Let's stop using interest rates to throttle people with mortgages

What this country needs at a time like this is economists who can be objective, who’re willing to think outside the box, and who are disinterested – who think like they don’t have a dog in this fight.

On Friday, Reserve Bank governor Michele Bullock, with her lieutenants, made her first appearance as governor before the House of Reps economics committee.

See if you can find the logical flaw in this statement she made: “The [Reserve’s] board understands that the rise in interest rates has put additional pressure on the households that have mortgages. But the alternative of lower interest rates and high inflation for a prolonged period would be even worse for these households, as well as all the households without mortgages.”

Sorry, that’s just Bullock doing her Maggie TINA Thatcher impression, mindlessly repeating the assertion that “There Is No Alternative”. Nonsense. There are various alternatives, and if economists were doing their duty by the country, they’d be talking about them, evaluating them and proposing them.

What’s true is that the Reserve has no alternative to using interest rates to slow demand. Some economists can be forgiven for being too young to know that we didn’t always rely mainly on interest rates to fight inflation, just as we didn’t always allow the central bank to dominate the management of the economy.

These were policy changes we – and the rest of the rich world – made in the early 1980s because we thought they’d be an improvement. In principle, now we’re more aware of the drawbacks of giving the central bank dominion over macroeconomic management, there’s no reason we can’t decide to do something else.

In practice, however, don’t hold your breath waiting for the Reserve to advocate making it share its power with another authority. Nor expect the reform push to be led by economists working in industries such as banking and the financial markets, which benefit from their close relations with the central bank.

What those with eyes should have seen in recent years is that relying so heavily on an instrument as blunt as interest rates is both inequitable and inefficient. It squeezes the third of households with mortgages – or the even smaller proportion with big mortgages – while hitting the remaining two-thirds or more only indirectly.

It’s largely by chance that the Reserve’s need to jam on the demand brakes has coincided with the worst shortage of rental accommodation in ages, thereby spreading the squeeze to another third of households. Had this not happened, the Reserve would have needed to bash up home buyers even more brutally than it has.

Clearly, it would be both fairer – and thus more politically palatable – and more effective to use an instrument that directly affected a much higher proportion of households. This should mean the screws wouldn’t have to be tightened so much, another advantage.

One obvious alternative tool would be to temporarily move the rate of the goods and services tax up (or, at other times, down) a percentage point or two.

Another alternative, one I like, is to divide compulsory employer superannuation contributions into a part permanently set at 11 per cent, and a part that could be varied temporarily between plus several percentage points and minus several points.

This would leave workers less able to keep spending (or more able to spend), as the managers of demand required to stabilise both inflation and unemployment.

Its great attraction is that it involves the government temporarily fiddling with people’s ability to spend, without actually taking any money from them. Surely, this would be the least politically painful way to manage demand.

Experience with central-bank dominance has shown us one big advantage: the economic car has been driven markedly better when the brake and the accelerator are controlled by econocrats independent of the elected government.

But this simply means we’d have to set up an independent authority to control all the instruments of macro management, whether monetary or fiscal.

Not all our economists have been too stuck in the mud of orthodoxy to think these new thoughts. They were canvased by professors Ross Garnaut and David Vines in their submission to the Reserve Bank inquiry – which, predictably, was brushed aside by a panel of economists anxious to stay inside the box.

A century ago, Australians were proud of the way we showed the world better ways of doing things, such as the secret ballot and votes for women. These days, our economists are dedicated followers of international fashion.

This means the country that should be leading the way to better tools to manage demand will wait until it becomes fashionable overseas. Why should we be first? Because our unusual practice of having mainly variable-rate home loans means our use of the interest-rate tool bites a lot harder and faster, thus making our monetary policy a lot blunter than theirs.

Economists may not fret much about how badly some punters are hurting as the economic managers rapidly correct the consequences of their gross miscalculations – the Reserve played a big part in the excessive stimulus during the COVID lockdowns – but one day the politicians who carry the can politically for these miscalculations will revolt against the arrogance of their economic gurus.

Reserve Bank governors – and, in earlier times, Treasury secretaries – privately congratulate themselves for being the last backstop protecting the nation against inflation. When no one else cares, they do. When no one else will impose a cost of living crisis on spendthrift consumers, they will.

Don’t you believe it. If they cared as much as they think they do, they’d care a lot more about effective competition policy. But when the economists leading the Australian Competition and Consumer Commission – Allan Fels and later, Rod Sims – were battling to get more power to reject anticompetitive mergers, they got precious little support from their fellow economists.

While the (Big) Business Council was lobbying privately to retain the laxity, backed up on the other side by a few Labor-Party-powerful unions that had done sweetheart deals with their big employers, the Reserve and Treasury were missing in action.

The people at the bottom of the inflation cliff boast about the diligence of their ambulance service, while doing nothing to help the people at the top of the cliff trying to erect a better safety fence.

If you were looking for examples of oligopolies with pricing power, you could start with the big four banks. If you were looking for examples of “regulatory capture” – where the bureaucrats supposed to be regulating an industry in the public interest get sweet-talked into going easy – you could start with the Reserve and banking (with Treasury not far behind).

In the natural conflict between the goals of financial stability and effective competition, the Reserve long ago decided we’d worry about competition later.

But the more concentrated we allow our industries to become, the more often the Reserve will have to struggle to control inflation surges, and the harder it will need to bash home-buyers on the head.

Read more >>

Don't let an economist run your business, or bosses run the economy

A lot of people think the chief executives of big companies – say, one of the four big banks - would be highly qualified to tell them how high interest rates should go and what higher rates will do to the economy over the next year or two.

Don’t believe it. What a big boss could tell you with authority is how to run a big company – their own, in particular. Except they wouldn’t be sharing their trade secrets.

No, in my experience, when bosses step away from their day job to give Treasurer Jim Chalmers free advice, their primary objective is to tell him how to run the economy in ways that better suit the interests of their business (and so help increase their annual bonus).

But when it comes to keeping our banks highly profitable, our treasurers and central bankers are doing an excellent job already.

Of course, it’s just as true the other way around: don’t ask an economist to tell you how to run a business. It’s not something they know much about.

Running big businesses and running economies may seem closely related, but it’s not. They’re very different skills.

One of the ways the rich economies have got rich over the past 200 years is by what the father of economics, Adam Smith, called “the division of labour” – dividing all the work into ever-more specialised occupations. By now, managing businesses and managing economies are a world apart.

But as Free Exchange, the economics column in my favourite magazine, The Economist, explains in its latest issue, there’s more to it than that.

Conventional economic theory sees the economy as composed of a large collection of markets. Producers use resources – labour, physical capital, and land and raw materials – to produce goods and services, which they sell to consumers in markets.

Producers supply goods and services; consumers demand goods and services. How do producers know what to supply and consumers what to demand? They’re guided by the ever-changing prices being demanded and paid in the market.

So economists see economics as being all about markets using the “price mechanism” to ensure the available resources are “allocated” to the particular combination of goods and services that yields consumers the most satisfaction of their needs and wants.

It wasn’t until 1937 that a British-American economist, Ronald Coase, pointed to the glaring omission in this happy description of how economies work: much of the allocation of resources happens not in markets but inside firms, many of them huge firms, with multiple divisions and thousands of employees.

Inside these firms, the decisions are made by employees, and what they do is determined not by price signals, but by what the hierarchy of bosses tells them to do. A key decision when something new is wanted is whether to buy it in from the market, or make it yourself.

The Economist says another gap between economic theory and the world of business is the economists’ assumption that firms are profit-maximising. Well, they would be if they could be.

Trouble is, contrary to standard theory, they simply don’t have the information to know how much they could get away with. Gathering a lot more information would be expensive and, even then, they couldn’t get all they need.

As the American Herbert Simon – not really an economist, which didn’t stop him winning a Nobel Prize – realised, businesses live in a world of “bounded rationality” – they make the best decision they can with the information available, seeking profits that are satisfactory rather than ideal. They are “satisficers” rather than maximisers.

It took decades before other economists took up Coase’s challenge to think more about how companies actually go about turning economic resources into goods and services.

The Economist says a key idea is that the firm is “a co-ordinator of team production, where each team member’s contribution cannot be separated from the others.

“Team output requires a hierarchy to delegate tasks, monitor effort and to reward people accordingly.”

But this requires a different arrangement. In market transactions, you buy what you need and that’s pretty much the end of it. But, because a business can’t think of all the things that could possibly go wrong, a firm’s contracts with its employees are unavoidably “incomplete”.

Without these legal protections, what keeps the business going is trust between employer and employee, and the risk to both sides if things fall apart.

Another problem that arises within companies is ensuring employees act in the best interests of the firm, and are team players, rather than acting in their own interests. Economists call this the principal-agent problem.

In law, and in economic theory, businesses are owned by their shareholders, with everyone employed in the business - from the chief executive down – acting merely as agents for the owners. Who, of course, aren’t present to ensure everyone acts in the owners’ interests, not their own.

Economists came up with the idea of ensuring the executives’ interests aligned with the owners’ interests by paying them with bonuses and share options.

Trouble is, these crude monetary incentives too often encouraged executives to find ways to game the system. Ramp the company’s shares just before you sell your options and let the future look after itself.

Elsewhere, linking teachers pay to exam results encourages too many of them to “teach to the test”.

More recently, economists have decided it’s better to pay a fixed salary and avoid tying rewards to any particular task – which could be achieved by neglecting other tasks.

But whatever economists learn about how to manage businesses, it’s hard to see them supplanting management experts any time soon.

As The Economist observes, when a business hires a chief economist, it’s usually for their understanding of the macroeconomy or the ways of the central bank, not for advice on corporate strategy.

Read more >>

Economists: lonely, misunderstood angels in shining armour

If you’re tempted by the shocking thought that economists end up as handmaidens to the rich and powerful – as I’m tempted – Dr Martin Parkinson wishes to remind us that’s not how it’s supposed to be. The first mission of economists is to make this world a better world, he says. But don’t expect it to make you popular.

Let me tell you about a talk he gave on Friday night. It was a pep talk to the first of what’s hoped to be a regular social gathering for young economists come to Canberra to study, teach or work in government or consulting.

Apparently, working in Canberra can be a tough gig if you don’t know many economist mates to be assortative with.

Parkinson’s own career has had its downs and ups. He was sacked as Treasury secretary by Tony Abbott – who feared he actually believed in the climate change policy the Rudd government had him designing – then resurrected by Malcolm Turnbull as secretary of the Department of Prime Minister and Cabinet, the Treasury secretary’s bureaucratic boss.

He began the pep talk with a story about the woman with only six months to live, who’s advised by her doctor to marry an economist so as to make it seem like a lifetime.

That may be because, as Parko says, economists are trained to be analytical. To be rigorously logical and rational in their thinking. (I define an economist as someone who thinks their partner is the only irrational person in the economy.)

“Economics gives you insights into the way the world works that other professions cannot,” he says. Economists see things that others can’t. Sometimes that’s because the others have incentives not to see them.

As Upton Sinclair famously put it, it’s difficult to get someone to understand something when their salary depends on them not understanding it.

Ain’t that the truth. The endless bickering between our politicians explained in a single quote. And the economists’ limited success in persuading people to take their advice.

Economists are trained to see “opportunity cost” which, according to Parko, is “the core tenet of the profession”. “This under underlies everything we do.

“This leads us to positions that are often counter-intuitive [the opposite of common sense] and unpopular – but are right.”

True. It may amaze you that so much of what economists bang on about boils down to no more than yet another application of opportunity cost: be careful how you spend your money, because you can only spend it once.

It’s a pathetically obvious insight, but it’s part of the human condition to always be forgetting it. So it’s the economist’s role to be the one who keeps reminding us of the obvious. If economists do no more than that, they’ll have made an invaluable contribution to society – to making this world a better world - and earned their keep.

But here’s the bit I found most inspiring in Parko’s pep talk. “Economists are not ‘for capital’ or ‘for labour’ . . . We do not see the world through constructs of power or identity, even though we see the importance of them.

“We are ‘for’ individual wellbeing regardless of race, gender, sexual orientation or capabilities. Because of this, we are often against entrenched interests and for those without a seat at the decision table.

“Economists view the past as ‘sunk’ [there’s nothing you can do to change it] and argue for decisions about the future to be made free of sentiment and in opposition to special interests. Now, this is in sharp contrast to the incentives in our political system, which favour producer interests over that of consumers.”

Ah, that’s the point. The ethic of neo-classical economics is that the customer is king (or queen). Consumer interests come first, whereas “producer interests” (which include unions as well as business) matter only because they are a means to the ultimate end of the consumers’ greater good.

Economists believe in exposing business to intense competition, to keep prices no higher than costs (including a reasonable rate of return on capital) and profits no higher than necessary. Competition should spur innovation and technological advance, while ensuring the benefits flow through to customers rather staying with business.

Business doesn’t see it that way, of course. Unlike some, my policy is to tell business what it needs to know, not what it wants to hear. Some people – suffering from a touch of the Upton Sinclairs – tell themselves this makes me anti-business. No, it makes me pro-consumer. That’s the ethic we so often fall short of.

Read more >>

Positions vacant: economists (women preferred)

Never in the field of economic conflict was so much analytical effort devoted to so few... as in Reserve Bank governor Philip Lowe’s one-man crusade to save the economics profession.

This latter-day Lord Kitchener wants more young Australians studying economics at high school and university, then enlisting as economists in the holy war against economic inefficiency.

His message: Your country needs you. Opportunity cost is being flouted on every hand, yet we have just 3000 professional economists fighting the tide of economic illiteracy.

Young women, in particular, should look at themselves in the mirror and ask the hard question: what good reason have I not to become an economist? Why should I squander my life on any lesser calling than the orderly regulation of mammon?

And let’s have no weak excuses that you know nothing about being an economist – what kind of people they are, what they do, where they work, how hard it is to find a job. Not forgetting a question that could cross the mind of someone with the right stuff to be a dismal scientist: how well does it pay?

Field marshal Lowe has had his people working night and day scouring data bases far and wide to answer all such questions. Rochelle Guttmann (ably assisted by James Bishop, a mere male) does so in the subtly titled paper, Does It Pay to Study Economics? taken from my rapidly dwindling pile of unused reports, seasonally adjusted from 2018.

According to the 2016 census, fewer than 3000 people work as economists, even though there are 73,000 people with post-school qualifications in economics. What’s worse, only about two-thirds of people working as economists actually hold a qualification in economics.

But this is misleading. It’s not nearly that bad. For a start, the 3000 excludes about 2000 academic economists, who are classed as university lecturers. More significantly, to be classed as holding a qualification in economics, you must have that word in the name of your degree.

This is silly. In the day, the title of your degree said as much about which uni you went to as about the subject you majored in. Economics majors at Melbourne or UNSW walked away with a BCom, whereas accounting majors at Sydney got a BEc.

Little wonder people holding an “economics” degree are more likely to work as an accountant than as an economist. And you can forget the notion that a third of working economists are unqualified academically.

Returning to the recruiting drive, the authors make two observations about the huge disparity between those having done an economics degree and those getting a job as an economist.

First, it probably shows it’s hard for someone with an economics degree to actually get a job as an economist (ie, S > D). But it probably also shows that an economics degree is generalist in nature and provides a breadth of skills that allows you to work in a broader range of jobs compared to other degrees.

Get this: “80 per cent of economics graduates work in high-skilled white-collar occupations”.

More than a third of economists (narrowly defined) work in public administration, well over a quarter in private-sector professional services and about 15 per cent in financial services. But people with economics degrees work in a broader range of occupations and industries than people with degrees in most other fields.

Whether you’re talking economists or people with economics degrees, more than 60 per cent of them are men. Lowe believes – as does his teenage daughter, apparently – this disparity must be corrected. (The daughters of powerful men are far more influential than is commonly understood.)

Now to the question no economist would regard as sordid. Figures from the Australian Tax Office say economists have hourly earnings that put them in the top 3 per cent of earnings by occupation.

Graduates with economics degrees typically have higher full-time earnings than other graduates. They’re comparable with STEM (science, technology, engineering and maths) degrees, and higher than for business and other social science degrees.

Guttmann and her male sidekick say the labour market tends to pay the highest wages to people with the skills, abilities and knowledge that are in shortest supply [relative to employers’ demand].

So which skills make economists well-paid? Apart from their knowledge of economics, economists have skill in maths that’s way above the average for other skilled occupations, and above-average analytical skill, for reasoning and problem solving (which is what brings the big bucks).

Looking for the catch? You’ve found it. If you’re weak on maths, you might be happier as a journo.

Read more >>

Economists: male, upper class, out of touch

Could there ever be a shortage of economists? And if there were, would that be a bad thing?

At the risk of being drummed out of the economists’ union, it wouldn’t be a big worry of mine.

What I do find of concern is the decline in the number of students studying economics at school and university, as outlined by the Reserve Bank’s Dr  Jacqui Dwyer in a recent speech.

Why should people study economics? Well, as the world’s greatest female economist, Joan Robinson – a contemporary of Keynes – famously said, “the purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.”

Too true. But Dwyer offers a more positive sales pitch: “Economics is relevant to us all. Every day our lives are affected by economic decisions – ones we make personally and ones that are made by others.

“Economics is about how individuals and societies choose to allocate their limited resources to meet their needs and wants. It’s about how we respond to incentives, make trade-offs, weigh up costs and benefits – and how we decide what is efficient and [sometimes] what is fair.”

I’ve been known to find fault with the performance of economists on the odd occasion, but Dwyer is dead right to say economics “contains some powerful concepts and useful frameworks”.

At its best, economics “can help us better understand the choices involved in many personal decisions we make, and better understand the economic conditions and policies that affect our lives”.

If economics is relevant to daily life, and economic literacy brings benefits to society, how widely is it studied at school and university? Short answer: much less than it was.

Dwyer says that year 12 enrolments in economics have fallen by about 70 per cent over the past 25 years. In NSW the decline has been greater, beginning in the early 1990s when economics was displaced by the introduction of business studies, a subject Dwyer diplomatically refers to as “less analytically demanding”. The name of a Disney character comes to mind.

In 1991, economics was the third most popular subject choice in NSW, surpassed only by English and maths. It was taught in nearly all high schools. These days, it’s taught in less than a third of NSW government schools (many of them selective schools) and a little over half of non-government schools (particularly independent schools).

Back in the day, there were roughly equal numbers of males and females, whereas today males outnumber females roughly two to one. Dwyer says this gender imbalance is worse even than for the STEM subjects – science, technology, engineering and maths.

“So over the course of a generation, there has been a pronounced fall in the size and diversity of the economics student population at Australian high schools,” Dwyer says.

At university, Dwyer’s figures are, on their face, better news: the number of economics enrolments have been fairly constant since the early 1990s, falling only slightly since 2001.

But this isn’t so reassuring when you remember that, over the 15 years to 2016, total under-grad and post-graduate enrolments have grown at the average rate of more than 3 per cent a year.


The average annual rate of growth in enrolments has been about 3.6 per cent for banking and finance, 2.75 per cent for management and commerce, and even about 2.5 per cent for STEM, but a small negative for economics.

It’s not known whether this decline represents reduced demand for economists in the job market. But for those who are economically literate, a clue is that graduate starting salaries are higher for economics students than for those taking business-oriented subjects.

I wonder if the apparent decline in economics is partly just the unis’ greater marketing emphasis in naming their degrees. “Finance”, for instance, is actually a specialisation within economics. And banking, management, commerce and accounting are so theory-light that many such degrees would be beefed up intellectually with a fair bit of economics (as was my own commerce degree).

One strange fact is that of the many fewer unis still offering economics, more than half of those that do are in NSW and the ACT.

But the biggest cause for concern are the signs of diminishing diversity among uni students of economics. The proportion of females has fallen to about a third. And well over half of uni economics students are in the top quarter of socio-economic status, with only about 10 per cent in the bottom quarter. It’s similar, but not quite so extreme, for high school economics students.

If you rank the relevant uni degrees according to the proportion of students from high socio-economic status families, economics comes well ahead of banking and finance, then management and commerce, which is well ahead of STEM.

Oh, dearie me. This may explain a lot.

Read more >>