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Podcast episode

The Greedflation hypothesis – EP186

Economics Explored host Gene Tunny talks about the “greedflation” (greed + inflation) hypothesis with his colleague Arturo Espinosa from Adept Economics. They discuss whether greedy corporations might be responsible for high inflation rates in advanced economies such as Australia and the United States. Gene talks about how the excessive fiscal and monetary stimulus during the pandemic has been a major contributor to higher inflation. 

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

What’s covered in EP186

  • [00:01:28] Australia’s high inflation rate.
  • [00:06:57] UK windfall tax on oil and gas companies. 
  • [00:10:27] Greed inflation hypothesis. 
  • [00:13:29] Markups as a contributor to inflation. 
  • [00:16:20] Industry concentration and inflationary pressure. 
  • [00:21:11] Inflation outbreak and COVID stimulus relationship. 
  • [00:25:45] Problems with Covid stimulus. 
  • [00:27:58] Excessive stimulus and inflation. 
  • [00:32:35] Corporate power and antitrust.

Links relevant to the conversation

Greedflation articles:

Blaming inflation on greedy business is a populist cop out

Profits and Inflation in Mining and Non-Mining Sectors | The Australia Institute’s Centre for Future Work 

Underlying Australia’s inflation problem is a historic shift of income from workers to corporate profits

Corporate profits have contributed disproportionately to inflation. How should policymakers respond? | Economic Policy Institute

‘Greedflation’ is the European Central Bank’s latest headache amid fears it’s the key culprit for 

price hikes 

How Much Have Record Corporate Profits Contributed to Recent Inflation? – Federal Reserve Bank of Kansas City 

Cost-Price Relationships in a Concentrated Economy – Federal Reserve Bank of Boston 

Inflation is being amplified by firms with market power  

Chris Murphy’s economic modeling on stimulus and inflation in Australia:

https://onlinelibrary.wiley.com/doi/full/10.1111/1759-3441.12382

UK windfall profits tax:

What is the windfall tax on oil and gas companies? – BBC News

Energy Profits Levy Factsheet – 26 May 2022 – GOV.UK

RBA on sources of inflation in Australia:

Box C: Supply and Demand Drivers of Inflation in Australia | Statement on Monetary Policy – February 2023 | RBA

Charts:

Australian bank deposits

Australian money supply (M3)

Transcript:
The Greedflation hypothesis – EP186

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  00:00

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 and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you could join me for this episode, please check out the show notes for relevant information. Now on to the show. Thanks for tuning into the show. In this episode, I chat with my colleague Arturo Espinosa from adept economics about the greed inflation hypothesis, our greedy corporations to blame for the high inflation that we’ve been living through. After you listen to the episode, please let me know what you think about the greed inflation hypothesis. You can email me at contact@economicsexplored.com. I’d love to hear from you. Okay, let’s get into the episode. I hope you enjoy it. Arturo, good to have you back on the programme.

Arturo Espinoza Bocangel  01:12

I’m very happy to be here.

Gene Tunny  01:14

Excellent. Arturo. So it’s at the end of the week, it’s Friday the 28th of April 2023. Earlier this week, we had the March quarter inflation number for Australia. It came in at 7%. So it was lower than at its peak of 7.8%. The quarter before but it’s still it’s still high. And mean, there’s still concerns about cost of living in Australia for sure. I mean, that’s something we’ve all been noticing as we go to the supermarket and other stores. So for sure inflation is still high. One of the things I think is interesting, and I must admit I’ve come to this issue late. Is this issue or this accusation of greed, deflation? Have you heard about this concept of greed, deflation? Arturo?

Arturo Espinoza Bocangel  02:05

Well, lately, yes. But when I was student in Peru, I haven’t heard that

Gene Tunny  02:11

nine. I think it’s a it’s a new term that that’s been thrown around. There’s this accusation that a lot of the inflation we’re seeing is due to profiteering it’s due to greedy corporations. So obviously, we do need to be concerned about big business and monopoly power. There’s, that’s a legitimate thing to be concerned about. But there is this question of, to what extent can we explain the inflation that we’ve seen by greedy corporations? So is it greed, flotation. And this has been quite prominent in the media. So there’s a think tank here in Australia, the Australian Institute, and it’s put out a paper in which they’re saying that this is a big part of the inflation problem. So we might talk about that in a moment. And it’s an accusation that’s been thrown around in other countries, too, in the States. And also in Europe, there was an article in Fortune magazine earlier this week. Greed flash deflation is the European Central Bank’s latest headache amid fears it’s the key culprit for price hikes. And I mean, what we see in whether it’s in Europe, or whether it’s in the States, or whether it’s here in Australia or the UK, if you just look at the data, if you look at data on inflation, you look at data on corporate profits and wages, and you look at data on other input costs. It is the case that profits have been have been high and they have grown in this post pandemic period. And this has led some people to argue that, well, they’re just profiteering they’re putting prices up more than can be justified. Now, I think this is a difficult hypothesis to prove it been thinking about it a bit and how you might demonstrate whether it’s the case or not that this is true, or whether you can whether we can rule it out, or or is it something that is it is a legitimate possibility. We do know that certainly profits for oil and gas companies and also coal mining companies here in Australia. They’ve been, they’ve been very high and also profits in other sectors to have been, have been higher. So in banks and, and in other sectors, and that’s what The Australia Institute argues. One of the challenges I see however, is that in economics as in other sciences, you need to be careful to distinguish should join correlation and causation. I think what Institute’s such as research, researchers think tanks, such as The Australia Institute have found I think they’ve found a correlation isn’t causation I think that’s a lot harder to establish and might go into, into why that’s the case. So I want to talk about correlation versus causation, how might you prove whether there’s green inflation is, is a legitimate thing or not? And we’ve also got to think about here, what’s the what’s the scientific way to look at this and to come to a conclusion now, The Australia Institute is a think tank, and it has a particular agenda. It has a progressive or a left wing bias. And so this type of hypothesis of green inflation appeals to it. So we need to keep that in mind. And we should think rigorously about whether it makes sense or not. Okay, so that’s, that’s a bit of an intro to this idea of greed, inflation. Or one of the other things I just wanted to mention in the intro is that there have been calls for a windfall tax on oil and gas companies in, in many countries, and they did impose one in the UK, I don’t know if you saw the news about the that windfall tax that they imposed on oil and gas, know, what will happen are they put on a, an energy profits Levy, because arguably, a lot of the the excess profits that the oil and gas companies were making, that was due to the higher prices associated with the war in Ukraine. And if you think about it, from an economic perspective, they really didn’t need those profits to have been motivated to invest in the first place. So you could argue that they were, they were x supernormal profits. And so therefore, you could make a case for a some sort of excess profits. Levy. And so that’s what they did in the UK, they put on a an energy profits levy a 25% surcharge on extraordinary profits, the oil and gas sector is making and, and that’s we saw a similar thing here in Australia wheeling, Queensland with the higher royalty rates on coal. So they put in a new, a couple of new tiers in their royalty rates. I think they had a 40%. There’s now a 40. What is it a $40 a tonne royalty rate, once the coal price gets above a certain, certain level? And I mean, this, this is something that’s controversial, because then companies say, Well, there’s a sovereign risk that oh, there’s a risk of that, that we didn’t anticipate before. Now, we have to really think about whether we invest in your state or your country. So there’s that that to consider. But that’s just to say that why this is relevant is because if you think that this green inflation is a problem, then you might be more inclined to to advance policy measures like that, like a windfall profits tax or higher, higher company tax or something like that. So I think that’s a that’s one of the issues in the policy debate I thought I’d mentioned. Okay, Arturo, any thoughts on ADD or green inflation? So far,

Arturo Espinoza Bocangel  08:26

it seemed that probably these inflation can be caused by these corporate big multinational corporation that wants to maximise the profits. Without taking into account what happening in the White House household level, the pressure of these inflation particularly is on the household Australian households, that they need to pay higher prices in energy, fuel, my grocery staff, so that is, that is painful.

Gene Tunny  09:04

Yeah. How plausible Do you think there’s greed inflation hypothesis is so basically it’s saying that the corporations are taking advantage of this concern over inflation? Or that they see that? Okay, so prices have started to rise and corporations think, okay, let’s just keep increasing prices, because we’re, we’ve got the cover to do. So now. We’re, it’s, we can get away with it, essentially. Now, what’s the problem with that argument? So we’re thinking like economists would say that the problem with that argument is that if one company decides to do that, and they’re doing it illegitimately that their costs of production really haven’t increased. Wouldn’t another company try and undercut them or try to they just, they wouldn’t raise their prices as much and then they could steal some market share from them. Yeah, the third point? Yep. So it requires some time. coordination among the companies, doesn’t it some sort of implicit collusion. And I think this is where some of these models, there are some theoretical models that appears which are trying to lend support to this greed inflation hypothesis. Did I think you found a study, didn’t you, Arturo, that said that this or that? Was that an empirical study you found that said that where there’s market power, it looks like there is some tendency to have

Arturo Espinoza Bocangel  10:25

there’s a few of them, the the those paper have found positive correlation between higher concentration higher inflationary pressure,

Gene Tunny  10:36

really? Okay. And do you think they’re good studies, though they published in good journals, do we what do we know?

Arturo Espinoza Bocangel  10:42

Those are probably most of them are publishing good journals. And also in economy, we know that the mythologies bar are different. And also each metal he has his pros and cons. So we need to, to consider that and analyse in detail what is.

Gene Tunny  11:05

So probably too much for us to do in this episode. But we’ll put links in the show notes. So if you’re in the audience, and you’re interested in having a look at those studies, you can check them out, and I might have a closer look at them after this. I know that there are studies like that, and that would lend support to this greed inflation hypothesis. And so maybe we can’t completely rule it out. There’s a paper by John Quiggin and Flavio ministers, and John and Flavio, their professors at University of Queensland and economics. I know both of them. Well. And John’s actually been on the show before. And they wrote a piece in the conversation. I think they had a working paper to back it up and inflation has been amplified by firms with market power. And so their argument is that where one or more firms is big enough to have market power for any given quantity sold, prices will be higher. Yep, and increasingly higher as demand for the product climbs, okay. This means that after a boost to demand such as the one that followed the COVID stimulus, in the end of the lockdowns, firms with market power amplify the resulting inflationary shock. Okay, so they’ve got a model where they come to a conclusion that having market power means that you’re more likely to be able to take advantage or to put your prices up if there’s this, this demand shock, okay. Possibly. I mean, my feeling is that if there is a level of competition in the market, then that should constrain that. But look, if there is market power, maybe that’s an interesting, interesting hypothesis. And there are studies from the States did you see this isn’t just something in Australia, there are studies from the US as well as a Kansas City Fed study from 2021 There’s a really interesting point they make in this that I think it’s worth thinking about in this whole green inflation conversation. So I think Andrew Glover Jose, I think you know how to pronounce his name. Yeah, cuz Sam was traded veal. Okay, that’s great. And Alice Vaughn and Rebecca they present evidence that markup growth so markups on products sold. So for the to get the profit. So the markup growth was a major contributor to inflation in 2021 markups grew by 3.4% over the year, whereas inflation as measured by the price index for personal consumption expenditures was 5.8%. Suggesting markups could account for more than half of 2021 inflation. This is what I think’s fascinating. They note that the timing and cross industry patterns of markups growth of markup growth are more consistent with firms raising prices in anticipation of future cost increases rather than an increase in monopoly power or higher demand. I think that’s a really critical point. So look, it might be the case that if you look at the data, at the moment, that it looks like the businesses are doing incredibly well. So they’ve got high profits. And they’ve they’ve increased their prices, but it could be that they’ve increased their prices in anticipation of future cost increases. Now to some extent, you have seen those future cost increases will in fuel I mean fuel prices were higher for I think they’re starting to come down. But energy prices here in Australia are still going up. Costs of other inputs are increasing labour costs. Labour hasn’t responded as much as some people have been forecasting for years. So wages growth is still It hasn’t really been that spectacular. But look, I mean, there’s something to that that could be the case that what we’re seeing is businesses. It’s not as if they’re being greedy. They’re just concerned about their own costs rising and they’re increasing their profits. Another thing to keep in mind, of course, is that that profits are procyclical. And this inflation has occurred at a time of a booming economy, the economy post COVID boomed. And as we came out of the pandemic, and that’s a time when you’d naturally expect to see higher profits. And we’ve also seen high inflation, unfortunately. So it could be correlation rather than causation. Again, look, lots of there’s a lot going on. There are lots of aspects of the economy. And I think that Kansas City Fed study, and I’ll link to that in the show notes that makes a good point about how you need to consider expectations in assessing what companies are doing. Okay. There was also a study by the Boston Fed that you found wasn’t there. So this is one of the other Federal Reserve Banks. So what was that cost price relationships in a concentrated? Economy? Was this a study you were talking about before?

Arturo Espinoza Bocangel  16:15

Exactly if the concentration, right,

Gene Tunny  16:19

okay. So the US economy is at least 50% more concentrated today than it was in 2005. So they, their findings suggest the increase in industry concentration over the past few decades, could be amplifying the inflationary pressure from current supply chain disruptions in a tight labour market? Okay, so this was a paper from 2000, until I’ll put a link in the show notes. Right. So that’s, that’s supporting that greed foundation thesis. Look, there’s there’s a whole bunch of you know, there’s studies that support it to an extent and then there’s others that question it, or there’s commentary that questions that. And one of the things you found Arturo, which I think was fascinating was that the so the Reserve Bank of Australia, so as central bank, and here in Australia, it doesn’t really give any credence it doesn’t really think much of this whole green inflation idea, does it or it hasn’t hasn’t raised it or doesn’t talk about it as a possible explanation does

Arturo Espinoza Bocangel  17:20

exactly here that RBA pointed out that there’s a place I fuck towards accounting for around half of the increase in inflation over the year to September 2022. But they didn’t mention anything about really corporations.

Gene Tunny  17:35

Right. Okay. So what I’ll do is so I can be to be objective and to be to be fair, on both sides of the argument, I’ll put links to, to, to what the RBA has been saying to both of those fed studies and also to what The Australia Institute has been, has been saying, I mean, they’re been the most vocal about about this. I mean, their analysis to them suggests this is an analysis of national accounts data. Again, it’s it’s an analysis of correlations of data that’s that they seen these things happening at the same time and drawing a conclusion based on that now, can you make the conclusion that this is due to greedy corporations, or corporations being more greedy than normal? Okay, I mean, we live in a capitalist economy. Okay. So businesses are going to maximise profits. There’s no doubt about that. But look, that’s the system we’re in. But is this something that in times of inflation, does it amplify the inflation or lead to, to more inflation than you you’d otherwise expect? I think that’s the hypothesis, The Australia Institute, based on their correlation, all analysis I call it says just looking at correlations, they would argue that it does. So their analysis suggests to them that 69% of excess inflation, so above the, the Reserve Bank’s target of two and a half percent, since the end of 2019, came from higher unit corporate profit margins, while only 18% of the student labour costs. Right. Okay. And they go on in that report to say that, look, it’s not just the profits in the mining sector, because it was just profits in the mining sector. And whereby, okay, the miners are really profitable. And so there’s a lot more profit in the Australian economy that’s on that’s because of all these export earnings. Right? So it’s not as if they’re making all of these profits by exploiting people in the domestic economy. So that’s where that argument of theirs would fall down. But then they do go on to point out it’s not just mining, that where there’s these excess profits in their view, there’s, you know, higher profits in it. in financial services and banking and in other sectors, so, yeah, check that out. And I think they ask a good question. And it’s good that they’ve made this contribution to the debate, because it forces us to think rigorously about what’s been driving inflation and what’s the cause of inflation. And we’ll get on to that again, in a moment. Okay, we’ll take a short break here for a word from our sponsor.

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Gene Tunny  21:03

Now back to the show. One of my old Treasury colleagues, John to in the financial review, John has written an opinion piece, which is very good. John’s good writer. Blaming inflation on greedy business is a populist cop out. And I think what John is saying here, I think this is where a lot of the economists in the Reserve Bank or the Treasury, I think they would agree with John, I think I largely agree with John, and I’ll go into into why in a moment. And John’s main message is that it was the spillover of public sector stimulus that lasted for too long, not price gouging by companies that fueled the inflation outbreak. Did you have a look at that? That article by John?

Arturo Espinoza Bocangel  21:55

Yeah, yes, I rebuilt the conclusion. Yes. He made a good point.

Gene Tunny  22:00

Yeah. And he relied on a study by Chris Murphy, who’s a former Treasury model. I actually work with Chris’s daughter in Treasury, Carol, I believe, if I remember correctly. So Chris, is a well known Australian macro, economist. And he was at KPMG e contact for a while. Now he’s a visiting fellow at ASU. And he’s done something a bit more advanced than what The Australia Institute did. The Australian Institute just looked at the national accounts and inflation data and tried to draw conclusions from that from just basic data analysis. Now, I think the problem in economics is, you can only go so far doing that, if we’re talking about testing hypotheses, what’s the scientific approach to do that, you probably need something a bit more than just the basic data analysis. Now, one of the problems we have in economics, of course, is that you can’t run controlled experiments as you can in the lab. So we’re always trying to come up with clever ways to, to analyse the data, to do econometric modelling of some kind, to work out whether these hypotheses can be maintained, or whether they’re, they’re rejected. That’s what I’d say on that. And what Chris Murphy does is he runs a simulation. He’s got this macro economic model, this econometric model of the Australian economy based on a broad range of macro economic data, and relationships that have some basis in economic theory. And what he does is he simulates the economy, if it was subject to COVID. But there wasn’t all of the arguably excessive monetary and fiscal policy response there was the there was some contraction in GDP. I mean, there’s a quite a substantial contraction in GDP still in that first quarter of COVID. Because people just would have naturally socially distanced anyway, right, even in the absence of policy measures. And we did say that in in some economies, that there was no, there was no way of avoiding the the economic shock from COVID entirely. But if you didn’t have the, all of that stimulus than by his estimates, you would have avoided a lot of the inflation. And I think this is really, really interesting, really interesting modelling. And Chris Murphy has a paper in the economic papers journal, which is a journal that’s actually published by the Queensland branch of the Economic Society was aranea, which I was once the secretary of. No longer though, but you can get that online, I’ll put a link in the show notes, fiscal policy in the COVID, 19. Euro. Really good paper. And what he does in this paper, which I think is excellent, is he just highlights how massively generous the COVID stimulus was, the stimulus during COVID was particularly job keeper, which was just incredibly generous, and he ended up because of the eligibility rules, there are all these people who are they were only employed part time, but they effectively get compensated as if they were full time workers. So there are a lot of people getting access excess money. And there’s an argument that that stopped some of those people from searching for a new job, if they were if they are on job keeper, or if they’ve been supported by job keeper. So, yeah, lots of problems with that, that stimulus and I think we’re, if we had another pandemic, I mean, let’s hope we don’t, I mean, still getting recovering from that last one. I mean, it was just the excessive response was just at it, and just, yeah, incredible. But if we do have it, I think we would have a much better, or a hope, whatever much better economic policy response. But what Chris Murphy found was that the fifth and this is in Australia, the fiscal response to compensate for income losses. In services industries meant that unemployment was around two percentage points lower for three years than otherwise, than it otherwise would have been. And there was over compensation for every $1 of income, the private sector lost under COVID, fiscal policy provided $2 of compensation. And then there was of course, the ultra low interest rates, point 1% cash rate, the hundreds of billions of dollars of monetary stimulus via quantitative easing, all of this additional money in bank accounts, I’ve got some charts that I’ll put in the show notes. So just show how much the Australian money supply is grown. I think since 2020, the amount of money so the stock of money in Australia has increased by nearly a third or around a third or something like that. And think about that. This is part of this whole. And this is something that what I’ve been saying on this show for the last couple of years, I mean, what we’ve got is too, too much money chasing too few goods, if you looked at what happened during the pandemic, and within the fiscal policy and monetary policy, what we saw with the inflation now, no doubt, significant part of it was due to the invasion of Ukraine. But what we end up seeing with inflation is what you would have expected based on the the massive stimulus and particularly the massive monetary growth that we saw. And so therefore, you don’t need this green inflation hypothesis. You can explain a lot of it by the excessive stimulus. And this is what Chris Murphy shows in that paper. Germany thoughts on that, Arturo?

Arturo Espinoza Bocangel  28:09

Whoa, this point, you the last point that you have mentioned is very clear. It made me think, okay, yes. The these re the cooperation argument is not 100%? Sure, shall we, whether if some academics, or you know, researchers will try to understand the drivers behind inflation. When I mentioned, drivers, of course, we include these government expenditure in increments. And also lit, we can include another factors at fame level, like, for example, to, to use markups in order to maximise profits. So that kind of thing is,

Gene Tunny  29:03

yeah, I think you made a good point before. I mean, we really want to have a look at what’s been happening in specific firms. I think we’ll have to wait for studies that really examined what’s happened at that firm level, maybe using that business longitudinal database data? I don’t know. But yeah, clearly, this is a it’s a big issue. And I think it’s one that we need more evidence to resolve. But I guess what I would say is that we shouldn’t jump to the conclusion. I mean, I’m pretty confident that we shouldn’t jump to the conclusion that it’s greed flesh, and that is just because a greedy corporations, I think there’s there’s a lot more. I’m not even sure to what extent that’s a significant factor. In fact, the corporations more greedy than normal. I mean, it’s this idea that it could amplify a shock that is inflationary, possibly, but I’d like to see, yeah, I have to sort of think deeply about what that means. It’ll is and what that mechanism is, I mean, my view is that you don’t need that great inflation hypothesis to explain what’s happened because it’s perfectly understandable if you just think about the the massive, the massive shock that we saw now. So think Chris Murphy, what he found was that if you didn’t have the stimulus, if you just had COVID, then then by the end of 2022, you’d have inflation at around 4.2%. So you would have ended up with some inflation as the economy bounced back after COVID. But what ended up happening, of course, is that inflation went far beyond 4.2%. In Australia, we ended up with 7.8% in Australia. And what Chris Murphy’s modelling shows is that, in his scenario, his his actual forecast scenario, he’s worked out that the excessive macro stimulus drives inflation, three percentage points higher, so three percentage points higher to a peak of 7.2%. Okay, which is in the wall ballpark of where it did get. So in his model, he can you explain it with the stimulus. Now, of course, it’s a macro model and models that we all know the problems of trying to forecast the economy and modelling the, the actual path of the economy with an econometric model with with equations. We’ve got parameters estimated, statistically or using econometric methods there. They have their limitations. But to me what, what Chris Murphy does is, is a better way to think about this sort of try and answer this question than just this basic correlation analysis that’s done, where we go, oh, well, profits are up. inflation’s up. wages aren’t up by much. It looks like it must all be inflation’s. At the same time as we’re having inflation companies are making more money. Therefore, it’s greedy, greedy corporations, I think I don’t really think that’s, that’s the right way to think about it. Having said that, I mean, it’s worth having the conversation and forces us all to think more rigorously about the causes of inflation and what we should do about it. And he thought cetera? No, I think that’s pretty much all I wanted to go over. I’ll put links in the show notes, to all these various papers and reports we talked about. The RBA has put something out on inflation drivers where they look at the different factors and they don’t seem to think much of this whole green inflation, explanation. But look, I think it’s worth covering. I know that, you know, we do have to be mindful of corporate power we have to be mindful of, of monopolies or oligopolies that exploit their market power. There’s no doubt about that. I mean, then that’s why we have things like the a triple C, the Australian Competition and Consumer Commission, or we have the we have the antitrust statutes in the US. And we have whatever the equivalent is in the UK. Did you see in the in the they’re quite muscular in the UK? Did you see the they’re blocking that? Microsoft’s acquisition of Activision Blizzard? Oh, I haven’t seen that. Oh, yeah. That’s quite interesting, because one of the things I’ve covered on this show is this issue of big tech and to what extent we should be concerned about big tech, so might have to come back to that in a in a future episode. I thought that was a really interesting development, because they’re concerned about Microsoft’s already a behemoth, right. Concerned about Microsoft getting getting even more market power in games. Okay, well, thanks so much for your time and for helping me think about this issue of greed, inflation, it’s helpful to talk about these issues with with colleagues. So I can think about really clarify how I’m thinking about it. Am I on the right track? Am I being biassed? Am I too sceptical of this hypothesis, which might actually have some merit. But yeah, I think my view is that we can probably explain inflation most, if not all of the inflation by the excessive fiscal and monetary stimulus. We don’t need this great inflation hypothesis that said, Look, if they can provide convincing evidence that it is a thing then sure let’s let’s look at it a bit more closely. So think that’s where all I’ll end up. Tomorrow. Thanks so much for your time.

Arturo Espinoza Bocangel  34:37

Thank you for having me, as well was my pleasure. Very good.

Gene Tunny  34:43

rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

35:30

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Credits

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Podcast episode

What are Goldbacks and who’s buying them – e.g. preppers, libertarians, collectors?  w/ Goldback Founder Jeremy Cordon – EP183

The Goldback is a local commodity currency operating in several US states, including Nevada and Utah. The Goldback is described as “the world’s first physical, interchangeable, gold money that is designed to accommodate even small transactions”. Each Goldback is embedded with 1/1,000th of a Troy Oz of 24 karat gold. Show host Gene Tunny is joined in this episode by the Founder and CEO of the Goldback company, Jeremy Cordon. According to Jeremy, “Gold is money.  Everything else is credit.” Among other things, Gene asks Jeremy who’s buying Goldbacks and how widely are they being used? 

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

What’s covered in EP183

  • What is a Goldback? [1:36]
  • The USD value of a Goldback relative to the value of Gold in it [5:20]
  • How can you create your own local currency in the US? Is it legal? [6:44]
  • What are the different types of gold buyers? Why Goldbacks are popular with preppers [11:30]
  • What’s the acceptance of Goldbacks by local businesses? [14:12]
  • Why are Goldbacks better than the old gold standard? [20:56]

Links relevant to the conversation

Goldbacks website:

https://www.goldback.com/

Jeremy’s bio:

https://www.goldback.com/meet-the-team

Related previous podcast episode:

Why fiat money means higher inflation & why a radical Reserve Bank review is needed w/ Darren Brady Nelson – EP179

Transcript:
What are Goldbacks and who’s buying them – e.g. preppers, libertarians, collectors?  w/ Goldback Founder Jeremy Cordon – EP183

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  00:06

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 and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, thanks for tuning into the show. This is Episode 181 on goldbacks. A local commodity currency operating in several US states including Nevada and Utah. The gold back is described as the world’s first physical interchangeable gold money that is designed to accommodate even small transactions. Each goldback is embedded with 1/1000 of a troy ounce of 24 karat gold. At the end of March 2023, they could be exchanged for a bit over four US dollars. I’m delighted to say that I’m joined this episode by the founder and president of the gold back company, Jeremy Cordon. According to Jeremy, gold is money, everything else is credit. Okay, let’s get into the episode. I hope you enjoy my conversation with Jeremy. Jeremy Corbyn, president of gold back, welcome to the programme. Thanks

Jeremy Cordon  01:36

for having me.

Gene Tunny  01:37

It’s a pleasure, Jeremy, I’m keen to chat with you about gold backs. One of the issues we cover on this show is the fiat money and the issues associated with that. And I did a show a few weeks back on fee it versus commodity standards for money. And I mean, what’s fascinating is that you’ve introduced your own commodity money, it appears with gold back, could you tell me a bit about gold back, please?

Jeremy Cordon  02:04

Sure. Well, just like you said, it is a commodity money. And it might be one of the most successful commodity money’s out there right now. You know, we produced maybe $50 million worth of gold backs that are circulating. And that was true up until the end of 2022. You know, last month, I want to say that we’ve sold between six and $7 million worth of gold backs. So we’re seeing this huge amount of interest and growth. And people that are looking for kind of these inflation proof commodity monies. Yeah, if you haven’t seen one a gold back, it looks about the shape and size of $1 Bill, there’s gold encased in it, it kind of gives it like a like a Willy Wonka ticket look. And they go down from 1000th ounce of gold. So you know, it’s like a $4 Gold product, and they go all the way up to a 50, which has 50 times the amount of gold, it’s a 20th of an ounce. And those are worth about $200 a piece. So people carry these around like bills spend is just like cash, but the gold is in them. And that’s that’s what gives them you know, a lot of their value there.

Gene Tunny  03:12

So in terms of what they’re worth, or what that exchange for in US dollars, is it broadly equivalent with the value of the gold within the notes? Within the goldbacks?

Jeremy Cordon  03:25

Yeah, I’d say that’s about that’s about half the value. You know, because if you melted them down, you know, if you had a giant pile of gold backs, you melted the whole thing down, you got to realise that we’re splitting an ounce of gold into 1000 pieces. And that cost money, right? If you destroy all that, you know, craftsmanship and labour and effort to do that effectively, you know, you’re only going to recover about, you know, half of that value and melt, which is still really good. It used to be far more expensive to break gold down at that level. The other half of the value is just the utility value of having a money that works well and maintains its value, which you know, for fiat currencies, 100% of the value is utility value.

Gene Tunny  04:06

Yeah, yeah. And so where are these being used in exchange.

Jeremy Cordon  04:11

Now when we launched goldbacks, it was about four years ago is 2019. And we started in Utah. Utah’s a very special law that recognises gold and silver as legal tender. And, you know, we figured we couldn’t find a more hospitable, legal environment anywhere in the Western world. Right. So we started in Utah, and I was thinking that the Utah gold back would be a it would be a Utah specific project, and that we probably wouldn’t do any more gold back projects anywhere else. And what we found really quickly is that 90% of goldbacks for Utah were selling outside of the state of Utah. And then I started getting stories, you know, these kind of anecdotal stories not just from all over the US but all over the world, that people were bartering and trading with gold backs for things because go figure the value of a gold back. Is it just because it says Utah, It’s, you know, it’s because the fixed amount of gold. It’s a known quantity. It’s a known value and it’s very usable and bearable, anywhere in the world because gold has value everywhere in the world.

Gene Tunny  05:20

Yeah, exactly. I suppose I guess one thing I’m most interested in is that the value of the gold is about half of the value of the note you were saying so. And that’s how you’ve made like all the goldback company makes the money because you’re selling these notes for more than the cost of production, which makes sense. I mean, obviously, you’ve got to make money out of it. Yeah. So that makes sense.

Jeremy Cordon  05:46

We don’t make half. It’s not like, you know, I mean, the profit margin isn’t as rich as you think.

Gene Tunny  05:51

Yeah, I wasn’t suggesting that. But yeah.

Jeremy Cordon  05:53

Some people think that’s the case like that the one denomination, which is the 1,000th of an ounce, that’s actually manufactured in the loss. It costs more than we can even sell it for to make.

Gene Tunny  06:04

Right, right. Okay. So, Utah, it’s got a special law, and I saw that there are other there are other states where they’re being used. Is that right? Is it New Hampshire, that I read that correct?

Jeremy Cordon  06:16

Yeah, we got New Hampshire and Nevada. Wyoming just came out. We got South Dakota coming out this year.

Gene Tunny  06:23

And the year of relying on specific state laws, because I remember there’s an episode of Riverdale, that Netflix show where Veronica Lodge tries to create her own Riverdale currency. I don’t know if you’ve seen that episode at all. And her father who’s the crime lord of Riverdale, Hiram Lodgy, he has it shut down by the US Treasury, he says, And he said, You can’t do this. You can’t create your own local currency. But you’ve managed to create a local currency here. How can you do that? If the US dollar is legal tender in the US? What does the Treasury say about this?

Jeremy Cordon  06:56

You know, you’re right. There’s federal law that prohibits you from making your own currency in the United States, unless otherwise authorised by state law. So if you don’t have a state law to support your currency project, then you can’t do it. It’s illegal. So you know, Utah was a very obvious first choice for us. We went in there and we said, Okay, we got a state law recognising gold and silver as legal tender, this is gold. So we’re under this umbrella of state law. So you know, because otherwise, if this is a federal project, it’d be illegal. And sure enough, you know, we support a huge network of businesses in the states that you mentioned, that advertise themselves as preferring to take gold back. So these do function and circulate as local currencies within the states. There’s businesses outside of these states that also do it. We don’t include them as part of any of our either they’re not like a supportive business. You know, people happen to barter with these things outside of the states, but it’s not, you know, that’s more because it’s a commodity money or a novelty, or, you know, they’re trying it out, you know, most of the economic activity per capita is happening inside the states, right, where you’ll see 10 times as much activity in Utah, per capita than than Colorado, you know, because Utah has its own series. So now, as far as the state laws, Utah, it’s kind of obvious, you know, it’s the legal tender act for Gold and silver. But when we went to New Hampshire or Nevada, you have to start to question that. So who doesn’t have to have a special law? You know, or does Nevada have a special law. So we actually took a really unique legal approach with the gold back. Now, if you’ve ever used and I’m going to an American law here, not federal but state level, if you’ve ever used a coupon or a gift card, if Walmart makes his own gift cards, you know, they can’t make their own local currency either. Right. If you make a coupon, you can be accused of making a local currency. The law that businesses use when they make you know, these kinds of you know, products is called the Uniform Commercial Code. The Uniform Commercial Code gives you you know, you have to put a cash value on the note or the unit and then it can have a separate value. And every state adopted that law. So gold backs we also plug into that law. And the way it works for us is the US Mint. I think Australia does this as well. They mint a one ounce gold coin, and it stamped with a $50 face value. Right? So we say okay, 1000 gold backs contain one ounce of gold will allow you to redeem 1000 Gold backs for a $50 one ounce gold coin it’s a promise that we can always keep you know, there’s never a question of can I can recover the gold because you can always trade it for another form of gold. You know, and we’ve got 10s of millions of dollars with a gold coins that are part of a contract where you know, if just about every gold back came in today, we could turn them all into gold coins. So at that point, the gold back becomes assumes a coupon for a gold coin that’s made out of gold.

Gene Tunny  10:05

Yeah.

Jeremy Cordon  10:06

Because the gold coin is federal us minted legal tender. You know, it falls neatly under the Uniform Commercial Code, which allows it to circulate and be used as money in any state in the country.

Gene Tunny  10:21

Right, so do you have a background in the law Jeremy has had this sounds like you have to have some legal knowledge to be able to figure this all out and get it up and running.

Jeremy Cordon  10:32

I was a paralegal but my main partner in gold back drafted the Utah legal tender act in 2011. He’s a little older, he’s got more grey hair, you know, he’s in his 60s. And, you know, he ended up being a very important partner to have in gold back. Because, you know, to your point, you’re right, I mean, you know, if you make something like this, you need to have all of your ducks in a row legally, because I didn’t I didn’t do this to you know, get in trouble or go to jail. We wanted to do this 100% right.

Gene Tunny  10:59

Yeah, yeah, absolutely. And who’s buying the gold back? So who’s using it? Is this because you mentioned this 50 million and, okay, I mean, that’s a good start. I mean, the US money supply is, what is it? 30 trillion or something?

Jeremy Cordon  11:14

For sure, yeah, no, it’s it’s a drop in the bucket. Yeah, it’s, it’s a it’s a mosquito compared to a blue whale, right? I mean, it’s not, it’s not very big.

Gene Tunny  11:23

Yeah, I’m not meaning to diss it. I’ll just say it’s at the early stages. So who are the early adopters of it? At the moment? What are their characteristics? Are they libertarians?

Jeremy Cordon  11:33

Yeah. Some of them, you know, I have a few different groups, you know, there’s not one single type. But you know, I mean, you have your true believers, right? You know, they look at Gold backs, they say, my goodness, you fixed money. And this is amazing. And I want to be part of it. And I want to have these, and I want to have in my wallet. And I want to try to spend them, I want to show everybody, but I’d say that that group is a minority of people that own gold backs, you also have people that are, you know, professionals. You know, they’re very, you know, average people and they look at Gold backs, they say, Hey, this is so cool, these are so pretty, the artwork is so incredible, I’d love to just own a set, and they’ll you know, they’ll drop, you know, 400 bucks, and they’ll buy a set of gold backs. And we’ll frame it and stick it on their wall. And they’ll show people because they’re the really gorgeous to look at. And it’s novel, you know, so they’ll go out and they’ll buy a set. And what happens with that second group is, you know, something will happen, like this banking crisis. And they’ll remember, Oh, hey, you know, like, maybe I should have some more of those gold backs, you know, maybe just in case or something, you know, and, you know, we’ll get conversions there or, you know, just stays as a novelty thing. I also get preppers that are, you know, they want to be prepared. And it’s like, okay, you’ve got, you know, your your toilet paper and your, your EMP proof, whatever, and your food storage. And, you know, pretty soon you run out of space for your food storage, you think, Okay, well, you know, all your dollar bills in the event of a hyperinflationary event aren’t worth much. Do you really think you’re going to be bartering with your one ounce gold coins? And can you imagine trying to banter with a one ounce gold coin? I mean, you mean counterfeits, we get off China. You know, it’s like, if you found someone that liked gold and had something worth 2000 bucks, you’d have to convince them it was a real gold coin. You know, so a lot of these folks, a lot of these kind of more preparedness minded individuals, they’re taking gold that they had stashed away for a kind of a just in case scenario. And they’re turning them into piles of gold backs, we’re starting to see more six figure and seven figure purchases of gold backs, as people buy larger orders and get more comfortable with it. So we have that group too. And then the final group is just people that, you know, they’re small buyers, they’re young people, and you know, they just want to buy a few they want to get their toes wet and precious metals, maybe they got one as a tip at a restaurant. Someone told them about it. And so cool, I’m gonna buy a five and a few ones. And they’re just, you know, I’d say that’s the majority of people that are in gold backs are people that are brand new to precious metals, you know, they’re between the ages of 23 and 45. And, you know, for whatever reason, this generation is just really excited about the gold back.

Gene Tunny  14:11

Yeah, that’s good. And where do you manufacture them? Are they made in the USA?

Jeremy Cordon  14:17

They’re all made in the USA.

Gene Tunny  14:18

Right? Very good. Okay. What’s the acceptance of gold backed by local businesses? So if I’m in say, Salt Lake City, and someone, someone gives me a tip in or they pay me and a gold back, can I then take that to the local Starbucks and buy a latte or, I mean, how, how widespread is its acceptance?

Jeremy Cordon  14:39

You know, it’s a lot more than you would think. When we started, I was hoping that I could get maybe 5% or 10% of business owners on board. I think there’s got to be some libertarian business owners that would support this and want to do this. If I could just make a list of them. Because the first question you get is okay, well, that’s cute, and that’s great. You made a commodity currency, but who takes it It like, that’s where the rubber hits the road. Is it a money? Or is it you know, something that belongs on my wall. So, you know, I went out, and I started signing up businesses. And like I said, I was hoping for five to 10%, what I found is that about 30 to 50%, of small business owners were willing to take gold as payment. And that really surprised me, I’m still surprised by it, that number has actually gotten higher now, especially in Utah, since the gold backs been out for four years, it’s a lot more common to have people already know about it. You know, it’s just yeah, how prevalent is.

Gene Tunny  15:36

I guess, you get good word of mouth. And then you must get a lot of shares on social media, if someone gets a gold back as a tip, or payment.

Jeremy Cordon  15:45

they’re, they’re fun to show off, you know, millions of people have seen him. Let’s say you’re in Australia, you know, it’s like, Okay, how many businesses in Australia? Maybe I can’t find the business. You know, like, what am I going to do with these? And like, well, you know, people give them as gifts, you know, they stick them in an envelope for their kids, you know, they use them as allowance, you know, and, you know, garage sales, they have about an 80% success rate for spending gold packs. And then you’re educating people, you’re saying, Hey, this is what commodity money looks like, did you know that our money is not commodity money? You know, it’s, it’s, you know, kind of faith and trust and hopes and dreams. And, you know, I mean, hopefully, that’ll work out for us. But, you know, can you imagine if we did have a commodity money, then we wouldn’t have to, you know, have 10% inflation every year or, you know, I’m gonna, I’m gonna pay you a piece of gold a real piece of 24 karat gold in exchange for that use birdcage. Yeah, 80% of the time. It’s, that sounds amazing. And I love that piece of gold. Because that’s what you’re doing is, you know, you’re you’re trading and spending gold, you know, that this rate of gold is high.

Gene Tunny  16:50

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

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Gene Tunny  17:25

Now back to the show. So I’d like to ask some questions, Jeremy about how scalable This is? And what growth trajectory you see for it, what competitors there are, I mean, how growth trajectory Do you see at the moment for gold backs?

Jeremy Cordon  17:43

We are on track this year to sell between 50 and $60 million, wroth of gold backs, that would be more gold backs that were produced from 2019 to 2022. The next year, so 2024, we’re looking at doing about 100 million. So that’s twice as many gold, you know, that’s, that’s about equal to all the gold backs produce all the previous years. So you’re kind of seeing this doubling, you know, the further you go into the future, the harder it is to predict. You know, I think we’re looking at a doubling for 2023. Also 2024, it gets a little bit more grey after that, because a lot of it depends on, you know, being able to scale up and seeing how the markets responding and everything else. But that’s, that’s what we’re looking at for growth.

Gene Tunny  18:29

Okay, and what about competitors? Is there anyone else doing something similar?

Jeremy Cordon  18:35

We want there to be so you know, we’re doing this as a private projects, you know, gold backs are starting to sell all over the world, you know, I mean, you can buy them in Europe and Australia, and but what we’re really interested in is foreign central banks. You know, you look at, you know, Zimbabwe, and they are making tiny gold coins for circulation in Zimbabwe. Because at the end of the day, the goal of a central bank is to make a money that people will actually use. That’s what they have to do otherwise your society is going to pull the collapse. There are about a half a dozen foreign central banks right now that are actively have projects designed to get people to circulate gold in their country. You know, one of them is us, Uzbekistan, they’ve been circulating gold there for about a decade. So going into these, you know, we have to build up our manufacturing capacity. But then the goal is to go into these countries and say, Hey, rather than using these tiny little coins are these tiny little bars, that you know, a tiny little bar could be worth 20, 30, 40 bucks. You know, what if you can get it down to $2 worth of gold. And it looks like a bill and you’re not going to lose it in your pocket. And all the gold is recoverable. And it’s serialised by the way, you know, I think there’s a real future for this technology, you know, first with, you know, foreign central banks that have these kind of hyper inflationary environments, but we can use that as a stepping stone to really build up the capacity, so it can become an option for any central bank. And that could be that could be a great solution for humanity and a decade from now, you know, we could be looking at a decade from now and it’s like, okay, well, if nobody trusts the currency, because the currency is falling apart, Oh, guess what? Central banks don’t half of the of the world’s gold reserves. Yeah. Maybe we could put those into circulation because maybe nobody trusts them to, you know, back, you know, $1 with gold, you know, they want to hold the gold, the trust is broken. You know, but this could, ironically, the something that ends up saving central banks in the end. And that’s, and that’s the the company, this is a technology company. You know, we’re really trying to develop a technology that makes gold a better money than it’s ever been. Because, you know, I mean, if, if I were to put on my libertarian hat, you know, libertarians have been saying this for 50 years. Oh, we need to go back to the gold standard. That will excuse me, Mr. Libertarian, you realise that the gold standard was 100 copper pennies to silver dollar and 20 silver dollars to a gold piece? Well, what do you do when 100% of your copper is used in industry? Are you going to take all of your copper out of your power lines and melt them down so you can wear them out as pennies in your pocket? Are you going to take all your silver out of your solar panels, you know, 80% of silver is used in industry, you’re going to you’re going to take all the silver out of your electronics, so you can wear them out as coins in your pocket, are you going to have the government force peg three industrial metals together to Fixed Ratio under penalty of death. Because gold has never been small enough to circulate by itself. That’s been 2600 years, we’ve always had to have tiny little bronze, the widow’s mite. And the Bible, I was a bronze coin, tiny little bronze point. So you’ve always had kind of this copper bronze silver gold system. And the gold back is so revolutionary as a technology. Gold has never been able to be this small. If you had to go back 100 years ago, in the US, it would have the equivalent purchasing power of for wheat pennies. It’s not just replacing silver, it’s replacing copper is a monetary metal.

Gene Tunny  22:12

Okay, so you’re saying if you had this technology, so there have been there are technological improvements in the production that you’re taking advantage of? Is that, is that what you’re saying?

Jeremy Cordon  22:22

No, I’m saying that as a as a money. You know, we’ve never had the technology to me. Gold as a precious metals small enough to buy coffee. You had to use copper or silver, you could never use gold directly as a commodity money to buy coffee. Not a cup of coffee, maybe like a you know, a barge of coffee.

Gene Tunny  22:42

Right what because we couldn’t get it into a form to trade. To exchange?

Jeremy Cordon  22:51

You couldn’t get gold small enough. There wasn’t a, it’s called the small coin problem. You couldn’t have a small enough gold coin to buy little things.

Gene Tunny  22:56

Yeah, gotcha. Yeah, that makes sense. And you’re talking about foreign central banks. And I was interested in the the acceptance of gold backed by the financial system, to what extent will local banks recognise gold backs? Will they recognise or financial institutions? Would they recognise them as collateral? For example, if you wanted to borrow US dollars, for example? You know, there’s

Jeremy Cordon  23:22

private organisations, that’ll they’ll recognise them as collateral, you know, but you’re looking like faulting institutions, right? You know, this is kind of more of the precious metal space in the United States. Yeah, you couldn’t walk into a credit union with a bunch of Walmart gift cards to get alone? You know, it’s not, it’s not really their thing. You know, and it might not be for a long time. You know, I’m hoping that, you know, maybe in 20 years from now, we could see a future where a lot of the cash that we have is replaced with the same technology. You know, maybe they’re not called Gold backs. But you know, if you’re a cash if you’re Australian dollars, you know, we’re made out of gold using the same technology, and we wouldn’t have to worry about inflation anymore. In fact, there’s enough gold now, you talk about scalability, there’s enough gold now owned by central banks today, to replace all of the cash in the world with a technology like gold back, and they could still have fractional reserve deposits and lending and you know, it would, it wouldn’t necessarily, it wouldn’t necessarily break anything.

Gene Tunny  24:26

Do you have a sense of how much of the demand for gold backs is related to transactions? How much is speculative? How much is an investment?

Jeremy Cordon  24:35

It’s a great question. It’s hard to know, because because of the private nature of it, if I pay somebody as a gold back, nobody else knows about it. Right? So it’s not reported to me. It’s not on a blockchain. You know, unless the two people that were parties to the transaction talk about it. It’s unknowable. That said, my guess is that I don’t think they move as fast dollars. You know, and there certainly are a lot lot of buyers that buy and save, you know, which is a valid use of money. But there’s there’s a decent amount of anecdotal evidence out there that, you know, I was at a restaurant the other day that it takes callbacks to have a sticker, you know, outside their restaurant, hey, we accept the gold back. I asked them, I said, you know, how often you actually got how often you guys actually get these? You know, I’m the girl working there says, Well, you know, maybe once a day. So you know, I mean, you’re looking at several 100 transactions a year, where people are spending gold backs in the local community. Now, it’s not a lot. I’m sure it’s less than 1% for them, but it shows that it’s not only being used as a savings or as a novelty item.

Gene Tunny  25:41

Yeah, that’s interesting. So you’ve sold some to Australians? I want to check with some libertarian friends, whether they’ve they’ve bought any do they have any. I think I saw on the website, how that what they look like, are they stamped with? Does it have Utah or the state that it’s the name of the state on the the gold back?

Jeremy Cordon  26:02

Yep. Yeah, we got we got a lot of great images on gold pack.com. You know, you can see them there. And like I said, they’re, they’re very gold, right? You know, it’s like, I don’t know what the currency looks like in Australia. But it’s the background colour of the whole thing is gold. And what you’re actually seeing is the 24 karat gold. So raw, yeah, the way the technology works is you have a piece of polymer, like a giant sheet. And it goes through what’s called a vacuum deposition chamber. You know, some people think a gold back is made out of foil. Really, it’s the same technology that puts gold in microchips in Taiwan, in diabetic test strips, or, or in a layer of a golden sunglasses, right? So the polymer goes to the machine, the machine hits in a vacuum chamber, a target of gold was a laser, the gold falls down onto the polymer, and then it gets sandwiched in with another layer of polymer. So all the gold is contained inside the gold back. And we know exactly how much gold is in it. That’s the idea there.

Gene Tunny  27:06

Okay. Okay. And finally, the value of gold backs in terms of the exchange rate with the US dollar does that is that linked to the gold price does that move? It’s very highly correlated with the gold price?

Jeremy Cordon  27:23

Yes, but we’ve seen it jump a few times. So I’m getting an example. For any commodity for any thing out there. The price is determined by supply and demand. And the gold back as a unit is a little bit separate than the rest of gold in general. Because gold backs are easy to spend and uses money. So I’ll give you an example in 2020. In March, when when COVID really kind of hit the US, every gold back sold out. Every gold back and every store, they were gone in a matter of days. And the only place to buy one was on eBay. And they were $50 a piece. Because you know, supply and demand didn’t happen to all the products out there. It happened to gold backs because I think that people were concerned that the bottom could fall out of the currency and they wanted to have a currency with value.

Gene Tunny  28:14

So you mentioned $50 What were they trading at before COVID?

Jeremy Cordon  28:25

Like $3. So it was quite the spike. And it really surprised me, you know, this is, you know, people are really serious about this. It’s, well, it’s like, you know, you have the best lifeboat on the Titanic. It’s got the motor and then the heated seats. And you know, GPS is the nicest one on the whole Titanic. But you’ve only got 16 spots on it. Yeah, not that hard to throw up the lifeboat but when it’s time to get on the lifeboats, you know, it’s like that the value of those spots goes up because all the other lifeboats you know, if it’s gold coins, you’re bartering with the $2,000 gold coin. That’s your money now like that might sucks. Okay, you know so people you know, we’re starting to see people again that are preppers that have been buying gold for a long time. There’s kind of this gestation period where they find gold back they discover it I think about it, they have it they buy some more and then you know, something clicks in their mind or they say hey, you know what, I own $200,000 worth of gold for a just in case scenario. The only gold that’s useful in my house for a just in case scenario are these gold backs. You know, no, you know, the building one of our retailers they’ll ship and all their gold clients and they’ll trade for gold backs. And you know, blacks they’ve they’ve doubled in price since 2019. And gold bullion gold coins, hasn’t, you know, it’s gone up maybe you know, 60-70% gold backs has actually been outperforming gold bullion and gold coins. And that’s that’s what surprised everybody including myself.

Gene Tunny  29:56

Yeah, yeah. Okay. Any other points you think are important about gold backs, Jeremy? I’m, I’m happy with the responses. So far. I’ve learned a lot. And I think it’s fascinating. Fascinating to have a commodity money out there. So yeah. Any other points that would be good to get across?

Jeremy Cordon  30:16

Yeah, I’ll give you a couple of data points. I’ll let you go. Because I find talking about callbacks all day. But we don’t want to do a five hour podcast, right? I mean, but I’ll tell you this in 2023, we think that gold back is going to produce more individual callbacks, more units of gold than any other producer of gold in the world, including the Perth Mint, including the US Mint, we think there’s going to be more total individual gold backs out there than any other product. So that’s, that’s what we’re looking at for growth. You know, when I say that, it sounds extraordinary. But you know, I tease people like, Do you know who the biggest manufacturer of tires is? In the world? Care to guess?

Gene Tunny  30:58

Oh, is it? I don’t know. Is it Bridgestone? Or is Lego? Lego? Oh, of course, with their with the toys you say is that? Well, they’re tiny?

Jeremy Cordon  31:12

Yeah, it’s not it’s not that different for gold back? Yeah. I mean, you know, if I have a one 1000th of a ounce product, yeah. It doesn’t take me that long to catch up to the big boys in terms of total production numbers. But, you know, I mean, we are taking a bigger piece of the gold market, you know, right now, we’re about a third of 1% of the value of all the gold sales in the US, which is not bad. You know, we’re probably the number one for hyper fractional. And, you know, gold back is also the number one for most successful local currencies in the United States. If you added up all the value of all the other legal local currencies in the United States, the gold back collectively the four different hold back states, it’s bigger. So that’s, that’s exciting, too.

Gene Tunny  31:59

Yeah, I was just trying to do the numbers in my head. So if you’re going to be, you mentioned that 50 to 60 million of gold backs that you could be producing and therefore, and half of the value is the gold. So that’s 30. Say 30 million, and the price of gold, what is it nearly 2000 an ounce or something. So he was just trying to do the numbers, and they had to figure out how much how many ounces of gold, you must be using a year, do, I could put it in the show notes. But is that something you disclose? I’m just interested in that.

Jeremy Cordon  32:32

But we do have a graph on our website that we put out. We update every quarter showing backs are out there. I think last update shows 11.8 million gold backs. Yeah. You know, and if you figure they’re worth about four bucks apiece, you know, you’re looking at right around $50 million worth. Yeah. But like I said in the month of March alone, yeah, we might have done more than 10% of that in one month. And just march, you know, we’ve we’ve seen a huge spike in interest, with all the banking turmoil out there as people are looking for safer places to put their money.

Gene Tunny  33:07

Yeah, yeah. Understandable. Okay. Jeremy Cordon this has been fascinating. I’m gonna look more into it. And yeah, it looks like you’re you could be at the start of something really big. I mean, I guess it’s, you know, you’re doing well, already. If you think about where you are, and I mean, the potential for it. I mean, it’s, you know, it’s even much bigger than that. It’s huge.

Jeremy Cordon  33:30

It’s very early days, right. It’s very early days, you know, and, you know, I really hope that we see greater adoption of the technology, there’s, you know, possibly a global demand, you know, stable inflation proof commodity currency. And, you know, the future I think a lot of it depends on, you know, how are central banks gonna react, how our governments gonna react, you know, people tend to really like them, but, you know, you have these established kind of powers. And I’m hoping they look at this as, you know, technology and an opportunity, as opposed to, you know, an antagonistic competitor, you know, because really, who owns all the gold? It’s not me, you know, it’s that, you know, and if I can make more useful, maybe there’s something there.

Gene Tunny  34:13

Yeah, yeah. Yeah, exactly. Okay. Jeremy Cordon, president of Goldback, thanks so much for appearing on the show are really found that fascinating, and it’s, it’s good to see practical examples of commodity money in the modern world. So it’s terrific. So thanks so much for your time.

Jeremy Cordon  34:35

Yeah, no, I think I think you’ll be really pleased with it. I’ll just send you some Goldbacks. Standalone and then pass them around. Please do you know

Gene Tunny  34:43

Excellent. Okay. Thank you, Jeremy. You have a have a great day. Thank you. Take care. Okay, I hope you found that informative and enjoyable. Jeremy is super passionate about gold backs. And I must say I was impressed by the rate of growth of gold backs in circulation. And I enjoyed learning about the different types of people who have been buying them. And I must say I was surprised that it appears many local businesses have been accepting them as payment. Certainly, it’s an interesting experiment, and one I’ll keep an eye on in coming years. The one reservation I have about gold backs is that you have to pay substantially for the privilege of having gold back money. Given only half the value of a gold back is due to the gold content. One gold back costs over four US dollars and it contains 1/1000 of a troy ounce of gold. Currently, a troy ounce of gold is worth nearly 2000 US dollars, that is around $2 for 1/1000 of an ounce. Of course, if you’re worried about a future hyperinflation or societal collapse, paying $4 for each gold back could be a good deal. As Jeremy has argued, in that scenario, gold backs could end up serving as a widely accepted currency. I don’t think we’re headed for that scenario, but I’m less sure about that than I have been in the past and hence, I can understand why some people may see gold backs as a useful thing to buy. Furthermore, I admit they do look impressive, and there would be some novelty or show of value in owning some gold backs. And yes, I’m I’m actually looking forward to getting my hands on some. Of course, none of this is financial or investment advice. Okay, I’d be interested in your thoughts on gold backs. Do you see value in them? How widespread Do you think the use of gold backs could become? Please send me an email with your thoughts. You can reach me via contact@economicsexplored.com. Thanks for listening. Righto, Thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

37:36

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Credits

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Categories
Podcast episode

Why fiat money means higher inflation & why a radical Reserve Bank review is needed w/ Darren Brady Nelson – EP179

In his recent Spectator Australia article, Darren Brady Nelson argues for a radical, not a reserved review of Australia’s central bank, the Reserve Bank of Australia (RBA), which he describes as reckless. In Economics Explored episode 179, Darren provides an Austrian economics perspective on central banks, fiat money, and inflation. Show host Gene Tunny wraps up the episode with a discussion of the historical evidence on different monetary systems and inflation, evidence which confirms economies with fiat money are much more inflation prone. Gene then discusses whether a return to the gold standard would be desirable. 

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

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

What’s covered in EP179

  • Darren’s thoughts on the current review of the Reserve Bank of Australia [1:46]
  • How the RBA interprets the stability of the currency objective [6:54]
  • What is the Austrian School? [10:19]
  • Would the Austrians recommend abolishing the central bank? [21:08]
  • The Bank of England’s report on modern banking [25:54]
  • The need for a broader review of the Reserve Bank of Australia [30:35]
  • Fiat money systems are much more prone to inflation than commodity money systems [34:20]

Links relevant to the conversation

Darren’s bio on the Economics Explored website:

https://economicsexplored.com/regular-guests/

Darren’s opinion piece on the Spectator Australia website:

The RBA (reckless bank of Australia) needs a radical, not reserved, review

Bank of England paper on money creation:

Money creation in the modern economy | Bank of England  

Minneapolis Fed paper on fiat money, commodity money, and inflation:

Money, Inflation, and Output Under Fiat and Commodity Standards | Federal Reserve Bank of Minneapolis

US Gold Commission Report 

Minority report of the Gold Commission, co-authored by Ron Paul:

The Case for Gold: Minority Report of the US Gold Commission 1982  

Alan Greenspan’s autobiography discusses his advice to President Reagan regarding gold:

The Age of Turbulence

Another great book on Greenspan which discusses Friedman’s views too:

The Man who Knew: The LIfe & Times of Alan Greenspan

*You can help support the show by buying a copy of either book via the links above. 

Transcript: Why fiat money means higher inflation & why a radical Reserve Bank review is needed w/ Darren Brady Nelson – EP179

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  00:06

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 and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, thanks for tuning in to the show. This is episode 179. In this episode, I chat with my old friend Darren Brady Nelson about his recent spectator Australia opinion piece on the Reserve Bank of Australia. Darren’s piece is titled The RBA reckless Bank of Australia needs a radical not reserved for review. Although Darren’s article focuses on Australia’s Central Bank, the issue is considered irrelevant to central banks around the world such as the US Federal Reserve and the Bank of England. Before we get into it, I should note that Darren is coming from a non mainstream school of thought known as Austrian economics. While it’s outside of mainstream economic thinking, I think the Austrian perspective is valuable. Nonetheless, it’s forced me to confront some of the things I take for granted about the modern mixed economy, such as fiat money and the existence of a central bank at all. I’ve had to think more deeply about whether they make sense. Please stick around to the end for some additional thoughts from me. Okay, let’s get into the episode. Darren Brady Nelson, welcome back to the show.

Darren Brady Nelson  01:46

Thank you. Thank you. It’s been a while now actually.

Gene Tunny  01:48

It has Yes, I’ve given you a breakdown. And I’ve tried to get here a broad range of guests on the show. But yes, sir. Good to have you back on the show to chat about some recent work that you’ve done. So work in both public finance or fiscal policy, you could say, and monetary policy. Darren, so we’ve got a monetary policy review in Australia at the moment, and you’ve written a piece on the monetary policy review. And could you just tell us what your thoughts are on that review, please?

Darren Brady Nelson  02:21

Well, look, just to step back slightly from that, you know, I’ve kind of been disappointed over, you know, probably the course of a decade or something like that, that, you know, obviously, it’s good to have a variety of different takes on things like the Reserve Bank are obviously, you know, this review, that’s, you know, nearing the end, I believe the reporting to government next month. But, you know, there’s, there’s this never been, you know, look, I’d love to see kind of more of an Austrian take on things, at least once in a while in the Australian media, or even in Australian think tanks. To tell you the truth, I’d settle for a bit of a Chicago take on things and you just don’t get really neither of those takes for the most part, certainly not in the media. You know, look, I’ve never had a chance to read our friend, Tony, Megan’s take on the Reserve Bank. I know, he wrote an article for spectator, just like the article I’ve just written is meant to be published soon by the spectator, Australia. So I’m not sure his his exact take, and maybe you can tell me if you’ve read his article, I’m not sure, Gene, if you can give a little bit of overview of what how he viewed things, but so I just wanted to kind of bring a little bit of a, you know, an Austrian, take two things, in terms of, you know, linking sort of, you know, the Reserve Bank, the money supply and inflation, in a nutshell. And also, I found that people often didn’t kind of step back. And they, they vaguely mentioned what the Reserve Bank is supposed to do, and kind of leave it at that just kind of go into in to have a very different take than what I wanted to give. So, as not only an economist, but also a former law student, I also wanted to kind of start out and go, Hey, this is, you know, this is what, you know, the legislation says, for instance, about the Reserve Bank, and what they’re doing what they’re supposed to do, and then kind of jump in to, you know, like I said, sort of an Austrian economics take on things and, and also kind of stir the hornet’s nest a little bit, you know, by using a little bit of satire at the beginning and at the end of the article.

Gene Tunny  04:29

Right, okay, so yeah, we might get into a few of those things. So what does the law say? What, what does the what was your analysis of the, of the legal underpinnings or what they’re supposed to do under the is it the Reserve Bank act?

Darren Brady Nelson  04:45

Yeah, I mean, some people really just don’t understand what it is, you know, exactly, you know, sort of made that clear this, this is a central bank, you know, they, they basically have a monopoly control over currency in Australia. And you know, people kind of vaguely maybe understand that, but just to make that kind of really clear, you know, this is what it is. It has some other roles, of course, it has, you know, kind of these other banking, regulatory functions, but they really, you know, those are really to support the main goal, which is, obviously, Reserve Bank’s not unusual, it’s a central bank, very similar to the other central banks around the world, like the Bank of England or the Federal Reserve. But just to remind people, Hey, this is, you know, this is a government entity, it has a monopoly on on money, essentially, but at the same time, it’s required to do, you know, in that context, it’s, it has, you know, some of these broader sort of things, it’s three main things, you know, where it goes under Section 10, A, the stability of the currency, the maintenance of full employment, very, you know, 1940s 50s sort of thing that was thrown in, because the, you know, the Reserve Bank act is from 1959. So, you know, very Keynesian sort of thing there. And the other one kind of, you know, somewhat more vaguely, but, you know, still important, obviously, the economic prosperity and welfare, the people of Australia. Now, you know, look, there’s only so much you can say, in an in an article, even though my article is a bit longer than your average op ed, if you like, but there’s even within that there’s so much you could say, and I couldn’t say, but, you know, obviously like to say the audience, I think they got some issues, because these things conflict, or, you know, you can interpret these things and quite different ways. You know, clearly, I think, you know, I would argue, and I do to some extent, at least I think in my piece is, you know, certainly printing the sort of amounts of money that they have, and not just not just recently, and not just since COVID, but actually over a much longer period of time. is, you know, quick, you know, I would question that that really helps the stability of the currency. You know, that seems to me to be at least something questionable. I think it harms the stability of the currency, but I think it’s at least questionable. It also argued that it actually helps out the other two, I don’t think it may help with statistical, full employment. But does it really help with economically efficient, full employment, much less, you know, actual economic prosperity and welfare? Yeah, sorry. Go ahead.

Gene Tunny  07:19

I was just thinking it was an interesting point you made about stability, the currency. And you don’t think that the growth of the money supply we’ve seen that the RBA has overseen is consistent with stability of the currency, they have essentially redefined stability of the currency, they now we now define stability, the currency is not zero inflation, we define it as a two to 3% inflation on average over the economic cycle. So we’ve accepted a certain, a small well – I won’t make any judgement a lower than average historical average rate of inflation as the target. That’s what they’re going for. And over the last 30 years, they would argue that they’ve achieved that. And it’s much better than the performance in the post war period prior to that. So they would argue that they’ve done a good job at achieving stability of the currency in that regard. But yeah, it just occurred to me that when you said that that’s in the Reserve Bank act, that they’ve redefined what stability actually means, in turn, using that inflation target.

Darren Brady Nelson  08:24

Yeah, look, I mean, it’s fairly easy to pull up what, for instance, CPI looks like, and it’s an, even though CPI is only accounting for, you know, something like 40% of the economy, and we, you know, it’s a big chunk of the economy, but people have this impression that accounts for 100% of the economy or something like that. So even in that context, it’s not a pretty picture, you know, and we’re not talking about just like, oh, for a quarter or two, or for a year or two, we’re talking over, you know, quite long, you know, timeframes, you know, we’re talking from the basically the 1970s, with some flattening out, I would argue, do some pretty good counter reforms, if you like more that counter reforms that, you know, reforms that, you know, would counter some of the bad effects of, of just, you know, kind of having fairly loose monetary policy. And that not equally loose throughout that whole period of time. But, you know, it’s really, really hasn’t had a Volcker, for instance, you know, that I’m aware of, in the same sort of timeframe that, you know, since Volcker appeared on the scene in the late 70s, and has since left it. So putting aside, you know, again, my pieces and obviously, to go, so, do some technical thing to go like, Well, did they meet their own sort of technical requirements, and then just criticise them that way? Because there’s plenty of articles like that. You know, my aim was to point to the broader thing that just looks money like this. And if you look, I mean, CPI doesn’t look good over time. But if you start looking at money supply, whichever one you want to pick, it’s not a pretty picture.

Gene Tunny  10:00

right. Okay, so can I ask what do you mean by an Austrian Economics take?

Darren Brady Nelson  10:05

Yeah, look at that. So for those who don’t know, Austrian Economics is, I mean, I mean, a lot of people even economist for some reason don’t fully are aware that there’s actually different schools of thought, quite a few different schools of thought. And one of them is the Austrian School. It started with Karl Menger, in the sort of mid to late 1800s. He’s also, you know, attributed along with a couple other economists is kind of starting the marginal revolution as well. In the end, they call it Austrian School, basically, because he is actually from Austria. And then some of the other sort of people who followed him like Bomba Virk, Mises, Hayek, etc, they were also literally from the country of Austria. So I guess that stuck, obviously, is the name of the school of thought. I mean, I mean, the very free market, I argue that the there’s certainly the most free market oriented, I’d argue that they’re not the most free market oriented because they have an ideological stance. So you can always say that, you know, certainly, like someone like Mises, certainly, you know, went to great pains to go like, this is what I think the logic and even the data, even though they’re not sort of like the, they’re not, they use data, they’re not they don’t think data, without theory tells you anything, but they would argue that, you know, they take a scientific approach to things like, you know, like other schools of thought would also argue, and, you know, they have very, they, they have the most comprehensive take on understanding money, basically, including, you know, I mentioned Bomba Virg actually Menger even before that, that even from the start Menger Bomba, Varick and Mises were, were and still are kind of, you know, the greatest thinkers on money. Some may argue that you could put Keynes in that category, you know, that was one of his, you know, one of his big sort of focuses prior to him writing the general theory. But, you know, the Austrians certainly have a lot to say, and I think, a lot of credible things to say, with the, you know, you ultimately agree with them or not, you know, I just want to get those kinds of ideas, you know, out there in the Australian public.

Gene Tunny  12:20

Okay, and what are those ideas, Darren, and how are they relevant to the RBI review?

Darren Brady Nelson  12:25

Well, look, I mean, in a nutshell, and, you know, I’ve used this quote, a million times, it seems, you know, using Milton Friedman, who’s not Austrian, but Chicago School, who him and Anna Schwartz, you know, sort of took a an empirical approach if you like, I mean, I don’t think you’re setting out to, if you, like, test the theories of Mises, and people like that as such, but they confirm that, you know, inflation, it’s a monetary phenomenon. And it’s always in, at least in practice, you know, you know, maybe the Chicago school don’t necessarily agree that in theory, things like central banks, are really the root cause of inflation. They certainly agree that in practice, that’s what actually happened in history. So but the Austrians, like I said, they go, they go one step further, they go in great detail, to set out the case of why central banks are at the centre of, of why we have ongoing inflation. And the only way you’ll ever solve the inflation problem is to do something about central banks, and they would argue you have to do something stronger than just holding them within certain bounds. As you know, the Chicago school would argue,

Gene Tunny  13:38

Rod, okay, and I mean, fiat money is relevant to isn’t it? So you’re yes, you’re saying the the issue is that you’ve got a central bank that has the monopoly on fiat money, the monopoly control of the currency, which is fiat money, and they can just print it, they can create it out of thin air. And we saw that during the pandemic in Australia, when they finally the RBA, finally engaged in quantitative easing, the Federal Reserve had done it previously, the Bank of Japan and Bank of England and ECB, but we hadn’t actually gone that we hadn’t taken that step yet. But we did during the pandemic,

Darren Brady Nelson  14:15

well, the Austrians were there to drag, you know, central banks always are involved in a process and printing money out of nothing. Now, quantitative easing, took it to new levels, makes the new mechanisms, new levels, and then obviously, modern monetary theory sort of opens the floodgates to go further than, you know, quantitative easing, but if you like allow within that sort of framework of thinking, and we may get onto this later on, but, you know, the Bank of England produced a couple, you know, excellent papers that an Austrian or a neoclassical or a Keynesian or Chicago can all appreciate. It takes something out of just like, you know, just clearly setting out how does the central bank work, but also You know, just as importantly, how does the banking system more broadly, in cooperation, if you like, with the central banks operate, you know, How is money created? I mean, I think the, the title of the paper is money creation in the modern economy, you know, that sets it out quite nicely, they have a different view of that, the course they don’t think that’s an issue as such, you know, it provided obviously, or you stay within certain bounds and all that type of thing. But it does set out the fact that, you know, money is being created from nothing, which is quite a different system, to what, you know, say, for instance, the gold standard, you know, the classical gold standard with all its whatever foibles it had, because Austrians would argue that there could have been a better gold standard, but fine, there was a gold standard, and even central banks. Were part of that system previously, if you like, and the Bank of England also nicely sets that out that history as well. Yeah. So basically, again, coming back, you know, the Reserve Bank’s not any different from the Bank of England Federal Reserve, largely speaking, I mean, there are differences, you know, obviously, you know, the Federal Reserve, obviously, they’re different sized economies, different sides, sizes of the Australian dollar, the US dollar being traded around the world, obviously, the US dollar is special in the sense that it’s still the reserve currency for the world. So you know, their, their prolific money printing, they can get away with it a lot better than, you know, a smaller economy or economies, it’s not the reserve currency of the world, you can get away with Australia being does punch above its weight, and its currency is traded a lot more than you would expect for a small country. Because of you know, obviously, Australia is a big player in commodities, for instance. And that kind of part of the reason is, Australia, punches above its weight if you like.

Gene Tunny  16:45

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

Female speaker  16:50

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Gene Tunny  17:20

Now back to the show. Now I’m just on the what the RBA review is doing it’s it has rather than a narrower terms of reference is looking at the monetary policy framework inflation targeting is looking at the governance the board, whether we have a separate Monetary Policy Committee, I think that’ll end up being one of the recommendations. And the way that John Humphrys described it to me on his Australian taxpayers Alliance live stream, he just said, Well, look, there’s an Overton window of what it’s going to look at, right? I mean, there’s things that are in the Overton Window, there’s things that are outside, and I think you are advocating that they should they should go outside of that window, they should go outside of what’s conventional and actually think about the role of the the RBA as a central bank, is that the type of thing we need? Is that working for us? Or Are there alternative approaches? Is that what you’re you’re arguing? Darren?

Darren Brady Nelson  18:18

Yeah, look, I think I’ve I pull out some recommendations I did. When for Liberty works at the request of Senator Malcolm Roberts, you know, did a submission to his rural banking inquiry, because he wanted to get on the record. And so did I just kind of some of these broader issues of monetary policy and how they do impact the kind of the more narrow review that he was doing at the time. And, yeah, basically suggests, you know, kind of a three pronged approach, you know, sort of, in a shorter term, doing something, you know, a bit broader than what this current review is doing, but nothing, you know, something that might still be within the Overton Window, as you say, and then, you know, what I’m suggesting over the medium term in the longer term are certainly things that, you know, I guess the average policy person, monetary policy person would think, would be outside the Overton Window, like, you know, the Overton window. It’s a good thing to understand in terms of what is, but it can be a very big obstacle to what should be, but because, because I can point to, you know, the reforms, the Hocking Kingdom reforms of the 19, mid 1980s were, you know, not particularly within the Overton Window, national competition policy when it came along in the early 1990s. Not quite in the Overton window. There’s been a lot of good reforms that that are not in the Overton window. Obviously, you know, there’s obviously a politics involved and making sure that even though it’s not quite the Overton window that you know, you don’t scare the horses too much. And people who who’ve been pushing things In the direction of more and more government interference in the economy, including if you like the more draconian stuff, you know, the the over the top lockdowns, the the censorship, all these sorts of things. Putting aside the fact that no a lot of censorship are done by private companies, but they’re done by the best of government, they’re done by the best of government, if you don’t do it, you know, there’ll be trouble for you, private company. So, you know, it’s it’s certainly not, I don’t think, you know, the libertarians have suggested that, so it’s private property, so doesn’t matter. That’s not right. So, you know, people on the left, in a nutshell, don’t care, a rat’s butt about the Overton window for the most part. They keep on plugging away. And they are largely winning. So which is why I wanted to point out some of these reforms, if you like, went more in the direction of the right centre, right, for instance, including, you know, a Labour Government and including, you know, some liberal governments in the past, things can be done. So the Overton window, you got to be aware of it, you got to understand it. And it’s something you need to deal with, but it shouldn’t be something that just stops you from doing

Gene Tunny  21:08

something. Right. And so what would, what would the Austrians recommend abolition of the central bank? I mean, what would happen? What would you recommend?

Darren Brady Nelson  21:18

But look, you know, look, the Austrians there’s quite a variety of views, even within the look, you know, there’s sort of a high IQ, sort of, like competing currency approach, there’s the Roth bar, it’s more, let’s do a new and improved version of the gold standard, if you like, obviously, these things are digitised. No one’s ever suggesting that, you know, that we carry hunks of gold. That’s fine. If you want to carry hunks of gold with you. You know, it’s probably not going to be a huge market for that. That’s going to be but I mean, they recognise that centuries ago anyway. So like, you know, the gold standard, really, there were people running around with bits of gold with them all the time that that was never the case. You know, because the goldsmith’s figured it out before the official gold standard came around today, certificates, it seemed to be a little bit more convenient, you know, which that’s where actually money came from your paper money, I should say, sorry, paper came from from those certificates. So have John freeze. It, he always has a bee in his bonnet about Murray Rothbard. In particular, his argument that he considers, you know, today’s system of fractional reserve banking to be fraud. You know, from a, from a common law perspective, you know, is that Rothbard is arguing literally, in the laws on the books, that it’s actually fraud. He’s saying, under common law, this would be considered fraud. Yeah, okay, maybe, maybe not. But certainly the market would allow a whole lot of fractional reserve banking, I’m sure there won’t be like a one to one alignment all the time, you know, between, you know, reserves and loans and all that sort of stuff, that’s fine. But there wouldn’t be such a huge disconnect that we have, you know, we’re talking 90% and above disconnect between, you know, safe savings and what’s being lent out, getting back to sort of Rothbard is not given sort of credit for being more practical than he was. Yeah, he goes like, here’s the ideal I want. Yeah, you get rid of central banks, and fractional reserve banking. But any little step in that direction, could be pain. How about is a start? What’s just what’s just audit this thing? And, you know, like they talked about in the US sometimes, so let’s just audit the Federal Reserve. Yeah. What are they up to? How do they do things, but the public know, this is what it is, you know, are you happy with this? Is this make sense? You know, yeah. Do you? Are you happy with the consequent the inflationary consequences? Are you happy with the fact that I mean, this thing is very inexorable. You know, like, it causes the booms and busts as well, at least from an Austrian perspective, because inflation and bubbles, it’s the same thing. Inflation doesn’t uniformly happen. It goes, it ends up in asset bubbles, it goes over here, it goes over there. Some people can make a killing out of really not being very good at what they do. They just, they’re just in the right place at the right time. Now, we’re not talking about discouraging proper entrepreneurialism, sometimes, you know, this is kind of like, you know, sort of not very good, sloppy, property oriented sort of entrepreneurialism. And there’s a lot of it, there’s a lot just, it’s a lot of just kind of transfers from, from the poor to the rich. I mean, let’s just get that all out there and report, I’ll be happy with multiple views, you know, red versus blue type of project, Hey, what are the Keynesian think of this, you know, what are the Austrians think of this, whether neoclassical think of this, you know, you know, get it all out there. And, you know, just make it more transparent would be a great start, rather than this kind of, you know, tweaking at the edges. There’s basically a lot of people in political and business power, who, who obviously liked the system as it is,

Gene Tunny  24:55

or they or they don’t want to, I mean, yeah, they haven’t really thought too deeply about Got it? Yeah, they don’t want to rock the boat too much, perhaps. I think we might have to come back to Rothbard views. That sounds interesting. And because it’s probably we probably don’t have enough time to go into it now. That yeah, I think it’d be worth coming back to that. Because yeah, I’m all for a more wider ranging review. I think it’d be fascinating. I think we chatted about this last time we caught up, but we hadn’t seen the terms of reference yet to the review. And I think you’ve predicted that it’d be quite narrow. And it’d be very, you’d get standard sort of mainstream economists on it as we ended up doing, as we ended up doing. I’m not critical of any of them. I think. But yeah, they could have had a broader terms of reference. For sure.

Darren Brady Nelson  25:44

Just one thing to say that the Rothbard you know, some people go look here, you’re kind of in your libertarian utopia, you don’t understand how the system works. He wrote the very best book on how banking works. modern banking, what’s the book called modern banking, is it? No, it’s called the mystery of banking, the mystery of banking. Okay. It’s in great detail exactly how so it’s basically the Bank of England, you know, they they don’t refer to the mystery of banking, they, but they did a very good job of doing something smaller. Got some really good graphics, you know, in the Bank of England report bits, they’re very much aligned. They just have different conclusions. You know, obviously, they don’t come to the same conclusion that Rothbard does.

Gene Tunny  26:26

Right. Yeah. I mean, that’s the article where they describe how the banks essentially, they’re at the vanguard of creating money, or they’re the, the money supply is endogenous to an extent, because the banks are extending credit. And when they’re extending more new loans and paid back then that’s an expansion of the monetary money supply. Now, the central banks involved, the central bank can influence the money supply. But the banks are heavily in the private banks are heavily involved in it. And I think that’s what they’re arguing with they it’s that endogenous view of the money supply. And yeah, I think it is worth reading. What What was the main takeaway for you out of it, Darren, what the Bank of England wrote, I’m just trying to remember what they what was in those articles.

Darren Brady Nelson  27:16

The main takeaway wasn’t like, wow, I’m surprised. This is how they do it. My main takeaway was, Wow, I’m surprised he said it. And I guess another WoW is Wow, thank you. That’s, you know, they explained it really well. It was a really clear, I mean, rock bards. Book mystery. bankings really big, you know. So, you know, it’s, it’s a tome, it’s huge. So, you know, the Bank of England’s report has both an introduction, if you don’t want to redeem read the more detailed report, but even the more detailed report is nowhere near the size of the mystery of banking, but they’re all saying the same thing in terms of like, describing the process, right. You know, you know, what is central banks do what do the commercial banks to? I mean, so basically, the thing, you know, when right away when someone gets gets a loan, that’s money already. So you’ve just increased the money supply right there. Yeah. They don’t need things to happen. It’s right there. They whack it in your bank account. Obviously, people do all sorts of different things with that. Yeah. But yeah, the right there. So there is one thing I must admit, I figured, you know, fractional reserve banking, or those banks creating money, I knew that I was, you know, over time, I was trying to understand that they were actually printing most of the money. It wasn’t the central banks themselves. But when I saw when I saw the Bank of England, I didn’t realise the percentage was quite as big as it is. They said, 97% 97% of all money. Yeah, in the UK. And it wouldn’t be very different from you know, going to any Western country, it’s probably all gonna be the 90s to some extent, was this, you know,

Gene Tunny  28:54

they actually used the term fountain pen money. Yeah. Okay. So I guess I was even surprised at the size. Right. Yeah. Okay. And so you see that as a, as a confession or just acknowledgement of the Bank of England by the Bank of England of, of how the money supply can grow. And in you’re taking from that, that the system that we have naturally leads to expansion of the money supply into inflation. Is that what you’re inferring? From that, Darren?

Darren Brady Nelson  29:27

Yeah, but basically, it’s, it’s that it’s even more than that. It is literally inflation. But, but obviously, there’s certain levels of inflation, the other can be vary quite a bit. I think it incentivizes, you know, high inflation or certainly, it’s certainly incentivize booms and busts. Yeah, I wouldn’t say necessarily there was a confession or anything like that, but they do actually, early on in the report. Take the method that I certainly read in my economic textbooks, you know, that basically banks are just purely these intermediaries who get savings and then lend them out. Obviously take a little bit of a cut. Okay, fine. That’s, that’s, that’s fine. I don’t have a problem with that as a business. Yeah. They basically knock that on the head. Yeah. But interestingly enough, they don’t do it in a way that they say this is bad. But for me, I read it and go, you know, because of my kind of Austrian take on things I go, Well, that’s not good. You know, they’re just kind of, they’re just saying, This is what it is basically, it’s not this. They’re not just simply intermediaries. This is what these banks are. And this is how we, as a central bank, interact with those banks. Again, I think any any economist of any school of thought would find it, you know, an informative paper.

Gene Tunny  30:42

Oh, absolutely. I’ve talked about it on the show before I’ll put some links in the show notes. I think it’s good paper. And yeah, I’ll link to your spectator article. Once it’s out. Gee, Darren, there’s so much to talk about. Really appreciate your time, we dealt with some big issues, and we’ve still got more to talk about. Certainly, I want to come back to Rothbard. Yeah, that’s, uh, I’ll have to have a read of his of his book, and mystery of banking. And, yeah, I really appreciate your time. So thanks once more for coming on to the show.

Darren Brady Nelson  31:15

Thank you for having me.

Gene Tunny  31:26

Okay, I hope you found that informative, and enjoyable. I welcome Darren’s call for a broader review of the Reserve Bank of Australia. Given the importance of the Reserve Bank in the economy, we should be thinking about what presuppositions were making about the bank, and we should subject them to critical thought. The current review of the bank appears to take for granted that the reserve bank should continue as an entity and it should retain its extensive powers under the Reserve Bank Act. The review focuses on the appropriateness of the inflation targeting regime and the governance of the bank, but it should be much broader. The reviews Terms of Reference noted explicitly that the review will exclude the RBS payments, financial infrastructure, banking and bank note functions. Arguably, it would have been desirable to review even these functions of the RBA. So I think Darren is on the right track here. Even if I disagree with him over what a broader review would recommend. There are at least two big related questions that a wider review would consider. First, do we need a central bank? That is Do we need a government owned or authorised bank which acts as a bank for other banks and is ultimately responsible for the currency. Secondly, would commodity backed money where money is convertible to gold at a fixed rate? Would that be preferable to fiat money, where money is decreed to be the legal tender of the land by the government and the money supply is the responsibility of the central bank. In a Wi Fi at money presupposes a central bank or an arm of government such as the Treasury which effectively acts as a bank. But a central bank can exist in a commodity money system too, and indeed several such as the Bank of England and US Federal Reserve. They did exist during the years in which the gold standard was in place or some of the years in which the gold standard was in place. A central bank can perform an important role regardless of the monetary standard in place. As the 19th century British polymath Walter Badgett illustrated in Lombard Street, a central bank and perform an important role by acting as a lender of last resort. That is lending to banks when they temporarily get into trouble. And, you know, saving those banks from collapsing and causing lots of hardship. My view is that a central bank is an indispensable part and an unavoidable part of a modern economy. Regarding the second big question, I wouldn’t recommend a return to commodity money by say reintroducing the gold standard. But I will concede that advocates of a gold standard have some good arguments on their side. These arguments are even more appealing in times of high inflation such as the time we’re now living in. Most importantly, in my view, it is clear that fiat money systems are much more prone to inflation, then commodity money systems. A 1998 study by economists at the Minneapolis Fed found that the average inflation rate for the Fed standard observations so this is observations and the data set they’re analysing the average inflation rate for the Fed standard observations is 9.17% per year. The average inflation rate for the commodity standard observations is 1.75%. That’s a big difference. The data set they use contain data on 15 countries including In the US, UK, France, Italy, Germany, Spain, Argentina and Brazil, among others. Every country in the data set had a higher rate of inflation under a feared standard than a commodity standard. What’s going on is that obviously, there are physical constraints on the amount of commodity money available. It’s limited by the rate at which it can be discovered dug up and produced. Under a feared standard, new money is virtually costless to produce. As Darren and I discussed, the central bank and commercial banks are both involved in new money creation. And it’s possible for the money supply to expand faster than the productive capacity of the economy, leading to inflation, there can be too much money chasing too few goods. This is not to say that you can’t have inflation in a commodity money system. For example, there was prolonged inflation in Spain in in the UK in the 16th and 17th centuries, due to new silver mining and Mexico and Peru following European conquest. Still, as the Minneapolis Fed economists point out the average inflation rates over the period in these countries, it was only around one to 1.2% over 100 to 150 years. That’s one to 1.2% per annum. I’ll link to that study in the show notes so you can check it out. To me, it really clearly shows that fiat money systems are much more prone to inflation and you end up with inflation at higher rates than under a commodity money system. While a commodity standard would yield better inflation outcomes and a feared standard, it would be very difficult to return to say the gold standard. US President Reagan appointed a Gold Commission in 1981. To consider whether the US should return to the gold standard. The majority of the commission rejected such a move, and prominent economists such as Milton Friedman and Alan Greenspan, they advised Reagan against the return to gold. GREENSPAN did, however, suggest issuing some US Treasury bonds backed by gold, something which would provide some fiscal disciplined. He did not, however, advocate a full return to the gold standard. GREENSPAN thought that a return to the gold standard would be impractical given the nature of the modern economy with a large role for government and a welfare state. A gold standard requires fiscal discipline for several reasons, which I might have to cover in a bonus episode. One of these reasons is that under a gold standard, a government can’t rely on future inflation to erode the real value of the debt it owes. In his 2007 autobiography, The Age of turbulence, Greenspan wrote the following. I have always harboured a nostalgia for the gold standards inherent price stability, a stable currency was its primary goal. But I’ve long since acquiesced in the fact that the gold standard does not readily accommodate the widely accepted current view of the appropriate functions of government. In particular, the need for government to provide a social safety net. The propensity of Congress to create benefits for constituents without specifying the means by which they are to be funded, has led to deficit spending in every fiscal year since 1970. With the exception of the surpluses of 1998 to 2001, generated by the stock market boom. The shifting of real resources required to perform such functions has imparted a bias toward inflation. In the political arena, the pressure to make low interest rate credit generally available, and to use fiscal measures to boost employment and to avoid the unpleasantness of downward adjustments in nominal wages and prices has become nearly impossible to resist. For the most part, the American people have tolerated the inflation bias as an acceptable cost of the modern welfare state. There is no support for the gold standard today, and I see no likelihood of its return. Austrian economists would say that Greenspan gave into big government into inflation, and there may be some truth in that. But Greenspan’s position is entirely pragmatic. I’ll put some links in the show notes so you can learn more about this fascinating episode of the Gold Commission, and about Friedman’s and Greenspan’s advice to Reagan. I’ll also add a link to the minority report of the Commission which recommended a return to the gold standard. It was co authored by Ron Paul, the noted libertarian politician. I’ll leave it there for now, but I recognise there are several aspects of monetary economics that I need to explore and explain some more. I think the process of money creation and how the central bank can influence the money supply would be good to go over in some depth, as it’s challenging to understand. My conversation with Darren also reminded me that it would be good to look at how we ended up with inflation. targeting in the first place? Why do we think it’s sensible to have a two to 3% inflation target rather than a zero target? I hope you’ll forgive me if I leave these questions to a future episode. Among other topics in coming episodes, I’ll have a closer look at the growing US China tensions and the rise of authoritarianism around the world. geopolitics obviously can have a big impact on economy, so I think it’s important that I cover it on this show. If there are topics you’d like me to cover in future episodes, please let me know. As always, feel free to email me at contact at economics explored.com Thanks for listening. rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economicsexplored.com or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

41:26

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Credits

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Categories
Podcast episode

Normalization of interest rates & monetary policy – EP173

Last year we saw the beginning of the normalization of interest rates and monetary policy, as central banks responded to accelerating inflation. Show host Gene Tunny talks about the current tightening cycle and when it might end with his colleague Arturo Espinoza. Among other things, Gene and Arturo discuss what history tells us about typical interest rates and returns on capital, referencing UK bank rate since 1694, interest rates on UK government consols, and returns on land written about by Jane Austen and Honoré de Balzac. They also consider whether we might see 17-18 percent interest rates again in Australia, rates which were last seen in 1989-90. 

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

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

What’s covered in EP173

  • What’s been happening with interest rates? [3:00]
  • What is monetary policy normalization? [6:00]
  • How many more interest rate increases will be needed? [11:11]
  • Will we have a recession this year? [19:12]
  • Is there a risk that we could get back to the crazily high interest rates seen in 1989-90 in Australia? [24:00]
  • What is the equilibrium rate of interest? What is the real interest rate? [26:54]
  • The main takeaway from this episode: monetary policy is still in a tightening cycle because inflation is too high [38:43]

Links relevant to the conversation

Data released since the episode was recorded

Australian retail trade fell 3.9% in December, suggesting interest rate increases are starting to bite, meaning the RBA faces an even more difficult challenge in deciding how many more interest rate increases to make:

https://www.abs.gov.au/statistics/industry/retail-and-wholesale-trade/retail-trade-australia/dec-2022

CBC article “U.S. inflation and consumer spending eased in December, new numbers show”:

https://www.cbc.ca/news/business/us-consumer-spending-holidays-1.6728173

Nine News story “Inflation in Australia rises to higher-than-expected 7.8 per cent”:

https://www.9news.com.au/finance/australia-inflation-consumer-price-index-december-quarter/9ef0ed13-e606-4c9e-b7db-feaccfae39fb

Inflation targets

US: 2%; see https://research.stlouisfed.org/publications/economic-synopses/2022/09/02/inflation-part-3-what-is-the-feds-current-goal-has-the-fed-met-its-inflation-mandate

Australia: 2-3%; see https://www.rba.gov.au/inflation/inflation-target.html

UK: 2%; see https://www.bankofengland.co.uk/monetary-policy

Bank of Finland article on monetary policy normalisation:

https://www.bofbulletin.fi/en/2022/3/what-is-monetary-policy-normalisation/

Chatham Financial article on US tightening cycles:

https://www.chathamfinancial.com/insights/historical-interest-rate-tightening-cycles

Jo Masters, Barrenjoey Chief Economist on how “Everything must go right for Australia to dodge a recession”

https://www.afr.com/markets/debt-markets/australia-will-dodge-close-call-recession-20221216-p5c71b

Chart on historical UK bank rate:

https://drive.google.com/file/d/1NDH7WjQBY0ZjWDWgY430qZdrrIf017_4/view?usp=share_link

Chart on central bank policy interest rates since 1960:

https://drive.google.com/file/d/1Mrzre-ijAKAvrU0j4YeQt71FkTr-gzob/view?usp=share_link

Chart on inflation in the US, UK and Australia:

https://drive.google.com/file/d/11lp880Wwb9bk_GI5wJ0EQ975h-ZkAuDK/view?usp=share_link

Wikipedia article on the Fisher equation:

https://en.wikipedia.org/wiki/Fisher_equation

Wikipedia article on UK consols:

https://en.wikipedia.org/wiki/Consol_(bond)

Guardian article on “UK bonds that financed first world war to be redeemed 100 years later”:

https://www.theguardian.com/business/2014/oct/31/uk-first-world-war-bonds-redeemed

What Jane Austen can tell us about historical rates of return:

https://janeaustensworld.com/2008/02/10/the-economics-of-pride-and-prejudice-or-why-a-single-man-with-a-fortune-of-4000-per-year-is-a-desirable-husband/

Transcript: Normalization of interest rates & monetary policy – EP173

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  00:00

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 and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, thanks for tuning into the show. This episode I talk about the normalisation of interest rates and monetary policy with my colleague Arturo Espinoza. Please note, the episode was recorded on the 11th of January 2023. Now, obviously, we weren’t able to cover any new economic data released after that date. So I’ve added some info into the show notes about important developments since then. One of the most important bits of data was the December US inflation rate. It came in at 6.5% yearly down from 7.1% in November. This figure was interpreted by economists as supporting the view that the US Fed will slow the pace of interest rate hikes in 2023. No longer increasing the federal funds rate in increments of half a percentage point or three quarters of a percentage point. Interest rates still need to increase because inflation is still too high and well above the 2% target. On the first of February, the Fed will probably increase its federal funds rate target by a quarter percentage point from the 4.25 to 4.5% range to the 4.5 to 4.75% range. If it doesn’t do this, I’ll release a short bonus episode looking at what’s going on. Economists expect there’ll be at least another interest rate rise in 2023. Beyond the quarter percentage point increase on the first of February, a view supported by the stronger than expected fourth quarter 2022 GDP figure that came out on the 26th of January. Unlike in the states in Australia, our latest inflation figures surprised on the upside coming in at 7.8% over 2022. I must say I was stunned yesterday when I noticed a 560 gram jar of Vegemite now cost $9 at Woolworths. The Reserve Bank of Australia really has no choice but to continue with its interest rate increases until it sees inflation falling or the economy crashing. As I noted my conversation with Arturo so much depends on how rapidly the economy slows down over 2023. Okay, let’s get into the episode. Please stick around to the end because I have additional thoughts after my conversation with Arturo. Okay, this is episode 173 on the normalisation of monetary policy. So, I’m joined by Arturo, my colleague at Adapt Economics. Arturo, good to have you with me today.

Arturo Espinoza Bocangel  02:58

Hi Gene, it’s my pleasure to be here.

Gene Tunny  03:01

Excellent. Arturo. So I thought for our first episode of the year, it would be good to talk about interest rates. So one of the big developments last year was the, you know, the increases in the interest rates by central banks, their policy interest rates. So the cash rate here in Australia, the federal funds rate, we had some rather unexpected increases in interest rates, all unexpected by many people in response to the high inflation rates that we’ve been experiencing. And so this did catch quite a few people by surprise, and our RBA governor here in Australia, Philip Lowe, as late as I think November 2021, he was saying that, he thought they’d probably be able to keep their cash rate at 0.1% until 2024. So that was his central case scenario, as he was calling it. But it turns out that inflation was ended up being higher than the Reserve Bank expected. And you know, perhaps they should have seen it coming because you would seen inflation accelerating in 2021 in the US and the UK. And so maybe the central bank should have seen it coming, but they didn’t. And we ended up going from a 0.1% cash rate. And now it’s at 3.1%. And that was over a period of from May 2022 to December 2022. And they had the last cash rate increase. So the same three percentage points over seven months or so. So just an extraordinary rate of increase. And similarly in the US, we had high rate of increase. And what we’re seeing is that interest rates are responding to the high inflation. And one thing I thought it’d be good to talk about is, well, where do we think these interest rates are going? Is there any guidance historically, or is there any guidance from theory regarding what’s a normal level of interest rates? So that’s one question we could ask. And how I came to think about this is that I saw increasingly these references to normalisation, so normalisation of monetary policy, normalisation of interest rates, and, and it got me thinking, Okay, well, what’s normal? So I thought that’d be good to explore. Do you have any thoughts on that, Arturo? Does that sound like a reasonable thing to talk about?

Arturo Espinoza Bocangel  05:51

Yeah exactly, that is gonna be an interesting topic, to know, what will be the normal interest rate?

Gene Tunny  05:59

Yes, well, this is a bit of a spoiler, but I think the key message will be that there really isn’t any normal interest rate that we can say that the interest rates are adjusting to that’s one of the challenges it’s it just depends on a whole range of factors, variables that we’ll talk about in this conversation. So to begin with a lot I’d read this article I found from the Bank of Finland, this was back in October and I thought this was really quite a neat way of talking about this normalisation. So they talk about the articles called what is monetary policy normalisation. And so they’re written in monetary policy normalisation, key interest rates or policy rates are once again becoming key instruments of monetary policy. At the same time, the central bank is gradually withdrawing from asset purchases and other unconventional measures. Monetary policy normalisation may also involve adjustments to forward guidance, normalisation leads to a tightening of financial conditions, helping the central bank reduce the inflationary pressures in the economy. Okay. So what they’re talking about there is that during the pandemic, when all of those policy interest rates were effectively cut to zero, our cash rate here in Australia got cut to 0.1%. Right, so it’s effectively zero. That’s what economists call the zero lower bound. So there’s nowhere else for the that policy rate to go, then what central banks what the Australian Central Bank did for the first time. So this has been done previously by the US, and the ECB and Bank of Japan, in response to the financial crisis back in the late 2000s. But we hadn’t done this yet. We did the quantitative easing, what they call quantitative easing, which is printing money. well printing money electronically, and then using that to buy bonds or other financial assets to drive down yields to drive down borrowing costs, with the idea of stimulating the economy that way. So that’s unconventional monetary policy. So what the Bank of Finland saying is that part of this normalisation story is yes, increasing that policy rate getting it away from that zero, lower bound, and moving away from the unconventional monetary policy. Yeah, that’s essentially what they’re saying in that passage there. Okay. And then they go on to talk about where are interest rates going to settle in the future. And this is where this is where they’re essentially saying that will no one, no one really knows, it’s very difficult to forecast that. They’re saying that the normalisation of monetary policy does not mean that the central bank is attempting to restore its balance sheet and interest rates to a past levels such as that preceding the 2008 global financial crisis. Okay, so what they’re saying is don’t necessarily look to what interest rates have been in the past, rather than the aim of monetary policy normalisation is that the inflation rate should accord with the price stability objective. In the absence of further economic shocks, interest rates should in the longer term settle at a level where economic resources are in full use and inflation is at its target, ie at the equilibrium real interest rate, also known as the natural rate of interest. However, the level of the equilibrium real interest rate is affected by a number of factors unrelated to monetary policy. Okay, so, gee, there’s a lot going on that passage there that I’ve just read. The way I interpret this is that essentially, we’ve got to get to an interest rate. So what the central bank is trying to do, its increasing interest rates to get inflation under control. And after it gets inflation under control, the interest rate is going to settle at a rate whereby it’s consistent with keeping inflation in the target band. So in Australia, that’s two to 3%. On average, other countries have similar target rates for inflation and that sort of 2%.

Arturo Espinoza Bocangel  10:28

Between two and 3%. Yeah,

Gene Tunny  10:31

yeah, yeah. So just, I’ll just put some links in the show notes, clarifying that what they are for all other economies. So we’ll end up with an interest rate where it’s consistent with that. And it’s also consistent with a reasonable level of economic activity. So a stable, well, a sustainable rate of economic growth. And I mean, you could call it full employment, but I’d probably say unemployment at what you’d say is the natural rate of unemployment rather than full employment, which is, I think, a difficult concept to actually to define in practice. So, I mean, what would that be? I mean, it’s hard to know, because it depends on how the economy will first we’ve got to find out how the economy responds to the current interest rate increases, and just how far the central bank has to increase the rates from here. So I think there’s generally agree that well, there’s quite a bit of agreement among commentators among the market economists, that interest rates will have to increase a bit more from where they are now. Because we’ve still got inflation in Australia over 7% Us 7% over 7%, we’ve still got these high rates of inflation or higher rates than we’ve experienced for a long time. We’ve pushed the policy interest rates up to 3.1% in Australia, 4.25 to 4.5%. In the US, I think, is the current target band for the federal funds rate. There seems to be a view that there’s still scope for them to push those up further. So in Australia, we could have another maybe two up to two cash rate increases. That seems to be you know, that’s a possibility depends on what your outlook is for the state of the economy. Some people are thinking that might be too much given that, you know, these interest rate increases are really starting to bite already is having a big impact on house prices. We’re seeing that already. So house prices are really coming off. If I look at the ASX this thing called the ASX 30 Day interbank cash rate futures implied yield curve. So this is based on market pricing for financial market products. So this is this What is it 30 Day interbank cash rate future. So, essentially you can bet on what the cash rate is going to be in the future. And from this, it’s showing that the markets essentially expecting that the cash rate will peak at a bit over 3.8% later this year, and then it starts coming off from a peak around I think that’s October, and then it’s slightly falling. And then by June 2024, it’s down around 3.6%. So the market here in Australia is expecting two to three additional increases in the cash rate it appears of around 25 basis points or a quarter of a percentage point. So the markets expecting two to three more increases. I think other economists would be but there’s debate about just how many and the current state of the economy and how the economy will react to that. That’s one of the great unknowns, how will households react to these higher interest rates. And that’s one of the unknowns too in other countries in the States. It looks like there’s probably there will probably be another, at least one more increase in the federal funds rate in the States. There was a report in the Financial Times yesterday regarding some comments from one of the Federal Reserve officials, Mary Daly think she’s from San Francisco fed and the FT reported that Mary Daly became the latest Federal Reserve official to raise the prospect of the US central bank slowing the pace of its interest rate increases to a quarter point rise next month, even as policymakers backed the benchmark rates surpassing 5% Okay, so if you, I think in the Federal Reserve in their publication when they publish their decisions, they have these charts, which show what the Federal Open Markets Committee members, what they forecasting for future federal funds rate, which is a really interesting way to do it. And it gives you some insight and into how the members are thinking and where federal funds rate could be going. It’s really quite a clever thing to do and possibly something the Australian reserve bank could think about doing. And I don’t know whether this is an issue that they’re considering in their manage their review of the reserve bank that’s going on at the moment, I might have to look into that. But it looks like yep, so. So members are the people who are responsible for monetary policy, and the states are expecting a couple more increases in that federal funds rate. So they expect it’ll end up getting beyond 5%. They’re currently targeting 4.25 to 4.5%. But what this is saying is based on recent data in the States, which suggests that the economy might be losing some of the some steam, its inflation may not be as much of a problem as previously, based on that. They’re saying, well, the Federal Reserve can slow down the rate of interest rate increases. So that’s what’s going on there. Okay, so the general expectation that we’d have is that there will still be a few more interest rate increases this year in the US and the in Australia, maybe two, maybe three? I don’t know, it’s so difficult. Everything depends on how the economy reacts. New data. It’s just very difficult to forecast. But one thing I think we can say is that there will be additional interest rate increases. Do you have any thoughts on that? Arturo?

Arturo Espinoza Bocangel  17:01

I have a question about, at what point those heights interest rates will cause a slowdown in the economy. What do you think about that? We will face a slowdown or not?

Gene Tunny  17:21

Yeah, yeah, I think that’s starting to occur. All in Australia, I think households are really starting to feel those interest rate increases and, and more households will this year, because we’re seeing mortgages that were taken out. So the home purchases, they borrowed at fixed rates, and that was for a fixed term, a couple of years, or whatever it was. And then after that, these fixed rates reset to another level. And so that’s going to happen increasingly over this year, we’re going to see more people who borrowed at a fixed rate, they will end up facing a higher interest rate. So those rates that they’re paying reset at a higher level based on current rates, and the current variable rate based on that, and they will therefore have, they will have to pay more to service their mortgage. So there are various estimates of what it means it depends on the type of loan you’ve got, it depends on the amount you’ve got outstanding on your home loan, but for many households, the interest rate rises, we’ve seen it could mean an extra thing is $1,000 a month or something that they have to pay in mortgage

Arturo Espinoza Bocangel  18:43

and depending on what loan.

Gene Tunny  18:46

Yeah, it depends on a whole range of things. It depends on what was the deal you got originally and how much you borrowed, how much is outstanding still in, in what you owe and the principal that you are? So look, it’s going to depend, but there’s no doubt that it will be a substantial hit to the budgets of many households. And we should start seeing consumption spending slow. But look, I mean, the last year the Australian economy performed, I think extraordinarily well. And unemployment got down to under three and a half percent, which is just incredible. Yeah, but I think definitely will go we shouldn’t see, nothing’s definite in economics in macro economics. Yeah. Things could judge. You just don’t know what’s around the corner sometimes. But look, I mean, my guess would be that we will start to see the economy slow this year. Will we have a recession? Well, I hope not. I think I’ve seen some forecasts from some of the bank economists might have been Jo Masters, or I’ll have to dig it up. But basically, they, they’ll say, oh, look, we think it’s more likely than not we won’t have a recession. But the probability of a recession is, I don’t know is 30% or something or 40%. I don’t know, I have to look that up. But I know that there are some people saying, Look, yes, it is possible that there could be a recession here, and also in the States. In fact, there were some people last year saying, Oh, the US had already had a risk that it was in recession last year, because they were two negative quarters of GDP. But it turns out that that was a bit of a statistical anomaly or just a freak result, and really didn’t signal that an economy then in recession. So yeah, look, it’s possible, we could see some recessions. But I mean, as always, I mean, I think, given the complexity of the economy, and all of the moving parts and all of the shocks that could occur, it’s just so hard to actually forecast that sort of thing. I mean, I remember when I was in Treasury, and right up until 2008, we were saying, and most macro economic forecasters, were saying, Oh, we’re in this new era of the Great Moderation, and we didn’t have to worry about the business cycle anymore. And then, I mean, then we have the financial crisis, and it’s the worst, worst crisis since the Great Depression. So things can change the I’m always reluctant to to provide any, any forecasts. Okay. So yeah, those are my thoughts. I mean, what do you think, Arturo, do you have any thoughts on it?

Arturo Espinoza Bocangel  21:42

Well, I think that we are under a period of higher certainty than other times after the global financial crisis. Of course, there are a lot of Australians that are suffering with these higher tax rates. Mortgages, as you have mentioned, I think we need to be cautious about this period.

Gene Tunny  22:07

Yeah, exactly. I found that that article by that mentions, recession forecasts by Jo  masters, she’s with think it’s a bank or some sort of investment being Baron Joey, is it. So masters thinks Australia will avoid a recession, but it will be a very close call. So this is an article in the financial review January 3, this year, so we’re recording this on the 11th of January, everything must go right for Australia to dodge a recession. Okay. So she’s one of the people who is concerned that because of these higher interest rates, then yeah, it’s going to have a significant impact on consumption, then she’s saying that offsetting that is the fact that we’re getting all of these international students coming back into Australia. So that’s one thing that’s going to add to demand. Okay. I’ll put a link in the show notes to this article by that mentions, Jo masters, predictions. Okay. So that’s, that’s where to from here. Okay, we’ll take a short break here for a word from our sponsor.

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Gene Tunny  24:00

Now back to the show. One thing that is concerned some people is wondering, Well, is there a risk that we could get back to some of the crazily high interest rates that have been seen in past periods? So in Australia, for example, we had interest rates at 17 to 18%. At one time, back in the late 80s, early 90s, we had really high interest rates, but that was also at a point in time. When we had inflation of around 8% We had money supply growth of 20% plus. So we had a big boom in the late 80s. This was the age of the entrepreneurs a lot of lending a lot of property, lots of speculation, and I would say that it’s probably unlikely I can’t see interest rates getting back to anywhere near that sort of crazy heights. Given that the macro economic conditions are different today, there was much more entrenched inflation, people expected high inflation. I think if you look one year ahead, some market economists are expecting inflation of over 4% or something like that. But it’s not as if every year we’re expecting inflation of 8% or something like that. So monetary policy doesn’t have to be as restrictive to get inflation under control to to get all of the money creation, all the credit creation that’s leading to the growth in the money supply, it doesn’t need to be as aggressive to get that under control. So my expectation is that we don’t have to, we wouldn’t see that, again, just because inflation is not at those Well, it’s not entrenched at those rates. So we’ve got high inflation at the moment at 7%. If it turns out that the RBA can’t get inflation down, then they will have to increase, keep increasing the cash rate. But I would expect they wouldn’t have to increase it anywhere near some of those really high interest rates that they have in the past, because it seems like your households are already they’re going to start suffering even with the interest rate increases that we’ve seen. So if they increase the interest rates a bit more, say another half a percent, then the hope is that that will start you know slowing the economy taking the heat out of the economy enough that we can get inflation under control. So yeah, we won’t get back to those, those crazy interest rates that have been seen in the past, just because the nature of the economy is different. We haven’t had sustained inflation over such a long period as we had back then over several years. And then having that inflation, getting expected having these entrenched inflation expectations which the central banks have to then act aggressively against. I’ll put some links to some charts on on inflation and interest rates and what we’ve seen in the past, and just so people can see if you’re in the audience, you’re interested, you can have a look at what what these things have been in the past. They what strikes me is when I look at, well, interest rates, which is what we’re talking about today, you look at interest rates historically, and they’ve been all over the place. This is why when we’re talking about normalisation when we’re talking about normalisation to some, what do they call it some equilibrium rate of interest where we’ve got the economy balanced, we’ve got inflation at Target, we’ve got the economy going along smoothly. We don’t know there’s no one interest rate over history, that’s it’s not going to be the same interest rate, it’s going to depend on the macro economic circumstances at the time. There was an estimate that the Reserve Bank put out of what the equilibrium real interest rate is. And the central estimate they came up with, I think it averaged at 1%. Now, that’s a real interest rate. And then if we think about what would the nominal interest rate be, this is something I may not have defined yet, Arturo. But we’ve got to think about, one of the reasons you end up with a 17% or 18% interest rate is because inflation is expected to be about 8% or something, or whatever it is. So the interest rate at least has to compensate for the inflation that’s expected. And then you’ve got the real component of the interest rate, the so called real interest rate. And the inflation gets added to that to get the nominal interest rate. So when this is one of the tricky things with interest rates, it needs to be appreciated. There’s a there’s a nominal interest rate and all of these, these rates that we’ve been talking about the policy, the cash rate, the RBA cash rate, or the federal funds rate, that’s a nominal interest rate. That’s not the real interest rate that has been paid. Because one thing that inflation does, it erodes the real value of debts. So if you’re only earning, I mean, you’d be earning more than the cash rate, if you’ve invested if you’ve bought a you know, an asset of some kind of financial asset. But let’s just say you, the cash rates 3.1% at the moment, the inflation rate 7.1%. Now, you could argue or looking backwards, this is an ex post view of things. So after the fact, if you’re only earning 3.1% per year on your asset and inflation was 7.1% then you’ve gone backwards 4% hit right. Yeah. Now that’s an ex post calculation another way, well, what ends up happening is that the market is going to adjust these interest rates will adjust to incorporate expectations of future inflation. And so, therefore, the interest rate that you see at a point in time, should equal whatever people demand on the market determined real rate of interest, plus the expected rate of inflation, which I think is that’s the Fisher equation, I think, isn’t it? There’s a relationship between inflation and interest rates. That’s called the Fisher equation after Irving Fisher, that I’ll put it in the show notes. Yes. Okay. So that’s a that’s a bit of technical detail. I’ll put some links on all of that. Yeah. And what I find extraordinary is that just over recorded history, there are all these different types of interest rates that we’ve observed. And I always go back to this great passage from John Maynard Keynes, one of the great economists, obviously. And Keynes, in chapter 15 of the general theory, incentives to liquidity wrote that it might be more accurate, perhaps to say that the rate of interest is a highly conventional rather than a highly psychological phenomenon, for its actual value is largely governed by the prevailing view as to what its value is expected to be. Okay, I think that’s quite clever and observation. And, yeah, what he’s getting out there is that it ends up being conventional, in a way, it depends on what it’s expected to be. And I think that’s quite interesting, because for a long time, well, after the financial crisis, there was this expectation of low interest rates, and that was supported by the central bank’s pumping a lot of money into the economy. But now, I mean, who knows, I mean, the expectation could be of higher interest rates. So we’ll have to wait and see where things settle, and what expectations and being and what people, people think as an acceptable interest rate. Historically, we’ve seen interest rates and the ones I’m quoting, they’re going to be nominal interest rates of around three to 4%. On government bonds. And so this can be considered a risk free rate, this could be considered as similar to the the cash rate, although a bit higher due to the fact that there’s a yield curve that if you borrow for, for a longer period, you generally have to pay a higher interest rate. But if we look at what we see in the data, or what we’ve observed in history, these UK consoles, which are perpetual bonds, whereby the government, the UK government borrowed, say, I don’t know let’s say they borrow 100 pounds, and then you get this console, this note that says, The UK government will pay you three to 4% of that. So three pounds or four pounds every year, in perpetuity, on that, that console of 100 pounds. I don’t know if that was the  actual denomination, but this is just to explain it. So these were perpetual bonds that the government never repaid. It just paid an interest rate each year. And historically, that was three to 4%, depending on when they issued the console, and what they thought was necessary to attract the people to buy the console to lend money to the UK Government, it turns out I think was about seven or eight years ago, the UK actually bought back the final consoles that are on issue. So there were these consoles that were that have been on issue for decades or centuries, that were still owned by nothing to various investors in England in the UK that the HM Treasury bought back finally, so I’ll put a link in the show notes there. So if we look at the historical evidence, we see consoles, they were yielding three to 4%. And if we look at the history of what’s called bank rate in the UK, which is the last day, that overnight interest rate, the policy rate, that the Bank of England influences historically, it’s ranged from, if we look at, from when the Bank of England was set up, so in 1694, it was looks like it was 6% or so I’ll put a link in the show notes to the actual data, and then it dropped down to what’s that nearly 3%, around 3%. Then for a long period from 1720 to 1820 it was about it was 5%. And then it fluctuates a bit more, I’ve got a chart that I’ve pulled off macro bond that I think that’s a great chart, I’ll put a link in the show notes. And then in the 19th century, it fluctuates quite a bit. And at times, it gets up to 10%. This must be related to the UK trying to maintain the gold value of sterling. So this is related. I think this is related to the gold standard, and having to maintain that and adjusting bank rate to do that. But I think what’s fascinating about that is for a very long time, so for about 100 years, it had the interest rate it at 5%. And that’s their policy rate. Okay, so we’ve been talking about interest rates, and these are interest rates related to financial securities. And other bit of evidence that is, that is interesting is the evidence, or the data points that you’ll see in novels by Jane Austen or Balzac? So Jane Austen, obviously, right Pride and Prejudice, Sense and Sensibility, etc. Balzac wrote old man glorioso, his French writer, this is something Thomas Piketty pointed out in his book on capital in the 21st century that if you read these novels, you’ll see that it was generally understood that the rate of return on land was about four to 5%. That’s a rate of return on an investment that’s different from the interest rate. But it gives you an idea of what was people were expecting to earn from investments in assets, and there’s some risk associated with land, or owning anything. So it’s not going to be a risk free interest rate. But I think it gives you gives you some idea of what rates of return were so right rate of return on land, historically, 4 to 5%. And it was taken for granted, that land yields 5% is what picket is writing. So the value is equal to roughly 20 years of annual rent. So I think that’s, that’s a really interesting data point. So what we’re getting is that, but another thing to consider is that that’s probably in a time when, historically there wasn’t a lot of inflation. I mean, there was during war time. But generally, until we had this, we adopted fiat currency in the 20th century, inflation wasn’t usually a problem, although you could have episodes of inflation, if there was a crisis of some kind. But I think you could probably interpret that as those is real rates, real rates of return almost. What we could conclude is that, yeah, I mean, interest rates are normalising historically, we’ve seen a range of interest rates, rates of three to 4%, four, or 5%. For risk free rates. That’s something you might expect, where current interest rates and up, it’s difficult to say it’s going to depend on the state of the economy, or how the economy reacts to those rate rises. I mean, this is something we’ll we’ll keep tracking we’ll keep following this year, and provide some more commentary, some more analysis on the future. Arturo, anything else you think we should cover?

Arturo Espinoza Bocangel  38:33

I think you have to cover most of the important things. So that was a good conclusion for this episode of the books.

Gene Tunny  38:43

Okay. Very good. Okay. All right. Thanks so much for your time.

Arturo Espinoza Bocangel  38:47

Thank you for having me.

Gene Tunny  38:50

Okay, have you found that informative and enjoyable. In my view, the main takeaway is that monetary policy is still in what’s called a tightening cycle. Interest rates will have to increase some more because inflation is still too high. It’s hard to know when the tightening will stop. The US experience suggests tightening cycles last a bit under two years on average, according to an informative note from Chatham financial, which I’ll link to in the show notes. The US Fed started tightening in March last year, and the Reserve Bank of Australia started last May, suggesting we could still have many months to go. Of course, this tightening cycle doesn’t necessarily have to conform to the average. Much depends on how the economy responds. In Australia, we’re hopeful we won’t need many more interest rate increases to sufficiently slow demand and get inflation under control. Even though the cash rate hasn’t been pushed up to a very high level in historical terms, the rate increases that we’ve seen could still be effective because of the heavy load of household debt that people have incurred to buy high priced properties. How much will the economy slow down? Will it just be a slowdown a reduction in the GDP growth rate or a contraction in which GDP falls? And we have negative growth for a couple of quarters at least that is a recession. Recessions in both Australia and the US are definitely possible. Indeed, recessions often occur after central banks tighten monetary policy. The 2009, New York Fed paper noted 11 and 14 monetary tightening cycles since 1955, were followed by increases in unemployment. That is, it’s very difficult for central banks to bring about a so-called soft landing. That was me speaking rather than the Fed. I’d note that some economists are even speculating that because economies will slow down substantially, we’ll start seeing interest rate cuts toward the end of 2023. Honestly, I don’t know whether we’ll have soft landings or recessions, a lot depends on psychology, and just how entrenched expectations of high inflation have become, the more entrenched they are, the more interest rates have to keep on increasing. We need to wait and see just how effective the interest rate increases we’ve seen already have been and will be. Obviously, this is one of the big economic issues of the year. And I’ll continue to keep a close eye on it. And I’ll come back to you in a future episode this year. Thanks for listening. Alright, thanks for listening to this episode of Economics Explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact@economicsexplored.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you, then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

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Chokepoint Capitalism w/ Rebecca Giblin – EP169

Corporations such as Google, Amazon, and Live Nation are allegedly taking advantage of chokepoints in the economy, earning excessive profits. That’s the thesis of a new book, Chokepoint Capitalism: how big tech and big content captured creative labour markets, and how we’ll win them back. The authors are Uni. of Melbourne Law Professor Rebecca Giblin and writer and activist Cory Doctorow. Show host Gene Tunny speaks with Prof. Giblin about Chokepoint Capitalism in this 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

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: Rebecca Giblin

Rebecca Giblin is an ARC Future Fellow and Professor at Melbourne Law School, and the Director of the Intellectual Property Research Institute of Australia. Her work sits at the intersection of law and culture, focusing on creators’ rights, access to knowledge and culture, technology regulation and copyright. Using quantitative, qualitative, doctrinal and comparative methods, she leads interdisciplinary teams with expertise across data science, cultural economics, literary sociology, information research and law to better understand how law impacts the creation and dissemination of creative works.

You can follow Rebecca on Twitter: 

https://twitter.com/rgibli

Links relevant to the conversation

Where you can buy Chokepoint Capitalism:

https://amzn.to/3HohDFV

Website about the book:

https://chokepointcapitalism.com/

Transcript: Chokepoint Capitalism w/ Rebecca Giblin – EP169

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  00:00

Coming up on Economics Explored.

Rebecca Giblin  00:03

We’re sharing less and less in the value that’s that’s created by our work. And that’s happening because we’ve got these increasingly powerful corporations, creating choke points that allow them to extract more than their fair share.

Gene Tunny  00:18

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host Gene Tunny broadcasting from Brisbane Australia. This is episode 169 on choke point capitalism. That’s the name of the new book from University of Melbourne law professor Rebecca Giblin and from writer and activist Cory Doctorow. Professor Giblin joins me this episode to discuss the book. Please check out the show notes, relevant links and information and for details where you can get in touch with any questions or comments. Let me know what you think about what either Rebecca I have to say in this episode. I’d love to hear from you. Right now. It’s my conversation with Rebecca Giblin on a new book with Cory Doctorow chokepoint capitalism, thanks to the publisher scribe for sending me a copy of the book. And finally, thanks to my audio engineer Josh Crotts for his assistance in producing this episode. I hope you enjoy it. Rebecca Gibson, welcome to the programme. 

Rebecca Giblin  01:00

Hi, Gene. 

Gene Tunny  01:01

Yes, good to have you on Rebecca keen to chat with you about your new book, Choke Point Capitalism: how big tech and big content captured creative labour markets and how we’ll win them back. So to begin with, Rebecca, could you explain what’s the meaning of a choke point? And why do you think capitalism can be labelled in this way? Or there’s a form of capitalism that is chokepoint capitalism?

Rebecca Giblin  01:40

Well, competition is supposed to be fundamental to capitalism. It is supposedly about the free exchange of goods and services. But you have this new orthodoxy that’s come out in the last 30 or 40 years. When you have Peter Thiel say competition is for losers. You have Warren Buffett salivating over companies that have what he calls wide, sustainable moats, which are barriers to competition that stop that, you know, lock in customers and lock in suppliers, and stop that free exchange. And once and this is now the orthodoxy that’s been taught in business schools, people are told that if you want to make a fortune, you don’t make something, don’t provide a service, but find a way to scrape off the value of other people’s labour. And these are the choke points. So it’s where you manage to lock people in. So you lock in customers, you lock in suppliers, you use, the power you get from that. And those increased margins you get from that to do a scorched earth approach where anybody in your kill zone gets eliminated so that there are fewer and fewer choices for those locked in customers and suppliers. And then ultimately, you shake everybody down for more than your fair share. And we see these choke pointed markets in throughout the culture industries in particular, that’s what we talk about in the book to demonstrate this problem. But they’re everywhere. We’ve started seeing the term getting used in the context of all different kinds of businesses. We’ve had people talking about on social media emailing us to tell us about it. One of the more interesting ones and somebody saying this is exactly what’s happening in the global ornamental plant industry is a big plant is a problem as well.

Gene Tunny  03:28

Ornamental what? Sorry?

Rebecca Giblin  03:30

Plants, Yes. Yeah, it’s a big problem in the plant market, we discovered. And, and what we’re really trying to demonstrate here is the danger of this. And the reason why so many of us are feeling squeezed right now. It’s not our imaginations, it’s that we are being and that we need to become really aware of it if we want to change the material conditions in which we live and work.

Gene Tunny  03:54

Okay, so by many of us, are you talking about creative professionals?

Rebecca Giblin  03:59

But it goes much beyond that as well. If you’re working, or if you’re a supplier to Coles and Woollies, for example, you are dealing with a similar kind of buyer power as what we talked about in the book. And so let me mention this. This book, we talk about monopoly a bit, which is, you know, we’re all familiar with that concept, because we got a board game for that one. It’s where you’ve got a seller, that’s really powerful. So Amazon, for example, is a really powerful seller. And its relationship with consumers because it controls so many consumer markets, including the market for books, but it’s also an incredibly powerful buyer. So if you’re a publisher or an author, you you you need to go through Amazon to reach those customers. And so it’s, it’s it’s got monopsony power as well, which is where you’ve got a powerful buyer. So if you’re a supplier to Coles and Woollies, you’re dealing with people. I have to say this word monopsony, it does turn a lot of people off. It did appear a lot more often in the book in the first draft and people begged us to take it out, but we do think we can make it sexy. Technically what we’re talking about here is oligopoly, which is probably even worse, which is where you’ve got a couple of very powerful buyers. But I’m going to use monopsony just for simplicity. But that’s what you’re dealing with if you’re a supplier to Coles and Woollies, in Australia or so many other companies that have increasingly come to control their markets. And the reason why we’ve got this increased corporate concentration throughout the world is largely due to the emergence of what we call Chicago School of Economics reasoning, this, it gets a little bit wonky at this point, but this consumer welfare theory, that suggests that we should only be concerned about corporate concentration, not just because it exists, but where it has the effect of, of harming consumer welfare, which is often treated as just looking at the prices people pay. There’s many problems with that standard. And we’ve seen them the consequences of that really starting to play out now. But one of the consequences is that it really ignores the fact that when you’ve got a powerful buyer, right, it may be that the prices that the consumer pays are not affected. But that buyer has its hand in the pockets of its workers and its suppliers. And you’re it’s a little bit of a stage magic, sleight of hand misdirection where you’re looking over there at the Consumer Price, and not noticing that you’ve got somebody picking your pocket on the other. And we think I mean, it’s exactly the same end result. If you’re if you’re having downward pressure on your wages, the salary that you bring, bring in the what you get paid for your goods and your services, it has the exact same end result as higher prices at the checkout, which is that you’ve got less and less capacity to pay for what you need. And what we’re really seeing now in the current environment. And a lot of these prices, we are seeing big price increases at the checkout. And partly those are inflationary pressures. But we are seeing as well, there’s a lot of evidence of companies, these powerful concentrated industries, hiking up their profit margins and using inflation as an excuse for that. So we’re seeing higher prices at one end, and also these companies having their hands in our pockets at the other. And so it’s no wonder that everybody’s feeling squeezed.

Gene Tunny  07:30

Right. Okay, so you mentioned a few things there. You talked about antitrust, and I’ve chatted with Danielle Wood from Gratton about this, this issue of you know, there was this consumer welfare standard. And that meant that there may be, there wasn’t as much antitrust enforcement. But now there’s been a change, you’ve mentioned, is it Lina Khan in the States? So there’s more of a, a willingness to look at antitrust as a tool. And can we, Rebecca can ask about what mean, what companies you’re talking about? I mean, are you talking, you mentioned. Well, it’s could, though, there could be companies in the sort of more traditional economy, but it’s, is it mainly big tech? Are they these are the companies that are exhibiting the characteristics of being a choke point, capitalist, what are some of these companies?

Rebecca Giblin  08:23

Okay, so the ones that we talk about in the context of the creative industries, they go all the way through the chain. So if we think about just music to begin with, musician has to deal with the big three record labels, who control almost 70% of global recorded music rights. They own the big three records, the big three music publishers, which control almost 60% of global song rights, they structure the deals in ways that benefit their executives and shareholders, and work to the detriment of these creative workers. Then the streaming industry, which is where most of the increasingly most of the money from recorded music is generated, the streaming we lots of people know that music streaming really doesn’t pay very well. But fewer people are aware that the reason that works, the way that it does is because this is the way those big three record labels, arranged things, the streaming platforms had to have to go through those records, those record companies in order to get permission to play the songs. And in order to clear those rights, they have to enter into these deals that again, favour those record labels, again, to the detriment of the artists, and that give those those those major labels who should be far less relevant and indeed are far less relevant today than they were 30 or 40 years ago because they no longer control all of the avenues to distribution, but because they’ve got these huge reservoirs of copyrights that they’ve acquired often through buying up distressed companies very, very cheaply, that’s given them outsized power to control the future of music. And so you can see that those, the copyrights themselves create a choke point, at one point, the incredible complexity of the licencing systems that we have in music, create other choke points, because it is only Spotify and the big tech music offerings that can afford to go through the, you know, these hoops to pay that what’s demanded by the record labels and also to comply with these complex regulatory rules and that keeps lots of other companies that that could be started by people who love music and want to support artists and passionately believe in alternative ways of getting music out there. It stops them from being able to start up any kind of meaningful competition. And then if you look, and you say, Well, that’s all right, people don’t really need to make money from recorded music. No one’s really made money from recorded music except a few outliers. People make money from touring. Well, then we start looking at Live Nation, which is the behemoth in that space. It controls nearly all of the world’s largest and most prestigious music venues. It also has a music management and promotion business. And it bought Ticketmaster a few years ago to, you know, in the face of many, many warnings that what has happened would happen, the Department of Justice in the United States still permitted this merger to go ahead. Now, just think about this for a moment. Imagine you are a company. So you’re a music venue, right? And you want to book acts, you will have Live Nation tell you well, if you don’t use us for your ticketing, you won’t be able to book our biggest acts that we control through our management, business and promotion business, or, or any other kind of incredible threat that they’ve made. In the book, we talk about this we are in, we looked in an incredible range of creative industries in our research for this book. And we always gave people the opportunity to be synonymous or anonymous if they wanted to. And I think nobody took us up on that. Even when they were talking about these other really big, really scary giants like Amazon, who’s also known for not playing fair, except the people we spoke to about Live Nation. Almost all of those said that they could not be named. And they were really genuinely terrified about what kind of retribution could come if it got out that they’d spoken to us about this company. But it has a voyeurs, voyeurs view at the businesses of all of its competitors, right? If you’ve got to use Ticketmaster or if you’re a venue, or you face all of these other consequences, all of these other things that you miss out on. But that gives Ticketmaster the ability to see, well, okay, so which other acts that you are hosting are doing well, who are the artists that look like based on the ticket sales, they’re about to break out, and maybe Ticketmaster, Live Nation can jump in with its promotion and management business and snag up those acts. Now, even though they didn’t do the early investment, they can just sneak in and grab them now that they’re about to start making lots of money. And, you know, all kinds of other, you know, extraordinary advantages this gives them and we’re really seeing this play out at the moment with anyone who’s listening. Is there is there much crossover? Do you think Gene in the economics explained audience and the people who are big fans of Taylor Swift, and been waiting in a queue for days in order to get tickets to her concert? You have

Gene Tunny  13:47

Look, I have no idea. I mean, I quite like Taylor Swift. I wouldn’t line up for days to get tickets. But yeah, who knows? Tell me more.

Rebecca Giblin  13:55

Look, the Department of Justice is investigating again, they did do an investigation a couple of years ago that we talked about in the book, where a bunch of venues who all had to be assured of anonymity in order to speak, we’re talking about Live Nation’s mob tactics and ways in which it was using its power to crush other people’s businesses. It got a fine that was just really a slap on the wrist and told really sternly not to do it again. But in this kind of context of fine is a price. The Live Nation is quite happy to pay that kind of fine in, you know, in order to get to continue its predatory behaviour. It will only be stopped if there is sort of meaningful enforcement. And the DOJ hadn’t done anything since until this Taylor Swift controversy came up. And and and we are seeing now there’s going to be another investigation. So hopefully, there’ll be some kind of more meaningful enforcement here and what we really need to see is Ticket Master broken up. That’s one of the main domain remedies were there. antitrust breaches. You can have structural remedies, which is where you break a company up or conduct remedies, which is where you sort of get them to pinky swear they won’t do anything bad. Now, unfortunately, those remedies are not particularly easy to enforce. Right. It took literally decades to break up AT&T In the United States. I was it was a Bell. I think it was Bell before it became AT&T. So there’s so many, the Bell System we concentrated. Yeah, concentrated firms the sometimes I get mixed up. And it can be incredibly expensive and lasts for decades to take these actions and we don’t have decades. And the other problem with those antitrust remedies or competition law remedies is that they work even less well when you’re dealing with monopsony rather than monopoly for various reasons. And so what we argue for in the book is remedies that we know do work in response to monopsony power. And that’s things like encouraging new entrants into the market, directly regulating excessive buyer power by limiting what they can do and by taking measures to build countervailing power in workers and suppliers.

Gene Tunny  16:21

Okay, well, I want to come back to that that point about the monopsony you said, it’s harder for antitrust act on monopsony if you meant I think you said that I’d be interested in that if you can explain why or, and also the, I guess, I’d like to ask about, I mean, is this really so bad? I mean, you mentioned that it’s, it’s captured creative labour markets. I mean, okay, I’m, I’m against a lot of the surveillance capitalism. And I think you know, where to the extent there are choke points, and they’re really bad business practices, or they’re they are, they’re relying on some. Yeah, I guess it’s IP, they’re relying on these relationships they have and they’re, they’re preventing competition from, from coming into the market. Yeah, I can see the problem with Ticketmaster. At the same time, I mean, I think a lot of these platforms have enabled a lot of people to make a living out of content creation, haven’t they? I mean, if you look at YouTube, and you look at all the podcasting platforms, I mean, there are many more people that are able to, you know, quit their jobs and become full time content creators, aren’t there. So, I mean, is there a risk that we, we, we undermine this system that has actually created a lot of benefits? I mean, how do you see it, Rebecca?

Rebecca Giblin  17:48

Let me answer that second part. The second part first, I think we are constantly being sold the idea that we can’t have the good things without the bad things, right. So Amazon is constantly telling us that we can’t have a good search engine without surveillance. But we can have a great search engine without surveillance. Google didn’t surveil us for the first several years of its existence, right. And it was a terrific search engine. We, with the access to digital technologies and the Internet, we absolutely can have global virtually instantaneous gloop at virtually costless, like zero marginal cost of distribution, supply of many kinds of creative work. So we’ve got this potential for the good things anyway, what we don’t have to have is the bad parts, the lock ins, right, these strategies that are used to create these hourglass shaped markets, so that you’ve got audiences at one end, and creators, the other and these predatory companies squatting at the NEC, were they using that power that they’ve artificially created by locking everybody in to extract more than their fair share? So that’s what I say in response to that. And getting, I’m so glad you asked me more about monopsony. Most people run away screaming from that pot. So some of the reasons suddenly tell you a couple of things about it. One reason why monopsony is so dangerous is that it accrues at far lower market concentrations than monopoly power does. So you know, when monopsony when when when a buyer controls even eight or 10% of the market, that already gives it quite outsized power over its suppliers. And that says that’s assuming that there’s no alternative buyer for that. And we saw that when Amazon started out one of its one of its as soon as it got power over the physical book market. It started exerting that to try and squeeze margin out of everybody else. And, you know, this is a famous Bezos aphorism. Your margin is my opportunity. He’s very clear about what he’s trying to do. But sometimes when you look at how the sausage gets made, it can be a little bit frightening. They created something called the gazelle project, which is exactly what it sounds like the way that a cheetah cuts out the weakest Gazelle from the herd, they went after the smaller and more vulnerable publishers to squeeze margin from them. One of them was Melville House, who lots of people have read books from. And the publisher they resisted, he said, look, if you I cannot, we cannot afford to give you what you’re asking for our business won’t be sustainable on that basis, we just won’t do it. And Amazon instantly retaliated by removing the buy buttons for all the Melville House books on its platform. Okay and now at that, at that time, I think Amazon only controlled about 8% of the market for those books. But nonetheless, Melville House was forced to instantly get virtually instantly given because without that, that eight or 10% of sales, it was just no longer sustainable. And so if you look at how much power Amazon had, when it had such a small market share relative to what it has got now, you can see how dangerous that’s become. And then if we look at other industries, in so many of them, you’ve only got, you know, one or two or three buyers that are available. And coincidentally, they often seem to have very, very similar policies and very, very similar abuses. And this is what this is what puts them in that position where they can extract so much from the people that they’re dealing with. Yeah, the other. The other thing about monopsony that I think is relevant here to why the remedies are not particularly effective, is that there’s real concern that when you regulate a powerful buyer, that maybe the reason why it’s so powerful is because it’s very efficient. And this is what Amazon argues it argues that it has this highly efficient structure, that it has these lower costs, which leads to attracts customers, which then attracts suppliers. And then there’s a better customer experience, which brings more in and sort of feeds this loop which Amazon calls its virtuous cycle, right. But what we see when we look at Amazon, and my co author, Cory Doctorow just did a terrific thread, or blog post on his pluralistic website about this a day or two ago, is Amazon increasingly is a shitty place to buy from, because most of it has been taken up by advertising. People, people know that Google and Facebook have big online advertising businesses, but not many people know that Amazon is a close third now. It shakes down the people that sell on it. For placement fees, and for the right to be shown first and for the right to be earlier in the search listings. And that means that you know, rather than getting the best search experience, the best customer experience, you’re just being inundated with ads all the time. They’re making billions upon billions of dollars from this. So the evidence is that in practice, it’s probably not from efficiency, but regulators are concerned that they might not be able to tell the difference. And that makes them hesitant, even more hesitant to intervene in cases of monopsony than monopoly.

Gene Tunny  23:24

And Rebecca, how do you respond to the argument that these companies are simply being rewarded for the innovation, they’re being compensated for the innovation, that they’ve undertaken to deliver new services to consumers, because a lot of these platforms are delivering value or consumer surplus to a lot of consumers. And, you know, providing opportunities for content creators. I’m just wondering how you respond to that argument, because as economists, I mean, we’re very much a lot of economists are sympathetic to that Schumpeterian idea of creative destruction, that wherever there are these, you know, the opportunities for profits that encourages innovation. And I mean, who knows? I mean, will these companies survive? Or will there be new innovative innovators who take over?

Rebecca Giblin  24:10

Let’s see, that’s the thing. This is another thing that we’re constantly being sold this idea, but look at Google, how much innovation does it actually manage? Alright, it made a great search engine, and a pretty good Hotmail clone, right? And nearly everything else that it’s ever provided that’s had any kind of success. It’s bought from other people who did actually innovate with its monopoly profits that it’s making on from these choke points. Right. And so, you know, Google tried really hard, and we talked about it in the book to create a Google video service, right? Absolutely failed with all of its resources and all of its smart people it could not, it’s almost ludicrous, how hard and how many ways it failed on that. And so it had to buy YouTube, right, which scrappy people above a pizza shop where they were actually doing innovation. And we see this time and time and time again, you know Facebook came to control the messaging market, and to control the way you communicate with your community and your family and your friends, not by innovating and creating the products that we want. But by buying up what’s happened Instagram for billions of dollars each when they had, you know, virtually no employees, because these tiny companies were the ones who actually doing the innovation, okay, so we don’t need not only do we not need these, these massive companies in their massive war chest to be innovating, they’re actually getting in the way of other people innovating. Because everybody knows what happens if you get in the kill zone, right? So it’s a risk, you either get bought up. And that’s like, that’s what many, many people are aiming to do. If they’re trying to innovate in this area, they know that the only exit is to get acquired by these companies, or crushed by them. And so it’s called the kill zone. And if you and venture capitalists know, we know that there is less VC investment in territories that are controlled by big tech and other powerful corporations, because of these kill zones. So Amazon, for example, burned, I think it was 200 million US dollars in a single month, undercutting and going directly up against diapers.com, in order to control the nappy market in the US. And that’s an extraordinary amount of money drove this innovative competitor absolutely under because it had access to these, these war chests from its monopoly profits and access to capital markets that this scrappy little innovator didn’t have. Now $200 million in a month to control the diaper market might sound like a lot of money. But it’s actually incredible value, because it didn’t just get rid of diapers.com it sent an incredibly clear signal to anyone else that was thinking of entering any space that Amazon has marked that you will be absolutely burnt out if you even attempt it.

Gene Tunny  27:04

Yeah, it’s a real gangster move, as they’d say, isn’t it? I mean, really?

Rebecca Giblin  27:08

Yeah, they would say no, no, it’s just it’s just it’s good, hard. It’s good fair competition. But it’s not is it? Right. And all of that. There’s extensive research on this, we see that there’s less investment, less innovation in areas where you’ve got choke points.

Gene Tunny  27:26

Okay. Rebecca, I think I should have booked you for longer. There’s been fascinating, and I’m enjoying the conversation. But yes, if, if there’s anything else? Yeah, I’d love to if you had any final points, you know, feel free to make them otherwise. We might have to, we can wrap up. And yeah, I’ll, I’ll try and connect with you sometime in the future. Because I’m sure there’ll be a lot of discussion about your book and this debate will continue on into the future.

Rebecca Giblin  27:55

Yeah, I guess the final thing I would say just to sort of sum up the ultimate message is that you know, creators, but also the rest of us are getting choked, that we’re sharing less and less than the value that’s that’s created by our work. And that’s happening because we’ve got these increasingly powerful corporations, creating choke points that allow them to extract more than their fair share. But we don’t have to put up with it. There’s lots of things that we can do to widen these choke points out once we see them for what they are.

Gene Tunny  28:25

Okay. Rebecca Giblin. Thanks so much for your time. I really enjoyed the conversation. Thank you so much.

Female speaker  28:33

If you need to crunch the numbers, then get in touch with Adept Economics. We offer you Frank and fearless economic analysis and advice. We can help you with funding submissions, cost benefit analysis studies, and economic modelling of all sorts. Our head office is in Brisbane, Australia, but we work all over the world. You can get in touch via our website, http://www.adepteconomics.com.au. We’d love to hear from you.

Gene Tunny  29:03

Okay, I hope you enjoyed that conversation I had with Rebecca. Overall, I think Choke Point Capitalism is a book worth reading, although I disagree with some of its assertions. Regrettably, I didn’t book Rebecca Long enough to ask her all the questions that occurred to me from reading the book, so I’ll aim to get her back on the show next year for another conversation. The book includes many compelling examples of dubious business practices by big companies. So I must admit I am somewhat sympathetic to the choke point capitalism thesis. And if you’re a regular listener, you will know that I’ve covered surveillance capitalism and problems with big tech in the past. There does appear to be scope for some antitrust action against some of the badly behaved big tech companies for sure. That said, one reservation that I have about the book is that it appears to have a wider ambition than simply acting against the market abuses of big tech. In parts, it reads like a polemic against capitalism in general. For instance, the book concludes, we’ve organised our societies to make rich people richer at everyone else’s expense. I think that sweeping statement goes too far. Like some other popular economics books I’ve read in recent years, choke point capitalism adopts to negative view of our economic system. Capitalism, after all, has lifted hundreds of millions of people out of extreme poverty in recent decades. And it has fostered a bewildering array of innovative new services that have benefited billions of people. And we still have progressive tax systems in which the wealthy generally pay much more tax than the less wealthy. Of course, many wealthy people avoid paying tax I know. But I think it’s broadly true that we still have a highly progressive tax system, at least in Australia and European countries, possibly less so in the US. Okay. Despite some reservations, I’d still recommend the book for its vivid examples of so called choke point capitalism. The book makes a useful and stimulating contribution to the important debate over the regulation of big tech. So I’ve included a link to the Amazon page for the book in the show notes, so please consider buying a copy. 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.

Thanks to Josh Crotts for mixing 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 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.

Female speaker  24:01

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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

Global economic outlook + Aussie inflation & house prices – EP150

The message from the IMF July 2022 World Economic Outlook was that the outlook is “Gloomy and More Uncertain”. This week also saw the United States slide into a technical recession. Certainly there are big risks to the global outlook. It’s possible that central banks could tip many economies into recession as they hike interest rates to tame inflation. This episode considers the global economic outlook as well as the economic challenges facing Australia’s new federal government. It’s an abridged version of a conversation that show host Gene Tunny had with Decactivist host Randall Evans on his show. The conversation was recorded prior to the US GDP release, but Gene remarks on the data in his introduction to this episode.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

Randall Evans’ Deactivist show:

https://www.youtube.com/c/Deactivist

IMF World Economic Outlook July 2022: Gloomy and More Uncertain:

https://www.imf.org/en/Publications/WEO/Issues/2022/07/26/world-economic-outlook-update-july-2022

US recession news from NPR:

https://www.npr.org/2022/07/28/1113649843/gdp-2q-economy-2022-recession-two-quarters

Transcript: Global economic outlook + Aussie inflation & house prices – EP150

Gene Tunny  00:01

Coming up on Economics Explored.

Randall Evans  00:04

I don’t know if you saw the lineup for Qantas, I think two days ago. But it was out the door all the way down the road for Qantas flights in Sydney, like all the way out there. Never seen it like that, it’s insane.

Gene Tunny  00:21

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 150 on the Economic Outlook. 

We are at a risky point in the global economy. It’s possible that Central banks could tip economies into recession as they hike interest rates to tame inflation. Indeed, I’ve just seen the news that the US has experienced the second quarter of negative economic growth. So, according to the traditional definition, the US economy is in a recession. I’ll have to cover this in more depth in a future episode. But for now, I’ll know that there will be a big debate about this, given the jobs growth has been really good in the States, something noted by US Treasury Secretary, Janet Yellen, she’s claimed the two quarters of negative growth rule for a recession can be misleading. And you need to look at a broader range of indicators, as the National Bureau of Economic Research does when it calls recessions. There’s a lot to explore here, so I’ll leave it to a future episode. 

Okay, I should note that this current episode is an abridged version of a conversation that I had with fellow Australian podcaster, Randall Evans, on his Deactivators show earlier this week, on Wednesday, 27th, July 2022. I’ll put a link to Randall’s YouTube channel in the show notes. So, you can check out the full unedited chat, and Randle’s other videos. 

You may notice I’m short of breath at some points in this episode. That’s because I’m still recovering from COVID. I picked it up at the Conference of Economists in Hobart, two weeks ago. It was an awesome conference, but it was also a super spreader event. Alas. 

In the show notes, you can find relevant links and details of how you can get in touch with any questions, comments or suggestions. Please get in touch and let me know your thoughts on this episode. I’d love to hear from you. 

Right on, for my conversation with Randall on the Economic Outlook. I hope you enjoy it.

Randall Evans  02:38

Hello, everyone and welcome to the show. We’re here with Gene Tunny. Gene, how’re you doing?

Gene Tunny  02:42

Good. Thanks, Randall. How are you?

Randall Evans  02:44

I’m pretty well. For people who don’t know you, why don’t you give us a little background about yourself and what you do?

Gene Tunny  02:52

Okay, I’m an Economist. I’ve got my own consultancy business, Adept Economics. So, I do project work for different clients, private businesses, nonprofits, some government agencies, councils. So, often business cases for different projects or analysis of different policies or programs. So, I’ve been doing that for the last 10 years or so. Before that, I was in the Federal Treasury. So, we’ve got a broad background in Economics.

Randall Evans  03:27

And you’ve also got your podcast as well with over 130 old episodes I think, so far.

Gene Tunny  03:33

Yeah. Economics Explored. Yeah, that’s going well. I’m really happy with how that’s going. I mean, we’ve covered you know, a wide variety of issues on that, including housing and inflation and the RBA and the current review of the RBA. So, yeah, that’s going really well.

Randall Evans  03:55

What’s the current review of the RBA? Is to get rid of it? 

Gene Tunny  04:02

Some people might want that. There are some libertarians out there who are pushing for the abolition of Central banks and the abolition of fiat currency. But no, they’re not going to do that. I mean, they probably won’t do anything too radical, they might make some changes to the board composition, they might make some changes to the language around what the Reserve Bank is supposed to do in terms of targeting inflation. But yeah, there won’t be any radical changes, I’m afraid. Particularly if you look at the people who are who are going to be doing the review. They’ve got an academic Economist. They’ve got a former government bureaucrat, Gordon Brewer, and then they’ve got a deputy head of the Central Bank of Canada. So, you’ve got fairly mainstream people there. So, I don’t think we’ll see big changes. Having said that though, I mean, the Reserve Bank certainly needs reviewing, because there’s been a lot of concern that their policy settings have been wrong at different times. Phil Lowe’s, arguably misled people last year, and there are a lot of people who are concerned about that. His forecast, which was widely reported that interest rates wouldn’t be increasing until 2024. And he was saying that late last year, and now, they’ve already gone up from 0.1; this is the official cash rate, the overnight cash rate, which is lower than what people pay for home mortgages. Now it’s at 1.35. It’ll go up to 1.85 tomorrow, sorry, not tomorrow, on Tuesday, next week.

Randall Evans  06:02

Is that just people wishful thinking that believed that it wouldn’t go up till 2024? I mean, we had mass quantitative easing and the inflation followed, and then the logical step was; interest rates are going to go up. So, who was saying we can hold off till 2024?

Gene Tunny  06:22

Well, I guess there was this view that the economy had changed. And, I mean, there was quantitative easing, not in Australia, but in other countries during and after the financial crisis. So, starting around, 09, 0-10. And there were people forecasting, oh, this is going to lead to runaway inflation at the time, and that didn’t really happen. But what we’re seeing in the last was over the pandemic period, is that we’ve had, you know, more quantitative easing, and we’ve had big budget deficits to try to stimulate the economy as well. And I think the combination of that has meant that, you know, inflation has really soared. So, they were lucky last time, it didn’t happen. Last time, they got away with it. I think perhaps they thought that they might be able to get away with it again. Yeah, they were wrong.

Randall Evans  07:32

Imagine my shock that they might have. So, I guess first off, one of my first questions would be, as you see, is it all doom and gloom for Australia, or are we In a place we have to be? Where do you see us going over the next 12 to 18 months?

Gene Tunny  07:55

Well, I think it’s doom and gloom for Australia. I mean, really, things have been pretty good when you think about it. I mean, we’ve recovered very strongly from the pandemic. And unemployment is now at three and a half percent, right? This is extraordinary. And now there’s talk about sign-on bonuses. I don’t know how legit this report is. But there was a report in Perth now, that McDonalds in WA is paying sign-on bonuses of $1,000 due to the shortage of people; how difficult it is to get people. And the mining sector is paying $10,000 sign-on bonuses just to get people, there’s a shortage. Partly, that’s related to the fact that we haven’t had; I mean, immigration starting to increase now. But we had a year or so when we weren’t letting anyone in the country. So, I guess we’ll start to see that impacting wages. That could end up leading to inflation itself. I mean, one of the things we want to avoid is what they call a wage price spiral, where inflation just keeps feeding on itself. And prices and wages just sort of, go up in this; once leads to so high wages lead to higher prices, higher prices lead to higher wages, because people need to be compensated for that and they push for it in their wage bargaining. So, yeah, that’s the sort of thing that people are concerned about.

Randall Evans  09:35

The unemployment rate, typically, when there’s high inflation will be low. And I think that’s on the Phillips curve, if I’m not mistaken. Can you just explain that for the for the layman viewing?

Gene Tunny  09:52

I probably should finish the previous question, first. I will get on to that, Randall. I just realized you asked me about if it’s gloomy; I don’t want to be too positive, because, there certainly are risks in Australia, I better clarify that. Because of the rising interest rates, and it looks like, people probably; many households possibly overextended themselves, borrowed too much. There was that fear of missing out. And so therefore, as interest rates increase, even though they’re not going to get up to the really crazy levels that they got up to, in the late 80s, when they were up around 17, 18%. I mean, that won’t happen. But I mean, still many households could get into trouble. We’ve seen consumer’s confidence really plummet, and it’s at you would associate with before, like just before a downturn or a recession. So, there are levels that are almost recessionary. I think one of the bank economists, may have been the ANZ, economist, who said that. So, there’s certainly concerns about that.

On this point about unemployment and inflation. Yes, I mean, the traditional view, and this is a view that we learned was not correct. It broke down in the 70s was that, there is this tradeoff between unemployment and inflation; one story you can tell is if you have low unemployment, that means that workers have more bargaining power. Labor is scarce and so, workers are able to negotiate better with their bosses, and that pushes up wages. So, that’s the theory. 

So far, at least in the official data we’ve had up till March, we haven’t really seen a wages breakout in Australia, that’s why there’s was all their talk about declining real wages. And I think that cost Scott Morrison at the last election. That was really a strong attacking point that the then opposition, now government were able to make against the then government that you’ve got inflation running at the time was 5.1%. Now 6.1% yearly, and wages are only grown at 2½%  So, you’ve got a real wage decline of over 2 ½%. So, that was a bit of a worry. 

The traditional story was that, if you had low unemployment, you’d get high inflation. Conversely, you could, if you wanted to reduce inflation, you had to have high unemployment, because that would give workers less bargaining power. Okay, so there’s this tradeoff between unemployment and inflation. And this was based on a study by a New Zealand economist, Bill Phillips, who was actually an engineer, but he was an economist as well. And he might have been at LSE, in London, at the time. But that whole thing sort of, broke down in the 70s because what we noticed is that there wasn’t this stable tradeoff between inflation and unemployment. What there was, was the possibility that you could have both high unemployment and high inflation, and indeed, you could have unemployment increasing and inflation increasing, you could have what’s called stagflation. 

So, there’s no real trade off in the long run between unemployment and inflation. You can have high unemployment and high inflation at the same time, if people come to expect inflation, if there are, what you call inflationary expectations if they increase. So, that’s one of the concerns that people have about the global economy at the moment. The IMF, World Economic Outlook came out overnight. So, it came out Tuesday, in the US, and it’s gloomy; it’s talking about a gloomy outlook, globally. And I think it’s suggesting  we have very high inflation globally. Was it 6 or 7? It was it was a high rate. I’ll have to just check it. But there’s a lot of talk globally about stagflation, where they will end up in stagflation. And then there’s acknowledgement by international agencies that we could end up in a situation with high unemployment and high inflation down the track. I mean, it’s not likely at the moment. I mean, we are having global growth slowdown, because we’ve had this shock from the war in Ukraine, which has increased the oil price and petrol prices. So, one of the reasons you can have a stagflation is if you have this shock to the economy, such as higher oil prices, which push up the costs of production. And that means that it’s less profitable for businesses to produce what they were doing. And so that could lead to reductions in economic activity, and at the same time as costs of production is increasing, that’s passed on to consumers and increases prices. So, that’s one of the great concerns now.

That’s certainly something that, you know, people are concerned about, and you couldn’t rule it out as a possibility. I’d like to be a bit more optimistic than that, though. But so much depends on what happens with this war in Ukraine, and whether we can resolve that; the oil prices are coming down, but they’re still higher than they were a few years ago. So, a lot is going to depend on what happens there. Also the pandemic, which is causing all sorts of problems with the supply chain, it’s very disruptive. Things just don’t work now, as they did before. I mean, you’d see you see all the delays with Qantas and the disruptions that are occurring.

Randall Evans  17:04

I don’t know if you saw the lineup for Qantas, I think two days ago. But it was out the door all the way down the road for Qantas flights in Sydney, like all the way out there. Never seen it like that, it’s insane. I did want to ask you, and perhaps you should explain the theory first because the question from cue, which disappeared off the chat, was whether the RBA will actually increase interest rates enough to slow down inflation. But first of all, what is that theory though? How does that work? And then, what do we expect the right to probably go to?

Gene Tunny  17:46

Okay. Let’s begin with the fact that inflation is a monetary phenomenon. So, this is a famous quote from Milton Friedman. So, inflation is always in everywhere, a monetary phenomenon. In that, it’s associated with an expansion of the supply of money or the stock of money. So, this is currency that we have, but it’s largely; it’s mostly deposits sitting in the bank accounts of households and businesses. Okay, so, there’s the view that although the understanding that we end up with inflation, because the amount of money is expanding, and it’s expanding faster than the capacity of the economy. So, what we have is too much money chasing too few goods. 

So, inflation is a monetary phenomenon. The Central bank, the Reserve Bank is responsible for the money supply. And so therefore, it’s the RBA that has responsibility for dealing with inflation through monetary policy. So, the way they do that is by manipulating the overnight cash rate, this is the standard way of doing it, the official cash rate. This is what they call the cash market, which is a market in which banks and other market participants will borrow money overnight. And banks need money so that they can settle their accounts with each other at the RBA. The RBA controls this overnight interest rate. And what it’s trying to do is it’s trying to influence all the interest rates in the economy that are have a longer term. And so, what happens is as the cash rate increases, though the cost of borrowing money overnight increases, and that has a knock on effect to the cost of borrowing money for 30 days and six months and 12 months, etc. 

What they’re trying to do there is a few things and the RBA talks about different channels by which monetary policy works. Now, let’s think about what those channels are; one of those channels is through the amount of credit that’s created in the economy. One of the reasons we’ve had the big expansion in the money supply in the last couple of years during the pandemic, it’s not just because of the quantitative easing that the bank has engaged in, it’s not just because of their own money printing in their purchases of bonds. It’s also because with the very low interest rates that the bank has said, that’s meant that more people have borrowed money, or the bigger mortgages. So, we’ve had this expansion of Housing Credit. And the new credit, so the net additions the Housing Credit, that is expanding the money supply, I mean, there’s additional money in the economy. 

Okay, so one thing that the bank needs to do through increasing interest rates is reducing the amount of borrowing for housing and new credit creation. So, that’s one thing they’re trying to do. The other way it works is possibly more direct, or more immediate. It’s the fact that I mean, when they increase the cash rate, and that flows through to variable interest rates, mortgage rates, and eventually to fixed rates, when they reset, people have fixed rates for a few years, and then they reset at higher interest rates. What that means is households have less money to spend, they’re paying more to the bank, the bank gets the money, but the bank may not necessarily lend it to someone who’s going to spend it then. So, you have this subtraction from demand that way. So, that’s another channel by which monetary policy works, what the what the bank, what the Reserve Bank, what all Central banks are trying to do is they’re trying to take some of the heat, well, they’re trying to take the heat out of the economy, they want to have the economy go on this Goldilocks path, not too hot, not too cold. So, make sense? 

So, with the interest rate increases, the idea is you can pull some money out of the economy; will have the money supply, expand at a slower rate, or even contract, so that you can get inflation under control. And because you’ve got less, people don’t have as much to spend, that puts less pressure on the economy; it’s not overheating, there’s not as much demand out there. There’s not as much money chasing the few goods that we talked about before; too much money chasing too few goods. So, that’s the general idea. There are multiple channels, we know that if you do increase interest rates, it does eventually slow the economy. The great challenge is knowing how far you have to do that. And it’s not always obvious in advance how much you have to do that. And the problem in the 80s, the late 80s, in the lead up to the recession, is that they discovered that they really did have to increase those interest rates a lot to be able to slow the economy.

Randall Evans  24:18

Yeah. I was going to ask you a question, but then I was reading a comment.

Gene Tunny  24:28

Was the comment okay?

Randall Evans  24:31

Yeah, it was just should Australia be concerned with China’s financial issues that seem to be compounding? And also, these crazy images coming out of China of the tanks rolling in front of the banks not lending money out. What are your thoughts on what’s going on in China, and will it will impact us? I know, that’s kind of off topic to inflation and the housing market, but can we have your initial thoughts?

Gene Tunny  24:59

Clearly, we need to worry about what happens with China given that it has become such an important part of the global economy. And yes, if the Chinese economy did crash; it is slowing. So, we know that it has been slowing down. And the IMF is concerned about the outlook. I mean, there are risks from you know, that the property market, and construction sector, we know about Evergrande. Look, , it could be a could be a real concern for us, because so much of the commodities boom that we experienced, starting around 2003; we had the first phase of that over about 2003 through to 2013. And then, late to late last decade, commodity prices started rising again, then there was a bit of a downturn before; I think coal prices came down even before the pandemic. But since, end of last year, I think this started picking up with the global recovery, the global recovery was stronger than we thought. And then this year, commodity prices have gone absolutely nuts because of what’s happened in Ukraine. So, I guess, China is important. At the moment, it’s hard to forecast what would happen if we did have a downturn in China, because they’re probably, given all the disruptions that have occurred in the world and the fact that they need our; the world needs our coal, and coal prices are crazily high because of that. We probably would be okay in terms of coal. Iron ore would suffer because China has been a major purchaser of that. So, yeah, I mean, it certainly would be a problem. I mean, it’s hard to know what’s going on with China. Just a very difficult place to understand, really?

Randall Evans  27:33

Yeah. I did remember my other question relates to housing as well, you were talking about interest rates in the economy at different times, because a lot of people on mortgages might be on a fixed term mortgage, and that might go for X number of years. So, that flow-in effect might not hit them, and might not actually reflect in the numbers, two years down the track. So, what do we expect for the housing market, even though interest rates just going to keep going up?

Gene Tunny  28:09

Well housing prices are already coming down. I don’t know if you’ve seen those statistics. But Christopher Joy, who’s one of the top financial commentators in Australia, he writes for the Australian Financial Review. I’ve actually done some work for him in the past. He’s incredibly a bright guy. He’s got a company called Coolibar Capital Investment. And they’ve got billions of dollars of money under management. So, they’re really paying attention to this stuff. Look, you just look at the losses in or the reductions in housing prices since the first interest rate increase in May. And this is suggesting that, look, this is already impacting how sales was. I don’t know the exact breakdown; I should have looked it up before I got on. But I mean, there are a lot of households that are on variable rates. We see in the data that house prices are falling. I guess that will be, because as the interest rates increase, people won’t be able to borrow as much as they could have previously. And so that means they don’t have as much or they can’t go to the auction with the same expectations as they did before. Or maybe they’re more cautious about borrowing. They’re more concerned they’re less willing to bid at an auction because they are worried about the future. We know that consumer confidence has dropped. So, I think the interest rate increases have started to have an impact. So, there are obviously enough people worried about it. And it’s also impacting prices because it’s reducing the ability of people to the amounts that they can borrow. So, what was seen as Sydney’s fall and 5%, Melbourne, 3%, Brisbane, around 1%. That since May, since the first rate hike, capital cities overall, that minus 2 ½%. So, look here we prices are going down.

Randall Evans  30:35

I was just saying you’re recovering from COVID and I forgot to thank you for coming on.

Gene Tunny  30:43

Thank you. I usually think I’m okay. I thought I was okay, before I started. And then as I keep talking; should be okay. So, what Chris was writing was, if you look at Sydney, it’s declining at an annual rate of 22%. So, house prices are falling, and it looks like they’re falling at an accelerating rate.

Randall Evans  31:10

That’s a huge number to be dropping at 22%.

Gene Tunny  31:15

That’s if you take the rate it’s dropping out at the moment and annualize it. So, it may not last over the year. Although, it’s possible that it could; house prices soared during that pandemic period, even though many forecasters were expecting they might fall, it actually, surged because there was all this additional borrowing. There’s the fear of missing out. And, the market went nuts. And so, they’ll probably land above where they were at the start of the pandemic, but a lot of the gains will have been lost; it’s looking like that now. Because those interest rate increases are having more of an impact than was expected.

Randall Evans  32:11

Yeah, I couldn’t believe how much housing prices rose during the pandemic, it was just so counter to what I thought was going to happen. But it did, and I guess we’re going to see that correction. Probably not an overcorrection, though maybe, like you said, probably just above pre pandemic levels.

Gene Tunny  32:35

Yeah. And that’s what we’re seeing. It’s it started for sure. The big unknown is just how vulnerable households are to interest rate increases and whether you will start; they will massively cut back on their spending and that could then lead to a downturn. At the moment, the labor markets going ridiculously strongly, we’ve got 3 ½% unemployment, 300,000 vacancies, I think I saw someone report the other day.

Randall Evans  33:11

The unemployment figure that includes people actively looking for work, right. Yes. So, I’m not sure if that’s a great signal to our strength, if there’s a lot of vacancies and a lot of people looking for work, or am I missing something?

Gene Tunny  33:33

But that’s showing that there’s hardly anyone looking for work compared with before the pandemic. And there’s lots of vacancies. So, this is why we would expect wages to start increasing or perhaps we hope that they will. I think they probably are. We’re certainly seeing well, the sign- on bonuses that have been reported, there’s a story about McDonald’s. Possibly, who knows whether that’s true or not, it’s hard to know whether McDonald’s would be paying $1,000 sign-on bonuses, but that was the Perth Now report. I believe it in the mining sector though.

Randall Evans  34:12

Yeah, I could fly to Perth for like 400 bucks, have a job for a week and I’ll pay for my holiday.

Gene Tunny  34:20

You probably have to serve at some time. I’m sure they’ve got something or their agreement to cover that. So, I think the unknown is just how the economy will react as interest rates increase and just how much people will cut back their spending and whether you know, we had a boom and then we’ll have a burst. One of the challenges is going to be; and this is a big issue for the new government. You will recall that the previous government cut the fuel excise in half, so it’s down at about 22 cents a liter now, and what’s going to happen is that that’s going to go up to, it has to be 44 cents because they cut it in half, at the end of September. People will notice that unless petrol prices come down a bit more, they’ll really notice that and that’s going to come at a bad time, because we know interest rates are still going to go up. They’ll go up half a percentage point next week.

Randall Evans  35:38

What are your thoughts on how the Albanese government is going to shake up the economy? I guess some of the things that are promising, like, I guess the government backing certain home loans by 40%, and things like that. Does anything about his election promises stand out to you that will have a big impact?

Gene Tunny  36:06

Not really. They wouldn’t implement policies that I would probably implement at the moment to try to get inflation under control, they wouldn’t do that, they wouldn’t go that far. There was a discussion that we had? Well, I think we have to massively reduce his budget deficit we’ve got now. So, Jim Chalmers, the Treasurer, he’s talking about the need for savings. One of the reasons they’ve got to find savings; they need to get the debt under control – the trillion-dollar debt, but also because the government at the moment is contributing to the inflation problem we’ve got by running these large budget deficits. Still large, what you call a structural budget deficit. so that they’re still running these large structural deficits of 3 to 4% of GDP, if you look at the budget documents. So, what that means is that if you adjust for the state of the economy, you take into account the fact that the economy has been doing very well. At this point in time, the government should be running much smaller deficits or surpluses than they actually are, and they’re not. They’re still running reasonably sizable deficits. So, there’s this structural deficit, and that’s contributing to inflation. They’re adding to the demand in the economy, they’re contributing to the overheating. So, what this federal government has to do is to really cut back on their spending. Or, one alternative, I don’t know whether they’ll do it or not, because they promised that they would follow the stage three tax cuts. I think in stage three. There’s another tax cut coming through, that’s going to knock out one of the marginal tax brackets, if I remember correctly. And so, there are some people on the left who are arguing that the government shouldn’t go through with those, those tax cuts that are programmed in.That’s one possible thing they could do. To address that structural deficit. I’d probably prefer that they cut their spending, because they’ve got some big spending programs that are really getting out of control. So, NDIS, it’s well intentioned; I think a lot of people support the principle of it. But it’s growing, it’s tens of billions of dollars, or 30 billion, or whatever it’s going to overtake Medicare, in terms of the amount of money that’s spent on it over the budget estimates, over the next four years. 

So, that’s something they’ve really got to get under control, but that’s going to be difficult for them. I think it’s a well-intentioned program. The challenge is, where do you limit it? That’s the problem. There’s the desire to keep expanding it and to make it to provide as high level of service as possible and I think yeah, that’s just financially unsustainable at the moment, we need to really fix that up. 

That’s what I think needs to happen. There needs to be the expenditure restraint, or you know, the larger cuts than anything Jim Chalmers would be contemplating. I’m former Treasury, the Treasury would have provided some list of the things that should be cut. And knowing how these things work, Treasury have this huge book full of potential savings that could occur. And the government will probably pick a handful of them, because they look at most of the things Treasury’s proposing and they go, how could you ever contemplate cutting all of these things? Politically naive, so that that’s what will happen, that’ll be the reality. 

Randall Evans  40:38

Well, one of my questions is that, I know the RBA is supposed to be a separate entity, but allowing the RBA to increase interest rates to such a level that’s going to hurt your voter base. It’s almost political suicide. And I know they don’t really have a say, but, there was that kind of situation where I think it was Roosevelt who grabbed one of the members of the Federal Reserve by the scruff of his neck and was like, you’re destroying my presidency. So, is there a situation where the Australian Government can effectively halt the interest rate rise for political reasons? Or do we have enough kind of checks and balances to stop that happening?

Gene Tunny  41:31

Okay, they actually could, there’s, they have the power to do that. I’m trying to remember this is a point that Nick Growing often makes, I’m trying to remember correctly, I think there’s a provision in the Reserve Bank Act that the treasurer can table something in Parliament and tell the RBA what to do, right. So, the Treasurer could direct the RBA. And I don’t know if you remember, back in the 80s, we had a treasurer of Paul Keating, the Labor treasurer at the time, and he gave a famous or probably infamous speech. It was in the lead up to his challenge to Hawk when he said, I am like the Placido Domingo of Australian politics. And I’ve got the Treasury in this pocket, I’ve got the RBA in the other pocket. That was a great speech; it was not a modest man, it was a very coveted man. But yeah, Keating thought he ran the RBA. So, back in the day, the government had a lot more control over the RBA. The problem then is that, you don’t want monetary policy set by the government. Because for that reason, because the government’s going to want to have it more well, looser, they probably want to have the economy more prosperous in time for their reelection. And they’re not thinking longer term about what the inflationary consequences of that are. 

So, what economists have learned from that problem, the problem that if you have a Central bank politically influenced and you can get you can get higher inflation is we need to have Central banks independent of the government. So, we need to give them some independence. And so, what our governments have done is that they’ve struck an agreement with the Reserve Bank, there’s an agreement on the conduct of monetary policy. That was first, I think it was first formalized by Peter Costello, and in the fall, and in the 90s, in 96. And what that did was that codified in an agreement, the inflation targeting goal that we have now. So, the Central bank, the Reserve Bank, is targeting inflation between 2 to 3%, on average, over the economic cycle, so it’s of which means that they don’t have to be zealous or they don’t have to solely target inflation, if they’re going to crash the economy, they could ease up a little bit on interest rate increases, but ultimately, their goal is to get inflation under control, get it 2 to 3%. That’s what they’re accountable for. So, they’re going to be doing everything they can without crashing the economy to get inflation under control. But look, who knows? We hope we’re not in a situation that the Americans or that we were in the late 80s or the Americans were in the sort of early 80s and Britain too when you really had to increase interest rates a lot to get inflation under control because you had double digit inflation. Now we’re not there yet, hopefully we’ve moved in time to prevent that from occurring. But if you get to a situation where you’ve got double digit inflation, then you might have to increase interest rates much more than the economy can bear and then you end up in a crash. 

I’d like to think that we haven’t left it too late. And we’ll need to resort to those measures. But, let’s wait and see. So, I guess the answer is that, the government could direct the RBA. But then, the bad press they would get over that would be incredible. You’d have all the financial journalists around the country, criticizing them over compromising the independence of the RBA, Jim Chalmers wouldn’t be able to finish a press conference.

Randall Evans  45:52

You’re acting like they answer the presses questions. I think Anthony Albanese is the fondest to just brush off questions. But I understand completely what you’re saying. And I wasn’t suggesting; just for my viewers that the government should do that. I was just putting the thought out there. As a former Treasurer, what do you think the current government values most when it comes to the economy? Because everything seems to be a trade-off, right? It’s either we can get inflation under wraps, or we can have high job growth or, we can have housing affordability, so what do you think that they’re actually going to? Because you can’t have all of them or maybe you can? What do you think their focus should be, moving forward?

Gene Tunny  46:49

Well, I think the focus should be on the overall health of the economy. So, it should be about making sure that we’ve got the right tax policy settings or we’re spending on the right things, we’re not wasting money. We’re not contributing to the inflationary situation. We’re not enacting silly policies. 

One thing I have been encouraged by is the fact that they’re not doing really silly things, or they’ve knocked back this idea from the greens that we should have a moratorium on coal and gas projects, right? At a time when the coal price has been; well, that’s what Adam Danza saw, right. And at a time when the global coal prices being up at 500, or 400 US a ton for thermal coal, that’s extraordinary. 500 a ton for metallurgical coal, for coking coal. The idea that you’d actually wouldn’t develop any new coal mines when the world is crying out for it, because there’s no gas. We’ve got a global conflict and Europe’s worried about their gas supplies and whether they’ll have enough gas in the winter. Yeah, it’s a bit crazy. Full credit to the prime minister for knocking that back. 

I think there’ll be broadly sensible, but what you’ll see with a labor government is that they’ll be more aligned to what they perceive as the workers. Okay, and they won’t care as much about the costs they impose on business. Okay. And so, you’ve seen that recently. The problem we’ve got is that there are a lot of well-intentioned policies and so it’s hard to argue against a lot of these things, but they are costly to business. This government will probably do more things like this, we saw that there was that recent decision about from about, what is it? Paid leave for if you suffered domestic violence, or family violence? I can see what why that would be a good thing to have, at the same time, there is already paid leave available, you get four weeks if you’re a full-time employee. And this is an additional cost to employers. And you’d have to be a pretty nasty employer if you didn’t look after an employee of yours who was in that situation. I wonder why this sort of move is necessary from the government. Maybe they think it’s not going to have much of a cost because your employers would probably do the right thing, to begin with. 

I guess it’s a signal that this government is probably going to be more focused on the workers, it’s going to be less concerned about the impacts of its policies on employers. One thing that worried a lot of people, a lot of economists and financial commentators, John Keogh wrote a great column on this in the Finn review was when Anthony Albanese in the lead up to the election, talked about how the Fair Work Commission should just agree to wages going up at the rate of inflation. And there was a concern that, well okay, that’s a good thing that just leads to that wage price spiral where, if prices go up, oh, let’s increase wages by the same amount. And then that increases the cost to employers, they pass it on in prices. And then oh, let’s have wages go up again, prices go up again. And they just sort of gradually creep up a little, not gradually, they can increase, they can go up very quickly. And organizations such as the Bank for International Settlements and various other economic agencies around the world have warned about this wage price spiral, and one of the quickest ways to get there is to have automatic indexation of wages to inflation. 

So, there were people concerned about what the PM said there back in the election campaign. Ultimately, it was up to the Fair Work Commission, the Fair Work Commission recommended an increase that wasn’t complete. It was just a bit; I think it was a bit lower than the inflation rate. For non-minimum wage workers is about 4.6% or something, if I remember correctly.

So, that would be my take on it. I think they won’t do anything too crazy. They’ve resisted that crazy proposal from the greens, so, good on them for that. Sorry, go ahead.

Randall Evans  52:15

I follow a few greeny pages on Facebook just to see what they’re yapping on about. And I did see a lot of angry people today about that very thing you’re talking about. Saying, you can’t be for sustainability, but then allow coal mines to open. 

Gene Tunny  52:42

Yeah, well, just on that. it’s a real threat to labor. So, it was the coalition that got smashed on the climate change issue, last election, they ended up losing some of the blue-ribbon seats. But labor’s similarly threatened, right. Labor got what was it? 31% primary vote. So, labor was lucky to, it’s just the way that it played out in terms of the seats that were that were lost. And it managed to be able to form government, even though it ended up getting fewer votes than the coalition. But yeah, it’s in trouble from the greens as well.

All of these inner city seats are turning green. So, I’d be interested to see what happens in the future, whether Labor has to; how it survives, it’s under threat, as well as the coalition. So, I think that’s one thing that’s going to be fascinating to watch in the next few years.

Just on housing, the government’s policy isn’t going to do much for affordability because it was only going to apply to 10,000 people or so. It was it was limited in the amount of people that would apply to and it has to apply to hundreds of thousands of people to really make any sort of impact. The reality is there’s not much the federal government can do because the states are more relevant when it comes to housing because well, one, they’ve got responsibility for social housing. Now, my view is they’re just never going to be able to build enough of that. One of the problems with social housing is that they’re aiming to offer it at below market rent. The challenge there is you’re going to have a huge demand for your social housing because you’re offering something that’s cheaper than what the market is able to provide right? So, you’re never going to win there. You’re always going to be attracting more people, than you’re going to be able to build houses for. 

So, that’s probably not the answer. I think the answer is having a more liberal approach to development, allowing more development, particularly in the inner cities where we have heritage restrictions. There are all sorts of zoning rules around our capital cities. And even across the whole metro area here in Brisbane, for example, where I am, there’s a ban on townhouses in low density neighborhoods. And that’s just really silly. Because, that’s constraining the supply of housing. And there was research by Peter Tulip, at the Reserve Bank when he was there at the Reserve Bank, that showed that these zoning restrictions, they’re massively increasing the cost of housing, like 50, or 60%, something like that. So, that’s up to councils, but state governments, they possibly could do something like that with some of their planning legislation. But the commonwealth really can’t do much about housing. So, even though it’s an issue, it’s a big issue. I’m not sure they really can do much about that. 

The big issues the Commonwealth is facing; there’s the general economic management issue, what its budget deficit is doing for the economy, what its budget deficit means for the accumulation of debt and risk to the credit rating in the future and our ability to service that debt. And so therefore, that’s why Jim Chalmers is having to trim the budget where he can. He’s going to find it difficult though, just because that reason we discussed. Labor sees itself as the party of the workers, it also sees itself as more socially caring, more compassionate than the conservative side of politics. And so, it’s going to be very hard for them to make the substantial budget savings that are necessary.

Randall Evans  57:15

Well, we’ll touch base with you again, in a couple of months’ time and see where we’re at as a nation. And if people want to watch, we’ve had Gene on before, so you can just search for it in the little YouTube bar and watch that episode too. But apart from that, make sure you check out his website. It’s on the screen right now. If you want to have some more in-depth conversations.

Bye Gene. Thanks for your time. Thanks for being here.

Gene Tunny  57:42

Pleasure. Thanks. Thanks, Randall and thanks to everyone listening. Yeah, glad to be to be connecting with you. So, it’s been great. 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 Randall Evans for letting us borrow the audio from his latest Deactivist show for this episode. Also, thanks 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

Reserve Bank of Australia being reviewed after big mistakes w/ Peter Tulip – EP149

The Reserve Bank of Australia has allegedly made some bad calls in recent years and now the Australian Treasurer has commissioned a major review. This episode’s guest, Dr Peter Tulip of the Centre for Independent Studies, has long pushed for a review of the RBA. Peter, a former RBA and US Fed economist, thinks the RBA can learn from other central banks such as the Fed and Sweden’s Riksbank, and it can avoid future bad policy decisions which cost hundreds of thousands of jobs. 

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

Here’s a video clip of Peter’s conversation with show host Gene Tunny to give you a flavour of what is covered in the episode.

About this episode’s guests – Dr Peter Tulip

Peter Tulip is the Chief Economist at the Centre for Independent Studies, a leading Australian think tank. Peter has previously worked in the Research Department of the Reserve Bank of Australia and, before that, at the US Federal Reserve Board of Governors. He has a PhD from the University of Pennsylvania.

Peter’s twitter handle: @peter_tulip 

Links relevant to the conversation

Peter’s previous appearance on Economics Explored: https://economicsexplored.com/2022/04/11/the-high-cost-of-housing-and-what-to-do-about-it-w-peter-tulip-cis-ep134/

Australian Treasurer’s 20 July 2022 announcement of RBA review:

https://ministers.treasury.gov.au/ministers/jim-chalmers-2022/media-releases/review-reserve-bank

Peter’s CIS paper on the RBA: https://www.cis.org.au/publication/structural-reform-of-the-reserve-bank-of-australia/

Kevin Warsh’s review of the Bank of England Monetary Policy Committee: https://www.hoover.org/sites/default/files/transparency_and_the_bank_of_englands_monetary_policy_committee.pdf

This is the 2010 Statement on the Conduct of Monetary Policy that Peter refers to at the end of the episode:

https://www.rba.gov.au/monetary-policy/framework/stmt-conduct-mp-5-30092010.html

This is the most recent statement:

https://www.rba.gov.au/monetary-policy/framework/stmt-conduct-mp-7-2016-09-19.html

Transcript: Reserve Bank of Australia being reviewed after big mistakes w/ Peter Tulip – EP149

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.

Peter Tulip  00:01

Coming up on Economics Explored. Many of us, including me, think that the Reserve Bank has been making big mistakes and is in need of structural reform.

Gene Tunny  00:15

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 149 on the review of Australia’s Central Bank, the Reserve Bank of Australia, or RBA. This review was announced by Australia’s new Labour government on the 20th of July, 2022. 

My guest this episode, is Dr. Peter Tulip. Peter has long pushed for a review of the RBA, and he’s been extensively quoted in local media on what needs to change. Peter thinks that the RBA has made some big mistakes in the past, and it could learn from other central banks, such as the US Federal Reserve, and the Bank of England, as he explains in this episode. 

Currently, Peter is the Chief Economist at the Centre for Independent Studies. And before that, he’s worked at the RBA, and at the US Federal Reserve Board of Governors. So, he knows how central banks work on the inside, and his perspective is a valuable one. 

This is Peter’s second appearance on the show. He previously appeared in Episode 134 on the high cost of housing. So, if you haven’t listened to that yet, please listen to it after this episode; it’s great. 

In the show notes, you can find relevant links and details of how you can get in touch with any questions, comments or suggestions. Please get in touch and let me know your thoughts. I’d love to hear from you. 

Righto. Now for my conversation with Peter Tulip on the review of the Reserve Bank of Australia. Thanks to my audio engineer Josh Crotts for his assistance in producing this episode. I hope you enjoy it. 

Peter Tulip, Chief Economist at the Centre for independent studies, welcome back to the program.

Peter Tulip  02:01

Good, Gene, how are you? 

Gene Tunny  02:03

Good. Thanks, Peter. It’s great to be chatting with you again. I’m keen to speak with you about the review of the Reserve Bank of Australia that was announced earlier this week by the treasurer, Jim Chalmers. One of our colleagues, Steven Kirschner; Stephen has been on the show before too. He wrote that the RBA review is; he wrote about it that everything is on the table, and that’s good. So, it is a very expansive review. The only thing it looks like they’ve left off the table to me, is that they’re not reconsidering the split in responsibilities between the Reserve Bank and the Australian Prudential Regulation Authority. They obviously still see a role for that as a separate entity, rather than rolling, prudential regulation back into the RBA. But other than that, it seems like a very broad ranging review. Are you generally happy with what’s been announced?

Peter Tulip  03:02

I’m delighted. Many of us have been calling for something like this for a long time. And the terms of reference are fairly deep and broad. The people running the review, first class, and there’s a good mix of people too. I mean, they’ve got a central banker, an academic and central bureaucrat. And any substantial reform, the RBA is going to require integrating those three perspectives. So, that’s useful also.

Gene Tunny  03:41

Right, okay. So, we’ve got an international expert, someone who’s been on the committee, the Monetary Policy Committee in the UK;

Peter Tulip  03:49

The Financial Policy Committee, slightly different. That’s financial stability rather than monetary policy.

Gene Tunny  03:55

All right. Okay. But she’s had a senior position in the Canadian Central bank, is that right? Caroline Wilkins? 

Peter Tulip  

Yeah, sure.

Gene Tunny  

And also, Renee A. Fry-McKibbin, who is an academic at the Australian National University, so highly regarded macro Economist, and also Gordon Brewer, who I worked with in the Treasury many years ago. And I mean, I think Gordon’s an excellent choice for that. So, yeah, it looks like;

Peter Tulip  04:24

And before that, Gordon worked at the RBA, so it’s good to have some internal experience.

Gene Tunny  04:31

Right, okay. But it wasn’t exactly what the RBA wanted, was it? Even though it looks like the RBA has had some role in shaping the terms of reference, I saw an interview with Jim Chalmers on, was either Coffee show or the Today show here in Australia. And he was saying that the RBA said some input in the terms of reference, but originally, they just wanted to review themselves, didn’t they? Which would have been a great idea if you think about it.

Peter Tulip  04:58

To be credible, it needs to be external and independent. They’ll have a secretariat, which will be largely staffed, I think, from Treasury and the RBA. So, they’ll be able to call on the resources of the bank, and it’ll be informed by the bank by insiders, but the ultimate judgments will be independent and external, which I think they need to be.

Gene Tunny  05:26

Well certainly will, particularly if they’ve got Rene on the review committee. So, Rene is the editor of the Economic Record here in Australia, which is the top Economics journal here, and she’s well known in the economics profession and her husband, Warwick McKibbin, is actually a former board member, isn’t he? I mean, she’s obviously a separate person to Warwick. But I mean, I’m wondering if this is a way that Warwick’s views are actually getting inputted into the review in some way, even though obviously, she’s her own individual.

Peter Tulip  06:03

Yeah. His views will clearly get a lot of weight. But Rene is an expert in her own right. Yes.

Gene Tunny  06:09

Yeah, along with other economics colleagues. So, it’s not going to be something that the Reserve bank is going to necessarily get its way on, which is good. There’s going to be input from a broad range of sources, including yourself, I mean, I’m guessing you’ll be making a submission to the review.

Peter Tulip  06:26

I’ve already written my submission. I mean, so I did a big paper calling for reform of the RBA, just a few months ago. In the context that this review has been called for. And I set forward my views on what I was hoping the review would look at and what it would conclude. So, I’ve done my bit, and now it’s up to them.

Gene Tunny  06:48

Great., I mean, you’ve certainly been one of the most influential people in in this discussion so far. And you wrote a fascinating AFR piece earlier this year, which was titled Reserve Bank must be made accountable for inflation mistakes. So, might chat about that in the moment. But to begin with Peter, could you tell us why do you think this review was necessary in the first place? Is it because of those inflation mistakes?

Peter Tulip  07:14

Can I give a long answer to that? So, there are three levels of an answer in increasing areas of being controversial. The first and simplest answer is that, it’s just good practice to regularly review your monetary framework every few years, in the light of new research and new experience. People are writing about these frameworks all the time, and you need to, every now and then have a stock take of that. And this is what all of our foreign, not all, most other Central banks do. It’s standard amongst foreign central banks to have regular reviews. And the format of those varies, and we’ll talk a bit about that. Some of them are external, some of them are internal. Some of them have a heavy academic focus. Some of them are on; the Bank of Canada does is on a regular five years schedule. Others are more ad hoc. So, that’s one thing. It’s just regular practice. 

The second bigger argument is that the Reserve Bank has been missing its targets that prior to the pandemic, the inflation rate was well below the target of 2 to 3%. And the unemployment rate for an even longer period was well above estimates of its sustainable or full employment level. And so, particularly with the inflation rate, which is the reserve bank itself describes as a key performance indicator, when you’re persistently failing to hit your targets, there is there has to be a presumption that a review is necessary that otherwise there’s just no accountability at all. 

And then the third layer of arguments I gave, which is more controversial, is that many of us, I mean, including me, think that the Reserve Bank has been making big mistakes, and is in need of structural reform. And it’s great to have a chance to hear those views. And these are arguments that part of them are related to the composition of the board that these are decisions for the government and parliament often, rather than for the bank itself. And so, you need some kind of external review to evaluate this widespread argument.

Gene Tunny  09:53

Yeah, I think they’re good points. Peter, can ask you about that inflation target of 2 to 3%. Now, there could be two possibilities couldn’t there? It could be that either the 2 to 3% target doesn’t make sense, or we should review that target; we should, maybe we could downgrade it or just set it at 2% or have it at 1 to 2%? Or another possibility is the Reserve Bank; I mean, it was derelicting its duty. So, is that right? There are two possibilities there, there could be; and this is why a review would be desirable because you’d either look at the appropriateness of the target, and also whether the Reserve Bank is actually doing what it would need to do to achieve that target.

Peter Tulip  10:36

Correct. So, the reviews that other Central banks have had, often have had a strong focus on the specification of the targets. And that should be part of this review. And there are many people that would prefer a different target to the 3%. There are some people who think the inflation target should be lower, there are some people who think it should be higher. There are respectable arguments for both that the review should be considering. And that should be an important part. In my view, those arguments are really secondary, oh sorry, I should also say, there are other people who want to target a different objective completely, such as nominal income. And we’ll talk about that later on. 

In my view, those arguments are really secondary. That for most of the past decade, the bank has not been hitting its targets, it hasn’t even been trying to hit them. So, it’s a bit pointless specifying worrying about how you exactly define the target. If the bank isn’t just going to ignore. The most important question is governance, and how can we change the incentives of the RBA so that it actually does hit the targets it’s given? And you need to get that right before you worry about what that target actually is.

Gene Tunny  12:04

Okay, a bit of follow up on that. Peter, you’re saying that it hasn’t even been trying to achieve those targets?

Peter Tulip  12:11

Sorry, I’m wording that too strongly. You’re right.

Gene Tunny  12:13

I think I understand the point you’re making. I want to just explore that a bit. 

Peter Tulip  12:18

Can I give you an example? 

Gene Tunny  

Yes, please.

Peter Tulip  

So, in November 2019, just before the pandemic came along, the Reserve Bank issued a set of forecasts, and it had underlying inflation staying outside the target range for the whole horizon. And it had unemployment exceeding the bank system, it’s a full employment for the whole horizon. 

Gene Tunny  

So, inflation was below 2%?

Peter Tulip  

Yeah. Unemployment was I think, being forecasted 5% or higher, varying depending on the horizon. And despite what you would think is an obviously unsatisfactory outlook. The Reserve Bank didn’t change interest rates, either at that November meeting or subsequent meetings until the pandemic came along. And it did so because it was worrying about other things, in particular, financial stability. So, there was a disregard, or at least down weighting the bank statutory responsibilities in the legislation that says, the objectives stability of the currency, which we interpret is 2 to 3% inflation, and full employment, which we would interpret now as the preferred terming, that other Central banks uses, maximum sustainable employment, which were estimated about four and a half percent. So, there was a down weighting of those objectives in favor of this new objective that the bank invented about indebtedness, and we’ll talk about that later on too.

Gene Tunny  14:01

Okay, so shouldn’t central bank be concerned about indebtedness and the related issue of financial stability? I mean, that’s ultimately what they’re concerned about, isn’t it that if they’re worried that monetary policy, if it’s too loose, if it’s too accommodative, then households could take on too much debt and then get into trouble at a later date and that could have adverse economic consequences.

Peter Tulip  14:28

Sure. So, we know from the global financial crisis, that if your banks start failing, then it’s catastrophic for the economy. Australia had a similar experience in; when was it? In the early 1990s. When several of our small banks failed and some of our big banks came close. And again, that that was one of the worst recessions Australia’s had in living memory. So, yes, financial stability matters a huge amount. The question is how you deal with that? And what’s the appropriate instrument for that? And there’s a very large volume of research saying that it’s not interest rates or monetary policy, it’s prudential policy. And they were in particular, about the capital requirements that banks are required to have. And the way to avoid a repetition of the GFC is not to put 270,000 people unemployed, is to raise your capital requirements. So that if in the event of losses, banks making losses on their loans, banks have sufficient equity to cover that. And so, the important objective is, yes, we do very much want to avoid a repetition of the GFC. The way to do that is with high capital requirements.

Gene Tunny  16:04

This 270,000 jobs number Peter, is this from an analysis by, is it Andrew Lee and?

Peter Tulip  16:15

And Isaac Gross. So, Andrew Lee is now an assistant Treasurer, he’s a government minister. And Isaac Gross is an academician at Monash University of Economists. And they, just recently, published a paper in the economic record, which you were referring to before. That’s the journal that Renee A. Fry-McKibben edits. Where they found that, yes, the reserve bank kept interest rates too high, between 2016 and 2019. And because of these worries about debt, and because of that, unemployment was 270,000, higher than it should have been.

Gene Tunny  17:08

Yeah, it’s interesting. I mean, I’ll take the point there about; if you do run that simulation, and I think they use the Reserve Bank’s own macro-economic model Martin, I think they’d call it. And so, look, yeah, good point. I mean, if I were on the board, I’m probably one of those who wouldn’t have minded them having kept the rates where they are. I probably wouldn’t have supported cutting them, as that model would suggest, given that I would have those concerns about financial stability. But I do recognize that there are a variety of views. And I’ve been interested to learn about that literature that you’ve written about, and also Steve Kirschner talked about when I spoke with him on nominal GDP targeting. And I want to have a closer look at that. 

Peter Tulip  18:00

I’m happy to argue the merits of that particular argument further if you want, but what’s maybe a more important point to make here is that the process was bad. Yes, the bank never really explained or defended its position in public, that there seems to have been a real lack of scrutiny of the decision. So, there are people such as yourself, who were sympathetic to what the bank did. But those arguments, I would say, the large majority of expert opinion is on the other side, which is that you should regulate these considerations with prudential policy, not with monetary policy, that the most direct instrument is almost always the most efficient, and involves the least collateral damage? Yeah. 

And even though, a majority of expert opinion in a majority of other central banks were explicitly opposed to the bank, there was no real defense of that position in the bank’s documentation. Beyond a few brief sentences. The bank never quantified its concerns, was never actually very precise, even about whether it was really worried about the level or the growth rate of indebtedness. It didn’t even say what; no discussion of what’s the best way to measure this, no real clear discussion of the consequences of this. But maybe even more important, even though most expert opinion was against the bank, there was no; counter arguments were never addressed. 

So, in the paper I wrote that earlier this year, I mentioned another half a dozen arguments against the bank’s focus on indebtedness, any one of which I think would be fatal. And none of these were publicly addressed. Just to give one, a lot of research studies find that low interest rates don’t actually have almost negligible effect on indebtedness, that the debt to GDP ratio has a numerator and a denominator. And low interest rates will encourage both. And a lot of research says that actually, you have a bigger effect on GDP than you do on the debt. So, low interest rates have a greater effect on the capacity to repay, or to bear a burden than on the actual burden itself. Insofar as what the bank was doing, it was counterproductive. And there are more arguments and people; rather than going through succession of arguments on it. Yeah, actually, this is the paper. It’s called structural reform of the Reserve Bank of Australia. I mentioned a lot of further reasons as to why the bank was wrong in targeting indebtedness at the expense of its core objectives.

Gene Tunny  21:35

Yeah. I’ll put a link in the show notes to that paper for sure. Peter, in fact, I’ve got it in front of me, it’s a Centre for Independent Studies analysis paper, 36, April 2022. And in that paper, I mean, you, I mean, it’s Frank and fearless for sure. You’re someone who used to work at the bank. And you’ve probably still got a lot of friends there at the bank. But you mentioned or you talked about their poor communication and poor process. Now, I mean, you’re talking about that before. What do they need to do better? How do we improve it? I’m guessing this would be one of your hopes for what the review recommends. But how do we improve the process in the communication?

Peter Tulip  22:27

So, let’s start with this particular issue, the bank needs to fully explain itself, that it needs to outline the pros and cons of its arguments and address obvious counter arguments. And preferably, if something is important, you need to say what’s the evidence, both consistent with the bank’s position and how do we address evidence that people think weakens the position? And some kind of quantification of these effects is, well, I mean, some of these things can be measured, and there is substantial research on aspects of this question. And that really needs to be discussed and its relevance to policy explained. 

So, that’s dealing with one specific error, and why that’s important, is, unless you do that, mistakes will happen. And so, regardless of your position, on this particular question of indebtedness, the process was clearly flawed. That if you keep making big decisions that slip hundreds of thousands of people out of work, without a full, open public discussion, sometimes you’re going to make mistakes. And when you make mistakes, they will persist. An open discussion is the best antidote to making serious mistakes. Because this was not just a one off, the bank has a record of very controversial decisions that run counter to mainstream economics. For example, Warwick McKibbin, we mentioned earlier, was pushed out of the bank when he objected to its policy. This is back in the late 80s, early 90s of targeting the current account deficit. The bank had interest rates far too high, because it was worried about the current account deficit. Warwick McKibbin said that that was wrong. And essentially, he was told he wasn’t welcome. So, he left.

So, this is a cultural problem within the bank, its resistance to criticism and to scrutiny, even internal scrutiny.

Gene Tunny  25:09

Peter, can I just ask what are they doing now? So, at the moment, they do publish; there’s a decision, there’s a monetary policy decision every month regarding what they do with the cash rate, there’s a page or so of, you know, discussion of where the economy’s at and some sort of; all they make clear what their decision is, you’d like to think there’s some logical connection with their analysis of the economy in that decision. The governor does make himself available to give speeches, he appears that I mean, parliamentary committees, from time to time. So, what more needs to be done? And are there any examples around the world of how it’s done better?

Peter Tulip  25:54

Yeah, I think most Central banks are clearer and more transparent than the RBA. Where it matters most is in reasons better decision. So, where transparency, I think is most necessary is for the banks to say why it made a decision, and why its choice was preferable to alternatives. So, for example, at the moment, the bank with the rising rates, the market expects to be going up about 50 basis points a month, the next few months. It would be very useful, in fact, I think it’s necessary for the bank to say, what would be the consequences of alternative choices? Suppose interest rates were to rise slower, and interest rates could rise higher, and what would be the unemployment and inflation consequences of those alternatives? My guess is that a faster path of increases would give us lower inflation and higher unemployment, in both cases, bringing those variables closer to the bank’s targets. 

So, why is that not the preferred choice? That strikes me as the central requirement for transparency, explaining why you’re not doing something different, and the bank doesn’t really do that. It certainly doesn’t quantify it. But other central banks do. The Federal Reserve, the Risk bank are prominent examples. I mean, all it takes is just a little four panel chart to show; again, this is the Goldilocks path in the middle, and this is too high and this is too low. And these are the consequences and we pick the path, the Goldilocks path with the best outcomes. Other central banks do that as a matter of routine, so should the RBA.

Gene Tunny  28:05

Right, so you’re talking about the Federal Reserve and the Bank of England? Okay. 

Peter Tulip  28:09

The Bank of England does it in a slightly different way with scenario analysis. That would not be my preferred model. Either the Riksbank or the Fed approaches, or just very clearly convey the central issues in the monetary policy position.

Gene Tunny  28:27

Yeah. In preparing for our chat, Peter, one thing I noticed was a review that was done of the Bank of England’s Monetary Policy Committee by Kevin Walsh, 2014. Actually, I may have learned about that from you. I’m trying to, I can’t remember exactly, but I thought that was very good. If I’m reading one of his tables correctly, it does suggest that we have very low transparency here in Australia relative to those other countries. I think that’s.

Peter Tulip  28:57

So, about Kevin Walsh, he used to be a governor of the Federal Reserve and went to the Bank of England. This is an example of the kind of external reviews we were talking about, specifically to review their processes for transparency and openness. And it ended and it’s a very good thoughtful report, and anyone interested in that issue, I strongly recommend it. As part of his review, he looked up the Central bank practices and then yeah, the RBA was terrible. And the RBA is partly rectified. It as been more opened since that report was done. And in particular one, one of his glaring findings was that Australia was the only country he looked at where the Central bank didn’t give regular press conferences and and other countries find that a very useful way of explaining that as decision, and in particular, having important decisions challenged and defended. But since then, Philip Lowe has started getting press conferences, so, that’s a great thing. I’d still like them to be more frequent. He only does them occasionally, I would think you should do them, at least quarterly.,

Gene Tunny  30:34

Yeah. They certainly need to improve their communication. I’ll have to think myself about what that would best look like. I quite like the idea of having scenarios or having different, you know, looking at what different policy parts could mean for inflation and unemployment, but also being honest about what’s the uncertainty around that. And I mean, one of the things that our Governor, Philip Lowe has got into trouble for in the last few months is just the fact that their forecasts appear to have been just so bad. Perhaps, if they’re more honest about just how unreliable economic forecasts can be, given that the economy is hit by shocks all the time, and I mean, we’re not even sure we’re properly modelling the underlying mechanisms. Perhaps that would have; he would be held in high regard now. But everyone’s mad at him because he was, people were taking his word for it, that interest rates would stay where they were until 2024. And so, he’s in a heap of trouble now.

Peter Tulip  31:37

If I can comment on that. So, I think people exaggerate how bad these forecast errors were, and in particular, their relevance to the review. You have to remember that Jim Chalmers came out in support of a review of the RBA, over a year ago. So, before inflation took off, in fact, back a year ago, inflation was below the target. So, what’s happened? There are these unusually large forecast errors, but they’re not the reason we’re having a review. And forecasting is difficult, and in particular, if you’re forecasting in the middle of a pandemic that you’ve never been through before, you’ve got no historical experience to go by. And as it turned out, vaccines came on stream very much quicker than expected. And they worked much better than they’re expected. And the RBA got that wrong. You know what, no one can forecast accurately. I’ll be impressed with criticisms about the bank’s forecast record from people who actually do forecasts better than the bank. Hearing a lot of criticisms that we’re forecasting for people that don’t actually present forecasts themselves makes me roll my eyes a bit. Yeah, fair point. And the bank will always make forecast errors. And it has processes to improve its forecast performance and it does reviews of its models and this and the databases and things like that. The review will probably look at that. I’ve actually been involved in that process. I don’t see great scope for change or even questioning what the bank is doing there.

Gene Tunny  33:48

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

Female speaker  33:53

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Gene Tunny  34:22

Now back to the show. 

Okay, can I ask you about this transparency, like how we improve that? One of the suggestions that came from a panel member at the conference of economists last week when we’re in Hobart, you were there? I can’t remember. Sorry, Peter, were you in that session? You were in that session, weren’t you? There was that recommendation that I forgot who made it. But that part of members of the board of the Reserve Bank that their deliberations or their decisions are published or someone’s got a dissenting opinion that’s published. So, we get more communication from the board members. And so, we understand that there is a difference of views and that could help the public understand the deliberations and realise that the Reserve Bank isn’t this all-seeing, all-knowing entity that’s fully in command, or maybe that’s the wrong way of putting it. But maybe that would make people realise that they’re human, and mistakes can be made. And so, when we have a governor who says, oh, interest rates will remain this, at this level until 2024, we should realise, well, he’s talking about based on these assumptions. I mean, you can never guarantee anything. But what do you think about that idea of having more information about what different board members are thinking?

Peter Tulip  35:51

I think that’s a great idea, partly to improve the incentives have individual board members, that individual board members should be accountable for their decisions. And at the moment, there isn’t any individual accountability, these decisions are presented as decisions of the board. And so, I think there’s no incentive for a board member to say, I think this decision is wrong. The research says opposite. We need to pursue an alternative course of action. So, partly, there’s inadequate challenge within the board process, as and as a result, less need for the bank to defend itself. But also, it means the public is not brought into these highly consequential debates and decisions. And that would improve things. And where a board is divided on a particular course of action or a particular piece of analysis, this is where external research and external opinions are most valuable. But no one knows that. So, people talk about monetary policy, including you and me, but we’ve got no idea whether we’re talking about something that the board regards has completely settled, or as a 50-50 decision. And so, a lot of what we say is not relevant. And there are big questions on which further evidence would be useful. That we don’t know about.

Gene Tunny  37:30

Right. On the members of the board, you’ve been quite prominent in the media recently, and in the commentary on this RBA review, you’ve made the point that the level of expertise of board members is not really where it should be. I mean, obviously, there are some that have the expertise. But are you arguing for more economists on the board rather than business people? Is that correct?

Peter Tulip  38:01

Yes. And to be precise, more monetary policy experts. And this would be my number one recommendation for reform of the RBA. We talked earlier about the bank making mistakes, the first place that they should be caught and challenged is at the board level. But at the moment, the board seems to be operating as a rubber stamp for the governor, and that’s not good. I mean, so Phil Lowe is a very talented economist who gets lots of things right. But he is human and he’s just one person and he makes mistakes. You’ll have you will have fewer mistakes, if the decisions were instead, made by a committee of experts.

Gene Tunny  39:04

And is that what they’ve got in the States or in England or in or in the UK?

Peter Tulip  39:09

Yeah. So, I mean, that’s an interesting comparison. So, in 1959, when the RBA board was being set up, it was actually common to have non economists making monetary policy decisions. But since then, other Central banks have decided these are technical questions on which research is relevant and needs to be apply. So, they’ve moved to monetary policy committees, overwhelming, really comprised with monetary policy experts. Actually, it’s not just experts, but they have some of the leading economists in the world on monetary policy, sitting on their monetary policy committee. These the people that wrote the textbooks I learned my monetary policy from are often on the FOMC, or the Monetary Policy Committee of the Bank of England. So, whereas other countries have stars making their monetary policy decisions, we have part-time amateurs.

Gene Tunny  40:19

Yeah. Well look at who’s been the Federal Reserve Bank Governor in the US. You’ve had Ben Bernanke. You’ve had, I mean, he’s made huge contributions to macroeconomics. Janet Yellen.

Peter Tulip  40:33

The deputy of Stanley Fischer.

Gene Tunny  40:35

Right. And he’s the person who wrote the textbook;

Peter Tulip  40:39

And Bernanke and Frederick Michigan. Yeah, they’ve written textbooks on how to do monetary policy.

Gene Tunny  40:48

Okay. Yeah, good point. That’s a very good point,

Peter Tulip  40:52

Let’s say a bit more about the composition of the board. So, there are two parts of it, you would get better decisions with more experts on the board. And it’s just like, any other technical decision being made by a government bodies on immunisation or building a bridge or whatever you want. You don’t want business leaders making these decisions, you want experts in the field. Within that, you want a diversity of views. So, you want a mix of hawks and doves, for example, some empirical people, some theoretical people. Instead of that diversity of expertise, sorry, that diversity of views, we have a diversity of expertise, that there are some members of the board that are capable of challenging the governor, but most are not. And that results in groupthink and status quo bias and other flaws in decision making that we see in our monetary policy decision.

Gene Tunny  41:59

Yeah. So, look, I agree with you on that, Peter. And I think the government will find it, I mean, I don’t think that I’ll accept a recommendation along those lines, unfortunately. They’ll probably want to have a trade union member on the board. I think there’s going to be a push for that. Some people pushing for, let’s have a regional representative on the board. I mean, I don’t necessarily think we should be selecting people for the board for that reason. But what you’re going to have is, you’re going to have; there are people who are sceptical of experts, because there’s this general view out there now in western economies, that look, experts have led us down. And you know, people are upset about things that happened during the pandemic, and even before then. So, there’s a larger scepticism about experts. And there’s this issue of democracy, isn’t there? I mean, so, there could be an objection. Well, we don’t want all these technocrats running things. We think there should be some democratic element there. But then I think the issue there is that if you don’t have an independent Central bank, then you get worse inflation outcomes.

Peter Tulip  43:15

See, you’re raising several issues there, Gene. So, think about the other big important decisions that have been made in the news lately. I’m going to say public health. Do you want doctors and Epidemiologists making decisions on whether vaccines are approved? Or do you want business leaders?

Gene Tunny  43:36

I want the doctors and the Epidemiologists for sure. 

Peter Tulip  43:41

If a bridge is being built, you want that decision to be made by engineers or by business people? I mean, so in other areas, government policy, we rely exclusively on people that prompt eminent experts with technical expertise, and monetary policy is the same. It used to be that the values of monetary policy and even the objectives were vague and not clearly decided. And so, the board had a lot of discretion as to why monetary policy should be set but that’s no longer the case. Central bank has moved to a world of clearly defined objectives, essentially set by the government by the elected representatives. So, they decide that the objectives of the RBA are full employment and inflation of 2% to 3%. And it then becomes a technical question as to how to best achieve that, and that’s the decision that should be made in the national interest. It should not be made by representatives of sectional interests. Excellent point. And this interacts with the other recommendation we’re talking before about public votes. 

So, if you have a representative of say, the mining industry or the agricultural industry; industries that are heavily exposed to the exchange rate, do you want them making decisions that affect the exchange rate for the national interest or that will affect their sectional interests? I mean, if it’s the sectional interest one, they’ll always be voting for lower interest rates, and a depreciation of the exchange rate, and their constituencies will be expecting and demanding that. So, if you do have so called sectional interests, but you want the vote to be a national interest, you would need to keep the votes private. And this is an unusual way of dealing with a conflict of interest. Normally, we think conflicts of interest are best dealt with by transparency, not by secrecy.

Gene Tunny  45:58

Okay, what about the banks themselves, the staff on the banks themselves? Do you have views on how our reserve bank, how it compares with its peers with the Federal Reserve or Bank of England in terms of its ability to analyse the economy and to provide the advice to the board?

Peter Tulip  46:20

Yes. So, as background to that, before I worked at the Reserve Bank, I worked with the Federal Reserve Board of Governors, I was on the staff there for 11 years. I also worked at the OECD, on monetary policy, going on around the world talking to Central bankers about how they were sitting, making their decisions. And so it’s interesting, I mean, that background shows real differences in character and culture between different Central banks. I mean, have you noticed that just in government departments, different cultures, but even with Central banks, where they’re technically doing the same decision from different countries, they vary enormously. The RBA tends to be much less interested in research, and much less interested in technical modelling than other Central banks. And most clearly, with the Fed where the Fed has 400 PhDs on his staff, essentially putting together its forecast. The RBA has a very different human capital model, where academic qualifications and less important promotion and research is not ending, external research is not expected of most staff. And again, that is something that the review could look at a lot of people. I mean, there are differences on views as to whether that’s appropriate, and reflects lots of reasons that I mean, culture and history is a lot of it.

Gene Tunny  48:08

Yeah. So, your big recommendations for this review, or what you hope to get out of this review, improvements in transparency and communication.

Peter Tulip  48:18

Can I list them in order? Yes, please. 

Number one, we want more monetary policy experts on the board. 

Number two, we want those members to be individually accountable. That means public votes and public explanations of decisions. 

And third, the bank needs to be more open and transparent. And in particular, needs to do clear reasons for its decisions, and why alternatives are not taken. They would be my three main recommendations.

Gene Tunny  48:53

Okay. So, no changes to the inflation targeting regime, this flexible inflation targeting regime they talk about?

Peter Tulip  49:00

That’s why I have views on that. But as I said before, I think they’re secondary. So, the main changes I would make is, first of all, every time there’s a change in government or change in governor, there’s a new agreement between the bank and the government called the agreement on the statement of conduct of monetary policy. And that is where the target is specified in detail, which I think is appropriate. Currently, that says the main objective of the bank is inflation 2 to 3%. In my view, it should also specify full employment, or to be precise, maximum sustainable employment as an objective of equal status to the inflation rate. So, in legislation, the bank has a dual mandate that’s not reflected in the agreement on the statement of conduct and I think that causes a lot of confusion. People think that when people read the bank’s explanations of what it does, they often think that the bank is an inflation nutter. Which it’s not, it takes its unemployment objective very seriously. And it does it in this vague way, because flexible, inflation targeting, which should be specific about what flexibility is required and what isn’t. There would be other changes, but that would be the main one I would make.

Gene Tunny  50:31

Do you think there’ll be any changes to that framework? There seems to be a view from the RBA, and I guess from others that the inflation targeting approach seems to have worked pretty well in keeping inflation low over the last few decades, I mean, you mentioned, there is that issue of the times it might have meant we had higher unemployment than otherwise.

Peter Tulip  50:56

No, that was because they abandoned their inflation target. They had inflation too low, accompanied by excess unemployment, you would have sold both of those problems with lower interest rates. It didn’t do that, because it did invent this other objective of indebtedness that it should not have done. And it certainly shouldn’t have done it without a more open, transparent and accountable process. So, I think the main proposal for a change in the framework is for nominal income targeting, which Warwick McKibbin and Steve Kirschner and numerous other monetary policy experts think would be preferable. I think that’s a minority position. And I think you’re right, that the consensus of informed opinion doesn’t think that the framework needs to change much. I mean, I think there are some minor tweaks that shouldn’t be implemented. 

Nominal income targeting is not popular, partly because no other Central bank does it. So, there’s no example to show that it works. And the RBA is not a pace setter in these things. It’s a follower, not a leader, which is useful in a lot of ways. But also, the American literature on nominal GDP targeting some phrases in terms of nominal GDP targeting, which would just be inappropriate for Australia, because we have such volatile terms of trade. And we don’t want monetary policy being jerked around to target the coal price. Which just would mean big dislocations for most households. Not much apparent benefit.

Gene Tunny  53:02

Yeah. There seem to be some recognition of that in that panel discussion in;

Peter Tulip  53:08

So, Warwick McKibbin has said, you would target a slightly different variable, maybe some measure of nominal income. And that makes more sense. Warwick keeps contrasting his arguments for nominal income targeting with inflation targeting, which is what the bank says it is that it’s not what the bank is, in practice. In practice, the bank has a dual mandate. And we’re its main argument, as I take it is that inflation targeting is wrong, because activity is an appropriate objective of the Central bank and being explicit about the dual mandate would avoid that confusion.

Gene Tunny  53:50

Yeah. Okay. I’m just thinking about the tweaks; one tweak that seems clear to me that needs to be made is clarification on this point about what do you do about indebtedness? So, one way or the other, make that clear. Is the bank targeting financial stability or not?

Peter Tulip  54:09

And in my view, I mean, it’s the bank as an institution needs to worry about financial stability, but primarily, it should be dealt with, with prudential policy, not monetary policy.

Gene Tunny  54:23

And by that, you mean the Prudential Regulation Authority, which is looking at the banks and, you know, in looking at their balance sheets and making sure that they don’t make a bunch of risky loans.

Peter Tulip  54:34

Well, the nature of banking is you make risky loans. The big question is whether you’ve got an equity buffer to deal with those risky loans in the event that they all go sour at once. I mean, there are arguments about lending controls. That’s another controversial argument. But for this review, what’s going to be relevant is the status of financial stability within monetary policy. And in my view, I liked the wording. I think it was the 2009 agreement that the government had with the RBA, which said financial stability is an objective of the RBA, but it’s secondary, it’s subordinate to the core objectives. Or it should be said to be subordinate to the core objectives of full employment and stable inflation.

Gene Tunny  55:39

Okay. I’ll look that up and put in the show notes. Right, Peter, that’s been great. I mean, there are so many other aspects of this, I guess we could explore but we’ll probably have to wrap up because you’ve been generous with your time so far. Any final thoughts before we go? Anything we missed that you think is important to convey?

Peter Tulip  55:58

Oh no. I think it’s been good discussion of the key points. People who do want more, again, a lot of it is in my earlier paper.

Gene Tunny  56:11

Yes. You’ve been incredibly influential on this, Peter. So, well done. I saw you on ABC the other day, and it’s terrific that you’ve had this impact. And let’s say we get a really high-quality review with some recommendations that improve monetary policy in the future. 

Peter Tulip  56:34

Thanks for that, Gene. That’s great.

Gene Tunny  56:35

Pleasure. Thanks, Peter.

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 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 PodcastsGoogle Podcast, and other podcasting platforms.

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Podcast episode

Stagflation: be alert, not alarmed – EP143 + transcript

In early June 2022, the World Bank downgraded its global economic growth forecast and warned of the rising risk of stagflation, the uncommon combination of high inflation and high unemployment, or falling GDP growth. Stagflation is a portmanteau word, combining stagnation with inflation. Economists first noticed stagflation in 1970s USA (see the chart below) and other advanced economies, when it was triggered by the 1973 oil price shock, which pushed up prices and reduced industrial output as input costs soared.

A simultaneous acceleration of inflation and an increasing unemployment rate in the mid-1970s surprised many people at the time, because it was contrary to the Phillips curve trade-off between unemployment and inflation.

In Episode 143 of Economics Explored, show host Gene Tunny and his colleague Arturo Espinoza discuss how the current global situation is similar and dissimilar to the 1970s, including consideration of recent perspectives from the World Bank and BIS.  While we also have a commodity price shock, associated partly with the war in Ukraine, it is less in proportionate terms than in the 1970s, and we also have better macroeconomic policy frameworks (i.e. explicit inflation targets) than in the 1970s. So the takeaway of the episode is that, while we should be alert to the possibility of stagflation, at this stage we shouldn’t be alarmed.

You can listen to episode 143 using the embedded player below or via Google PodcastsApple PodcastsSpotify, and Stitcher, among other podcast apps. A transcript and relevant links are also available below.

Links relevant to the conversation

Is a US recession imminent? w/ Michael Knox, Chief Economist, Morgans Financial – EP142 – Economics Explored (Previous episode with Michael Knox)

Jobs report May 2022: Payrolls rose 390,000 in May, better than expected as companies keep hiring 

https://trends.google.com/trends/explore?q=stagflation&geo=US (Google Trends for stagflation)

The Fed must act now to ward off the threat of stagflation | Financial Times

Are major advanced economies on the verge of a wage-price spiral? (BIS Bulletin 53)

Commodity market disruptions, growth and inflation (BIS Bulletin 54)

Robert Heller’s paper on International Reserves and Global Inflation (from p. 28)

Stagflation Risk Rises Amid Sharp Slowdown in Growth (World Bank report) 

Stagflation danger prompts  World Bank to cut growth outlook (Washington Post article)

EP59 on the Natural Rate of Unemployment (re. Milton Friedman’s AEA presidential address)

Friedman’s presidential address

Chart of the Week – The real price of crude oil – Callum Thomas

Clarification

Australia’s wage price index increased 2.4% through the year to March 2022 (see Wage Price Index, Australia, March 2022 | Australian Bureau of Statistics

Transcript of EP143 – Stagflation: be alert, not alarmed

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. My personal feeling is that; and this is informed by my conversation with Michael Knox last week. I don’t think we’ll end up with stagflation similar to the 70s or rather, I hope not. I don’t see at the moment.

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 143 on Stagflation.

Joining me this episode is my colleague at Adept Economics, Arturo Espinosa. Arturo, good to have you on the show again.

Arturo Espinoza Bocangel  00:44

Thank you, Gene. I am glad to be here.

Gene Tunny  00:48

Excellent, yes. It should be a good conversation because we know that this issue of Stagflation is topical with the recent World Bank report that we’ll get into in this episode. But before we do that, I just thought I’d provide an update on last week’s episode.

So, in Episode 142, I spoke with Michael Knox, who is the Chief Economist at Morgan’s, which is a major Australian wealth management and stock broking firm. And Michael and I chatted about the prospects for the US and Australian economies and what’s been happening with monetary policy. And Michael made a bold prediction in that episode, on where the Australian cash rates, so the policy rate that’s controlled by the Reserve Bank of Australia, so that’s the equivalent of the Federal Reserve in the US or the Bank of England. And he forecast that they would lift it by 50 basis points. So, half a percentage point from 0.35%, he forecast that they would increase it to 0.85%. He was the only economist in Australia who was forecasting there, and he explained why he thought that was the case in the episode.

So, if you’re in the audience, you haven’t listened to that episode yet, please, think about having to listen to it because Michael, I think is one of the best economic forecasters out there. He looks at the global economy, he looks at the Australian economy. And it turned out that the Reserve Bank did increase the cash rate by 0.85%. And it surprised all of the other market economists, all the commentators, and now there’s all this talk about what does this mean for the economy?

Will people now have trouble paying their home loans? Will they get into financial trouble? And there’s a huge conversation about that now in Australia; well done to Michael Knox for forecasting that correctly.

And we were also chatting about this idea or this concern that there could be a recession coming up in the US. So, there’s been a lot of commentary about that. It’s associated with all of this commentary, all this discussion at the moment about stagflation, which we’re going to get into. But Michael is very optimistic about the US economy as we talked about, and just after that episode was published, there was some new data that came out from the Bureau of Labor Statistics; at the BLS. And they reported better than expected, employment numbers in the US for May, CNBC reported that the US economy added 390,000 jobs in May, better than expected despite fears of an economic slowdown and with a roaring pace of inflation. The Bureau of Labor Statistics reported Friday, at the same time, the unemployment rate held at 3.6% just above the lowest level since December 1969.

Okay, so that’s an update on last week’s episode. Okay. Any questions or thoughts on that, Arturo?

Arturo Espinoza Bocangel  04:04

No, let’s start discussing about the topic.

Gene Tunny  04:09

Yep, about stagflation, absolutely. So, I want to devote the bulk of this episode, or the rest of this episode to talking about stagflation. This is something that I asked Michael about last week in our conversation. And I mean, this is something we haven’t; it’s a term that, that I remember, you know, I learned in when I studied Economics, and as you did, we would have learned this term stagflation about what happened in the 1970s. But we haven’t really heard it in the economic commentary for a while. So, there were decades when no one was really talking about it. And then there was this revival of interest in it, I think, from around late last year.

And if you look at the Google Trends Data, and I’ll put this chart on the show notes, so you can see, when interest in the concept of stagflation has picked up again. And that was from around, I think it was around September, 2021. And we’ve had various commentators talking about the risks of stagflation. So, on 25th of May this year, Martin Wolf; so Martin Wolf is one of the leading financial economic commentators in the world. He writes for The Financial Times. He wrote a column; “The Fed must act now to ward off the threat of stagflation.” And we know from the 1970s, the time to throttle an inflationary upsurge is at the beginning. And is there going to be a recession in the US and other leading economies? This question has naturally arisen among participants at this year’s meeting of the World Economic Forum in Davos. So, you probably saw, I think that meeting, they had their World Economic Forum meeting in Davos, Switzerland last week.

Martin Wolf wrote that this is however, the wrong question, at least for the US. The right one is whether we are moving into a new era of higher inflation and wage growth, similar to the stagflation of the 1970s. If so, what might this mean? That was one of the motivations for having this conversation today.

And almost as if I forecast that the World Bank would produce this study on stagflation, they released it overnight, or it came overnight our time. And so, we’ve just been looking at this morning, this new report, from the reserve; sorry, not the Reserve Bank, that’s our bank here in Australia, the World Bank. And the press release; June 7, press release, I’ll put this in the show notes. So, if you listen, and you’re interested, you can find that; stagflation risk rises amid sharp slowdown in growth.

So, you had a look at this earlier, Arturo, didn’t you? What were your main takeaways from this report from the World Bank?

Arturo Espinoza Bocangel  06:59

Well, I think these are very good reports, where they dedicate special focus on globalist inflation. And there is a section which they talk about similarities to the 1970s. They mentioned that they are three of them. The first is that supply shocks after a prolonged monetary policy accommodation, the existence of weaker growth. Also, there are some significant problems or inabilities in emerging economies. Those three things can be similar from 1970s to the current period.

Gene Tunny  07:51

This is because these supply side shocks really hurt those emerging economies more than the richer economies; is that the idea? Because they generally have lower incomes in those countries. And so, they’re going to be very badly affected by increases in oil prices, increases in food prices, and that can bring not only economic turmoil, but political turmoil as well.

So, what we might do is; we might revisit those, those similarities. Again, in the podcast first, it just occurred to me that we probably should, or I probably should just talk about what Stagflation is, what does it mean? And I couldn’t find any or there’s no strict definition of what it is. It’s a combination of unemployment and inflation or low GDP growth and high inflation. But there’s no agreed definition of it’s stagflation, if unemployment and GDP growth are x and y and inflation is there; there’s no quantitative definition as far as I can tell.

So, stagflation; it’s a pretty horrible word, if you think about it. I mean, it’s one of these, what do you call it? A portmanteau word. So, it’s a word that is a combination of other words, to try and convey a particular meaning, the combination of themselves. So, it’s a combination of stagnation, plus inflation. Glenn Hubbard’s introductory Economics textbook. So, Glenn Hubbard was the chair of the Council of Economic Advisers for President George W. Bush, in the early 2000s. In his textbook, they define it as a combination of inflation and recession, usually resulting from a supply shock. Okay, and like with everything in Economics, we’ve defined a concept by referring to another concept, we have to define a lot of times. So, supply shock. What do we mean by that? We mean, something that increases the cost of inputs; it’s a shock on the supply side of the economy, our ability to produce.

It’s not like a demand shock, where there’s an increase in spending or an increase in the amount of money. It’s a shock to our productive capacity. So, this concept, I think, originally came into Economics, or it became prominent in the 1970s, when there was the huge spike in oil prices in 1973, when OPEC, because of the Arab countries are upset with the West because they were backing the Israelis in the war, I think it was the young people war. That meant that the cost of inputs increased. And when those inputs increase, we use oil, well for petrol and, you know, across the economy. And so, it’s pushing up costs of production and produces; firms will try and pass that on to customers. That can be inflationary. Okay.

And you mentioned supply shocks before, didn’t you? In terms of the similarities with the 70s? So, we’ve had that,

Arturo Espinoza Bocangel  11:10

Yeah, we have the impact. However, there is a difference there in the case of the World Bank report, they say that the current shocks or current supply shocks are smaller, compared to those shocks in 1970s.

Gene Tunny  11:33

That’s right. I should have checked the numbers before I came on to record. But if you look at the real oil price back in the 70s, that was in proportionate terms, that was a huge increase, wasn’t it? I mean, it was multiples of the then current price, and it really shocked people. It was a huge shock to face those price rises.

So, I’ll have to dig out what that stat was and put it in the show notes. But that’s what they’re driving out there, aren’t they? They’re saying, well, okay, we’ve seen some big increases in commodities prices, but they’re, they’re smaller still than what we saw in the 1970s. So, they may have a chart and that report that we can refer people to in the show notes. Okay.

So, just on this definition of stagflation again, that was one definition. Now, note, there’s no quantitative; there aren’t any numbers in that definition. Dornbusch and Fisher; so, that was the textbook I use when I studied macro Economics back in the 90s. Rudy Dorn, Bush and Stan Fisher, so very prominent, US macro economists, I think are at MIT. They wrote that stagflation occurs when inflation rises, while output is either falling or at least not rising. And on well, actually, there’s probably no point me giving textbook page references, because this is sort of the 1994 edition. But in that edition, they wrote that during periods of stagflation, such as 1973, 74, 1980, and 1991. There are articles in the newspapers that the laws of Economics are not working as they should, because inflation is high or rising, even though output is falling.

So if we go to the, the data for the US, so I’ll put this chart in the show notes as well. We look at what happened in 1973 – 74. And this was a huge shock, I think at the time. We see that inflation went from a rate of 2 to 3%. And it ended up at a rate of over 10%. I think it looks like nearly 12½ % on this chart, I’ve pulled up. And so, we had those two years; well, after the ‘73 oil shock, so 74, 75 inflation is accelerating. And unemployment is also increasing, and it’s increasing from about 5% to nearly 8 to 9% or so. I’ll put this chart in, and I’ll just check those numbers. And this came as a big shock, because there was this concept of the Phillips Curve wasn’t there? There was this idea that there was this tradeoff between unemployment and an inflation, that if you had high unemployment, then at the same time, you should have low inflation. Or if you had high inflation, you’d have low unemployment. There was this idea that there was this trade off; because empirically, if you looked at the data for the 50s and 60s in the States, or for the UK or other advanced economies, it looked like there was this trade off. It looked like there was a menu from which economic policymakers could choose.

The typical story about the Phillips Curve was that, you could get unemployment down by stimulating your economy, a bit of Keynesian fine tuning, a bit of pump priming. You could reduce unemployment, but if you get unemployment; if you if you do reduce that, that puts more power in the hands of Labor relative to capital, you can tell stories about unions, you can tell stories about people being more aggressive in their wage negotiations, because Labor is scarcer, and that leads to higher inflation.

So, there’s this idea of a tradeoff. And this Phillips Curve was something that was found by Bill Phillips, who was a professor, Bill is from New Zealand originally. And he ended up being a professor at the London School of Economics. Have you heard about that? This is a bit of a tangent, but he built that hydraulic, economic model. Have you ever heard of that, ever heard of LSE?

Arturo Espinoza Bocangel  16:08

No, I haven’t heard about it.

Gene Tunny  16:11

And he developed this hydraulic, economic model in the 50s and 60s. They built a representation of the economy; they’re essentially modelling the circular flow of income with using water and mechanical parts. And this was a model that London School of Economics; I just remember that because she gave a lecture at the University of Queensland in 2016, Mary Morgan, she’s a professor at LSE, London School of Economics. She wrote a great book on the World in a Model. So, she’s done some great work on the history of economic modelling. Her first job, she said, was looking after that hydraulic computer.

So, Bill Phillips, one of the great economists, he discovered this correlation between all this trade off; the Phillips Curve, the relationship that ended up being influential in economic policy in the 60s until it broke down in the 70s. As we are talking about, he looked at UK wages growth, so wages, inflation and unemployment data. Even though what he did was look at wages data, well, it soon transferred as a concept to a tradeoff between price inflation and unemployment, because well, there is obviously a link between wages and prices, because employers will try and pass on those increases.

Does that all make sense? I was just trying to explain why this idea of this stagflation came as such a shock in the 1970s.

So, what was wrong with that Phillips Curve concept? Why didn’t it work out? Well, it was because of this supply side shock, wasn’t it? This was something that wasn’t really anticipated in that Phillips Curve story. And the other problem was that when you have high inflation, the expectations of people in the economy of workers and businesses, your expectations of inflation increase. You essentially, come to expect inflation and inflation becomes a self-fulfilling prophecy, because every time there’s a wage negotiation, or a contract negotiation, you essentially allow for the future inflation, you expect it. And you have things like cost-of-living adjustments, you essentially build it into contracts and under wage bargaining. So that’s one of the reasons why the traditional Phillips Curve breaks down. And there was a very famous speech by Milton Friedman; the presidential address to the American Economic Association in 1968. And I’ve talked about this in a previous episode – Episode 59, on the Natural Rate of Unemployment. And Friedman argued, well, in the long run, there’s really no Phillips Curve, you might think that there’s some sort of tradeoff in the short run, that you can get unemployment down if you pump-prime; if you stimulate your economy, and you’ll get some inflation as a result of that or you could go the other way and try and contract the economy to reduce inflation.

But in the long run, there is no trade off; there’s no Phillips Curve to speak of this. The economy should gravitate towards a natural rate of unemployment. And inflation can be whatever is consistent with people’s expectations.

There’s a big problem if you don’t get inflation under control, and people come to expect inflation, and then you can just have persistently high inflation, and you can have that with high unemployment as well.

Have you seen those diagrams of the Phillips Curve, with the vertical long run Phillips Curve? And then if you start off at a point on that Phillips Curve, so say you’re at your natural rate of unemployment, and you’ve got high inflation expected, then what can happen is, there some sort of shock that increases unemployment. And so, you start off at that high point with high inflation already. Maybe, it eventually has some sort of; it does contribute to a reduction in inflation somewhat, but you still at that higher level of inflation. And so, you can have higher unemployment or high unemployment and high inflation still.

So, that was probably a bit more technical information than we needed. If you have a look at an intermediate or advanced macroeconomics textbook, they’ll have some diagrams; I have some models that go over, that we probably don’t need to look into that. But the main point is that this Phillips Curve, discovered by Bill Phillips; people thought it was this stable tradeoff between unemployment and inflation, didn’t hold in the long run. And if your economy is subject to the supply side shocks, so increase in the price of oil, for example. And then if people come to expect inflation, then you can get high levels of inflation. And they can be very persistent, and you can have the economy slow down, you’re going to have high unemployment, and inflation can still persist for a long time.

And if you did want to get that inflation down, you really need a change in monetary policy, you need a much more aggressive monetary policy, and you need a credible Central bank that can deliver it. And I think this is what Paul Volcker in the US did in the early 80s. And this is what when they massively tighten monetary policy, high interest rates, crunch the economy, but they did get inflation under control. And I think this is related to this point that the World Bank made. There was a point about better monetary policy frameworks. Is that right?

Arturo Espinoza Bocangel  22:37

Yes, that’s right. After that economic event occurring 1970s, most of Central banks started to control prices, try to target inflation. Also, they incorporated the old thing related to these rational speculative in order to take into account potentials proven that pulling golden, been analyzed before 1970s since the Phillips Curve wasn’t explained correctly, the prequel evidence, as you mentioned. In the short run, that Phillips Curve is playing well, but in the long run, they didn’t account other factors, and relationships was different. So, I think most of the Central bank started to work better in terms of expectations.

Gene Tunny  23:45

Yeah. And so, this is this point, that Central banks, they need to have a credible monetary policy. And one way of having a credible monetary policy is to have an explicit inflation target that you’re judged on. And that’s why our Reserve Bank of Australia has a 2 to 3% inflation target, and the Bank of England and the Federal Reserve, they’re aiming for, I think it’s 2%. I’ll put that in the show notes. But they sort of; all of these Central banks tend to have inflation targets in 2 to 3%, which is a recognition that you’re going to have some inflation, but what you want to avoid is higher rates of inflation or double-digit inflation, or even worse, that’s what you really want to avoid, because that really causes a lot of misery. People can sort of, live with inflation of 2 to 3%.

So, that was this point about monetary policy; another thing that helps signal a credible monetary policy. So, by credible, we mean that people in the economy, businesses and workers know that if inflation starts to accelerate, the Central bank is going to squash that inflation as soon as it can. And that helps keep inflationary expectations down so people don’t come to expect higher inflation.

Okay, and one other thing that does help with the credibility of a Central bank is having an independent Central bank, who the worst thing you can have is if your Central bank is influenced by politicians; if it’s controlled by politicians, because, say they’re coming up to an election, there might be inflation increasing, but the politicians don’t want the Central bank putting up interest rates just before an election.

Arturo Espinoza Bocangel  25:43

That’s right. In the world, we have seen many examples. For example, Peru is a good example of a thing that would the government shouldn’t do. For example, in the middle of 80s, Peruvian government, had a high level of debt. That moment, government Allan Garcia took place, and he didn’t recognize the debth. So, they didn’t want to pay. And also, in the government, they started to print money because the other Central bank, was subordinated to the current government. And that was the world’s respond for [unclear] because Peru initiated a stage of hyperinflation. And also, Peru faced a recession period.

Gene Tunny  26:52

So, hyperinflation; there is a quantitative definition of hyperinflation. It’s when you have inflation running at about 50% a month or something. It’s a very high rate, and you can end up with annual inflation rates of over 1,000% or something, which is just mad. What they had in Germany in the 1920s. But also, we’ve seen it in South American countries in the;

Arturo Espinoza Bocangel  27:18

Most South American countries, experience periods of hyperinflation.

Gene Tunny  27:23

So, you are highlighting one of the; when it gets really bad when you don’t have that independence. And because the Central bank is the bank for the government as the government just commits to making all of these payments, and it might not actually have the money, but the Central bank just prints the money. It just pays the bills for the government; the money is just created. So yeah, what they call modern monetary theory nowadays; bad results.

We’ve chatted about the Phillips Curve, why it’s not reliable. I’ll put links to all of these things I’ve mentioned particularly to Milton Friedman’s presidential address, which is just brilliant.

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

Female speaker  28:18

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Gene Tunny  28:47

Now back to the show.

Okay, now, one of the things Central banks are essentially wanting to avoid is this idea of a wage price spiral. So, we’ve talked about inflationary expectations, you want to avoid inflation becoming expected, and then it becoming a self-fulfilling prophecy. So, one of the concepts that disgusts is a wage-price spiral.

Okay, so in early May 2022, the Reserve Bank of Australia; this was a report in the Australian Financial Review. The Reserve Bank of Australia has warned of a wage price spiral if unions exploit the low jobless rate to push for higher pay rises to compensate for an inflation rate to peak at a higher than expected 6%.

So, what is a wage-price spiral? The Bank of International Settlements in Basel in Switzerland; it’s defined a wage price spiral in the following way, and this is in a bulletin that they produced, BIS bulletin number 53 on Major Advanced Economies on the verge of a Wage Price Spiral.

A wage price spiral entails feedback in both directions between wages and prices. Inflation then rises persistently on the back of such a spiral. Once the economy enters the spiral, workers bid up nominal wages more than prices, prompting firms to raise prices further, the likelihood of an economy entering the wage price spiral depends in part on macro-economic conditions.

Workers bargaining power is typically greater when Labor demand is strong and Labor supply is tight. Similarly, firms may have more pricing power when aggregate demand is strong. Labor market institutions also influenced the likelihood of a wage price spiral emerging.

Automatic wage indexation and cost of living adjustment. So C-O-L-A or COLA clauses make wage price spirals, more likely.

And this was important in the; well, it became an issue in the Australian election campaign, because the then opposition leader now Prime Minister, Anthony Albanese; did you see his comments when he was saying that, if we were in government, we would support workers being getting a wage rise in line with inflation. Inflation was rising at well; inflation was 5.1%. That was the last reported estimate from the Reserve Bank, which was higher than expected. And then, Anthony Albanese came out and said, yes, workers, their wages should increase by at least 5.1% To make up for that. And then, the then Prime Minister, Scott Morrison tried to make a big thing out of that and he said, Anthony Albanese is a loose unit, because this could then lock in inflation permanently.

So, this is his concern about a wage price spiral and the BIS was arguing that, this sort of thing; there’s automatic wage indexation, which is almost what well, it’s essentially what Anthony Albanese, our current prime minister here in Australia was almost hinting at. I think he regretted making that comment, because they really don’t want to do that. And if I think they’ve walked back a bit from that position, I mean, they put a submission to the Fair Work Commission, ultimately, it’s up to the Fair Work Commission to decide the increase in minimum wages in Australia.

There was some criticism of the opposition leader at the time, because it could have; there were commentators who were saying, this is a sort of thing that risks a wage price spiral. And you could take that BIS note as supportive of that position. Ultimately, I don’t think that mattered much in the election campaign. So, who knows? I mean, it could have even increased support for Anthony Albanese. People think, well, that sounds fair enough that we’re compensated for inflation. Most people are wage earners as more wage earners than business owners in the country. So, it could have been a popular thing. The PM at the time was trying to say, well, he’s a loose unit, who knows how much impact it had on the election campaign?

Ultimately, I think the election was decided over concerns about climate change. There was this general perception out there that the government wasn’t doing enough on climate change, rightly or wrongly. And that was the dominant consideration.

Do you remember that whole debate or that whole discussion around the opposition leader’s comments?

Arturo Espinoza Bocangel  33:43

I remember that. I saw some news about it. I also reviewed some comments from some Australians, And some people or some citizens mentioned that the proposal is not correct for the current situation in the global economy. Because of course, if you want to raise salary, that will be loads, let’s say factor, or determinant to boost inflation pressures in Australia.

I remember that I checked some economic paper; it’s okay to raise the wages, but it could be implemented gradually. Or maybe you can target some sectors in order to improve the salaries but it’s not a good policy response to increase generally, the wages in the whole Australia.

Gene Tunny  35:01

Maybe limited to the lowest paid workers, rather than have at across all of the wage agreements in the economy so that; fair enough. Okay, we might have to come back to this whole issue of how wages are set in a future episode.

So, what did the BIS conclude about whether major economies are on the verge of a wage price spiral? Well, with most economic issues, they weren’t able to reach a firm conclusion. I mean, none of us has a crystal ball. I mean, I’m always very reluctant to give firm or precise forecast, because you just can’t, because there’s so much uncertainty.

So, my reading of what the BIS was saying in that wage price spiral bulletin, is that, well, they’re not really sure. The key things that they noted in their analysis were that while inflation is returned, it’s reached levels not seen in decades, whether inflation enters a persistently higher regime will depend on labor market developments and on whether a wage price spiral emerges. To date, evidence for a broad acceleration in wage growth is mixed. It’s picked up significantly in the US, but it remains moderate in most other advanced economies. So, it’s certainly still moderate in Australia, it is picking up a bit, but it’s not near what arguably, we’d like to have. And this became an issue in the election campaign to you probably remember this. Well, this is why Albanese made those comments to begin with. Because if you looked at wage’s growth, which was, 2.7 or maybe it was a bit lower through the year, compare it with inflation of 5.1%, then you get a real wage decline of 2.6%.

I will put the exact numbers in the show notes. It must have been about 2½%. If we’ve got a 5.1% inflation rate, I think they were saying the real wage decline was 2.6 or 2.7%, that it must have been a 2½% wage price index increase. I’ll put the right data in the show notes.

That became an issue in the recent election campaign.

Here is where the BIS basically admits; we really don’t know:, Extrapolating behavior from low inflation periods is problematic if inflation remains high, households may ask for higher wages to make up for lost purchasing power and firms may raise prices to protect profit margins. And stubbornly high inflation may lead to institutional changes, such as automatic indexation and cost of living adjustment clauses. So, that’s the sort of thing we want to avoid. And that’s why people were worried about what our current Prime Minister was saying, because there was a concern that we could effectively do that sort of thing, if he followed through on what he was saying.

Did you have any thoughts on that wage price spiral article? You had a looked at that today, didn’t you Arturo?

Arturo Espinoza Bocangel  38:17

Yes. I think, in the report, they also mentioned that some condition must be complied to be under these kinds of wage price spirals. But from my point of view, I think is quite complex to determine if all the countries are going to face that wage price spiral? I think that depends on the particular condition from each country.

Gene Tunny  38:50

Yeah, that’s the problem that the World Bank and the BIS, or the IMF have, because they’re trying to produce forecasts, or do analysis for the whole world or all major economies, whereas there are differences in the institutions within those economies; a very good point.

Okay, so let’s get back to the central question. I mean, all of these things we’ve been talking about, are related to because if we have a wage price spiral, and then we have some shock or the economy goes into a downturn, then we could end up with stagflation. So, it’s all related.

We’ll talk about now, the prospects for stagflation. So, is this something we should be worried about? And it turns out the BIS looked at this last month, so before the World Bank, so this is obviously something that economists in these major institutions are concerned about, and the BIS had to report commodity market disruptions, growth and inflation.

We’ve talked about the broad base supply shock increasing inflation, food and energy prices spilling over to other components of inflation, and possibly; well contributing to a reduction in global economic growth. And we should talk about the World Bank’s forecasts because the World Bank now is forecasting a reduction in global growth, isn’t it? That was one of the major things in that latest report. I’ve got it here.

The bank slashed its annual global growth forecast to 2.9% from January’s 4.1% and said that subdued growth would be likely to persist throughout the decade because of weak investment in most of the world.

And so, the BIS was saying that this is the sort of thing that would happen. It was saying this last month, and I guess, I mean, a lot of other economists have been concerned about that. There’s a recognition that what’s happening with Ukraine, what’s happening with commodity prices, that is going to compromise, global economic growth.

Now, it looks like the BIS; they’re saying similar things to the World Bank and the World Bank, probably. I mean, I’m sure it read what the BIS analysis is pretty much; I think they reach the same conclusions almost. So, let’s go over what the BIS says, and then we’ll compare it with what the World Bank says. So, the BIS has concluded, recent shocks have been smaller than the 1970s oil shocks, but broader based encompassing food and industrial commodities as well as energy. Nonetheless, structural changes, as well as stronger policy frameworks and nominal anchors.

So, by a nominal anchor, they mean, something that’s keeping prices down. They’re talking about inflation targets. So, they make stagflation less likely to return. But this is where they acknowledge that.; we’ve said that, but ultimately, things can happen that derail the economy that can mean our forecast is incorrect. And they know commodity price increases in the wake of the war in Ukraine are likely to weigh on global growth and add to inflation. While lower energy dependence and stronger policy frameworks make a repeat of the 1970s stagflation unlikely, high and volatile commodity prices could still be disruptive. This puts a premium on restoring low inflation quickly before it becomes ingrained in household and corporate decisions.

Absolutely. I think that’s a very good point to make. So, that’s what the BIS said, That’s pretty similar to what the World Bank said, isn’t it?

We might have a look at that now, again. Let me just go back to the media release. They also got a comprehensive report and that chapter, the focus on stagflation, which I’ll link to in the show notes, which is worth reading. I’m just going to consult their media release, which is a really good summary and well written.

Let’s just talk about how the current situation resembles the 70s. And why? What are the reasons why we might think that we could end up with global stagflation?

The current juncture resembles the 1970s in three key aspects: persistence supply, side disturbances, fueling inflation, preceded by a protracted period of highly accommodative monetary policy and major advanced economies, prospects for weakening growth and vulnerabilities in emerging market and developing economies face with respect to the monetary policy tightening that will be needed to rein in inflation.

Let’s have a look at what they’re talking about there. We’ve talked about the persistent supply side disturbances, preceded by a protracted period of highly accommodative monetary policy. By accommodative, we mean, loose, we mean, ultra-low interest rates, we mean lots of money printing, that sort of thing; credit creation, due to the low interest rates. And that’s what we’ve seen in Australia, we’ve seen in the US, we’ve seen it in other advanced economies. So, there’s no doubt about that. And the argument is that buildup of that additional money, that additional liquidity will end up with too much money chasing too few goods, accelerating inflation, right. We’ve talked about that on the show before.

They also talked about vulnerabilities that emerging market and developing economies face with respect to the monetary policy tightening that will be needed to rein in inflation.

So, let’s have a think about what they’re driving out there. I mean, as the western economies increase interest rates, that’s going to mean; this is just one aspect of it. That will attract investment capital, portfolio investment to the US or to other major advanced economies. And if those developing economies don’t put up their interest rates, then that will lead to a depreciation of their exchange rates, which means that the cost of imported goods in those economies will be compromised, or if they’re trying to fix their exchange rates, it puts pressure on their balance of payments. So, it’s a bad situation for those emerging economies.

And also, the thing is, when you have situations like this in the world, when there’s concerns about volatility, there is this flight to safety and money can flow to the advanced economies where there’s a perception, it’s safer, and that could compromise these emerging economies. I wouldn’t be forecasting this yet, but things can happen unexpectedly or rapidly. We know that there can be crises in emerging economies that are difficult to predict, such as the Asian crisis in the late 1990s.

 Any thoughts on any of those key aspects, Arturo? About how, how there are similarities with the 70s?

Arturo Espinoza Bocangel  46:19

No. Your explanation was very clear.

Gene Tunny  46:23

Okay, well, then we should; before we conclude this episode, we should talk about how the ongoing episode also differs from the 1970s. The dollar is strong, a sharp contrast with a severe weakness in the 1970s, the percentage increases in commodity prices are smaller, and the balance sheets of major financial institutions are generally strong.

More importantly, unlike the 1970s, Central banks in advanced economies, and many developing economies, now have clear mandates for price stability. And over the past three decades, they have established a credible track record of achieving their inflation targets.

And they go on to conclude as the World Bank global inflation is expected to moderate next year, but it will likely remain above; I think I’ve missed the words there, it must be above average.

And they talked about; something’s gone wrong with my printout. They do talk about, you know, there is a risk of stagflation. So, stagflation risk rises amid sharp slowdown in growth, okay, so, there’s going to be some moderation in inflation, but it’s likely to still remain high or higher than the normal. And you couple that with the fact that there’s a risk of a slowdown, and they’re talking about a slowdown in global growth. That’s what they’re forecasting, then, yes, certainly, stagflation of some kind is a risk.

My personal feeling is that; and this is informed by my conversation with Michael Knox last week, I don’t think we’ll end up with stagflation similar to the 70s, or rather, I hope not. I don’t see at the moment. I think the US economy based on the indicators I’ve seen in my conversation with Michael, I think, at least for the next year or so, the prospects for the US economy are very good. Likewise, for Australia, I mean, there are always risks. We’ve got some heavily indebted households; we’ve got interest rates increasing. That’s one of the great unknowns at the moment. But if you look at the indicators, such as job vacancies, you look at the fact we’ve got a 3.9% unemployment rate. You look at what’s happening with commodity prices, which were in net terms benefiting from, because we’re a net exporter of energy and minerals to the world. Like, our coal prices have been $400 – $500 US a ton.

Queensland is a huge producer of coal; and that’s benefiting our state and budget. I mean, there’s ultimately; there may have to be a transition out of coal because of concerns over climate change. But at the moment, it’s something that is beneficial to the state economy. So, I think in Australia, I’m not concerned about stagflation at the moment, but as always, I need to say, I don’t have a crystal ball.

Any thoughts, Arturo? I mean, what’s your general feeling on stagflation? Is this just the latest thing that we’re worried about? Perhaps for no really good reason? I mean, it certainly; I haven’t seen this interest in the concept for a long time. And yes, is it something we should be worried about? What do you think?

Arturo Espinoza Bocangel  49:35

I think the case is; it’s good to have these discussions and it’s good to know that most of the Central banks are considering these potential, let’s say, this potential event. If they are well prepared, they can avoid that kind of situation for some countries. As I mentioned this thing, if a cure isn’t going to be general, so some countries perhaps are going to face stagflation. In some cases, if they don’t manage properly their monetary policy and some fiscal responses.

But of course, there are many risks that are out there, for example, as the World Bank report mentioned, if the supply disruption proceeds or the commodity prices continue to climb, inflation could remain above Central bank’s target. So, I think those are potential risks, the Central bank must consider giving good response.

Gene Tunny  51:00

Yeah, good point.

One other point I wanted to make is; and this is related to the other thing that differs from the 70s, which is, the World Bank set out a few ways that the economy is not the same as the 70s. And, one of the important ones, I think, is they talk about the US dollar, don’t they, the dollar is strong. Now, this is a very technical issue, it’s a hard one to sort of get your head around, because you have to go back to the situation in the 60s and the early 70s, before the era that we’re now in, in advanced economies of floating exchange rates. When we had the Bretton Woods system.

Michael Knox referred to the growth in international reserves, he talked about the growth of foreign currencies, held by Central banks in the early 70s that just massively increased in the early 70s. Because what was happening were because of the issues in the US and higher budget deficits and concerns about inflation, people around the world were trying to get out of US dollars. And because of the Bretton Woods system, they were trading their US dollars for their own currency or other currencies, or for European currencies, because there was the strong; well, in those that post-war recovery in Europe and Europe was becoming more prominent. And so, there was a move out of US dollars and to buy those US dollars, the Central banks essentially printed money, they created new money.

So, these changes in international reserves that Michael was talking about, I think was like 80%, over from the end of 1972, sometime in 1972. It was a huge growth in these international reserves, that led to a big increase in domestic money supplies, and that fueled inflation.

This is a great article by Robert Heller, that was in one of the IMF journals; might have been finance and development. I put a link to it in the show notes before, I’ll put it again, because it’s just well worth reading. But I think for us to do that justice, we will probably have to come back and talk about Bretton Woods and the whole international financial system pre 1970s. And look, that’s going to be a lot of work.  

This shows the complexity of the issues that we’re dealing with. In the economy, so many moving parts, it’s all interconnected. And yes, but what we’re trying to do, I think on this show is to simplify it as much as possible. And really make sure we understand those mechanisms because in a lot of economic discussion, there’s just too much that’s assumed in terms of the knowledge of the people reading or listening. There are too many concepts explained by reference to other concepts without explaining those concepts. And I want to try to make sure that we’re as clear as possible.

I think we’re probably in a position to wrap this up. Arturo, any final words? Thoughts?

Arturo Espinoza Bocangel  54:18

I think this conversation was pretty clear. And you’re to understand what is going on globally, in terms of inflation, potentially stagflation problems that some country may face. So, I think let’s stay alert. I think that Central banks are going to react properly in order to address that problem.

Gene Tunny  54:56

Okay, so you said, be alert, I like that. As our Former Prime Minister John Howard once said, Be alert, not alarmed. We will be alert to the prospects for global stagflation. But we’re not going to be alarmed at the moment.

You may not have been in Australia when he said that. That was something that people had amusing. There was about a serious issue is talking about international terrorism, which was, of course, a serious issue. And he said, be alert, but not alarmed. And then that sort of prompted all of these sorts of jokes about, what does that exactly mean to be alert, but not alarmed? I mean, how worried should we be?

And there was the old joke in Australia. Be alert, Australia needs Lurtz. I don’t know if you’ve heard that one. So, I think people would probably; as soon as John Howard said, Be alert, not alarmed. People were instantly sort of thinking, this is a bit of a funny thing to say. But maybe because I remembered that all joke about being alert.

Thank you, Aturo, I really enjoyed that conversation. And if you’re in the audience, and you’re listening, and you’d like to know more about these issues, I’ll put links to everything we chatted about in the show notes. I’ll also make any corrections. If I’ve got anything wrong I discover, in terms of numbers. I generally think the concepts and the facts; I think we got that right. But it’s possible some of the numbers I may have misremembered. So, we’ll put clarifications links in the show notes. And thanks again for listening. Arturo, really appreciate your time today. Thanks so much.

Arturo Espinoza Bocangel  56:43

Thank you again. Thank you very much.

Gene Tunny  56:46 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 EP143 guest Arturo Espinoza and to the show’s audio engineer Josh Crotts for his assistance in producing the episode and to Peter Oke for editing the transcript. 

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

A UBI advocate on its benefits and costs – EP137 show notes & transcript

In episode 137 of Economics Explored, Australian Universal Basic Income (UBI) advocate Michael Haines chats with show host Gene Tunny about the benefits and costs of a UBI, with an extensive discussion of how it’s paid for in Michael’s proposal. The conversation considers money creation and so-called Modern Monetary Theory (MMT).

You can listen to the conversation using the embedded player below or via Google PodcastsApple PodcastsSpotify, and Stitcher, among other podcast apps. A transcript and relevant links are also available below.

About this episode’s guest – Michael Haines

Michael Haines is the CEO of VANZI, the Virtual Australia and New Zealand Initiative. Michael has 40+ years of experience in a wide variety of senior management and consulting roles across a range of industries: government, telecommunications, brewing, construction, consumer goods, car manufacturing and transport and logistics covering a wide range of disciplines. While he has previously sat on the Board of the Australian Logistics Council and remains a member of Austroads Intelligent Transport Industry Reference Group, he was instrumental in establishing VANZI and his entire time is now devoted to the VANZ project.

Links relevant to the conversation

What’s Better: Welfare, A Job Guarantee, Or A Universal Basic Income? | By Michael Andrew Haines. | Apr, 2022

UBI: Universal Basic Income w/ Ben Phillips, ANU – EP126 – Economics Explored

Poverty In Australia 2018

Basic Income Australia (overview of UBI policy Michael is proposing)

Money creation in the modern economy | Bank of England

Transcript of EP137: UBI advocate Michael Haines on its benefits and costs

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.

Michael Haines  00:04

Whether it’s through accident, the health, being sacked, being divorced and losing the income of your partner. All sorts of reasons why suddenly you lose that income. Well, if you’ve got a UBI coming in, at least you’ve got enough to live on.

Gene Tunny  00:24

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 137, on benefits and costs of a UBI, or universal basic income.

I’m joined this episode by a retired Australian CEO in the manufacturing and logistics sectors, Michael Haines, who has been doing a lot of thinking about the benefits of a UBI and how to cover its costs. This conversation will give you a good idea of what advocates of a UBI see as its major benefits. You’ll also hear a discussion about the relevance of so-called modern monetary theory, MMT to the UBI debate. If you’re a regular listener, you’ll know that I’m highly sceptical about both UBI and MMT. But I did my best to remain openminded in my conversation with Michael.

Please check out the show notes for relevant links, any clarifications and for details of how you can get in touch with any comments or suggestions. I’d love to hear from you. As Michael indicates in the discussion, he’d welcome your thoughts on his ideas and his proposal. So please send them my way. And I’ll pass them on to Michael. Righto. Now for my conversation with Michael Haines on the benefits and costs of a UBI. Thanks to my audio engineer Josh Crotts with his assistance in producing this episode. I hope you’ll enjoy it. Michael Haines, welcome to the programme.

Michael Haines  02:01

Well, thank you, Gene, very much for having me here. I’m really excited to have the opportunity to speak to your audience who is probably more educated in these topics than the people I normally speak with. So I’ll be looking forward to any feedback you receive.

Gene Tunny  02:17

Okay, yeah. So keen to chat with you about universal basic income. I’m interested first in your journey to becoming an advocate for a UBI. Could you take us through that, please, what got you interested in this as an idea, and then we can go into what you see as the merits of it.

Michael Haines  02:39

Have you got time for a life journey, Gene?

Gene Tunny  02:41

Oh, please.

Michael Haines 02:42

Back in the 1980s, I was group general manager of one of the top 200 public companies, and first to actually, as far as I know, get involved in the use of trusts to minimise tax in a public company. And in the course of that, I guess I began to query myself as to the whole issue of why we pay tax and the complexities of our tax system and money system. And so through that, I just took a journey myself to explore tax law and integration with the money system, banking system, and so on, and develop thoughts then around how we might integrate a flat tax system on spending with a flat payment, which is effectively a UBI, which would turn the tax on spending effectively into a progressive tax on income if it was structured correctly. So I have worked my way through that for quite a few years and talked to a few people about it. But it really never gained any traction. I didn’t have the academic background, because I was involved in business, to really progress it, and drifted over the years.

And then I guess more recently, it’s become apparent that across the world, there’s a lot more interest in a UBI. And that spurred me to… I’m now 73. So I’m effectively retired. It spurred me to do something about it. So, a bit over a year ago, I got involved with a group called Basic Income Australia. And through them, I undertook the task to write a policy document, which is about 111 pages long, and I don’t expect anybody to read it. It was really aimed at capturing our understanding of all of the ins and outs of a UBI across the world, pilots that have been undertaken, what they tell us, what the academic community feels about it, pros and cons, and then to, I guess, evolve the ideas that I hope to talk to you today about, which we believe provides a bit of a different wrinkle to how UBI is seen and how it can be implemented with relatively low risk. So that’s my journey.

Gene Tunny  05:17

Right. And can you tell us a bit about Basic Income Australia, please, who’s involved in it?

Michael Haines  05:23

It’s just a small group that was started by a guy called Josh McGee a few years ago. He’s a highly talented mechatronics engineer, and he’s just qualified. And he took an interest in the UBI quite a few years ago, and gathered together a group of miscellaneous miscreants who had a similar interest. And so it’s not a professional group. It really is a cross-section of people who are interested in seeing the basic income become a reality in Australia. So I guess I’ve endeavoured to bring some sort of more rigour into the specifications of what a UBI might entail. And that was through the process of writing that policy document. So I’d very interested in, as I’ve been speaking to you earlier, to get the feedback from your audience, as to what they think about the proposal.

Gene Tunny  06:27

Absolutely, and I’ll put a link to that policy document and some other articles that you’ve prepared, or that you were telling me about, some Medium articles, is that right?

Michael Haines  06:37

I’ve just completed a series, or completed a series of about seven articles that look at the rationale for UBI compared with welfare and the job guarantee, look at how we can implement it without increasing taxes or debt or taking money from other programmes or incurring excessive inflation. So that sounds like magic. But we believe that there is a way to do it. Another article then considers in more detail, how to implement it with low risk. And then three papers looking at the benefits. About 24, we’ve identified for the individuals, about 19 or so I think, or 17 for business and the economy and maybe 19 for government and individuals. So that series, we hope, they’re only about a five-minute read each, should give people a good understanding of what we’re about.

Gene Tunny  07:39

So it’s interesting, you were thinking about this in the 80s. And that it’s recently that you’ve come across this UBI idea, that this is something that is, this idea is taking off worldwide. And I’m trying to remember when I first heard about it. It probably would be in the last maybe 5 to 10 years, it’s associated with the sort of Silicon Valley crowd, isn’t it?

Michael Haines  08:05

[Unclear 00:08:05] and BIEN as well, Basic Income Earth Network, which Guy Standing and others have been involved in. I think the history of it goes back to Thomas Moore, and others. So we’re talking about people throwing these ideas around for a long time. But one of the biggest concerns people seem to have, and rightly so, is the cost because most people say that’s a wonderful idea. And, you know, if I was to say, well, we’re gonna give everybody a super yacht, similarly, that’s a great idea. Yeah, I’m all for getting my own super yacht. But, you know, quite realistically, we can’t pay for it. So that’s one of the major focus points that we’ve looked at, you know, how do we afford it.

Gene Tunny  09:03

Yeah, yeah, we’ll definitely come to that. I just want to start off with… Before we get to that, I’d like to ask you, what do you see as the merits of a universal basic income? And I know that you’ve referred back to, well, prehistory in a way, haven’t you, in thinking about that? So could you take us through what you see as the merits of it, please?

Michael Haines  09:28

If we go back to prehistory, every human born had a basic birthright, which was to live off the land. And the richness of the land would determine basically how well you lived, but that birthright was there regardless. With the advent of property rights and money and a system of paid work, that is no longer available for most people to live off the land. It’s meant that the human species now, at least in the developed world, is absolutely reliant on money. You have to have money if you want to buy a sandwich down the street, a bottle of water. It doesn’t matter what, money is the source, or the access point for the resources that you need to survive.

And so given that, we then have to look at well, while this whole new system has been really advantageous for the great bulk of people, lifting living standards, health and so on, for a section of the population, it has really left them out. About 12 to 14% of the population, in most of the developed world, live in poverty. They’re mostly single women with kids, aged, disabled, they’re unpaid carers, mostly family, and also people who are between jobs, all of whom lack savings and family support. So in Australia, that’s about 3.2 million people and 17% of all children.

So it’s an indictment not of those individuals, but of the system, that they are living in poverty in what is essentially a very wealthy country. So there is no doubt that we have the resources to ensure everybody has enough to survive, food, clothing, housing, and so on. So what is lacking is neither the resources nor the money. We create the money. So what the problem is, is getting the money into the hands of people who need it, and the way that we’ve traditionally done that is through welfare.

But welfare comes with a poverty trap. And that is, it is perfectly rational for a person to look at a benefit and say, I’m gonna take the benefit instead of this shitty low paid job. So it’s nothing to do with moral failings. It’s, you know, you and I, given the choice between the two, we’re gonna say, well I’m gonna take the low pay benefits. So it is then perfectly rational for government to say, well, hang on, we’ve got work out there that needs to be done. We got people who are capable of doing it. So we must keep the benefits really low in order to encourage those people to take the work that’s available. And that works in the main, right? People, if they can get off the welfare benefit and into work, and they can do it, they will.

But there is a whole section of the population who cannot do paid work, which as I said, is the single women who are caring for kids and they’re carers for the aged and so on, so that it’s creating a poverty trap, which we could solve with more welfare, or higher benefits, if we absolutely could guarantee the ability to identify those people who genuinely can’t work at any time, and have a real time system that as soon as people fell into poverty or came out of it, we could always capture them immediately. And some countries do that better than others, but nobody has really solved it, because as we said, across the world right now, we are faced with 10, 11, 12, 14% of the population who are in poverty.

So what we’ve looked at is said, well, a universal basic income in which everybody has, as of right, a payment to ensure they can meet their needs, well then they’ve got that money, there’s no need to apply. There’s no need to justify. And if you suddenly find yourself without an income, so most people are at risk of losing that income overnight, whether it’s through accident, their health, being sacked, being divorced and losing the income of your partner. All sorts of reasons why suddenly you lose that income. Well, if you’ve got a UBI coming in, at least you’ve got enough to live on.

And so yeah, that’s where, I guess what we saw as the rationale for a UBI. But we’ve also identified over 50-odd benefits that once you do have it in place will flow from it. So I don’t know where you’d like to go from here. I can talk through how we might fund it, how we can introduce it, we believe, with low risk, and what some of the benefits are.

Gene Tunny  14:51

I’m keen to stay on the benefits for a while. What do you see as those as those benefits? I mean, you talked about the fact that it is an income redistribution tool.

Michael Haines  15:04

Can I stop you there, Gene? I don’t see it as an income redistribution tool. And this is why it’s necessary to explain how we see funding it. Because we don’t believe it is necessary to take anything away from anybody in order to ensure that everybody has the basics, simply because we do have the resources in Australia, to feed people, to clothe them, and ultimately to house them. What we don’t have is a mechanism to get the money into people’s hands. And so we believe we can do it without redistribution, which is what I’d like to explain.

But if we put that aside for the moment, and again, just look at the benefits, for a very simple one, it would reduce for an individual reliance on debt. So no more payday loans and the stresses that that brings. It provides us with sort of indicated income and basic income insurance, because if you lose your job, at least you’ve got that money coming in to live on. It eliminates, as we said, the welfare poverty trap. It eliminates bureaucracy for people. You no longer have to be worried about, you know, these mutual obligations and ticking boxes and just going through the hoops, for the sake of quotes, proving your entitlement. It eliminates social stigma and intrusion into your life, because you’re just getting it as of right like everybody else is. It underpins lifelong learning. It means that people who might want to take some time off to do a short course will cut back their hours. So I can’t do that. I’m struggling to meet my daily needs. With the UBI coming in, it will assist them in that.

It empowers people also to do the right thing. So we know that people through the threat of poverty are forced to do unsafe, illegal and unethical work. And when now as a society getting to the stage where we’re recognising the need for consent in the bedroom, a UBI empowers people to have that same consent in the workplace to be able to say, no, this is unsafe, this is illegal, this is unethical.

It provides some flexibility too for where you might work and the type of work you do, because it gives you some income to actually move to where the work is. If you are destitute, it’s all very well to say, hey, there’s new work in New South Wales. But how do I get there, and my few goods from where I am to where the work is? But with the money coming in, it provides increases in employment opportunities, because what it means is that as the money gets spent into the economy, it is going to generate more demand, which will generate more need for more labour.

It provides some recognition for in-home care and home maintenance and looking after families and creating the social bonds that people do who are not in quotes paid work. But maintaining those social bonds in the home are critical to a well-functioning society. At the moment, we don’t place any monetary value on that, and a UBI would, by paying a person to do that work. In effect, it provides respite for home carers. So people who are struggling to look after aged and disabled now will have a bit more money coming in to maybe put the person that they’re looking after into care or taking some time themselves. It actually adds to the income also of the aged and disabled.

We see it working such that the UBI would be treated as income under our existing welfare systems. So as the UBI increased, it would naturally reduce benefits, but the benefits would remain intact. And so depending on the level of the UBI, it would supplement the benefits that are netted from the existing system so nobody can be worse off. But most people in that circumstance should be better off.

Another big factor is it ought to reduce the incidence of family violence and also facilitate escape, because a lot of family violence is created from the financial stress that occurs when people are living on the edge. And so by leaving that financial stress, it should reduce the incidence of violence, but for women, and it’s mostly women who are caught in that sort of relationship, they now find that they can’t escape, because where are they going to live? How are they going to survive? They’ve got no income, they’ve got no job, whereas with a UBI, they’ve got that money coming in and can move anonymously and set up a new life. So it helps them. As we said, it is enables escape from poverty. That’s probably number one.

From around the world, we’ve seen studies where ensuring people have enough to live on, it improves their cognitive function and improves behavioural disorders, prevents suicide that is driven by financial stress, helps kids focus on schoolwork and higher education, for the same reasons it improves cognitive function. And evidence from the pilot says that it also improves nutrition, and in fact, reduced alcohol and tobacco use.

Gene Tunny  21:18

Right. Do you know which pilot that was?

Michael Haines  21:20

Yeah, I can give you that detail. I haven’t got it off here. But I can certainly give you that. And it would enhance self-determination, which is especially important for our First Nations people who have for a couple of centuries now been treated as a society of dependent individuals who have to be looked after, and so on. Whereas, if we pay UBI, unconditionally to everybody, well, that includes those of our First Nations people who can then make their own decisions that they are able to thrive instead of just simply survive, especially by pooling their resources, and so on.

So, I mean, these aren’t silver bullets that are going to solve all the problems, but they are additive and cumulative in the way that they can help us address some of these issues. So that’s just the 23-odd benefits for the individuals. There’s a whole lot for, as I said, business and the economy, for government and for the people in general. I don’t know whether you want me to go through all of those how much time we’ve got.

Gene Tunny  22:38

I can put a link in the show notes to that list. I want to ask you about this concept of technological unemployment. Is that one of the motivating factors behind UBI? Have you thought about that? Is that one of the reasons you’d advocate for it?

Michael Haines  22:57

Yes, absolutely. And so one of the things that we’ve looked at is that once we get the UBI to the poverty line, and there’s a whole process to get there, then what we’re suggesting is, in fact, the UBI be set up and managed by a new authority under its own charter, independent of normal government. Funding would not go to the government deficit, because the money would not be going to the government, it’s actually going directly to the people. And so that authority would manage the money. Now I’ve lost track of what the question was you asked me.

Gene Tunny  23:37

I was asking about technological unemployment.

Michael Haines  23:41

So that authority then would have the capacity to say, well, we’ve now got the UBI to the poverty line. If as a result of automation and virtualization, we start to see a drop-off in employment, we can then increase the UBI and allow the market to rebalance dynamically, back to full employment, because everybody has a different propensity to take on paid work, depending on their age, the commitments or the money they might have coming in.

And so as the UBI is raised, there will be people will say, hmm, I will now live on this money with whatever else I might have. I’m no longer going to worry about looking for work. And so we can tell, as people drop out of the workforce, we will begin to see a lengthening of standard recruitment times. The labour market will be seen to be tightening and the authority says oops, well, we don’t need to go up any higher. We’ve gone as far as we need to go. The market is back at…

So it gives the government through the authority a much more targeted or more precise tool to help manage and balance the labour market than simply the cash rate through the Reserve Bank or fiscal spending, which is a very indirect means for managing it. But because the UBI is income for people, then as their incomes change, they will make real time decisions about whether or not to move in or out of the labour market. So we see it as a very valuable new tool for the government to manage this disruption. Personally, I don’t see there’s any end to work. It’s going to be a never ending requirement for people to be doing different things. But there will certainly be disruption as traditional work is overtaken through automation and virtualization.

Gene Tunny  25:53

Okay, just thought I’d ask you that. Because my impression was that one of the reasons that a lot of the Silicon Valley people have been advocating for a UBI is that they see this new world in which there’s all this automation and AI, and you’ll have lots of people without work. And I mean, I know with automation of the vehicle fleet in the United States, for example, that they’re talking about the next 10 or 20 years, you could have 3 million people driving trucks who are no longer needed.

Michael Haines  26:32

It’s going to come quicker than that, through what I’ve just recently seen, that there’s a new robotics company, which is taking a very different approach to robotics in the workplace. Whereas there’s two types of robots, or three types, there’s the traditional type, which is very structured and has to go through these very specific steps. There’s a new type that has got some spatial awareness and some ability to act autonomously. But nowhere near the general intelligence required to do sophisticated manual handling work and so on and making decisions on the fly. Well, what this company is doing is saying with high-speed internet, now, we can actually globalise the workforce, while the worker is the robot in the local economy, controlled remotely by somebody anywhere else in the world. And that, in my mind is a major shift in how our labour markets… So now again, I’ve lost my train of thought.

Gene Tunny  27:45

We were talking about robots and being controlled by people remotely.

Michael Haines  27:51

It’s just that new way should see the continued globalisation of the workforce, despite the re-localization of the production capacity. So we’re seeing more and more production capacity relocalized. A lot of it is automated, but still a lot would remain with a need to have local people doing many of the jobs. But if a robot can be controlled remotely, then that’s a whole different ballgame again, so yeah.

I think the essence where I differ with maybe the Silicon Valley tech view, which has been promoting quotes a basic income as truly basic, and that what you end up with is, you know, millions and millions of people just eking out a living and a terrible society, structured with a few earning huge money and the rest eking it out. If we take the view that the UBI should be set to balance the labour market, then individuals are making their own choice about whether I go off and do other things, creative things or become more engaged in the community and sport. I mean, there are hundreds of thousands of things that human beings can do other than work once they actually have the freedom of mind to do that. You know, there is the whole issue around work providing meaning, and it does but there are lots of things that people find meaningful which don’t necessarily involve paid work, and a lot of paid work is hardly meaningful. It can be bloody soul-destroying. What it does, it allows each person to make their own choice in a market where the UBI is set to achieve balance.

Gene Tunny  30:05

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

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Gene Tunny  30:40

Now back to the show. So we might go into the particular plan that you have, Michael. I’m keen to sort of explore that. Because as you know, I mean economists are going to be… Well, I think economists are very concerned about the cost of a UBI. They would say that you need to pay for it somehow. There’s no free lunch. So that’s a maximum of economics, there’s no such thing as a free lunch. So would you be able to take us through your concept, please, and explain just how it works? Because I know I’ve got some questions about it. But I want to make sure I understand the logic first, please.

Michael Haines  31:27

Well, you’re absolutely right about no free lunch. I guess the lunch part of it is to do with our actual resources, right, the sandwiches we eat, the houses we make, the engineers we have, and the chefs available to do the work. So that is the constraint. And one of the things that we’ve looked at is to the whole modern monetary theory, and which doesn’t have a good name broadly through the economics profession, and I think, to some extent, rightly so, because unfortunately, the way in which it has been pitched is as effectively an unlimited flow to government to then make decisions about how the money gets spent into the economy. You then have politicians and bureaucrats, you know, with their hands on this, quotes, unlimited spigot of money, and expecting that they are going to make good decisions that support the wellbeing of the whole economy. So we’ve looked at it different.

And so let’s go back to first of all understand how money gets into the economy. And apart from quantitative easing, which in fact, most of the money went into the financial economy, the real economy, but most of the money, as I’m sure your audience knows, gets into the real economy through bank lending. And so as a borrower goes to a bank, the bank creates the money, the borrower says, thanks very much and spends it in the economy, creating new activity that would not have occurred had that borrowing not take place, because the money is effectively new purchasing power, and it redirects our resources. It’s the source of growth in the economy, as businesses borrow and others borrow to spend into the economy.

So if we are creating money for that purpose, then the opportunity is to do the same thing, create money out of thin air, but instead of giving it to borrowers who are obliged to repay it, and so they should, because they’re getting an advantage purchasing power that they haven’t created or added to themselves. So they should work, add value out of that value, earn the money to repay the loan. So that works fine.

But if we’re now going to pay, create money and pay it to every single person to meet their basic needs, then we’re able to look at this and say, well, if there’s an example where suggesting that the amount of money should be $500 per week per person. Now, that comes out, for 20 million adults, about 520 billion bucks a year. Absolutely can’t be sustained.

But if you offset it against the welfare benefit, if you recover a substantial proportion through earned income and allow for the fact that some of the money is going to be recovered again via taxes, as the economy grows through the spending, some is going to go offshore, some into the financial economy. We think there’s about $100 billion net that would get injected into the economy of new money every year.

Now, some of that can be offset simply by reducing bank lending, because bank lending is putting new money into the economy every year. So instead of the new money all going in via bank lending, some of it now would come in through the UBI. And we can manage that as we do now, by managing interest rates. So as interest rates go up, there’ll be less bank lending, but there’ll be more UBI coming in, which should continue to ensure the economy maintains full capacity. But more of the capacity will be going to meet basic needs and less on other spending.

Business will have to adapt to that new pattern of demand. And we are suggesting a way to implement that with low risk by starting small, so just 10 bucks a week to start with, paying everybody, ramping up over five years. So what that does is allows the supply chain time to adapt to the new pattern of demand without causing shortages that drive inflation. And then you’ve got, at the end of the day, more money going in via UBI, and less via bank loans.

If there’s a net addition, we’re still looking to grow the economy 3or 4%, we’re looking for 2 to 3% inflation, and $100 billion in a 2 trillion economy is about 5%. So we see that it ought to be feasible to get to that 500 bucks a week level with the offsets that we’ve designed in. But we don’t know, and nobody knows, and nobody can really model it. But we don’t have to model it or guess, because if we start small and increase slowly, we can actually see what happens. We can see what’s happening in the economy. And if it looks like the negatives are starting to outweigh the positives, then we hold it and address the negatives.

My feeling is that, as we talked about the benefits to the individuals and the many other benefits, we will see a wealth of positives. And that’ll encourage us to actually speed up the rollout rather than cut it back. We don’t have to guess because we can actually see what happens. So that’s how we’re looking to implement it. And I haven’t spoken in detail about the offset and the recovery. But I’ll leave you to ask the questions now.

Gene Tunny  37:53

Yeah. So that recovery, I think one of the things you were talking about is what Ben Phillips was talking about when I spoke with Ben about the claw-back. I mean, what is that recovery as you as you earn money from work? And you know, what happens to the UBI payment? I mean, is there any claw-back of that? Is that what you’re talking about?

Michael Haines  38:17

Yeah. So what we see us that we don’t want to touch welfare as it is, but we treat it as income for welfare. So all of the rules and entitlements and everything stay the same. And the same with our tax system. We don’t want to touch the tax system, because that gets into all sorts of arguments. What we want to do is, under the separate authority, every week, they will be paying out the 500 bucks a week to every person, but they will appoint the tax department as their agent to recover the UBI from people via group tax, the GST system or the annual returns based on a very simple formula, that you will have to pay back 32.26% of your gross income through the tax system, in addition to whatever tax you’re paying, because the tax you’re paying relates to your income. The recovery relates to your UBI. So we’re going to give you the UBI. But the more you earn, the more you will have to pay back, so that by the time you get to $80,600, everybody earning that and more, they’ll be getting their 500 bucks a week in, and every week or so over the paying the 500 bucks back to the authority. That money gets put back in and recirculated in the next cycle.

And you say well, hang on, why pay people 500 bucks just to take it back off them? And the answer is because circumstances change overnight. And by paying people the money, it becomes like basic income insurance. It ensures that if I suddenly lose my job, I get sick, I have to care for a family member, for whatever reason, my income is suddenly lost, a pandemic comes along, there’s floods, fires, storms, whatever throws people into… They get divorced. That money is there coming in.

And now when I’ve lost my income, there’s no more recovery. So I’m getting the full amount, there’s no delay, there’s no need to apply. And then when I find I’m in a position to look again for work, I can do it without having to go and tell anybody. I don’t have to tell anybody what I’m doing to get it or whether I’m retraining myself. I don’t have to tell anybody how much I’m earning or any details at all, other than, of course, the tax department, which I normally have to do. And through that tax department, once I start earning again, the recovery would start to take place. But again, I’m better off because whatever I’m earning, at less the tax, is on top of the net that I get out of the UBI.

So up until $80,600, I am going to be better off by having the UBI. And we think that covers probably 75% of the population, and the other 25% are no worse off, which is why I said earlier, we don’t see this as a redistribution. What we see it is as a way of providing people with the means to express their needs in the market, and for the market to respond to meeting those needs. without taking anything off anybody else. You could say that if interest rates are going up, then people are unable to borrow as much as they might have. But on the other side, the money that’s going into the economy is going in debt-free. And that money will therefore, as it flows through the economy, to profits and investment, it’ll help the economy to grow and stabilise without the need for such high levels of increasing debt. So we see that’s also an advantage for the economy.

Gene Tunny  42:29

Yeah. Okay. So I think that argument would be more persuasive if we did have this high level of technological unemployment, if we had a large amount of unemployed resources. And that argument is going to be more persuasive. I guess the concern that economists would have is that, well, if you’ve got an economy that’s operating near full employment, as you could argue the Australian economy is now, then we don’t really necessarily want to be adding that additional demand to it because it could be inflationary. So concerns about inflation will be one of the major concerns about this proposal.

Michael Haines  43:12

So you’re right. And that’s why we are proposing to start small, because at 10 bucks a week, that is really a big deal for somebody living in poverty. That’s food for a day. So it might not seem much to you, or to most people, but at 10 bucks a week, it’s a start, but it’s not going to destroy the economy. It’s not going to, you know, cause havoc. But in a quarter’s time, we would see that being increased by $25 a week. So people are now getting 35 bucks a week. So it’s a bit more, and we can see what is happening.

Our expectation is that while there are inflationary pressures, they are in specific parts of the economy. And for things like food and clothing, and some of the basics, the opportunity is there for businesses to redirect resources. At the moment, you’ve got cafes and people like that crying out for labour and so on. But if the resources are directed towards meeting more basic needs, because people now have the money to express those needs, we would simply see over time, a shift in the way the economy is structured, which is why we are wanting to do it slowly, so over five years. Otherwise, you put 500 bucks a week into the economy, even with the claw-backs, it would create havoc, as we have seen with the disruptions due to the pandemic and now the war, where you alter the supply chain overnight, literally. It creates bottlenecks that are really hard to manage.

I was once manufacturing manager for Toyota, and also on the board of the Australian Logistics Council and ran a major logistics company in my day. So I really understand how the supply chain works. And you can’t just turn a tap on and say, okay, now people start spending this money, and expect it to just flip overnight, but you can expect it to change over a period of five years. And in that time, we are going to see more and more automation. And the UBI, in fact, could assist in helping firms to automate, because there’ll be a number of factors in play.

You will have people who are getting the UBI, who now say, well, I’m not going to work, I’m happy to live on the UBI. So the labour market might tighten. But you also might have people who are you saying, well, I’ve now got the UBI as a base, I’ll actually take on this extra work, which wasn’t previously worth my while because of the benefits I lost. But now I’ll take it on. And the new automation pressures might come in that interplay. We don’t know whether there’s going to be more people wanting that extra work or less.

But over time, regardless of what people are doing in terms of offering themselves to the labour market, it’s clear that there is going to be more and more automation, and virtualization. So virtualization is a hidden factor in that you don’t realise what you don’t have. And if you look at all of the devices that the smartphone replaced, there’s a huge amount of what used to be physical work and effort in producing all the goods that’s now all done by software on a little phone. And that’s just going to continue now. And so we are going to see this automation play out more and more.

Gene Tunny  47:24

Remember when there used to be Kodak processing centres all over the country, all over the world, and don’t have those anymore. Right. Okay. Now, one of the other things I want to ask you about, Michael, is this… You do recognise rightly that your proposal is leading to an expansion of the money supply. And look, you’re right about bank lending and what it means for the money supply. That’s correct. There’s a Bank of England article about that. And I’ll link to that on money creation.

Michael Haines  48:01

That is the best article. When I said I was back in the 1980s, one of the things that I – realisation I came to was actually how money was created. And talking to economists back in those days, it was absolutely shot, because until that Bank of England paper came out, there was often not the recognition of just how money was created. And so, yes, I really appreciate you making that link. Because it is such a good, clear, concise paper.

Gene Tunny  48:40

Yeah, money creation in the modern economy. I think I mangled it before. I mispronounced it. Yeah, well, I think, yeah, there was this debate in the ‘60s and ‘70s, about monetarism. And there were economists at the time who were pointing out that money was actually endogenous to the economy and that it was associated with the actions of banks and people borrowing money from banks. Who was it? Was it Nicholas Kaldor, who was one of the famous Cambridge economists? He was a student of John Maynard Keynes, whereas I think Friedman made a lot of great contributions, but he was probably off track a bit where he was assuming almost that the money supply was this exogenous variable that could be controlled easily by the central bank. Now central banks, obviously, they can influence it, but it’s not necessarily…

Michael Haines  49:46

It’s not easy to control. And so, one of the things that we would see is that the new authority with the central bank, as the UBI was raised, it’s very important that because that UBI is now signalling new demand, that firms and individuals be able to borrow, to increase capacity to meet that demand. And we don’t want the cost of that borrowing to go up. And so what we would want is for individual banks on a case by case basis, under guidelines, making decisions to say, well, you’re asking for this loan to help increase our capacity to meet the basic needs of our citizens. So you’re going to get this at no extra cost. But if you’re borrowing for other, say, nonessential purposes, then we want that borrowing to be reduced to free up resources to shift across to meeting more basic needs. And so the cost for you to borrow is going to go up. Now, this is a whole different way of thinking about it. It’s applying a premium on top of a set of loans rather than increasing the base, which is what we do with the cash room.

And so let’s take an example of how that could work, say in housing. At the moment, housing prices go up and the bank starts to worry, we’re into an inflationary period, we’ve got to crunch it and increase interest rates. That increases interest rates for everybody, including the poor little guy who’s got his highly productive business, but now it’s pushing him on the margin, when really all we want to do is we want to increase the supply of houses and reduce the price pressures in the housing market. And the way to do that is very simple, to say, well, if you’re going to borrow for an existing home, you’re going to have to pay an extra margin, and that margin won’t go to the bank. It will go to the central bank. It’s there purely to dissuade you from borrowing for an existing home. We’re not going to charge anything extra on the cost to create a new home because that’s what we want. We want new homes built. And so what it does is it depresses the price of existing homes, in favour of new builds.

And so again, this is I guess, outside the whole UBI debate. But again, we would see that treating the money as an essential part of the driver of economic activity, and making specific decisions about what it is that we as a society want. We want, for example, basic needs met. And we want houses built to meet accommodation needs. And so we ought to be able to make those high-level targets and aims, but leave then market to sort out where it’s done and how it’s done and what’s provided based purely on the availability of funds made at specific interest rates under those guidelines.

What I’m talking about here I don’t think is entirely necessary for the UBI to be put in place as a starting small and growing it, because we can do that, whatever happens in the broader economy, because at any point, we can stop increasing. So we might, under normal circumstances, not get to the poverty line, but we’ll get somewhere. If we then begin to think about how else we can manage this broader economy to rebalance the inflow from borrowing and the UBI, then I think we can get to that poverty level with maintaining full employment, maintaining full economic activity without high inflation.

And we’ve got plenty of time to sort of sort through. We are aiming for, we would like to see a government, not in this Parliament, but three or four years’ time at the beginning of the next Parliament, agree to implement it. And that might be 2025. And it wouldn’t be fully implemented until 2030. So in that intervening period to then discuss these other mechanisms to refine them and test them and talk them through. So we don’t want to hold up the UBI until we’ve sorted out all these other problems, because we think that the low-risk way of implementing it should address concerns regardless of what the final decisions are.

Gene Tunny  55:21

Right. Okay. Look, that’s given me a lot to think about, Michael. Yeah. Now did this issue, did this idea of yours of, well, you have to intervene in bank lending, so you’re trying to control the growth of the money supply by… You need to increase the cost of borrowing for… You’re saying that you’ll just have that limited to borrowing for existing property. Now, that’s a lot of the borrowing that does occur. Right. But then you’d say that you would have it that they wouldn’t be able to… I’m just trying to think about how this would work in practice. I mean, are you saying that there’s a particular interest rate you have to lend to people who want to build a new house or buy a new house?

Michael Haines  56:14

So the market, whatever the cash rate is at the moment, there is a market rate for lending. And so the idea is that you don’t interfere with that, that what you do then is simply say, well, we want to discourage certain types of lending and borrowing, because it’s not achieving our overall economic objective. Our overall economic objective is, A, to meet our basic needs. And we want business focused on doing that. So it’s not a socialist method of providing the goods and services. It’s simply targeting the money to drive the market.

And so we’re saying that, yeah, we would need to have banks be given some guidelines. And they only need to be broad guidelines about the types of lending we want to promote and the types of lending we want to discourage. And then seeing what happens in the market, that if interest rates increased by an extra margin, that then goes to the Reserve Bank. If those interest rates start to really negatively impact the economy, just like increasing interest rates do anyway, at some point, you will then say, okay, well, that’s enough, we’re not going to do any more, we’ve achieved as much as we can do, because to go any further now might end up pushing us into recession. And in fact, our feeling is that the Reserve Bank is never going to get it right, we are going to go through these cycles that we already have. They’ll push it too far. It’ll start to go into recession.

But with the UBI, we can make that a very shallow recession, just like we did with JobKeeper. we put the money into the people. It keeps them going and keeps the economy going. So we will still have swings and roundabouts. But they should be less severe than we’ve seen in the past using the UBI as a floor.

Gene Tunny  58:33

Hmm, that’s an interesting concept. I’d like to just look at it a bit more closely and think about how’d it all work. I mean, I think you’ve got the right idea. It started off low, and you’d experiment with it, just to see how it actually works in in practice. I mean, my natural inclination is, against intervening in the banks in that way to say, well, we think you should be doing that lending rather than this other lending, because who’s the… The bank should be making that decision based on what it thinks is sensible? It should be looking at, well, can the person actually afford this loan? Are we going to get our money back? And they should be charging for that based on the cost of their funds, right?

Michael Haines  59:38

So what you say is true, Gene, all of that process should still happen. The difference is that instead of the cost of funds being pushed up from the bottom, across all lending, it would be added to on the top, so the banks will still be making the same margin that they would have, because instead of having to pay a higher cost of funds, their cost of funds won’t have changed, they will be making the same decision to lend to the same people. But the person who is borrowing will now have to factor in that in addition to paying the bank’s interest, I’ve now got to pay this extra margin. And that will dissuade some people from borrowing. If it dissuades some people from borrowing, that means that there is less money that is being created through the banking system going into the economy. Now, that is what we want, because we are at the same time putting money into the economy through the UBI. And there should simply be over time, a shift in productive capacity from spending more on basics and less on whatever else would have been done.

So it is a policy decision of society to say, yes, we want everybody in our society to have their basic needs met, as a priority for any other things that money might be spent on. And the reason is, because we have now created this wonderful system of property rights money and paid work, which is delivering huge value for us. But in its design, at the moment, it is forcing millions of people into poverty. And we don’t want that. So it is a policy decision. Right. And once we make that decision, I believe the economy will chug on even better than it has, because you’ve now got a demand being expressed that was previously latent. And that’s bad for the people who miss out on the goods and services. It’s bad for the businesses who could meet that demand. And ultimately, it’s bad for society.

So yeah, look, we recognise that this is not going to be a simple discussion, but hoping over the next three years to get one of the major parties at least, if not both, to begin to seriously examine it with a view to, as we said, implementing it, not in the upcoming parliament, but the one after, and that taking this slow approach should make people feel comfortable that it is a pretty low-risk strategy for what potentially could be massive, massive benefits.

Gene Tunny  1:02:45

Right. Okay. So I’ve got two more questions, and then we might wrap up, just on the cost of it. And you talk about this authority. And I think you’re suggesting that this could be off budget. Now, have you had any advice on this, or have you talked to any statisticians about this issue? Because it just seems to me that this is effectively government spending, this is a transfer payment, and therefore, under the guidelines from the IMF, on government finance statistics, it should strictly be counted as government spending. So have you thought about that? Do you have any advice on that?

Michael Haines  1:03:35

You’re right, this hasn’t been an issue, up until now. And so there isn’t a neat place to put it. But the way I try to characterise it was to say, look, new money is created under the banking system, under the auspices of the Reserve Bank, and the other banking authorities. And so it’s government regulated, but the money when it’s created, goes to individuals who spend it. And that money, even though it’s created under the auspices of the government, is not treated as government spending, because it isn’t government spending, it’s spending by individuals. And the same thing here that what we’re doing is that we’re reducing the amount of money that is spent by individuals through bank borrowings and increasing the money spent by individuals through direct payments to them of new money. So it’s not transferred, it’s not come out of tax. It’s not come out of anybody. It is just like the bank lending new money, but it’s now going to everybody to meet their basic needs.

And so this does require a different categorization, a different way of thinking. And you’re right, probably as things stand, people will struggle, Gene, with coming to grips with that. But yeah, if we don’t regard bank lending as government spending, why should we regard spending by individuals who are not being directed by the government, it’s not supplying government goods and services, it’s not coming out of the hands of taxpayers, it is new money created by the Reserve Bank, just like it’s new money created by the banks for the borrowers.

Gene Tunny  1:05:26

Okay, I can tell you what the economists will argue. And I mean, I don’t necessarily want to be negative about this, because I’m trying to be open minded. But what they will argue is that how you’re paying for this in part is through an inflation tax. So that’s one way that you would be paying for that, because there’s this, you know, there’s the money creation, and in the long term that will be inflationary. And so there’s a transfer of resources from between households, because with the inflation, that’s going to be reducing the value of money holdings of other households in the economy. That’s why economists I think would argue that there is a redistribution and it’s being paid for by an inflation tax. So I think that’s what they would come back with. They would just argue it is effectively… It’s similar to government, a government transfer payment.

Michael Haines  1:06:39

And you’re right, to the extent that it is inflationary. But as you would know, we’re looking for some amount of inflation, maybe 2 to 3%, in order to maintain a sort of a forward-looking economy. And we’re also looking for, 2 to 3 to 4% growth. And that amount of money has to be to support that inflation target and that growth. New money has to get into the economy. And so at the moment, it’s coming in virtually all through bank lending, through newly created money, driving additional activity. And so what we’re saying is that, yes, there would be a redistribution then, not out of the past earnings or the past wealth. So we’re not taking it away from your earning capacity, or out of the wealth that you have. What we would be doing is shifting the ability of some people to borrow and get new money versus the payment directly to people without borrowing. And so that certainly will result in a shift in economic activity. But it’s a prospective shift. It’s not a past shift or a current shift, because you’re restricting people’s ability to borrow for the future.

And so it is a slightly different view. But even if that view isn’t accepted, then we would be arguing that the amount of inflation is not excessive, if given our $100 billion a year net payment, is the total amount being put into the economy every year, which is about 5% of our GDP. But beyond all of that, we are suggesting that by starting small, we don’t have to theorise, we don’t have to guess, we can actually see what happens. And if through automation and through other adaptive means the supply chain shifts to provide extra basics, we might find that that extra capacity is generated over five years without changing anything, that the economy will continue to grow with people borrowing for new housing and everything happening, and people won’t even notice the shift because the economy is continuing to operate at full capacity.

Gene Tunny  1:09:44

Right. Okay. Well, I think, yeah, it would be an experiment. I mean, I’m not entirely sure what would happen. I mean, I’ve got my suspicions of how it would play out, but I think it’s something that you would want… To get the best evidence, you really need to implement it, right? This is something that would be very difficult to model. And so, yeah, so I think that’s good you want to start out small just on the bank lending. The other point I’d make is that the bank lending, as you know, that it is accompanied by a requirement that it’s paid back by the household. The money supply expands with the bank lending, and then as households pay it back, then that’s pulling it back in.

Michael Haines  1:10:42

It’s the net of advances versus repayments that actually drives the growth. So over time, if you’ve got more new lending than you have repayments, you’ve got a net extra going in. And so we would see that people are still going to borrow for homes. They’re going to borrow for all sorts of reasons, as they do now. And we don’t want to stop anything any more than the banks, the central bank now looks at housing prices and other prices and says, look, things are heating up too much, we’ve got to quiet it down. So the same approach would exist except hopefully a bit more targeted, and with an additional tool, which is the UBI to keep lifting the floor up, so that we don’t send the economy into the dire depths that sometimes occurs when the central banks get it wrong, and they go too far. So we’re not changing that approach. We’re changing the way in which the tweaks are done, to some extent.

Gene Tunny  1:11:53

Okay. Now, finally, yeah, there are actually two things I wanted to sort of ask. One was about poverty. And you were mentioning, several million in poverty. I’m interested in where you get that that impression from. I mean, I know that there are certainly households that are doing it tough. Yeah, I just want to, because I know a lot of people will go, oh, hang on, there are a lot of… The problem with our poverty definition is that is relative and, and we’re often over-counting the number of people who are in poverty. So I’m just interested in that. And second, did you think about whether this sort of thing could be funded with a wealth tax or inheritance tax, or are you just against that sort of thing?

Michael Haines  1:12:37

Well, I’ll answer the last one, at least. Look, if somebody can get it up with a carbon tax, a wealth tax, income tax, GST, that’s great. Our concern is that if we go that route, you are setting up oppositions and arguments and having a fight that really is unnecessary, because if we do it, as we’re suggesting, and starting small, we don’t have to say to anybody, other than possibly some borrowers, that it’s going to impact you negatively at all. There’s going to be a lot of people who it’s going to impact positively. But we’re not going to have any negative impact. So we’re removing that fight. But yeah, I’d be happy if anybody can get up a tax to partly fund it, then that means that there is a less pressure on managing the money supply through bank lending. So yeah, it’s not out of the question, but it’s not vital.

As for the poverty stats, I’ll send you the link. I haven’t got it on the top of my head, but it’s come through I think, might have been Anglicare or Uniting or somewhere who are looking at the stats based on their data, for people who are looking for charity and support. As I’ve said, it’s mostly single women with kids, aged, disabled, they have family who are caring for them without any pay, and people who are literally between jobs, while they have no work, they’ve got no savings, and they’ve got no family support. And when you add up all those people at any…

This is why it’s a system problem and not a moral failing because the people in that group constantly change. The kids grow up. The disabled age. The aged die. The unpaid carers and the jobless find work, but they’re replaced by a new cohort continually. So despite 30 years of continuous growth up until the pandemic, that percentage of population has hardly budged. So all those factors show that it is a system problem. And the UBI tackles that problem at root, by providing the money to allow people to express their needs in the market. So it’s not a socialist ideology driving it. It’s a market ideology, because in order for people to participate in the market, they need money.

Gene Tunny  1:15:36

Yeah. Now, you know, there are certainly people who are falling through the cracks of our existing welfare system. I mean, just look at the growing number of homeless people in Australia. So yeah, certainly people who are–

Michael Haines  1:15:52

I mean, who could live on, what is it, 43 bucks a day?

Gene Tunny  1:15:55

So we’re talking about the JobSeeker payment, are we?

Michael Haines  1:15:58

Yeah. I mean, who can live on that? I mean, it’s just nonsense. But as we said, there is a rationale for it. It’s not because people in government are cruel by nature. It’s evidenced when the JobSeeker supplement was being paid, the employers are saying, hang on, I’ve got young kids and others here, they’re not prepared to work, because they’re getting all this money. And so you drop the money, and now they suddenly are looking for a job. And that’s all rational behaviour. It’s rational behaviour by the people who want to stay on the benefits rather than work. And it’s rational behaviour by the government to say, well, we’ve got to create these at poverty level. But what it does indirectly is push all of these people who can’t do paid work into poverty. And that is an indictment on our current system.

And we can solve it, we’ve got the resources, we’ve got the means of creating the money, we’ve got a means to manage the way in which the money goes into the economy without creating excessive inflation. And we can keep the economy at full capacity, which is in the interest of business, by allowing over time a shift in the pattern of production to meet the new needs that are evidenced by the UBI.

Gene Tunny  1:17:26

Okay, I mean, what I would say in response to that, Michael, is that that is your hope for the policy. I mean, as you’ve mentioned, you’d roll this out, you’d start off small, and then we’d test whether that would be the case or not, because I mean, economists, as I’ve mentioned, they’re going to be concerned that, well, this is inflationary, this is modern monetary theory.

Michael Haines  1:17:53

Not all of it I agree 100% with, Gene. If we can do it slowly, then there should be no reason why. In effect, what we’ve had is lots of pilots around the world where it’s been focused on a particular group of people or a particular region. And it’s been set at a level which from day one, is regarded as adequate for whatever the purposes of the policy are. But people look at it and said, well you put that across the whole of the country and who knows what’s happening.

So by starting small, we are effectively doing a proper pilot at a national level, to see what are the impacts. And at a very low level, there are probably zero negative and plenty of good impacts. And as we increase, we can determine, are the negatives becoming unsustainable here? And if they are, then we better halt it, keep the UBI at the level, whatever we’ve reached, and look at well, can we measure these problems and go forward, or is that it, we’ve gone as high as we can go? So we’re not taking away any welfare. So whatever level we get to is better than it was. We’ve not increased anybody taxes. So again, there’s been no negative as a result of that step. And up until that stage two, we’re not even saying to the banks to change their lending practices. We’re not changing any of the interest rate margins, or adding any extra margin on top, so we’re just paying the benefit and seeing what happens.

Gene Tunny  1:19:41

Michael, any final words before we conclude?

Michael Haines  1:19:45

I think you’ve exhausted me. I’ve been able to give you something of an insight. But there are a series of I think about seven articles that I’ve now written on Medium, and I’ll send you a link to the first article, and each article then links to the next, which hopefully is a bit more coherent than I’ve managed in our discussion, having lost my train of thought a few times, but yeah, the articles ought to spell out what I’ve been trying to explain here. And yes, I really look forward to hearing from your audience, their feedback, and, you know, whatever concerns that they might have. I will certainly be looking to take them on board and see how we might address them. And maybe another day, Gene, in the future we look at those, and come back and have a talk about it.

Gene Tunny  1:20:50

Yeah, absolutely. I mean, I know there’s a lot of interest among listeners in this topic. And it was suggested by one of my listeners, and then I had been on and then I’ve had other people get in touch. And I know that there certainly is a lot of interest. So yes, sorry if I’ve exhausted you, but I wanted to chat about it, because it’s an interesting proposal, and it’s innovative. And you have thought about the implications of it. So now, while I might disagree on whether, you know, this would be a good thing to do or not, I understand that you actually have thought about it, and in your judgement, this is the right way to do it. Now, I think that’s good you’ve thought through the implications of it and what you’d have to do to manage it. And that was the discussion we had about bank lending. So look, it’s given me a lot to think about. And if you’re listening in the audience, and you’ve got thoughts on the proposal, then please get in touch and I’ll pass them on to Michael. And Michael, as you suggested we could possibly talk again?

Michael Haines  1:21:57

That would be really appreciated, Gene, after we get the feedback from your listeners, because that will be valuable for me as well, because as I said, I’m now beginning to talk to people in the political parties, and whatever views your listeners express, I’ve gotten to encounter in those broader discussions. As they say, forewarned is forearmed. So I really, really appreciate the opportunity to chat with you, Gene. And thank you.

Gene Tunny  1:22:33

Oh, pleasure. Okay. Michael Haines, thanks so much for your time. Really appreciate it.

Michael Haines  1:22:38

Thank you, Gene. All the best. Bye.

Gene Tunny  1:22:42

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 EP137 guest Michael Haines 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.