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.
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.
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
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 email@example.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.
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.
Transcript: US recession, climate change & monetary policy w/ Darren Brady Nelson – EP151
N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.
Gene Tunny 00:01
Coming up on Economics Explored
Darren Brady Nelson 00:05
like to see seemed to have sold or sold for political purposes as the head of Treasury in the US each year is a political appointee. So, that is, to some extent a political position.
Gene Tunny 00:19
Welcome to the economics explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional Economist based in Brisbane, Australia, and I’m a former Australian Treasury official.
This is episode 151 on whether the US economy is in a recession. Joining me is returning guest, Darren Brady Nelson.
Darren is Chief Economist of the Australian Think Tank Liberty Works. And he’s also an Economics Associate at the CO2 coalition in Washington DC. As well as chatting about the US economy. Darren and I discuss climate change and the review of the Reserve Bank of Australia.
In the show notes, you can find relevant links and details of how you can get in touch. Please let me know your thoughts on what either Darren or I have to say. I’d love to hear from you.
In the show notes. I’ll include links to some great commentary on whether the US actually is in a recession from two previous guests, Michael Knox and Steven Kirschner. So, make sure you check those links out.
Right on, for my conversation with Darren. Thanks to my audio engineer, Josh Crotts, for his assistants in producing this episode. I hope you enjoyed it.
Darren Brady Nelson, Chief Economist at Liberty works. Welcome back unto the program.
Darren Brady Nelson 01:35
Thank you. Good to see you. I guess it’s been a while since we last spoke about Work Capitalism, I think.
Gene Tunny 01:41
Yes, that’s right. That was a few months ago. So yes, it’s good to catch up again. This is a 151st episode, and this is your 11th appearance on the show if I’m counting correctly. So yeah, we get around to another chat every 15 episodes or so. So, it’s about time to catch up with you. So, it’s great to have you on the show again.
Darren Brady Nelson 02:06
Yeah, congratulation, because I’ve been so prolific. 151 That’s great.
Gene Tunny 02:11
Yeah, well, it’s just drip by drip, really. It’s one per week, and they mount up, yes. Thankfully, we’re out of the COVID period, although I had it recently. And I was in isolation, but we’re over all of that craziness which was dominating the conversation for a while, and now we’re getting on to other issues.
Okay, so I thought we could chat now about the US GDP figures and we had some big news last week, in Australia. You’re still on Saturday there; I think Darren, there in the states in DC. And now we’ve got two consecutive negative quarters of GDP growth. So, GDP grew at an annualized rate or didn’t grow, it fell at an annualized rate of 0.9% in the June quarter, and that followed a decline of, I think it was 1.6% in the March quarter, that’s at an annualized rate. Okay, so there’s a big debate about whether the US is in recession or not. Darren, what do you think? Is the US in a recession at the moment?
Darren Brady Nelson 03:26
Well, yeah, I would say so. I must admit, in this conversation, certainly, you’re going to be more expertise than I. You’re a guru of sort of macro-economic indicators, and all that, particularly from your treasury background, but other things you’ve done, too. So, maybe I’ll be asking you some questions, too, and hoping to get some answers. But yeah, I’m not sure; maybe you know the answer to this, but, the entire time I’ve been, first studying economics and being an economist, putting aside the debates on whether two consecutive quarters is the greatest definition or not, it seems to have been the definition for a long time. And the most interesting thing I’ve seen recently, and I guess this would have been headlines, I imagined in Australia as well, was the Biden administration going. No, no, that’s not really the technical definition of a recession.
I don’t think I recall an administration, democrat or republican ever; they may come up with excuses and say, it’s not well, it’s not our fault. It’s the previous administration and all that sort of stuff, or you know, external circumstances. But this is really the first time someone’s ever, including, some of the economists that the Biden administration has. On record, obviously, talking about in the past that yes, the recession. You know, the technical definition, if you like, is the two consecutive quarters of negative growth. So, it’s been very interesting times. Again, I guess in the 2020s, including a lot of media organizations and our favorite, sort of Neo Keynesian Economist, Krugman coming out and also defending that the Biden administration on oh, well, it’s not really a recession. So, it certainly fits the technical definition that, if you’d like I grew up with. And, that’s certainly my impression, just actually being in the US. Is it dire just yet? Yes. On the inflation front, yes. But unemployment, still is fairly low. And putting aside the fact that participation rate, that’s a little bit of a worry, but the unemployment rates not so bad at this stage. And usually, obviously, that’s, if you’d like a key secondary indicator, besides GDP itself, that people usually turn to right away, before they maybe dig into, what aspects of GDP have gone down, energy manufacturing, etc, etc.
Gene Tunny 06:02
Yeah. Okay. So, there are a few things you mentioned there, Darren,
Darren Brady Nelson 06:09
So, yes. Not a strong yes. So, yeah, I’d say yes. Technical definition? Kind of weak, yes in a kind of more judgement point of view.
Gene Tunny 06:16
Yes. So, you referred to what the White House was saying, and what Janet Yellen in the Treasury was saying. So, I might just read that out. And then we can go from there. And I can let you know what I thought about that.
So, what Janet Yellen said and this is reported by the Financial Times. “The White House has maintained that the US economy is not at present in a recession, with Treasury Secretary Janet Yellen saying earlier this week that she would be amazed if the NB declared it was okay.” So, what she’s talking about there is the National Bureau of Economic Research, which is I think it’s attached to; is it attached to Harvard or MIT or one of those East Coast universities? There’s this elite group.
Darren Brady Nelson 07:01
I think it’s independent. I mean, look, I don’t know, but I think it’s more independent than even being associated with one particular university, I think.
Gene Tunny 07:10
Yeah, I think you’re right. Yeah. But it’s an elite group of macro economists, some of the top people and you’ll have some of the leading lights of economics on it. And they will date the business cycles, they will declare whether the economy’s in recession or not. And generally, what they’re looking for is a sustained downturn that lasts several months, so more than one quarter. And they look at a broad range of indicators. So, it’s not just GDP. But that having said that, it looks like GDP is an important part of it, because it’s that comprehensive measure of economic activity.
And one thing I noticed when I was preparing for our chat, is there was a report from CNBC, where it noted that I don’t think there’s ever been a recession that the NBR has called, which didn’t have two consecutive quarters of GDP growth, if that makes sense. So, where’s the actual passage?
Darren Brady Nelson 08:21
I think that’s not correct. I think they call the recession, during the pandemic, and that wasn’t two quarters, I think. So, they do have a bit of leeway. But they tend to usually use the two quarters as part of the definition as a key component.
Gene Tunny 08:38
Okay, look, I’ll have to check that, I thought I read that earlier today. I had that somewhere here in my notes.
Okay. So, we might go back to what Janet Yellen, what she said here. She underscored the message at a press conference on Thursday, emphasizing that the economy remains resilient. Most economists and most Americans have a similar definition of recession, substantial job losses and mass layoffs, businesses shutting down, private sector activities slowing considerably, family budgets under immense strain. In some abroad-based, weakening of our economy. She said, that is not what we’re seeing now.
Okay. It seems to me that’s a pretty risky call from her because she is running the risk that the NBA does eventually define this as a recession. And that’s going to be incredibly embarrassing for the administration. So, yeah, that would be my sense of it. I think it is a big call from Janet Yellen. And it may be too early to tell. But look, there are a lot of Economists out there who seem positive about the US economy. But that said, it does appear that I mean, is it the interest rates, is it what the Federal Reserve’s been doing that’s causing issues? Is it inflation that’s hitting Consumers? What do you think are the main forces affecting the US economy at the moment, Darren?
Darren Brady Nelson 10:06
Yeah, I think, you’ve definitely touched on two key components. But just to comment on Janet Yellen. But you know, Janet Yellen was totally wrong on inflation. So, that didn’t seem to impact her credibility within her circle that she goes around with, and the people who hire her; that didn’t seem to make any difference. So, probably when she’s proven wrong on recession, which I think she already has been. Yeah, I mean, that inflation is like, one of the key things; it’s the biggest problems in the US, and obviously, even the Federal Reserve, which has been; our Federal Reserve is part of the process of creating inflation. So, they’ve gotten spooked. Biden administration itself has not, which they, at least publicly, they keep on, they don’t seem to be, they acknowledged it a bit, but they don’t really kind of acknowledge it as bad as, even though the official statistics are showing. So, you have, like, I guess we’ve talked about this many times, but, you have kind of two things going on at once, the unprecedented levels of money printing, and the credit that goes with it, which, if you’d like, from a macro point of view, is hitting the demand side. And then on the supply side, they’re doing all sorts of, the Biden administration’s policies are just hurting supply, and hurting productivity and competition.
So, that can sometimes, make up a lot for that money printing. The supply side can react to it, and really dampen what, it’s for the money to the demand side of things. So, energy is a classic one, they had a complete 180 on their energy policy. So, the US went from the number one energy producer in the world to not that anymore, and, record time, essentially?
Gene Tunny 12:08
And is that the Biden administration’s fault in your view?
Darren Brady Nelson 12:12
Well, exactly. It’s not just their fault, that is literally their policy. You know, they’re going for the green transition, if you like, come hell or hot water, right? So, which includes, not allowing oil companies to extract oil and all sorts of things. Oil, natural gas, coal, etc. And they’ve also hit agriculture with bad policies as well. You know, manufacturing; yeah, literally, if you want to destroy an economy, the Biden’s administration is basically ticking all the boxes with their policies. And, putting aside, you can argue whether that’s intentional or unintentional, but I think there’s not too many, if you like, remotely free, market friendly economists who think the Biden’s policies are particularly good.
Gene Tunny 13:10
Right, okay, I’ll have to have a closer look at some of the policies and come back to that. I just want to go back to that definition of recession; I think I might have missed or may not have communicated properly what that factoid in that CNBC report was. So, what they were saying was that, in fact, every time since 1948, the GDP has fallen for at least two straight quarters. So, they’re not saying that, there could be recessions if you don’t have this, and that’s what you were saying with the pandemic, that was, like you could call a recession, if you don’t have the two negative quarters. But what this point is, is that, in fact, every time since 1948, the GDP has fallen for at least two straight quarters. The NBER ultimately, has declared it a recession. So, you can have a recession, even if you don’t have the two quarters, but every time you’ve seen it in the data, the NBER has ultimately called it a recession. So, what Janet Yellen has done is, yeah, that’s a really big call on her part. And, I mean, Janet Yellen, someone with a distinguished academic reputation, and yep, so really, really big call and potentially, it will backfire on her. We have to wait and see about that. Yeah.
Darren Brady Nelson 14:38
Janet Yellen in not going to make, you know, like she’s she seemed to have sold or sold for political purposes. Not unusual that; it’s not like this has never been seen before. Most of her sort of, like topics when she gets into public is less focused on inflation and recessions and she’s talking about equity and diversity and inclusivity and all that sort of stuff. Well, I guess as the head of Treasury in the US, each year is a political appointee. So, I guess, that is, to some extent, a political position. Although, usually in the past, it’s been Department of Justice and Treasury have, usually been less partisan, if you like. The people regardless of whether it was democrat or republican in charge, but you know, things have changed quite a bit. Certainly, this century and certainly in the 2020s.
Gene Tunny 15:33
Yeah, exactly. Okay. So, you mentioned the supply side before, well, one thing we’ve had in Australia here is just the ongoing disruption to supply chains. And I mean, the random things just been unavailable in the supermarket’s. Quantas seems to have lost its mojo; can’t seem to run a flight on schedule any time anymore. And partly, that’s because they lost people during the pandemic. And now we’ve got people on isolation leave, like if you get COVID, you have to isolate for seven days, and that’s disruptive. Things just don’t seem to be working as they once did. Is that the same in the States? Have you noticed that in the US?
Darren Brady Nelson 16:21
Yeah. I think some extent, less. Although I understand aviation has been kind of bad here, too. But I haven’t actually been, I’m just going on to sort of news reports and talking to other people that, yeah, they’ve had, things. Well, what happened in the US probably, maybe more than Australia is a lot of pilots, either were, let go or just left because they didn’t want to get the vaccine, right? And the federal government has a bigger say in aviation than they do and other industries, for instance, particularly on employment. And so yeah, that’s all contributed, including also I understand, not just pilots, but other people in the aviation industry, various hubs, the people needed at the airports and the hubs as well, similar sort of circumstances. The supply chain disruption in general, I haven’t noticed it as much in terms of like at the grocery store, there was a period where there was a little bit of that. Not as bad, but certainly, there were issues as well, in the US, perhaps, maybe not as bad in terms of like, grocery stores and whatnot.
So, the 2020s have been very weird times. And I don’t think it’s some sort of like natural market outcomes as such. Obviously, markets wrecked, and they impact, but I think there’s just the amount of, really over the top interventions and status sort of policies in the 2020s have taken me by surprise. We’ve been prepping backwards, if you like, towards bigger and bigger government, and I think, reaping the rewards. I don’t know why people, even people who; seasoned economists, who should kind of, know better, the more the government does stuff and interferes, the worse things get. It literally, is becoming, more and more like an Atlas Shrugged world. I don’t know if you’ve read Atlas Shrugged; probably familiar with the premise anyway. It’s like that. I’m like Atlas Shrugged there, but, there were places to escape to in that world, the fictional world of as many, as you can see, in this world, when, all the governments are, have uniform sort of policies on COVID and uniform policies of not tackling inflation, and all that. And maybe it will be interesting to see if the elbow government copies the Democrat lead, which I suspect they will, if Australia gets two quarters of negative growth, they’ll go that’s not really a recession, we’ll be interesting to see if they go down that road as well.
Gene Tunny 19:12
Yeah, one thing that we’ve traditionally relied on to keep the economy growing is migration, just the addition of people and that those consumption, and so that’s starting to pick up again. Possibly, that try and redefine it. I mean, I don’t think we’re at risk of that at the moment. Although having said that consumer confidence has dropped with the higher interest rates, so people are freaking out over just the increases in interest rates we’ve seen already, because it looks like they just borrow lots of money when interest rates were really low. The Reserve Bank, Governor, I couldn’t believe it. Last year, he was saying, oh, the interest rates will; our official cash rate will stay at 0.1 until 2024. And arguably, he misled people. And so, I mean, he really has a lot of questions to answer for. And there is the Reserve Bank of Australia review, which I’ve talked about in this program. I don’t know if you’ve had a look at that at all, Darren?
Darren Brady Nelson 20:22
No, no. Give me a synopsis of what drove that. And what’s happening?
Gene Tunny 20:28
Well, the RBA has been under a lot of criticism in recent years for different reasons. There’s been one group of economists who’ve been critical of it, because they argue that they didn’t; that they had interest rates too high in the lead up to the pandemic. Now, whether that’s true or not, I think it’s debatable. But I’ve had people like Peter Tulip and Steve Kirschner on the show. I mean, they’re very good economists. I think it’s worth considering their view for sure.
Their argument is that if you’re trying to achieve the inflation target of 2 to 3%; they were arguing that because inflation was actually lower than that, you had scope to have looser monetary policy, lower interest rates, to have more employment growth. And there was some modelling that was done by Andrew Lee, who’s a Labor Party MP and a former and new professor, and Isaac Gross, who’s an economist at University of Melbourne, I think. And they showed that if the RBA had met its inflation target, if it had lower interest rates and let the economy grow faster. You could have had; I think it was like 250 to 300,000 more jobs in the economy. So, there were a group of economists criticizing the RBA from that direction. And they were saying that the RBA was too concerned about households taking on too much debt. So, they didn’t want to put interest rates lower.
I could see why the bank would be concerned about that. So, that’s why I’m not fully on board with that criticism of the bank. That said, I think it is good to review the Reserve Bank, because it is a bit of a; it’s not exactly transparent what they’re doing. So, I think there could be greater transparency. And since last year, when Phil Lowe was making those sorts of bold calls, that turned out to be wrong within months, right. It was obvious that we’re in the in the new year when we started getting those inflation numbers that the Reserve Bank would have to act. So, I think they lost a lot of credibility over that.
So, it’s important now to have this review. And they’ve appointed Caroline Wilkins from, she’s a former Deputy Governor of the Canadian Central bank. They’ve got Gordon De Brouwer, who’s a former bureaucrat, I worked for him when he was in the treasury. And he was also at a new at times. He’s good. He’s good value. And Rene Fry McKibbin, who’s a professor of Economics at ANU.
They’re going to review the board like there are issues to do with board composition, who’s on the board? There are issues to do with the inflation target; but I’m not sure they’ll do much about that. They might tweak some of the language. And then there’s issues to do with the transparency of the board’s decision making; what do they release to the public every month? So that’s essentially what the review is about and I think it’s, it’s a good thing that they’re doing that. So, yeah, that’s it. So, yeah, it’s worth definitely worth keeping an eye on.
Okay, we’ll take a short break here for a word from our sponsor.
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Gene Tunny 24:30
Now back to the show.
Darren Brady Nelson 24:33
So, are they the reviewers? Are they sort of, left or center, for the most part, like a Keynesian and MMT and, something else or what? What’s the story there?
Gene Tunny 24:47
I’d say the typical mainstream macro economists. So, however you’d like to characterize that, they’re definitely not MMT. If you had to give them a label, maybe you give them a new Keynesian label, possibly. But yeah, they’re not I don’t think they’re radical in any particular direction. They’re nonpolitical appointees, which is a good thing. One of the big questions and something that I think the Prime Minister, Anthony Albanese, Albo, as we call him, one thing he will be, he’ll be getting pressured to put a trade union representative on the board. So, they’ve had one in the past, I think Bob Hawke, our former Prime Minister was on the board in the 70s, when he was the head of the ACTU.
And then we’ve had various other ACTU secretaries on the Reserve Bank Board. There are some people pushing for a regional rep., but, one thing that Peter Tulip, who’s Chief Economist at Centre for Independent Studies has been pushing for is, he said that the problem is, we don’t have enough people who know about inflation and monetary policy on the board. And so, we need more of those people. We need more, it’d be better to have more economic experts or economists on the board.
Darren Brady Nelson 26:05
Yeah. And maybe, also further, how about a variety of use, and not just the one kind of, you say, mainstream, and but that’s still a worldview, it’s still a way of looking at things. And it’s not the only way of looking at things. The combination of, essentially New Keynesians, for the most part, with maybe a little, like 80-20 Keynesian monetarist; that’s maybe what, most mainstream sort of, macro folks, that’s kind of what they’ve learned and whatnot, be good to have somebody else. Have an Austrian point of view, have maybe a full on monetarist point of view, whatever; just something that’s not just the one point of view, , so it’s not just Tweedledee and Tweedledum, every time either on the board or this review.
I’m not saying these people aren’t smart, or anything like that; the three people you mentioned, but I suspect there’s not going to be a whole lot of push and shove between the three.
Gene Tunny 27:04
So, I think the review in a way, presumes that there won’t be radical changes. The Reserve bank is going to continue as an institution, we’re still going to have Fiat money. Is that the sort of thing that you think should be up for review, that we should be looking at something more fundamental?
Darren Brady Nelson 27:25
Well, at least you have one person on there who can be the dissenting voice to say, something like that, but I’m saying, even if it was, say, one Keynesian, one monetarist, and one Austrian, I think you might get a pretty decent review out of that, with the monetarist if you like, in between the two, to some extent.
So, you still have 2 – 1, want to keep a central bank going, but we just, good to kind of be realistic about, what a Central bank does and what inflation is, what monetary policy is, all that sort of stuff. That’s fine, if the board, I’m not saying, the board should be all full of economists, even if it was a mix of those types of economists, I think it’s fine to have some other, you know, depending on how big the board is, you know, there would be room, I guess, for a union and a business representatives and maybe some other stuff as well, that’s fine.
And then they should also review, also the goals of the Reserve Bank; what’s legislation. There’s a lot of stuff in there besides inflation, maybe, just to look at it, and kind of whether all that needs to be in there, or whether there’s should be a better balance, or you should prioritize and go, inflation is number one, and then something, that type of thing. It’d be great.
A lot of these reviews aren’t all that genuine, they already have a political goal. I mean, you say they’re not political, but it always is, you know, to some extent, they’re under certainly under pressure anyway, regardless of who they stick in there to review things. Now, in the past, some of these reviews have been a lot less political than others, there’s always a political element, like the competition policy review wasn’t particularly political, but there’s always a little bit of an aspect to it, of course, I’d be surprised if they’re not under, some fairly great political pressure to start going beyond and started looking at, kind of cultural war type stuff, too, that they want to ingrain, sort of, race and gender and all that other stuff. I’ll be I’ll be pleasantly surprised as if that isn’t going to be a part of the review.
Gene Tunny 29:37
So, as far as I’m aware, race and gender won’t be at this stage, I don’t think. But one thing that possibly will be, now whether there’s a culture war issue or not, I don’t know. I think I’m not sure it’s, I guess there are aspects of it that are part of the cultural war but the debate about the climate. So, Warwick McKibbin, who is he’s a Professor of Economics at ANU, and he’s actually the husband of one of the reviewers. But you know, she’s independent of; she’s her own person… Renee Fry McKibbin; she’s Warwick’s wife.
Darren Brady Nelson 30:22
Actually, by definition, at least the old school definition marriages, you’re not, you’re one flesh. But anyway, I understand what you’re trying to say.
Gene Tunny 30:29
Okay, yes. So, I don’t think she’ll necessarily go along with Warwick’s view. But Warwick was at the conference of Economists in Hobart two weeks ago, where I caught COVID. And, it was a good conference other than that, it was a great conference.
Darren Brady Nelson 30:46
And super spreader of it.
Gene Tunny 30:49
Yeah, that’s right. And Warwick was on the panel. And now we’re talking about the Reserve Bank review. And one of the points he made is that we may have to amend actually, I think he’s saying we will have to amend our inflation targeting settings or our goals or objectives. We’ll have to amend that to incorporate climate change, because we have to recognize that if we’re going to be responding to climate change, we’re going to introduce a carbon price and one that increases over time. So, that’s what you need to have that sort of lowest cost adjustment path. So, to minimize the cost of adjusting to climate change, you’ll need to have a carbon price that increases and so that’s going to be increasing prices. So, you’ll need to look through the inflation, you’ll have to ignore the inflation that comes from the carbon price. So, I think culture war issues won’t come into it. But I think the climate change will come into the RBA review.
Darren Brady Nelson 32:01
Okay, well, that’s good to know. It’s terrible news. But it’s not surprising though.
Gene Tunny 32:06
But doesn’t it make sense what Warwick is saying? I mean, if a government does introduce a carbon price, and you’re going to have increasing prices because of that, then that’s not really inflation that the Central bank should be concerned about. What do you think of that perspective?
Darren Brady Nelson 32:25
It still should be concerned about it, even if, you know; this is all about thinking about the costs and benefits. It sounds like, just assuming, okay, well look, we’re just not going to worry about the downside of our carbon tax and our climate policies, because it’s such a, unquestionable good to pursue this. That’s ideology, that’s not economics, that’s really bad economics. And it’s also bad constitutional law, like, to what enshrine you know, certainly a very long-standing fad, of the climate sort of industry. But, the concept of inflation is something that stands the test of time. You can disagree on various aspects of it, but it’s always going to be, to the extent you’re going to have monetary policy, inflation is going to be an important thing to be thinking about, right. Climate change, may not be.
I’ve been following this debate since the mid-90s. And, I can tell you; well, just look at the polling, I can’t speak for Australia, but in the US, it’s something along the lines of; it’s well outside the top 10 of topics that people are concerned about in the US, for instance, then you want to start because, elites like him, are in a position to influence these things. They want to shove in the things that they care most about. And I think it’s just atrocious to think you can stick that into the Reserve Bank act. I assure you another government can come along and potentially change that if they want, if the electorate says, alright, you’ve been trying to convince us that the end of the world has been coming for 30 years, it hasn’t arrived, we no longer trust you. Sure, that might happen. And then, government could change things, but you know, so it’s a bit hard to change stuff in legislation, a lot of damage can be done in the meantime.
Gene Tunny 34:20
Okay. So, on where is where they’d make the change? It probably wouldn’t be in the act, they would have it in the agreement between the treasurer and the Reserve Bank. If I remember correctly, I think the general view on the Reserve Bank act from the late 50s was that, look, some of the language is a bit outdated. But you know, maybe leave that alone, you can do all you need you want to do within the agreement between the treasurer and the Reserve Bank. So, I think that’s where they would adopt something like that.
Just on that Reserve Bank Act, I think what they talk about in that is that the Reserve Bank is supposed to set monetary policy to have a stable currency to achieve full employment and to promote the prosperity of Australians or something. Something broad like that. Yeah. So, they’ll probably leave that and they’ll do whatever they want to do with if they did want to put some wording in about climate change, it’ll probably be very vague, because it is all very vague. We don’t really, I mean, I’ve got no idea what’s going to happen here in Australia. Politically, it’s, it’s such a vexed issue. And you’re saying is not in the top 10 issues in the US, it’s certainly in the top 10. It’s top five; top 3 here in Australia.
I mean, the previous government lost Blue Ribbon seats, seats that it’s held for decades, seats in affluent areas of Sydney and Melbourne. And it lost them because of climate change, because people in those seats are extremely concerned about it.
Darren Brady Nelson 36:07
Yeah, there’s a different point of view. Certainly, they did, but I wouldn’t extrapolate to say that means Australia as a whole has the same views as these inner-city suburbs, they’ve just changed the demographics and the ideological viewpoints of these people. That’s why they lost. Just like we’ve seen around the world, it’s the rich and upper-class professionals who gravitate towards status policies and status causes, like climate change. The working class, and in the middle, and lower middle classes do not. And electoral politics, isn’t just a straight representation of what the entire nation views necessarily. And putting aside the fact that the polling is often biased and bad and misleading and all that sort of stuff, but that decide.
I’ve seen some other people who; intelligent Australian commentators, James Allen, and people like that. We’ve been having a bit of look at that, to see whether, that mainstream narrative is actually true. They certainly lost obviously, those seats, they were blue ribbon, but they’ve been changing and moving left for a while now. So, particularly in the US, how climate change is almost really a non-issue from a broad electorate point of view, not any specific electorates.
Yet, that doesn’t stop the policies from carrying on and then you have all these perverse outcomes of like, I imagined Albanese will get more copy a lot of what the Biden administration so, the push for electric vehicles. Well, electric vehicles are still being produced by coal and natural gas, you know. So, you’re really in many ways, you actually might even be increasing carbon dioxide emissions through transitioning to electric vehicles from petrol vehicles. And the fact is, most of the world is actually increasing the use of coal, mostly India, China, Brazil, etc. And there’s even been a coal like I said, there’s been a coal comeback, even in Western countries as electric vehicle usage gets ramped up. So, these people don’t go, oh, no, we; the same people who say there’s an existential problem, keep on producing, keep on pushing electric vehicles, for instance. So, that their actions speak louder than their words that it isn’t really an existential crisis. Putting aside the fact obviously, all these elites tend to keep on buying beach side homes and all these sorts of stuff. I think just look at their actions, speak much louder than their words.
So, we’re getting this system where we get a worse electrical system because they keep on showing throwing more and more unreliable and expensive renewable energies on top of it, yet, they’re not actually starting to take much of the load of electricity production, they’re just sitting there costing more money and hurting the rest of the system. Yet, we’re still relying, and we’re going to keep on relying on coal and natural gas and the only renewable energy we’re going to lie and it’s going to be, water – hydro. Putting aside the fact you know, allow many new hydro to be built, but it’s bloody reliable. In the US, if it wasn’t for Quebec, all the hipsters in New York would be having more blackouts because they’re running on water; hydro from Quebec coming down into the US.
Gene Tunny 39:55
Where is that is that near Niagara Falls, or is it is that up in that Region.,
Darren Brady Nelson 40:00
Yeah. Quebec is like, the king of hydro in that part of the world, not just for Canada. In fact, Quebec is mainly supplying electricity to the US, part of the population that’s bigger. And that sort of the northeast of the US. So, that’s kind of insulating on, they can shove on some more solar panels and wind, but that’s not really generating a lot of electricity. And we also have the perverse effect from the main thing that, besides all the kind of pollutants, actually the toxic sort of, chemicals, and all the stuff that it’s needed for electric vehicles, needed for solar panels, needed for wind turbines, which obviously have detrimental environmental effects. They need coal, natural gas, and hydro to make those things in the first place. Not just to be the ones that really, supplemented when the wind’s up blowing, and the sun’s not shining. But if it wasn’t for all the fossil fuels, it couldn’t even build this stuff in the first place. So, all you’re doing is shoving all this stuff, people making a lot of money. A lot of people are virtue signaling, sort of, they keep on crying wolf for what, like 30 years now. There’s, nothing; there’s no significant evidence that we have a problem.
Gene Tunny 41:15
Well, I’ll push back and say we just had a 40-degree Celsius day in England that they’ve never had in their whole history.
Darren Brady Nelson 41:23
That’s not true. You go back, and we look at the Paleo challenge. You look at the evidence. For instance, in the US, this damn out in the Colorado River is having; it’s because of climate changes is at its lowest level, lo behold, a study, two weeks prior to them making such statements show that they’ve had more levels on the Colorado River 2000 years ago.
We’ve had warmer periods, we’ve had more carbon dioxide in the atmosphere in times. No, none of this is accurate. It’s all cherry picked to scare the poop out of people to accept these policies they want anyway. And you watch it when we’re old men, we’re going to be the people will go yeah, we’ll look okay, this thing didn’t happen. But I think it was the right thing to do anyway.
You hear that a lot, even now. They go like it will even for wrong, it’s the right thing to do. How’s it the right thing to do to make people poor? And have people in Africa starve? How’s that the right thing to do?
Gene Tunny 42:22
Okay, so in a future episode, we’ll have to come back to this, Darren, and we’ll see where we are with the with the data.
Darren Brady Nelson 42:28
You want to see the green policies and action? Look at Sri Lanka.
Gene Tunny 42:31
Yeah. Look, I’m not advocating for these policies, necessarily. Yeah. But I do recognize;
Darren Brady Nelson 42:42
That’s not about you, that’s just kind of aim at whoever’s watching this. It’s like, you want to see the future? The potential future? That’s Sri Lanka. That’s the way Australia could look, if they’re not careful.
Gene Tunny 42:55
And what did they do? They actually required organic produce, did they? Did they ban the importation of some fertilizers or something?
Darren Brady Nelson 43:07
Yes, fertilizers. Fertilizer was the main thing using green organic things instead of actual fertilizer. This is what’s happened in countries like Sri Lanka and African countries is to get their aid money. They do the green agenda, essentially. And it’s just a disaster.
I’ll tell you the countries that won’t be, it won’t be China, it won’t be India; the bigger countries that don’t need the foreign aid. And there’s also strategic implications, obviously. Who controls the green energy market, ultimately? China – communist China.
Gene Tunny 43:51
They are producers of a lot of the solar panels. That’s correct. Yeah.
Darren Brady Nelson 43:54
They are almost a monopoly on this, and increasingly, all the support technology for it as well. So, in China, this is not a coincidence. It’s not like, oh, the market chose China, they were just the best people to do it. This is like, this is a plan. It’s a strategy by the Chinese government, and you can see it’s written down. There are books written on this by them to say, oh, this is what we’re going to be trying to do. That basically, it’s their mind calm. So, don’t be surprised, when some of this stuff comes true.
They have a plan that the Chinese economy is not a free market economy by any stretch of the imagination. You know, it’s a government controlled run for the purposes of, for the benefit of the Communist Party and the strategic interests of China. It’s not like you’re dealing with the Netherlands, that sort of thing. So, that’s also a huge thing. Because they’re an aggressive military power.
When the time’s right, they’re going to take action. Taiwan and whoever else, eventually over time gets in their way. So, to aid and abet this through these green policies that are aimed at a problem that doesn’t really exist or certainly not in the scale. And certainly, even if the problem doesn’t exist, too deep, to essentially decarbonize the economy is just like literally the worst solution for it. And to decarbonize it in a way that, benefits China immensely. These’re just terrible policies the whole way through and people hopefully one day will be held accountable for this.
Gene Tunny 45:46
Right, okay. We might go back to GDP just before we wrap up, and yeah, I think I agree. There’s a big debate to be had about those policies for sure. I mean, from Australia’s perspective, given that we’re such a small part of the world, doesn’t make sense for us at this stage to adopt those policies on a large scale. My view is we should try to cooperate internationally. But we need to ensure that other countries are following through with their commitments. And I’m not sure that that has always been the case, or it is the case. So, that my perspective on that.
On GDP, I guess the view is that; my sort of thought is that, Janet Yellen certainly went too far. The US possibly could be in a recession, despite the fact that jobs growth has been strong, despite the fact that you’ve got unemployment at 3.6%, you could be going into; you could be in a downturn. The GDP figures, if you look at the composition of them, you had inventories falling, that was a big part of it. So, businesses were selling goods, but they weren’t replacing their inventories. So, that could be a signal that they’re not expecting; they’re worried about the future, about future sales. We had a drop in residential construction. That was one and that’s probably driven by the increase in interest rates. At the same time consumption spending was up. So, that’s why the summer economists are thinking it’s a bit of a mixed report. And we’re not entirely sure, but my take on it would be the GDP numbers are definitely something be concerned about and Yellen probably went too far when she said, we’re not in a recession. I think that certainly could come back and bite her.
Darren, do you have any final thoughts on the GDP numbers? Or where the US economy is that?
Darren Brady Nelson 47:55
Pretty much agree with what you just said. And obviously, time is going to tell. I think the bad ministration policies are very bad. And that’s going to come home to roost. So, I think, it’s not going to be good times, economically for the US and if it’s not good times, economically, for the US, it’s not worth it. China is obviously a major player, but it’s not the engine of growth for the world just yet. The US still pretty much is. When the US sneezes, everybody catches a cold.
Gene Tunny 48:39
Yeah, that’s right. I remember that. That was a popular saying in Australia, at the Reserve Bank and Treasury. So, yeah, absolutely.
Okay. Darren Brady Nelson. Thanks so much for your time. It’s great to catch up, yes. And I look forward to chatting with you again in the future.
Darren Brady Nelson 48:58
Always great to be on your show and see you, Gene, thank you.
Gene Tunny 49:02
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 firstname.lastname@example.org and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.
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.
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.
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 email@example.com And we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.
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.
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.
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?
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?
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.
So, inflation was below 2%?
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.
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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 firstname.lastname@example.org and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.
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.
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.
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.
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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 email@example.com And we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.
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.
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).
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.
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
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.
Female speaker 30:10
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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 firstname.lastname@example.org and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.
Big thanks to EP137 guest Michael Haines and to the show’s audio engineer Josh Crotts for his assistance in producing the episode.
Market monetarists such as Stephen Kirchner argue nominal GDP targeting would be better than inflation targeting and could help central banks such as the RBA and the US Federal Reserve get back on track. Stephen is Director of the International Economy Program at the United States Studies Centre at the University of Sydney.
Stephen spoke about nominal GDP targeting with Economics Explored host Gene Tunny in episode 135 of the show, recorded in April 2022. Among other details of nominal GDP targeting, Stephen discussed the potential role of a nominal GDP futures market and for blockchain and Ethereum in such a market and in financial markets more broadly. You can listen to the conversation using the embedded player below or via Google Podcasts, Apple Podcasts, Spotify, and Stitcher, among other podcast apps.
About this episode’s guest – Dr Stephen Kirchner
Dr Stephen Kirchner is Director of the International Economy Program at the United States Studies Centre at the University of Sydney. He is also a senior fellow at the Fraser Institute in Canada, where he has contributed to research projects comparing public policies in Australia, Canada and New Zealand.
Previously, he was an economist with the Australian Financial Markets Association, where he worked on public policy issues relating to the efficient and effective functioning of Australian financial markets and Australia’s position as a regional and international financial centre.
Stephen has been a research fellow at the Centre for Independent Studies, a senior lecturer in economics at the University of Technology Sydney Business School and an economist with Standard & Poor’s Institutional Market Services based in both Sydney and Singapore. He has also worked as an advisor to members of the Australian House of Representatives and Senate.
He has published in leading academic and think-tank journals, including Public Choice, The Australian Economic Review, Australian Journal of Political Science and The Cato Journal.
His op-eds have appeared in publications including The Wall Street Journal, Straits Times, Businessweek, The Australian Financial Review, The Australian, and Sydney Morning Herald.
Stephen holds a BA (Hons) from the Australian National University, where he was awarded the L. F. Crisp Prize for Political Science, a Master of Economics (Hons) from Macquarie University, and a PhD in Economics from the University of New South Wales.
Transcript of EP135: Nominal GDP targeting w/ Stephen Kirchner
N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.
Gene Tunny 00:01
Coming up on Economics Explored.
Stephen Kirchner 00:04
If you want to avoid, you know hitting the zero lower bound or expanding your balance sheet by a significant amount, the way to do that is to respond quickly and aggressively upfront. If you don’t do that, then you fall behind the curve and then monetary policy has to work a lot harder to stabilise the economy.
Gene Tunny 00:23
Welcome to the Economics Explored podcast, a frank and fearless exploration of the important economic issues. I’m your host, Gene Tunny. I’m a professional economist based in Brisbane, Australia and I’m a former Australian Treasury official. This is Episode 135 on nominal GDP targeting. My guest this episode is Dr. Stephen Kirchner, who is Director of the International Economy Programme at the United States Studies Centre at the University of Sydney in Australia. In this episode, Stephen tells us why nominal GDP targeting would be better than inflation targeting and how central banks such as the Reserve Bank of Australia and the US Federal Reserve can get back on track. Please check out the show notes for relevant links and for details of how you can get in touch with any comments or suggestions. I’d love to hear from you. Righto, now for my conversation with Dr. Steven Kirschner on nominal GDP targeting. Thanks to my audio engineer Josh Crotts for his assistance in producing this episode. I hope you enjoy it. Dr. Steven Kirchner of the US Studies Centre. Welcome to the programme.
Stephen Kirchner 01:36
Thanks for having me, Gene.
Gene Tunny 01:37
It’s a pleasure, Stephen, keen to chat with you about a paper you wrote last year on Reforming Australian Monetary Policy: How Nominal Income Targeting Can Help Get the Reserve Bank Back on Track. So there’s a lot to talk about here. And I think this is of general interest to people in other countries, as well, other than Australia, because this idea of nominal income targeting, it’s been raised in other countries, I know that you’ve appeared on David Beckworth’s podcast, Macro Musings, and I know that David Beckworth is a proponent of this in the United States. So I’d like to ask about, essentially, what is this nominal income targeting compared with how we normally, or how central banks have been running monetary policy? Would you be able to give us an overview of that, please?
Stephen Kirchner 02:38
Sure. I think nominal income targeting is actually not a huge change from where we are at the moment. So most central banks do what they call inflation targeting. And as part of an inflation targeting regime, they’re typically adjusting their monetary policy instrument, usually an official interest rate in response to deviations in inflation from target. But also responding to deviations in output from its full employment, or potential level. And the reason you have output as part of your reaction function is the output gap is predictive of future inflation outcomes. So if you’re running an inflation targeting regime, you want to respond to both deviations inflation from target, and output from potential.
Well, if you think about those two things, inflation on the one hand, and output on the other, if you put those two things together, then you’ve got nominal income, or nominal GDP. So in some respects, nominal GDP targeting or nominal income targeting is just a really weighting of that standard central bank reaction function. So if you think about a Taylor rule, which is just an empirical description of how the interest rate responds to deviations and inflation from target, and output from potential, all nominal GDP targeting is doing is saying you want to put inflation output together and weight them equally in terms of the interest rate response.
Gene Tunny 04:14
Ah, right. Okay. Yeah, that’s a good way of describing it. Yeah, please go on.
Stephen Kirchner 04:18
Yeah, so in that sense, it’s not a huge leap from where we are at the moment. But what it does mean is that the central bank is a bit more agnostic about its response to inflation, and deviations in output from potential. So it’s saying really we want to stabilise both, and the reason you want to stabilise both is if you’re just focusing on inflation, one of the problems you face is not all of the deviations in inflation from target are reflective of aggregate demand shocks. As we know, especially at the moment inflation can deviate from target due to supply shocks. Supply shocks have the effect of lowering output. And so this creates a dilemma for a central bank in how do you respond to a supply-driven inflation shock, or deviation from target. Because if you respond to the deviation in inflation from target and raise interest rates, then that’s going to compound the reduction in output you’d get from a supply shock.
Gene Tunny 05:28
Right. So one example, I’m just thinking, Stephen, is one example of this, did this occur, arguably a policy mistake? Was it 2008 when the European Central Bank put up its policy rate? Not long before the financial crisis? Because there was a supply shock? Or was there an increase in the price of oil? I’m trying to remember, is that one of the examples I give?
Stephen Kirchner 05:55
Well, I think the canonical example here is what happened in the 1970s, when you had very significant increases in oil prices giving rise to higher rates of inflation. And central banks did respond to those oil price shocks through tighter monetary policy. And so there’s an influential paper by Ben Bernanke, Watson and Gertler in 1997, which showed that the propagation of the oil price shock to the US economy was essentially through the monetary policy reaction. And so it was the central bank that actually put the stag into stagflation.
Another example of this would be if you go to September 2008, the FOMC meeting took place a couple of days after the failure of Lehman Brothers. And this was at a time when inflation expectations were collapsing and nominal GDP expectations were collapsing. At that meeting, the FOMC incredibly left the Fed funds rate unchanged, and cited inflation pressures arising from higher oil prices as the reason for keeping monetary policy steady. So this is a very good example of monetary policy being led astray by inflation outcomes that are being driven by supply shocks rather than aggregate demand shocks.
And so what we want is the central bank to respond to inflation pressures to the extent that they’re reflective of aggregate demand shocks, not aggregate supply shocks. And nominal GDP lets you do that without actually having to take a view on what’s driving inflation. So nominal GDP outcomes will tell you the extent to which your inflation issues are being driven by aggregate demand rather than aggregate supply.
Gene Tunny 07:51
Okay, so yeah, a few things to try and explore here. Stephen, inflation targeting. So it’s typically going for something around well, in Australia, it’s 2 to 3%, we’ve got a target band for inflation. And in the US, is it 2%? Or I remember thinking of Bank of England? But the different countries have just slightly different targets.
And what’s fascinating is that when these things were first formulated, we had much higher inflation. And I think no one ever expected we’d be getting consistently, we’d inflation outcomes consistently lower than those targets. And it makes it difficult to think about what’s the appropriate monetary policy response.
I better make sure I understand your argument about why you think the Reserve Bank needs to get back on track. Are you suggesting that the fact that Australia is similar to some other advanced economies, who’ve had inflation outcomes below the target for a substantial amount of time, that would imply that the Reserve Bank, the central bank had scope to expand to have a more expansionary monetary policy which could have pushed the economy closer to full employment? Is that the argument, broadly?
Stephen Kirchner 09:14
Yeah, that’s certainly true of the sort of pre-pandemic period basically, the period in which the RBA was undershooting from approximately 2014 through to the onset of the pandemic and even into the pandemic. So it’s certainly in the last couple of quarters that inflation has returned to target. I mean, I think the specification of the inflation target inevitably is a little bit arbitrary. What matters most is not the exact target range, but the fact that you hit that target more often than not over time and thereby establish your credibility in relation to that target. So ultimately, what you’re trying to do is condition the expectations of price, and wage setters in the economy should be consistent with that target. And so whether it’s a 2% target or 2 to 3% target, it’s less important than the fact that you have one and that you actually stick to it.
But the case for nominal income targeting is to say if you’re only targeting inflation, and this creates a bit of a presentational problem and a sort of implementation problem, which is that what happens in the context of a supply shock when inflation might be above target? How do you explain to people the fact that you’re not hitting your target, even though there’s probably a very good reason why you’d want to look through that supply shock.
If you’re expressing your monetary policy target in terms of nominal GDP, that task becomes a lot simpler, because yes, you may be above target on inflation, but in the context of a supply shock, output is going to be lower. And so you don’t get the same sort of deviation from target under a nominal GDP targeting regime than you would under an inflation targeting regime. Policymakers are less likely to be led astray, because by focusing on nominal GDP, they don’t have this issue of trying to figure out whether inflation outcomes reflect demand shocks or supply shocks.
Gene Tunny 11:23
Okay, so how would this work in practice? So in nominal terms, so by nominal, you’re talking about, we’re not talking about a real GDP measure where we adjust for inflation, we try and get things in consistent dollars, you’re just talking about the total value of the economy, in GDP in nominal terms, so what it is in current dollars, and say that it’s over $2 trillion in Australia annually. And so would the Reserve Bank have a target? They would have an expectation of what that nominal income for Australia should be in 2022, what it should be in 2023. So it should be 2.3 billion by this date or something? Is that Is that how it’s formulated? A trillion I meant, not billion. Sorry,
Stephen Kirchner 12:16
You can’t express it in level terms. So with a nominal GDP target, you can express it both as a growth rate or an implied path for nominal GDP. But I think it’s important to emphasise that, just as with inflation targeting, you don’t target inflation outcomes, necessarily. What you’re targeting is actually the inflation forecast. So what you’re saying is, in future, you’re going to be realising inflation outcomes consistent with target, or with nominal GDP targeting, it’s exactly the same thing. So you want to specify a target path for the future evolution of novel income or novel output. And you want to adjust your monetary policy instruments to be consistent with that target path.
So if in any given quarter, your level of nominal GDP is a little bit above or a little bit below the target path, that’s not necessarily a problem. Again, what you’re trying to do is conditions people’s expectations in relation to what future nominal income will be. And I think that has very useful properties from the point of view of stabilising the economy, because if you think about things like wage and price contracting in the economy, people borrowing and lending, all those activities are conditional on expectations for future normal income. And so if you can stabilise both expectations for that future nominal income path, and by implication, also nominal GDP outcomes, then I think that’s a recipe for macroeconomic stability, more so than if you’re targeting inflation without regard to whether inflation is being driven by demand or supply shocks.
Gene Tunny 14:13
Right. Okay. Might go back to that Taylor rule. So you mentioned the Taylor rule. And you mentioned you can actually think of nominal GDP targeting in a, you call it a reaction function, so how the central bank reacts to the macroeconomic variables. And you said this gives equal weight to deviations of inflation from the target end of real GDP from the target. What does the Taylor rule typically do? Do ou know, what sort of normal parameters there are in that reaction function and what that means?
Stephen Kirchner 14:53
So the Taylor rule was due to John Taylor, who in the early 1990s sat down and said, well empirically, how do we characterise movements in the Fed funds rate. So he regressed the Fed funds rate on various macroeconomic variables. And the empirical description that he came up with for the Feds reaction function was to say, well, the Fed responds to deviations in inflation from target, and had estimated a weight of about 1.5 on that deviation, and also response to deviations and output from potential. And he estimated a weight of .5 on that.
But to sort of round out that empirical description of the Fed funds rate, you also needed an estimate of what the neutral Fed funds rate would be. So in other words, what happens when inflation is a target and output is a potential? What is the Fed funds rate consistent with that? And so that just ends up being a constant regression.
One of the big issues that sort of comes out of that is that’s obviously a historical estimate. What happens if your equilibrium real interest rate changes over time. So you then have the issue of, if you’re responding based on those historical relationships, but the actual equilibrium interest rate changes, and you may end up with monetary policy being miscalibrated. And I think that arguably happens in the United States, and to a certain extent here in recent years, where I think the equilibrium real rate probably fell considerably. And that meant that monetary policy ended up being tighter than central banks intended.
Gene Tunny 16:53
Okay, we might come back to that, I just want to go back to the Taylor rule that you mentioned 1.5. So that means for every percentage point that inflation would be above the target, so if the target’s 2%, and inflation is 3%, the central bank would put up the policy interest rate, the overnight cash rate or the federal funds rate by 1.5 percentage points. And the idea is there that you’re trying to engineer an increase in the real interest rate. So you want to make sure the interest rate increases more than the inflation component of it. Actually, yeah,
Stephen Kirchner 17:41
Yeah, that’s right. So this thing actually has a name, it’s called the Taylor principle. And the Taylor principle says that you want to move your nominal interest rate by more than one for one with the deviation inflation from target, because if you just do a one for one or a less than one point move, then you’re not going to move the real rate, you’re not going to move it in the desired direction. So it has to be a move that is more than the change in inflation. So that’s why you get a parameter estimate of a little bit more than one.
For some central banks, you get higher responses to inflation. So the BOJ, Bank of Japan, the ECB, depending on what sort of model that you look at, sometimes their reactions will be up around two. But yeah, the basic Taylor principle is that you want a response to inflation that is greater than one. But essentially, nominal GDP targeting says that you want to combine inflation and output in the form of nominal GDP, and you want to respond to that.
Gene Tunny 18:46
So I guess one of the points that you make, and I think it is a good point, that to do this Taylor rule properly, you need estimates of these unobservable variables, such as this equilibrium real interest rate. And as you rightly point out, I mean, this is something that… Interest rates are much lower now than we ever expected. You compare historically, it’s quite extraordinary what we’ve seen since the financial crisis in Australia, and the US and UK, and even before then in Japan, since the ‘90s. Absolutely extraordinary.
So I want to make sure I understand the logic again. You mentioned that this means that monetary policy was not as aggressive or as accommodative, or however you describe it, because the equilibrium real interest rate, whatever that is, whether it’s… Say it was 4% and now it’s much lower than that. How does that logically work, Stephen? Can you take us through that logic? I just want to make sure I understand how it would lead a central bank to go astray.
Stephen Kirchner 20:00
Actually, the problem is a bit broader than that. So there are potentially three unobservable variables it would impact. Taylor rule style reaction function, and potentially monetary policy Australia. So one is the real equilibrium interest rate, as we’ve discussed. It’s not directly observable. And it could be higher or lower than we think. But I would say it’s probably been lower than policymakers have thought. In terms of the output gap, then you have the problem that we don’t directly observe potential output either. And so that could be higher or lower than we think. And so policy can be miscalibrated on that basis.
An alternative way of thinking about the output gap is to think in terms of an unemployment gap. So the deviation in unemployment from its full employment level, and this is of course where we get the NAIRU from. So the idea that there’s an unemployment rate that’s consistent with the stable interest rate. And both the Federal Reserve and the RBA have conceded in recent years that the NAIRU has actually been a lot lower than they realised. So they have downwardly revised their estimates of the NAIRU.
And so for much of the post financial crisis period, I think both the Fed and to a lesser extent, the RBA were conditioning monetary policy on a view that the unemployment rate was pretty close to the NAIRU, when in fact, it was probably sitting quite a bit above the NAIRU. And so what that meant was we had monetary policy that was two tight. They could have actually pushed the unemployment rates lower. And done it in a way that would have meant that inflation was more consistent with target as well.
So you can see that the problem with a sort of Taylor rule type approach is that embedded in the Taylor rule, you’ve got at least two unobserved variables. You’re trying to estimate what those unobservable variables are and condition policy on it. So what nominal income targeting says is well, in fact, you don’t need to take a view on either the equilibrium real rate or the NAIRU or potential output, because nominal GDP in and of itself is a complete description of the stance of monetary policy. And in the long run, nominal GDP is fully determined by the central bank. So the central bank can both influence the long run level of nominal GDP, and the level of nominal GDP tells you whether monetary policy is too easy or too tight at any given time.
You don’t need to do what’s sometimes called navigating by the stars, which is, in macroeconomics, when you write this stuff down in the form of equations, the equilibrium values, the real interest rate, the NAIRU and potential output, those variables denoted with an asterisk or a star. And so we were first and policy that sort of conditions on those variables as navigating the stars. This is what leads monetary policy astray. It’s the problem that nominal GDP targeting seeks to address
Gene Tunny 23:24
Okay, so by NAIRU, N-A-I-R-U, which stands for non-accelerating inflation rate of unemployment, such a horrible expression. We use it all the time. Okay, we’ll take a short break here for a word from our sponsor.
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Gene Tunny 24:14
Now back to the show. So how’s this gonna work in practice, Stephen? I’m wondering, and does that mean the main thing the central bank is looking at it in their deliberations, so the board meeting of the Reserve Bank or at the Federal Open Markets Committee, or the Monetary Policy Committee, in the UK, or in the FOMC and in the US, they’re just looking at what the latest data are telling them about GDP, about nominal GDP? They’re trying to forecast that themselves based on a range of indicators, I suppose. Have you thought about how it’s going to work in practice?
Stephen Kirchner 24:55
I think central banks should basically look at all the information that’s available to them in forming a view. So the question is more in terms of what their target is and how they specify that target. And, importantly, also how they describe their policy actions in relation to that target. And so, the purposes of adopting a nominal GDP target, one way to do that is to specify a target path for the future evolution of nominal GDP. So you can do that out a few years in advance. And you would then explain your changes in your operating instrument in terms of an attempt to hit that target path.
So for Australia, for example, it would be a simple matter of rewriting the agreement with the treasurer, what we call a statement on monetary policy, which basically sets out what the RBA is trying to achieve through its conduct of monetary policy. And you would specify that in terms of a path, the future path for nominal GDP.
One of the things I do in my paper for the Mercatus Centre is to estimate an implicit forward-looking nominal GDP targeting rule for the Reserve Bank. So I basically do for the RBA, what John Taylor did for the fed back in the early 1990s, and say, How would an empirical description is nominal GDP targeting of how the RBA has actually changed the cash rate in the past?
And as it turns out, it’s actually not a bad empirical model of what they’ve been doing historically, because even if you’re thinking of monetary policy material type framework, you know, you’re still trying to stabilise nominal GDP. You’re just putting different weights on those two components of inflation output. But if you think of monetary policy as just responding to the nominal GDP, well, to some extent, the RBA is already doing that. Where I think nominal GDP targeting is helpful is, at the margin, I think it would lead to better monetary policy decisions, for the reasons that we’ve already talked about that. At the margin, they would be focusing more squarely on nominal demand shocks and looking through supply shocks, which I think is where monetary policy has run off track in the past.
Gene Tunny 27:34
Okay, so I want to ask about the RBA. So you want to get the RBA back on track. And one of the areas or one way you think that it’s off track is that over the last decade or so, or maybe over the last five years, or maybe a bit longer than that, it’s paid too much attention. Am I getting this right? You think it’s paid too much attention to financial stability risks, and this is called leaning against the wind? I think it’s denied that it actually does lean against the wind. Is this one of your criticisms of it, Stephen? And if so, what’s wrong with taking financial stability risks into account when setting monetary policy?
Stephen Kirchner 28:15
So there’s a long running debate about the role of financial stability, inflation targeting framework, and to what extent you should take financial stability concerns into account when doing inflation targeting. And one conception of this is to say that if you are doing inflation targeting, and you’re underpinning nominal stability in the economy, that this in itself is conducive to financial stability. And so, you want to prioritise nominal stability and that is the way you get financial stability.
And to the extent that financial instability becomes a problem, then monetary policy can always address that ex post. So the way the debate is sometimes characterised is between leaners and cleaners. So if your reaction to financial instability is ex post, then you’re cleaning up after you get a financial stability problem. If you’re a leaner, then you’re trying to sort of anticipate those financial instability problems. And to that extent, you’re going to potentially sacrifice your inflation target in order to head off some of those concerns.
So central banks will always obviously have to respond to financial instability after the fact to the extent that it creates problems for the macro economy. The real question is, to what extent do you try to do that preemptively. And I would argue that we don’t have enough information about financial stability risks to really do that successfully, preemptively. And traditionally, that was kind of the view that the RBA took. So if you look at the 2010 statement on monetary policy agreed between the treasurer and the RBA governor, that statement was the first to incorporate financial stability as a consideration. So it was the first statement after the financial crisis. And so it’s no surprise that that statement took on financial stability concerns.
And in that 2010 statement, it says very explicitly that, yes, the Reserve Bank should take account of financial stability, but without compromising the price stability objective. So financial stability concerns were made explicitly subordinate to price stability. And so that reflects the view I talked about before where you view nominal stability as being the most conducive way to address financial stability risks. So that would be the way that I would tend to formulate that relationship between price stability and financial stability.
What happened when Philip Lowe became governor in 2016 is there was a change in the wording on the statement on the conduct of monetary policy, which essentially turned that relationship on its head. So that statement explicitly provided for short-term deviations in inflation from target in order to address financial stability risks. So that agreement was essentially saying that there may be times when in the short run, we’re going to allow inflation to deviate from target in order to address financial stability concerns. And those concerns were explicitly nominated as a reason why you might look at the inflation target.
Gene Tunny 31:51
They might accept lower than the target inflation, because they don’t want monetary policy so stimulatory that it means that there’s a big growth in housing credit and house prices. Is one of the criticisms of what the RBA is doing now. I mean, I’m interested in your views on what it’s done during the pandemic, because we’ve had very aggressive monetary policy response. And this has arguably contributed to the boom in housing credit and house prices where we’ve got double digit, we’ve had house prices increase by over 20% In some cities. And I mean, to me, I mean, it looks like monetary policy has been too aggressive during this period. But yeah, I’m interested in your view on that, Stephen. And I mean, how does what they’ve done, how do you assess that given you’re an advocate of this nominal income targeting? How compatible is what they’ve done with that, please?
Stephen Kirchner 32:58
So if you look at the period from 2016, through to the onset of the pandemic, that changed, and the wording of the statement in the conduct of monetary policy ended up then being a very good description of monetary policy under Governor Lowe. So, through that period, the RBA very explicitly traded off concerns around, in particular the household debt-to-income ratio, and said, Well, the reason why we’re letting inflation run below target is we’re worried that if we provide more stimulatory monetary policy settings, then that would trigger more household borrowing, and potentially create risks in in the housing market. And the concern was that by the household sector taking on increased leverage, that this would increase the household sector’s exposure to a shock. So essentially, you’re trying to fight the last war in terms of the 2008 financial crisis. They were trying to mitigate what they saw as the risks that led to that particular event.
Now, one of the criticisms of leaning against the wind, I think, and this is a criticism that’s been made very persuasively, I think, by Lars Svensson, Swedish economist, is to say, well, if you’re conducting monetary policy on the basis of an apprehended financial stability, its annual trading off inflation and output against those risks, then in a sense, what you’re doing is you’re setting yourself up to have a weaker starting point if and when a financial crisis does occur. So the starting point for the economy is actually going to be weaker because you’ve been running monetary policy, it’s been too tight. And so this is a mistake that the Swedish central bank made In the early 2010s, and which led Lars to sort of formally model leaning against the wind and coming up with that characterization.
Peter Tulip who was a former Reserve Bank economists, when he was at the bank. He also did some work, basically applying Svensson’s framework to Australia and showing that in terms of the trade-off between the central bank’s objectives and financial stability risks, the RBA was basically incurring costs anywhere from three to eight times the benefit in terms of mitigating financial stability risks. So the cost in terms of having unemployment, for example, higher than would have been otherwise, you know, more than offset any gain in terms of reducing financial stability risk.
So essentially, I think this is a hierarchy in knowledge problem that the central bank really does not have enough knowledge about the economy to be able to successfully lean against the wind. This explains why the RBA undershot its inflation target for the better part of seven years. And it was an explicit policy choice, you know. This wasn’t an accident.
Going into the pandemic, I would say that the initial monetary policy response was inadequate. And this was essentially a function of the RBA trying to conduct monetary policy within its traditional operating framework. So they were still trying to use the cash rate as their main operating instrument, even though the cash rate was constrained by the zero lower bound on a nominal interest rates.
Gene Tunny 36:43
So we had a cash rate of, was it .25% going into the pandemic?
Stephen Kirchner 36:49
Going into the pandemic, it was point .75.
Gene Tunny 36:52
Oh, right. Yeah, sorry.
Stephen Kirchner 36:54
In March of 2020 they lowered it by 50 basis points in 2 increments of .25. And that took it down to a quarter of a point, which they argued at the time was an effective lower bound inasmuch as the RBA operates a corridor system around that target cash rate. And so the bottom of the corridor would have normally been at zero, if they had maintained that system. Subsequently, of course, the RBA did lower the cash rate below .25. So it turned out that it wasn’t a lower bound after all. It was very much a self-imposed constraint.
But going into the pandemic, they tried to conduct monetary policy very much within that conventional operating framework with the cash rate as the main operating instrument. And I think, because they allowed the level of the cash rate to determine how much stimulus they would provide… And initially, monetary policy was way too tight. So even though they had lowered the cash rate, what we saw between March 2020 and November 2020, when they finally adopted QE, was that the Australian dollar appreciated significantly. So the Australian dollar outperformed all of the other G10 currencies over that period. The appreciation on the trade-weighted index was about 10%.
And so what this is telling you is that in relative terms, we were not doing nearly as much as other central banks. And we were paying a penalty for that on the exchange rate. The other element of this, of course, was the macroeconomic policy mix, so the relative weight on monetary and fiscal policy. So our fiscal policy response was one of the strongest in the world. But our monetary policy response wasn’t.
Gene Tunny 38:52
Initially, yeah, gotcha.
Stephen Kirchner 38:54
At least up until November 2020. And so this is a recipe for the open economy crowding out effects that you discussed with Alex Robson, when you talked about Tony Makin’s work on open economy crowding out. So if you have a fiscal policy response, if you’re overweighting on fiscal policy relative to monetary policy, you’ll pay a penalty for that exchange rate. And that’s exactly what happened. And that was a pretty strong indication that monetary policy of this period was too tight. The RBA could have done more but didn’t because it was trying to conduct policy within its traditional operating framework.
Gene Tunny 39:33
Right, and by more you mean quantitative easing or large scale asset purchases, creating new money, printing money electronically and then using it to buy financial securities bonds, for example?
Stephen Kirchner 39:48
Yeah, so there are two alternative operating frameworks that they could have used. One is negative interest rates and the other is large scale asset purchases or QE. And so by November 2020, the RBA conceded that other central banks had done more to expand their balance sheet. And they needed to do the same. They also lowered the cash rate target from .25 to .1. And they lowered the bottom of the cash rate corridor from one to zero. So effectively, they conceded that they could have done more and needed to do more, and they finally delivered. And at that time, they did adopt a very aggressive asset purchase programme because they were playing catch up to other central banks. And so by the time we’ve got to the end of 2021, in fact, the RBA had expanded its balance sheet as a share of GDP by an amount that was broadly equivalent to what the Fed had done.
So one of the ironies here is that the RBA’s attempt not to expand its balance sheet actually ended up being a balance sheet expansion that was comparable to that of the Fed. And I think this is an important lesson for monetary policy generally, that typically, if central bank is using its policy instruments aggressively, and over a very extended period of time, that’s usually an indication that it didn’t do enough upfront. So in fact, if you want to avoid, you know, hitting the zero lower bound or expanding your balance sheet by a significant amount, the way to do that is to respond quickly and aggressively upfront. If you don’t do that, then you fall behind the curve, and then monetary policy has to work a lot harder to stabilise the economy. And I think that’s what ended up happening in Australia in response to the pandemic.
Gene Tunny 41:42
Right, okay. You’ve written another fascinating paper on this, Stephen. The paper’s titled The Reserve Bank of Australia’s Pandemic Response and the New Keynesian Trap. So this was published in Agenda, which is a journal put out by the Australian National University. And I want to ask you what you mean by New Keynesian trap. But I think I sort of know, I think you’re sort of alluding to the fact that a new Keynesian policy approach would be inflation targeting, but you can correct me on that. But the point you make, and I think this is fascinating, you want to explore this and make sure I understand what you mean here, you write, “A monetarist conception of the monetary transmission mechanism would have encouraged more rapid adoption of alternative operating instruments.” So could you explain what you mean there, please?
Stephen Kirchner 42:33
Yeah, so the New Keynesian trap was exactly what I was describing in terms of the monetary policy response to the pandemic. The New Keynesian framework for monetary policy analysis relies excessively on an official interest rate as not just the central bank’s only operating instrument, but also the only way that you get monetary policy into that model. And the problem with this is that if the central bank thinks of monetary policy implementation and monetary policy transmission exclusively in terms of an official interest rate, then that’s going to be a problem when your official interest rate hits the lower bound, because at that point, your model basically blows up, because if you can’t lower the nominal interest rate, in a situation which is calling for easy monetary policy, then that’s a recipe for macroeconomic instability. And in fact, it becomes a downward spiral because the economy deteriorates and you can’t respond through your conventional monetary policy instrument.
And in the sort of New Keynesian literature on monetary policy, there are all sorts of ways in which they try and sort of solve this problem. So in some of that literature, for example, there’s just an assumption that fiscal policy steps in to bail out the central bank. And to some extent, that’s what we saw with the pandemic response, which was that you might have noticed during the early stages of the pandemic, the Reserve Bank Governor was begging the federal and state governments to do even more with fiscal policy than they were actually doing, even though the fiscal policy response is quite large. And so really what he was saying was, my hands are tied, you need to do more to stabilise the economy.
Now, were the central bank’s hands tied by its operating framework? Well, only in the sense that they perceive that framework to be binding on their decision making. If you go back to November 2019. Governor Lowe gave a speech in which he addressed the issue of negative interest rates and quantitative easing. And he was arguing that it was very unlikely that the central bank would have to go there. And if you read that speech, you can see he’s very reluctant to contemplate using either of those policy instruments. So for me, the New Keynesian trap, it’s a self-imposed constraint on monetary policy. It’s because of the way you’re conceiving both the monetary policy instrument and the monetary policy transmission mechanism, it leads you to pull your punches in an environment where you need to adopt a new operating frame.
And for me, the fact that the RBA walked away from that framework in November of 2020 basically concedes the point, they realised that their traditional operating framework was not adequate in responding to a massive shock when the interest rate was hitting the zero bound, and so they needed to think of monetary policy in an alternative framework. And so this is where an RBA officials started giving speeches about the role of quantitative policy instruments and quantitative transmission mechanisms in the monetary policy implementation. If they had done that back in March of 2020, I think we would have had a more timely, more effective monetary policy response and avoided what I’ve called the New Keynesian trap.
Gene Tunny 46:22
Yeah, yeah. Okay. I mean, I think you’ve been rightly critical of the RBA. If they eventually had to adopt these measures, and arguably, they should have done them earlier. So very good point. I want to make sure I understand why it’s a monetarist conception, why that would have led to more rapid adoption. Is that because a monetarist would have been looking at the monetary aggregates, they would have been thinking about, well, how, how could we make the monetary aggregates grow at the rate that would be optimal? Is that what you’re thinking? And you’re just not thinking in terms of a cash rate? You’re thinking in terms of the money supply?
Stephen Kirchner 47:03
Monetarists have always been very critical of the idea that an official interest rate is both the best characterization of what monetary policy is doing, but also the idea that it’s a complete representation of the role that monetary policy plays in the economy. So it’s true that, you know, in equilibrium, you could say that an official interest rate might be a good representation of the contribution of monetary policy.
The way monetarists tend to think of the long run evolution of the price level is in terms of the long run supply and demand for real money balances. And so they tend to think of the evolution of monetary policy in a quantity framework rather than a price framework, the price being the interest rate. So you can think of monetary policy instruments either working through a price, which is the interest rate, or quantity, which is the supply and demand of real money balances. I think both modes of analysis have their place, and they’ve clearly linked. But the focus on official interest rates, I think has been very misleading, because you know, of itself, the level of the cash rate, tells you very little about the stance of monetary policy.
I think one of the mistakes monetary policymakers have made internationally and in Australia has been to assume that because the nominal cash rate is low, monetary policy must be stimulatory. And one of the points that Milton Friedman made repeatedly was to say, if the nominal interest rate is low, then that’s probably indicative of tight monetary policy because that probably means that inflation is very low as well, if you think of the contribution that inflation makes to the nominal interest rate. So if you’ve got very low nominal interest rates, that’s probably an indication that monetary conditions are too tight, rather than too easy. And I think it’s a mistake that monetary policymakers have repeatedly made.
Milton Friedman warned against it in his 1968 presidential address to the American Economics Association. And throughout his life, he tried to impress upon policymakers the significance of this. But it’s something that’s still eludes policymakers, I think, and you can see it in some of the comments that the RBA and Governor Lowe has made in recent years where they often emphasise the low level of the cash rate as being self-evidently indicative of an easy monetary policy stance when, in fact, if anything, it’s probably an indication that monetary policy is too tight.
By the same token, if you go back to say, the late 1980s, in Australia, when we had double digit inflation rates, well, we had double digit interest rates as well. At that time, very high level of interest rates was in fact indicative of the fact that the RBA had run monetary policy in a way that was way too easy, giving us high inflation.
Gene Tunny 50:34
Yeah. And it was that experience that did prompt the adoption of inflation targeting because we weren’t inflation targeting back then. They had some checklist approach or whatever. This was just after they had the brief experiment with monetarism, and then they had a checklist or something and they didn’t have an explicit inflation target until the early ‘90s. I mean, Stephen, would you agree that arguably, inflation targeting was a good thing to adopt at the time? I mean, did it actually improve? Do we get better monetary policy for a while with inflation targeting? Was it better than what we had before?
Stephen Kirchner 51:09
I think inflation targeting was a very important and helpful innovation. They’ve got central banks focused on nominal stability, which is what you want them to do. And I mean, I’m still a defender of inflation targeting as much as I think you could make the current inflation targeting framework work better. And the way in which you would do that would be to focus on as you’re looking through supply shocks, so in other words, not responding to increases in inflation that are clearly driven by supply side constraints, like some of the inflation pressures that we’re seeing at the moment. Where nominal income targeting is helpful I think is helping you to do that.
So one way of thinking about nominal income targeting is you could think of nominal income as an indicator variable or an inflation variable, which tells you when you need to respond to inflation with monetary policy and when you shouldn’t. So that would be one way in which you could improve an inflation targeting regimen would be to sort of look at both variables and use that to help you sift through what inflation shocks you want to respond to, what inflation shocks you want to look through. I don’t think we have to necessarily give up on inflation targeting but we probably do need to change the way we do it, because I think inflation targeting in recent years has failed on its own terms, because central banks have said, well, we’re targeting inflation, but in fact, they’ve missed the target. So if you’re missing the target, you’re not doing it properly. So clearly, you need to change the way you’re doing it.
Gene Tunny 52:49
So as an implication of what you’ve said, are you implying that there’s a risk of the Reserve Bank could increase the cash rate too much, because it’s reacting to CPI data that partly, the inflation is going to be driven by this supply shock? Is that a concern of yours?
Stephen Kirchner 53:12
Yeah, I mean, we’ve certainly seen that in the past. So we talked before about the Fed, and the ECB in 2008 I think clearly made that error. And I think it’s a risk at the moment. At the moment, we have both supply and demand shocks driving inflation. So there’s been a huge dislocation in the supply side of the global economy due to shifts in demand, so that the speed of the recovery has basically caught the supply side of the world economy short. It’s struggling to keep up. And so there’s a big supply component to existing inflation pressures.
In the United States, I’d say there’s also a demand component inasmuch as one of the things that Mercatus Centre has done has been to develop what they call an NGDP gap, which is basically a measure of the deviation in nominal GDP from long-run expectations. At the moment, we have a positive nominal GDP gap in the United States. And so consistent with the nominal GDP targeting framework, that’s saying that there are excess demand pressures in the US economy. And so you would want monetary policy to respond to that. And so I think this is why the Fed is tightening at the moment. It’s appropriate that they do so because there is excess demand in the US economy, and GDP expectations are a good guide. But at the same time, there’s a very significant supply side component to this. And that is something you probably want to look through.
So one way to think about US monetary policy at the moment is the Feds should be tightening with the views of closing that nominal GDP expectations gap on the Mercatus measure. That would require some tightening of monetary policy but not nearly as aggressive as if you were trying to fully stabilise consumer price inflation.
Gene Tunny 55:13
Right. So nominal GDP in the US by that Mercatus measure, it’s higher than that path that long-run path. Is that right?
Stephen Kirchner 55:25
Yeah, that’s right. So on their measure, the level of nominal GDP is running at about, I think, 3% above the path implied by long-run expectations for nominal income. So from a nominal GDP targeting framework, you would certainly want to respond to that.
Gene Tunny 55:41
Right. Now, this is one thing I’ll want to just make sure I understand. In your paper, you talk about how it’s good to correct for deviations from that target path, that nominal path. Why does a target path in nominal terms? Why is that relevant? I think one of the points you make is that, traditionally, central bankers wouldn’t really worry about the nominal path, or they if you did have low inflation for a period, and that meant that you were below that nominal level, it’s not as if you’re going to ramp up, they wouldn’t have a more stimulatory monetary policy just to try and hit a particular GDP number in nominal terms, say two and a half trillion or something, because well, what does the actual nominal value of it matter? What matters is what’s the real value of it and how many people are employed, that sort of thing? I want to understand that. Are you saying that we should try and get back to some sort of the nominal GDP number that was implied by the path we’re on?
Stephen Kirchner 56:54
Yeah, I would say that nominal GDP stabilisation is still implicit in what the RBA and the Fed do today. So if you’re stabilising inflation around target and output around potential, then that will certainly be conducive to stability in nominal GDP. It’s just that we’re not explicitly framing monetary policy in those terms. So at the moment, we frame it in terms of the cash rate responding to deviations in the inflation target, or deviations in output or the unemployment rate from their assumed equilibrium values. All I’m saying is you want to reframe the way in which you implement monetary policy in terms that are currently implicit, but arguably should be explicit.
So really, I’d say monetary policy is trying to stabilise a path for the future path of nominal GDP. Were just not explicit about it. So it’s really reframing monetary policy in those terms, to bring out those relationships. But I think it does it in a way that’s less conducive to monetary policy running off track, for all the reasons that we’ve talked about, that you’re no longer making guesses about the equilibrium interest rate, the equilibrium unemployment rate, or the equilibrium level of real output. You can abstract from all of those things and just ask the question, How is nominal GDP evolving relative to, A, expectations, or B, in my sort of operating framework, you know, where you want monetary policy to be. So just be explicit about that and nominate a target path.
One of the advantages of doing that is in fact, I think, better financial stability outcomes, reason being if you think about the decisions that lenders and borrowers are taking in credit markets, whether it be in relation to housing or business lending or any other type of credit, the serviceability of those contracts depends entirely on the future flow of nominal income. So putting yourself in the shoes of a holder of a mortgage, for example. The amount I borrow is very much a function of what I think my future nominal income is going to be. And the lender is making the same assessment, right? They’re saying, Does this person have the capacity to service a mortgage? Well, that’s a function of what’s going to happen with their normal income in the future.
So by stabilising both expectations for nominal income and actual outcomes for nominal income, I think that’s conducive to financial stability because then the economy is going to evolve in line with the expectations embedded in those credit contracts. So I think you’re less likely to run into financial stability concerns in that context.
So this is essentially Scott Sumner’s critique of US monetary policy in response to the global financial crisis. So what Scott Sumner argues is that the recession in the United States was made deeper by the fact that nominal GDP and expectations for nominal GDP in the early stages of the crisis were allowed to collapse, and that more than anything affected the ability of people to service their mortgages.
Gene Tunny 1:00:42
That’s an interesting argument. I’ll have to have a look back over his work. I’ve seen it in the past. But have you got time for two more questions or do you have to get going? Because there are a couple –
Stephen Kirchner 1:00:52
Oh no, absolutely. Take all the time in the world.
Gene Tunny 1:00:55
Great. There are a couple other things I want to chat about. On page 27 of your Mercatus Centre paper you write, “There’s a growing empirical literature on the advantages of NGDP targeting relative to inflation targeting and other policy rules. I’m interested what that literature is. What does it comprise of? Is it cross-country regression studies, or how do they determine that, that this actually is superior to what we’re doing at the moment?
Stephen Kirchner 1:01:23
So there’s a long history is who the literature on monetary policy rules. And it really goes back to a Brookings Institution project back in the early 1990s. And it was as part of that project that John Taylor published his Taylor rule estimates. And Warwick McKibbin, the Australian economist, was actually an early contributor to that literature as well. And I mean, one of the things I did, as part of that Brookings Institution project was to just simulate different types of rules. So on one hand, you can estimate empirically what the central bank response to macro variables is . But you can also do simulations, where you say, well, what would happen in a economic model if the central bank responded to nominal GDP or some other specification of the monetary policy reaction function.
And I think it’s fair to say that, in that early literature, both nominal GDP targeting, whether in level or growth rate terms, did not fare well, relative to the sort of more Taylor rule type specification. The problem with that literature was that it wasn’t taking account of the knowledge problems that we talked about earlier, which is the unobservability of some of the key conditioning variables, namely the real equilibrium interest rate, either potential output or an estimate of an error. Once you take account of those knowledge problems, then the Taylor rule literature becomes much less robust. And nominal GDP targeting becomes much more robust. So once you allow for the fact that there’s uncertainty around those assumed equilibrium values, then inflation targeting as it’s currently conducted in a Taylor rule framework looks a lot less attractive. So really, that early literature was conditioning on historical relationships, which, when you’re operating in real time, become much more problematic.
Gene Tunny 1:03:53
Okay. I have to ask you about an NGDP futures market. So this was mentioned in your Mercatus Centre paper. Why would that be useful? And what’s the role of Ethereum, so a cryptocurrency, isn’t it? What’s the role of Ethereum in that?
Stephen Kirchner 1:04:15
So if you’re targeting nominal GDP, then one of the things that would be very helpful in that context would actually be a market-based estimate of where nominal GDP is going. People like myself who call themselves market monetarists, the market part of that expression refers to the fact that we think that markets are in fact the best gauge, financial markets at the best gauge of the stance of monetary policy and also what effect any given policy change is likely to have on the economy.
So if you take that view, then what you want to do is get a market-derived estimate of where nominal GDP is going and then base your monetary policy response on that estimate, because that’s going to be your best guess of where nominal GDP is going. And there are various versions of this. Scott Sumner has a version where the central bank would actually tie its open market operations mechanically to prices in that nominal GDP market. So monetary policy would then basically become market-driven. But you don’t need to go quite that far. I mean, it would be sufficient, I think, just for the central bank to take account of what the nominal GDP market was telling you about the stance of monetary policy.
The beauty of this is that any macroeconomic policy measure that you might implement, the nominal GDP futures market will give you instant and real time information on what the market thought that was going to do to the economy. So for example, if you had a fiscal stimulus package, a nominal GDP futures market would tell you basically on announcement, what it thought the impact of that package would be. And my expectation would be that if we had a nominal GDP futures market and you announced a big fiscal stimulus, we would actually probably see very little movement in the nominal GDP futures market because most of the economy crowding out effects that we discussed before, I suspect that in a small open economy with a floating exchange rate like Australia, fiscal policy actually doesn’t do very much in terms of aggregate demand.
Gene Tunny 1:06:45
Stephen Kirchner 1:06:46
We see that a little bit already, because although we don’t get sort of very clean or discreet announcements of fiscal policy measures, typically when the budget lands every year, and they announce what the change in the budget balance the share of GDP is going to be, which is your sort of best measure of the impact that fiscal policy is going to have on the economy. The national markets very rarely move in response to that announcement.
So the case for a nominal GDP futures market is you want that market to basically inform monetary policy decision making. And it really goes to the issue of what paradigm do you want for monetary policy? The market monetarist paradigm is essentially to say central bank is a lot smarter than financial markets when it comes to assessing where the economy is going. And we should do away with the fiction that they know more than what’s embodied in financial crises. And so conduct monetary policy on the basis of the best available information, which is what financial markets are telling you about the evolution of the economy,
Gene Tunny 1:08:01
What does this instrument look like? And who sets up the market? Does the central bank set up the market? I mean, people are gambling, or they’re betting on what future nominal GDP is. But how’s the market actually work? Has anyone thought about how it would be designed? Does the central bank have to run out or could it be a privately owned market?
Stephen Kirchner 1:08:26
So this could be a conventional futures markets? So we have at the moment futures contracts available, various financial instruments, so there are futures contracts for 10-year bond yields for the Australian dollar. We effectively have futures contracts on inflation outcomes, which is the difference between the prices on bond yields and index bond yields, so that it’s bond yields adjusted for inflation. So we actually already effectively have a futures market in inflation outcomes. And that’s actually a very important input into monetary policy decision making.
So one of the things that the RBA pays very close attention to is what market prices are saying about the future evolution of inflation? So we already have one half of the equation. What we need is the other half, which is to say, a view on what’s going to happen with real output. But if we combine those two things, and what we’re saying is we want a financial market view on where nominal GDP has gotten. So it’s very straightforward to design a futures market contract that you would list on the Australian Stock Exchange, which would be traded by financial market participants.
And I think another thing that would be useful that comes out of this is it would be a very good hedging instrument. So we think of corporations, their top line revenues are in fact often largely a function of nominal GDP. So one of the things the company will look at when they’re forecasting their revenues is an assumption about what nominal GDP is going to do. So corporates could actually use a nominal GDP futures market as a hedging instrument. And that increases the information content of NGDP futures prices. It becomes highly informative of what decision makers in the economy are expecting in relation to the future evolution of nominal income. That information is very useful for policymaking.
And my argument to the Reserve Bank, when I’ve presented this work to them, is to say, Do you think that would be useful input into monetary policy decision making? And of course, the answer has to be yes. You know, you want more information, not less. And so my argument to them is, well, if that information will be useful, then it’s probably worth incurring some costs in order to get that information. So what I’ve suggested is they need to remove some of the regulatory barriers to the creation of a nominal GDP futures market.
A huge regulatory barrier to any sort of financial innovation in Australia is the fact that the costs of financial system regulation in Australia are paid for by the financial sector. So all of the costs of ASIC and APRA in regulating the Australian financial system is recovered from market participants, economic institutions. But that cost recovery framework has a public interest clause, which basically says you should be able to get relief from cost recovery if there’s a public interest in doing so. And so I like it that the creation of a nominal GDP futures market is a perfect application of the public interest case for relief from cost recovery. So basically, the institutions and the Securities Exchanges that would put together that market should basically get an exemption from regulatory cost recovery. I think that would give a huge boost to making that sort of market commercially viable.
Gene Tunny 1:12:37
It’s a fascinating idea, because occasionally, you do have these new financial instruments. I mean, I know in the US they have a market in… Is there a futures market for house prices based on the Case-Shiller Index?
Stephen Kirchner 1:12:51
Yeah, that’s right. There’s derivatives around house prices in the United States. The NSX tried to get a derivatives market in house prices up and running a few years ago. I would argue that, yes, we should have house price futures as well, for exactly the same reasons. It’s informative for policymakers, t gives them information that they would not otherwise have. It will tell you, for example, when APRA changes its regulation of financial institutions. A house price futures market would tell you straightaway what the implications for that are for house prices. It’d be useful hedging instrument as well. So yeah, ideally, I think we should have both markets.
I think the impediments to those markets, given that they are potentially so useful, are most likely regulatory in nature. And so we need to lower the regulatory barriers to the creation of those markets. And arguably, I think there’s a case for implicit public subsidies for those markets as well, so relief from regulatory cost recovery. I think the RBA could use its balance sheet to become a market maker in those markets. So not with a view to influencing the prices, but just providing, being a liquidity provider, which would lower costs for other people transacting in those markets and would help get them up and running.
Gene Tunny 1:14:25
I was just thinking, I was just trying to think, how would this actually start up? And, I mean, you’d need someone to actually develop the instruments, create the contracts and sell them, so that could be say, an investment bank, for example. It could be a Goldman Sachs or it could be a Morgan Stanley or one of those businesses. It’s a fascinating idea.
Stephen Kirchner 1:14:50
Yeah, I mean, in my Mercatus paper, I make the case that the council of financial regulators should jointly mandate the creation of a nominal GDP futures market. And I mean, when regulators mandate something in financial markets, it usually happens. So it’s not uncommon for the financial regulators to actually come out and say to financial market participants, okay, we’re doing this. If it becomes a regulatory mandate, then the financial market participants will cooperate with that mandate. And you know, I think it would be enthusiastic participants. So I think it’s really incumbent upon the RBA to say this is something that we want and need, would be helpful for policymaking and for hedging, as I’ve described. And so we’re going to sit down with financial market participants and make it happen
Gene Tunny 1:15:46
And just finally, you’ve mentioned that there could be a role for blockchain. So you talk about how US NGDP futures have already been implemented on the Augur blockchain. Did I pronounce that right? And then, Eric Falkenstein has also developed Ethereum-based derivatives contracts. These contracts could provide competitive alternatives to listed securities, okay, on existing exchanges and require little or no public support while still yielding useful information about monetary policy in the economy. So is there anything special about the blockchain in this context?
Stephen Kirchner 1:16:22
Well, the role for blockchain I think is just in terms of lowering the costs of doing it. So as we’ve already discussed, there are significant cost barriers to listing nominal GDP futures on our traditional securities exchange. I’ve argued that we should try and lower some of those costs. But another way of doing this is to implement it in blockchain space. There’s already been some interest in doing this in the US. I think, eventually, almost all financial derivatives will move off exchanges and onto the blockchain at some point, main reason being you can then do instantaneous clearing and settlement. So you no longer have trillions of dollars tied up in collateralizing clearing and settlement of financial derivatives. So if derivatives markets are going to move onto blockchain, then arguably NGDP futures should move on to blockchain as well. But I think there’s more scope for innovation in the blockchain space at the moment, just because it’s a different regulatory environment.
And so I’ve sort of argued for a two-prong approach where on the one hand, you want to go through sort of the conventional channel other listed securities market for NGDP futures. But at the same time, I think there’s scope for entrepreneurs to innovate in the blockchain space and do something similar. And hopefully, what we get out of this is a viable future market, not just in nominal GDP, but [with] other macro variables included. And I think it would not only provide policymakers with useful information, but it would really change the way people think about financial markets and monetary policy, because you can’t beat the sort of real-time financial market verdicts on what policy is doing.
It would eliminate a lot of arguments about the implications of various types of public policy, because let’s say the government is proposing a change in some tax rate, and there’s an argument about what the implications of that tax change is for the economy. Well, a nominal GDP futures market will instantaneously settle that argument, because when the tax change is announced, you can observe what the change in the nominal GDP futures is. And that basically tells you what the economic impact is,
Gene Tunny 1:19:07
Assuming the market expectation is correct.
Stephen Kirchner 1:19:11
It doesn’t have to be correct. It’s probably our best guess.
Gene Tunny 1:19:15
Best guess, gotcha. Yeah. I agree. I was just wanting to –
Stephen Kirchner 1:19:19
Ex post it could be completely wrong. At the time of the announcement, it would be the best guess of everyone who actually has a real-time financial stake in that outcome.
Gene Tunny 1:19:31
Yeah, very good point. Okay, Stephen, this has been terrific. I’ve learned so much and it’s made me think about a lot of a lot of things that hadn’t been thinking about before. I love this idea of futures markets in economic indicators. I think that’s brilliant. So yes, I’ll have to come back and explore that in the future. So Stephen, you’ve got a sub stack, which I’ll put a link to in the show notes. I’ll also put links to your two fascinating papers on monetary policy. Any final words before we wrap up?
Stephen Kirchner 1:20:06
I think this has been a great conversation. I’ve really enjoyed it, Gene.
Gene Tunny 1:20:09
Thank you, Stephen. I’ve really enjoyed it too. I must admit, initially I don’t think I’ve really understood this nominal income targeting idea and its merits and what the problems with inflation targeting were as much as I do now, I think I’ve got a much better understanding. So absolutely, really appreciate that. So, again, thanks so much for coming on to the programme. And yeah, hopefully, I have you on again, sometime in the future. We could chat more about these issues. So thanks so much.
Stephen Kirchner 1:20:46
Thank you, Gene. It’s been a pleasure.
Gene Tunny 1:20:49 Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to email@example.com And we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.
Big thanks to EP135 guest Stephen Kirchner and to the show’s audio engineer Josh Crotts for his assistance in producing the episode.
Paul Mladjenovic, CFP is the author or co-author of several dummies guides on investing, including Stock Investing for Dummies and Investing in Gold and Silver for Dummies. Paul shares his views on what makes for successful investing with show host Gene Tunny in episode 133 of Economics Explored. They discuss what types of companies to look for, an often unappreciated benefit of investing in gold and silver, and what Paul thinks about real estate and crypto assets.
This episode contains general information only and does not constitute financial or investment advice. Please consult a financial planning professional for advice specific to your circumstances.
About this episode’s guest – Paul Mladjenovic
Paul Mladjenovic, CFP, is a certified financial planner practitioner, writer, and speaker. He has helped people with their financial and business concerns since 1981. You can learn more about him at ravingcapitalist.com. He has authored or co-authored several popular Dummies guides on investing and affiliate marketing. You can learn more about Paul and his online courses at https://www.ravingcapitalist.com/.
Transcript of EP133 – Investing for success w/ Paul Mladjenovic
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.
Paul Mladjenovic 00:04
The bottom line is, Gene, is that healthy quality companies will keep zigzagging upward no matter what you throw at them.
Gene Tunny 00:13
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 133, on investing for success. My guest this episode is the author of several of those yellow dummies guide that you may have seen in bookstores, Paul Mladjenovic. He’s written Stock Investing for Dummies, High Level Investing for Dummies, and Investing in Gold and Silver for Dummies, among other books. Paul Mladjenovic, CFP is a certified financial planner, practitioner, writer and speaker. He has helped people with their financial and business concerns since 1981. You can learn more about him at ravingcapitalist.com.
The usual disclaimer applies to this episode. This is for general information only, and nothing in this episode should be interpreted as financial or investment advice. Please consult a financial planner for advice specific to your circumstances.
Please check out the show notes for links to materials mentioned in this episode and for any clarifications. Also, check out our website, economicsexplored.com. If you sign up as an email subscriber, you can download my e-book, Top 10 Insights from Economics. So please consider getting on the mailing list. If you have any thoughts on what Paul or what I have to say about investing in this episode, then please let me know. You can either record a voice message via SpeakPipe – see the link in the show notes – or you can email me via firstname.lastname@example.org. I’d love to hear from you. Righto, now for my conversation with Paul Mladjenovic on investing for success. Thanks to my audio engineer, Josh Crotts, for his assistance in producing this episode. I hope you enjoy it. Paul Mladjenovic, welcome to the programme.
Paul Mladjenovic 02:20
Thank you kindly. What a pleasure to be on.
Gene Tunny 02:22
Yes. Thanks, Paul. Yes, it’s good to be chatting with you today about investing. You’ve written several books on investing. One of your books I’ve been reading is Stock Investing for Dummies. I’ve been getting a lot out of that. I think it’s a really great book and has a lot of sensible things to say that are consistent with economics. Really, really positive about that book. I’d like to ask, just to start off with, what is your general approach to investing? Does that vary over the lifecycle? Would you be able to take us through that place?
Paul Mladjenovic 03:04
Oh, absolutely. First of all, as you know, probably one of the most important foundations of investing is good economics. You’re on the right topic in many respects. If people make good choices, and with some economic reasoning, they could prosper, among the many choices you can make out there. And it also depends on many other things, such as politics and that kind of economic environment, etc. For me, I prefer looking through things through the prism of value and fundamental analysis.
Like many folks, when the people who make sense about this, whether it’s economics from that gentleman who’s behind you there, Mr. Friedman, or in my case, somebody more in the narrow vertical of stock investing, someone like Benjamin Graham, who was like the father of value investing. And I think it’s an important concept, because many things have to make sense. In economics, once you understand the basics of your own chequebook and household budget, it’s not that far-fetched to understand choosing good companies to invest in, etc.
I’ve been teaching about investing since the 1980s. I find that if you have common sense and have some basic of economics and grasping long-term success in stock investing and other assets as well, it’s not that difficult. You are much more proficient. It’s when you understand that. Common sense and value, it goes a long way in the world of investing.
Gene Tunny 04:34
Okay, so you’re looking for companies that are reliable over the long term. Am I reading that right?
Paul Mladjenovic 04:46
Absolutely. Actually, I’ll give you a few points from my investing class that I love. You’re a very astute man, and the people in many of my classes, many of them are beginners or beginning intermediates, and the first thing I tell them is, select… I say, remember two words, when you’re choosing your investments, whether it’s directly in stocks, or indirectly through ETFs and mutual funds, two words, human need. Think about all the products and services people will keep on buying, no matter how good or bad the economy is. And I think that especially for beginners who are looking for long-term success, human need will really, I think, crystallise it very much for folks moving forward.
For example, some of the greatest companies in the last 20 years that have been chugging along, no matter what, with the crises and market crashes and booms and busts and all the rest, companies that are profitable, involved in things such as food, water, beverage, utilities, etc. This is where you start. You start with human need before you start going into other pursuits, such as growth investing, or speculating, or everything else for that matter. The first thing is get to the right category.
The second thing is, I look for companies that are profitable and have low debt. Those may sound common sense to maybe folks like you and I, but when I’ve seen the kind of selections people have made for their portfolios over the last, I don’t know, ever since I’ve started teaching, my eyes bug out. People go for the flashy stocks, big names, glamour headlines, and that kind of thing. Those stocks may go up or down in a short term. But if they don’t have star power, in terms of their fundamentals, good profitability that they’ve done year in and year out profitable… Very important.
To me, profit isn’t just a cornerstone of a good stock. I can make the argument that it’s the cornerstone of a successful economy. I was born in a communist country. They obliterated the concept of profit, which means you obliterate the incentive to produce. That’s why you invest in companies because these produce goods and services. That’s the hallmark of a successful company, so profitability.
Again, anybody in our audience, you look at your own budget, what do you look at? If your income is greater than your expenses, you’re doing fine, especially whether you’re a billion-dollar company, or you’re a household budget. That’s one aspect of it. The second one is I like companies that have good balance sheet. And again, assets exceeding liabilities, it doesn’t have to be complicated. Many people think when you’re looking at stock investing, you have to have a degree from the Wall Street school of analysis, but no. A lot of them have gone wrong, because they went beyond the scope of good economics and good common sense.
Those are the things I look for, human need, profitability, do they have good balance sheets, in other words, making sure they’re not overloaded with debt, etc. Of course, they have to be in a free market economy, because obviously, the free market is a very important and very powerful part of any successful economy out there. Beyond that, I look at other things as well, does it pay dividends and so forth.
A lot of these things, obviously, I detail that in my book, Stock Investing for Dummies. I try to also crystallise that in my courses online, etc, whenever I’m doing live programmes or recorded, because I think people, I don’t know, to me, the more they understand about good investing and their own situation, the better choices they make, not only for their portfolios, but also when they walk into the voting booth, believe it or not. I feel that’s part of it. People forget that during the Great Depression of the 1930s, people forget that many people unwittingly voted for the Great Depression, because they voted for policies, because they didn’t understand economics, and those in turn, created just wretched conditions in many respects. But anyway, on to your other points, my friend.
Gene Tunny 09:09
I’m interested in this concept you mentioned, value investing. That’s contrasted with what’s called growth investing, if I remember correctly. This is one of the things you write about in the book. Would you be able to explain what those differences are, please, Paul?
Paul Mladjenovic 09:28
Well, value investing means that you’re not going to be putting your money into a company that’s overvalued right now. And how do we mean about valuation? You see, when people are buying a stock, they’re buying the company, and if they’re buying a stock that’s very overvalued, then you have less chance for it to grow or do well over the long term. You’ve seen that happen very frequently. I look for something like is it a fair valuation, because I can look at a company and see things like its book value, the price-to-earnings ratio. Again, I’m happy to explain all of these to folks that need it. But there are some very key ratios that tell you if you’re paying too much.
How often have people saw a company that was say losing money, but it had a very hot sexy technology, people kept on bidding up the stock, bidding up the stock, and all of a sudden, you’re paying a fortune for a company that’s not making a profit, which means that the moment the economy starts to get a little bit worrisome, unstable, recessionary, these are among the first that that see that stocks fall. If people are paying a fair amount for the company itself…
Here in 2022, it isn’t like the way it was when I first started investing. You had to go to the library and dig through 27-pound books just to find some of the right numbers. But now you’re online and on your smartphone, and you can find out the key numbers and the key metrics very quickly. And so it should be easier than ever before. But I think people get waylaid because they see all the financial commentators and everybody is… There’s that sales pitch from Wall Street, etc. But my thing is, you always go back, the way you look at the ingredients of a good recipe, you look at the ingredients of a good company, and then say to yourself… One of the things I mentioned was the price-earnings ratio. I like to find a price-earnings ratio of under 25, because that’s a fair valuation. But people buy these stocks where… Would you like me to briefly just explain the P/E ratio for the audience?
Gene Tunny 11:36
Yes, please. Yes, I think that would be great, please, Paul. And yeah, what it roughly means.
Paul Mladjenovic 11:44
The price-earnings ratio tries to make a relationship between the stock, what you’re buying, and the essence of the company. The essence of the company is its profit, of course. And what we do is take a look at the price per share and the earnings per share.
Let’s say for example, you have a company that makes a million dollars net profits, and they have a million shares outstanding. Well, that’s a $1-per-share profit. The earnings per share is $1. Okay, so we can understand it. A million shares, a million dollars. It’s $1 earnings per share. Great. But now, let’s say that company’s stock is $10. Alrighty, so basically, you’re paying $10 for the stock, and you’re paying for $1 of earnings. So that’s a 10-to-one ratio. But that’s a P/E ratio of 10. Very fair valuation. Of course, if the stock is $15 or $20, you’re still in the ballpark. I think that’s a good price that you’re paying for it. In that case, if it’s 15, you’re paying $15 per stock, and you’re getting $1 of earnings.
What happens is this. If everyone’s excited about the stock, and they bid that stock all the way up, but the earnings are still down here, then you start getting into dangerous territory where you’re over, that there is an overvaluation, the price is much higher than what the company has in basic intrinsic worth. Back when the Internet stocks crashed, many of those P/E ratios were not 15 or 20 or whatever. They were north of 100. Some of them were over 1000, which means you’re paying an awful lot of money for the company. When it’s a nosebleed territory, then it’s in greater danger of a pullback.
The reason why they bid up the stock is that they’re assuming, oh, that’s a great company, the earnings are going to come in. They’re assuming that they’re buying up the stock, that the earnings are going to eventually rise, but you don’t know that. You’re basically speculating. You’re buying stocks today, hoping that tomorrow or next year, they can have a sensational profit, but that doesn’t always materialise. So at that case, you’re speculating. You’re not investing. Investing means you look at the reality of the moment, what you’re paying for, and the actual key components that a company are in a good price range, a good valuation, and the price is closer to it. Then it’s less risky.
I prefer people starting off with value investing, because it brings out much of the risk to begin with, because if you’re paying a lot of money for a stock, then the risk is, what happens if the earnings don’t materialise? What if they start to have losses? What if the economy slows down, and 100 other variables. Then that stock gets up here. It could easily be in bubble territory, pop and come back down and you’re sitting on a loser. That’s the issue with this. You want to go for valuation early on.
It’s like if you buy a dozen eggs, if they’re on sale for $1.99 for a dozen eggs, it’s a lot cheaper than if you were going to pay 10 or 20 bucks for the same dozen eggs. The eggs don’t change, but the price in the relationship does matter. This is among the things I emphasise, hopefully, throughout the book, and to casual readers everywhere. Hopefully that are not that casual with their money.
Gene Tunny 15:03
Yes, yes. I was just checking the P/E ratio for Tesla at the moment. I’m just looking at this one site. It says it’s 193.24, March 22, 2022. That’s a P/E ratio well in excess of–
Paul Mladjenovic 15:24
Exactly. Now, I have no problem with people investing in that type of stock. But they need to tell themselves that they’re not investing. They’re speculating. Could Tesla stock keep going up? Sure. Could it crash? Yes. And if there’s a slowdown out there, and less people are buying automobiles, and that puts a drag on the entire automotive industry, that’s going to put a drag on Tesla as well. Plus, it doesn’t pay a dividend. It’s not that you’re getting paid to hold the stock. For me, that’s a speculative choice. Nothing wrong with that. There’s nothing wrong with people speculating. But they need to know that there’s a very material difference between an investment and a speculation. And they need to know that.
Gene Tunny 16:06
If my portfolio was heavy with stocks like Tesla, I would be a growth investor, rather than a value investor. Is that how I should be–
Paul Mladjenovic 16:21
If they all have that kind of valuation, you’re hoping for growth. But the thing is, in reality, you’re speculating, because you’re expecting a stock with a 200 P/E ratio, that you’re hoping that it goes to 250 or higher, translation meaning that their income is coming in and the stock price is going up. They’re bidding it up, and that way you’re holding it, and your stock went up. But you don’t know that. To me, there’s a greater risk in those kinds of stocks. But the thing is this. Fortunately, it’s not all or nothing. There’s nothing wrong with having a few aggressive speculations in your portfolio, but they better not make the majority of the foundation of your portfolio, otherwise you’ll be at risk, especially since when you juxtapose it today’s macro economic environment, it is riskier out there.
I don’t see anything here that’s going to say that a particular automotive company are going to double the number of their cars they’re going to sell next year, when there’s a lot of debt out there. Interest rates are rising. A lot of people buying automobiles. Some of them, fine, you could buy it all cash, well, good for you, I cheer you on. But the majority of the market out there would tend to be borrowing money. And if interest rates go up, then they may not choose that Tesla. They might choose a competing model for now. I think there’s a lot of fragility in today’s economy, if a lot of these things continue the way they’ve been going. I was expecting inflation and everything else over a year ago, and it’s materialising now. Gene, from what I know about you, you’re a smart guy. You were probably there even before me, and hopefully people have benefited from some of your insights months ago.
Gene Tunny 18:10
Our mutual friend Darren Brady Nelson and I were chatting about this, definitely last year, the potential inflation, just because of, as you would have seen, all of the money growth that we’ve been experiencing associated with quantitative easing, and the housing credit boom that we’ve had in here in Australia, and then in other countries. So yeah, certainly something we’ve been expecting. I’d like to ask all about the P/E ratio again. Clearly, it’s relevant to particular stocks. Are you also looking at it from the whole market point of view? There’s a measure of the P/E ratio for the whole market is in there. Is it the cyclically adjusted P/E ratio?
Paul Mladjenovic 18:58
Exactly. Whenever I see that, what is the cumulative P/E ratio for the S&P 500, for example, which is considered obviously a major yardstick and a major barometer of the general health of the stock market. I haven’t looked at it lately, but I do know that it is elevated. It is higher than it should be the last time I looked. That is also a cautionary tale.
For me, because I like to invest in human needs stocks, they tend to have a lower P/E ratio. And so that’s a measure of safety for me. Not the only one, but certainly one of the primary ones. The other side I like to look at, again, especially when I’m dealing with beginners or beginning intermediates, one of my criteria is also they should be investing in stocks that are paying dividends. We call them stock dividends, but they’re really company dividends, because a dividend that’s being paid out by a company. Obviously, if it’s a successful company, the dividend tends to rise, over an extended period of time, like years and decades. And it’s a sign of health. It’s a clear, tangible measurement of the company’s financial success. If they’re having a dividend that’s rising every year, that’s a good sign. So I like that.
And the other point of it is too is that whenever there’s a market crash or a major market event and stocks go down, you’ll find out that dividend stocks tend to be among those that tend to recover a little bit sooner. For me, if my stock goes up or down 10 or 20%, but my dividends are coming in, quarter in, quarter out, I’m not that worried about it. For many reasons, including in family accounts, we talk about having the cash flow coming in. I have clients and students that I remember from decades ago, that today, they’re getting annual dividend payouts greater than their initial stock investment from decades ago. It’s gotta make you feel good.
If a stock falls, then what happens is that… For example, again, using a simple example, if I have a $20 stock, and it’s paying a $1 dividend, that’s the equivalent yield of 5%. 5% of 20 is $1. All right. So let’s say that today, the market is crashing big time, and my $20 stock went to $10 a share. All right. Obviously, I’m not happy. But the thing is, now that $10 stock, if it’s still paying a $1 dividend – again, I’m looking at the health of the company, it’s making a profit or whatever – if it’s still paying $1 dividend and the stock is $10 now, that tells me that the dividend yield at this moment would be 10%. That is a very attractive yield. So what happens is other investors will go in and bid it back up again. And so it has an easier time recovering.
The bottom line is, Gene, is that healthy, quality companies will keep zigzagging upward, no matter what you throw at them, whereas companies that are not financially stable, don’t have all the numbers, are losing money, they’re going to be zigzagging downward. So, which zigzag you want to be part of? You look at these things, because they’re not mysteries. This is public data.
Gene Tunny 22:18
Yeah, I think it’s great advice. And it’s consistent with what David Bahnsen recently told me when I chatted with him, and he was talking about his views on dividends. He’s very pro dividends. I think it’s also consistent with Warren Buffett, isn’t it? I mean, Warren Buffett looks for those companies that deliver reliable earnings over the long term. And in his day, I’m not sure if it’s still the case now, it was Geico, the Government Employees Insurance Company, and also Coca-Cola, I think. So those are the sort of dependable companies that… Not that I’m making any particular recommendations, but it’s those sort of companies, I’m guessing.
Paul Mladjenovic 23:06
And by the way, the human needed investing, as much as I love it for beginners, etc, in the generic sense, also it tends to be a great approach and strategy during inflationary times. The last year and a half, especially with my end with the Federal Reserve, printing up trillions, look, people forget that inflation is not the price of goods and services going up, it’s the value of money going down. When you over-produce something, and you have more units of it out there, chasing the same basket of goods and services, then don’t be surprised that the prices go up.
Plus, in addition, during the pandemic, and people were worried about their economic situations, etc. , when people are worried, and there’s anxiety, and there’s a declining or low consumer confidence, then people will not invest in their wants. They won’t spend on their wants. They’ll spend on their needs. They may want fancy whatever, trips and vacations and snazzy restaurants and so much more. But if the economy is contracting, and there’s more worry on the radar screen, and people are worried about their companies, their jobs, etc, then they’re going to shrink what they’re spending on that that is want-driven. And they will keep on buying things that are need-driven, so that they’re trying to adjust accordingly to the economic environment.
So all of a sudden, you start to think that those things that we do need, all of a sudden in an inflationary environment, it’s almost like they’ve switched hats to be more growth-oriented. You have found that in the last 3, 6, 9, 12 months, the things we’ve invested in that we needed, all of a sudden, they become spectacularly solid things to put your money in. Grains, for example. I spoke to some of my students last year. I said, “If you’re investing in money, where it’s tied to things that are rising in price such as human need, and you’re talking about energy, gasoline, you’re talking about groceries, which means food and commodities, those things have performed very well.” So, in many cases, I tell people out there and yeah, yeah, good, you can keep complaining about inflation, but part of your action plan is to be invested in those things that benefit from inflation versus being hammered by inflation.
Gene Tunny 25:34
Okay, we’ll take a short break here for a word from our sponsor.
Female speaker 25:39
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Gene Tunny 26:08
Now back to the show. Now with an action plan, Paul, I’d like to explore that, what that means for an individual or for a household, because we need to think about how diversified should your portfolio be, and then also how actively or passively you should manage it. Do you have views on those that you could take us through, please?
Paul Mladjenovic 26:35
Yeah. There’s the simple 80/20 rule, if you want. All things being equal, I’d love to see people put 80% of their foundational investment money into human need things, food, water, beverage, utilities. Again, it’s a very simple question. Ask yourself, what will people keep on buying, no matter how good or bad the economy is. If people are unemployed, they’re still going to eat, they’re still going to turn on their lights. And that’s where you should have your money, especially if you’re a beginner, and especially if these are worrisome times.
And I like the dividend portion, because then I know that, in many cases, especially many brokerage accounts, they give you the ability to reinvest the dividends. So even if you don’t need the money, if the stocks are down and contracting, the dividends will buy more of it. Then on the other side of it down the road, when you’re ready to have the money being sent home to you, it’d be good to know that over a period of years, and you started with 50 shares, now you have 75, 100, 150, and now their dividends are higher, plus there’s more shares, which means you’re going to have more money coming in to make yourself more financially secure in your later years.
A lot of stock investing, it doesn’t have to be mysterious or crazy. A lot of people think that to make the real big bucks got to be extra risky and extra speculative and extra growth-oriented. Well, that might be true with a portion of your money, but it shouldn’t be the bulk of your money. Absolutely. So 80% value to human need. And I’m saying this real time too, March 2022. And I think a lot of people’s experience with human need is bearing these points out. There, at least 80%. How’s that?
Gene Tunny 28:24
So yeah, 80% on investments–
Paul Mladjenovic 28:27
Of your investable money should be in human need things.It doesn’t have to be just stocks. There are ETFs. There’s actually excellent dividend ETFs, where they’re tied to human need and pay dividends. Again, I can’t get specific with this audience because I don’t know who I’m talking to. But everybody knows they can go on a search engine and find dividend ETFs. They can find ETFs.
For example, when the economy is doing very well, and everybody is flush with cash and they’re positive, then they might go for, I said wants, and that basically is a reference to consumer discretionary. When you have extra cash, what do you do? Fancier restaurants, vacation, take the missus out for the weekend somewhere, all good stuff. When you’re talking about a contracting or problematic economy and commensurate issues in the stock market, then you think consumer staples, that’s where a lot of those human needs are going to be.
There are ETFs that invest just in consumer staples or utilities. You don’t have to worry about trying to choose one winning stock. Why not a winning ETF or winning mutual funds? There’s a lot of sector mutual funds out there. There are food and beverage mutual funds. There are food and beverage ETFs. And these would make a lot of sense in today’s environment, for 2022 and probably for the remainder of this year, because I don’t see any spectacular rebound coming in the economy. And if they’re going to raise interest rates, because they’re fighting inflation, somebody’s going to win, somebody’s going to lose.
Right now, there’s people out there who have a lot of fixed bond. That bonds market is huge. You can have a spectacular problem with the bond market, because if there’s a lot of fixed debt, and interest rates are rising, what will people do? You want to get rid of your, whatever, 2.5% bond and buy a 5% bond? That’s fine, but then that means a lot of selling. And so in this environment, I tell people, if you are going to be in bonds, make sure they’re high-quality AAA, and that they’re adjustable rates. And that could be another component of your portfolio, if you want something diversified away from the stock market. Those are the kind of choices, AAA, high quality, and adjustable rates involved so that you’re not stuck. You don’t want to be stuck with a fixed interest rate, like say, 30-year bonds, and rates are going to be driven upward. That’s going to be like a hammer to the value of the bonds you’re currently holding. Okay, so adjustable rate, quality, AAA, if you can have that, that’s the kind you should have.
Gene Tunny 31:03
That’s 80%. There’s another 20%, is there?
Paul Mladjenovic 31:09
Yeah, exactly. If you’re ultra worried, and you don’t want growth, then maybe 20% should be an adjustable rate, high-quality bonds.
Gene Tunny 31:16
Oh, gotcha. Right. So that’s a really safe part of it.
Paul Mladjenovic 31:20
That’s a possibility, exactly. If you’re more growth-oriented, then put 20% into growth-oriented stocks or ETFs, again, depending on… See, the interesting thing is that investing and speculating can be something in a generic, but in many cases, it depends on the person involved. If I’m talking to somebody who’s a year or two from retirement, then you’d bet they’d have to be much more so into very secure things, human need, high-quality, adjustable rate bonds, money in the bank, low debt, and a few other features. That would be important. But if you’re talking to a 25-year-old, I’d still say, keep the bulk in your human need, but now you could put your money into growth-oriented things that are out there, some types of commodities, because inflation is pushing some of these things up. If people have seen the price of gasoline and wheat in recent months, then they get a good idea about the kind of things that grow in an inflation-driven environment, as we’re in right now.
Gene Tunny 32:18
Yeah. What are your thoughts on real estate, so both your own home and also investment properties? Do you have any thoughts on that? One of the challenges we’ve got in many advanced economies is just the very high cost of housing at the moment. And I’ve seen some commentators questioning whether buying your own home actually does make sense for a lot of young people. So yeah, I’m interested in your thoughts on that.
Paul Mladjenovic 32:48
First of all, obviously, owning your own home I think is fine. I see no problem with it. Obviously, I don’t argue with real estate folks. I know some people who will rent a cheap apartment, then they have their money and invested it and buy rental real estate. That’s fine. Some of this is a personal proclivity. Me, for example, I love real estate, but I don’t buy fixer uppers or other type of thing. My favourite type of real estate investing is true real estate investment trusts that I can buy with a few mouse clicks through my brokerage account. Those people who want to be beginners in the world of real estate, and you’re nodding your head so I think you generally agree, that I think real estate investment trusts is a great place for the beginners to be.
I like the idea that with a few mouse clicks I can get in, and a few mouse clicks, I can get out. The same rules of real estate apply when you’re talking about real estate investment trusts, REITs. You look at the type of real estate, and you look at the location, very important. For me, I like that there are a couple of hundred different REITs out there, certainly in the American market. I’m sure there’s more. I’m sure there’s some in your neck of the woods, etc. But REITs are a way that I can buy a few shares, whether it’s 5 shares, 50 shares, 100 shares, or more, I can participate in a real estate property, get my dividends, CD appreciation, but somebody else is… You have an executive team that’s managing all the properties and that’s their specialty. I prefer that.
Keep in mind, real estate investing, think about the types of real estate. Right now, in the last couple of years, I’ve told my students that I would avoid things like office building real estate investment trusts, because I think if the economy’s going to shrink, and you got pandemic residual issues, why do you want to be there? I would be invested in REITs that are in the residential complex. For example, the last few years I’ve avoided like the plague shopping centre REITs, and instead I’ve been looking into REITs that specialise in data storage. They still pay dividends. And you see more movement there. There are REITs that are cell tower REITs. In other words, their property is cell towers. They pay good dividends. And cell towers won’t go out of style anytime soon. And if you have teenagers, you know what I mean.
Gene Tunny 35:23
That’s interesting. I’ll have to have a look at some of those. I wasn’t aware of those. That’s fascinating. Paul, can I ask you about gold and silver? You’ve written on gold and silver in the past.
Paul Mladjenovic 35:36
I’ve written two books on precious metals. And I’ve been very bullish on gold and silver and other metals over the last few years. And I feel that when everything finally shakes out, I see no reason why gold and silver couldn’t be at new market highs in the coming months. I have associates of mine who feel that these things will go to new multiples of where they’re at now. That remains to be seen. But the bottom line is, I do think that gold and silver will be appreciating for a variety of reasons. And I think they’re part of a portfolio that’s really…
Let me tell you, I can give one important reason why everybody in your audience should own at least a little bit of gold and silver. Are you ready? I’m going to give you a reason that you won’t hear very often. And by the way, if your financial advisor talks you out of them, tell them to call me. And this is what I meant. Okay, so anybody within the sound of my voice, remember the following phrase, counterparty risk. Counterparty risk. That’s the number one reason why you should have some. I’m not asking you to head for the hills and live in a cave and have a tonne of either one. No, not really. You should be diversified away from the risks of paper assets.
Me, I love gold. I love stock investing. I love the paper assets, definitely. But I favour gold and silver, the physical, because gold and silver are two assets that are among the few assets on the landscape of choices, of investment choices that do not have a counterparty risk. You talk to your financial advisors about this, see if they know this point. It’s very important. Years ago, I remember I used to even teach financial advisors, and I think this is an important factor.
What is counterparty risk? See, here’s the thing. If you invest in any type of paper assets, you’re undergoing counterparty risk. For example, if I buy stock, the counterparty risk is the performance of the company. In other words, counterparty risk means that if you invest in an asset, the value of this asset is directly dependent upon the promise or performance of the counterparty. If I buy stock, and that company is doing great, my stock will be fine, I’m sure. At the moment that counterparty fails, falters, goes into debt, goes bankrupt, what’s going to happen to the value of my stock at that point? You follow? There is counterparty risk with stocks.
Bonds, perfect example of counterparty risk. If I invest in a bond, the first risk I think of is that, will the payer of this bond pay back the principal and the interest as stipulated in bond agreements, to me as the bond holder. There’s counterparty risk there. What if that entity defaults? Many times in history, especially during bad economic times, people have defaulted on bonds. And so you have to understand that, but also to currencies.
Right now, inflation means that that money is losing value. And that’s a counterparty risk, because a currency is only as good as the counterparty being the central bank of that country, managing, hopefully, properly, that money supply. And we’re seeing that there’s inflation everywhere, the ruble falling apart in Russia, because of the conflict, runaway inflation in Venezuela, etc. In many cases, the currency of a country is similar to the dynamic of the stock with the company. When the company is doing well, the stock does well. If the country is strong and doing very well, and they’re managing their currency, then that currency will be strong. But once you mismanage that, and the currency goes into hyperinflation…
By the way, you’re talking to a guy who has experiences personally with my family. In 1963, as a four-year-old with my family, we escaped communist Yugoslavia. And by the way, communism is a horrible thing, but that’s a different conversation. But they, in 1993, 1994, tried to help out their own economy with inflating the currency, the dinar, and you had one of history’s greatest hyperinflationary catastrophic incidents occur in Yugoslavia, and it collapsed into nothing basically. No more Yugoslavia as of 1994 . I got married in 1993. So my wife and I were thinking about going to Yugoslavia for our honeymoon, but as the civil war it was going through and collapse, these things ruin a good honeymoon. So we opted for the Caribbean instead. And in retrospect, am I glad I did.
Gene Tunny 40:18
Paul Mladjenovic 40:19
Currencies have counterparty risk. Virtually every paper asset you can think of has a counterparty risk. Its value is directly tied to the promise or the performance of a counterparty. Gold and silver have their own intrinsic value. Gold and silver have never gone to zero. They had value thousands of years ago, they have value now, and likely, gold and silver will continue to have value far into the future. So precious metals, and I mean, the physical, look into bullion coins and the like. Do your shopping. As you know, I did the book Investing in Gold and Silver for Dummies. It’s a whole book on how to choose and shop for it, etc. But gold and silver, again, are a diversification away from currency mismanagement, away from the risk of paper assets, away from geopolitical and other risks. And I think that that is an important fact. And let’s face it, you hear about the rich over the aeons, the centuries, they always had gold and silver. The people are in the know. They know something, I think that’s something for you, that should be a clue to you to start figuring it out and seeing if a small portion does make sense in your overall picture. And I think given today’s economic realities, a portion of it doesn’t make sense.
Gene Tunny 41:38
What about NFTs and crypto that everyone’s talking about? Have you had any exposure to that or do you have any thoughts on that? There’s a lot of excitement about it.
Paul Mladjenovic 41:52
Let me tell you, a few years ago, I was asked about writing a book on cryptocurrency. And the point is, I think I’m good at what I know, but I know the limits of what I know. And I got them a great author on that book. So my publisher does have one called Cryptocurrency Investing for Dummies, and she does a great job with it.
Again, I feel the same way, having a small portion of it is not a bad idea. But there’s been just a lot of, I don’t know, overwrought speculation about it in recent years. And the thing is this. Part of the success of cryptocurrency, again, was the idea that it’s limited in scope. And, and so obviously, if you don’t over-produce it, and more people are buying it, then of course, you’ve seen how well it’s performed. I mean, it’s been amazingly volatile, crashing here and there. And I think investing small amounts here and there, again, as a small diversification away from everything else, is not a bad idea, but a lot of these people who are going whole hog into it, etc, we have to be careful. You have to remember that the governments of the world look at cryptocurrencies as a competitor, and nothing stops them from waking up one morning, passing a few laws and regulations, and all of a sudden, your cryptocurrency becomes problematic versus being an asset. So again, tread lightly here. Obviously, you may get a cryptocurrency expert on who will have a totally different opinion. And I’m not here to argue with those folks.
Again, I think having some cryptocurrencies is fine. And for me, some of my clients, I say to them, why not get some of the blockchain technology companies, because that way, you’re indirectly working with it. And that worked out to be a pretty good speculation. But again, same feelings as with gold and silver, have some of it, not an overwhelming amount, because you never know, because cryptocurrency… Everything we’re talking about has some kind of risk. With cryptocurrencies, what happens? I mean, it’s extremely dependent on electricity. What happens when there’s a power outage? Can you trade with it then? I doubt it.
The whole point about guys like me, in my industry… I was a certified financial planner for 36 years. I retired it a year ago, but I’m still active with education and teaching about this and I love my topic. I doubt I’ll retire anytime soon. I love what I do too much. However, the world of CFPs and financial advisors, they live and breathe the word diversification. Every asset has some type of risk attached to it, if you have money in the bank, fine, you’re away from financial risk, but now how about inflation risk, purchasing power risk, and a few other ones out there? What if the bank closes its doors because there’s a national crisis with the central bank, etc?
This is why you have a little bit across the board. That diversification just makes you stronger and not dependent on the goodness or wellness or the speculative success of an individual entity or asset class. Again, have some cryptocurrencies, fine. Have a couple of different ones, fine. But don’t have your life savings in it. Don’t put too huge of a percentage of your investable assets in it. Same thing as I would say with many other things that are out there. And of course, everything mitigates things. If you are a real estate expert, then having more of a portion of your assets in real estate is not that big of a deal, because your personal expertise is mitigating the extra exposure, but that’s fine. Knowledge is always the thing you should be accumulating the most, after accumulating your wealth, because the both of those things are tied together.
Gene Tunny 45:40
Yeah. Very good observation there, Paul. A couple more questions on how actively should a person be managing their portfolio. Typically I’ve just sort of said, maybe I made some decisions, like a couple of years ago, I’ll invest in this ETF or I’ll have these investments. And I’ll just commit to putting a certain amount in every month or whatever. And you get that, they call it that dollar cost averaging technique. You’re not worried about what the prices are at any particular time. And then over time, you do better out of that. How do you think about how actively investors should be managing their portfolios? How frequently should they be reviewing their selections? Any thoughts on that?
Paul Mladjenovic 46:36
Again, everyone’s a little bit differently, but if you’re not reviewing monthly or quarterly statements, if you’re not speaking to whoever you trust at least once a year or once every half year, then there’ll be issues, obviously. The more you’re aware about what you have, the better. I mean, I look at decisions every day, for my family. And the interesting thing is, if there’s one thing that people need to understand also, it is that to be successfully monitoring your situation, keep in mind that successful investing isn’t just what you invest in, but how do you go about doing it. If your positions are residing in a brokerage account, then nothing stops you. I highly encourage everybody within the sound of my voice to speak to your customers, to your brokerage firm’s customer service department, ask about things, about tutorials and things like stoploss orders, trailing stops. Sometimes you could do some, again, to a small extent, things such as covered call writing, which gives you income. It’s a hedge on a position as well, in some cases.
For example, trailing stops, I’m a big one on this, if, if you’re nervous about what you’re holding, alrighty, then again, it’s not just what you invest in, it’s how you go about doing it. Then you should consider trailing stops to minimise the downside. Now, what does that mean? Well, well, first of all, the generic about a stoploss order. If I bought a stock at 20, and I’m nervous about it, then I should put a stoploss order in at 18, 10% below, just as a generic point. 10% lower, you give it room to fluctuate. My stock at 20, if I bought it, obviously, there’s no upside limitation. But at 18, I now have downside limitation. In other words you’re adding discipline to your situation. You’re not just blindly watching this stuff. You could put that stoploss order in for the day or make it good until cancelled. It could sit there for three months.
If you’re worried about the coming weeks and months, go through your portfolio. If you need to go with your financial advisor, by all means, and say, I’m nervous about position x over here, what should I do? Well, they should be telling you. First of all, if it’s quality, that should remove some of the anxiety. But if you’re still worried, then either, A, sell it if you need the money, or if you don’t need the money, then put in a stoploss order in it. And then what happens? Let’s say your $20 stock zigzags up to 30. Okay, well, now what? That $18 stoploss, cancel it, like it says, good until cancelled, and replace it with one at 27, as an example. Now, what happens? The stock is at 30, you put a stoploss in at 27. Well, now what? Now if there’s a market crash, stock will go down, will trigger a sell order at 27, and you’re out. And you kept 100% of your original $20 plus a $7 per share profit. You added diligence and safety and discipline to your situation, not because you were expecting it, but because you started worrying etc. Then put those on. What’s the worst that happens? You’re selling and protect your money and keep a portion of your profits. Well then, that’s the very essence of prudent investing. You follow?
So in other words, everybody within the sound on my voice, if you have a brokerage account, go to their site. They’ve got to tutorials and other things. Call them up. Ask them, hey, what can I do if I’m worried about my stock dropping? What can I do? Have that conversation. But I find that a lot of people don’t have those conversation, and then what? Then when there is a market crash, and your positions plummet all the way down to the bottom or whatever, or lose 50%, then you do could’ve, would’ve, should’ve, you have anxiety, and so much more.
Right now, as I’m talking to you, the markets are generally in good shape today. But that could change next week. You could have a 1,000-point drop on a Monday morning, because you have trillions flowing in and out. You’ve got sanctions and unintended consequences. You don’t know when the next crisis is going to blow up, which in turn will blow up point A, point B, point C, and all of a sudden, you wake up one morning and your position or your broker has been hammered to pieces. Again, diversification. Remember that you have many tools and tactics in your pocket with these brokerage firms that you should be fully aware of. When you’re fully aware of these and you start applying some of these things in a very modest way, your confidence grow, your knowledge grows, which means more importantly, your financial security does better.
Gene Tunny 51:18
Yeah. Okay. I might ask one more question before we wrap up, Paul. There was an interesting passage in your book on Stock Investing for Dummies, where you’re asking what school of economic thought does the analyst adhere to? So this is things you should ask about analysts when you’re assessing the value of their contributions, what they’re saying, what their advice is. You make a point that if there was one that adhered to the Keynesian school of economic thought, that’s analyst A, and analyst B adhered to the Austrian School. Guess what? I’d choose analyst B, because those who embrace the Austrian School have a much better grasp of real world economics, which means better stock investment choices. Could you explain what you mean, there, please?
Paul Mladjenovic 52:05
Well, it’s funny, you brought up an interesting point. I mean, I love the Austrian School. And as you know, Darren is a devotee of that. It doesn’t necessarily mean the Austrian School… There’s a couple of other schools that are pretty good. There’s the Chicago school, Milt Friedman, I admire his work. It’s just that there are many financial advisors out there who… Obviously, Maynard Keynes, I don’t think highly of him. I mean, if I had a financial advisor who loved Karl Marx, I would be terrified, because that tells me they know nothing about economics. I’m serious about this. Yeah, I’m very serious about it.
By the way, to me, it’s not that I look for a financial advisor who’s into these particular schools. Question number 17, that helps me hone my selections. I want to make sure that they’ve been around for a few decades, they’ve seen bear markets and bull markets. That’s a much more important criteria for me that they understand these things. But if it ever comes down to the school, I’m going to make sure they understand, because remember, it was the free market schools out there were warning about the Great Depression, they were warning about stock market bubbles, and they were warning about these things. I found out that these disciplines helped me be a better tactician and strategist with the money.
I mean, I remember when I read an article about the stock market bubble in 1999, and that was from the point of view of the economics. That just cemented some of my concerns about the stock market. What did it mean? For those students and clients who were your conservative, retirement-oriented, made sure they were in safer waters. But those people out there who were speculators, like me, for example, I made sure that I was not invested in the internet stocks of 2000, because the first wave, you don’t know which ones are going to survive or not. They were all losing money. So in terms of investment, I stay away from them. However, my speculative side, I was buying long-term put options on these. So when these things collapsed, my speculative put options garnered some very nice gains. And that was my speculating.
Understanding basic economics and following some of these schools of thought would just enhance your ability, because obviously, understanding the macro picture makes you a better choice of which micro choices, which stocks and ETFs are going to either survive or thrive in that kind of economic environment, and it actually gives you another leg up. When you understand the big picture, it just makes it better choices in your own portfolio, so you could sleep better at night and serve the family that you love.
Gene Tunny 54:48
Okay, that’s a great point, Paul. I was just thinking about Keynes. Keynes himself was a rather good investor and made a lot of money for King’s College in Cambridge. However, I think there’s some speculation that he may have benefited to an extent from insider knowledge he gained while working for the Treasury.
Paul Mladjenovic 55:13
That’s very possible. And actually, when you think about it in the 1920s, look him up, there was an economist called Irving Fisher. When the stock market was in bubble territory, he was notorious for making the call that he feels that they’ve reached a permanent plateau. And this was whatever, like six or nine months before the crash of 1929, and he had been filing for bankruptcy. So no one should have listened to Irving Fisher, including Irving Fisher.
Gene Tunny 55:42
Exactly. Okay. Paul, any final points before we wrap up? I think this has been great. You’ve given me a lot to think about. And I mean, I think we could chat for hours on this stuff. But I think I’ll have to wrap up now. And yeah, I’d be keen to chat with you again.
Paul Mladjenovic 55:57
I really appreciate it. I mean, obviously, you mentioned Stock Investing for Dummies, I’ve done a lot of books out there. So I certainly invite people to see if those things help them with theirs. And if people want to find me, I’m at ravingcapitalist.com. But the point is this. Knowledge is really so important with all of this, and the idea that you’re a better consumer or a better investor, it also makes you a better voter, too, , and it also makes you much more aware of what policies out there will do harm and which ones will do right, and which investments will go up or down accordingly. It’s all about the knowledge. Ignorance is going to be extremely problematic in the coming months. So I invite them to get as much knowledge as possible, apply it, talk to everybody, you’ll be much better off. If they keep on listening to gentlemen such as Gene Tunny, then I think they’ll be served well, and thank you again and again. God bless your audience, and I wish them all prosperity.
Gene Tunny 56:54
Thank you. Paul, it’s been a pleasure. Really appreciate your time. And yeah, I hope to chat with you again soon. Thanks so much.
Paul Mladjenovic 57:02
Continued success to all of you. Take care, Gene.
Gene Tunny 57:04 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 email@example.com And we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.
Big thanks to EP133 guest Paul Mladjenovic and to the show’s audio engineer Josh Crotts for his assistance in producing the episode.
With US inflation at a 40-year high, who wins and who loses? Are greedy corporations to blame as some pundits are suggesting? Episode 127 of Economics Explored features a wide-ranging conversation with Darren Brady Nelson, Chief Economist of LibertyWorks, an Australian libertarian think tank, which also considers so-called Woke Capitalism and what’s going on with China. Here’s a video clip from the episode featuring Darren chatting with show host Gene Tunny about the 40-year high US inflation rate.
In the second part of the show, the Grattan Institute’s Economic Policy Program Director Brendan Coates explains the franking credits controversy, related to some peculiar Australian tax rules, to show host Gene Tunny.
Darren Brady Nelson is an Austrian School economist and liberty evangelion as well as a C.S. Lewis and G.K. Chesterton style Christian. He is currently the Chief Economist at LibertyWorks of Brisbane Australia and a long-time policy advisor to The Heartland Institute of Chicago USA. He is also a regular commentator in traditional and online Australian and American media. Check out his full profile at Regular guests – Economics Explored.
Brendan Coates is the Economic Policy Program Director at Grattan Institute, where he leads Grattan’s work on tax and transfer system reform, retirement incomes and superannuation, housing, macroeconomics, and migration. He is a former macro-financial economist with the World Bank in Indonesia and consulted to the Bank in Latin America. Prior to that, he worked in the Australian Treasury in areas such as tax-transfer system reform and macro-economic forecasting, with a strong focus on the Chinese economy.
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.
Gene Tunny 00:01
Coming up on Economics Explored.
Larry Reed 00:04
When government comes in and says, “We don’t like prices rising as fast as they are. We’re going to impose controls to prevent that from happening.” First of all, it is treating a symptom of something else. It’s not dealing fundamentally with the issue at hand that produced the rising prices in the first place. It’s a political diversion.
Gene Tunny 00:25
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 125 on price controls, which some commentators are suggesting could be used to reduce inflation. We also explore some other topics, such as whether Jesus was a socialist, why Joe Biden arguably should look back to the 21st president Chester Arthur, and why the separation of bank and state is so important.
My guest this episode is Lawrence W. Reed, President Emeritus of the Foundation for Economic Education, a leading pro-free market educational nonprofit headquartered in Atlanta, Georgia. Larry has authored nearly 2000 newspaper columns and articles and dozens of articles in magazines and journals in the United States and abroad. His writings have appeared in The Wall Street Journal, The Christian Science Monitor, USA Today, The Epoch Times, and The Washington Examiner among many other places. Larry is frequently interviewed on radio talk shows and TV, including on Fox Business News.
Please check out the show notes for the links to materials mentioned in this episode and for any clarifications. You’ll find the show notes via your podcasting app or at our website, economicsexplored.com. If you sign up as an email subscriber, you’ll be able to download my new eBook, Top 10 Insights from Economics, so please consider getting on the mailing list. If you have any questions, comments, or suggestions, please either record them in a message via SpeakPipe. See the link in the show notes or email them to me via our contact at economicsexplored.com. I’d love to hear from you.
Now, for my conversation with Larry Reed from the Foundation for Economic Education. Thanks to my audio engineer, Josh Crotts for his assistance in producing this episode. I hope you enjoy it.
Lawrence W. Reed, President Emeritus of the Foundation for Economic Education, welcome to the programme.
Larry Reed 02:45
Thank you very much, Gene. It’s a pleasure to be with you.
Gene Tunny 02:47
It’s great to have you on, Larry. I have been reading a lot of your writings lately. You’ve started off the year very well and coming on important issues, crazy proposals such as price controls. We might chat about that a bit later. But first, I’d like to ask you about the Foundation for Economic Education. Could you tell us a bit about what its role is and the type of activities it engages in place?
Larry Reed 03:16
Your listeners and viewers can learn a great deal more by visiting its website, which is FEE.org. The foundation was created in 1946 by a great man named Leonard Read. He was no relation to me. He spelled his name R-E-A-D. But after World War Two, he looked around and realised that there was no organisation in the world that was full-time devoting itself to explaining and defending how free enterprise, the profit motive, private property, how that system works. He created the foundation for the purpose of spreading those ideas.
Over the years, our message and our principles have not changed. But the focus of our message and principles has somewhat changed. It’s become a bit more focused on young people, specifically high school and college age. We do that through programmes in-person all over the country, in the US, and abroad, as well as the website videos, on the website courses, you name it. All designed to explain how freedom and free markets work.
Gene Tunny 04:31
You mentioned Leonard Read? Did he write that famous essay, “I, Pencil”?
Larry Reed 04:37
Yes, he did in December of 1958. That has had a remarkable impact on people all over the globe.
Gene Tunny 04:45
Absolutely. I think it shows how complex even products that we think of as simple are and there’s no way any central authority and this is what we discovered with the Eastern European socialist economies with the Soviet Union. You can’t plan this sort of thing. You need to rely on the market mechanism to be able to produce even something that we might think as mundane as a pencil. I’ll put a link in the show notes to that essay because I think it’s brilliant. I think Milton Friedman quotes from it in Free to Choose, if I remember correctly.
Larry Reed 05:23
After someone reads it, they are well-armed to take on a central planner type. Every time I run into somebody that thinks that he knows enough that he can plan an economy of millions of people, I always say, “Wait a minute. You don’t even know how to make a pencil, let alone an entire economy.”
Gene Tunny 05:44
That’s right. You got to think about it. You’ve got to get the timber, you’ve got to cut it, you’ve got to get the graphite, etc., combine them all together. A great essay. Is Hazlitt associated with the foundation? He wrote that book, is it “Economics in One Lesson”? Is that one of the books that you promote?
Larry Reed 06:07
Yes, it is one of the more popular offerings from FEE in the last 70 years. Henry Hazlitt was long associated with FEE. He was one of the charter members of its board of trustees, a good friend of our founder, Leonard Read, and was on the board for decades. I’m happy to say that I knew him personally for the last decade of his life.
Gene Tunny 06:33
That book has had a big impact too. He must have been pleased with how that was received.
Larry Reed 06:40
Gene Tunny 06:42
Very good. We might get on to some of the topical issues. The big economic issue at the moment is inflation. We’re seeing accelerating inflation in advanced economies. In a way, this probably should have been expected, given the big expansion in the supply of money that we’ve seen in United States, United Kingdom, Australia, to a lesser extent, but still a substantial increase.
Now, we’re starting to see that in inflation. Some people are saying it’s temporary. There could be some temporary element, there’s a supply-chain disruption. Who knows? My view is that it is something we’ve got to worry about. People are starting to talk about, “What do we do about it?” There’s a monetary policy response. But there are people who are thinking, “Let’s be careful because we don’t want to constrain economic growth and cost jobs. Why don’t we look at price controls?” You’ve written a great article, “Price Controls: Killing the Messenger If You Don’t Like the Message”, could you talk about what you mean by that please?
Larry Reed 07:51
Yes, I’d be happy to. We should think of prices as conveying immense amounts of information. Prices result from the free interplay of supply and demand, which in turn reflect the individual choices, ambitions, opportunities, tastes, and you name it of endless consumers in the marketplace. Prices don’t accidentally arise. The notion that you can fiddle with them by government decree with no consequences is ridiculous. It’s anti-science. It’s anti-economics. Prices are what they are in free markets for good reason because they’re reflecting conditions of supply and demand and people’s preferences and tastes and so forth.
When government comes in and says, “We don’t like prices rising as fast as they are. We’re going to impose controls to prevent that from happening.” First of all, it is treating a symptom of something else, it’s not dealing fundamentally with the issue at hand that produced the rising prices in the first place. It’s a political diversion. It’s politicians, who on the one hand, have got their hand on the printing press cranking out easy money at low interest, easy credit, and pumping up prices. At the other hand, they got a club in their fist and they want to beat people for responding the way you would.
If at any time you massively increase the quantity of something, it will affect the value of every single unit and they’ve been expanding the money supply immensely. If they put on price controls to prevent prices from being at some higher level, all that does by treating a symptom not the cause, is to create economic problems of their own. It creates shortages, for instance, if the market price of something would be $10. But government says, “No, you can’t charge any more than $7.” What happens is at $7, more people want the stuff and fewer suppliers will provide it. That would be the case at $10. You got a double whammy. You got less of the stuff coming on the market and more people wanting it at that artificial price. Bingo! Long lines at stores and shortages. People who propose price controls are ultimately anti-economic science and oblivious to the effects that we have seen historically, literally for centuries with no exception.
Gene Tunny 10:22
One thing about this issue, it seems to be something that the vast majority economists seem to be in agreement on which is good. You quoted in your article, there was an Op-Ed in The Guardian. The title was, “We have a powerful weapon to fight inflation price controls, it’s time we consider it” and Paul Krugman responded, “I am not a free market zealot. But this is truly stupid.” Absolutely. You’ve had experience in the US in living memory of price controls? Was it in the 70s that Nixon’s Whip Inflation Now and then Carter, perhaps with their controls on the price of gasoline that did lead to these big lines at gas stations in the States?
Larry Reed 11:21
The Whip Inflation Now thing actually was Gerald Ford. That was a campaign to get people to wear buttons that said, “whip inflation now” as if that would somehow whip it. Before him, it was Richard Nixon, who actually imposed wage and price controls. First, in the form of a 90-day freeze on virtually all wages and prices and then followed by government directed prices that limited by how much they could rise.
Every economist worth his salt knows that that produced disaster. That was no solution to anything. It gave us long lines at the gas pump and empty shelves in the stores. It was ridiculous. I used to know a man, he’s deceased now, but he was chairman of the Council of Economic Advisers, Paul McCracken, great economist. He cautioned Nixon not to do this. He said it’s never worked in 4000 years, don’t even think of it. Nixon went ahead anyway and shortly thereafter, McCracken resigned.
We’ve had lots of experiences. Lots of countries have had experiences with it. Revolutionary France in the 1790s, the government imposed the so-called Law of the Maximum, which said that government will fix the maximum price of things and the penalty for violating that will be death. They guillotined a lot of people for that and it did not make anybody produce more of anything.
Gene Tunny 12:55
That’s a negative supply shock too, isn’t it? Killing your producers? Terrible. That’s some good stuff there. I take it your view would be that inflation is a monetary phenomenon. Therefore, the key to controlling it is to get your monetary policy, right? This isn’t about monetary policy, but I’m guessing that’s where you’re coming from. There’s a big debate about what that means and role of the Fed, etc. But would that be your view?
Larry Reed 13:33
Inflation, Milton Friedman famously said, “is anywhere and everywhere a monetary phenomenon.” I’m sympathetic to that but I also point out that there’s another dimension here. Prices ultimately reflect, to a great extent, what’s going on in people’s minds. There are extraordinary circumstances, but there are occasions when you could have soaring prices without an increase in the money supply. One of the examples I like to point to is the Philippines.
During World War Two, when the Japanese had occupied it, they imposed their currency on the Philippines. General MacArthur was attempting to ultimately take the Philippines and he was jumping from island to island, getting closer and closer. The Japanese weren’t dumping any more of their paper money into the Philippines and yet, prices would leap every time word came that MacArthur was now a few hundred miles closer. That’s because people’s estimate of the value of that money declined because they knew if he gets here and takes the Philippines back, the Japanese currency will be completely worthless. Given that prospect, we’re happy to pay any price to get anything now while it’s worth something. That’s a rare occasion.
We’re not facing that circumstance today. We do have to fall back on the fact that today’s inflation that we’re witnessing is not a Philippine-style rise in prices. It is a monetary phenomenon, reflecting the massive increase in money and credit that our Federal Reserve in the US has manufactured. Many central banks around the Western world have done as well.
Gene Tunny 15:21
That’s a great story about the Philippines. I’ll have to look that up. MacArthur is a great hero to many of us in Australia because there’s a view that he essentially saved Australia. He based himself in Australia after he fled from the Philippines and he had an office a little bit down the road from where I am here in Brisbane in the ANP Building during World War Two. That was one of the locations from which he waged the war in the Pacific. Great story. Very good. That’s a good discussion of price controls, Larry.
I’d also like to ask you; you’ve also written about whether Jesus was a socialist. I’d like to ask you about that. Also, I don’t know if you saw the recent controversy around Dave Ramsey’s comments. Dave Ramsey, the esteemed financial commentator in the US.
Larry Reed 16:21
Yes. Although I may not be aware of recent comments that you’re bringing up.
Gene Tunny 16:26
Essentially, someone asked him a question, “As a Christian, should I feel bad if I raise the rent on my properties to the market rent, and then that means that some of my tenants can’t afford to live in those properties anymore. It causes them financial hardship.” Dave Ramsey’s comments weren’t received by many, particularly on the progressive side of politics because he said, “There’s no problem with doing that because it’s not me that is evicting you. It’s actually the market.” He was appealing to the market. I’d like to ask you about that. If you haven’t seen his comments, and it’s probably worthwhile considering the whole context of them, feel free not to comment on that.
But I would like to ask you about your work on, was Jesus a socialist? Could you take us through what your analysis of that question has revealed, please, Larry?
Larry Reed 17:29
I’d be happy to, Gene. In fact, the best way to begin that is to tell the story from the New Testament that answers your first question. Along the lines of what Dave Ramsey apparently said. Jesus Himself told nearly 40 parables and most of them deal with things like eschatology and salvation and so forth. But at least three of them have very strong economic content.
One of them that’s relevant to what you’ve just raised is the parable of the workers in the vineyard. This is about a man who apparently owns a substantial vineyard and he needs to bring the grapes in, it’s harvest time. Jesus tells a story of how he gets a group of workers together first thing in the morning and he says, “I’ll give you each a denarius for a full day’s work.” They say, “Okay.” They go out and they start picking grapes.
Around noon time, the owner realises, “I’ve got to get even more out there.” He gets another group together, and he says, “Look, I know that the day’s half-gone, but if you’ll go out for the rest of the day and pick grapes, I’ll give you each a denarius.” Finally, at the end of the day, with maybe an hour before a dark and he still has grapes that have to come in, he calls another group of workers and says, “If you’ll take time out, go out for an hour and pick some grapes, I’ll give you a denarius.”
Later, according to the story, the owner gathers all these three groups of workers together to pay them. The first group is very angry, because they’re saying, “We worked a full day and you’re giving us the same as those guys who showed up at the later, even the ones that only worked for an hour.” You would think that if Jesus were a socialist, he would have the vineyard owner saying, “You’re right, this is unfair. I’m sorry about that.” But instead, Jesus has the vineyard owner say to these guys, “It’s my money. You signed the contract. I’m giving you what I promised. Now, take it and get out of here.”
That’s Jesus basically saying, private property, voluntary contract, keeping your word, honest dealings, and I think supply and demand all defend what the vineyard owner is saying. Presumably, he had to pay that last group of workers a hefty premium to get them. They probably worked for somebody else all day and now, they’re being asked to go for yet another hour, he has to pay them a premium to do that to bring the grapes in.
Jesus does not say, “Let’s be compassionate and give this group the same as that group or in proportion to their time.” Instead, he says, “Each man is getting what he was promised when he agreed to by contract.”
I think Dave Ramsey is essentially right. There is no obligation, moral or otherwise, for someone to endure a loss or to get less than he could for property that’s his when market conditions suggests that a higher rent is worth it. It’s the higher rent that will likely bring more housing units into the marketplace, which will solve the problem in the long run anyway.
Gene Tunny 20:47
By inducing more supply, more investment in rental properties. That’s a good point. I’ll put a link to the article on Dave Ramsey. I thought it was a fascinating discussion. Also, I’ll find something to link to that. Was it a parable?
Larry Reed 21:12
The parable of the workers in the vineyard. I discuss that in more detail in my book, “Was Jesus a Socialist?” if anybody cares to look at it from that perspective.
Gene Tunny 21:25
It’s an interesting question. I must say, I’m surprised that it is something that’s up for debate. Is this because a lot of people on the left side of politics have appealed to Christianity as a way to support what policy positions they’re advocating for?
Larry Reed 21:51
I think so. I don’t give the left much credit for their economics, but I do give them credit for their marketing, because they’re always out there saying, “Go with us because our way of thinking will produce more for people. We’re going to take care of people. We’re going to give them stuff. It won’t cost them anything, they won’t have to worry about where it’s coming from.” The rhetoric is always very promising, but the results and the outcomes are pretty dismal and miserable.
A lot of people come to this mistaken conclusion that Jesus may have been a socialist because He talks so much about helping the poor. But I think in capitalist countries, where more wealth is produced, you have more giving and more caring and more philanthropy than you have in socialist countries. In fact, even government-to-government foreign aid is primarily from the predominantly capitalist countries to the predominantly socialist recipients.
If Jesus came back today and spoke to a large audience of people and said, “I was interested in the poor. Tell me what you all did for the poor?” If you raised your hand and said, “I voted for all the politicians who said they’d take care of that.” I don’t think He’d be impressed. I think He would say, “You’ve resorted to theft? I told you not to steal and I told you furthermore that the poor are folks that you, from the generosity of your hearts and your own resources, ought to help. I never told you you could pass it off to politicians. If they solved the problem, it’ll be at 10 times the price.”
Gene Tunny 23:33
Yes, that’s a good point. I’ll have to come back to this in a future episode and looking at what are the best ways to reduce poverty of it if we’ve actually figured that out? Clearly, the welfare state that we’ve got in countries like Australia, the UK, to a lesser extent, the US, you could argue it has relieved some absolute poverty. But at the same time, it does, arguably, traps many people in poverty in a way.
Larry Reed 24:07
To make a long story short, you can’t solve poverty if the pie is shrinking. You have to make a bigger pie and there is no known system in the history of mankind that makes a bigger pie faster than the system of freedom and free markets.
Gene Tunny 24:24
Absolutely. We’ll take a short break here for a word from our sponsor.
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Gene Tunny 25:03
Now, back to the show. The other things I wanted to chat with you about before we wrap up are some recent articles of yours. There was a piece, “Why I Wish We Could Put Chester Arthur and Joe Biden in a Room Together to Talk Infrastructure Spending”. I’d love to hear about that, particularly about Chester Arthur, because he’s one of the lesser-known US presidents.
Larry Reed 25:34
Yes, he is one of the lesser-known ones. He served less than one full term. He took office as vice president, became president when James Garfield was assassinated in the middle of 1881. He served about three and a half years, the rest of Garfield’s term. He’s often written off as sort of—he was tied to the corrupt Tammany Hall machine in New York and so forth. On the good side, historians will remember that he did support civil service reform and made the federal government a little less corrupt. That was a good thing.
But he also understood the Constitution and appreciated it more than Joe Biden does. I wrote that article pointing out what Arthur’s view on infrastructure spending was compared to Joe Biden’s in America. We recently went through a national discussion, a bill passed, supposedly bipartisan. It was a massive, almost $2 trillion in infrastructure spending.
An equivalent bill was called a Rivers and Harbors Act and Arthur vetoed it. In his veto, he raised some great objections, all of which are applied to the bill that Biden recently signed. He said, “This is way too much. There’s no way that a government of our size can know where all this money’s going to go. It looks like a small portion of it is even earmarked for infrastructure. There’s a lot of pork barrel stuff in here. Quit doing this, loading our bills and all this other nonsense.”
That’s what Joe Biden should have said about the recent infrastructure bill. But he was all for it from the start. I think about 10% was aimed at infrastructure, the rest is pork barrel and progressive agenda stuff. I would like to put Joe Biden and Chester Arthur in the same room and say, “Chester, go at it. Tell this guy what infrastructure is and why it’s wasteful to spend so much on.”
Gene Tunny 27:46
At the same time, would you say that there is an issue with infrastructure in the US with the quality of infrastructure? This is something I’ve chatted with Darren Nelson about in a previous episode and Darren’s view was, “We need to get the private sector more involved in public-private partnerships, perhaps.” Do you have any thoughts on that, Larry? What is the quality of infrastructure like? Is there a problem to solve and how would you go about it?
Larry Reed 28:19
With infrastructure, I think there has always been some measure of problem, because government has assumed from the start that this is a legitimate profits of government. Once you do that, you have to at least expect that they’ll keep it up and do it right and keep an eye it to prepare for when it falls apart. But politicians come and go and they’re more interested in the flash in the pan. They show up to cut the ribbon at the start of a bridge that’s being built. But once it’s built, it’s no longer politically sexy to stand around and keep an eye on it in case it collapses because they figure, “If that happens, it’ll be a long after I’m gone. Why should I care?”
You do end up with politicians putting more focus on the construction of the stuff and less on its repair and maintenance. That’s where you can get a bigger bang for your dollars or if you will, by writing contracts with the private sector that require ongoing maintenance and inspection and so forth. I wouldn’t want the government with its own employees and its own infrastructure monopoly becoming a bridge builder. They don’t know about bridges. That’s best done by the private sector. They should be contracting with private sector providers to do it and monitor the contracts. Put all the provisions in those contracts that would require proper maintenance.
Gene Tunny 29:52
That’s a good point. It’s one of those great challenges, how do you get the infrastructure that you need cost-effectively? In Australia, one of the problems we’ve got, there’s a lot of government investment going into infrastructure at the moment that it seems to be at very inflated prices all over the country. There’s a powerful construction union, which is allied with the government in the state that I am, Queensland, which has ended up inflating the cost of any infrastructure project by 30% or 40%. It’s quite extraordinary and taxpayers end up wearing that.
Larry Reed 30:43
I wouldn’t be surprised if you have some of the same kind of history in Australia, as we do in the US. But there’s a lot of history in America of government spending on infrastructure that produced disaster, because it dangled subsidies in front of private contractors, who then went after the subsidies and cared little about how well the infrastructure itself was actually built. The best example is America’s transcontinental railroads.
There were five of them built across the country. Four of them got extensive federal government land grants and subsidies. Not only land grants, but they got subsidies on a per mile basis. Four of them threw down tracks just to get the goodies. And in fact, the two famous ones that met at Promontory Point, Utah, as they were getting closer, they were crossing over to the other companies’ territory and blowing up the tracks because they wanted to get more subsidies by laying more track down. There was only one transcontinental that got no government subsidies. That was James J. Hill’s’ Great Northern. It was not by coincidence the only transcontinental that never went bankrupt because they had to put down tracks when it made economic sense, not because the government was throwing money at them,
Gene Tunny 32:06
Another good example I’ll have to investigate. This is the last question; I’d like to ask about some of your other writings and it looks like you have been prolific or regular traveller. Obviously, COVID cut back on all of our travels, but you’ve written some great pieces. You’ve made observations on what we can learn from other countries around the world and in some places that you generally don’t hear about. One of your articles is, “The World’s Oldest Republic Reveals the Secret to Peace and Prosperity”.
Larry Reed 32:46
Gene Tunny 32:48
You’ve also drawn lessons from economic history in Italy. I think it was in Italy, your article, “Why the Separation of Bank and State is Important”. Would you be able to explain what is that secret to peace and prosperity? How that’s revealed by the world’s oldest republic and also the point about the separation of bank and state, please.
Larry Reed 33:13
Both of these articles, you can at FEE.org and you can find them also on where I blog on lawrencewreed.com. With regard to the oldest constitutional republic, we published that last Sunday, it’s about the tiny country of San Marino. It’s the fifth smallest country in the world. It’s entirely enveloped by Italy. It’s in the northeast of the Italian peninsula. Right in its middle is this big rock called Mount Titan.
It’s the oldest Republic in the world, dating back to the early fourth century when that chunk of territory was gifted from its private owner, a woman in Rimini, now part of Italy. She gifted it to a Christian stonemason who had fled there to avoid the persecutions of the Emperor Diocletian. She said, “You can have this property.” He, in effect, declared the first, and now the oldest constitutional republic.
Only twice in its history has it been invaded. In both cases, within a matter of months, the pope ordered the invaders out, lest they be attacked by papal forces. They maintained their independence all these years. They have a GDP per capita that’s a shade below that of the United States. The secret is that they have kept themselves economically free.
Freedom House is non-profit that rates countries as to their degree of economic freedom and they rate San Marino as the 12th freest country in the world. Its capital gains tax is only 5%, which is a third of what ours is in the US. It’s much lower than it is in the European community. A great little success story in that quiet little enclave in the Apennine Mountains.
The other example or article that you’re referring to comes from Genoa, on the other side of northwest Italy. Genoa was, for hundreds of years, an Italian city state, much as Pisa and Venice and Gaeta and some others were. The secret to its success, more than any other single entity, was a private bank that was so private, it was in effect, a country within a country. It was called the Bank of St. George.
When it was chartered in 1407, the separation between the bank and the government of Genoa was as complete as it could get. It basically said, “We’re not paying any attention to you and you don’t have to pay any attention to us but you need us.” Because the bank consistently bailed out the state when it got in trouble. But the bank was very firmly on a gold standard, it had a policy of not issuing any paper for which you did not have gold coin on deposit. It was reliable, it was honest, and for hundreds of years, until Napoleon invaded and shut the bank down, it was a rock of stability and a big reason that Genoa became a maritime trading giant in the Mediterranean.
Gene Tunny 36:37
This wasn’t something positive Napoleon brought then. That’s interesting, I have to read more about it. How does it illustrate that the separation of bank and state is important? How does it illustrate that?
Larry Reed 36:52
The Bank of St. George exerted an anti-inflationary pressure on the government of Genoa. Governments love to inflate, and the moment they get in charge of banking, that’s what they do. They print the stuff and makes it easier for them to pay their bills and to run deficits and so forth. The Bank of St. George did not abide by that. They wouldn’t have recognised any coin or paper from the city of Genoa if it hadn’t been sound. Their example spoke volumes to the people of Genoa and across Europe. Here’s a bank that’s in great shape. It has to bail out the government of the region every now and then because they’re profligate, but the bank is not.
I think the separation of bank and state is an issue I wish we spent a lot more time on these days. We’ve assumed that government should be orchestrating the banking system, but the history of government and banking is not a positive one. They take over banking whenever they can because it’s their avenue to depreciating and debauching currency.
Gene Tunny 38:06
I think it’s a big concern when governments set up these banks or shadow banks to promote particular policy objectives. I remember, back in the late 2000s, there was a lot of talk about an infrastructure bank that was something the Obama administration was looking at but didn’t go through with. There were similar moves here in Australia that didn’t amount to anything because it reminded people of what happened in the 80s with the state banks of South Australia and Victoria, the Tricontinental merchant banking arm and they got heavily involved in speculative property development, if I remember correctly, and ended up going bust and costing taxpayers billions of dollars. People still remember that. There’s a risk if governments get involved in banking and financial shenanigans.
Larry Reed 39:06
Too often anyway, we judge government by the stated intentions rather than by actual outcomes and results. If a government came to me and said, “What do you think about us getting into the banking business?” I would probably say to them, “Aren’t you in the post office business already? Aren’t people complaining about that? Why don’t you get that right before you go into banking?” In US, everybody complains about the post office. What makes you think the same entity can manage a nation’s banking system?
Gene Tunny 39:38
Exactly, very good. Larry, any final words? Anything you think we should be thinking about or looking out for?
Larry Reed 39:48
I would say this thing that people everywhere should be thinking more than they are about the importance of individual liberty. We take it for granted in places where we’ve had a lot of it. But there’s nothing about it that’s either automatic or guaranteed, and it can disappear with bad ideas almost overnight. And yet, life without liberty, in my estimation, is unthinkable. We better think about it. I can’t imagine a life in which you aren’t living yours. You’re not making your choices, somebody else is imposing their choices on you. They’re living their lives through you.
I can’t imagine living in that environment as they, to a great extent, do in places like North Korea or Cuba. Liberty is precious, it’s rare in history. It’s never guaranteed and it deserves the conscious deliberation, and sometimes sacrifice of everyone wants to be a free person.
Gene Tunny 40:50
Absolutely. It just occurred to me, we probably should have touched on the pandemic. Feel free to respond to this if you like. Otherwise, we can wrap up. In Australia, we’ve had quite severe restrictions relating to COVID at times and they’ve raised eyebrows around the world. People have thought, “What’s going on there in Australia?” But what a lot of people in Australia say is that’s necessary for the public good.
You may bang on about civil liberties and I have, at times, think some of these restrictions have been excessive. But you get a lot of pushback and people say, “You think you’ve got the rights to do that but you don’t have the right to spread a deadly virus and spread the disease.” That’s how they push back. I agree, I think we’ve lost the original commitment, a strong love of liberty that we’ve had. I think we’ve lost that. People are terrified of this virus and they push back with that line, “You don’t have the right to spread the virus.” I don’t know how to win those arguments, to be honest.
Larry Reed 42:12
There’s something to be said for this and that is that this circumstance was unprecedented and it’s not over yet. That the jury may not yet be completely in with all irrelevant verdicts. I have a sense though, that the more we learn, the more of this we go through, the more experience we have with it, the more we’re likely to look back and say, “Those lockdowns were counterproductive. The mask mandates went on far longer than they should have, if they ever should have been in existence in the first place.” I think a lot of the tools that government employed will come under more scrutiny and questions.
If you’re a cheerleader for them now, I would say, “Why don’t you hold off because you may be embarrassed in the not-too-distant future?” But what concerns me the most is that all of this totalitarian impulse sets dangerous precedents because people who love power, who want it to be concentrated in government and think that the right people will do the right things, they don’t stop with the power that they get. They usually say, “It’s necessary now, I’ll hold on to it.”
In the long run, if we allow this COVID experience to set the new norm for government intervention, radical intervention in our lives across a broad front, we may look back and say, “We would have been a lot better off if we simply endured COVID.” Because one of the worst things that people can do is to consign their lives to politicians. There are a lot of things they end up regretting whenever they do that.
Gene Tunny 43:51
I think that’s a good point, Larry. We might end there. Thanks so much for your time. I enjoyed that conversation. Some great points and excellent historical examples that I’m going to have to look up and add to my arsenal of historical examples that I can bring up. Very good. Lawrence W. Reed, President Emeritus of the Foundation for Economic Education. Really enjoyed the conversation. Thank you so much.
Larry Reed 44:20
My pleasure. Thank you, Gene.
Gene Tunny 44:22
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 at economicsexplored.com and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.