandemic levels, and businesses’ capacity utilisation has been restored to high levels not seen since before the global financial crisis.
As a result, planned spending on business investment in the year ahead is about the highest in nearly three decades.
Yetsenga says the Reserve would like some of the rise in the rate of inflation to be permanent. “If monetary policy can deliver [annual] inflation of 2.5 per cent over time, rather than the 1.5 to 2 per cent that characterised the pre-pandemic period, it’s not just the rate of inflation that will be different.
“We should expect the ‘real’ side of the economy to have improved as well: more demand, more employment and more investment.”
“The role of wages in sustaining higher inflation is well known, but wage growth doesn’t occur in a vacuum. To employ more people, give more hours to those working part-time, and raise wage growth, business needs to see demand strong enough to pay for the labour.
“Some of the additional labour spend will be passed on to higher selling prices. The need to invest in more labour is likely to go hand-in-hand with more capital investment.”
I think Yetsenga makes some important points. First, the policy of keeping unemployment high so that inflation will be low has come at a price to growth and contributed to the low-growth trap.
Second, inequality isn’t just about fairness. Economists in the international agencies are discovering that it causes lower growth. So, the policy of ignoring high and rising inequality has also contributed to the low-growth trap.
Third, the idea that we can’t get higher economic growth until we get more productivity improvement has got the “direction of causation” the wrong way around. We won’t get much productivity improvement until we bring about more growth.
Despite all this, I don’t share Yetsenga’s optimism that the shock of the pandemic, and the econocrats’ switch to what I call Plan B – to use additional fiscal stimulus in the 2021 budget to get us much closer to full employment, as a last-ditch attempt to get wage rates growing faster than 2 or 2.5 per cent a year – will be sufficient to bust us out of the low-growth trap.
Yetsenga’s emphasis is on boosting household income by making it easier for households to increase their income by supplying more hours of work. He says little about households’ ability to protect and increase their wage income in real terms.
Another consequence of the pandemic period is the collapse of the consensus view that wages should at least rise in line with prices. Real wages should fall only to correct a period when real wage growth has been excessive.
But so panicked have the econocrats and the new Labor government been by a sudden sharp rise in prices (the frightening size of which is owed almost wholly to a coincidence of temporary, overseas supply disruptions) that they’re looking the other way while, according to the Reserve’s latest forecasts, real wages will fall for three calendar years in a row.
Since it’s the easiest and quickest way of getting inflation down, they’re looking the other way while the nation’s employers – government and business - short-change their workers by a cumulative 6.5 per cent.
This makes a mockery of all the happy assurances that, by some magical economic mechanism, improvements in the productivity of labour flow through to workers as increases in their real wage.
Sorry, I won’t believe we’ve escaped the low-growth trap until I see that, as well as employing more workers, businesses are also paying them a reasonable wage.
