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GDP & the National Accounts: What they are and why they matter w/ Brendan Markey-Towler – EP153

The National Accounts are a huge intellectual achievement and an incredibly useful set of data, including GDP and its components. Chatting about the National Accounts with Economics Explored host Gene Tunny is fellow economist Dr Brendan Markey-Towler, author of the Substack newsletter Australian Economy Tracker. Brendan explains how the National Accounts help us track the current state of the economy as well as longer-term trends, such as shrinking manufacturing sectors and growing services sectors in many advanced economies.

You can listen to the episode via the embedded player below or via podcasting apps including Google PodcastsApple PodcastsSpotify, and Stitcher.

Links relevant to the conversation

Brendan’s Australian Economy Tracker Newsletter

Brendan’s post discussed in this episode

Planet Money episode on Simon Kuznets

Australian Financial Review article (pay-walled, alas) which reported “Federal government business generated $1.7 billion in revenue for the big four accounting and consulting firms over the past five years – though the government has a different take on the contract value of that business.”

Transcript: ROI of education: how economists estimate it + US economic update – EP152

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:01

Coming up on Economics Explored.

Brendan Markey-Towler  00:04

So, that’s where we get the view that Australia is less and less a country that makes things and builds things. Construction, manufacturing declining as a share of GDP.

Gene Tunny  00:16

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional economist based in Brisbane, Australia, and I’m a former Australian Treasury official. 

This is episode 153 on GDP and the National Accounts. What they are and why they matter. 

Chatting about the national accounts with me this episode, is my good friend and fellow economist, Dr. Brendan Markey-Towler, who started a new sub stack newsletter, Australian Economy Tracker. Brendan explains how the national accounts help us track the current state of the economy, as well as longer term trends, such as shrinking manufacturing sectors and growing services sectors in many advanced economies. 

In the show notes, you can find relevant links and any clarifications. Please send any comments or questions to contact@economicsexplored.com. I’d love to hear from you. I’ve been very grateful for all the comments on recent episodes. Your comments really helped me figure out the issues that you’re interested in, and the types of guests that you’re interested in hearing from. So, please keep the comments coming to me.

Right oh! Now for my conversation with Brendan Markey-Towler on the national accounts. Thanks to my audio engineer, Josh Crotts for his assistance in producing this episode. I hope you enjoy it. Brendan Markey-Towler, welcome back to the program.

Brendan Markey-Towler  01:43

Gene, it’s always a pleasure to be here. Sorry, I’m a bit husky today, but I’ve bruised my throat. I’d like to pretend that it was under heroic circumstances, but it was not.

Gene Tunny  01:52

Okay, well, thanks for participating. I understand it’s not damaging your throat, you’re able to talk, you’ve been talking all day. And you’re still happy to talk.

Brendan Markey-Towler  02:01

I could talk under wet cement, mate. So, a bruised throat isn’t going to stop me.

Gene Tunny  02:07

Well, you know, now, you can get a job as a rugby league commentator, possibly?

Brendan Markey-Towler 02:14

That’s true. I’m more of a union man. Yeah, but I will go with league. That’s good. 

Gene Tunny  02:18

Right oh, okay. So, the topic of today, national accounts, what it is, why it matters? You’ve started a sub stack and one of your first pieces that came out on the sub stack was on the national accounts. And you displayed a level of enthusiasm for the national accounts that is very rare. And it actually reminded me of just how marvelous the set of data – the national accounts are, and what a superb intellectual achievement. 

So, going back to the work of Simon Kuznets, and Colin Clark, who, was it Stone as well, Richard Stone, who formulated the methodology financial accounts, and then it was like a system a toss by the UN. So, I think, what your note did was it really helped us; well, it really reminded me of just how impressive those national accounts are. So, could you just tell us first, what you were trying to do in that note? And what’s your sort of general take on the national accounts, please, Brendan? Why do you think they’re so important?

Brendan Markey-Towler  03:28

Partly to justify why I had no friends at school. Because I get excited about nerdy stuff like this. But look, when you actually know what the national accounts are, they’re extremely interesting. And what they really do is they aim to provide a snapshot of the activity within an economy over a set period of time. So, in Australia, and throughout almost the world, I’m not sure of any country that doesn’t do it this way. It gives you a snapshot of all the activity that went on in an economy over the previous quarter. And the central number that depicts that activity is the number that we call gross domestic product. And gross domestic product is a measure of how much wealth was added to the economy, how much production, how much activity, and under the three great categories production, exchange, and income, or earning. That’s what the national accounts do. And they add that up into a single number, GDP. And that tells you how much activity went on in the economy over that quarter. 

Now, where it gets really interesting, is that number not alone would be kind of cool. And we talk about the GDP growth rate. That’s what we mean when you hear on the news that people say economic growth or the economy grew by, that’s what they meant that GDP number increasing or decreasing. But where it gets really interesting is that we approach GDP in three ways. And you can think of this as looking at the economy as the same thing, but from three different directions. And that changes the way that you interpret that number. So, we call these GDP I, or at least I call them GDP I, GDP O, and GDP E. That is, GDP expenditure, GDP income and GDP output. 

And what those numbers are doing are adding up GDP, the activity in the economy, looking at that activity from one to three ways: as a production, as an expenditure, and as an income, right. So, if you think about it this way, when you go down and you buy something that’s dear to our heart, here in Queensland, you go down into buy your coffee, there’s three things going on, there’s three ways that they get that same transaction gets measured and add to GDP. From the expenditure side, the expenditure that you make, when you buy that coffee goes into GDP E, and we add all of those up together, and we get GDP. That expenditure becomes income from the perspective of the person behind the bar. And that gets added up into GDP income. 

And there’s also an interesting concept of gross value add, which is how much value has been produced by that transaction. The way that we measure that in GDP O, is we take the value of the output that was sold and subtract the value of the inputs that went into it. And that by definition, that’s the value that was added. 

So, that’s the three ways that we add up GDP and we get an interesting view of the economy from that. A little bit further breaking that down, obviously, you can break that down to the level of the individual transaction. But the you know, you don’t get a huge amount of information that you get so much information, you have no information. So, we categorize at a high level, these different activities to get a sense of what’s driving GDP. So, within GDP E, the expenditure, which is the most popular and most focused on of the national accounts measures of GDP, we break down expenditure by consumption, investment; in Australia, we break down by housing, as well, government expenditure, both consumption and investment, and net exports.

Gene Tunny  07:34

And by investment, we mean capital investment, we mean expenditure on capital goods. So, we mean, new housing developments, or we mean, new, non-residential buildings, new schools, new factories, new capital equipment that’s purchase.

Brendan Markey-Towler  07:55

That’s right. Yeah. So, in Australia, we call it gross fixed capital investment, which is at the addition to the capital stock of the country in the capital stock of the country is; in Australia, again, we trade a little, perhaps, oddly, that we add housing into that. But factories, equipment; we actually add intellectual property as well. So, science and technology research get added into that figure. And so that’s what we that’s, that’s the way that we break down the economy. 

So, when we break down GDP E that way consumption, investment, government spending net exports, we get a sense of which sector of the demand side of the economy is pulling the economy along. Is it household consumption? Is it buying new houses or building new houses? Is it businesses investing? Is it government consuming, spending money? Or is it government investing? Or is it coming from the international sector? And that gives us a lot of information about the activity within a country, it also gives us information about what might be dragging economic growth as well. So, that’s expenditure. 

Another really interesting measure, well, I mean they’re all interesting, but the second measure GDP O – GDP output, sometimes called GDP gross value add, gives us a sense more of the supply side of the economy. 

So, expenditure gives us a view of what’s driving the economy on the demand side. GDP O gives us a view of what’s driving the supply side. So, we get GDP in Australia, broken down by industry. And that’s where it gets really interesting because we can see which industries are adding the most to GDP. So, that’s cool. We can say, oh, mining adding more? Or how much is mining adding to GDP and how much is it driving or dragging on GDP? Ditto for professional scientific and technical services is another one that we use, agriculture and fishing, public administration safety; how much are these sectors adding to GDP and how much are they dragging or driving GDP. And then finally, the GDP I number. This is typically not quite as informative as the others, which is kind of ironic because it’s the easiest to add up because we just look at the tax returns. GDP I, breaks down GDP by income. And in Australia, we do it by what we’d call the greatest states of Australian society. So, wage earners, non-financial corporations, financial corporations, and government. And we can get a view of who’s earning the income within GDP. How what of that GDP that’s expended and outputted. Where is the income from that activity accruing to? Is it accruing to wages? Is it accruing to company profits? If it’s an accruing company profits, is it occurring to financial or non-financial companies? So, that’s some of the really interesting stuff that we get from GDP, it gives us this, really, especially in Australia, because our accounts are quite amazing.

Gene Tunny  11:05

Yeah, we’ve got some of the best in the world for sure. 

Brendan Markey-Towler  11:09

They really are and we get a really rich view of what’s driving and dragging the Australian economy. What’s creating the wealth in our economy and what’s potentially dragging on the wealth of our economy. And kind of, we get a sense as well, where it’s going.

Gene Tunny  11:26

Okay, so the few things I want to talk about there, Brendan. Okay, so you mentioned that GDP; well, is it an approximation of the addition to wealth? Let me think about this. I mean, part of it is in addition to wealth, to the extent that you’re increasing the capital stock, but then part of it is consumed, and then part of the investment is consumption of fixed capital. So, I mean, it’s national income really, isn’t it? I mean, it’s related to wealth. Yes. So, it’s certainly related to that. It gives us a picture of our national income. I think national income was the original term for it, wasn’t it?

Brendan Markey-Towler  12:11

Yes, although national income gets a little trickier because the we focus on GDP, because it’s really limited to the geographical definition of the country. And that distinction was made early on in the development of the methodology, because national income is a bit fuzzier because it’s typically added up by nationals, rather than by where the activity occurred. So, that’s why the classic example that we give in an economics course, is that national income for a country like Luxembourg is, I think, Ireland, sorry. National income for a country like Ireland is actually much higher than its GDP, because a lot of its nationals live overseas. So, there’s few distinctions that we make within it. But really, what it’s giving you is a view of the activity that’s occurred in the economy, the economy being that system of human behavior, why we produce and exchange stuff that we need for everyday life. And so obviously, that adds to the stock of wealth in the economy, because some of that gets consumed and taken out and other elements of it gets allocated to the national wealth. 

So, yeah, it’s a flow metric in the classic distinction between stocks and flows. It a reflection of the consumption and investment activity in an economy during a particular period.

Gene Tunny  13:40

Yes, it was developed during, well; the need for it became obvious during the 30s, when they were trying to quantify the extent of the Great Depression, I think Kuznets produced a report for the US federal government that strangely became a best seller. I mean, it was the first time someone had produced numbers like this. There’s a great planet money episode on that. I’ll try and find it and link to it in the show notes.

Brendan Markey-Towler  14:09

Well, that’s a good point, right? Because before then everyone kind of knew when times were good, or times were bad. And so, you could tell there were panics and manias and crashes as Charles Kindleberger famously said, but before the national accounts were developed, we never really were able to quantify what that was. And a lot of this was crystallized by John Maynard Keynes, his famous book, The General Theory of Interest, money and employment. I’ve got that wrong, interest money I think I got three. I’m one of the few in my in my generation, I think who actually read the book, which is, which is why it’s embarrassing I can’t remember the name because we always refer to it as the general theory.  And what Keynes was trying to do there was give a theory of why we experienced these manias, panics and crashes, you know, boom and bust. And the problem was that when he wrote it, he was dealing with a lot of abstract thoughts and that needed to be measured. And I’ll actually give a little plug here for our home state of Queensland because Queensland was at the forefront of this, currently the building out at UQ, which houses the School of Economics, the University of Queensland, the School of Economics there is housed in the Colin Clark building, which is kind of ironic because Colin Clark didn’t become an academic at UQ until much later in life, I think around the 1980s. But Colin Clark was at the forefront of developing the methodology, not only for what the national accounts are, but how you actually design the surveys that add up those numbers and find out what the numbers are. 

Gene Tunny  15:49

And he’s quoted in Keynes’s book because Keynes used his estimates of consumption spending for Great Britain, if I remember correctly, in the general theory. 

Brendan Markey-Towler  16:01

And it’s kind of funny. So, Colin Clark who came out here to Australia and did a tour of Australia and he was the hotshot wizkid political economist from Cambridge. And he met with all of the premiers because back in those days, we understood the constitution. So, the premiers were much more powerful than the prime minister. And when he came up here to Queensland, the premier at the time William Forgan Smith, which the alumni of UQ will know, is that is the main building at the University of Queensland. Kind of, a nice little coincidence. Forgan Smith basically said to him, look, do you want to come and be my adviser on all things economics? As Forgan Smith was a great reformer and trying to develop the Queensland economy, he needed to be able to measure the size of the Queensland economy: what was driving, what was dragging, what was causing development, what was dragging on development. And there’s a famous letter that Colin Clark writes back to Keynes to say, I’ve been offered a job to basically become the shadow premier of Queensland. I’m not going to turn that down. And Keynes, I think said something to the effect of where is Queensland. So, then, Colin Clark came out, join the Queensland Statistical Bureau and, he was instrumental in the development of the national accounts and as a point to why the national accounts are so important. While Colin Clark was doing that, he’s obviously thinking about what goes into an economy? What is an economy? What exactly does it mean to say an economy? Because when you actually; we all kind of know what it is, is the economy stupid?

Gene Tunny  17:44

It’s an abstraction, isn’t it? 

Brendan Markey-Towler  17:47

But it is an abstraction. And so, he had to think about, Okay, what does it actually mean? What is an economy, what counts as economic activity? And this is becoming very pertinent again, in these days, where we’re talking about things like Facebook and Amazon and Google where a lot of the activity that goes on there, we sort of think of as economic but it doesn’t measure it. But what happens as a result of Colin Clark thinking through these questions, is he’s starting to develop views of how economic development occurs. So, he ends up writing a large book, which sort of became a classic and development economics on how economies develop, what the basis for economic development are, what the settings for economic policy should be to encourage development. Particularly important question here in Queensland, which was a quite underdeveloped economy at the time.

And as a result, he became a very close adviser to Bob Santamaria, who those diehard fans of Australian politics will know was instrumental in the foundation of the Democratic Labor Party. So, this is the guy who invented a lot of the methodology behind the national accounts. So, when you understand something at that level, when you understand what an economy is, when you know how to measure it, imperfect as that measure may be, you get really rich insights into how an economy is tracking over time. And you get really rich insights as a result that develop over a long period of time of working with these things of what drives economic growth. You can situate those numbers in a history that tells you why the economy is growing, or why it’s not.

Gene Tunny  19:32

Yeah. Where do you get that Colin Clark story from? Is that in that book you keep talking about by, was it Millmow?. 

Brendan Markey-Towler  19:38

Yeah. Alex Millmow, A History of Australasian Economics Thought. I think that’s where I got it from. Yes, it is where I got it from. It’s a really good book because Alex points out that a lot of Australia’s economic contributions to economic thought came from really practical questions like this. How do we measure?

Gene Tunny  19:57

Absolutely. Yeah, yeah, absolutely. Okay, we’ll take a short break here for a word from our sponsor.

Female speaker  20:07

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Gene Tunny  20:36

Now back to the show. Okay, now, I did want to go back to the point you made about the difficulty of well, the issues around the modern economy and the India head, etcetera. There was a great lecture that John Quiggin, who’s a professor at UQ. And if any Australian economist is going to win a Nobel Prize, it’d be John. I mean, he’s one of the most cited academic economists that Australia has. I mean, maybe, Warrick McKibben could win one. So, but yeah, certainly, John is;

Brendan Markey-Towler  21:11

I always like for John Foster personally.,

Gene Tunny  21:15

Well, John Quiggin, is incredibly distinguished economist and his view at the this lecture he gave was that the problem with GDP is that it’s gross, its domestic and its product. Okay, so we’ve already talked about the domestic issue. So, the fact that you could have a lot of production, but if all your incomes remitted overseas, okay, because it’s just foreign mining companies producing and sending profits home, and then you may not see all of that benefit. But the point he was making is it because its product, and it’s measured at market prices, what you could be missing out on is consumer surplus, you’re not necessarily measuring the benefit to consumers, because all of these products are provided for, well, a lot of them for free. But yet, the foreign company makes money out of you in some other ways, because it’s monetizing your attention, isn’t it?

Brendan Markey-Towler  22:11

Yeah. And so, this is a debate that’s been really reopened, it’s been a perennial debate in economics, and there’s a lot of interesting ideas floating around, inspired by it, which is that when we talked about, you know, how GDP is added up, we talked about the exchange, okay. But the only way that we really observe and exchange is by the exchange of money, right? So, the price multiplied by the quantity of goods or services sold. Now, the problem merges; what happens in a world full of freemium models? What happens in a world where the price of a Facebook membership is zero? That sort of kind of, well, I don’t particularly like Facebook. So, you know, I would challenge just how much consumer surplus is creating, but there’s, you know, many people would argue that there is a value added.

Gene Tunny  23:11

I think TikTok is creating the most at the moment. Especially among the younger generation..

Brendan Markey-Towler  23:16

Massively, yeah. the only thing that shows up in the national accounts from Facebook, Google, TikTok, Instagram, is the data sales. That’s the only thing that shows up in the national accounts. I mean, apart from the marketplace exchanges that go on as well in the Facebook marketplace, and so on like that. But really, it’s ultimately the advertising for Google the sales of data from all of them. That’s the only thing that shows up in the national accounts. So, but there’s more than that, as well. Another problem, And Peter Thiel has recently raised this issue.

Gene Tunny  23:53

Oh, the billionaire? Right.

Brendan Markey-Towler  23:57

The chap who founded PayPal, he thinks that we’ve actually had no economic growth or very little economic growth in the past 70 years. And the reason he says that is because he contends that what is observed as economic growth in the past 70 years, is actually just us bringing production and exchange; valuable production exchange that used to happen in the home, into markets. So, cooking, cleaning, keeping the house in order, gardening; all this stuff gets done on marketplaces, rather than in the home. And that’s a bias in GDP. It doesn’t measure that stuff because it’s not on a marketplace. It can’t be observed. So, that’s another argument. 

You know that GDP doesn’t measure the actual value that’s being created. Now, the problem ultimately is, this goes back to a problem of micro economic theory, which is what is utility? And what is consumer surplus? And actually, from my perspective, why I ultimately say, look, let’s stick with GDP. It’s the worst measure we have, except for all the other things. Some countries have toyed with measuring gross national happiness. You know, New Zealand is toying with that at the moment, Bhutan famously measured it. The UN uses the Human Development Index, which is a weighting of GDP per capita literacy rates and life expectancy, I think.

Gene Tunny  25:31

All of which are highly correlated, aren’t those?

Brendan Markey-Towler  25:33

Yeah, and so, that was a March Ascends Brainchild, Jagdish Bhagwati famously said, well, yeah, they’re correlated. So, what are we talking about here? So, all those debates over replacing GDP ultimately, were reduced to a deep, deep philosophical problem, which economists are not well placed to solve, which is, what is value? What is good, what is true, what is beautiful? And I got some views on that. But as an economist, I ain’t got nothing to say about that. And so, when economists start dabbling in it, you kind of go, I used to be a fan of the happiness literature. But now I read and go, ah, this is, you know, it’s very simplistic. We’re going to use subjective wellbeing measures to add up Gross National Happiness. Okay, fine, that’s a really subjective and not very tangible measure. Whereas I can look out the window and see the cranes on the skyline here in Brisbane and see that’s an objective, measurable thing.

Gene Tunny  26:37

Well, it stood the test of time, hasn’t it? So, we’ve been using it for decades now. And there’s a general feeling that it does capture the state of the economy reasonably well. I mean, there are going to be people who grumble about it from time to time, but generally well, in Australia, at least when we had the recession, I mean, I always remember the 91 recession, because I was in high school at the time. And like, things just look bleak for anyone who was in high school and wanted to get a job. But then that was the period when retention rates at high school really ramped up. So, it was it was telling us something important there and it tends to; like it could give false signals, there’s a big debate at the moment over what’s happening in the US. But then look, the economy’s looks like it is slowing to an extent. There’s the impact of the Federal Reserve hikes. So, let’s wait and see how it all plays out. I mean, my feeling is, it’s generally a pretty good indicator of the state of the economy. 

Brendan Markey-Towler  27:38

I look bad, I’m a Queenslander first, Australian second, and as a result, I do have a bias which is towards tangible reality. Right, feelings are very ephemeral. And feelings are important, right? They are very important, but they’re really difficult to measure. And they’re very subjective, and they can be easily manipulated. Now, GDP can be manipulated as well, depending on how you count things up. But at the end of the day, it’s stuff that’s being produced stuff that’s being consumed. And it’s tangible, observable goods and services. So, insofar as I really have a criticism of GDP, my major criticism is that it really; I agree with Peter Thiel largely, biases us away from realizing the value that is produced in a house. 

And look, I’ve got a young, I’ve got a four-month-old son now so and my wife is at home, taking care of that. And I tell you what, that is incredibly mind blowing valuable work that she’s doing; doesn’t show up anywhere in GDP. Now, that doesn’t negate GDP. Because I think the solution to that is really, let’s just realize what GDP is actually measuring. Now, that does work in a political debate, because in politics and the way that the media works, you need a number and you need that number to be growing, otherwise, elections get lost, and so on and so forth. But when you’re, you know, when you’re doing grown up analysis instead of politics, I think the solution is to look at what GDP is actually measuring. It’s not a measure of value and if you think of it that way, then you’re wrong. Stop thinking of it like that. Think of it as it’s a measure of the production of stuff and the exchange of stuff within the economy, within the market that we can observe. Don’t try and start thinking about as a measure of all of the economic activity that ever happens in an economy. Just recognize the limitations, it doesn’t measure this stuff that goes on the household and that’s incredibly important.

Gene Tunny  29:51

Yeah, fair enough. That’s a good point. I’ll have to come in another episode to this issue of what’s in GDP? What’s out? What does it all mean? I’ll try and have that discussion in a future episode because there is a couple of other things I wanted to pick up on from your note; your note reminded me of a couple of things. And it’s the fact that this system is so beautiful, I mean, we end up getting from two different directions, possibly two different sets of data. I mean, we can look at what spend on consumption goods, final consumption goods, now, we have to be careful, we’re talking about final consumption goods and final investment goods, because what we’re trying to do is avoid double counting, we’re trying to get; because there are a lot of business to business transactions, businesses selling to other businesses inputs, so you have to take care of all that and make sure you’re not double counting title output, you want the expenditure on final goods and services. 

So, if you look at that, that ends up telling you what GDP is, once you add exports, subtract imports, because, well, if you import something, then you don’t have to produce it here. So, there could be stuff that shows up a consumption spending or an investment spending that’s imported, and we didn’t produce it here. So, you have to subtract it. And likewise, if we’re exporting something, well, we produced it here, we know we produced it here, then that adds to our output. But then, you look at spending data, on the other hand, you can look at income data. So, you are saying, look at the wages data, look at the profits data. And yeah, I guess it is coming from the ITR. I’m not sure exactly where the IBS gets it from. But I mean, that’s a likely source. I do surveys of businesses.

I’d have to check exactly how much they’re using ATO data, but I know they do surveys of businesses to get that information. They’ve got a household expenditure survey, they’ve got surveys of, well I guess they got their business server; I’d be looking at what they spending on capital goods. Looking at what they’re earning. And so, they build up this picture of earnings that way, and also the gross value added in the business. Which as you described, is their revenue less their production costs, and wages are part of the value added to. So, wages plus the gross operating surplus, is your value added in the business?

Brendan Markey-Towler  32:21

Yeah, it’s a very slippery definition, because it’s not quite profits. But it’s, you know, the value of inputs minus the value of outputs. And that by definition has to be the value that is added by that business to the economy, insofar as we can measure it.

Gene Tunny  32:35

This is because we’re talking about gross domestic product. So, we haven’t subtracted for the depreciation of capital stock, because some of the investment that occurs is just replacing existing capital stock. So, the building wears out and we have to replace it.

Brendan Markey-Towler  32:52

Too hard. We set that aside. Depreciation is very funny thing to talk about.

Gene Tunny  32:56

Right? Yeah. Well, we’ll leave that for now. You got time just to chat about your great quote? I should have brought it in earlier. You use these different perspectives on GDP to provide a really nice summary of what’s been happening in Australia. I thought this was very good. Exactly. Okay, so after you analyze where the growth has occurred, and you know, it’d be good if you could explain this at the moment. You concluded this; to put it somewhat tribally, Australia is less and less a country that derives its wealth from making and building things. Still a country that makes its wealth by digging stuff out of the ground and renting houses, and more and more a country that consults and cares. Could you please explain how you came to that conclusion, Brendan?

Brendan Markey-Towler  33:53

Well, you so what I did there, this is one of the most informative aspects of the national accounts I’m very interested; everyone focuses on the demand side of the economy, because we’re all Keynesian.

Gene Tunny  34:07

What we’ve been heavily influenced by Keynes, yes. There’s no doubt about that, whether we’re Keynesian. So, that’s another question. You can go ahead. Yes.  

Brendan Markey-Towler  34:13

We are all Keynesians. But the supply side of the economy is super interesting. See which sectors of the economy are generating the wealth. Now, the way that you can do that is by looking at gross value add, right. So, then you take the gross value added by each industry divided by the total GDP and you get the share of GDP, economic activity, economic value that is being created by that industry. And you can track that over time. Now, the problem with that data why almost no one really uses it? Some people do, but almost no one does. And you’ve used it, Gene, is that there’s a lot there, the ABS breaks the economy down by I think its 20 sectors. possibly 25. So, you’ve got to kind of cut it down to get some useful insights from it. 

So, the way I did it was alright, let’s cut out everything that’s less than 5% of the economy and look only at things that produce more than 5% of Australian GDP. Now, no sector really produces more than about 15. But there’s a clear standout. And there are clear standout trends once you do that, and you clean the graph up by eliminating all the Martin “minor sectors”. And you see some very strong trends. 

Trend number one that’s quite striking, and I should emphasize, this is all by real data. So, we hold prices constant to see what’s going on at the volumetric level in each of these sectors. So, we hold P constant, and we look at what’s changing in Q. Q is for quantity. And so, there’s benefits and costs to doing that. But it’s valuable as an exercise as long as you’re aware of the limitations of doing that. First interesting thing, manufacturing and construction are in decline in Australia. They’re not producing as much value add. In volumetric terms, they’re not producing as much value add anymore. They’ve been declining for the past 10 years as a share of GDP. So, that’s where we get the view that Australia is less and less a country that makes things and builds things; construction, manufacturing declining as a share of GDP.

Gene Tunny  36:30

So, with manufacturing, we had a car industry once, we subsidized a car industry, we tried to buy ourselves a car industry, and it just could not be viable on its own. And there wasn’t any more money we could throw at it to keep it open. 

Brendan Markey-Towler  36:48

And you look at somewhere like Maroubra or Ipswich. Which would you know, once kind of manufacturing ish areas in Queensland. Maroubra main manufacturing now is government contracts, building bullets for the Australian Army.

Gene Tunny  37:03

And do they build trains, still?

Brendan Markey-Towler  37:06

They do now. Yes, Maroubra now has a trains contract to build trains for the Queensland Government as well. And I think Ipswich still has a little bit of a train industry as well. But really not too much, by the way of price manufacturers. It’s not to say that it doesn’t exist, and it’s not to say that it’s very valuable. Queensland, for instance, has very vibrant medical manufacturing sector. That’s kind of grown up on the back of our extremely good hospitals and medical research. But generally, across Australia, the story is one of the car industries; we don’t really make stuff anymore. It’s just not competitive to build stuff. And so, that number is reflecting something that you see a lot when you go down to Fortitude Valley here, which, you know, the state would like to think Silicon Valley. Yes. Anyway, it’s Fortitude Valley, Queensland Silicon Valley, you see that a lot of the companies there just want to grow big enough that they can afford to offshore their manufacturing elsewhere. And the classic one is, I think Trivium, the electric car battery manufacturer, which is, as soon as they got big enough, they got a loan from the Queensland Government and then went to build factories in Tennessee.

Gene Tunny  38:17

Is that right? Is that a good use of taxpayers’ money?

Brendan Markey-Towler  38:21

Well, I’m completely agnostic on that. So, that’s what’s that number is reflecting. Similarly, construction,  this runs a bit counter to the crane index that we’re seeing in the city at the moment, but construction has been adding less and less to the economy. It’s not just large construction projects, but construction is declining as a share of GDP. 

Gene Tunny  38:48

Well, I’ll have to look at this. But I think what could be explained is 10 years ago, we had that massive project up in Gladstone at Curtis Island where we built the three LNG terminals or what are they? Refrigeration or liquification facilities. They turn the methane that comes from the coal field, the coal seams to liquefy it so, they can put it on a boat economically and ship it to Japan or Korea. And that was like $70 billion.

And it basically doubled the level of capital expenditure in Queensland at the time. It’s absolutely extraordinary.

Brendan Markey-Towler  39:31

There’s a huge effort on part of government corporations to get that going. 

Gene Tunny  39:35

And then in the southern states, maybe a few years later, I can’t remember the time; we had that big apartment construction boom. So, that could be explained. I’ll have to look at the data but go on. 

Brendan Markey-Towler  39:48

And that’s what’s really good about the national accounts is kind of counter to what you’re seeing if you’re walking around, particularly, Brisbane at the moment. The number of cranes in the sky is astounding, but this is why statistics are important because what’s local loss to a particular area is not necessarily true of the entire country. And what’s even true of a particular sector of construction, residential construction, government construction is not necessarily true, it might mean that we’re not building that many mines, which ties into the second point, which is, although it has declined in volumetric terms, the mining sector is still the single biggest contributor to Australian real GDP. And it’s not close, it’s way up; I forget the exact number, but it’s well up towards 10% of the entire Australian economy value added is produced by the mining sector. 

So, that’s, you know, digging stuff out of the ground, selling it to various countries around the world.. Behind that really interesting sector is, is the rental sector. So, a lot of value added in the Australian economy. It’s the only sector that holds candle to mining is the rental sector where people are building houses and renting them.

Gene Tunny  41:03

Okay. So, when you analyzed that, did you look at the industry, is it rental services? Or did you look at what’s in the national accounts as; there’s rental income, isn’t there? What do they call it? Trying to remember what the label is in the national accounts, but they impute rent for owner occupied dwellings as well, in that sector. If I remember correctly.

Brendan Markey-Towler  41:29

Rental services. I’m pretty sure is the exact name of the sector.

Gene Tunny  41:33

Looking at it by industry. Okay. Yeah.

Brendan Markey-Towler  41:36

So, that’s an important point, right? Because rent to also shows up as an income segment as well. Not nearly as big there. But the value add is quite large. And so that’s saying, you know, the Australian economy is very much one that is dominated at the moment, by digging stuff up out of the ground, and then sending it offshore, and providing housing for people. Those are the two biggest sectors of the Australian economy. And then, finally, the very long-term trend, we come to the third part of that bond ma that you so ably quaffed, which is, surprisingly, the sectors that are growing fastest as a share of the Australian economy are; you’ll have to double check me on this, but I’m pretty sure it’s called health care and social assistance.. And professional scientific and technical services. Those have gone quite strongly over the last few years as a share of GDP. 

Scientific and Technical Services is obvious enough, right? That’s the IT department and you know, the lab.

Gene Tunny  42:45

There’s professional too. 

Brendan Markey-Towler  42:49

Yeah. Professional Services is the big one. So, this is your consultancy lawyers. So on and so forth, right. It’s Eagle street, the consulting firms along Eagle street.

Gene Tunny  42:58

Where we are in Brisbane, in the top end of town, would you call it the big end of town? You’re sitting in water from place to the moment and the offices of Hopko Gannon, thanks, again for allowing us to use.

Brendan Markey-Towler  43:13

And so this area is growing really strong. I forget where the legal services are counted among professional service.

Gene Tunny  43:18

But I think I would be Yeah, sure.

Brendan Markey-Towler  43:21

They might be under administration, administrative services. But professional, scientific and technical services, basically, scientific and technical can kind of be in house. But a huge majority of that professional services is consulting, right? So, Australia is doing a lot more consulting as a share of GDP.

Gene Tunny  43:40

And this is business to business, typically? Business-to-business consulting services or business to government.

Brendan Markey-Towler  43:47

Business to government is the big one, especially here in Queensland right now. That’s not backed by a number. But that’s you know, that’s kind of;

Gene Tunny  43:58

There are numbers for the Australian Government. I’ll put them in the show notes, because I looked at what the Australian government has spent on the Big Four consulting firms like KPMG and PwC. And it’s hundreds of millions a year, right? It’s big money. 

Brendan Markey-Towler  44:12

And then, you go step below and the state governments will probably be even bigger again, because every consulting project by the Department of Public Works now gets a cut benefit cost analysis written by one of the big firms, right. So, just because of the procurement rules around that, so professional, scientific and technical services really growing as a segment of GDP, but also health care and social assistance. And so that I would posit is really a reflection of the ageing population. Ageing population, you need more health care and social assistance, certainly. That sector is growing very strongly – aged care.

Gene Tunny  44:49

Yeah. Which is NDIS too, the National Disability Insurance Scheme.

Brendan Markey-Towler  44:53

Absolutely massive, huge boom. You throw a stone in Brisbane and you hit NDIS provider, which is really not good, you shouldn’t do that because that’s naughty. And that getting on the back of Yeah, health departments are in Queensland; Queensland Health is the largest single employer in the state. That’s a massive sector. It’s a $20 billion in the state budget. That’s a big number, right? And we’re always trying to spend more on it. So, very big sector that. So, those are the two real growth sectors in the Australian economy. And again, I should stress by volumetric measures, right? So, notice that that kind of cuts against the mining booms like us, and that goes to the difference between real and nominal GDP. Real being a volumetric thing where we’re trying to hold prices constant, and the reason we do that is because nominal GDP could be growing because the actual underlying productive capacity of the economy is growing, or because inflation is growing. And real GDP tries to say, what’s the underlying volumetric productive capacity of the economy? How’s that growing and contracting. And in that measure, you really see the big growth sectors, mining is actually declining as a volumetric share of GDP as a share of real GDP, but it’s still the biggest by far professional, scientific and technical services, and healthcare and social assistance really, really growing. Yeah, that’s where the saying, that’s where my little trite way of putting it came from. Australia is less and less a country that makes things and build things. It’s still very much a country that digs stuff out of the ground and provides housing, but it’s more and more something of a white collar economy.

Gene Tunny  46:43

Oh, yeah. It’s postindustrial. We’re moving more to services. Yeah.

Brendan Markey-Towler  46:49

Natural I mean, with the natural resources sector.

Gene Tunny  46:52

Yeah. that’s right. And I mean, because the world wants to buy our resources. And for the last year or so, they’ve been paying ridiculously high prices for them. It’s an open question over whether we want to sell it. Right. Well, yes. I mean, there’s the big issues there of course that we don’t have time for.

You’ve been very generous with your time, Brendan

Brendan Markey-Towler  47:22

You are very generous letting me on the podcast to talk to people again, Gene.

Gene Tunny  47:27

You’re a great talker. Always enjoy having you on.

Brendan Markey-Towler  47:30

Even with the bruised throat? Like I told you, I could talk through a wet cement.

Gene Tunny  47:35

Very good. So, any final points before we wrap up?

Brendan Markey-Towler  47:39

No, it just ends up on I ended up with the note of circling back to where we started, which is don’t underestimate the national accounts. They’re a really, really, really interesting data set. They give us such a rich view. We didn’t even talk tonight about how in Australia, they break down by state as well, so, we can get an even richer view of how the different states are doing because you know, Australian economy tracker – my blog.

Gene Tunny  48:06

Okay, right. On Sub stack, is it?.

Brendan Markey-Towler  48:09

Yeah, on Sub stack. Please subscribe and contribute to the Markey-Towler retirement fund. It’s founded on two points, which is that one, the perfect graph says more than a doctoral thesis and two, there’s no such thing as an Australian economy. There’s actually six different city state economies and two territories. So, the national accounts in Australia are amazing, not just because of the depth of analysis, they allow us on the supply side of the economy, but on the demand side as well. We get some really, really rich version. So, a plug to remember has to diehard nerds who didn’t have friends at school, but now we have the national accounts.

Gene Tunny  48:53

I’m sure you had friends at school, Brendan. Brendan Markey-Towler, that’s been terrific. I really enjoyed talking to you about the national accounts. 

Brendan Markey-Towler  

I really enjoyed talking to you, Gene. Thanks for having me. 

Gene Tunny  

Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com and we’ll aim to address them in a future episode. Thanks for listening. Till next week, goodbye.

Credits

Thanks to Josh Crotts for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.auPlease consider signing up to receive our email updates and to access our e-book Top Ten Insights from Economics at www.economicsexplored.com. Also, please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

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Podcast episode

US recession, climate change & monetary policy w/ Darren Brady Nelson – EP151

US Treasury Secretary Janet Yellen claims the US economy is not in a recession,  despite two consecutive quarters of declining GDP. Economics Explored EP151 guest Darren Brady Nelson disagrees with the Treasury Secretary and argues she is taking a political position. Whether she’s being political or not, Janet Yellen has certainly taken a big risk, as Darren and Gene discuss. Darren and Gene also talk about the review of the Aussie central bank, the Reserve Bank of Australia, particularly how climate change could figure in that review. Darren argues the review team should have a broader range of views represented, including Monetarist and Austrian perspectives. 

You can listen to the episode via the embedded player below or via podcasting apps including Google PodcastsApple PodcastsSpotify, and Stitcher.

About this episode’s guest – Darren Brady Nelson

Darren is Chief Economist of the Australian think tank Liberty Works and he’s also an Economics Associate at the CO2 Coalition in Washington, DC. For Darren’s bio, check out the regular guests page.

Links relevant to the conversation

While it’s the NBER that declares whether the US economy is in recession, this CNBC report notes: “Since 1948, the economy has never seen consecutive quarterly growth declines without being in a recession.”

But many economists are skeptical about whether the US is in a recession, including recent podcast guests Stephen Kirchner and Michael Knox. 

Stephen Kirchner on the US recession question.

Michael Knox’s Economic Strategy: Fed hikes rates, but Fed says no recession (PDF).

Transcript: US recession, climate change & monetary policy w/ Darren Brady Nelson – EP151

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:01

Coming up on Economics Explored 

Darren Brady Nelson  00:05

like to see seemed to have sold or sold for political purposes as the head of Treasury in the US each year is a political appointee. So, that is, to some extent a political position.

Gene Tunny  00:19

Welcome to the economics explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional Economist based in Brisbane, Australia, and I’m a former Australian Treasury official. 

This is episode 151 on whether the US economy is in a recession. Joining me is returning guest, Darren Brady Nelson. 

Darren is Chief Economist of the Australian Think Tank Liberty Works. And he’s also an Economics Associate at the CO2 coalition in Washington DC. As well as chatting about the US economy. Darren and I discuss climate change and the review of the Reserve Bank of Australia. 

In the show notes, you can find relevant links and details of how you can get in touch. Please let me know your thoughts on what either Darren or I have to say. I’d love to hear from you. 

In the show notes. I’ll include links to some great commentary on whether the US actually is in a recession from two previous guests, Michael Knox and Steven Kirschner. So, make sure you check those links out. 

Right on, for my conversation with Darren. Thanks to my audio engineer, Josh Crotts, for his assistants in producing this episode. I hope you enjoyed it. 

Darren Brady Nelson, Chief Economist at Liberty works. Welcome back unto the program.

Darren Brady Nelson  01:35

Thank you. Good to see you. I guess it’s been a while since we last spoke about Work Capitalism, I think.

Gene Tunny  01:41

Yes, that’s right. That was a few months ago. So yes, it’s good to catch up again. This is a 151st episode, and this is your 11th appearance on the show if I’m counting correctly. So yeah, we get around to another chat every 15 episodes or so. So, it’s about time to catch up with you. So, it’s great to have you on the show again.

Darren Brady Nelson  02:06

Yeah, congratulation, because I’ve been so prolific. 151 That’s great.

Gene Tunny  02:11

Yeah, well, it’s just drip by drip, really. It’s one per week, and they mount up, yes. Thankfully, we’re out of the COVID period, although I had it recently. And I was in isolation, but we’re over all of that craziness which was dominating the conversation for a while, and now we’re getting on to other issues. 

Okay, so I thought we could chat now about the US GDP figures and we had some big news last week, in Australia. You’re still on Saturday there; I think Darren, there in the states in DC. And now we’ve got two consecutive negative quarters of GDP growth. So, GDP grew at an annualized rate or didn’t grow, it fell at an annualized rate of 0.9% in the June quarter, and that followed a decline of, I think it was 1.6% in the March quarter, that’s at an annualized rate. Okay, so there’s a big debate about whether the US is in recession or not. Darren, what do you think? Is the US in a recession at the moment?

Darren Brady Nelson  03:26

Well, yeah, I would say so. I must admit, in this conversation, certainly, you’re going to be more expertise than I. You’re a guru of sort of macro-economic indicators, and all that, particularly from your treasury background, but other things you’ve done, too. So, maybe I’ll be asking you some questions, too, and hoping to get some answers. But yeah, I’m not sure; maybe you know the answer to this, but, the entire time I’ve been, first studying economics and being an economist, putting aside the debates on whether two consecutive quarters is the greatest definition or not, it seems to have been the definition for a long time. And the most interesting thing I’ve seen recently, and I guess this would have been headlines, I imagined in Australia as well, was the Biden administration going. No, no, that’s not really the technical definition of a recession. 

I don’t think I recall an administration, democrat or republican ever; they may come up with excuses and say, it’s not well, it’s not our fault. It’s the previous administration and all that sort of stuff, or you know, external circumstances. But this is really the first time someone’s ever, including, some of the economists that the Biden administration has. On record, obviously, talking about in the past that yes, the recession. You know, the technical definition, if you like, is the two consecutive quarters of negative growth. So, it’s been very interesting times. Again, I guess in the 2020s, including a lot of media organizations and our favorite, sort of Neo Keynesian Economist, Krugman coming out and also defending that the Biden administration on oh, well, it’s not really a recession. So, it certainly fits the technical definition that, if you’d like I grew up with. And, that’s certainly my impression, just actually being in the US. Is it dire just yet? Yes. On the inflation front, yes. But unemployment, still is fairly low. And putting aside the fact that participation rate, that’s a little bit of a worry, but the unemployment rates not so bad at this stage. And usually, obviously, that’s, if you’d like a key secondary indicator, besides GDP itself, that people usually turn to right away, before they maybe dig into, what aspects of GDP have gone down, energy manufacturing, etc, etc.

Gene Tunny  06:02

Yeah. Okay. So, there are a few things you mentioned there, Darren, 

Darren Brady Nelson  06:09

So, yes. Not a strong yes. So, yeah, I’d say yes. Technical definition? Kind of weak, yes in a kind of more judgement point of view.

Gene Tunny  06:16

Yes. So, you referred to what the White House was saying, and what Janet Yellen in the Treasury was saying. So, I might just read that out. And then we can go from there. And I can let you know what I thought about that. 

So, what Janet Yellen said and this is reported by the Financial Times. “The White House has maintained that the US economy is not at present in a recession, with Treasury Secretary Janet Yellen saying earlier this week that she would be amazed if the NB declared it was okay.” So, what she’s talking about there is the National Bureau of Economic Research, which is I think it’s attached to; is it attached to Harvard or MIT or one of those East Coast universities? There’s this elite group.

Darren Brady Nelson  07:01

I think it’s independent. I mean, look, I don’t know, but I think it’s more independent than even being associated with one particular university, I think.

Gene Tunny  07:10

Yeah, I think you’re right. Yeah. But it’s an elite group of macro economists, some of the top people and you’ll have some of the leading lights of economics on it. And they will date the business cycles, they will declare whether the economy’s in recession or not. And generally, what they’re looking for is a sustained downturn that lasts several months, so more than one quarter. And they look at a broad range of indicators. So, it’s not just GDP. But that having said that, it looks like GDP is an important part of it, because it’s that comprehensive measure of economic activity. 

And one thing I noticed when I was preparing for our chat, is there was a report from CNBC, where it noted that I don’t think there’s ever been a recession that the NBR has called, which didn’t have two consecutive quarters of GDP growth, if that makes sense. So, where’s the actual passage? 

Darren Brady Nelson  08:21

I think that’s not correct. I think they call the recession, during the pandemic, and that wasn’t two quarters, I think. So, they do have a bit of leeway. But they tend to usually use the two quarters as part of the definition as a key component.

Gene Tunny  08:38

Okay, look, I’ll have to check that, I thought I read that earlier today. I had that somewhere here in my notes.

Okay. So, we might go back to what Janet Yellen, what she said here. She underscored the message at a press conference on Thursday, emphasizing that the economy remains resilient. Most economists and most Americans have a similar definition of recession, substantial job losses and mass layoffs, businesses shutting down, private sector activities slowing considerably, family budgets under immense strain. In some abroad-based, weakening of our economy. She said, that is not what we’re seeing now. 

Okay. It seems to me that’s a pretty risky call from her because she is running the risk that the NBA does eventually define this as a recession. And that’s going to be incredibly embarrassing for the administration. So, yeah, that would be my sense of it. I think it is a big call from Janet Yellen. And it may be too early to tell. But look, there are a lot of Economists out there who seem positive about the US economy. But that said, it does appear that I mean, is it the interest rates, is it what the Federal Reserve’s been doing that’s causing issues? Is it inflation that’s hitting Consumers? What do you think are the main forces affecting the US economy at the moment, Darren?

Darren Brady Nelson  10:06

Yeah, I think, you’ve definitely touched on two key components. But just to comment on Janet Yellen. But you know, Janet Yellen was totally wrong on inflation. So, that didn’t seem to impact her credibility within her circle that she goes around with, and the people who hire her; that didn’t seem to make any difference. So, probably when she’s proven wrong on recession, which I think she already has been. Yeah, I mean, that inflation is like, one of the key things; it’s the biggest problems in the US, and obviously, even the Federal Reserve, which has been; our Federal Reserve is part of the process of creating inflation. So, they’ve gotten spooked. Biden administration itself has not, which they, at least publicly, they keep on, they don’t seem to be, they acknowledged it a bit, but they don’t really kind of acknowledge it as bad as, even though the official statistics are showing. So, you have, like, I guess we’ve talked about this many times, but, you have kind of two things going on at once, the unprecedented levels of money printing, and the credit that goes with it, which, if you’d like, from a macro point of view, is hitting the demand side. And then on the supply side, they’re doing all sorts of, the Biden administration’s policies are just hurting supply, and hurting productivity and competition. 

So, that can sometimes, make up a lot for that money printing. The supply side can react to it, and really dampen what, it’s for the money to the demand side of things. So, energy is a classic one, they had a complete 180 on their energy policy. So, the US went from the number one energy producer in the world to not that anymore, and, record time, essentially?

Gene Tunny  12:08

And is that the Biden administration’s fault in your view?

Darren Brady Nelson  12:12

Well, exactly. It’s not just their fault, that is literally their policy. You know, they’re going for the green transition, if you like, come hell or hot water, right? So, which includes, not allowing oil companies to extract oil and all sorts of things. Oil, natural gas, coal, etc. And they’ve also hit agriculture with bad policies as well. You know, manufacturing; yeah, literally, if you want to destroy an economy, the Biden’s administration is basically ticking all the boxes with their policies. And, putting aside, you can argue whether that’s intentional or unintentional, but I think there’s not too many, if you like, remotely free, market friendly economists who think the Biden’s policies are particularly good.

Gene Tunny  13:10

Right, okay, I’ll have to have a closer look at some of the policies and come back to that. I just want to go back to that definition of recession; I think I might have missed or may not have communicated properly what that factoid in that CNBC report was. So, what they were saying was that, in fact, every time since 1948, the GDP has fallen for at least two straight quarters. So, they’re not saying that, there could be recessions if you don’t have this, and that’s what you were saying with the pandemic, that was, like you could call a recession, if you don’t have the two negative quarters. But what this point is, is that, in fact, every time since 1948, the GDP has fallen for at least two straight quarters. The NBER ultimately, has declared it a recession. So, you can have a recession, even if you don’t have the two quarters, but every time you’ve seen it in the data, the NBER has ultimately called it a recession. So, what Janet Yellen has done is, yeah, that’s a really big call on her part. And, I mean, Janet Yellen, someone with a distinguished academic reputation, and yep, so really, really big call and potentially, it will backfire on her. We have to wait and see about that. Yeah.

Darren Brady Nelson  14:38

Janet Yellen in not going to make, you know, like she’s she seemed to have sold or sold for political purposes. Not unusual that; it’s not like this has never been seen before. Most of her sort of, like topics when she gets into public is less focused on inflation and recessions and she’s talking about equity and diversity and inclusivity and all that sort of stuff. Well, I guess as the head of Treasury in the US, each year is a political appointee. So, I guess, that is, to some extent, a political position. Although, usually in the past, it’s been Department of Justice and Treasury have, usually been less partisan, if you like. The people regardless of whether it was democrat or republican in charge, but you know, things have changed quite a bit. Certainly, this century and certainly in the 2020s.

Gene Tunny  15:33

Yeah, exactly. Okay. So, you mentioned the supply side before, well, one thing we’ve had in Australia here is just the ongoing disruption to supply chains. And I mean, the random things just been unavailable in the supermarket’s. Quantas seems to have lost its mojo; can’t seem to run a flight on schedule any time anymore. And partly, that’s because they lost people during the pandemic. And now we’ve got people on isolation leave, like if you get COVID, you have to isolate for seven days, and that’s disruptive. Things just don’t seem to be working as they once did. Is that the same in the States? Have you noticed that in the US?

Darren Brady Nelson  16:21

Yeah. I think some extent, less. Although I understand aviation has been kind of bad here, too. But I haven’t actually been, I’m just going on to sort of news reports and talking to other people that, yeah, they’ve had, things. Well, what happened in the US probably, maybe more than Australia is a lot of pilots, either were, let go or just left because they didn’t want to get the vaccine, right? And the federal government has a bigger say in aviation than they do and other industries, for instance, particularly on employment. And so yeah, that’s all contributed, including also I understand, not just pilots, but other people in the aviation industry, various hubs, the people needed at the airports and the hubs as well, similar sort of circumstances. The supply chain disruption in general, I haven’t noticed it as much in terms of like at the grocery store, there was a period where there was a little bit of that. Not as bad, but certainly, there were issues as well, in the US, perhaps, maybe not as bad in terms of like, grocery stores and whatnot. 

So, the 2020s have been very weird times. And I don’t think it’s some sort of like natural market outcomes as such. Obviously, markets wrecked, and they impact, but I think there’s just the amount of, really over the top interventions and status sort of policies in the 2020s have taken me by surprise. We’ve been prepping backwards, if you like, towards bigger and bigger government, and I think, reaping the rewards. I don’t know why people, even people who; seasoned economists, who should kind of, know better, the more the government does stuff and interferes, the worse things get. It literally, is becoming, more and more like an Atlas Shrugged world. I don’t know if you’ve read Atlas Shrugged; probably familiar with the premise anyway. It’s like that. I’m like Atlas Shrugged there, but, there were places to escape to in that world, the fictional world of as many, as you can see, in this world, when, all the governments are, have uniform sort of policies on COVID and uniform policies of not tackling inflation, and all that. And maybe it will be interesting to see if the elbow government copies the Democrat lead, which I suspect they will, if Australia gets two quarters of negative growth, they’ll go that’s not really a recession, we’ll be interesting to see if they go down that road as well.

Gene Tunny  19:12

Yeah, one thing that we’ve traditionally relied on to keep the economy growing is migration, just the addition of people and that those consumption, and so that’s starting to pick up again. Possibly, that try and redefine it. I mean, I don’t think we’re at risk of that at the moment. Although having said that consumer confidence has dropped with the higher interest rates, so people are freaking out over just the increases in interest rates we’ve seen already, because it looks like they just borrow lots of money when interest rates were really low. The Reserve Bank, Governor, I couldn’t believe it. Last year, he was saying, oh, the interest rates will; our official cash rate will stay at 0.1 until 2024. And arguably, he misled people. And so, I mean, he really has a lot of questions to answer for. And there is the Reserve Bank of Australia review, which I’ve talked about in this program. I don’t know if you’ve had a look at that at all, Darren?

Darren Brady Nelson  20:22

No, no. Give me a synopsis of what drove that. And what’s happening? 

Gene Tunny  20:28

Well, the RBA has been under a lot of criticism in recent years for different reasons. There’s been one group of economists who’ve been critical of it, because they argue that they didn’t; that they had interest rates too high in the lead up to the pandemic. Now, whether that’s true or not, I think it’s debatable. But I’ve had people like Peter Tulip and Steve Kirschner on the show. I mean, they’re very good economists. I think it’s worth considering their view for sure. 

Their argument is that if you’re trying to achieve the inflation target of 2 to 3%; they were arguing that because inflation was actually lower than that, you had scope to have looser monetary policy, lower interest rates, to have more employment growth. And there was some modelling that was done by Andrew Lee, who’s a Labor Party MP and a former and new professor, and Isaac Gross, who’s an economist at University of Melbourne, I think. And they showed that if the RBA had met its inflation target, if it had lower interest rates and let the economy grow faster. You could have had; I think it was like 250 to 300,000 more jobs in the economy. So, there were a group of economists criticizing the RBA from that direction. And they were saying that the RBA was too concerned about households taking on too much debt. So, they didn’t want to put interest rates lower. 

I could see why the bank would be concerned about that. So, that’s why I’m not fully on board with that criticism of the bank. That said, I think it is good to review the Reserve Bank, because it is a bit of a; it’s not exactly transparent what they’re doing. So, I think there could be greater transparency. And since last year, when Phil Lowe was making those sorts of bold calls, that turned out to be wrong within months, right. It was obvious that we’re in the in the new year when we started getting those inflation numbers that the Reserve Bank would have to act. So, I think they lost a lot of credibility over that. 

So, it’s important now to have this review. And they’ve appointed Caroline Wilkins from, she’s a former Deputy Governor of the Canadian Central bank. They’ve got Gordon De Brouwer, who’s a former bureaucrat, I worked for him when he was in the treasury. And he was also at a new at times. He’s good. He’s good value. And Rene Fry McKibbin, who’s a professor of Economics at ANU. 

They’re going to review the board like there are issues to do with board composition, who’s on the board? There are issues to do with the inflation target; but I’m not sure they’ll do much about that. They might tweak some of the language. And then there’s issues to do with the transparency of the board’s decision making; what do they release to the public every month? So that’s essentially what the review is about and I think it’s, it’s a good thing that they’re doing that. So, yeah, that’s it. So, yeah, it’s worth definitely worth keeping an eye on. 

Okay, we’ll take a short break here for a word from our sponsor.

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Gene Tunny  24:30

Now back to the show.

Darren Brady Nelson  24:33

So, are they the reviewers? Are they sort of, left or center, for the most part, like a Keynesian and MMT and, something else or what? What’s the story there?

Gene Tunny  24:47

I’d say the typical mainstream macro economists. So, however you’d like to characterize that, they’re definitely not MMT. If you had to give them a label, maybe you give them a new Keynesian label, possibly. But yeah, they’re not I don’t think they’re radical in any particular direction. They’re nonpolitical appointees, which is a good thing. One of the big questions and something that I think the Prime Minister, Anthony Albanese, Albo, as we call him, one thing he will be, he’ll be getting pressured to put a trade union representative on the board. So, they’ve had one in the past, I think Bob Hawke, our former Prime Minister was on the board in the 70s, when he was the head of the ACTU. 

And then we’ve had various other ACTU secretaries on the Reserve Bank Board. There are some people pushing for a regional rep., but, one thing that Peter Tulip, who’s Chief Economist at Centre for Independent Studies has been pushing for is, he said that the problem is, we don’t have enough people who know about inflation and monetary policy on the board. And so, we need more of those people. We need more, it’d be better to have more economic experts or economists on the board.

Darren Brady Nelson  26:05

Yeah. And maybe, also further, how about a variety of use, and not just the one kind of, you say, mainstream, and but that’s still a worldview, it’s still a way of looking at things. And it’s not the only way of looking at things. The combination of, essentially New Keynesians, for the most part, with maybe a little, like 80-20 Keynesian monetarist; that’s maybe what, most mainstream sort of, macro folks, that’s kind of what they’ve learned and whatnot, be good to have somebody else. Have an Austrian point of view, have maybe a full on monetarist point of view, whatever; just something that’s not just the one point of view, , so it’s not just Tweedledee and Tweedledum, every time either on the board or this review.

I’m not saying these people aren’t smart, or anything like that; the three people you mentioned, but I suspect there’s not going to be a whole lot of push and shove between the three. 

Gene Tunny  27:04

So, I think the review in a way, presumes that there won’t be radical changes. The Reserve bank is going to continue as an institution, we’re still going to have Fiat money. Is that the sort of thing that you think should be up for review, that we should be looking at something more fundamental?

Darren Brady Nelson  27:25

Well, at least you have one person on there who can be the dissenting voice to say, something like that, but I’m saying, even if it was, say, one Keynesian, one monetarist, and one Austrian, I think you might get a pretty decent review out of that, with the monetarist if you like, in between the two, to some extent. 

So, you still have 2 – 1, want to keep a central bank going, but we just, good to kind of be realistic about, what a Central bank does and what inflation is, what monetary policy is, all that sort of stuff. That’s fine, if the board, I’m not saying, the board should be all full of economists, even if it was a mix of those types of economists, I think it’s fine to have some other, you know, depending on how big the board is, you know, there would be room, I guess, for a union and a business representatives and maybe some other stuff as well, that’s fine. 

And then they should also review, also the goals of the Reserve Bank; what’s legislation. There’s a lot of stuff in there besides inflation, maybe, just to look at it, and kind of whether all that needs to be in there, or whether there’s should be a better balance, or you should prioritize and go, inflation is number one, and then something, that type of thing. It’d be great. 

A lot of these reviews aren’t all that genuine, they already have a political goal. I mean, you say they’re not political, but it always is, you know, to some extent, they’re under certainly under pressure anyway, regardless of who they stick in there to review things. Now, in the past, some of these reviews have been a lot less political than others, there’s always a political element, like the competition policy review wasn’t particularly political, but there’s always a little bit of an aspect to it, of course, I’d be surprised if they’re not under, some fairly great political pressure to start going beyond and started looking at, kind of cultural war type stuff, too, that they want to ingrain, sort of, race and gender and all that other stuff. I’ll be I’ll be pleasantly surprised as if that isn’t going to be a part of the review.

Gene Tunny  29:37

So, as far as I’m aware, race and gender won’t be at this stage, I don’t think. But one thing that possibly will be, now whether there’s a culture war issue or not, I don’t know. I think I’m not sure it’s, I guess there are aspects of it that are part of the cultural war but the debate about the climate. So, Warwick McKibbin, who is he’s a Professor of Economics at ANU, and he’s actually the husband of one of the reviewers. But you know, she’s independent of; she’s her own person… Renee Fry McKibbin; she’s Warwick’s wife. 

Darren Brady Nelson  30:22

Actually, by definition, at least the old school definition marriages, you’re not, you’re one flesh. But anyway, I understand what you’re trying to say. 

Gene Tunny  30:29

Okay, yes. So, I don’t think she’ll necessarily go along with Warwick’s view. But Warwick was at the conference of Economists in Hobart two weeks ago, where I caught COVID. And, it was a good conference other than that, it was a great conference.

Darren Brady Nelson  30:46

And super spreader of it.

Gene Tunny  30:49

Yeah, that’s right. And Warwick was on the panel. And now we’re talking about the Reserve Bank review. And one of the points he made is that we may have to amend actually, I think he’s saying we will have to amend our inflation targeting settings or our goals or objectives. We’ll have to amend that to incorporate climate change, because we have to recognize that if we’re going to be responding to climate change, we’re going to introduce a carbon price and one that increases over time. So, that’s what you need to have that sort of lowest cost adjustment path. So, to minimize the cost of adjusting to climate change, you’ll need to have a carbon price that increases and so that’s going to be increasing prices. So, you’ll need to look through the inflation, you’ll have to ignore the inflation that comes from the carbon price. So, I think culture war issues won’t come into it. But I think the climate change will come into the RBA review.

Darren Brady Nelson  32:01

Okay, well, that’s good to know. It’s terrible news. But it’s not surprising though.

Gene Tunny  32:06

But doesn’t it make sense what Warwick is saying? I mean, if a government does introduce a carbon price, and you’re going to have increasing prices because of that, then that’s not really inflation that the Central bank should be concerned about. What do you think of that perspective?

Darren Brady Nelson  32:25

It still should be concerned about it, even if, you know; this is all about thinking about the costs and benefits. It sounds like, just assuming, okay, well look, we’re just not going to worry about the downside of our carbon tax and our climate policies, because it’s such a, unquestionable good to pursue this. That’s ideology, that’s not economics, that’s really bad economics. And it’s also bad constitutional law, like, to what enshrine you know, certainly a very long-standing fad, of the climate sort of industry. But, the concept of inflation is something that stands the test of time. You can disagree on various aspects of it, but it’s always going to be, to the extent you’re going to have monetary policy, inflation is going to be an important thing to be thinking about, right. Climate change, may not be. 

I’ve been following this debate since the mid-90s. And, I can tell you; well, just look at the polling, I can’t speak for Australia, but in the US, it’s something along the lines of; it’s well outside the top 10 of topics that people are concerned about in the US, for instance, then you want to start because, elites like him, are in a position to influence these things. They want to shove in the things that they care most about. And I think it’s just atrocious to think you can stick that into the Reserve Bank act. I assure you another government can come along and potentially change that if they want, if the electorate says, alright, you’ve been trying to convince us that the end of the world has been coming for 30 years, it hasn’t arrived, we no longer trust you. Sure, that might happen. And then, government could change things, but you know, so it’s a bit hard to change stuff in legislation, a lot of damage can be done in the meantime.

Gene Tunny  34:20

Okay. So, on where is where they’d make the change? It probably wouldn’t be in the act, they would have it in the agreement between the treasurer and the Reserve Bank. If I remember correctly, I think the general view on the Reserve Bank act from the late 50s was that, look, some of the language is a bit outdated. But you know, maybe leave that alone, you can do all you need you want to do within the agreement between the treasurer and the Reserve Bank. So, I think that’s where they would adopt something like that. 

Just on that Reserve Bank Act, I think what they talk about in that is that the Reserve Bank is supposed to set monetary policy to have a stable currency to achieve full employment and to promote the prosperity of Australians or something. Something broad like that. Yeah. So, they’ll probably leave that and they’ll do whatever they want to do with if they did want to put some wording in about climate change, it’ll probably be very vague, because it is all very vague. We don’t really, I mean, I’ve got no idea what’s going to happen here in Australia. Politically, it’s, it’s such a vexed issue. And you’re saying is not in the top 10 issues in the US, it’s certainly in the top 10. It’s top five; top 3 here in Australia. 

I mean, the previous government lost Blue Ribbon seats, seats that it’s held for decades, seats in affluent areas of Sydney and Melbourne. And it lost them because of climate change, because people in those seats are extremely concerned about it.

Darren Brady Nelson  36:07

Yeah, there’s a different point of view. Certainly, they did, but I wouldn’t extrapolate to say that means Australia as a whole has the same views as these inner-city suburbs, they’ve just changed the demographics and the ideological viewpoints of these people. That’s why they lost. Just like we’ve seen around the world, it’s the rich and upper-class professionals who gravitate towards status policies and status causes, like climate change. The working class, and in the middle, and lower middle classes do not. And electoral politics, isn’t just a straight representation of what the entire nation views necessarily. And putting aside the fact that the polling is often biased and bad and misleading and all that sort of stuff, but that decide. 

I’ve seen some other people who; intelligent Australian commentators, James Allen, and people like that. We’ve been having a bit of look at that, to see whether, that mainstream narrative is actually true. They certainly lost obviously, those seats, they were blue ribbon, but they’ve been changing and moving left for a while now. So, particularly in the US, how climate change is almost really a non-issue from a broad electorate point of view, not any specific electorates. 

Yet, that doesn’t stop the policies from carrying on and then you have all these perverse outcomes of like, I imagined Albanese will get more copy a lot of what the Biden administration so, the push for electric vehicles. Well, electric vehicles are still being produced by coal and natural gas, you know. So, you’re really in many ways, you actually might even be increasing carbon dioxide emissions through transitioning to electric vehicles from petrol vehicles. And the fact is, most of the world is actually increasing the use of coal, mostly India, China, Brazil, etc. And there’s even been a coal like I said, there’s been a coal comeback, even in Western countries as electric vehicle usage gets ramped up. So, these people don’t go, oh, no, we; the same people who say there’s an existential problem, keep on producing, keep on pushing electric vehicles, for instance. So, that their actions speak louder than their words that it isn’t really an existential crisis. Putting aside the fact obviously, all these elites tend to keep on buying beach side homes and all these sorts of stuff. I think just look at their actions, speak much louder than their words. 

So, we’re getting this system where we get a worse electrical system because they keep on showing throwing more and more unreliable and expensive renewable energies on top of it, yet, they’re not actually starting to take much of the load of electricity production, they’re just sitting there costing more money and hurting the rest of the system. Yet, we’re still relying, and we’re going to keep on relying on coal and natural gas and the only renewable energy we’re going to lie and it’s going to be, water – hydro. Putting aside the fact you know, allow many new hydro to be built, but it’s bloody reliable. In the US, if it wasn’t for Quebec, all the hipsters in New York would be having more blackouts because they’re running on water; hydro from Quebec coming down into the US.

Gene Tunny  39:55

Where is that is that near Niagara Falls, or is it is that up in that Region.,

Darren Brady Nelson  40:00

Yeah. Quebec is like, the king of hydro in that part of the world, not just for Canada. In fact, Quebec is mainly supplying electricity to the US, part of the population that’s bigger. And that sort of the northeast of the US. So, that’s kind of insulating on, they can shove on some more solar panels and wind, but that’s not really generating a lot of electricity. And we also have the perverse effect from the main thing that, besides all the kind of pollutants, actually the toxic sort of, chemicals, and all the stuff that it’s needed for electric vehicles, needed for solar panels, needed for wind turbines, which obviously have detrimental environmental effects. They need coal, natural gas, and hydro to make those things in the first place. Not just to be the ones that really, supplemented when the wind’s up blowing, and the sun’s not shining. But if it wasn’t for all the fossil fuels, it couldn’t even build this stuff in the first place. So, all you’re doing is shoving all this stuff, people making a lot of money. A lot of people are virtue signaling, sort of, they keep on crying wolf for what, like 30 years now. There’s, nothing; there’s no significant evidence that we have a problem. 

Gene Tunny  41:15

Well, I’ll push back and say we just had a 40-degree Celsius day in England that they’ve never had in their whole history. 

Darren Brady Nelson  41:23

That’s not true. You go back, and we look at the Paleo challenge. You look at the evidence. For instance, in the US, this damn out in the Colorado River is having; it’s because of climate changes is at its lowest level, lo behold, a study, two weeks prior to them making such statements show that they’ve had more levels on the Colorado River 2000 years ago. 

We’ve had warmer periods, we’ve had more carbon dioxide in the atmosphere in times. No, none of this is accurate. It’s all cherry picked to scare the poop out of people to accept these policies they want anyway. And you watch it when we’re old men, we’re going to be the people will go yeah, we’ll look okay, this thing didn’t happen. But I think it was the right thing to do anyway. 

You hear that a lot, even now. They go like it will even for wrong, it’s the right thing to do. How’s it the right thing to do to make people poor? And have people in Africa starve? How’s that the right thing to do?

Gene Tunny  42:22

Okay, so in a future episode, we’ll have to come back to this, Darren, and we’ll see where we are with the with the data.

Darren Brady Nelson  42:28

You want to see the green policies and action? Look at Sri Lanka.

Gene Tunny  42:31

Yeah. Look, I’m not advocating for these policies, necessarily. Yeah. But I do recognize;

Darren Brady Nelson  42:42

That’s not about you, that’s just kind of aim at whoever’s watching this. It’s like, you want to see the future? The potential future? That’s Sri Lanka. That’s the way Australia could look, if they’re not careful.

Gene Tunny  42:55

And what did they do? They actually required organic produce, did they? Did they ban the importation of some fertilizers or something?

Darren Brady Nelson  43:07

Yes, fertilizers. Fertilizer was the main thing using green organic things instead of actual fertilizer. This is what’s happened in countries like Sri Lanka and African countries is to get their aid money. They do the green agenda, essentially. And it’s just a disaster.

I’ll tell you the countries that won’t be, it won’t be China, it won’t be India; the bigger countries that don’t need the foreign aid. And there’s also strategic implications, obviously. Who controls the green energy market, ultimately? China – communist China.

Gene Tunny  43:51

They are producers of a lot of the solar panels. That’s correct. Yeah.

Darren Brady Nelson  43:54

They are almost a monopoly on this, and increasingly, all the support technology for it as well. So, in China, this is not a coincidence. It’s not like, oh, the market chose China, they were just the best people to do it. This is like, this is a plan. It’s a strategy by the Chinese government, and you can see it’s written down. There are books written on this by them to say, oh, this is what we’re going to be trying to do. That basically, it’s their mind calm. So, don’t be surprised, when some of this stuff comes true. 

They have a plan that the Chinese economy is not a free market economy by any stretch of the imagination. You know, it’s a government controlled run for the purposes of, for the benefit of the Communist Party and the strategic interests of China. It’s not like you’re dealing with the Netherlands, that sort of thing. So, that’s also a huge thing. Because they’re an aggressive military power. 

When the time’s right, they’re going to take action. Taiwan and whoever else, eventually over time gets in their way. So, to aid and abet this through these green policies that are aimed at a problem that doesn’t really exist or certainly not in the scale. And certainly, even if the problem doesn’t exist, too deep, to essentially decarbonize the economy is just like literally the worst solution for it. And to decarbonize it in a way that, benefits China immensely. These’re just terrible policies the whole way through and people hopefully one day will be held accountable for this.

Gene Tunny  45:46

Right, okay. We might go back to GDP just before we wrap up, and yeah, I think I agree. There’s a big debate to be had about those policies for sure. I mean, from Australia’s perspective, given that we’re such a small part of the world, doesn’t make sense for us at this stage to adopt those policies on a large scale. My view is we should try to cooperate internationally. But we need to ensure that other countries are following through with their commitments. And I’m not sure that that has always been the case, or it is the case. So, that my perspective on that. 

On GDP, I guess the view is that; my sort of thought is that, Janet Yellen certainly went too far. The US possibly could be in a recession, despite the fact that jobs growth has been strong, despite the fact that you’ve got unemployment at 3.6%, you could be going into; you could be in a downturn. The GDP figures, if you look at the composition of them, you had inventories falling, that was a big part of it. So, businesses were selling goods, but they weren’t replacing their inventories. So, that could be a signal that they’re not expecting; they’re worried about the future, about future sales. We had a drop in residential construction. That was one and that’s probably driven by the increase in interest rates. At the same time consumption spending was up. So, that’s why the summer economists are thinking it’s a bit of a mixed report. And we’re not entirely sure, but my take on it would be the GDP numbers are definitely something be concerned about and Yellen probably went too far when she said, we’re not in a recession. I think that certainly could come back and bite her. 

Darren, do you have any final thoughts on the GDP numbers? Or where the US economy is that?

Darren Brady Nelson  47:55

Pretty much agree with what you just said. And obviously, time is going to tell. I think the bad ministration policies are very bad. And that’s going to come home to roost. So, I think, it’s not going to be good times, economically for the US and if it’s not good times, economically, for the US, it’s not worth it. China is obviously a major player, but it’s not the engine of growth for the world just yet. The US still pretty much is. When the US sneezes, everybody catches a cold.

Gene Tunny  48:39

Yeah, that’s right. I remember that. That was a popular saying in Australia, at the Reserve Bank and Treasury. So, yeah, absolutely. 

Okay. Darren Brady Nelson. Thanks so much for your time. It’s great to catch up, yes. And I look forward to chatting with you again in the future.

Darren Brady Nelson  48:58

Always great to be on your show and see you, Gene, thank you.

Gene Tunny  49:02

Thank you. 

Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.

Credits

Thanks to this episode’s guest Darren for the great conversations, and to the show’s audio engineer Josh Crotts for his assistance in producing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au

Please consider signing up to receive our email updates and to access our e-book Top Ten Insights from Economics at www.economicsexplored.com. Also, please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple Podcasts, Google Podcast, and other podcasting platforms.

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Podcast episode

Nominal GDP targeting w/ Stephen Kirchner – EP135

Market monetarists such as Stephen Kirchner argue nominal GDP targeting would be better than inflation targeting and could help central banks such as the RBA and the US Federal Reserve get back on track. Stephen is Director of the International Economy Program at the United States Studies Centre at the University of Sydney. 

Stephen spoke about nominal GDP targeting with Economics Explored host Gene Tunny in episode 135 of the show, recorded in April 2022. Among other details of nominal GDP targeting, Stephen discussed the potential role of a nominal GDP futures market and for blockchain and Ethereum in such a market and in financial markets more broadly. You can listen to the conversation using the embedded player below or via Google PodcastsApple PodcastsSpotify, and Stitcher, among other podcast apps.

About this episode’s guest – Dr Stephen Kirchner

Dr Stephen Kirchner is Director of the International Economy Program at the United States Studies Centre at the University of Sydney. He is also a senior fellow at the Fraser Institute in Canada, where he has contributed to research projects comparing public policies in Australia, Canada and New Zealand.

Previously, he was an economist with the Australian Financial Markets Association, where he worked on public policy issues relating to the efficient and effective functioning of Australian financial markets and Australia’s position as a regional and international financial centre.

Stephen has been a research fellow at the Centre for Independent Studies, a senior lecturer in economics at the University of Technology Sydney Business School and an economist with Standard & Poor’s Institutional Market Services based in both Sydney and Singapore. He has also worked as an advisor to members of the Australian House of Representatives and Senate.

He has published in leading academic and think-tank journals, including Public Choice, The Australian Economic Review, Australian Journal of Political Science and The Cato Journal.

His op-eds have appeared in publications including The Wall Street Journal, Straits Times, Businessweek, The Australian Financial Review, The Australian, and Sydney Morning Herald.

Stephen holds a BA (Hons) from the Australian National University, where he was awarded the L. F. Crisp Prize for Political Science, a Master of Economics (Hons) from Macquarie University, and a PhD in Economics from the University of New South Wales.

Stephen posts regularly on his substack: 

https://stephenkirchner.substack.com/

Links relevant to the conversation

Stephen’s papers on nominal GDP targeting:

Reforming Australian Monetary Policy: How Nominal Income Targeting Can Help Get the Reserve Bank Back on Track

The RBA’s pandemic response and the New Keynesian trap

Transcript of EP135: Nominal GDP targeting w/ Stephen Kirchner

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:01

Coming up on Economics Explored.

Stephen Kirchner  00:04

If you want to avoid, you know hitting the zero lower bound or expanding your balance sheet by a significant amount, the way to do that is to respond quickly and aggressively upfront. If you don’t do that, then you fall behind the curve and then monetary policy has to work a lot harder to stabilise the economy.

Gene Tunny  00:23

Welcome to the Economics Explored podcast, a frank and fearless exploration of the important economic issues. I’m your host, Gene Tunny. I’m a professional economist based in Brisbane, Australia and I’m a former Australian Treasury official. This is Episode 135 on nominal GDP targeting. My guest this episode is Dr. Stephen Kirchner, who is Director of the International Economy Programme at the United States Studies Centre at the University of Sydney in Australia. In this episode, Stephen tells us why nominal GDP targeting would be better than inflation targeting and how central banks such as the Reserve Bank of Australia and the US Federal Reserve can get back on track. Please check out the show notes for relevant links and for details of how you can get in touch with any comments or suggestions. I’d love to hear from you. Righto, now for my conversation with Dr. Steven Kirschner on nominal GDP targeting. Thanks to my audio engineer Josh Crotts for his assistance in producing this episode. I hope you enjoy it. Dr. Steven Kirchner of the US Studies Centre. Welcome to the programme.

Stephen Kirchner  01:36

Thanks for having me, Gene.

Gene Tunny  01:37

It’s a pleasure, Stephen, keen to chat with you about a paper you wrote last year on Reforming Australian Monetary Policy: How Nominal Income Targeting Can Help Get the Reserve Bank Back on Track. So there’s a lot to talk about here. And I think this is of general interest to people in other countries, as well, other than Australia, because this idea of nominal income targeting, it’s been raised in other countries, I know that you’ve appeared on David Beckworth’s podcast, Macro Musings, and I know that David Beckworth is a proponent of this in the United States. So I’d like to ask about, essentially, what is this nominal income targeting compared with how we normally, or how central banks have been running monetary policy? Would you be able to give us an overview of that, please?

Stephen Kirchner  02:38

Sure. I think nominal income targeting is actually not a huge change from where we are at the moment. So most central banks do what they call inflation targeting. And as part of an inflation targeting regime, they’re typically adjusting their monetary policy instrument, usually an official interest rate in response to deviations in inflation from target. But also responding to deviations in output from its full employment, or potential level. And the reason you have output as part of your reaction function is the output gap is predictive of future inflation outcomes. So if you’re running an inflation targeting regime, you want to respond to both deviations inflation from target, and output from potential.

Well, if you think about those two things, inflation on the one hand, and output on the other, if you put those two things together, then you’ve got nominal income, or nominal GDP. So in some respects, nominal GDP targeting or nominal income targeting is just a really weighting of that standard central bank reaction function. So if you think about a Taylor rule, which is just an empirical description of how the interest rate responds to deviations and inflation from target, and output from potential, all nominal GDP targeting is doing is saying you want to put inflation output together and weight them equally in terms of the interest rate response.

Gene Tunny  04:14

Ah, right. Okay. Yeah, that’s a good way of describing it. Yeah, please go on.

Stephen Kirchner  04:18

Yeah, so in that sense, it’s not a huge leap from where we are at the moment. But what it does mean is that the central bank is a bit more agnostic about its response to inflation, and deviations in output from potential. So it’s saying really we want to stabilise both, and the reason you want to stabilise both is if you’re just focusing on inflation, one of the problems you face is not all of the deviations in inflation from target are reflective of aggregate demand shocks. As we know, especially at the moment inflation can deviate from target due to supply shocks. Supply shocks have the effect of lowering output. And so this creates a dilemma for a central bank in how do you respond to a supply-driven inflation shock, or deviation from target. Because if you respond to the deviation in inflation from target and raise interest rates, then that’s going to compound the reduction in output you’d get from a supply shock.

Gene Tunny  05:28

Right. So one example, I’m just thinking, Stephen, is one example of this, did this occur, arguably a policy mistake? Was it 2008 when the European Central Bank put up its policy rate? Not long before the financial crisis? Because there was a supply shock? Or was there an increase in the price of oil? I’m trying to remember, is that one of the examples I give?

Stephen Kirchner  05:55

Well, I think the canonical example here is what happened in the 1970s, when you had very significant increases in oil prices giving rise to higher rates of inflation. And central banks did respond to those oil price shocks through tighter monetary policy. And so there’s an influential paper by Ben Bernanke, Watson and Gertler in 1997, which showed that the propagation of the oil price shock to the US economy was essentially through the monetary policy reaction. And so it was the central bank that actually put the stag into stagflation.

Another example of this would be if you go to September 2008, the FOMC meeting took place a couple of days after the failure of Lehman Brothers. And this was at a time when inflation expectations were collapsing and nominal GDP expectations were collapsing. At that meeting, the FOMC incredibly left the Fed funds rate unchanged, and cited inflation pressures arising from higher oil prices as the reason for keeping monetary policy steady. So this is a very good example of monetary policy being led astray by inflation outcomes that are being driven by supply shocks rather than aggregate demand shocks.

And so what we want is the central bank to respond to inflation pressures to the extent that they’re reflective of aggregate demand shocks, not aggregate supply shocks. And nominal GDP lets you do that without actually having to take a view on what’s driving inflation. So nominal GDP outcomes will tell you the extent to which your inflation issues are being driven by aggregate demand rather than aggregate supply.

Gene Tunny  07:51

Okay, so yeah, a few things to try and explore here. Stephen, inflation targeting. So it’s typically going for something around well, in Australia, it’s 2 to 3%, we’ve got a target band for inflation. And in the US, is it 2%? Or I remember thinking of Bank of England? But the different countries have just slightly different targets.

And what’s fascinating is that when these things were first formulated, we had much higher inflation. And I think no one ever expected we’d be getting consistently, we’d inflation outcomes consistently lower than those targets. And it makes it difficult to think about what’s the appropriate monetary policy response.

I better make sure I understand your argument about why you think the Reserve Bank needs to get back on track. Are you suggesting that the fact that Australia is similar to some other advanced economies, who’ve had inflation outcomes below the target for a substantial amount of time, that would imply that the Reserve Bank, the central bank had scope to expand to have a more expansionary monetary policy which could have pushed the economy closer to full employment? Is that the argument, broadly?

Stephen Kirchner  09:14

Yeah, that’s certainly true of the sort of pre-pandemic period basically, the period in which the RBA was undershooting from approximately 2014 through to the onset of the pandemic and even into the pandemic. So it’s certainly in the last couple of quarters that inflation has returned to target. I mean, I think the specification of the inflation target inevitably is a little bit arbitrary. What matters most is not the exact target range, but the fact that you hit that target more often than not over time and thereby establish your credibility in relation to that target. So ultimately, what you’re trying to do is condition the expectations of price, and wage setters in the economy should be consistent with that target. And so whether it’s a 2% target or 2 to 3% target, it’s less important than the fact that you have one and that you actually stick to it.

But the case for nominal income targeting is to say if you’re only targeting inflation, and this creates a bit of a presentational problem and a sort of implementation problem, which is that what happens in the context of a supply shock when inflation might be above target? How do you explain to people the fact that you’re not hitting your target, even though there’s probably a very good reason why you’d want to look through that supply shock.

If you’re expressing your monetary policy target in terms of nominal GDP, that task becomes a lot simpler, because yes, you may be above target on inflation, but in the context of a supply shock, output is going to be lower. And so you don’t get the same sort of deviation from target under a nominal GDP targeting regime than you would under an inflation targeting regime. Policymakers are less likely to be led astray, because by focusing on nominal GDP, they don’t have this issue of trying to figure out whether inflation outcomes reflect demand shocks or supply shocks.

Gene Tunny  11:23

Okay, so how would this work in practice? So in nominal terms, so by nominal, you’re talking about, we’re not talking about a real GDP measure where we adjust for inflation, we try and get things in consistent dollars, you’re just talking about the total value of the economy, in GDP in nominal terms, so what it is in current dollars, and say that it’s over $2 trillion in Australia annually. And so would the Reserve Bank have a target? They would have an expectation of what that nominal income for Australia should be in 2022, what it should be in 2023. So it should be 2.3 billion by this date or something? Is that Is that how it’s formulated? A trillion I meant, not billion. Sorry,

Stephen Kirchner  12:16

You can’t express it in level terms. So with a nominal GDP target, you can express it both as a growth rate or an implied path for nominal GDP. But I think it’s important to emphasise that, just as with inflation targeting, you don’t target inflation outcomes, necessarily. What you’re targeting is actually the inflation forecast. So what you’re saying is, in future, you’re going to be realising inflation outcomes consistent with target, or with nominal GDP targeting, it’s exactly the same thing. So you want to specify a target path for the future evolution of novel income or novel output. And you want to adjust your monetary policy instruments to be consistent with that target path.

So if in any given quarter, your level of nominal GDP is a little bit above or a little bit below the target path, that’s not necessarily a problem. Again, what you’re trying to do is conditions people’s expectations in relation to what future nominal income will be. And I think that has very useful properties from the point of view of stabilising the economy, because if you think about things like wage and price contracting in the economy, people borrowing and lending, all those activities are conditional on expectations for future normal income. And so if you can stabilise both expectations for that future nominal income path, and by implication, also nominal GDP outcomes, then I think that’s a recipe for macroeconomic stability, more so than if you’re targeting inflation without regard to whether inflation is being driven by demand or supply shocks.

Gene Tunny  14:13

Right. Okay. Might go back to that Taylor rule. So you mentioned the Taylor rule. And you mentioned you can actually think of nominal GDP targeting in a, you call it a reaction function, so how the central bank reacts to the macroeconomic variables. And you said this gives equal weight to deviations of inflation from the target end of real GDP from the target. What does the Taylor rule typically do? Do ou know, what sort of normal parameters there are in that reaction function and what that means?

Stephen Kirchner  14:53

So the Taylor rule was due to John Taylor, who in the early 1990s sat down and said, well empirically, how do we characterise movements in the Fed funds rate. So he regressed the Fed funds rate on various macroeconomic variables. And the empirical description that he came up with for the Feds reaction function was to say, well, the Fed responds to deviations in inflation from target, and had estimated a weight of about 1.5 on that deviation, and also response to deviations and output from potential. And he estimated a weight of .5 on that.

But to sort of round out that empirical description of the Fed funds rate, you also needed an estimate of what the neutral Fed funds rate would be. So in other words, what happens when inflation is a target and output is a potential? What is the Fed funds rate consistent with that? And so that just ends up being a constant regression.

One of the big issues that sort of comes out of that is that’s obviously a historical estimate. What happens if your equilibrium real interest rate changes over time. So you then have the issue of, if you’re responding based on those historical relationships, but the actual equilibrium interest rate changes, and you may end up with monetary policy being miscalibrated. And I think that arguably happens in the United States, and to a certain extent here in recent years, where I think the equilibrium real rate probably fell considerably. And that meant that monetary policy ended up being tighter than central banks intended.

Gene Tunny  16:53

Okay, we might come back to that, I just want to go back to the Taylor rule that you mentioned 1.5. So that means for every percentage point that inflation would be above the target, so if the target’s 2%, and inflation is 3%, the central bank would put up the policy interest rate, the overnight cash rate or the federal funds rate by 1.5 percentage points. And the idea is there that you’re trying to engineer an increase in the real interest rate. So you want to make sure the interest rate increases more than the inflation component of it. Actually, yeah,

Stephen Kirchner  17:41

Yeah, that’s right. So this thing actually has a name, it’s called the Taylor principle. And the Taylor principle says that you want to move your nominal interest rate by more than one for one with the deviation inflation from target, because if you just do a one for one or a less than one point move, then you’re not going to move the real rate, you’re not going to move it in the desired direction. So it has to be a move that is more than the change in inflation. So that’s why you get a parameter estimate of a little bit more than one.

For some central banks, you get higher responses to inflation. So the BOJ, Bank of Japan, the ECB, depending on what sort of model that you look at, sometimes their reactions will be up around two. But yeah, the basic Taylor principle is that you want a response to inflation that is greater than one. But essentially, nominal GDP targeting says that you want to combine inflation and output in the form of nominal GDP, and you want to respond to that.

Gene Tunny  18:46

So I guess one of the points that you make, and I think it is a good point, that to do this Taylor rule properly, you need estimates of these unobservable variables, such as this equilibrium real interest rate. And as you rightly point out, I mean, this is something that… Interest rates are much lower now than we ever expected. You compare historically, it’s quite extraordinary what we’ve seen since the financial crisis in Australia, and the US and UK, and even before then in Japan, since the ‘90s. Absolutely extraordinary.

So I want to make sure I understand the logic again. You mentioned that this means that monetary policy was not as aggressive or as accommodative, or however you describe it, because the equilibrium real interest rate, whatever that is, whether it’s… Say it was 4% and now it’s much lower than that. How does that logically work, Stephen? Can you take us through that logic? I just want to make sure I understand how it would lead a central bank to go astray.

Stephen Kirchner  20:00

Actually, the problem is a bit broader than that. So there are potentially three unobservable variables it would impact. Taylor rule style reaction function, and potentially monetary policy Australia. So one is the real equilibrium interest rate, as we’ve discussed. It’s not directly observable. And it could be higher or lower than we think. But I would say it’s probably been lower than policymakers have thought. In terms of the output gap, then you have the problem that we don’t directly observe potential output either. And so that could be higher or lower than we think. And so policy can be miscalibrated on that basis.

An alternative way of thinking about the output gap is to think in terms of an unemployment gap. So the deviation in unemployment from its full employment level, and this is of course where we get the NAIRU from. So the idea that there’s an unemployment rate that’s consistent with the stable interest rate. And both the Federal Reserve and the RBA have conceded in recent years that the NAIRU has actually been a lot lower than they realised. So they have downwardly revised their estimates of the NAIRU.

And so for much of the post financial crisis period, I think both the Fed and to a lesser extent, the RBA were conditioning monetary policy on a view that the unemployment rate was pretty close to the NAIRU, when in fact, it was probably sitting quite a bit above the NAIRU. And so what that meant was we had monetary policy that was two tight. They could have actually pushed the unemployment rates lower. And done it in a way that would have meant that inflation was more consistent with target as well.

So you can see that the problem with a sort of Taylor rule type approach is that embedded in the Taylor rule, you’ve got at least two unobserved variables.  You’re trying to estimate what those unobservable variables are and condition policy on it. So what nominal income targeting says is well, in fact, you don’t need to take a view on either the equilibrium real rate or the NAIRU or potential output, because nominal GDP in and of itself is a complete description of the stance of monetary policy. And in the long run, nominal GDP is fully determined by the central bank. So the central bank can both influence the long run level of nominal GDP, and the level of nominal GDP tells you whether monetary policy is too easy or too tight at any given time.

You don’t need to do what’s sometimes called navigating by the stars, which is, in macroeconomics, when you write this stuff down in the form of equations, the equilibrium values,  the real interest rate, the NAIRU and potential output, those variables denoted with an asterisk or a star. And so we were first and policy that sort of conditions on those variables as navigating the stars. This is what leads monetary policy astray. It’s the problem that nominal GDP targeting seeks to address

Gene Tunny  23:24

Okay, so by NAIRU, N-A-I-R-U, which stands for non-accelerating inflation rate of unemployment, such a horrible expression. We use it all the time. Okay, we’ll take a short break here for a word from our sponsor.

Female speaker  23:45

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Gene Tunny  24:14

Now back to the show. So how’s this gonna work in practice, Stephen? I’m wondering, and does that mean the main thing the central bank is looking at it in their deliberations, so the board meeting of the Reserve Bank or at the Federal Open Markets Committee, or the Monetary Policy Committee, in the UK, or in the FOMC and in the US, they’re just looking at what the latest data are telling them about GDP, about nominal GDP? They’re trying to forecast that themselves based on a range of indicators, I suppose. Have you thought about how it’s going to work in practice?

Stephen Kirchner  24:55

I think central banks should basically look at all the information that’s available to them in forming a view. So the question is more in terms of what their target is and how they specify that target. And, importantly, also how they describe their policy actions in relation to that target. And so, the purposes of adopting a nominal GDP target, one way to do that is to specify a target path for the future evolution of nominal GDP. So you can do that out a few years in advance. And you would then explain your changes in your operating instrument in terms of an attempt to hit that target path.

So for Australia, for example, it would be a simple matter of rewriting the agreement with the treasurer, what we call a statement on monetary policy, which basically sets out what the RBA is trying to achieve through its conduct of monetary policy. And you would specify that in terms of a path, the future path for nominal GDP.

One of the things I do in my paper for the Mercatus Centre is to estimate an implicit forward-looking nominal GDP targeting rule for the Reserve Bank. So I basically do for the RBA, what John Taylor did for the fed back in the early 1990s, and say, How would an empirical description is nominal GDP targeting of how the RBA has actually changed the cash rate in the past?

And as it turns out, it’s actually not a bad empirical model of what they’ve been doing historically, because even if you’re thinking of monetary policy material type framework, you know, you’re still trying to stabilise nominal GDP. You’re just putting different weights on those two components of inflation output. But if you think of monetary policy as just responding to the nominal GDP, well, to some extent, the RBA is already doing that. Where I think nominal GDP targeting is helpful is, at the margin, I think it would lead to better monetary policy decisions, for the reasons that we’ve already talked about that. At the margin, they would be focusing more squarely on nominal demand shocks and looking through supply shocks, which I think is where monetary policy has run off track in the past.

Gene Tunny  27:34

Okay, so I want to ask about the RBA. So you want to get the RBA back on track. And one of the areas or one way you think that it’s off track is that over the last decade or so, or maybe over the last five years, or maybe a bit longer than that, it’s paid too much attention. Am I getting this right? You think it’s paid too much attention to financial stability risks, and this is called leaning against the wind? I think it’s denied that it actually does lean against the wind. Is this one of your criticisms of it, Stephen? And if so, what’s wrong with taking financial stability risks into account when setting monetary policy?

Stephen Kirchner  28:15

So there’s a long running debate about the role of financial stability, inflation targeting framework, and to what extent you should take financial stability concerns into account when doing inflation targeting. And one conception of this is to say that if you are doing inflation targeting, and you’re underpinning nominal stability in the economy, that this in itself is conducive to financial stability. And so, you want to prioritise nominal stability and that is the way you get financial stability.

And to the extent that financial instability becomes a problem, then monetary policy can always address that ex post. So the way the debate is sometimes characterised is between leaners and cleaners. So if your reaction to financial instability is ex post, then you’re cleaning up after you get a financial stability problem. If you’re a leaner, then you’re trying to sort of anticipate those financial instability problems. And to that extent, you’re going to potentially sacrifice your inflation target in order to head off some of those concerns.

So central banks will always obviously have to respond to financial instability after the fact to the extent that it creates problems for the macro economy. The real question is, to what extent do you try to do that preemptively. And I would argue that we don’t have enough information about financial stability risks to really do that successfully, preemptively. And traditionally, that was kind of the view that the RBA took. So if you look at the 2010 statement on monetary policy agreed between the treasurer and the RBA governor, that statement was the first to incorporate financial stability as a consideration. So it was the first statement after the financial crisis. And so it’s no surprise that that statement took on financial stability concerns.

And in that 2010 statement, it says very explicitly that, yes, the Reserve Bank should take account of financial stability, but without compromising the price stability objective. So financial stability concerns were made explicitly subordinate to price stability. And so that reflects the view I talked about before where you view nominal stability as being the most conducive way to address financial stability risks. So that would be the way that I would tend to formulate that relationship between price stability and financial stability.

What happened when Philip Lowe became governor in 2016 is there was a change in the wording on the statement on the conduct of monetary policy, which essentially turned that relationship on its head. So that statement explicitly provided for short-term deviations in inflation from target in order to address financial stability risks. So that agreement was essentially saying that there may be times when in the short run, we’re going to allow inflation to deviate from target in order to address financial stability concerns. And those concerns were explicitly nominated as a reason why you might look at the inflation target.

Gene Tunny  31:51

They might accept lower than the target inflation, because they don’t want monetary policy so stimulatory that it means that there’s a big growth in housing credit and house prices. Is one of the criticisms of what the RBA is doing now. I mean, I’m interested in your views on what it’s done during the pandemic, because we’ve had very aggressive monetary policy response. And this has arguably contributed to the boom in housing credit and house prices where we’ve got double digit, we’ve had house prices increase by over 20% In some cities. And I mean, to me, I mean, it looks like monetary policy has been too aggressive during this period. But yeah, I’m interested in your view on that, Stephen. And I mean, how does what they’ve done, how do you assess that given you’re an advocate of this nominal income targeting? How compatible is what they’ve done with that, please?

Stephen Kirchner  32:58

So if you look at the period from 2016, through to the onset of the pandemic, that changed, and the wording of the statement in the conduct of monetary policy ended up then being a very good description of monetary policy under Governor Lowe. So, through that period, the RBA very explicitly traded off concerns around, in particular the household debt-to-income ratio, and said, Well, the reason why we’re letting inflation run below target is we’re worried that if we provide more stimulatory monetary policy settings, then that would trigger more household borrowing, and potentially create risks in in the housing market. And the concern was that by the household sector taking on increased leverage, that this would increase the household sector’s exposure to a shock. So essentially, you’re trying to fight the last war in terms of the 2008 financial crisis. They were trying to mitigate what they saw as the risks that led to that particular event.

Now, one of the criticisms of leaning against the wind, I think, and this is a criticism that’s been made very persuasively, I think, by Lars Svensson, Swedish economist, is to say, well, if you’re conducting monetary policy on the basis of an apprehended financial stability, its annual trading off inflation and output against those risks, then in a sense, what you’re doing is you’re setting yourself up to have a weaker starting point if and when a financial crisis does occur. So the starting point for the economy is actually going to be weaker because you’ve been running monetary policy, it’s been too tight. And so this is a mistake that the Swedish central bank made In the early 2010s, and which led Lars to sort of formally model leaning against the wind and coming up with that characterization.

Peter Tulip who was a former Reserve Bank economists, when he was at the bank. He also did some work, basically applying Svensson’s framework to Australia and showing that in terms of the trade-off between the central bank’s objectives and financial stability risks, the RBA was basically incurring costs anywhere from three to eight times the benefit in terms of mitigating financial stability risks. So the cost in terms of having unemployment, for example, higher than would have been otherwise, you know, more than offset any gain in terms of reducing financial stability risk.

So essentially, I think this is a hierarchy in knowledge problem that the central bank really does not have enough knowledge about the economy to be able to successfully lean against the wind. This explains why the RBA undershot its inflation target for the better part of seven years. And it was an explicit policy choice, you know. This wasn’t an accident.

Going into the pandemic, I would say that the initial monetary policy response was inadequate. And this was essentially a function of the RBA trying to conduct monetary policy within its traditional operating framework. So they were still trying to use the cash rate as their main operating instrument, even though the cash rate was constrained by the zero lower bound on a nominal interest rates.

Gene Tunny  36:43

So we had a cash rate of, was it .25% going into the pandemic?

Stephen Kirchner  36:49

Going into the pandemic, it was point .75.

Gene Tunny  36:52

Oh, right. Yeah, sorry.

Stephen Kirchner  36:54

In March of 2020 they lowered it by 50 basis points in 2 increments of .25. And that took it down to a quarter of a point, which they argued at the time was an effective lower bound inasmuch as the RBA operates a corridor system around that target cash rate. And so the bottom of the corridor would have normally been at zero, if they had maintained that system. Subsequently, of course, the RBA did lower the cash rate below .25. So it turned out that it wasn’t a lower bound after all. It was very much a self-imposed constraint.

But going into the pandemic, they tried to conduct monetary policy very much within that conventional operating framework with the cash rate as the main operating instrument. And I think, because they allowed the level of the cash rate to determine how much stimulus they would provide… And initially, monetary policy was way too tight. So even though they had lowered the cash rate, what we saw between March 2020 and November 2020, when they finally adopted QE, was that the Australian dollar appreciated significantly. So the Australian dollar outperformed all of the other G10 currencies over that period. The appreciation on the trade-weighted index was about 10%.

And so what this is telling you is that in relative terms, we were not doing nearly as much as other central banks. And we were paying a penalty for that on the exchange rate. The other element of this, of course, was the macroeconomic policy mix, so the relative weight on monetary and fiscal policy. So our fiscal policy response was one of the strongest in the world. But our monetary policy response wasn’t.

Gene Tunny 38:52

Initially, yeah, gotcha.

Stephen Kirchner 38:54

At least up until November 2020. And so this is a recipe for the open economy crowding out effects that you discussed with Alex Robson, when you talked about Tony Makin’s work on open economy crowding out. So if you have a fiscal policy response, if you’re overweighting on fiscal policy relative to monetary policy, you’ll pay a penalty for that exchange rate. And that’s exactly what happened. And that was a pretty strong indication that monetary policy of this period was too tight. The RBA could have done more but didn’t because it was trying to conduct policy within its traditional operating framework.

Gene Tunny  39:33

Right, and by more you mean quantitative easing or large scale asset purchases, creating new money, printing money electronically and then using it to buy financial securities bonds, for example?

Stephen Kirchner  39:48

Yeah, so there are two alternative operating frameworks that they could have used. One is negative interest rates and the other is large scale asset purchases or QE. And so by November 2020, the RBA conceded that other central banks had done more to expand their balance sheet. And they needed to do the same. They also lowered the cash rate target from .25 to .1. And they lowered the bottom of the cash rate corridor from one to zero. So effectively, they conceded that they could have done more and needed to do more, and they finally delivered. And at that time, they did adopt a very aggressive asset purchase programme because they were playing catch up to other central banks. And so by the time we’ve got to the end of 2021, in fact, the RBA had expanded its balance sheet as a share of GDP by an amount that was broadly equivalent to what the Fed had done.

So one of the ironies here is that the RBA’s attempt not to expand its balance sheet actually ended up being a balance sheet expansion that was comparable to that of the Fed. And I think this is an important lesson for monetary policy generally, that typically, if central bank is using its policy instruments aggressively, and over a very extended period of time, that’s usually an indication that it didn’t do enough upfront. So in fact, if you want to avoid, you know, hitting the zero lower bound or expanding your balance sheet by a significant amount, the way to do that is to respond quickly and aggressively upfront. If you don’t do that, then you fall behind the curve, and then monetary policy has to work a lot harder to stabilise the economy. And I think that’s what ended up happening in Australia in response to the pandemic.

Gene Tunny  41:42

Right, okay. You’ve written another fascinating paper on this, Stephen. The paper’s titled The Reserve Bank of Australia’s Pandemic Response and the New Keynesian Trap. So this was published in Agenda, which is a journal put out by the Australian National University. And I want to ask you what you mean by New Keynesian trap. But I think I sort of know, I think you’re sort of alluding to the fact that a new Keynesian policy approach would be inflation targeting, but you can correct me on that. But the point you make, and I think this is fascinating, you want to explore this and make sure I understand what you mean here, you write, “A monetarist conception of the monetary transmission mechanism would have encouraged more rapid adoption of alternative operating instruments.” So could you explain what you mean there, please?

Stephen Kirchner  42:33

Yeah, so the New Keynesian trap was exactly what I was describing in terms of the monetary policy response to the pandemic. The New Keynesian framework for monetary policy analysis relies excessively on an official interest rate as not just the central bank’s only operating instrument, but also the only way that you get monetary policy into that model. And the problem with this is that if the central bank thinks of monetary policy implementation and monetary policy transmission exclusively in terms of an official interest rate, then that’s going to be a problem when your official interest rate hits the lower bound, because at that point, your model basically blows up, because if you can’t lower the nominal interest rate, in a situation which is calling for easy monetary policy, then that’s a recipe for macroeconomic instability. And in fact, it becomes a downward spiral because the economy deteriorates and you can’t respond through your conventional monetary policy instrument.

And in the sort of New Keynesian literature on monetary policy, there are all sorts of ways in which they try and sort of solve this problem. So in some of that literature, for example, there’s just an assumption that  fiscal policy steps in to bail out the central bank. And to some extent, that’s what we saw with the pandemic response, which was that you might have noticed during the early stages of the pandemic, the Reserve Bank Governor was begging the federal and state governments to do even more with fiscal policy than they were actually doing, even though the fiscal policy response is quite large. And so really what he was saying was, my hands are tied, you need to do more to stabilise the economy.

Now, were the central bank’s hands tied by its operating framework? Well, only in the sense that they perceive that framework to be binding on their decision making. If you go back to November 2019. Governor Lowe gave a speech in which he addressed the issue of negative interest rates and quantitative easing. And he was arguing that it was very unlikely that the central bank would have to go there. And if you read that speech, you can see he’s very reluctant to contemplate using either of those policy instruments. So for me, the New Keynesian trap, it’s a self-imposed constraint on monetary policy. It’s because of the way you’re conceiving both the monetary policy instrument and the monetary policy transmission mechanism, it leads you to pull your punches in an environment where you need to adopt a new operating frame.

And for me, the fact that the RBA walked away from that framework in November of 2020 basically concedes the point, they realised that their traditional operating framework was not adequate in responding to a massive shock when the interest rate was hitting the zero bound, and so they needed to think of monetary policy in an alternative framework. And so this is where an RBA officials started giving speeches about the role of quantitative policy instruments and quantitative transmission mechanisms in the monetary policy implementation. If they had done that back in March of 2020, I think we would have had a more timely, more effective monetary policy response and avoided what I’ve called the New Keynesian trap.

Gene Tunny  46:22

Yeah, yeah. Okay. I mean, I think you’ve been rightly critical of the RBA. If they eventually had to adopt these measures, and arguably, they should have done them earlier. So very good point. I want to make sure I understand why it’s a monetarist conception, why that would have led to more rapid adoption. Is that because a monetarist would have been looking at the monetary aggregates, they would have been thinking about, well, how, how could we make the monetary aggregates grow at the rate that would be optimal? Is that what you’re thinking? And you’re just not thinking in terms of a cash rate? You’re thinking in terms of the money supply?

Stephen Kirchner  47:03

Monetarists have always been very critical of the idea that an official interest rate is both the best characterization of what monetary policy is doing, but also the idea that it’s a complete representation of the role that monetary policy plays in the economy. So it’s true that, you know, in equilibrium, you could say that an official interest rate might be a good representation of the contribution of monetary policy.

The way monetarists tend to think of the long run evolution of the price level is in terms of the long run supply and demand for real money balances. And so they tend to think of the evolution of monetary policy in a quantity framework rather than a price framework, the price being the interest rate. So you can think of monetary policy instruments either working through a price, which is the interest rate, or quantity, which is the supply and demand of real money balances. I think both modes of analysis have their place, and they’ve clearly linked. But the focus on official interest rates, I think has been very misleading, because you know, of itself, the level of the cash rate, tells you very little about the stance of monetary policy.

I think one of the mistakes monetary policymakers have made internationally and in Australia has been to assume that because the nominal cash rate is low, monetary policy must be stimulatory. And one of the points that Milton Friedman made repeatedly was to say, if the nominal interest rate is low, then that’s probably indicative of tight monetary policy because that probably means that inflation is very low as well, if you think of the contribution that inflation makes to the nominal interest rate. So if you’ve got very low nominal interest rates, that’s probably an indication that monetary conditions are too tight, rather than too easy. And I think it’s a mistake that monetary policymakers have repeatedly made.

Milton Friedman warned against it in his 1968 presidential address to the American Economics Association. And throughout his life, he tried to impress upon policymakers the significance of this. But it’s something that’s still eludes policymakers, I think, and you can see it in some of the comments that the RBA and Governor Lowe has made in recent years where they often emphasise the low level of the cash rate as being self-evidently indicative of an easy monetary policy stance when, in fact, if anything, it’s probably an indication that monetary policy is too tight.

By the same token, if you go back to say, the late 1980s, in Australia, when we had double digit inflation rates, well, we had double digit interest rates as well. At that time, very high level of interest rates was in fact indicative of the fact that the RBA had run monetary policy in a way that was way too easy, giving us high inflation.

Gene Tunny  50:34

Yeah. And it was that experience that did prompt the adoption of inflation targeting because we weren’t inflation targeting back then. They had some checklist approach or whatever. This was just after they had the brief experiment with monetarism, and then they had a checklist or something and they didn’t have an explicit inflation target until the early ‘90s. I mean, Stephen, would you agree that arguably, inflation targeting was a good thing to adopt at the time? I mean, did it actually improve? Do we get better monetary policy for a while with inflation targeting? Was it better than what we had before?

Stephen Kirchner  51:09

I think inflation targeting was a very important and helpful innovation. They’ve got central banks focused on nominal stability, which is what you want them to do. And I mean, I’m still a defender of inflation targeting as much as I think you could make the current inflation targeting framework work better. And the way in which you would do that would be to focus on as you’re looking through supply shocks, so in other words, not responding to increases in inflation that are clearly driven by supply side constraints, like some of the inflation pressures that we’re seeing at the moment. Where nominal income targeting is helpful I think is helping you to do that.

So one way of thinking about nominal income targeting is you could think of nominal income as an indicator variable or an inflation variable, which tells you when you need to respond to inflation with monetary policy and when you shouldn’t. So that would be one way in which you could improve an inflation targeting regimen would be to sort of look at both variables and use that to help you sift through what inflation shocks you want to respond to, what inflation shocks you want to look through. I don’t think we have to necessarily give up on inflation targeting but we probably do need to change the way we do it, because I think inflation targeting in recent years has failed on its own terms, because central banks have said, well, we’re targeting inflation, but in fact, they’ve missed the target. So if you’re missing the target, you’re not doing it properly. So clearly, you need to change the way you’re doing it.

Gene Tunny  52:49

So as an implication of what you’ve said, are you implying that there’s a risk of the Reserve Bank could increase the cash rate too much, because it’s reacting to CPI data that partly, the inflation is going to be driven by this supply shock? Is that a concern of yours?

Stephen Kirchner  53:12

Yeah, I mean, we’ve certainly seen that in the past. So we talked before about the Fed, and the ECB in 2008 I think clearly made that error. And I think it’s a risk at the moment. At the moment, we have both supply and demand shocks driving inflation. So there’s been a huge dislocation in the supply side of the global economy due to shifts in demand, so that the speed of the recovery has basically caught the supply side of the world economy short. It’s struggling to keep up. And so there’s a big supply component to existing inflation pressures.

In the United States, I’d say there’s also a demand component inasmuch as one of the things that Mercatus Centre has done has been to develop what they call an NGDP gap, which is basically a measure of the deviation in nominal GDP from long-run expectations. At the moment, we have a positive nominal GDP gap in the United States. And so consistent with the nominal GDP targeting framework, that’s saying that there are excess demand pressures in the US economy. And so you would want monetary policy to respond to that. And so I think this is why the Fed is tightening at the moment. It’s appropriate that they do so because there is excess demand in the US economy, and GDP expectations are a good guide. But at the same time, there’s a very significant supply side component to this. And that is something you probably want to look through.

So one way to think about US monetary policy at the moment is the Feds should be tightening with the views of closing that nominal GDP expectations gap on the Mercatus measure. That would require some tightening of monetary policy but not nearly as aggressive as if you were trying to fully stabilise consumer price inflation.

Gene Tunny  55:13

Right. So nominal GDP in the US by that Mercatus measure, it’s higher than that path that long-run path. Is that right?

Stephen Kirchner  55:25

Yeah, that’s right. So on their measure, the level of nominal GDP is running at about, I think, 3% above the path implied by long-run expectations for nominal income. So from a nominal GDP targeting framework, you would certainly want to respond to that.

Gene Tunny  55:41

Right. Now, this is one thing I’ll want to just make sure I understand. In your paper, you talk about how it’s good to correct for deviations from that target path, that nominal path. Why does a target path in nominal terms? Why is that relevant? I think one of the points you make is that, traditionally, central bankers wouldn’t really worry about the nominal path, or they if you did have low inflation for a period, and that meant that you were below that nominal level, it’s not as if you’re going to ramp up, they wouldn’t have a more stimulatory monetary policy just to try and hit a particular GDP number in nominal terms, say two and a half trillion or something, because well, what does the actual nominal value of it matter? What matters is what’s the real value of it and how many people are employed, that sort of thing? I want to understand that. Are you saying that we should try and get back to some sort of the nominal GDP number that was implied by the path we’re on?

Stephen Kirchner  56:54

Yeah, I would say that nominal GDP stabilisation is still implicit in what the RBA and the Fed do today. So if you’re stabilising inflation around target and output around potential, then that will certainly be conducive to stability in nominal GDP. It’s just that we’re not explicitly framing monetary policy in those terms. So at the moment, we frame it in terms of the cash rate responding to deviations in the inflation target, or deviations in output or the unemployment rate from their assumed equilibrium values. All I’m saying is you want to reframe the way in which you implement monetary policy in terms that are currently implicit, but arguably should be explicit.

So really, I’d say monetary policy is trying to stabilise a path for the future path of nominal GDP. Were just not explicit about it. So it’s really reframing monetary policy in those terms, to bring out those relationships. But I think it does it in a way that’s less conducive to monetary policy running off track, for all the reasons that we’ve talked about, that you’re no longer making guesses about the equilibrium interest rate, the equilibrium unemployment rate, or the equilibrium level of real output. You can abstract from all of those things and just ask the question, How is nominal GDP evolving relative to, A, expectations, or B, in my sort of operating framework, you know, where you want monetary policy to be. So just be explicit about that and nominate a target path.

One of the advantages of doing that is in fact, I think, better financial stability outcomes, reason being if you think about the decisions that lenders and borrowers are taking in credit markets, whether it be in relation to housing or business lending or any other type of credit, the serviceability of those contracts depends entirely on the future flow of nominal income. So putting yourself in the shoes of a holder of a mortgage, for example. The amount I borrow is very much a function of what I think my future nominal income is going to be. And the lender is making the same assessment, right? They’re saying, Does this person have the capacity to service a mortgage? Well, that’s a function of what’s going to happen with their normal income in the future.

So by stabilising both expectations for nominal income and actual outcomes for nominal income, I think that’s conducive to financial stability because then the economy is going to evolve in line with the expectations embedded in those credit contracts. So I think you’re less likely to run into financial stability concerns in that context.

So this is essentially Scott Sumner’s critique of US monetary policy in response to the global financial crisis. So what Scott Sumner argues is that the recession in the United States was made deeper by the fact that nominal GDP and expectations for nominal GDP in the early stages of the crisis were allowed to collapse, and that more than anything affected the ability of people to service their mortgages.

Gene Tunny  1:00:42

That’s an interesting argument. I’ll have to have a look back over his work. I’ve seen it in the past. But have you got time for two more questions or do you have to get going? Because there are a couple –

Stephen Kirchner  1:00:52

Oh no, absolutely. Take all the time in the world.

Gene Tunny  1:00:55

Great. There are a couple other things I want to chat about. On page 27 of your Mercatus Centre paper you write, “There’s a growing empirical literature on the advantages of NGDP targeting relative to inflation targeting and other policy rules. I’m interested what that literature is. What does it comprise of? Is it cross-country regression studies, or how do they determine that, that this actually is superior to what we’re doing at the moment?

Stephen Kirchner  1:01:23

So there’s a long history is who the literature on monetary policy rules. And it really goes back to a Brookings Institution project back in the early 1990s. And it was as part of that project that John Taylor published his Taylor rule estimates. And Warwick McKibbin, the Australian economist, was actually an early contributor to that literature as well. And I mean, one of the things I did, as part of that Brookings Institution project was to just simulate different types of rules. So on one hand, you can estimate empirically what the central bank response to macro variables is . But you can also do simulations, where you say, well, what would happen in a economic model if the central bank responded to nominal GDP or some other specification of the monetary policy reaction function.

And I think it’s fair to say that, in that early literature, both nominal GDP targeting, whether in level or growth rate terms, did not fare well, relative to the sort of more Taylor rule type specification. The problem with that literature was that it wasn’t taking account of the knowledge problems that we talked about earlier, which is the unobservability of some of the key conditioning variables, namely the real equilibrium interest rate, either potential output or an estimate of an error. Once you take account of those knowledge problems, then the Taylor rule literature becomes much less robust. And nominal GDP targeting becomes much more robust. So once you allow for the fact that there’s uncertainty around those assumed equilibrium values, then inflation targeting as it’s currently conducted in a Taylor rule framework looks a lot less attractive. So really, that early literature was conditioning on historical relationships, which, when you’re operating in real time, become much more problematic.

Gene Tunny  1:03:53

Okay. I have to ask you about an NGDP futures market. So this was mentioned in your Mercatus Centre paper. Why would that be useful? And what’s the role of Ethereum, so a cryptocurrency, isn’t it? What’s the role of Ethereum in that?

Stephen Kirchner  1:04:15

So if you’re targeting nominal GDP, then one of the things that would be very helpful in that context would actually be a market-based estimate of where nominal GDP is going. People like myself who call themselves market monetarists, the market part of that expression refers to the fact that we think that markets are in fact the best gauge, financial markets at the best gauge of the stance of monetary policy and also what effect any given policy change is likely to have on the economy.

So if you take that view, then what you want to do is get a market-derived estimate of where nominal GDP is going and then base your monetary policy response on that estimate, because that’s going to be your best guess of where nominal GDP is going. And there are various versions of this. Scott Sumner has a version where the central bank would actually tie its open market operations mechanically to prices in that nominal GDP market. So monetary policy would then basically become market-driven. But you don’t need to go quite that far. I mean, it would be sufficient, I think, just for the central bank to take account of what the nominal GDP market was telling you about the stance of monetary policy.

The beauty of this is that any macroeconomic policy measure that you might implement, the nominal GDP futures market will give you instant and real time information on what the market thought that was going to do to the economy. So for example, if you had a fiscal stimulus package, a nominal GDP futures market would tell you basically on announcement, what it thought the impact of that package would be. And my expectation would be that if we had a nominal GDP futures market and you announced a big fiscal stimulus, we would actually probably see very little movement in the nominal GDP futures market because most of the economy crowding out effects that we discussed before, I suspect that in a small open economy with a floating exchange rate like Australia, fiscal policy actually doesn’t do very much in terms of aggregate demand.

Gene Tunny  1:06:45

Right.

Stephen Kirchner  1:06:46

We see that a little bit already, because although we don’t get sort of very clean or discreet announcements of fiscal policy measures, typically when the budget lands every year, and they announce what the change in the budget balance the share of GDP is going to be, which is your sort of best measure of the impact that fiscal policy is going to have on the economy. The national markets very rarely move in response to that announcement.

So the case for a nominal GDP futures market is you want that market to basically inform monetary policy decision making. And it really goes to the issue of what paradigm do you want for monetary policy? The market monetarist paradigm is essentially to say central bank is a lot smarter than financial markets when it comes to assessing where the economy is going. And we should do away with the fiction that they know more than what’s embodied in financial crises. And so conduct monetary policy on the basis of the best available information, which is what financial markets are telling you about the evolution of the economy,

Gene Tunny  1:08:01

What does this instrument look like? And who sets up the market? Does the central bank set up the market? I mean, people are gambling, or they’re betting on what future nominal GDP is. But how’s the market actually work? Has anyone thought about how it would be designed? Does the central bank have to run out or could it be a privately owned market?

Stephen Kirchner  1:08:26

So this could be a conventional futures markets? So we have at the moment futures contracts available, various financial instruments, so there are futures contracts for 10-year bond yields for the Australian dollar. We effectively have futures contracts on inflation outcomes, which is the difference between the prices on bond yields and index bond yields, so that it’s bond yields adjusted for inflation. So we actually already effectively have a futures market in inflation outcomes. And that’s actually a very important input into monetary policy decision making.

So one of the things that the RBA pays very close attention to is what market prices are saying about the future evolution of inflation? So we already have one half of the equation. What we need is the other half, which is to say, a view on what’s going to happen with real output. But if we combine those two things, and what we’re saying is we want a financial market view on where nominal GDP has gotten. So it’s very straightforward to design a futures market contract that you would list on the Australian Stock Exchange, which would be traded by financial market participants.

And I think another thing that would be useful that comes out of this is it would be a very good hedging instrument. So we think of corporations, their top line revenues are in fact often largely a function of nominal GDP. So one of the things the company will look at when they’re forecasting their revenues is an assumption about what nominal GDP is going to do. So corporates could actually use a nominal GDP futures market as a hedging instrument. And that increases the information content of NGDP futures prices. It becomes highly informative of what decision makers in the economy are expecting in relation to the future evolution of nominal income. That information is very useful for policymaking.

And my argument to the Reserve Bank, when I’ve presented this work to them, is to say, Do you think that would be useful input into monetary policy decision making? And of course, the answer has to be yes. You know, you want more information, not less. And so my argument to them is, well, if that information will be useful, then it’s probably worth incurring some costs in order to get that information. So what I’ve suggested is they need to remove some of the regulatory barriers to the creation of a nominal GDP futures market.

A huge regulatory barrier to any sort of financial innovation in Australia is the fact that the costs of financial system regulation in Australia are paid for by the financial sector. So all of the costs of ASIC and APRA in regulating the Australian financial system is recovered from market participants, economic institutions. But that cost recovery framework has a public interest clause, which basically says you should be able to get relief from cost recovery if there’s a public interest in doing so. And so I like it that the creation of a nominal GDP futures market is a perfect application of the public interest case for relief from cost recovery. So basically, the institutions and the Securities Exchanges that would put together that market should basically get an exemption from regulatory cost recovery. I think that would give a huge boost to making that sort of market commercially viable.

Gene Tunny  1:12:37

It’s a fascinating idea, because occasionally, you do have these new financial instruments. I mean, I know in the US they have a market in… Is there a futures market for house prices based on the Case-Shiller Index?

Stephen Kirchner  1:12:51

Yeah, that’s right. There’s derivatives around house prices in the United States. The NSX tried to get a derivatives market in house prices up and running a few years ago. I would argue that, yes, we should have house price futures as well, for exactly the same reasons. It’s informative for policymakers, t gives them information that they would not otherwise have. It will tell you, for example, when APRA changes its regulation of financial institutions. A house price futures market would tell you straightaway what the implications for that are for house prices. It’d be useful hedging instrument as well. So yeah, ideally, I think we should have both markets.

I think the impediments to those markets, given that they are potentially so useful, are most likely regulatory in nature. And so we need to lower the regulatory barriers to the creation of those markets. And arguably, I think there’s a case for implicit public subsidies for those markets as well, so relief from regulatory cost recovery. I think the RBA could use its balance sheet to become a market maker in those markets. So not with a view to influencing the prices, but just providing, being a liquidity provider, which would lower costs for other people transacting in those markets and would help get them up and running.

Gene Tunny  1:14:25

I was just thinking, I was just trying to think, how would this actually start up? And, I mean, you’d need someone to actually develop the instruments, create the contracts and sell them, so that could be say, an investment bank, for example. It could be a Goldman Sachs or it could be a Morgan Stanley or one of those businesses. It’s a fascinating idea.

Stephen Kirchner  1:14:50

Yeah, I mean, in my Mercatus paper, I make the case that the council of financial regulators should jointly mandate the creation of a nominal GDP futures market. And I mean, when regulators mandate something in financial markets, it usually happens. So it’s not uncommon for the financial regulators to actually come out and say to financial market participants, okay, we’re doing this. If it becomes a regulatory mandate, then the financial market participants will cooperate with that mandate. And you know, I think it would be enthusiastic participants. So I think it’s really incumbent upon the RBA to say this is something that we want and need, would be helpful for policymaking and for hedging, as I’ve described. And so we’re going to sit down with financial market participants and make it happen

Gene Tunny  1:15:46

And just finally, you’ve mentioned that there could be a role for blockchain. So you talk about how US NGDP futures have already been implemented on the Augur blockchain. Did I pronounce that right? And then, Eric Falkenstein has also developed Ethereum-based derivatives contracts. These contracts could provide competitive alternatives to listed securities, okay, on existing exchanges and require little or no public support while still yielding useful information about monetary policy in the economy. So is there anything special about the blockchain in this context?

Stephen Kirchner  1:16:22

Well, the role for blockchain I think is just in terms of lowering the costs of doing it. So as we’ve already discussed, there are significant cost barriers to listing nominal GDP futures on our traditional securities exchange. I’ve argued that we should try and lower some of those costs. But another way of doing this is to implement it in blockchain space. There’s already been some interest in doing this in the US. I think, eventually, almost all financial derivatives will move off exchanges and onto the blockchain at some point, main reason being you can then do instantaneous clearing and settlement. So you no longer have trillions of dollars tied up in collateralizing clearing and settlement of financial derivatives. So if derivatives markets are going to move onto blockchain, then arguably NGDP futures should move on to blockchain as well. But I think there’s more scope for innovation in the blockchain space at the moment, just because it’s a different regulatory environment.

And so I’ve sort of argued for a two-prong approach where on the one hand, you want to go through sort of the conventional channel other listed securities market for NGDP futures. But at the same time, I think there’s scope for entrepreneurs to innovate in the blockchain space and do something similar. And hopefully, what we get out of this is a viable future market, not just in nominal GDP, but [with] other macro variables included. And I think it would not only provide policymakers with useful information, but it would really change the way people think about financial markets and monetary policy, because you can’t beat the sort of real-time financial market verdicts on what policy is doing.

It would eliminate a lot of arguments about the implications of various types of public policy, because let’s say the government is proposing a change in some tax rate, and there’s an argument about what the implications of that tax change is for the economy. Well, a nominal GDP futures market will instantaneously settle that argument, because when the tax change is announced, you can observe what the change in the nominal GDP futures is. And that basically tells you what the economic impact is,

Gene Tunny  1:19:07

Assuming the market expectation is correct.

Stephen Kirchner  1:19:11

It doesn’t have to be correct. It’s probably our best guess.

Gene Tunny  1:19:15

Best guess, gotcha. Yeah. I agree. I was just wanting to –

Stephen Kirchner  1:19:19

Ex post it could be completely wrong. At the time of the announcement, it would be the best guess of everyone who actually has a real-time financial stake in that outcome.

Gene Tunny  1:19:31

Yeah, very good point. Okay, Stephen, this has been terrific. I’ve learned so much and it’s made me think about a lot of a lot of things that hadn’t been thinking about before. I love this idea of futures markets in economic indicators. I think that’s brilliant. So yes, I’ll have to come back and explore that in the future. So Stephen, you’ve got a sub stack, which I’ll put a link to in the show notes. I’ll also put links to your two fascinating papers on monetary policy. Any final words before we wrap up?

Stephen Kirchner  1:20:06

I think this has been a great conversation. I’ve really enjoyed it, Gene.

Gene Tunny  1:20:09

Thank you, Stephen. I’ve really enjoyed it too. I must admit, initially I don’t think I’ve really understood this nominal income targeting idea and its merits and what the problems with inflation targeting were as much as I do now, I think I’ve got a much better understanding. So absolutely, really appreciate that. So, again, thanks so much for coming on to the programme. And yeah, hopefully, I have you on again, sometime in the future. We could chat more about these issues. So thanks so much.

Stephen Kirchner  1:20:46

Thank you, Gene. It’s been a pleasure.

Gene Tunny  1:20:49 Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com And we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.

Credits

Big thanks to EP135 guest Stephen Kirchner and to the show’s audio engineer Josh Crotts for his assistance in producing the episode. 

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

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Economics Explored Live

Livestream featuring US jobless claims, Aussie GDP + farewell to Tony Makin

I did a livestream earlier today (Friday 3 December 2021) with my regular co-host Tim Hughes on the latest economic news of the week, including the latest US initial jobless claims confirming a strong US economy, the impact of the omicron COVID-variant on equity markets, and the September quarter Australian GDP figures which revealed the adverse impacts of NSW and Victorian lockdowns. You can click on and watch the video on YouTube below. You can also download the slides I showed.  

In the livestream, from around 22:05, I reflected on the late Professor Tony Makin’s contributions to the Australian economic policy debate, particularly on whether we should worry about the current account deficit in the late 80s/early 90s and on the effectiveness of the Rudd Government’s fiscal stimulus. On the current account deficit, Tony’s articles, along with the contributions of John Pitchford, clearly led to a change in the policy consensus on the current account, so it was no longer something that would be a macroeconomic policy target. Sadly, Tony died unexpectedly earlier this week. This came as a huge shock to so many of us, and it’s obvious from all the conversations I’ve had about Tony over the last few days just how much respect and admiration his colleagues and former students had for him. Tony’s funeral is on Monday on the Gold Coast (see notice below). 

Funeral notice for the late Griffith University Economics Professor Tony Makin, who will be greatly missed by his family, friends, colleagues, and former students.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

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Economics Explored Live

US inflation and Aussie jobs data – 15 October 21 livestream

Economics Explored Live for 15 October 2021, the first edition of what I’m planning to be a weekly livestream, covered:

  • the growing concern internationally about accelerating inflation, prompted by the latest US CPI figures (see chart below;
  • the September ABS Labour Force data revealing big drops in hours worked and workforce participation in the locked-down economies of NSW and Victoria; and
  • my state of Queensland’s relatively low vaccination rate (72% for 1st dose vs 84% nationally) and what it could mean for the state’s reopening and the economy – it’s pretty obvious the Queensland Premier should set a date for re-opening ASAP to encourage people to get vaccinated promptly, as suggested by the Queensland branch of the Australian Medical Association.

Here’s the video of the livestream, which was streamed to YouTube and LinkedIn Live:

Regarding inflationary pressures in advanced economies, I quoted leading market economist Stephen Roach from his recent Financial Times op-ed The sequencing trap that risks stagflation 2.0:

As brilliant and lucky as they have been, today’s generation of central bankers is afflicted with the same sense of denial that proved problematic in the 1970s. Due to a lack of experience and institutional memory of that tough period, the risk of another monetary policy blunder cannot be taken lightly.

Certainly, central banks have been running a massive monetary policy experiment with ultra-low interest rates and Quantitative Easing, which have been associated with double-digit growth rates in money stocks. I agree with Roach regarding the potential for a “monetary policy blunder”.

Other links relevant to the livestream include:

Pete Faulkner’s post Labour Force; national data hit by lockdowns while QLD powers ahead

QEW post featuring my The Other Side interview on Australia’s economic suicide

Vaccination numbers and statistics

ABS: New data shows lockdown impacts on business turnover

Cross-posted at http://www.queenslandeconomywatch.com. Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com. Economics Explored is available via Apple PodcastsGoogle Podcast, and other podcasting platforms.

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Podcast episode

EP90 – Lockdown Cost-benefit Analysis with Professor Douglas Allen

Episode 90 of Economics Explored features a discussion regarding COVID lockdown costs versus benefits with Professor Douglas Allen from Simon Fraser University, Canada. Professor Allen has concluded COVID lockdowns have been the greatest peacetime policy failure in Canada’s history. Please check out our conversation for Professor Allen’s justification for this claim.

Links relevant to the conversation include:

Professor Allen’s Lockdown CBA for Canada

Economist: Lockdowns ‘Greatest Peacetime Policy Failure’ in Canada’s History – Foundation for Economic Education

Our World in Data – Coronavirus

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com.

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Podcast episode

EP86 – Decarbonizing the Economy

In Episode 86 of Economics Explored, host Gene Tunny talks about the big challenge of decarbonizing economies to respond to climate change. Among other issues he considers the uncertainty around the impacts of climate change, the future of coal, and optimal policy responses to climate change. 

Relevant links include:

A Study of Long-term Global Coal Demand by Queensland Treasury
Structural Adjustment Policies Becoming Increasingly Important
Apocalypse Never
Unsettled: What Climate Science Tells Us, What It Doesn’t, and Why It Matters
How to Avoid a Climate Disaster by Bill Gates
The Spirit of Green by William Nordhaus

Please check out the episode and let us know what you think via email: contact@economicsexplored.com.

Economics Explored is available via all the usual podcast providers including Apple Podcasts and Google Podcasts.

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Podcast episode

EP68 – COVID and Wartime: Comparison of economic impacts

Economics Explored episode 68 COVID and Wartime features a conversation on whether COVID can be compared to wartime, which considers the different scales and scopes of the shocks, and what it all means for prospects for economic recovery. Economics Explored host Gene Tunny, an Australian professional economist and former Treasury official, speaks with businessman Tim Hughes, also based in Brisbane, Australia.

Gene and Tim conclude that a comparison of COVID to wartime isn’t valid. One reason is that World War II required a complete reorganisation of the economy to maximise production for the war effort, while COVID has involved restrictions that have reduced economic activity. 

Links relevant to the conversation include:

Comparing COVID-19 to past world war efforts is premature — and presumptuous

US Council on Foreign Relations Backgrounder on The National Debt Dilemma

Brookings on What’s the Fed doing in response to the COVID-19 crisis? What more could it do?

Australia’s Boldest Experiment (excellent book on Australia’s wartime economy)

Robert Gordon’s The Rise and Fall of American Growth (outstanding book by a leading US economist containing a great discussion of America’s wartime economy)

Aussies over-confident after being over-compensated by Gov’t for COVID-recession

Mint security lapse amazes judge (story about theft from the Australian Mint in early-to-mid 2000s)

Finally, the word Gene got stuck on at 6:55, irredentist, means, “a person advocating the restoration to their country of any territory formerly belonging to it”, according to Oxford Languages.

If you’d like to ask a question for Gene to answer in a future episode or if you’d like to make a comment or suggestion, please get in touch via the website. Thanks for listening.