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The role of experts in a democracy: pandemics, monetary policy & AI w/ Peter Kurti, CIS – EP201

Post author By Alec Krishna
Post date August 19, 2023
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The Centre for Independent Studies’ Peter Kurti asks “ Should those who know best rule the rest of us?” In this episode, host Gene Tunny chats with Peter about his new paper “Authority, Expertise and Democracy,” which explores the role of experts in government and how society should best utilize their knowledge in public policy making. They delve into the question of when it makes sense to delegate power to experts and the relevant considerations. The role of experts in decision making around the pandemic, monetary policy, and AI are discussed.

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

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

About this episode’s guest: Peter Kurti

Peter Kurti is Director of the Culture, Prosperity & Civil Society program at the CIS. He is also Adjunct Associate Professor in the School of Law at the University of Notre Dame Australia, and Adjunct Research Fellow at the Australian Centre for Christianity and Culture at Charles Sturt University. He has written extensively about issues of religion, liberty, and civil society in Australia, and appears frequently as a commentator on television and radio. In addition to having written many newspaper articles, he is also the author of The Tyranny of Tolerance: Threats to Religious Liberty in Australia; Euthanasia: Putting the Culture to Death?; and Sacred & Profane: Faith and Belief in a Secular Society, published by Connor Court. Peter is a Fellow of the Royal Society of Arts, and an ordained minister in the Anglican Church of Australia.

What’s covered in EP201

[00:02:30] Authority and experts in government.

[00:04:07] Impact of experts during COVID.

[00:09:29] Discrimination and lockdown restrictions.

[00:13:29] Delegating power to experts.

[00:18:12] Politicians’ difficult role in decision-making.

[00:21:11] Trade-offs in decision making.

[00:27:23] Vaccine mandates.

[00:34:27] AI and expert advice.

[00:37:35] Expert advice and self-interest.

[00:37:59] The importance of delegation of monetary policy decisions.

[00:40:19] Expert Failure book by Roger Koppl.

[00:43:33] Experts and human failings.

[00:50:32] The length of the leash.

[00:52:12] The role of experts in policy making.

Links relevant to the conversation

Peter Kurti’s new paper for the Centre for Independent Studies:

Authority, Expertise And Democracy. Should those who know best rule the rest of us?

Episode on Public Choice theory mentioned by Gene:

EP93 – Public Choice theory with Dr Brendan Markey-Towler – Economics Explored

Transcript:
The role of experts in a democracy: pandemics, monetary policy & AI w/ Peter Kurti, CIS – EP201

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

Gene Tunny 00:06

Peter Kurti 01:59

Thanks, Gene. Great to be with you. Very good. Peter.

Gene Tunny 02:02

You’ve recently had a new paper published by a centre for independent studies, authority, expertise and democracy. Should those who know best rule the rest of us, I’d like to ask to begin with what got you interested in this issue of expertise? Why did you think this was a good topic to write a paper on?

Peter Kurti 02:24

This all started really during the period of COVID and the lock downs. And I felt that here in New South Wales, and I know in other parts of the country in Queensland and Western Australia, and certainly Victoria, premiers, it seemed to me seated a great deal of authority to unelected chief medical officers, who determined what a government could and couldn’t do, and should and shouldn’t do, and certainly what the population should and should not do. And I felt that it in the course of managing an understandably complex public health situation. Nonetheless, politicians were ceding too much authority to experts, and that when politicians do this, they pose a threat to the liberal democratic society in in which we live, because we elect politicians to do a job we elect politicians on the basis of policies they undertake to implement. And we look to politicians to regulate the kind of society in which we live. But they are accountable, because if we don’t like what they do, we can we can talk them out of the next election. And we can turf out individual members of parliament, by elections. But when we have unelected unaccountable experts, such as chief medical officers dictating what can happen in any society, I think that it poses a great danger to us. And we saw the impact of this because there were social consequences. There were economic consequences. And there were cultural consequences as well. And I’m thinking when I talk about that I’m thinking about the impact on families of not being able to travel for funerals, not being able to visit people who are sick or terminally ill. And I think that the standard that chief medical officers set which was you know, keep everybody safe, and that there must be no risk of any contamination or, or contagion whatsoever, meant that the additional costs, the consequences that are borne or have to be borne from those decisions, were not taken into account. And that was really what made me start to think about the problem of experts. I mean, we need experts. They are an integral part of a bit of a technologically complex society. I don’t say we don’t need them, but we need to hold them to account and we need to make sure that But elected representatives, politicians who are appointed by us to do a job actually do do their job.

Gene Tunny 05:09

So would you say that the to an extent these experts were ruling over the rest of us during that COVID period? Is that That’s the argument you’re making there in 10, COVID?

Peter Kurti 05:18

Yes, I think they were. And I think that there are a number of reasons why that happened. One was that it was a once in a century, once in 100 year, public health emergency, and no politician really knew what to do. Nobody really knew what was coming. And there was a lot of anxiety and a lot of fear amongst the population at large. And politicians clearly had a responsibility to not just to set an example, I think, but to reassure by the easy populations, and one of the ways to do that is to cite medical advice, scientific advice. And the it to an extent, we all looked to chief medical officers to tell us, first of all, what is happening, and then tell us what’s going to happen next. And so as I said, a moment ago, it was a very understandable set of circumstances, but I don’t think it justifies or excuse, it justifies that it doesn’t excuse what happened. And I think that we must always be sure. Should such a pandemic ever occur again, that public health advice is just one part of the body of information, one part of the body of opinion that is taken into account?

Gene Tunny 06:38

Yeah, yeah, I agree. Yeah. There’s a something I’ve covered on this show before and I had concerns about is there’s a point you’re making the paper about how there. There are trade offs involved, and you need politicians to make those judgments. And there’s no real technocratic answer or no real. I mean, there’s that one of the arguments you’re making is I mean, the the idea of having an expert in charge or, or their view, almost prevailing all the time, the problem there is that that’s a technocratic answer. It assumes that there’s always a technocratic answer. Is that a fair reading?

Peter Kurti 07:17

I think that’s right. So Jean, and one of the reasons I think we got ourselves into this situation during the pandemic was the politicians didn’t really know what to do, because it was such an unexpected and unanticipated set of circumstances. And I think that they were speaking about in very general terms about a large group of people with different political affiliations. But on the whole, I think, political leaders did not want to be caught out, they did not want to be sort of caught out by the media, who might then say, if if things get worse that to say, well, you know, if you’ve taken that advice, this wouldn’t have happened. How do you account for that? And so I think we have an increasingly risk averse group of politicians who will just as it were hide behind or rely upon or depend upon that sort of expertise in order to, in a sense, make life easier for them. But we need that sort of, I mean, in a sense, we can’t, we cannot avoid engaging with experts. And we cannot avoid engaging with people who have expertise in public health when it comes to managing health issues such as the pandemic. But if we don’t hold people to account, if we just allow experts to make decisions for us, without regard for the broader set of consequences, those trade offs that you mentioned, then I think we’re in trouble. And we saw that we saw that in every state, and territory. But we certainly saw that here in New South Wales, where areas were locked down. So that there was an area in in in Sydney, from which a lot of traders needed to travel in order to work when they can’t travel, they can’t work when they can’t work, they can’t earn money. And well, I mean, we know what the economic consequences of and the social consequences of that are. And I think simply to say, you must stay home and stay safe is not enough, because everyday life is full of risks. And we take risks and assume risks and make calculations about risk every day.

Gene Tunny 09:26

Yeah. What area was that? Peter? Was that from Western Sydney? Fairfield? Fairfield. Gotcha. Okay. Was there also a an issue of the composition or the demographic makeup of that area that that suggested that I mean, this was almost discriminatory in a way because I know that some areas which had higher ethnic populations, they ended up being suffering worth restrictions, didn’t they? And that can lead to social tension.

Peter Kurti 09:54

That’s right. And that is exactly what happened because they found I mean, the police were very, in my view were very heavy handed during a lot of this time, and then the police or others found but in communities with large, the large ethnic component, people were not being as observant about the restrictions because, for example, in, in Muslim communities, there are larger families and getting together and mixing with one another is is very important. And they attracted, I think, the particular attention of the authorities because of this. And so the lockdowns and restrictions were more stringent. Again, you know, judging everybody by one standard, everybody must stay safe. Everyone must stay home, regardless of whether or not that’s something that’s practical or even necessary.

Gene Tunny 10:51

Hmm, yeah, exactly. He talks about this concept of double delegation. So I’d be grateful if you could explain that and also reflect on is this something that we’re increasingly seeing these chief medical officers, they’ve been introduced in the last couple of decades? I mean, we didn’t have a Chief Health Officer in Queensland, I don’t think until the early 2000s, we had a public health act in 2005 that came in, and this this new position they’ve created, and they delegate some powers to that position. And presumably there are other examples of this as is something that’s becoming more common. Is this something you’re concerned about the trend? Could you talk about that, please, Peter.

Peter Kurti 11:36

it is part of a larger trend. It was COVID that alerted me to the problem and brought it into focus. And I suppose maybe I have simply been complacent before because we are used to experts, advising government and all kinds of things. We just think, Oh, well, that’s the way the world works. But not in my lifetime. Have you seen what kind of impact this expert advice had? But I think it is part of a broader trend. And we see it in other areas. I’ll say something just about double delegation. Before I come back to that to that manifestations of that broader trend. It’s a phrase I picked up from the English political scientist, Adrian Papst who talks about the the fact that we describes this problem that arises when we as it were delegate to elected politicians, we delegate to them, we say we appoint you to do a certain job for a certain amount of time, we will assess you. I know this is not necessarily what we actually think. But we say we will assess you at the next election and decide whether you’re going to keep the job. Those to whom we delegate delegate in turn to, to this body of experts, and perhaps describes it like this. He says, double delegation arises when representatives elected by citizens delegate power to unelected officials, who are part of a professional political class. So it’s not just a matter of delegation, but delegation to a professionalised group of people who, who are then use their professionalised status to further entrench their position. And to argue that what they say not only is right but needs to be observed. Now, we’ve seen in public health that was the most obvious example but I think we also see it when, when there are discussions, for example, about energy, about climate and changes in in the climate. We do see it a lot in economics, although I think that’s to an extent a rather specialised example, because economics is so is so technical. Certainly monetary theory is very technical. But we hear these phrases that are put about when there are discussions about climate change, like the science is settled, for example, which I think is a contradiction in terms because I don’t think science is settled. But a group of professionalised. Climate scientists decided that this is this is the position we need to adopt. And they’re backed up by the media, who emphasise their opinions and so consolidate their position. So it’s part of a broader trend. And I think we’re going to see more of this, I think with when areas that really, so few of us actually do understand such as AI and the emergence of AI and development of AI. We need to be really vigilant about the way in which we use expert advice. The paper is not I’m not anti experts. I’m not saying we don’t need experts, we can we can make our own decisions any more than I’d say we don’t need we don’t need surgeons. I’ll do my own surgery. Thank you very much. Well, I’m not saying that. What I’m saying is that if we are going to use experts as we are bound to do we as soon as Since a liberal democracy in Australia, need to be thoughtful about the way in which we engage them in ways in which we hold them to account. And we also need to be stronger about defending freedom of speech in the sense that I think we need to be more willing to tolerate dissent, we need to be able to say, well, this group of scientists over here says, you know, there is a climate catastrophe, for example, whereas this group of scientists over here is saying, well, warming and cooling is just part of a trend. These are parts of trek, these are trends that that take place in on the earth over a period of years. We need to be able to tolerate dissenting views. I’m not saying we are necessarily able to determine which view is correct. But we are increasingly reluctant I feel to tolerate it today. We’re reluctant to tolerate dissenting views, because we want to have the right answer. We want to know what the right position is the right solution is. We saw that during COVID. Of course, when debates about the efficacy of vaccine mandates or mask mandates, or social distancing, dissent was not tolerated. And I think that if we are going to make an intelligent use of experts, we do need to be willing to tolerate dissent and to live with perhaps the discomfort that comes from having dissenting views.

Gene Tunny 16:24

Yes, yes, exactly. Yeah. It makes it difficult for politicians, though, if, if the experts don’t agree, so how, how do we think about that? Or what’s the relationship mean? You mentioned tolerating dissent, that’s one of your rules or your tips for getting experts, like using them effectively? I mean, there’s obviously a role for expertise and people who understand the issues, and they provide the advice to the government of the day. How do you think about how those experts should be used? And I mean, what the decision makers do when there is a situation of of that of that descend to mean, is it up to them to judge where the weight of evidence is? I mean, because the politicians will say, Well, look, the bulk of evidence is in favour of this hypothesis. It could be climate change, for instance. So yeah, how do you think about that, Peter, how should politicians use experts?

Peter Kurti 17:21

Well, I think it really adjust the way that you have outlined by examining what it is the experts are saying, By assessing the evidence by determining where the bulk of opinion lies, and then using judgement and skill to make a decision. We can apply that sort of framework to any policy area where might think about migration levels of migration, there are people experts who say Australia, we can’t have a big Australia, others say we can have a big Australia, and each side will mount will present evidence to bolster their own arguments. And I’m sure believe, quite passionately, the evidence that the cogency of the evidence they present, but somebody then has to make a decision about how we do that, and an elected government has to take a position, we can see it in terms of going to war, or whether we supply arms, for example, to Ukraine, we went into Iraq 20 years ago, very controversially, but we did so on the bait, I mean, at the Howard Government did so on the basis of evidence that was presented. And as we remember, because we know those around at the time, there was a huge amount of dissent in this country about that. At the end of the day, it’s elected representatives who have to make the call and are then held accountable. So I think it’s it’s a difficult role. And I’ve never been an elected politician. So I’ve never been in the position of having to implement this. I’m simply really someone on the sidelines who’s advocating for a certain as it were, a certain style of, of a certain style of living, if you like. But I think it’s by by weighing and assessing, carefully, evidence that is presented. And I think not allowing fear, I talked about the importance of political courage, not allowing fear of adverse consequences to deter somebody to do just hit you from making the right decision, for example. When I mean, how many years ago was it now it’s it’s must be nearly 30 years since the Port Arthur tragedy. And the Howard Government decided that they were going to take a stand on on firearms. And there’s a lot of controversy about that at the time. I remember not being illustrated very long. And the view was that people living in the country or people who are really attached to their weaponry wouldn’t be happy with this. And there were arguments on both sides, but I think the weight of public opinion, or rather, I should say this put it this way. I think the Howard Government made it made a decision based on on the evidence and the politics, and also having to judge which way public opinion whether public opinion would accept this. And it was a controversial decision. But I think, given the horror of what happened at Port Arthur, the Australian public did accept it. But there was no telling, which was the right what was the right decision or not? I think it’s in a sense, you only know whether you’ve made the right decision with hindsight.

Gene Tunny 20:33

Yeah. What really annoyed me during that COVID period was the politicians making decisions and saying, the science tells us this, we have to do this, this is the only the only thing we can do and, and not going into what the decision making process was all they didn’t show that they were weighing up pros and cons, whereas I really should have because there are going to be pros and cons of any decision. There are the trade offs we talk about, there was no right answer in necessarily, in my view, it’s always a judgement call to an extent when we’re we’re dealing with those trade offs. And what made that clear to me and to others, and this is something I was chatting with. One of my colleagues, Joe Brannigan about on this, this show when it happened, we had a Chief Health Officer who I don’t know if you remember, they let Tom Hanks in, you know, if you’re a movie star, you’re a footballer, you you had no problem getting into Queensland. But if you were just some regular, you know, person and yeah, bad luck, you got to do two weeks quarantine. And then we had a constraint on the number of hotels for quarantine. So that meant people were camping. On the border. It was just disgraceful. So that that’s one thing that annoyed me that I don’t think there was too much relying on the experts saying this is what the experts have told us that it’s based on science. And there’s no acknowledgement that they’ve actually, you know, there’s really a call that’s been made there, or there should be a call, there should be a judgement that the politician should be involved in. I think that makes sense. Does that make sense? What I was just saying, yes, it does.

Peter Kurti 22:16

And the trouble is that the politicians just caved in. I think there was a I mean, there were these sorts of stories all around the country. But there was that famous incident where a mother I think living in Tweed Heads needed to get her very sick child or children to a hospital. The nurse was in Queensland, but it’s quick. You can edit this bit out tweets, edits, Tweed Heads in New South Wales isn’t it’s not so correct. Yeah. She needed to get across the border. And Pat O’Shea said famously, are notoriously the Queensland hospitals of a Queenslanders? Well, I thought, you know, I mean, it was a disgraceful thing to say, because I felt what was also happening in this time of panic was that our national identity was fragmenting and we were becoming a sort of a collection of fragmented callers, and I would do your former columnist, and I thought that even our sense of national cohesiveness has, has has gone. Yeah, all kinds of stories, like I’ve had people who weren’t able to visit sick, sick relatives in hospital, because there was this fear of contagion. And I think, and politicians just seem to be happy to let that happen. In New South Wales, interestingly enough, when Berejiklian left, left the job of Premier and Dominick parity came into office, the first thing he did was reduced the period of isolation that you had to have if you tested positive from seven days to five days. And there was the usual concern expressed by public health experts that actually this you know, you could still be contagious after five days and, and, you know, this is really not a good decision to make, but parity had the wisdom to see that, in fact, people needed to get back to work and they need to get on with our lives. And that five days was enough. And that you just had then have to assume a degree of risk and in in what you do next, and we all of us, you know, we exposed to the flu virus every year. We know that if we’re sick, we stay home if we’re not if we if we feel really unwell we go to bed, and I think for the state to say and saying to people who are actually very well but happened to have tested positive on a on a on a rat rapid antigen test, which in itself was not 100%. Reliable, meant that people were exposed or subjected to all kinds of inconvenience. So I think there were lots of examples such as such as the ones that you cite, and and the ones that I’ve cited,

Gene Tunny 24:55

and just on Tweed Heads, so just to provide some context. So it’s part The same urban area as the Gold Coast effectively. I mean, if you if you drove through there, you wouldn’t unless you saw the sign, you wouldn’t realise you were crossing over Queensland and New South Wales. So it’s, and that was the that was part of the problem. And then they had to put the barricades up and have the police there. It was just just awful situation. So I should ask Peter about the those tips for dealing with experts. You mentioned them before, I just want to go over them again. Because I think there’s really good I think there’s one of the best things you do in this paper, you’ve got these three cultural contours. There are three of them that if cultivated, emphasised can underpin the approach to engage in experts and help encourage an efficient and responsible contribution to democratic decision making and one tolerance of dissent. Absolutely. political courage. So the elected representatives need to be less anxious about upsetting public and political opinion in determining the policy trade offs. I think that’s great. I think what would have worked? Now it sounds like I’m picking on the politicians or politicians during the pandemic, but of course, it’s it’s one of those, you know, it’s an example. It’s one of the, you know, it’s one of those crisis periods where you really, these issues come to the fore. So, look, I understand the human, I don’t want to be super negative about them. But they really did provide this, this example for us to talk about. So I will talk about it again that say, you know, what would have been better is if say, our premier had said, okay, look, yeah, this is what the Chief Health Officer advised. I’ve weighed this up, I’ve recognised the fact that this is going to cost the economy, but this is the judgement I make, which you should the politicians should have be more honest about that is that that’s what you’re getting out there?

Peter Kurti 26:45

Well, yes. And I think, not being frightened of making a decision. Lest it turn out to be the wrong one. I felt they played it safe, or all the time. And so I think that’s right. We saw it with the vaccine mandates that I mean, we were, for example, we knew that vaccine wouldn’t stop you necessarily stop you getting COVID. But it would alleviate the symptoms, you would have it less badly. But it didn’t. If I’m vaccinated. It doesn’t stop me from infecting you. It just something that affects me and yet we had in New South Wales and around the country, these vaccine mandates, and he got ridiculous, you couldn’t go in, you couldn’t go into shops, you couldn’t go into these unless you prove that you’ve been vaccinated, whereas vaccination really did not affect my vaccine status did not affect you or any other of my neighbours. And yet nonetheless, we were required to do this, and the horridly developed vaccines were presented to the Australian population as being safe. And we know that they were not entirely safe as I mean, no vaccine is because science 20 cent is an art. I mean, it’s a science, but it’s also it’s an art and we don’t, we can’t always be sure of an outcome. And certainly, I think with things like vaccination, especially when they’re rapidly developed, there will be there will be difficult, and they’ll be problems. But anyone who raised those sorts of problems would announced those who expressed concern about about the safety of vaccines, vaccines were, were denounced as being irresponsible. And it seemed to me that no politician was prepared to say, we don’t need to do. We don’t need to do things in exactly this way. We need to be calmer, we need to be more realistic about about the nature of disease, we panicked. I mean, Western Australia shut down the entire state, when there was one case, yet we seem to be blindly indifferent to the 1000s of people who die every year of flu. And I felt there again, you know, the politicians were just caught up in this pandemic. Panic. And I think that a degree of political courage, we don’t allow them to say, It’s okay, you know, we have sickness we have people do get sick, but life has to go on. And we need to make we to be responsible and take decisions in a way that minimises the harm that we expose others to, but that allows us to continue with the lives that we’re living. Yeah. And the the incomes that we’re earning. So yes, I think it’s, it’s that sort of response that I would like to see cultivated by when that I’m really scribing in terms of political courage.

Gene Tunny 29:45

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Gene Tunny 30:20back to the show. Okay, very good. So we talked about tolerance of dissent, political courage, and the final cultural contour is institutional integrity. Yes, exactly. Yes. So, no democracy today can dispense with experts, but institutional mechanisms of accountability can ensure that experts exercise autonomy, responsibly, could what? What mechanisms do you mean there? Peter?

Peter Kurti 30:49

I think? Well, they cite a number of examples. One is the oversight of budgets that are available to experts, the appointment of experts to advisory panels and boards, the codes of conduct that guide the behaviour of of experts, codes of ethics, just, you know, various sort of social and institutional frameworks that we put in place to ensure that people know experts know that they have to be accountable and cannot simply claim their expertise as a warrant for doing whatever it is they want. You know, it’s a slightly nebulous idea, because it’s not it’s not something it’s not like a switch that can be can be flicked. And suddenly we have institutional integrity. I think that is a that’s why I call them these three points I call cultural contours, because cultural culture evolves and cultural contours, something has to be cultivated. And in a sense, practised as well. Another form of institutional integrity might be the very fact that we can question experts and say, but, you know, you’re wrong. Going back to the pandemic, it was simply not acceptable to say that Sweden had got it right. And Australia got it wrong. I remember doctor as a doctor friend saying to me that ivermectin was, which, which in his ex medical experience was somebody that had that had the capacity to alleviate COVID symptoms, could now no longer be prescribed off label. And he was very indignant about that, because he felt doctors always have a discretion about prescribing medicines. And that whilst the medication can be prescribed for a specific condition, that is states on label, it might also have an effect on conditions not specified hence the description off label but they were actually prevented from prescribing of labour. Well, I think we need to also why is this why but even to utter the word, ivermectin would get you disconnected from, you know, various groups and various fora. So that’s another form of another manifestation of institutional integrity that we can actually, we can have systems in place that are robust enough to ensure that people are held to account and are not free to make those sorts of decisions without without regard for the wider consequences.

Gene Tunny 33:18

Yeah, exactly. I mean, to me, so they’re getting some scrutiny. I mean, there is some media scrutiny, arguably not enough, there was not enough probing, there weren’t enough probing questions during the pandemic of the politicians and the officials and the chief health officers, they should subject themselves to more media interviews. And part of the problem is the normal processes of government were suspended, weren’t they during the COVID period, because we had these public health acts that gave them these emergency powers. So there wasn’t the usual debate in the parliament or the you know, the committee processes where there’s something serious, you know, something of such magnitude or such. Such great impact on the economy and society would be debated for a minute should be extensively debated in parliament in committees, and it just wasn’t. So that’s that was what I see as one of the problems to agree. Yeah. Okay. Very good. So that’s one thing I really liked about that paper. And I’m going to put a link in the show notes because I think it’s Yeah, I think that’s great. Okay, AI, you mentioned AI, what are you concerned about there? Exactly. If the experts are formulating the response, what are you actually concerned about there?

Peter Kurti 34:37

Oh, no, I think we need we will need to be very attentive to expert advice when it comes to AI because it’s, it seems to me from my layman’s perspective as a non computer expert, that it seems to me that experts themselves are debating about the capacity of AI and these large language models and generative AI to assume increasingly demanding roles. And this is a long standing issue in, in areas like philosophy of mind, and certainly in cognitive science about what consciousness is and whether a machine can be conscious. And we don’t know. And I don’t think the experts know. And there are some AI some some experts who are calling for us to slow down and take things more steadily, others who are quite happy to let the horse out of the stable words out of I say what, but let the horse gallop at whatever speed it wants. So I think that that’s an example of an area where we clearly are going to have to depend upon experts. And it will be foolish not to, but at the same time, we need to, we need to accept that there will be dissent within expert groups. And we need to be comfortable with that a sense that with that dissent, and we need to, in a sense, not abdicate responsibility for my for making our own decisions about these things to experts, and to to attend as best we can, to what experts are saying and to think critically, about how we ourselves respond to what they’re saying. I think AI is very exciting. And I think it’s it’s whether it’s in, in in medicine, or space exploration or, or defence, AI is rapidly changing the way we we interact with technology, then we don’t quite know how it’s going to go. And I think we need to be, as I said, we need to be attentive to what experts are actually saying and to follow the debate, you know, not to give all the authority and all the power away.

Gene Tunny 36:47

Yeah, gotcha. One of the conclusions you reach United that this report has argued that any economic account of experts, which takes into consideration the tenants of public choice theory. So that’s something I’ve covered on the show before, I’ll put a link in the show notes to that episode. So any economic account must always allow for the influence of personal interest, opinions and prejudices of those providing expert advice. So do you see that that has been? That has been a serious problem? Do you have any examples of that? Peter, are there any examples that come to mind?

Peter Kurti 37:26

I know we’ve talked a lot about COVID in our conversation, but I think COVID provides a good example of that. This notion of information choice theory is an idea I discovered with the writings of Roger Koppel, who of course, develops as you’ve mentioned, public choice theory, but really, information choice theory. Kapil is arguing that perverse outcomes can occur when expert advice is is tended that experts themselves will be motivated by self interest. And he would say that what we have to do is abandon the idea that experts seek only the truth without regard to motives such as fame and fortune. And that sounds a bit cynical in some ways, but I think Kapil is is right that we can’t, we must imagine that experts themselves have got are devoid of human motivation or ambition or desire, and accepting that that’s just the case that is human nature, that Kapil argues that information choice theory suggests that what we need to do is have is to avoid situations where one body of experts has a monopoly over opinion, but they must be able to compete with one another, an example that he cites, and I’m not sure it applies in quite the same way in Australia, but one of the examples he cites is forensic medicine. And he argues that, that when there is no competition about forensic scientists, amongst forensic scientists, and forensic medicine is devoid of those the competing voices of experts, there’s a danger of, of scientific error, which of course, being forensic medicine can in turn lead to instances of injustice, and that where there is more than one forensic medical point of view, the there is a greater chance that error will be avoided and therefore injustice avoided. Now it does happen to an extent here we know in each state and territory of this country, forensic medicine has led to in just miscarriages of justice, which are then which are then corrected. The problem in the United States is that the death penalty is is reasonably widespread, and that all that can take many years, faulty forensic medicine, forensic research can lead to, you know, very draconian punishments. We don’t have that quite that problem here. But it’s an example of a couple sites and I think it’s a it’s an interesting one that You would do well to attend to.

Gene Tunny 40:02

Okay, I’ll have to look up his work. I wasn’t I’m not familiar with Kapil. Did you see in the public choice school?

Peter Kurti 40:09

Oh, he is. Roger Capo he’s actually it’s finance and financial management. He teaches drive. I’ve not got the book right beside me.

Gene Tunny 40:21

That’s okay. I’ll put it in the show notes. Is he at Syracuse in? In the States? Yes, I think he is.

Peter Kurti 40:26

I think he is. And the book that he wrote a really interesting book was expert failure, a book published in 2018.

Gene Tunny 40:35

Yeah, I’ll definitely look into that sounds. Sounds interesting. Okay. Before we wrap up, I just want to ask you again about? Well, I want to ask about monetary policy, because you mentioned this is one area where and this is a case study you given your paper, this is one area where delegation can be justified. Now, could you explain why that is? Peter, why we would delegate the monetary policy decision. So changing the cash rate in Australia, changing the federal funds rate, why we would delegate that to either the Reserve Bank of Australia board or the Board of Governors of the Federal Reserve Bank?

Peter Kurti 41:13

Well, it’s an interesting example. And I think, in a way, it’s a timely example, because the again, this really flowed out of the way in which the Reserve Bank was considered to have performed in the wake of COVID, not raising interest rates fast enough, not getting on top of the knock, knock, tapping, trapping that inflationary genie in the bottle promptly enough. And so there was a review. And there was a feeling one of the recommendations in the review was that there should be this, this monetary check, what’s it called a monetary? That’s right, the Monetary Policy Committee money, but money money policy board that said that there should be a separate board that will advise the Reserve Bank board about what to do. And there’s this view that, in fact, your view put forward by Peter here, that the the Reserve Bank, governors are well, meaning amateurs, and that’s possibly true. Not all of them are, but they’re engaged in business and corporate and economic life in the country, given that the Reserve Bank has a target band of inflation, and there are ways of meeting that target. And the board has to make a decision about interest rates in order to try to meet that inflation. retirements involves some very difficult some very technical decisions that are really beyond the capacity of ordinary members of the public. So I think I use as that as an example of an instance where we do need experts. But we mustn’t abdicate all responsibility, and that they need to be held to account in in some ways, and I think some it or the way the monetary policy board was promoted in the review. And the way it’s been greeted in the press, by some people, is that this body of experts will now correct and avoid all the failings of the Reserve Bank. And I think that’s a problem. I think that we need that sort of advice. But there were commentators like John Edwards was one of them, who wrote in the Australian saying that actually, the Reserve Bank didn’t do such a bad job when you consider other central banks around the world in western democracies, that the Reserve Bank board didn’t do such a bad job. And I think there’s this idea that now we’ve got the experts, everything will just be fine. And we won’t have those mistakes again. And I cited as an example, because I think it’s an area where we do need experts, we do need people who are proficient in the complex technicality of monetary monetary policy. But in the sense that an instance of that might be an example of information choice theory where you need to account for the fact that even these experts with these technocratic experts, even these people have, have human failings, desires, ambitions, and goals. We cannot think that somehow there is this pure, disinterested advice. That’s been that’s been tendered. And I cite the Reserve Bank. And the other example I cite is I CAC The Independent Commission Against Corruption, because it shows actually how in a sense how complex modern life in a country like Australia is, and that there’s no rule. You can’t say, well, we need experts in these situations that are not in those situations. We need experts in in different ways for differing rules, but we have to think about how we use them. So if we have a monetary policy board, is this board a board that is going to be accountable? To who? The treasurer, perhaps the board? Probably not, it’s independent, who appoints them, and how For how long are they appointed? and how they removed? Those are the sorts of questions that I think we need to ask about such a board. And that’ll be an example of the kind of institutional integrity that I’m talking about. When we think about what are the parameters of control? What are the terms of office? How are the people appointed, how they removed? What are the criteria that are used to make those appointments? And you may feel at the end? Well, that’s all a bit fuzzy. And I suppose in a sense, it is fuzzy. We these are, there is nothing, there are no hard and fast rules about how we approach these questions. I don’t think that means the questions are unimportant, nor do I think it means we should avoid asking them.

Gene Tunny 45:40

Yeah. So that Peter, the other Peter, you mentioned as Peter tulip, Chief Economist at Centre for independent studies, and Peters argued that there should be a separate monetary policy board separate from the the bank board with that could run the Reserve Bank. And yeah, look, there are some there are arguments in favour of it. I don’t know whether it’ll actually mean we get better decisions. It might. Because the the current board does have the, it’s got some RBA members on it. It’s got the Treasury Secretary, and then it’s got, you know, it’s getting all the advice from the Reserve Bank. So maybe we could get better decisions. I don’t know. I’d be willing to have the experiment as possibly worth doing the experiment. But one of the things I would point out to or one thing I should note is that, you know, there is a delegation already to the board from the government. I mean, the government, the Treasurer doesn’t make the interest rate decision that is delegated to the Reserve Bank, board and economists have generally, you know, most they all sort of agree that that’s a great thing, because, well, monetary policy is a technical decision, we want to keep the politicians as far away as that away from it as possible, because their political interests could be in favour of inflation, getting some short term, you know, giving the economy a short term boost prior to the election, accepting some inflation that comes later, because they want to get elected so that there’s a risk there. So that’s why that’s been delegated. And then what Peter’s arguing for as well, we should then go even further than that, and have a or have a special Monetary Policy Committee with expert economists on it. So you know, really increase the expertise of the body that’s making that interest rate decision here in Australia. Yeah.

Peter Kurti 47:37

And I should say that Peter was kind enough to read that section of the report and gave some helpful feedback. And it was I incorporated a number of his comments in that section. So that I, he corrected any sort of that I was drifting at one point. I mean, I’m not an economist, and I was grateful to Pete for so he’s read this. Yeah. And he knows what I’m, what I’m saying are very good.

Gene Tunny 48:00

Okay. And, yeah, I guess the point is that we’re delegating the the technocratic decision on the exact interest rate at a particular in a particular month. But the government does still decide what the target is it decides what the it reaches an agreement with the Reserve Bank on the conduct of monetary policy. So they’re not, they’re not completely abrogating or dodging responsibility for it. They are, they are still accountable. The government is involved in it, but they’re not making the technocratic decision on the interest rate, which could be problematic if they were involved in that. Because for that reason that I mentioned that the you could end up with really bad policy and evidence from the 80s. From before the 80s. It was, the evidence came, I think it was Alice Cena or in the 90s, late 80s, who showed that central banks that are more independent, that don’t have that the government telling them what they should be doing with monetary policy. Those countries ended up with better inflation outcomes, so lower inflation. So that’s, that’s why it’s good to delegate that decision to

Peter Kurti 49:17

and I agree with you, I remember when the the the Blair government was elected in 97. Very soon after the trailer, the chancellor, the Treasurer, Gordon Brown, declared the independence of the Bank of England that it needed to happen long ago. And I mean, Australia has got an independent bank had already got an independent central bank. And I think that that’s very important because we can imagine that for example, if the Anthony Albanese decides to go for a double dissolution, we’re talking now on the last day of July, but if he decides to go for a double dissolution, he’s not going to want to run on on on on his economic policy at the moment because Australians are very cheesed off with the way things are going and so it’d be very tempting for a government To tweak interest rates with if they’ve got their eye on an election. So I think having it depends is very important. And why I cite the example is because I think it’s an it shows the complexity of the relationship between experts and their elected overseers and how that relationship, how is managed, how they are held accountable, and how we decide to what extent they are. They enjoy autonomy and to what extent they need to be to be reined in. There’s a phrase that is used by one of the writers they quote on this, because there’s a lot of literature about expertise, which was, so it’s a very interesting paper to research and write. He talks, Michael shoots and talks about, we need to work out the length of the leash on which we keep experts, he can’t be too short. Otherwise, they won’t be able to do their job. But he can’t be too long. Otherwise, we won’t, you know, they’ll they’ll just make decisions without any kind of accountability at all. They have to be autonomous, but not to autonomous. How do we calculate the length of that lease? It’s a very difficult thing to do. But I think that I am completely in favour of an independent central bank. And I certainly wouldn’t want this paper to be interpreted by some as advocating for returned to government control.

Gene Tunny 51:20

Oh, no, no, no, not at all. I read that section that Oh, yep. That’s That’s right. And the one thing I would have added into it was that point about how having that delegation of the actual choice of the policy rate that’s, that’s good from the point of view that that independence does lead to better or lower inflation outcomes. So that’s something that’s been widely researched and, and proven so very good. Okay. Peter Kurti. Thanks so much. It’s been great. And I agree, we need to think more about the role of experts and how they’re used in policymaking. It’s important if we have another pandemic, let’s hope not, but also in decision making and all the other great challenges that we face challenges relating to climate change challenges related to AI. So it’s important to think about the role of experts in advising government and we want we want to avoid the experts taking over we need governments to be weighing up the the advice thinking about it, you had that the great the trilogy of of tips, which was good, the, you know, being courageous and tolerating dissent. And obviously thinking about those that accountability, institutional integrity, I call it institutional integrity. Very good. That’s great. Peter Carey. Thanks so much for your time. I really enjoyed it.

Peter Kurti 52:47

Thank you, Gene. It’s been a real pleasure. I’ve really enjoyed our conversation

Gene Tunny 52:53

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

53:40

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Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au. Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple Podcasts, Google Podcast, and other podcasting platforms.

Tags economics, expertise, forensic medicine, institutional integrity, monetary policy, pandemic, rba

Podcast episode

Do central banks stabilize or destabilize economies? w/ Addison Wiggin, NYT-bestselling-author – EP196

Post author By Alec Krishna
Post date July 15, 2023
No Comments on Do central banks stabilize or destabilize economies? w/ Addison Wiggin, NYT-bestselling-author – EP196

The episode delves into the effectiveness of monetary policy by central banks in managing the economy over the business cycle. Do the actions of central banks stabilize or destabilize economies? Show host Gene Tunny chats with Addison Wiggin, a bestselling author, market economist, and host of the Wiggin Sessions podcast, about monetary policy and financial crises. Addison also shares some reflections on the US debt ceiling drama. This is part 2 of the conversation Gene held with Addison in early June 2023, the first part of which was released as EP192 on the US banking crisis.
Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

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

About this episode’s guest: Addison Wiggin

Three-time New York Times best-selling author, Addison Wiggin, is a 30-year market economist with a passion for the real-world impact of financial markets on our lives. Addison is the author and host of The Wiggin Sessions, a podcast that connects key thinkers and industry experts for a deep dive into history, politics, and economics. Some of his most accomplished works as a writer, publisher, and filmmaker include the New York Times Best Seller The Demise Of The Dollar and the documentary I.O.U.S.A, an exposé on the national debt crisis in America.

What’s covered in EP196

How is it that the US dollar can be the reserve currency of the world? (2:37)
Why not just accept that the business cycle is a thing and not do anything about it? (7:25)
Minsky’s instability thesis. (11:42)
The debt ceiling is just political theater. (16:52)
Central bankers and economists thought we’d solve the problem of business cycle management. (21:29)
How monetary policy was determined during the Gold standard era (25:06)
When the Federal Reserve presided over the contraction of the US money supply as multiple banks failed, the money supply fell 30% from 1930 to 1933. (30:17)
What does all this mean in the current context? (35:54)
Central banks need to choose wisely and they need some methodology to do so. (41:23)

Links relevant to the conversation

Part 1 of Gene’s conversation with Addison:https://economicsexplored.com/2023/06/18/exploring-the-us-banking-crisis-with-addison-wiggin-ep192/
US Federal Reserve on what happened to monetary policy during the Great Depression, “From the fall of 1930 through the winter of 1933, the money supply fell by nearly 30 percent.”:
https://www.federalreservehistory.org/essays/great-depression
Episode with Stephen Kirchner in April 2022 in which the “lean versus clean” debate was discussed:
https://economicsexplored.com/2022/04/20/nominal-gdp-targeting-w-stephen-kirchner-ep135/
Till Time’s Last Sand: A History of the Bank of England by David Kynaston:
https://www.amazon.com.au/Till-Times-Last-Sand-1694-2013/dp/1408868563

Transcript:
Do central banks stabilize or destabilize economies? w/ Addison Wiggin, NYT-bestselling-author – EP196

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It was then checked over by a human, Tim Hughes from Adept Economics, to pick out any clangers that otters sometimes miss. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny 00:06

Hello, thanks for tuning in to this show. In this episode, I chat about monetary policy and financial crises with Addison Wiggin, The New York Times bestselling author, market economist and host of the Wiggin Sessions podcast. This is part of the conversation that I had with Addison in early June 2023. I broadcast the bulk of that conversation in an episode on the US banking crisis a few weeks ago. But this bit I’ve held back I held it back to this episode, because I wanted to have more time to reflect and comment on the excellent points that Addison makes in this segment. Please stick around until after my conversation with Addison for some additional thoughts from me on the issues. I should note that this conversation that we have about monetary policy, it was triggered by an observation that I made about recent market movements in the Australian dollar in early June 2023. So my observations about the exchange rate are dated. But the discussion which follows is evergreen. Okay, let’s get into the episode. I hope you enjoy my conversation with Addison Wiggin.

It’s interesting how markets react Yeah, it’s just, we just had this situation where because we had this surprise, monthly inflation number, and then we had the minimum wage decision or the award wage decision yesterday, then the markets go oh that makes it more likely that the central bank here the Reserve Bank will increase the cash rate. And so what we’re seeing now is that the dollar has appreciated against the US. So it was going down, it was going down to below 65 cents US and now it’s back up to around 66. Yeah, it’s funny how…

Addison Wiggin 02:37

And that’s one thing that I wanted to point out, because I think it’s it’s a concept that a lot of people either have trouble with, but in this book, I so I’m going to hold up the book again, because I think it’s worth the read. It’s pretty short. And my son helped me write it for millennials. So it’s like a quick read. But I was trying to wrap my head around, how is it that the dollar can be the reserve currency of the world? Meaning it’s the place where people, other banks and like big corporations hold their asset value? And how can we have that at the same that gives the United States a massive amount of advantage globally, when making trade deals, and whatever selling guns to go shoot Russians or whatever, whatever people want to do, we can do that, at the same time that we have inflation domestically, because there’s a difference between the reserve currency of the world which, you know, the Central Bank of Australia is going to is going to make deals with the Federal Reserve. Like that is an exchange trade thing. Or if I don’t know if Apple wants to open a plant in Brisbane or something like those exchanges happen in US dollars. And a lot of the commodities that Australia exports are priced in dollars, gold, and their earths and copper, like those things, they’re all priced in dollars. So there’s a tremendous advantage for the for the US economy that we have the reserve currency of the world, but at the same time, we have a payment currency, which is the stuff that we buy eggs in or we finance our homes or, or we take out loans to put our kids through school, whatever, that you can have massive inflation in that at the same time that the stability of the reserve currency. You know, you were talking about a penny between, it used to be five now it’s six or six like it’s pretty, pretty stable, globally. It’s a freaking nightmare at home when they can’t figure out how to slow prices down or the bizarre thing that we were just talking about. They want people to they want the unemployment and the jobs number rate to go up, but they actually want that to be the result of slowing the economy.

Gene Tunny 05:00

Well, yeah, I mean, they want a sustainable rate of economic growth and you want to avoid the overheating economy, you want to avoid the, the huge boom and followed by the, the big bust. And that’s a concern. I mean, in Australia what we’ve had because particularly because in a combination of the massively generous pandemic response, I mean, just like nothing that was just ever expected. And I mean, incredibly generous to, particularly to small business people, and also to welfare recipients who had their, if you’re on the Jobseeker you had that doubled, compared with what it was before, for maybe six months to a year. And there’s all this and people were allowed to pull money out of their retirement savings, their superannuation, their compulsory super, so there’s all this extra money. And I mean, the boom we had was just incredible. And unemployment nationally got down to three and a half percent. And I mean, I never thought it would go below four, like we we thought full employment in Australia was around, or the natural, the non accelerating inflation rate of unemployment or natural rate of unemployment, we thought it was around 5%. And then suddenly, it’s got unemployment rates got down to three and a half percent never thought we’d see it. Cutting off immigration was possibly part of that for a time. But the idea is to try and set the interest rate so that the economy doesn’t get on, I mean, you know, this, it doesn’t end up in that boom bust cycle or that or it’s not as amplified as it as it would be, if you…

Addison Wiggin 06:33

Yeah, so that I my issue with that is that they that’s that was the idea of lowering interest rates for as long as they did is that they wanted to mitigate the boom bust cycle. They wanted to use the tools that they had from history to figure out a way to mitigate the booms, but also mitigate the busts, they wanted to like level the whole thing out. And look what happened, we had a pandemic. And then we had, we had to throw a bunch of money at citizens, and then they saved it, the savings rate went higher than the credit rate at one point on each money. And then as soon as the market I mean, as soon as the economy started opening again, it plummeted all the way to the lowest rates, we saw the the fastest rate of disposable income drop, since 1933. It just went whoo bump. Like they did anything but mitigate the business cycle. In, in my view, I mean, I’m just a guy who studies and writes about it and talks about it write books about it, whatever. But in my view, why not just accept that the business cycle is a thing and not do anything about it? Let, let credit go to the market price that is this, it’s designed to go to, don’t have a central bank that is trying to manipulate overnight rates so that their buddies on Wall Street can get, can keep funding their projects and stuff. It messes with the natural cycle of booms and busts. And that’s what I honestly believe would would do away with these kinds of massive inflationary cycles that we go through, or the opposite, which they’re really afraid of, which is a deflationary period where they can’t sell anything, and the economy just falls apart. That’s what happened in the 30s. I’ve been reading a lot recently about what’s going on, what went on in the 30s. And that’s when we got all these regulatory agencies, it’s probably about the time that Australia started enacting its own financial regulatory systems too. They don’t help. And in fact, they’re always late and they’re always wrong. So it’s like, they’re not mitigating the business cycle. And they’re not actually helping anyone be more honest and truthful in the marketplace. It’s it’s politics, and it’s nastiness. And nothing actually, like they’re not achieving anything. And I’m costing, casting a wide net here because I’m talking about regulatory agencies within the financial network, like we’ve got the SEC, we’ve got the FTC, we’ve got the CFTC, there’s a bunch of lawyers out there trying to stop people from doing anything under the guise that they can mitigate the boom and bust cycle, and that’s just the natural order of things. That’s capitalism. Let’s, let’s go. That’s the way I look at it.

Gene Tunny 09:44

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

Female speaker 09:49

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 10:19

Now back to the show.

Yeah, look, I think there’s, I think some of the fine tuning they’re doing or if that’s the right term, I think there’s there is a concern that some of it may actually be contributing to the instability of the economy. I, I think that’s right. What Bernanke would argue is that if he hadn’t, so if we go back to say, ’08, I mean, he would argue in, you know, Paulson and Tim Geithner, they would argue that if they hadn’t done what they did, or some variation of it, you could have had a rerun of the 1930s. And you could have had unemployment of 20%, or something, or whatever you saw during the Depression. I don’t know to what extent that’d occur, but that’s what their argument would be. Yeah, it’s a it’s it’s something I’ve been thinking about. I mean, I don’t really know the answer myself. I am concerned like you that a lot of the actions that they’ve taken have contributed ultimately contributed to instability rather than making things more stable.

Addison Wiggin 11:26

Yeah, well, let me go back to Hyman Minsky who was writing in the 50s. And he was mostly describing what he read, he lived through the 30s. And then when he was an adult, he was a professor, I think, at MIT. And he was talking about, like, his area of study was the 1930s. And he studied like Schumpeter, and those guys who were writing during that time, Garet Garrett is another one that I’ve been sort of fascinated with. Because as we’re moving through our own like situation, the the stuff that I read, sounds like it was written yesterday, but it was written in like 1932, or whatever. So Minsky’s idea was the longer you have a period of stability, the stability, it, it’s actually called the Minsky Instability Theory, that the longer you have periods of stability, the more mistakes get made, and the inevitability of a crash is going to happen. So artificially creating periods of stability by lowering interest rates, or by keeping them low for longer than the market demands, or by incentivizing the couple of the things that were talking about before 2018, were alternative energy, and areas of the market that had been underserved by the regular stock market, they were passing political motives, or political policies that encouraged, you know, wind and whatever, I wish they had gone into nuclear at that time, but they failed, they missed on that one. But there was a lot of money going into areas of the market that that weren’t rewarded by a return on equity, like money that was put in was not rewarded. And so there was a shit tonne of money going into areas of the market that didn’t deserve it for a long period of time. And so the Minsky instability thesis is that when you do that, for a long period of time, there’s people make mistakes, they don’t, they don’t get punished by the market, that’s a kind of a harsh way to say it. But they don’t, they don’t lose their money, they get rewarded for making bad mistakes that are based on policy. And if that goes on long enough, when you have to clean up the mess after that, which is what Powell has been trying to do, it’s hard to figure out what Powell even thinks, but when you have to clean up the mess, then all of those mistakes that were based on false premises. They come to light in that, like if you’re watching anything of the financial news, currently, that’s each headline is about the mistakes that were made in like 2015 or 2018. Or what the hell happened during the pandemic. Like we’re still cleaning up that mess and we don’t know, a way forward other than this debate of whether the Fed is going to lower either pause or lower rates again, like that’s the only tool they have. They will they have two tools, they have one, they can lower rates and then other central banks around the world will follow. Or they can engage in another round of QE and support specific industries. Like I think we’re gonna see a heavy push either later this year or early next year to support in industries that are trying to develop new technology for cleaner energy, just because there’s so much private equity going into that space right now. That when they start losing money as they have been, there’s going to be a push for government to step in and bail them out.

Gene Tunny 15:24

Right, okay, even though, I mean you, you’ve just you’ve narrowly averted a debt default, haven’t you? And they’re going to have to have some cuts in discretionary spending. So yeah, I guess, yeah, maybe they’ll find some way to do it. But the

Addison Wiggin 15:39

let’s let’s talk about the debt default for just a second. It’s so absurd. Like, I’m like just a citizen of the United States. I grew up here. My dad is mildly conservative. I don’t really give a shit about politics at all, because I mostly think that they’re talking out of one side of their mouths, and then they’re making deals behind doors somewhere else, right. So the idea that we have a debt ceiling came about because Congress used to have to justify all of their spending every year, they had to, once they pass the budget, they had to like stand up and say, We want to spend money on this highway to do this, or this pipeline to do that, or whatever. They had to justify it. But when we went into the very expensive wars that we’ve been involved in World War One, World War Two, Korean War, war on poverty, war on drugs, war in Vietnam, war in Afghanistan, that’s our longest one, like you can’t justify spending that hasn’t happened yet. So they put the debt ceiling in place in 1960. Saying that, well, you can just spend money on whatever you want. But it can’t go above this amount. And 78 times now, I think it’s 79. Now that they’ve just reached a new deal, they’ve had to raise the debt ceiling since 1960. Like, the whole concept of a debt ceiling is just political theatre and it’s not even a useful tool to anyone. It just makes people anxious. I actually started watching the market. I was like, When is this gonna start impacting the market May 18. Nothing in the financial news. Like the banking crisis got wiped off the headlines, which I think is still sustaining right now. We’re gonna see more banks fail. And people other than the NVIDIA boost that we got last week, when AI started grabbing all the tech people’s attention, the markets were just trending slower and slower, lower, like, they were just kind of trending now. And everybody was waiting for Kevin McCarthy and Joe Biden, to come to an agreement. That’s it, it was like really boring. And all they were trying to do is figure out how much they’re going to pay their defence contractors, their buddies who make weapons to send to Ukraine, and that’s literally all they were talking about, one of the things they were talking about is the Republicans wanted work requirements for food stamps. And the Democrats didn’t want that. They just wanted people to get food stamps. And then there was a third one that was a pipeline from West Virginia to Virginia and the Democratic Senator Manchin, Manchin, wanted it to go through and the Democratic senator from Virginia didn’t want it to go through because his constituents, it was going to go through their farms, and they didn’t want it to go through their flocks. The details that they were fighting over were minuscule compared to that $31.4 trillion debt ceiling that they were arguing about. It’s all politics. It’s meaningless, and it’s it’s a charade that comes up and they supposedly put a cap on it for two years, but I’m gonna guess they’re gonna spend more than they agreed to. And we’ll be in this boat again next year or, or in 2025.

Gene Tunny 19:16

Yeah, because you’ve still got the problem of the unsustainability a lot of the the automatic spending really the

Addison Wiggin 19:24

Oh, yeah, that wasn’t even, that was off the table from the beginning. They’re like, Yeah, of course, they Social Security and Medicare and Medicaid and all that. We’re gonna pay that and that is adjusted according to the inflation rate, which earlier this year or late in 2022, it was 9% so that the adjustments were already baked in.

Gene Tunny 19:51

So unless they’re gonna do something about that, or you know, the alternative is to actually increase tax revenue, but no one wants to do that. And so if you not gonna do do that, then you do have to tackle those entitlement programmes. And again, you know, Donald Trump says, I’m not going to touch them. And so the other GOP people, they’re probably not going to do it want to do anything about it?

Addison Wiggin 20:12

It’s kind of ridiculous because one of two, or actually, both of two things need to happen. And I’m like, Libertarian, I don’t I I’m not, I don’t even vote. So for me to say this is like, I’m just talking about the economics, not the political side of things, but they need to raise taxes. And they have to cut spending, there’s no way out of this any other way, unless they can get a bunch of dumb ass central banks around the world to keep funding our debt by buying bonds. Like that’s, it’s just like, if, if I tried to teach this to a, you know, a class of like third graders, they would be like, those don’t make sense, like we can’t spend more than you take in and you have to borrow it from people who don’t like you. Pretty obvious that it’s unsustainable. And yet we tell ourselves day by day, week by week, month by month, year by year that we can do this forever.

Gene Tunny 21:24

Okay, I hope you found that informative and enjoyable. I think Addison made some great points about the effectiveness of monetary policy. At times, it may well have contributed to economic instability. Prior to the 2008 financial crisis, central bankers and many economists had thought we’d solved the problem of business cycle management. Inflation targeting policies were seen as contributing to the period known as the Great Moderation with low inflation and less volatile economies. But as we know, now, the victory was short lived. The fundamental problem of business cycle management has not been solved. It’s possible inflation targeting central banks, they didn’t pay enough attention to the financial risks that were building up in economies. They were too willing to cut rates to shore up financial markets with a view to preventing a wider panic which could cause a recession. There was the so called Greenspan put, named after Alan Greenspan, who chaired the Federal Reserve from 1987 to 2006. It was called the Greenspan put through a comparison to a put option in financial markets. So that’s an option, which allows the owner of stocks to lock in a certain price at which they can sell the stock in the future. There was a view in financial markets that Greenspan would intervene to shore up stock prices so they wouldn’t fall too much. Arguably, this created a moral hazard and encouraged excessive risk-taking in financial markets. So monetary policy could actually have been destabilising. I should note, there is an active debate on the extent to which and whether the central bank should intervene with a view to avoiding the accumulation of financial market risks. So this is the so called Lean versus Clean debate that I discussed with Steven Kirschner in Episode 135 in April 2022. So please check out that episode if you haven’t listened to it yet. I will put a link to it in the show notes. There’s no doubt that the monetary policy actions of Central banks can have significant impacts on economic activity, whether on the whole they are stabilising or destabilising is difficult to assess. In the 60s and 70s, Milton Friedman argued that the best thing for central banks to do would be to adopt a money supply growth rule, so committing to growing the money supply by a certain percent each year. This turned out to be easier said than done and Friedman’s approach known as monetarism was widely seen as a failure. We might come back to monetarism in a future episode for a closer look at how it was implemented and what went wrong. There’s a fascinating story there. The key point is that there’s been a an active debate for decades on the right way to conduct monetary policy and various approaches have been tried. We we’re still grappling for the right approach. The challenge is that central banks need some Northstar for setting monetary policy. So whether it’s inflation targeting or nominal GDP targeting, the latter being something that Stephen Kirchner advocated for in that discussion I had with him last year. It’s no longer as easy as it was during the gold standard, for instance. So if we look back to that period in history. In a 1908 speech to his Manchester constituents, Winston Churchill, who was then the President of the UK Board of Trade, he explained how the gold standard guided the hand of the Bank of England in setting its monetary policy rate, known as the bank rate. If England buys from America or Germany, more than she intends to buy having regard to our own productions, instantly, there is a cause for the shipment of bullion, that is gold, and bullion is shipped to supply the deficiency, then the bank rate is put up in order to prevent the movements of bullions. And the rise of the bank rate immediately corrects and arrests the very trade, which has given rise to this disparity. That quotes from David Kynaston’s excellent history of the Bank of England. Till time’s last sand, if I remember correctly, I’ll put a link to that book in the show notes. So if you want to get a copy of it, you can find it on Amazon. It’s a terrific read, and lots of great history in there. And yes, that quote from Churchill, is in there. So as the quote from Churchill suggests, setting the bank rate, or the federal funds rate in the age of the gold standard, would have been much simpler. Now, that’s not necessarily an endorsement of the gold standard as that system had its problems and economists such as I think it was Eichengreen, Barry Eichengreen have argued that the gold standard ended up contributing to the Great Depression. So there’s a, there’s a big debate around that, that we probably don’t have time to go into now. Going back to the gold standard, isn’t realistic. I’m just making the point here that in history, when there was a gold standard, it was more obvious what should be done with the monetary policy rate, the bank rate in the UK, the federal funds rate in the United States, or the cash rate in Australia. So we’re no longer in that era of the gold standard or even Bretton Woods, the era of fixed exchange rates, which ended in the early 1970s. And because of that, it’s much less obvious what should be done with with these policy interest rates of central banks, so we’re still trying to figure that out. Econometric evidence is only so convincing so any econometric evidence on which monetary policy regime might be more effective than others, which one might have lower inflation and lower economic volatility measured by the volatility of GDP, for example, it’s only going to be so convincing, it’s not going to convince everyone that there’s just so many influences on the economy, that it’s just very difficult to determine whether any particular policy, whether it’s making the impact, the size of the impact, it’s difficult to know what would happen in the absence of a specific monetary policy change. It’s difficult to know what the right counterfactual is so we can’t run controlled experiments in macro economics, there’s no, we can’t treat the economy like a laboratory in which we can test alternative monetary policy so we’re left with questions that are difficult, if not impossible to answer. For instance, what would have happened if the Fed hadn’t intervened so aggressively during the financial crisis or the pandemic? Would we have had repeats of the Great Depression? That was what the policymakers that was what the central bankers were worried about. Look, it’s hard to know there are many factors to consider, for instance, is fiscal policy fiscal policy is is set in a much better way in the post war era than it was during the depression or before that. We have automatic stabilisers in the budget such as progressive taxation and unemployment benefits and they can help prevent economic activity from collapsing and so therefore, there may be less case for an aggressive monetary policy response. So there are other things to consider it’s a very difficult question to answer. Regarding times of economic crisis we could ask, was aggressive monetary policy, so an aggressive monetary policy stimulus was that required, so was it required, or instead, did we simply need a monetary policy that didn’t make things worse. So there is an argument that the Great Depression was caused by bad monetary policy. When the Federal Reserve presided over the contraction of the US money supply as multiple banks failed. The US money supply fell nearly 30%, from 1930 to 1933. So that’s a statistic that you can find on the US Federal Reserve website. I’ll put a link in the show notes. As Ben Bernanke admitted to Milton Friedman in 2002. Regarding the Great Depression, we did it. We’re very sorry. We won’t do it again. That was Bernanke responding to the strong argument that Milton Friedman and Anna Schwartz made in their famous monetary history of the United States from the early 60s. It only took the Federal Reserve 40 years to to admit they agreed with Friedman on that. Now, if you do have a, an emergency, a major economic crisis, then look, the arguably there is scope for a monetary policy response, most economists, the large majority of economists would accept that there has to be some sort of central bank policy response, and probably even a stimulus of some kind, although there’d be debates on just how much that should be and how large it should be. One of the problems I think we’ve been we’ve had recently is that the well, the monetary policy response during the COVID period, when combined with the fiscal policy response was just massive, and it’s been massively destabilising. And it contributed to a very strong recovery, I mean, massive, massively. A very strong recovery in excess of anything that we really expected. And that’s contributed to the inflation that we’re experiencing that that we’re seeing in the United States and the UK and Australia. It’s, it’s what’s happening in Ukraine, of course, but it’s also a lot of it to do with just that, you know, the after effects of that massive fiscal and monetary policy response. So unintended consequences of of that, that policy response. So look, I think economists would accept that there is scope for some stimulus, some response in the face of a massive shock, adverse shock like that, but it looks like it was really over done. And then there’s the issue of just what central banks should do. Outside of these major crises just in the sort of normal course of events or the over the course of the business cycle, to what extent they, they should be actively managing interest rates, trying to control the money supply, trying to influence the course of the economy. There’s a big debate over that, this idea of fine tuning. Now, when I was studying in the early 90s, when I was at uni, the leading macroeconomics textbook at the time was, well it was called macro economics. It was by professors at MIT. So very famous professors Rudiger Dornbusch, and Stanley Fischer. I think Stan Fischer went on to be the governor of the Central Bank of Israel, if our if I remember correctly, he was a former Vice Chair of the Federal Reserve, and he served as the eighth governor of the Bank of Israel, from 2005 to 2013 so very distinguished economist, and what he wrote with Rudiger Dornbusch, in that textbook, they wrote that in discussing the desirability of activist, monetary and fiscal policy, we want to distinguish between policy actions taken in response to major disturbances in the economy. So, I was just talking about that earlier when we think about incidents like COVID or the financial crisis, or the depression. So there, so back to the quote. So in discussing the desirability of activist monitors monetary and fiscal policy, we want to distinguish between policy actions taken in response to major disturbances in the economy. and fine tuning in which policy variables are continually adjusted in response to small disturbances in the economy, we see no case for arguing that monetary and fiscal policy should not be used actively in the face of major disturbances to the economy. Fine tuning presents more complicated issues. The case for fine tuning is a controversial one. I think that’s a good summary of how economists think about monetary and fiscal policy as well, that was written in the early 90s but I think that is still a good summary of, of what the consensus would be. So what, what Dornbusch and Fischer were getting at in terms of the problems with with fine tuning, they’re thinking about the problem there is that you’re not sure whether a particular shock to the economy, is it permanent? Is it transitory? Is this just a normal part of the business cycle, and therefore, you shouldn’t really react to it. There’s also there’s the issue of of lags in policymaking, it can take time to recognise disturbances in the economy, then can take time to implement policy and for that, to have an impact on the the economy. So there are these lags, which complicate macro economic policy. And they mean that the case for having an activist policy, so trying to be clever in how you’re setting interest rates and making these fine adjustments to interest rates. It does make you wonder, just the extent to which we can do that the extent to which our policymakers will get that right, and won’t actually contribute to instability in the economy, which I think is a significant risk. What does all this mean, in the current context? Well, it probably would have meant after we got out of the, the emergency period during COVID, and it was clear that the economy was recovering very strongly. And inflation was a risk, I think, thinking about this, all these points that, that I’ve been discussing here, I think, possibly central bank should have increased interest rates much faster, they should have got them up to perhaps what you might call a neutral rate, or a bit higher than a neutral rate much more quickly than they did. And then leaving them there and not not adjusting them every month or every couple of months, depending on how various economic variables are tracking. I mean, it gets a it gets very difficult to, to do that, and to be sure that you’re making the right judgement. So perhaps that’s one, that could be an interpretation of what central banks could have done if they recognised that this whole approach and fine tuning so to speak, is is not really optimal. I think it’s an open question. I’m not necessarily saying that I’m not saying okay, this would have been the right approach that there isn’t, there isn’t still the potential to fine tune the economy, there may well be, but it’s not clear that some other approach may not be superior. And so therefore, I don’t think you can actually reject the hypothesis or reject the argument that these frequent adjustments of policy interest rates, they could actually contribute to economic instability. We, I think that’s, that’s a question economists should be thinking more about. So there are certainly real examples of where the monetary policy response as part of a fine tuning approach was probably excessive, and it sent the economy into recession. The example I always come back to is the early 1990s recession in Australia, which was arguably deeper than it should have been, much deeper. The unemployment rate went up to around 11% in 1992, our central bank, the Reserve Bank, increased interest rates to around 17 to 18% to slow down the economy so in Australia, we had this colossal boom in the 80s. It was the age of the entrepreneur. And there was a lot of investment particularly in commercial property. And the central bank intervened aggressively, it was also worried about the balance of payments, the it was worried about the current account deficit. And it thought that very tight monetary policy was justified. And at the time, they thought, Oh, well, the economy can handle this, they did their economic modelling the Treasury and the RBA, they were forecasting a soft landing for the economy, it turned out to be the worst downturn since the Great Depression. So when I think of that incident, I’m always reminded of just how difficult it is to fine tune the economy, so to speak, and, and looking back on it that early 90s recession, it happened when I was in high school, and it was something that really made me interested in economics. And it made me actively think about studying economics and, and even eventually becoming an economist. So that was one of the incidents that that stimulated my interest in economics for sure. Okay, so we’re going to start wrapping up this afterword. Central banks, they do need to set policy rates, so they’re at the centre of the monetary system, they can control the amount of liquidity in the overnight money market. So in the cash market, as we call it, in Australia. And that ends up setting the benchmark for interest rates across the economy. So central banks are playing a very important role in our monetary system in our, in our payment system in our financial markets. They need to choose wisely. And they need some methodology to do so. So whether it’s set and forget, some sort of set and forget methodology or some type of rule, whether it’s inflation targeting, nominal GDP targeting, some other method, they need something to help guide their decision making. And we still haven’t figured out what that should be. So for a while, we thought that inflation targeting was the right methodology but that’s imperfect, we’ve learned. Some critics of inflation targeting they argue, it’s given us too much financial instability. Other critics come at it from another direction, they argue central banks, they actually didn’t fully follow the inflation targeting policy, it hasn’t been properly implemented. So they would argue that central banks should have had looser monetary policy during the 2010s so that they could have got the inflation rate up. So it got into the target range. And, and they would argue that what we ended up getting was lower growth, lower employment, higher rates of unemployment than otherwise. So we’ve got criticisms of inflation targeting for a variety of reasons. So it looks like it hasn’t. It hasn’t lived up to the promise it, it’s been imperfect. Okay, in summary, there’s still an active debate over how to conduct monetary policy when it comes to fine tuning the economy. It’s possible that at times central banks have actually contributed to economic instability. We can’t say definitively one way or another, whether their policy actions have been stabilising or destabilising on average. I think that’s fair to say. That’s my interpretation of things. If you’ve got a different view, then please let me know. I would love to hear from you. I think that central banks are trying to do the best they can, I mean arguably, they have helped prevent a rerun of the Great Depression at at certain times, particularly in 2008, you could probably argue that actions by the Federal Reserve, in particular did help prevent a much more severe downturn, although that was a very bad downturn already. But look, outside of those sort of incidents, I guess maybe during COVID, the assistance was was was definitely some assistance was needed but then they overdid it, and now we’re suffering from the high inflation. So look, possibly they do some good in times of crisis, but then, in other times, it’s hard to know they could actually be destabilising. This is one of these issues where it’s difficult to read the evidence. And it’s, it’s unclear, and we’re still trying to figure things out. So that’s not a great answer. But that’s my understanding of what the evidence and the theory tells us at the moment. So yep, if you’ve got a different view, let me know. So any thoughts you have on what Addison or I had to say in this episode, please get in touch. You can email me via contact@economicsexplored.com. Thanks for listening.

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

45:45

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Tags central banks, debt, economics, fed, monetary policy, money, rba

Podcast episode

The Greedflation hypothesis – EP186

Post author By Alec Krishna
Post date May 6, 2023
No Comments on The Greedflation hypothesis – EP186

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

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

What’s covered in EP186

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

Links relevant to the conversation

Greedflation articles:

Blaming inflation on greedy business is a populist cop out

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

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

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

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

price hikes

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

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

Inflation is being amplified by firms with market power

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

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

UK windfall profits tax:

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

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

RBA on sources of inflation in Australia:

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

Charts:

Australian bank deposits

Australian money supply (M3)

Transcript:
The Greedflation hypothesis – EP186

Gene Tunny 00:00

Arturo Espinoza Bocangel 01:12

I’m very happy to be here.

Gene Tunny 01:14

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

Arturo Espinoza Bocangel 02:05

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

Gene Tunny 02:11

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

Arturo Espinoza Bocangel 08:26

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

Gene Tunny 09:04

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

Arturo Espinoza Bocangel 10:25

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

Gene Tunny 10:36

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

Arturo Espinoza Bocangel 10:42

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

Gene Tunny 11:05

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

Arturo Espinoza Bocangel 16:15

Exactly if the concentration, right,

Gene Tunny 16:19

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

Arturo Espinoza Bocangel 17:20

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

Gene Tunny 17:35

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

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Gene Tunny 21:03

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

Arturo Espinoza Bocangel 21:55

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

Gene Tunny 22:00

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

Arturo Espinoza Bocangel 28:09

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

Gene Tunny 29:03

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

Arturo Espinoza Bocangel 34:37

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

Gene Tunny 34:43

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

35:30

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Credits

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Tags covid-19, fed, greed, greedflation, inflation, monetary policy, money, qe, rba, stimulus

Podcast episode

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

Post author By Alec Krishna
Post date March 21, 2023
No Comments on Why fiat money means higher inflation & why a radical Reserve Bank review is needed w/ Darren Brady Nelson – EP179

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

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

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

What’s covered in EP179

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

Links relevant to the conversation

Darren’s bio on the Economics Explored website:

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

Darren’s opinion piece on the Spectator Australia website:

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

Bank of England paper on money creation:

Money creation in the modern economy | Bank of England

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

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

US Gold Commission Report

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

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

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

The Age of Turbulence*

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

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

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

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

Gene Tunny 00:06

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

Darren Brady Nelson 01:46

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

Gene Tunny 01:48

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

Darren Brady Nelson 02:21

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

Gene Tunny 04:29

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

Darren Brady Nelson 04:45

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

Gene Tunny 07:19

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

Darren Brady Nelson 08:24

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

Gene Tunny 10:00

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

Darren Brady Nelson 10:05

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

Gene Tunny 12:20

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

Darren Brady Nelson 12:25

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

Gene Tunny 13:38

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

Darren Brady Nelson 14:15

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

Gene Tunny 16:45

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Gene Tunny 17:20

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

Darren Brady Nelson 18:18

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

Gene Tunny 21:08

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

Darren Brady Nelson 21:18

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

Gene Tunny 24:55

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

Darren Brady Nelson 25:44

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

Gene Tunny 26:26

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

Darren Brady Nelson 27:16

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

Gene Tunny 28:54

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

Darren Brady Nelson 29:27

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

Gene Tunny 30:42

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

Darren Brady Nelson 31:15

Thank you for having me.

Gene Tunny 31:26

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

41:26

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Tags austrian economics, central banks, fed, fiat money, gold standard, inflation, monetary policy, money, rba

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Normalization of interest rates & monetary policy – EP173

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Post date February 4, 2023
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Last year we saw the beginning of the normalization of interest rates and monetary policy, as central banks responded to accelerating inflation. Show host Gene Tunny talks about the current tightening cycle and when it might end with his colleague Arturo Espinoza. Among other things, Gene and Arturo discuss what history tells us about typical interest rates and returns on capital, referencing UK bank rate since 1694, interest rates on UK government consols, and returns on land written about by Jane Austen and Honoré de Balzac. They also consider whether we might see 17-18 percent interest rates again in Australia, rates which were last seen in 1989-90.

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

What’s covered in EP173

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

Links relevant to the conversation

Data released since the episode was recorded

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

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

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

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

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

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

Inflation targets

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

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

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

Bank of Finland article on monetary policy normalisation:

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

Chatham Financial article on US tightening cycles:

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

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

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

Chart on historical UK bank rate:

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

Chart on central bank policy interest rates since 1960:

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

Chart on inflation in the US, UK and Australia:

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

Wikipedia article on the Fisher equation:

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

Wikipedia article on UK consols:

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

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

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

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

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

Transcript: Normalization of interest rates & monetary policy – EP173

Gene Tunny 00:00

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

Arturo Espinoza Bocangel 02:58

Hi Gene, it’s my pleasure to be here.

Gene Tunny 03:01

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

Arturo Espinoza Bocangel 05:51

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

Gene Tunny 05:59

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

Arturo Espinoza Bocangel 10:28

Between two and 3%. Yeah,

Gene Tunny 10:31

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

Arturo Espinoza Bocangel 17:01

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

Gene Tunny 17:21

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

Arturo Espinoza Bocangel 18:43

and depending on what loan.

Gene Tunny 18:46

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

Arturo Espinoza Bocangel 21:42

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

Gene Tunny 22:07

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

Female speaker 23:31

Gene Tunny 24:00

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

Arturo Espinoza Bocangel 38:33

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

Gene Tunny 38:43

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

Arturo Espinoza Bocangel 38:47

Thank you for having me.

Gene Tunny 38:50

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

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Credits

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Tags central banks, fed, inflation, interest rates, monetary policy, rba, recession

Podcast episode

Global economic outlook + Aussie inflation & house prices – EP150

Post author By Alec Krishna
Post date August 2, 2022
No Comments on Global economic outlook + Aussie inflation & house prices – EP150

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

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

Randall Evans’ Deactivist show:

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

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

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

US recession news from NPR:

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

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

Gene Tunny 00:01

Coming up on Economics Explored.

Randall Evans 00:04

Gene Tunny 00:21

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional Economist based in Brisbane, Australia, and I’m a former Australian Treasury official. This is episode 150 on the Economic Outlook.

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

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

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

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

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

Randall Evans 02:38

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

Gene Tunny 02:42

Good. Thanks, Randall. How are you?

Randall Evans 02:44

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

Gene Tunny 02:52

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

Randall Evans 03:27

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

Gene Tunny 03:33

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

Randall Evans 03:55

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

Gene Tunny 04:02

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

Randall Evans 06:02

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

Gene Tunny 06:22

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

Randall Evans 07:32

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

Gene Tunny 07:55

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

Randall Evans 09:35

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

Gene Tunny 09:52

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

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

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

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

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

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

Randall Evans 17:04

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

Gene Tunny 17:46

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

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

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

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

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

Randall Evans 24:18

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

Gene Tunny 24:28

Was the comment okay?

Randall Evans 24:31

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

Gene Tunny 24:59

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

Randall Evans 27:33

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

Gene Tunny 28:09

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

Randall Evans 30:35

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

Gene Tunny 30:43

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

Randall Evans 31:10

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

Gene Tunny 31:15

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

Randall Evans 32:11

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

Gene Tunny 32:35

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

Randall Evans 33:11

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

Gene Tunny 33:33

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

Randall Evans 34:12

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

Gene Tunny 34:20

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

Randall Evans 35:38

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

Gene Tunny 36:06

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

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

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

Randall Evans 40:38

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

Gene Tunny 41:31

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

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

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

Randall Evans 45:52

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

Gene Tunny 46:49

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

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

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

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

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

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

Randall Evans 52:15

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

Gene Tunny 52:42

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

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

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

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

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

Randall Evans 57:15

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

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

Gene Tunny 57:42

Pleasure. Thanks. Thanks, Randall and thanks to everyone listening. Yeah, glad to be to be connecting with you. So, it’s been great. Thank you.

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

Credits

Thanks to Randall Evans for letting us borrow the audio from his latest Deactivist show for this episode. Also, thanks to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au. Please consider signing up to receive our email updates and to access our e-book Top Ten Insights from Economics at www.economicsexplored.com. Also, please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. Economics Explored is available via Apple Podcasts, Google Podcast, and other podcasting platforms.

Tags australia, central bank, economics, inflation, interest rates, monetary policy, money, rba, stagflation, united states

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