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RBA Deputy Governor’s ‘Beware False Prophets’ talk: Reactions w/ Michael Knox – EP250

Show host Gene Tunny and Morgans Chief Economist Michael Knox explore the recent insights Reserve Bank of Australia Deputy Governor Andrew Hauser shared on monetary policy at the 2024 Economic Society of Australia (QLD) business lunch. They examine the RBA’s data-driven approach to interest rates,  the equilibrium real interest rate concept, and the impacts of Quantitative Tightening (QT). Michael is one of Australia’s leading market economists and RBA watchers, and he led the Q&A session with the Deputy Governor at the lunch. 

If you have any questions, comments, or suggestions, please email us at contact@economicsexplored.com  or send 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 Apple Podcast and Spotify.

What’s covered in EP250

  • Introduction. (0:00)
  • RBA’s monetary policy decisions and the influence of high US debt on interest rates. (4:13)
  • The equilibrium real interest rate. (10:29)
  • Monetary policy, inflation, and interest rates. (14:16)
  • Central bank balance sheet unwind and its potential impact on interest rates. (21:42)
  • US budget deficits, bond yields, and quantitative tightening. (27:09)
  • Chinese RMB’s decline in international reserve currency status. (34:18)

Takeaways

  1. RBA’s Data-Driven Approach: The Reserve Bank of Australia relies on actual data more than forecasts when making interest rate decisions.
  2. Criticism of Overconfidence: RBA Deputy Governor Andrew Hauser criticised the unwarranted confidence with which some commentators argue for monetary policy moves.
  3. Implications of Quantitative Tightening (QT): The recent period of quantitative easing has complicated the relationship between government budget deficits and bond yields. However, there are concerns that as QT continues and deficits remain high, this relationship could reassert itself and lead to higher long-term interest rates than otherwise.

Links relevant to the conversation

RBA Deputy Governor Andrew Hauser’s Beware False Prophets speech:

https://www.rba.gov.au/speeches/2024/sp-dg-2024-08-12.html

Chris Joye’s article ‘Arrogant RBA boss should stop trying to muffle opponents’:

https://www.afr.com/policy/economy/arrogant-rba-boss-should-stop-trying-to-muffle-opponents-20240813-p5k25p

Kevin M Warsh: Financial market turmoil and the Federal Reserve – the plot thickens 

https://www.bis.org/review/r080415e.pdf

Transcript: RBA Deputy Governor’s ‘Beware False Prophets’ talk: Reactions w/ Michael Knox – EP250

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, 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 and welcome to the show. This episode features a conversation that I had with Morgan’s chief economist, Michael Knox, it was about a recent event that the Economic Society of Australia, Queensland branch held with the Reserve Bank of Australia. Deputy Governor, Andrew Houser, it was a business lunch on the 12th of August 2024 in Brisbane. And given that I’m the current president of the Queensland branch of the society. I had to welcome everyone and Michael, he introduced the deputy governor and led the Q and A Michael had that role because Morgan’s sponsored the lunch. In his address, the deputy governor spoke about the challenges of setting monetary policy when there’s so much uncertainty, he suggested that some Australian commentators are overconfident in their assessments of what the central bank ought to do. We’ve had some commentators say the reserve bank hasn’t lifted interest rates enough, and we now have some commentators saying the reserve bank should be cutting interest rates because the economic outlook is so bad. Michael and I start off this episode talking about the deputy Governor’s speech, before we move on to a couple of meaty questions that Michael asked the deputy governor. These questions were about the equilibrium real interest rate and the effect of so called quantitative tightening. I get Michael’s reactions to the answers that the deputy governor gave him I should note that both Michael and I were impressed by the Deputy governor’s remarks, but the deputy governor has received some severe criticism in response to them. One of the strongest bits of criticism has come from well known financial economist and fund manager Chris joy. He’s written in the Australian Financial Review the following the newly appointed English Deputy Governor of the Reserve Bank of Australia, Andrew Hauser, apparently has a proclivity for lecturing Aussies on the history of our penal colonies, arrogance, overconfidence, and the importance of Never daring to criticize our supercilious central bank. Okay, so it’s, it’s a speech that has that’s got everyone talking and I mean, as President of the Economic Society of Australia, Queensland on, I am, I’m happy that people are talking about it. People have taken notice of what the deputy governor has said. What do you think about what he said. I’ll be interested in in your thoughts on it. If you want to get in touch, please do so. My contact details are in the show notes. I’d love to hear from you about the deputy Governor’s speech or his responses to Michael’s questions, or any ideas you have on how I can improve the show. I’d love to hear from you. Okay, without further ado, let’s dive into the episode. I hope you enjoy it. Michael Knox, good to be catching up with you. Good to see you too. We had a great economic society of Australia Queensland Business lunch earlier this week with the RBA deputy governor, Andrew Hauser, and you did a great Q and A session with the deputy governor. So I thought what would be good is to just catch up on that, and you know your reactions to his responses, because at least one of them, I think, was not, probably not what you’re expecting, certainly wasn’t what I was expecting. So just interested in your your thoughts on that. But to start with, what did you think generally of the deputy governor’s talk about the wearing urging us to be what is it? Beware of false prophets?

Michael Knox  04:12

Well, when I got up, I asked I before I asked him the scheduled questions that he and I had talked about before the presentation, I said to him, so it’s really true that the RBA makes its decisions on monetary policy on an inter rated basis, one step at a time. At every meeting, they are looking at the data. They are looking at where employment is. They are looking at what the inflation data is saying, and they and they’re looking at all the other variables and then, and then they’re making the decision on the data a step at a time, yes, yeah. And he said, and he said, Yes. He said, does that mean? I. Don’t have to answer any of your other questions.

Gene Tunny  05:06

Yes, I think that was actually something that the Kook, Steven kookis reacted to on Twitter, like when he heard the speech, his initial like he I think he liked the speech, but his reaction to it was, look, the RBA is confirming that they’re only going to move on hard data. They’re not going to move on, you know, people in the business community saying things are tough and you should cut rates now. They’re not going to move on forecasts from market economists as to what’s going to happen. They’re going to be solely focused on hard data, at least that’s what he took out of it.

Michael Knox  05:37

Yeah. Well, I think that, though, what he talked to me about before, before we were when he went up, was the the influence, and not so much the influence. But I think the annoyance of people like Warren Hogan and other economists saying that the rate should, rate should go up, yeah, or another people saying that rates should go down, and they’re more having their own theory on it, yes. And whereas the he felt that they were looking pretty much at everything that they needed to look at and making the decision the right way. And I think the presentation was about how is about? Was about false positives. Yeah, yeah. People make decisions on a view of what the RBA does, which is their view of what the RBA is doing, but the RBA is actually operating in a different way. Yeah,

Gene Tunny  06:28

yeah. I think so too. I think that gave us a really great insight into how the RBA is thinking about the cash rate decision. I thought that was I thought it was really useful. Can I ask you about the questions that you asked the deputy governor. So the first one you asked about was regarding the equilibrium real federal funds rate. Wasn’t it you were asking, you’re talking about, well, Larry. Was it? Larry Summers had argued that because of the Highland Olivier Blanchard and Olivia Blanchard, right? So some pretty heavy hitters, right? Yeah, real heavy hitters. And you are. They’re arguing that the because of the high level of US debt, you mentioned, that sovereign, net sovereign debt for the United States is going to get to 100% of GDP, of their GDP. And what that means is that the equilibrium federal funds rate nominal is 4% which means, in real terms, it’s 2% have I got that? Right? That’s

Michael Knox  07:29

exactly right, right? That’s what they’ve said. And if you look at the Peterson Institute, they in fact, have five published research papers, not just from them, but for other people who’ve done for the Peterson Institute and and they done over time and their empirical research, and they actually come up with the number of each 1% increase in net G debt to GDP increases the the the equilibrium Fed funds rate by a little over four basis points. So you get Right exactly. You get 450 basis points. Is the equilibrium level of of the Fed funds rate at 100% of GDP, the now the now the net debt of 100% of GDP, that’s a forecast from the International Monetary Fund. So if you go on their their quarterly database, and you’ll see the updated forecast for that 100% of GDP. Very interestingly, Andrews come from the Bank of England, yes, and the UK has exactly the same debt problem that their debt, net debt, is now 100% of GDP. So all of that debt that they paid back from North Sea oil and Margaret Thatcher and all of that kind of thing, they blew it all again, and maybe Boris blew a good bit of it, by the look of it. And and so they’re now in as much debt as they’ve ever been. I

Gene Tunny  09:02

mean, it’s like with all the, you know, many advanced economy governments after the financial crisis, there was, we just took we had the view, oh yeah, we’ve got to spend money to deal with this crisis, and then we don’t really have to worry about debt anymore because interest rates are so low. Larry Summers had secular the secular stagnation hypothesis. I think that’s part of it. There’s some changed attitudes. I mean, I don’t agree with that, but that’s what would you should we go over what? How Andrew responded?

Michael Knox  09:34

Okay, Andrew, so the first question was, in your presentation of 27 June, you showed that historically, Australia has been an importer of capital. And I remark that two noted economists, Larry Summers and Olivier Blanchard of the Pearson Institute, have suggested that the high level of us net sovereign debt to GDP, which reaches a. 100% of GDP next year, according to the IMF estimates, will generate an equilibrium Fed funds rate. This is, according to Larry and Olivier, an equilibrium Fed funds rate of not less than 4% that is to say a real rate of around about 2% so does this mean that the equilibrium real short rate in Australia is likely to move to higher a higher level going forward?

Andrew Hauser 10:29

So I think the this concept of equilibrium real exchange rate [NB he means equilibrium real interest rate] is a bit like the supply capacity number in my speech. It’s a latent variable. You can’t go and look for it anywhere, right if you if someone we Bank of England joined the first week. He wrote, and he said, Can somebody tell me where the measure of the equilibrium interest rate is? And some whip rope out? He says, the same place as the NAIRU, you know, and the sustainable level of output. In other words, who knows? And so that’s an important point to start with. Nobody knows the answer to that. Larry Summers is quite good at saying he does know the answer, although sometimes, if you look back over its forecasting record, it’s not quite, doesn’t always follow quite the certainty of his, of his predictions when you so there’s huge uncertainty about what this number is. It is interest when he when he says real rate of 2% he’s been provocative, right? Because if you look at the fomc.so called dots, for example, at the estimate of FOMC members, that’s us monetary policy makers estimates for the long term real interest rate, they have a number like half a percent. It’s quite low the John Williams estimate. John Williams is head of the New York Fed, the US, who’s made a bit of a name at running various models on this is probably somewhere between nought point five and one. So the two is a higher number, and that’s your point, or his point that he thinks it’s going to be higher. There are enormous number of different drivers of this number, right? I mean, ultimately, our star as it were, sorry to use the phrase, our star equilibrium. Real rate is the outcome of equilibrium in the savings and investment market. And if you think about all the things that could drive that, those who think that number, including John and others, is relatively low, will put weight on things like, well, demographics. People get their countries are getting older, so they’re having to dissave Rather than save they’ll put weight on things like productivity. Whereas when, you know, in Australia and elsewhere, productivity rate, growth rates in most Western countries, not the US, actually, but most countries, have been quite low. And we’ll say, Well, look, actually, I don’t buy this number like 2% it’s a lot lower than that. There’ll be others like summers and others who say, Well, look, you know, there’s new shocks and new issues around I mean, I think in talking about the US debt, he must be talking about a risk premium, if that’s right, which is to say, look, there’s so much debt that the US and the 7% deficit of GDP is pretty impressive. Sometimes there’s some they’re issuing so much debt, at some point there’ll be a wobble. There may even be concerns about default risk premium will go up and that our number will go up as people start charging up to lend to the US. And you could think of other reasons too many people who will think that the energy transition, for example, is going to lead to higher investment demand, which will raise that number. You know, who knows? Is the honest answer, whether it’s 2% 1% or half. You asked a question about Australia, and because it’s actually difficult to take no view on this at all, we have a swathe for our own equilibrium, short rate, equilibrium rate, which is similar to that swathe of numbers that I showed you for unemployment. And actually that’s all that has a central point of something like three and a half, three and three quarters in nominal space. Obviously, our current cash rate is a little bit above that. So I think you pay your money and you take your choice. I wouldn’t want to be someone actually trying to invest on the basis of these numbers. Summers may be right, but it may be wildly wrong.

Michael Knox  13:58

Okay, so what I’ve said about that is, if you go to the Peterson Institute website, you’ll find five studies, different done at different periods, and the most recent one is actually that you get, it’s actually four and a half percent, 450 basis points, 100% of GDP. That’s where you concluded. But what the real test of this when Larry Summers was and actually, Larry Summers did this talk last year, yes. So I’d actually saved this question up for a year, because I’ve been, I’ve been I model bonds myself, and I use deficits and that kind of things in my bond models. But the position that Larry Summers was putting when he talked about this last year, was that when the Fed started cutting rates for 535 basis points, it would be difficult to sustainably cut it below 400 basis points. Yeah. Okay, and so when you got to 400 basis points or lower. Up or you got below 400 basis points, there would be some reaction, either in inflation or the US dollar, which might would make it difficult to continue to cut rates to where the Fed that currently projects they’ll get to, which is 250 basis points, sometime at the end of 25 or 26 Yeah, is where they think on the summary of economic projections, yeah, but they put out every quarter, so, yeah. So expectations of the Fed, of interest rates falling down to two and a half percent might crash into the reality of net debt as proposed by Larry Summers and leveling a Blanchard on the way down, we’re going to find out, yeah, that’s one of the part of the adventure of economics, yeah?

Gene Tunny  15:44

So this equilibrium nominal cash rate, or federal funds rate, so the overnight money market rate, yeah, this is the rate that they believe is, is essentially that it corresponds to neither a monetary policy stance that is neither expansionary nor contractionary. It’s a, it’s a neutral monetary policy, stand. It’s

Michael Knox  16:06

a neutral monetary policy, but it’s, it’s the basic problem here is that there’s the net debt to GDP goes up in the United States. Yeah, the real rate has to rise to attract the inflow of savings to finance that higher level of debt. So the real rate, nominal rate, plus your inflation target goes up, okay, as net the jet to GDP, right? That’s the that’s the problem.

Gene Tunny  16:33

And what did you think of his like the the RBA view? So their view of the neutral cash rate in Australia, in nominal terms, is, was he saying three and a half or three and three quarters percent? Does that sound

Michael Knox  16:46

well, where they’ve where, where it is thought to be. Okay. So when Michelle Bullock, when she herself, presented in the Hilton for us two years ago when she was also deputy governor. At that time, she then thought that the equilibrium real rate in Australia was 50 basis points. That’s what she said at the time. Now, the commentaries of the of the RBA that I’ve read and the surveys they’ve read, so that’s now increased to 75 basis points. So instead of an equilibrium short rate of inflation at two and a half percent plus 50 basis points, saying that 3% is where the equilibrium short rate is, now that’s risen to 325, basis points, or 350 right? So in the surveys they put out in part of their publication in the quarterly outlook for the summit of their not the summary of economic projections, but the statement on monetary policy in their detailed section they they look at, they do a forecast of the detailed cash rate, and they see the detail they in that detailed forecast they see in 26 December, 26 the real cash rate will get down to three and a quarter percent, but that means the inflation of two and a half percent plus 75 basis points for the real rate. They now therefore see that that real rate is 75 basis points. So

Gene Tunny  18:35

real rate 775 basis points and a target, the inflation, the target band of two and a half percent, so that gives us three and a quarter percent. That’s where they expect it to be at equilibrium, right? Gotcha. Okay,

Michael Knox  18:50

so Larry Summers are saying, but I mean, our debt to GDP is half or less, yeah, debt to GDP is half or less what it is in the US. So summers and Blanchard suggest that their equilibrium will be higher,

Gene Tunny  19:03

yeah. Okay, yep. Now that all makes sense. Okay, very good. We might go to the next question that the second question you asked, also an excellent question. So we’ll just, we’ll just play that and then we’ll catch up on that one.

Michael Knox  19:19

So the second question is Kevin Warsh. Kevin Warsh is a previous member of the Federal Reserve Board of Governors, and now he’s he did that job for five years, and now he’s a visiting distinguished fellow at the Hoover Institute at Stanford. In an article on in Wall Street Journal on the 28th of July, Kevin Warsh said that US inflation and interest rates would be rising if the Fed was not reducing the size of its balance sheet. And if it’s reducing the size of its balance sheet, it’s reducing the money base and. Or that’s what’s driving inflation down. So my question is, the RBA is currently running down its balance sheet, and it’s quantitative tightening, and you can see this in the RBA chart book. So is this one of the reasons that the RBA has not have had, has not been forced to increase interest rates.

Andrew Hauser 20:21

So could I give you a one word answer, which is, no, you might not like that quite as much as you like my previous answer. So let me sort of elaborate a bit on that. The reason why people ask this question is obviously when interest rates were at zero or the effective lower bound during the covid period and beforehand in the UK, central banks had to find other ways of expanding of easing policy. And as you know, they did it in the most part, by buying assets, and actually also by lending to banks at longer than normal maturities, both of which the RBA also did before I before I arrived here. But certainly the Bank of England did a great deal of this as well. And it was fairly commonly felt that that effectively added to the amount of monetary stimulus in the economy, that, if you like, the effective short term interest rate went negative to some extent, right? So the thought underpinning the Kevin argument, I guess, is that if it worked on the way in, why wouldn’t it work on the way out? The trouble with that is that, by and large, and people are looking at this very carefully, can’t really find any material macroeconomic effect of unwinding the balance sheet at all, maybe a few basis points here or there, but no major central bank that’s doing it really considers that To be any part of its monetary policy strategy. We’re all watching in case that view learning turns out to be wrong. But our central estimate is that it’s likely that QE unwind, or so called Qt quantitative tightening, actually a bad phrase, right? Because the T implies more of an impact of the kind you’re describing than is actually the case. But there’s the most the central estimate at the moment across countries is the multiplier of the kuti effect is very, very small. Now, I have a particular personal engagement in this, because the Bank of England was one of the very few central banks. In fact, I think the only one that ran down its balance sheet, not only by allowing assets to mature, but by actively selling them back to the market. The New Zealand, RBN said, has been selling assets back to its own debt management agency and the RICS bank. The Swedish central bank has been doing active sales more recently. But when we first announced we had to do this, a reason we felt we had to do this is that the average maturity of the debt stock in the UK is very long, and we faced the prospect of having to hold gilts, government bonds, UK gun bonds, more or less forever, unless we started actively selling. Whereas for most countries, including Australia, the average maturity of bonds is far shorter. You can just let them roll off. We felt we had to do those active sales. I still think we had to do them. But the market, financial market, through its hands up in horror and said, This is a nightmare. You’re going to bring the market, the world to an end. You’re going to drive interest rates up in exactly the way that Warsh is describing, that will cause mayhem in the financial markets. And they were very pleased to say that prediction was another overconfident prediction of mayhem that turned out to be completely wrong. There is very little evidence so far that balance sheet unwind has driven market interest rate rates up materially, though we must continue to watch. So no, it’s not one of the reasons why the RBA has not had to lift rates. There’s one other reason before I finish, which is actually the big unwind in the balance sheet of the RBA that’s happened over the past six or 12 months has not been primarily allowing bonds to unwind. But as you probably know, it’s the maturity of the so called TFF, the term Funding Facility, which is a lending facility to banks. Again, I think there was a considerable concern here. It was, largely before I arrived, that that unwind might cause difficulties. It’s a very sharp reduction in the stock of money in the in Australia. But it has gone by practically without a whimper. So so far so good. At some point, if you keep reducing your balance sheet, you the stock of reserves will hit the demand for reserves. And if you hit that at two sort of sharpen angle, you may find that financial, you know, these relatively calm financial conditions turn into considerable instability again, and a lot of central banks are watching for that moment, but it hasn’t come yet.

Michael Knox  24:28

Okay, so, Kevin Warsh, yes, yes. I think I’ve always loved Kevin Warsh as a character, but particularly when he’s on the Fed, yeah, and he gives a speech, which you can google. Kevin Warsh, fish don’t know they’re wet. And it’s one of the great speeches I’d given at the worst part of the financial crisis about the need for liquidity and the fish. He’s describing other people in the financial market who don’t know that they’ve been swimming in this sea of liquidity until it’s. All gone, and then they they’re all flapping on the flapping on the beach in totally unable to cope with the situation. So I think that’s something you should read. Kevin Warsh fish don’t know they’re wet on the which is a speech of his when he was part of the Fed. So I think the problem, I think the problem that Andrew Hauser is talking about, when you examine this hypothesis now it’s difficult to measure it empirically. Yeah, and I think that’s true, but it doesn’t mean the fact that you can’t measure it empirically doesn’t mean that Kevin wash is wrong. I think Kevin Warsh is right, but talking about the problem of measurement, I’ve been running bond models for Australian bonds and US bonds for a couple of decades now, okay? And I know in that there’s a really big response to increases in decreases in deficit. Yeah, I remember back in the 90s at an Australian economist conference, which was in Tasmania. And at that time, bond yields, the Australian 10 year bond yield, was 9% yield was 9% Yeah. And I showed a model of based on forecasts of where the US budget deficit was going to go, because at that time what was under Clinton, yeah, and Gingrich, the US budget deficit was going back to balance. Yeah, it was extraordinary. And what I said is that that would reduce the budget reduction of budget deficit would drive bond yields down to 5% and I remember at this conference, doing this speech and being met with absolute disbelief that Australian 10 year bond yields, and us 10 year bond yields could ever fall again to 5% I mean, there was, it would be both miraculous and absurd if that, if that occurred. But it is, in fact, exactly what happened when the US balances budget deficit so but what’s happened is, but during the recent period, if you’ve got, if you’re running big budget deficits, at whiz we have in the last couple of couple of years, and at the same time, you’ve got quantitative easing, yeah, it’s what’s actually driving the market. Is not the theoretical level of the deficit, it’s the actual flow of funds, yeah, into the bond market, correct out of the bond market, yeah. And if you’re the Treasury, US Treasury, or the Australian treasury, is issuing a lot of debt, but at exactly the same time they’re being bought by the Central Bank, they’re having no effect upon the upon the bond yields, yeah, some interest rates, yeah. So it’s what happens is that that whites out this effect, which in previous periods you can see very strongly in the relationship between budget deficits and and bond yields. In this period because of quantitative easing and tightening, it’s wided out because you’ve got this influences of what the Reserve Bank is doing in each country, the reverse of what the Treasury is doing and but, but I confidently would suggest that as we go forward and we find that you’ve got big budget deficits, and the Fed is winding down smell and shoot the same time, bigger supply of bonds coming forward to the market in the next couple, one or two or three years time, that will begin to have significant effects upon bond yields. So what we saw two years ago was the lowest level of US Treasury bond yields since Alexander Hamilton invented the US Treasury bond in July 1799 and I believe he had it passed by two votes, maybe one, but I think it was a very small majority for passing the US Treasury bond back in July 1799 I’ve stood on the same floor of the old Congress building in in Philadelphia, where the bill was passed, you know. And I thought at the moment, you know, but as we go forward and we’re trying to the US is trying to finance these big deficits and yeah, and unwind the balance sheet at the same time, I think we will see that those low bond yields two years ago won’t probably be repeated for another 200 years.

Gene Tunny  29:46

Okay, so the Federal Reserve’s going to start or everyone expects them to cut. So we’ll see cuts in the federal funds rate, and so therefore longer term yields should theoretically go down as well. But. You’re saying that if you’ve got this quantitative tightening happening as well, they wouldn’t go down as much as otherwise. Is that? Is that how you’re thinking about it?

Michael Knox  30:07

Well, in the bond models, the bond models are a composition of different variables, yeah, things like budget deficits, things like inflation, short rates, are there. Yeah, capital inflow is really important, also in the early part of this century. So there’s a whole bunch of things in those bond models, but Well, firstly, what you would find is, if Olivier Blanchard and Larry sums are right, the Fed funds rate can’t go down as far as was previously thought. It doesn’t get to two and a half percent. It just gets to 4% or three and a half or something like that. And then they run into a wall for some reason. And that provides a floor in the model that will fly the floor to the to the US Treasury bond yield. And in addition that, what’s if we look at the IMF forecasts for the US budget deficit going forward to the end of this decade, you’ve got average deficits between six and 7% of GDP. Yeah, they have, and they’re really there because of the size of the debt and the amount that has to be refined, yeah, every year. And so you’ve got those two things so that’s supporting in my bond models, that itself is supporting the higher yield for us, treasuries and the and it’s working back in the Larry Summers thing, giving you a higher Fed funds rate. So both of those things will push up the equilibrium yield for the US 10 year bond over the next 10 years. So I think that, in short, the best way of looking at it is we had a bull market in bonds from 19, from when Paul Volcker was around in 8132 until about 2020, and that was a great bull market in bonds. But if you look at what happened during the 60s and the 70s, that was a bull market in bonds was followed by a bear market in bonds of about 15 years. Yeah. So I think the US Treasury bonds and our bonds are going to be in a bear market for about 15 years. And I think that’s the problem that is visitors upon us by the belief that you can spend money on whatever you like, particularly during the Biden Harris period or Biden Harris administration, and run big deficits forever, and it’s never going to cost you anything. And I think that’s wrong, and I think Larry Summers and Olivier Blanchard are right,

Gene Tunny  32:42

yeah. I agree with you about what the Biden, Biden Harris, or the Biden administration has done with inflation Reduction Act, I think that looks excessive. But I mean, if Trump gets in, he’s going to have a big tax cut, isn’t he, so that’s going to have a similar impact on the deficit, isn’t it? I mean, it’s going to potentially blow out the budget deficit, yeah,

Michael Knox  33:00

but empirically, if you actually look at the Trump period, yeah, Trump cut tax corporate taxes during that period. Yes, he put up import taxes on on China. And there was one other thing that he did, but if you remember it, I’ll, I’ll talk about that as well. And these are the things that are supposed to be inflation. But in fact, the average rate of inflation in during the Trump period was 1.9% which was one of the lowest rates of inflation of any presidential period since 1953 on the other hand, Biden and Harris didn’t do any of those things, but they had, I think it was four really big spending programs for which the inflation Reduction Act is the tiniest of those. I think there were four other ones, the American rescue plan, and all over a trillion dollars for each of the each of the those bills. Yeah, and it’s that combination of big budget deficits. It’s not just the big budget deficits, which is not was, wasn’t just short term relief spending. They built out major programs which are going out to the end of the decade. You know, they increased education spending on the on the premise that over the next 12 years there’ll be bigger school rooms and lower bigger school rooms, and therefore lower teacher student ratios in in public schools. And the reason, of course, for that was that if you had graduate dispersion of people in the in the classroom, you’d have lower, lower passage of covid, you see, because Okay, gotcha, and everything had to be Okay, gotcha. So there’s always. Endless spending, and in the inflation Reduction Act, as I’ve noted, the subsidies for making electric cars are only provided to work sites or companies that employ workers that are part of the United order Workers Union, yeah, and the International Brotherhood of electricians too, by the way, interestingly enough, both of these are significant donors to the Democratic Party. And interestingly, the and this is the subsidies for making electric cars. And interestingly, Elon Musk, who in Tesla, is the biggest single manufacturer of electric cars, receives none of these subsidies because he doesn’t employ workers who are part of the United order Workers Union or the International Brotherhood of electricians, and so his employees are not necessarily donors for the Democratic Party, so He doesn’t get a subsidy. So I think there’s that kind of thing built into a lot of these Biden Harris spending bills,

Gene Tunny  36:07

right? Michael Knox, it’s been a pleasure. I’ve really enjoyed your reactions, reflections on the the excellent Q and A session you had with Reserve Bank of Australia deputy governor, Andrew Hauser, anything before we wrap up? Anything else?

Michael Knox  36:23

You didn’t ask me the question about the run on the Chinese RMB,

Gene Tunny  36:28

oh, if we’ve got time for it, tell us what’s happening with the run on the Chinese RMB, please.

Michael Knox  36:33

Well, it’s very interesting that the RMB is, it is China’s announced plan to make it a dominant reserve currency, yeah, in the international monetary system. And it does appear that from by 2020 there was $230 billion worth of bonds held in the international monetary system, RMB bonds, and that was rocketing up. And by the end of 2024 that had got to about $340 billion worth of bonds. And in comparison, at that time, the level of bonds held in Australian dollars was about 215 billion, and the level held in Canadian dollars was about two 70 billion. And that so it rocketed well past the international reserves held in Canadian dollars and Australian dollars, which, by the way, are at that we are at the minnow end of international reserve currency. Yes, yes, but it’s a great thing that the RBA is an international reserve currency and but since that time, what’s actually happened is that the level of international reserves held in RMBs, in fact, crashing. There’s been a run on the RMB and it’s now fallen from about $340 billion at the end of 24 to about 200 less than $240 billion at the end of so the peak was at the fourth quarter of 21 Yeah. And now, at the in the first quarter of 24 it’s fallen from three and $40 billion to $240 billion and is now less than the amount of international reserves held in the Australian dollar. So the question is, why is that run happening? Yeah. And that was my one of my questions. And I said, Is it, is it just because of the trust that people put in the Reserve Bank of Australia that they prefer to hold Reserve Bank of Australia bonds rather or Australian bonds rather than Chinese bonds? And why do why do they trust the RBA so much? Yeah, my unanswered question. But having looked at it, it’s really nothing to do with any of that. It’s really just the fact that at the end of 21 international bond yields, US bond yields, Australian bond yields and Canadian bond yields, with a very, very low yield, the lowest yield for decades, if not, if not centuries. Yeah. And since then, those yields have been going up, whereas the yield on RMB bonds peak. Back then, there’s now, we now bonds are paying 4% RMB bonds are paying a little over 2% so that’s right, and that’s the reason the demand for RMB is forward. It’s just the market, just the market, and the fact that they’ve got a managed exchange rate rather than a floating exchange rate, yeah, so has an effect, but we might talk about that again another time. I think we’ll have

Gene Tunny  39:33

to, I think, yeah, we’ll have to come back to it. But you figured it out. You didn’t need Andrew Hauser to know to answer it in the

Michael Knox  39:40

just wondered what he thought about it. Yeah,

Gene Tunny  39:44

okay. Michael Knox, Chief Economist at Morgans, it’s been a pleasure. We’d better wrap up there. Thanks again. Thank you. You.

Credits

Thanks 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 and other podcasting platforms.

Categories
Podcast episode

Dollar Dominance: Can the US Keep Its Edge? w/ Stephen Kirchner – EP246

This episode features a conversation between Gene Tunny and Stephen Kirchner about the dominance of the US dollar in global finance. They examine the reasons behind the dollar’s strong position, the effects of US fiscal policy and public debt, and the debate over the future role of the US dollar. Kirchner provides insights into how the US’s status as a net oil exporter influences currency dynamics and global trade.

If you have any questions, comments, or suggestions, please email us at contact@economicsexplored.com  or send 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 Apple Podcast and Spotify.

About Stephen Kirchner

Stephen Kirchner is the Senior Economist at the Business Council of Australia, the former Program Director for Trade and Investment at the United States Studies Centre at the University of Sydney, and a Senior Fellow of the Fraser Institute. An expert in monetary and fiscal policy, financial markets, and trade economics, Mr. Kirchner was formerly a research fellow at Australia’s Centre for Independent Studies, an economist with Action Economics, LLC and a former director of economic research with Standard & Poor’s Institutional Market Services, based in Sydney and Singapore. He has also worked as an advisor to members of the Australian House of Representatives and Senate.

Mr. Kirchner holds a BA (Hons) from the Australian National University, a Master of Economics (Hons) from Macquarie University, and a PhD in Economics from the University of New South Wales. He blogs at http://www.institutional-economics.com and is active on Twitter (@insteconomics).

What’s covered in EP246

  • US dollar’s global role as reserve currency, benefits, and potential challenges. (0:00)
  • US fiscal policy and its impact on the US dollar’s global role. (8:40)
  • Monetary vs fiscal policy dominance in determining interest rates and exchange rates. (14:39)
  • US dollar’s role in global finance and its potential replacement by other currencies. (20:39)
  • China’s economy, currency, and trade agreements. (29:59)

Takeaways

  1. The US dollar’s dominant role in global finance is largely due to the unparalleled size, depth, and liquidity of US capital markets.
  2. Despite concerns about the US fiscal position, the demand for US assets remains strong, which supports the dollar’s value.
  3. Other economies, like the Eurozone and China, face challenges in rivaling the US dollar due to less developed capital markets.
  4. The US becoming a net oil exporter has altered the traditional relationship between the US dollar and commodity prices.
  5. Fiscal policy in the US, while concerning, does not currently pose an immediate threat to the dollar’s global dominance due to strong international demand for US assets.

Links relevant to the conversation

Stephen’s post on dollar dominance:

https://stephenkirchner.substack.com/p/dollar-dominance-if-you-can-keep

Stephen’s US Studies Centre article “The ‘reserve currency’ myth: The US dollar’s current and future role in the world economy”:

https://www.ussc.edu.au/the-reserve-currency-myth-the-us-dollars-current-and-future-role-in-the-world-economy

Stephen’s post on how the US dollar is now a commodity currency

https://stephenkirchner.substack.com/p/why-is-the-australian-dollar-so-weak

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Transcript: Dollar Dominance: Can the US Keep Its Edge? w/ Stephen Kirchner – EP246

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

Gene Tunny  00:00

Gene, 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. Stephen Kirschner, welcome to the programme.

Stephen Kirchner  00:36

Thanks for having me back. Gene,

Gene Tunny  00:38

oh, good to have you on, Stephen, you’re doing really interesting things in your newsletter. It’s, well, it’s a sub stack, the institutional economics sub stack. And I wanted to chat with you about some of the things I’ve been reading in your sub stack recently, and also some of these, you know, big international macro economic issues to start with. Might ask you about this recent post. You had dollar dominance. If you can keep it, could we start off? Could you explain what’s what do people mean by this concept of dollar dominance, please.

Stephen Kirchner  01:23

Mostly it’s referring to the fact that the US dollar plays an overwhelming role in as the currency of denomination for international finance. So it makes up the vast majority of global ethics turnover. It’s the currency of denomination for most of the world’s debt issuance and a lot of international lending as well. It’s about 60% of global FX reserves, and it’s the predominant currency of denomination for most of the global trade in goods and services. And so the US dollar plays this very prominent role, which I think is ultimately attributable to the fact that the US has capital markets that are really unrivalled in terms of their size, their depth and liquidity. And so that puts the US in a very good position to be a provider of financial services to the rest of the world. And I think that, more than anything else, is what underpins the role of the US dollar, where I think there’s been a lot of interest over many years, is how much longer this role can continue, and there’s constant speculation about the future role of the US dollar. And this speculation goes back a long way. So in my paper for the US study centre a few years ago on the reserve currency myth, I went back and pointed to lots of embarrassing quotes from the Economist magazine and various other sources predicting the dollar’s demise. All those predictions have proven to be incorrect, but it’s remarkable that half a week goes by, I would say, without an op ed in the FT speculating about the US dollar’s future, which I think about Oasis, sort of getting the cart before the horse. I think before you speculate about the US Dollars global role, you kind of need to think about what would actually change in terms of underlying fundamentals to really shift that position.

Gene Tunny  03:39

Got You Can I ask about that the role as the global reserve currency? Economists such as Joseph Stiglitz have argued that this, this gives the US an un an unfair advantage or an exorbitant privilege. Is that right? Is that? Is that a concern is, does it? Does it actually get is it? How, to what extent does it benefit from being that global reserve currency?

Stephen Kirchner  04:06

Yeah, I have a lot of problem with the idea or the term reserve currency, because I think it’s a little bit confusing. And if you look around trying to find definitions of what it means to be a reserve currency, most of them are somewhat tautological. And so when you invoke the term reserves, people will automatically think of central bank holdings, the foreign exchange reserves. And all central banks hold foreign exchange reserves. On average, about 60% of those reserves are denominated in US dollars, but I don’t think that’s what gives the US a dominant role in the US dollar, a dominant role in international finance. And in fact, if, if foreign central banks held no US dollars, I think that would actually have a fairly marginal impact on both the US dollar exchange rate and. And interest rates similar, because the turnover in foreign exchange markets on a daily basis is in the order of trillions of dollars. It’s probably eight or $9 trillion on a daily basis, and central bank holdings the US dollars in the billions. And so the effect that those reserves might have, and changes in reserve balances, I think you’re going to be very marginal. So the way I think, prefer to think about it is that the US provides a very deep set of capital markets which can accommodate the world’s saving and there is a demand for US dollar assets, and so that’s what I think of, in terms of the US dollar having a dominant role, or a reserve currency role, but it’s really a case of us being a supplier of safe assets to the rest of the world, and this is what’s responsible for the US Dollars roles. I think central bank reserves in this context are fairly marginal.

Gene Tunny  06:10

Yeah. Okay, so the couple of things to explore there in terms of, well, safe assets to the rest of the world. Are you talking about US Treasury bonds?

Stephen Kirchner  06:21

Principally, yes. So the US provides not only what is effectively a risk free benchmark asset for the rest of the world in the form of US Treasuries and treasury bills, but even in terms of a medium of exchange, about 40% of the US banknotes in circulation actually circulate outside the United States, so there’s a demand to hold the US Dollar as a medium of exchange as well.

Gene Tunny  06:53

Yeah. So does this all mean that that the US dollar its value in its exchange rate, so it’s more favourable than it otherwise would be. And so that means that Americans can get, you know, they can buy stuff from the rest of the world a lot cheaper than otherwise. Is that? Is that reasonable to say

Stephen Kirchner  07:17

that’s part of it? I mean, there are people like Michael Pettis, for example, who argue that the US dollar suffers from a structural overvaluation problem that’s because of its dominant role, as you say, would tend to contribute to a higher exchange rate than otherwise. But the way I think about it is in terms of the equilibrium US dollar exchange rate. You would want that exchange rate to reflect all underlying fundamentals, and this is just a one of the fundamentals that feeds into the US Dollars valuation. So I don’t see that as being a problem per se, and it’s certainly not a problem with the United States that there’s very strong demand to invest in the US, whether it’s in the form of debt securities, equity securities, or foreign direct investment. We had this debate in Australia for many years about whether the current account deficit was a problem or not, and I think most of those arguments carry over to the US setting, where it’s certainly not a problem that in the US there’s very strong investment demand, not all of that demand could be met through domestic saving, and it’s actually a vote of confidence on the part of foreign investors that they want to invest in your economy. Yeah,

Gene Tunny  08:39

it’s remarkable. Stephen, you just reminded me, if you go back to say, the mid to late 80s and then the early 90s, there was such an obsession with the balance of payments and the current account deficit. So, I mean, Australia’s now got a current account surplus, haven’t we, thanks to mining, which is a, yeah, very, very positive thing, but yeah, we were, we were obsessed about it, and there was a big debate about whether that made sense or not, or whether this was just a reflection of the great investment opportunities in Australia. So it was good to to remind me of that debate. Can I ask about the safe assets? So you’re talking about us, treasury bonds. And I’ve had guests on this show. I’ve had Romina from, I think she was a Cato. And I’ve had Dan Mitchell from, he’s, he’s got his own Centre for freedom and prosperity. He’s ex Cato, ex heritage. And Dan’s a prominent commentator. And I mean, they’re very worried about US fiscal policy as I am. I mean, it looks like they’re on a very, you know, very bad, well, you know, unsustainable trajectory. They’re gonna have to correct it in some way. But from what you’re saying, I mean, there’s still this healthy demand for US government bonds, isn’t there? So is how. Do. How do you actually reconcile these, these two facts?

Stephen Kirchner  10:04

Well, in fact, a lot of the commentary around the future of the US dollar over the decades has really turned on this question of is the US on an UNSUSTAINABLE fiscal trajectory, to the extent that this might actually compromise the US Dollars global role, and is certainly the case that the US, in terms of the debt held by the by the public, has reached levels that are just a little bit below the levels we saw at the end of World War Two, and the US government was obviously very heavily borrowing. The difference being, of course, that we’ve got this level of debt in the absence of wartime conditions, and with the US economy is still pretty much fully employed. So the question would be, what would happen in the event of an adverse macroeconomic shock when you’ve got such a bad starting point. So I mean on the one hand, the US debt position, the public sector debt position, is one which actually is useful from the point of view of providing a supply of risk free assets to the rest of the world. So there’s no shortage of demand to invest in US Treasury securities. And if there was going to be an issue around the sustainability of the US fiscal position, you’d kind of expect it to show up in the exchange rate and interest rates at some point. But if you if you’re not seeing that in the price, then I think there are fewer concerns about the sustainability of the US deposition. So one way of thinking about this is us, dollar exchange rate actually serves to sort of price this demand to hold us assets. I’d say there’s an excess demand globally to hold us dollar assets, and the US dollar exchange rate reflects that.

Gene Tunny  12:15

So is the market just thinking that, Oh, well, all of these fiscal problems, there still a fair way down the road, and it’s not going to affect our demand for five year or 10 year treasuries. Or are they thinking, Oh, well, the Americans that they’ll eventually sort it out in in Congress, I mean, that they’ll recognise the that they need corrective actions as they have. You know, the Americans managed to do that in the 90s with under Clinton and Gingrich. So is that what they’re thinking? I think

Stephen Kirchner  12:48

from the point of view of the exchange rate, you have to remember that the exchange rate is a relative price, and so it’s the relative price of US, output and assets compared to the rest of the world. And if you look at fiscal policy trajectories in other economies, they don’t look too great either. So Japan, Japan will be an obvious example of an economy which has an even worse net and gross debt position than the US. Fiscal policy settings in places like Italy, which is the world’s third largest market for sovereign debt, don’t look too flashy, either. So with exchange rates, you always have to ask yourself, how does a country look on a relative basis? And so I think the US still looks good in those terms. Yeah, of course, in an absolute sense, you know, I’d certainly agree that the fiscal position in the United States is of a concern. At some stage they’re going to have to address it. But they’re hardly alone in that regard. So thinking about the US Dollars role internationally, I don’t see the US fiscal position, per se as being a problem, okay, but ultimately, I think the issue for the US is that there’s a rising interest Bill associated with its public sector Debt. Just recently, that bill has eclipsed the US defence budget in terms of absolute science, right? And this in itself, is a constraint on US fiscal policy, because that rising interest bill ultimately constrains what the US government can do. Yeah,

Gene Tunny  14:39

yeah, that’s extraordinary. I’ll have to check that out. I mean, to think, I mean, given how large the US military machine is that, how large the Pentagon is, to think that that’s incredible, right? Why I asked that before Stephen was because you’ve got this fascinating chart from macro bond in. Your newsletter on dollar dominance. If you can keep it, I’ll add a link in the show notes that essentially shows practically no correlation between general government gross debt to GDP percentage and the 10 year government bond yield. And I mean, we all know that there’s challenges with doing cross country correlations. But what do you you know and inferring things from from cross country data? But what do you read into that, that that chart? What do you read into those, those data points?

Stephen Kirchner  15:34

Yeah, like the point I was making with that chart, and this probably applies more so to developed markets than emerging economies, but still holds broadly, I would say, is that the fiscal position of an economy is actually not a very good predictor of its borrowing rates, its government borrowing rates. I mean, most obvious example that would be in Japan, which probably has the worst fiscal position on a gross and net basis of any of the advanced economies, and yet has the lowest in interest rates. So I think what that’s telling you is that interest rates are ultimately determined by other things. So underlying productivity growth and monetary policy, and monetary policy, I think, is a much more powerful predictor of cross country variation in interest rates. So if you’re looking to try and predict movements in interest rates between economy and stuff looking at changing fiscal positions, I don’t think you’re going to get very far. And that then flows through to exchange rates, because, yeah, if it’s if it’s the case that interest rates are actually not that sensitive to fiscal policy, then it’s going to imply that exchange rates are probably, by extension, not going to be that sensitive either. So this comes back to the issue of monetary versus fiscal dominance, and that monetary policy ultimately is far more important in terms of determining interest rates than fiscal policy.

Gene Tunny  17:21

Yeah, I think that’s, I think that’s right, certainly in the I mean, I mean you, I can ask you this. I mean, you can, you may have answered this, but I mean, I can understand that in the short term, like I think about how market economists forecast the value of the Australian dollar, and they’ll look at the differential between you know, bond yields or or, you know, they’ll have different maturities, like they might be looking at, I don’t know whether it’s three three month bills or six months or a year, but they, I know they’ll have an interest rate differential or spread, and then they’ll have the terms of trade, for example, in there, but yep, they’re not going to have something like the, you know, what’s happening with the the debt or the budget, I suppose. Or maybe I’m wrong about that, but I take your point. I think it’s a it’s a good one. What does it mean for say, John Cochran theory of the fiscal fiscal theory the price level. I spoke with John Cochran at Centre for independent studies. There was an event we had last, last September in Sydney, and I asked him about the fiscal theory of the price level. What do you think this means for that theory? Have you looked at that at all? Stephen,

Stephen Kirchner  18:41

yeah. I mean this, I’ve addressed that in a number of posts on the newsletter, and I think this goes to your question about the long run. And the long run situation is a little bit different in that it’s possible to imagine fiscal policy and public sector debt getting to a point where it is so unsustainable that you enter a regime of fiscal dominance. In other words, fiscal policy ends up determining the price level, and that is certainly a possibility. So in that situation, the central bank is forced to effectively accommodate expansion fiscal policy. So it’s certainly the case that fiscal policy can play that role. But the way Australia, the United States and other advanced economies have set up their sort of macro policy frameworks is one in which, for the short term, at least monetary policy is dominant. So whatever the fiscal authority is doing with fiscal policy tends to get discounted by monetary policy actions. So as long as you have an independent inflation targeting central bank. Think, then I think you’re in a regime of monetary dominance, but it’s certainly possible that those institutional arrangements might fall apart in the context of a fiscal position that’s unsustainable in the long run, and then you are in that sort of fiscal theory of the price level type world,

Gene Tunny  20:21

yeah, yeah, for sure. Okay, yeah, I think that’s a good point. So if you’ve got an independent central bank, and it’s, it’s not just, you know, it’s, it’s setting monetary policy to target inflation, and it’s, you know, monetary policy doesn’t end up being determined by the government. I mean, if the gov, because you get into that problem in, say, some Latin American countries historically, or Weimar Republic, where the government just prints money to pay its bills, to cover its deficits, rather than borrowing from the bond market. And yeah, that’s where you end up in all sorts of strife, potentially even hyperinflation. So, yeah, I think that’s a fair point. Yeah. Just thought I’d ask you about that, because I think, yeah, John’s, he’s got a really fascinating theory there, and he’s a very, very compelling presenter, and a, you know, really top economist, obviously. So that that’s really good, one of

Stephen Kirchner  21:18

the Argentina, Argentina, good example of the sort of situation you’re referring to. So they’ve had a number of experiments with managed exchange rate regimes that have blown up, and the reason for the blow up in each case was basically that fiscal policy was incompatible with that regime, and it was fiscal policy the one out in the end. So the issue around Argentina, addressing both its inflation problem and the issues around its exchange rate ultimately depend upon it putting in place institutions that will constrain fiscal policy. Yeah,

Gene Tunny  21:58

one of the other posts that I’ll put a link to in the show notes, Stephen, I think it was a post of yours where you’re talking about how the US dollar, how it’s been or the exchange rate, how that’s been affected by the fact that the US has become such a Strong producer of was it shale oil and shale gas? I mean, it’s become a has it become a net energy exporter? Or have I got that wrong? Or how do you

Stephen Kirchner  22:29

Yeah, the United States is now a net oil exporter. Has been since about 2018, 2019, yep. And in fact, produces more oil than Saudi Arabia, which I think is a a fact that would surprise most people. Yeah, so. So the significance of this is that US dollar now trades, you know, as a positive correlation with its terms of trade. It’s it’s trading in much the same way as we’re familiar with here, where the Australian dollar has a very close relationship with our terms of trade. And so the US dollar is trading like a commodity currency. This has big implications for the Australian dollar exchange rate, because what it means is the US dollar is now positively correlated with commodity prices, and in terms of the Australian dollar, traditionally, the Australian dollar has exchange rate has been correlated with commodity prices, but we typically quote The Australian dollar in terms of the US dollar, if its correlation with commodity prices is increasing, then our exchange rates correlation with those prices is going to weaken. And you can see that in the data that the relationship between Australian dollar and commodity prices is essentially broken down since 2018 2019 coinciding with the US becoming a net oil exporter? Yeah,

Gene Tunny  24:06

yeah. But do we do? Is there still a correlation with trade weighted index? Do you know? I mean, I can check that myself, but just wondering, because I think that’s what, where you’re going at there. I mean, because we, we tend to, yeah, quoted in terms of US dollars, but there’s this broader exchange rate concept that you could use instead,

Stephen Kirchner  24:27

no, it affects the Australian dollar trade weighted index as well. So that was actually the charts that I used in that post were the Australian dollar twy. And the reason is, US dollar still has a big weight in the tui China has a big weight as well. But of course, China is running a managed exchange rate regime, largely targeting the exchange rate with the US dollar. Yeah, so China’s weight effectively becomes a US dollar weight in that measure. Gotcha. Yeah. Yeah. So this has huge implications for us, because it means that the with these australian dollar being less sensitive to commodity prices, we’re going to lose some of the shock absorbing role of the Australian dollar. The Australian dollar is not going to moderate those fluctuations now in terms of trade and quality of prices as it has historically. And I think one implication of this is that the reserve bank is going to have to become more activist in its conduct of monetary policy, because it won’t be able to rely on the exchange rate to do a lot of the heavy lifting in terms of setting monetary conditions. So if the exchange rate is not adjusting as aggressively as it has historically, then I think by implication, the cash rate is going to have to do more of the work. I

Gene Tunny  25:50

think that’s a really excellent point, because I remember when I was in Treasury, yeah, we always used to talk about that shock absorbing role of the Australian dollar. And there was a view that that’s why Australia got through the Asian financial crisis so well. So I think that’s a really excellent point. Just trying to remember where I was, where, what I was going to ask about the Yeah, so we’ve got the point about the the twy. I’ll the trade weighted index. I’ll link to that article. Is it China? Is that the in terms of who, which country could replace, the which currency could replace, the US dollar? Is it the the Chinese currency, or is it the euro? What are what are people speculating on? I

Stephen Kirchner  26:40

think the problem that people have there have trouble wrapping their head around is the idea that the US dollar and its role is somewhat disconnected from the relative size of the US economy and its importance in global trade. So the Chinese and the eurozone economies rival the US in terms of size, and they certainly rival the US in terms of their prominence in international trade. And people kind of expect that the respective roles of their currencies should reflect those GDP shares and trade shares where both Eurozone and China fall down is in terms of not having the capital markets that rival the US in terms of size, depth and liquidity. And so the US dollar’s role is essentially a function of the dominant role that the US has in global finance. Yeah, and I think that’s always going to be more important in determining the role that the US dollar plays. Certainly, when the Euro was launched in 1999 there were expectations that it would rival the US dollar and the ECB produces a an index which essentially tries to measure the role of the euro in global finance. So in terms of FX turnover, currency of denomination for debt securities, currency of denomination for global trade. And it does pick up a little bit immediately following the Euro’s launch. But of course, with all the problems in the eurozone and the Eurozone debt crisis, that role has essentially flatlined more recently. So I’d say the Euro has basically disappointed the expectations that were held for it in terms of taking on a global role, and the same with China. So China launched a campaign to internationalise the renminbi and toyed around with a more flexible exchange rate setting around about 2015 2016 but very quickly walked away from it when the exchange rate started to exhibit more volatility than they would like, and so they’ve clamped down in terms of exchange rate setting. They’re still running a managed exchange rate regime and a closed capital account, yeah, and if you’ve got a closed capital account, I think that’s always going to limit the prospects for internationalisation of your currency. And we saw exactly the same thing with the yen as well. In the late 1990s early 2000s the Japanese Ministry of Finance had this idea that they would internationalise the yen, make it the main currency of denomination for trade in the Asia region. They wanted to set up an Asian Monetary Fund without participation with the United States. And all of those efforts really went nowhere. Yeah.

Gene Tunny  29:59

Yeah. I think it’s Yeah, very good point, Steve. And I just remembered what I was going to note before, because why I thought that was interesting, that post of yours talking about how the US has become an oil exporter, and you were explaining why, more recently, the Australian dollar relative to the US, hasn’t got up to the highs that it got up to in the first in mining boom, mark one in the 2000s so where it got to parity, I think at one time. So I think that was a really good explanation of that.

Stephen Kirchner  30:36

I think the contrast is quite dramatic, because we had a big terms of trade boom around about 2011 when, as you say, the Australian dollar got about parity with the US. Well, the terms of trade actually got even higher in 2022 In fact, they were the highest terms of trades going back to about 1860 and yet you certainly don’t see that in the Australian dollar exchange rate. And so the difference is, by 2022 we had this situation where the US had become a very substantial oil exporter, and that just really changed the relationship between commodity prices and the Australian dollar. Yeah, yeah,

Gene Tunny  31:15

good stuff. Just for clarity. And I think this is a simple, I think this is a quick question, the capital control. So you’re talking about how they’ve got a closed capital account. So they’re, they’re limiting the the exchange of of their currency for others, they’re all, they’re limiting people’s ability to pull money out of China is that, is that what people will be concerned about and why they’re limiting the ability of investors to repatriate funds home? Is that why it it may be limited in its potential to be a reserve currency?

Stephen Kirchner  31:59

Yeah. I mean, part of it is just a function of having a managed exchange rate regime that you need to control your capital flows in order to do that, I think it’s worth pointing out that a lot of the outbound capital controls are really not targeting foreign investors. They’re targeting Chinese savers, who they worry might send, there might be capital flight from the Chinese themselves to offshore, and so they place strict limits on the amount of money you can take out of the country.

Gene Tunny  32:35

Yeah, good point. And we’re, we’re a significant recipient of that, aren’t we? I mean, if there was a lot more cap, if there was that capital flight, or a lot more of it, then, yeah, a lot of it would go into Australian real estate, I expect. So yeah, that’s more of a comment, right? Final question, Stephen, there’s a lot of talk about the breakdown of this agreement. That was apparent, I think, is it Jim Rickards, who I’m trying to remember, who goes on about this, but apparently there was some agreement in 1974 between Richard Nixon and the Saudis that all oil sales would be denominated in US dollars. And that agreement has expired. And so there, there are people arguing that this will have profound implications for the US dollar and the US economy. Are you across that issue? And what are your thoughts on it?

Stephen Kirchner  33:34

Yeah, I think people make too much of this issue of in which currency is global trade in goods and services denominated and there’s certainly been moves in the past to re denominate more of the global oil trade and other currencies, including euros. But I mean, in this sense, I think, you know money, the exchange rate is really just a veil. Ultimately, the demand for the US dollar is a function of people either wanting to purchase US goods and services or wanting to purchase US assets. And so that’s where the demand comes from. You can, and that’s a real that’s a real demand. You can denominate global trade in whatever currency you like. There’s no reason why the Saudis and the Chinese could not denominate their trade in oil in renby, for example. But ultimately, the US, US dollar exchange rate is going to reflect the demand for US goods and services and US assets. So, you know, I don’t think it really matters. Is that much what the currency of denomination is. So to give an example, a lot of our iron ore exports would be denominated effectively in US dollars, because it’s a US dollar market. But I don’t think that affects the issue of the demand for the Australian dollar, because ultimately, that money, to the extent that it comes back to Australia, has to be converted into Australian dollars. So yeah, the demand for Australian dollars still reflects the demand for international demand for our iron ore. Yeah,

Gene Tunny  35:38

I think that’s a good answer. I was just thinking about it then. I mean, so if you think about it, Say yes, say the Saudis are accepting US dollars. So they, they sell their oil, they get the US dollars, and then they’ll, they will want to convert it to either their own currency, or they’ll want to convert it to pounds because they want to buy properties in Knightsbridge or or Mayfair or wherever, or wherever they want to invest in around the world. So I think, I think that’s a fair point to make. That’s a, yeah, I think that’s a really good perspective, righto Steven, it’s been illuminating. I’ve really enjoyed this conversation, and I’ll put a link to your great newsletter, institutional economics. I think you’ll Yeah, you’re actually doing some really deep analysis. You’re thinking carefully about these issues, the theoretical considerations, the empiric so I’ve been really impressed by it, and I would recommend it. Are there any any final comments or any reactions to anything I’ve said in this conversation before we wrap up, please.

Stephen Kirchner  36:49

I think that’s been great. Gene. Thanks very much for having me back on.

Gene Tunny  36:52

Oh, it’s been terrific, Stephen. And yeah, keep up the great work, and hopefully we’ll catch up with you again soon.

Stephen Kirchner  36:59

Thanks very much. You.

Credits

Thanks 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

Categories
Economic update

Does Quantitative Easing primarily benefit the wealthy?

With aggressive fiscal and monetary policy responses to the 2008 financial crisis and the COVID-19 pandemic, new evidence has emerged of the unintended consequences of activist macroeconomic policies. This article considers the impact of Quantitative Easing (QE) on wealth inequality.  It is cross-posted on www.adepteconomics.com.au. 

QE is an unconventional monetary policy used by central banks such as the US Federal Reserve, Bank of England, or RBA to stimulate the economy. It was widely employed in the aftermath of the 2008 financial crisis and during the COVID-19 pandemic. QE involves the central bank purchasing government bonds and other financial assets with newly created money and is intended to lower long-term interest rates. While it is designed to benefit the overall economy, there is a debate about its impact on wealth inequality. 

Some argue that QE has primarily benefited the wealthy, as it has increased the value of financial assets, such as stocks and bonds, predominantly owned by the rich.1 This has resulted in a significant boost to the wealth of the wealthiest individuals and households.2 However, proponents of QE contend that it has prevented a deeper economic slump and reduced income inequality by preventing larger increases in unemployment.3 The distributional effects of QE are complex, and its impact on wealth inequality remains a topic of ongoing research and discussion.

Professor Gerald Epstein of the University of Massachusetts Amherst is one of those who argues that quantitative easing primarily benefited the wealthy. At the same time, its effects on employment and the cost of capital for borrowing were relatively modest. Professor Epstein expressed this view in an interview on his new book Busting the Bankers’ Club in Economics Explored episode 226. You can listen to the conversation wherever you listen to podcasts (e.g., Spotify) or use the embedded player below. 

Professor Epstein suggests that the main impact of QE in the United States was an increase in the wealth of the wealthy. This is because the rise in asset values, resulting from the central bank buying up these assets, primarily benefited those who already held significant assets, such as banks and other wealthy individuals. On the other hand, the cost of capital reduction for borrowers and investors was relatively modest.

Did Quantitative Easing Increase Income Inequality?

Professor Epstein does not argue that the Federal Reserve intentionally pursued a policy to benefit the wealthy primarily. Instead, the impact of the policy was an unintended consequence of quantitative easing. The increase in asset values and wealth accumulation for the rich due to QE can further widen the wealth gap. At the same time, the modest impact on employment and borrowing costs may not effectively address the needs of the bulk of the population.

The findings mentioned in the podcast conversation align with studies conducted in other countries during the same period, which also found that QE had a greater impact on asset values and wealth accumulation for the wealthy than on employment and borrowing costs. The European Central Bank (ECB) published a study showing that QE in the Eurozone primarily contributed to an increase in the wealth of the richest 20% of the population.4 Additionally, a report by the UK Parliament’s House of Lords Library stated that QE is likely to have exacerbated wealth inequalities in the UK. However, it noted Bank of England analysis concluding the effect was relatively small.5 Research published in the Oxford Bulletin of Economics and Statistics found that expansionary QE via asset prices led to net wealth inequality increases on some (but not all) metrics for most countries under review.6

These findings suggest evidence broadly supports the claim that QE has disproportionately benefited the wealthy and exacerbated wealth inequalities. However, it may only be a small net impact as there are effects in both directions. While many households benefit from house price growth, those at the top of the wealth distribution disproportionately benefit from financial asset price increases. 

Regarding the Australian experience, the Housing and the Economy study by UNSW and University of Glasgow researchers surveyed experts and found that two-thirds of economists either agreed or strongly agreed that “ Monetary policy reliance on low interest rates and Quantitative Easing has exacerbated inequality by boosting the prices of housing and equities.” However, this was based on a sample of fewer than 50 economists, so we should note that it would be subject to substantial sampling error.

In a 2021 Agenda paper, leading Australian macroeconomist Stephen Anthony identified the contribution of QE to “the enormous widening of inequality across advanced economies.” Anthony saw some value in QE as an “expedient remedy for short-term crisis management”, but he was mindful of its adverse longer-term consequences, such as impacts on inequality and economic efficiency. The adverse efficiency impact can occur because cheap money can end up directing significant resources to “lower-valued activities.” These could include the activities of some tech companies that saw valuations soar as ultra-low interest rates meant that speculative gains in the distant future had higher expected values in the present (see Investopedia’s explainer How Do Interest Rates Affect the Stock Market?).   

While some studies suggest QE has primarily benefited the wealthy, some research has also found evidence to the contrary. For instance, a study by the European Central Bank (ECB) indicated that its QE program increased the net wealth of the poorest fifth of the population by 2.5 percent, due to QE lowering the interest rate paid by this group on their debts, compared with just 1.0 percent for the richest fifth.7 However, it’s important to note that the overall consensus from multiple sources and studies suggests that QE has exacerbated wealth inequalities and primarily benefited the wealthy.

This article was authored by Economics Explored host Gene Tunny. For further information, don’t hesitate to contact us via contact@economicsexplored.com.

Endnotes

  1. https://www.theguardian.com/business/2012/aug/23/britains-richest-gained-quantative-easing-bank
  2. https://www.positivemoney.eu/2017/04/ecb-shows-qe-benefits-richest/ and https://positivemoney.org/press-releases/qe-richest-gained/
  3. https://www.bankofengland.co.uk/monetary-policy/quantitative-easing
  4. https://www.positivemoney.eu/2017/04/ecb-shows-qe-benefits-richest/
  5. https://lordslibrary.parliament.uk/quantitative-easing/
  6. https://onlinelibrary.wiley.com/doi/full/10.1111/obes.12543
  7. https://www.ecb.europa.eu/pub/pdf/scpwps/ecb.wp2170.en.pdf, p. 17.
Categories
Uncategorized

From Jekyll to Hyde: Exploring the Dual Nature of Finance | The Bankers’ Club w/ Prof. Gerald Epstein  – EP226

Show host Gene Tunny interviews UMass Amherst Professor Gerald Epstein about his new book “Busting the Bankers’ Club”, which is about the powerful influence of banks in politics and regulation. Epstein argues the bankers’ club maintains control through political allies and regulators. The conversation also covers financial deregulation, insufficient Dodd-Frank reforms, Quantitative Easing impacts, and alternatives like public banking and non-profit financial institutions.

Please get in touch with us 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 Podcast and Spotify.

About this episode’s guest Prof. Gerald Epstein

Gerald Epstein received his Ph.D. in economics from Princeton University, is a professor of economics, and is a founding co-director of the Political Economy Research Institute (PERI) at the University of Massachusetts Amherst. He has published widely on various economic policy issues, especially in central banking and international finance. His most recent book, Busting the Bankers’ Club: Finance for the Rest of Us, was forthcoming in January 2024 from the University of California Press. 

What’s covered in EP226

  • Banking industry’s influence in politics and regulation. (0:04)
  • Financial deregulation and its impact on the economy. (8:58)
  • Financial system’s impact on democracy and fairness. (13:24)
  • Financial system issues and regulation. (16:24)
  • Economic policy after the financial crisis, including impacts of Quantitative Easing. (22:50)
  • Financial regulation and publicly owned institutions. (28:08)
  • Public banking, crypto, and risk-taking in finance. (33:30)

Takeaways

Professor Epstein argues in this episode:

  1. The “bankers’ club” of allies including politicians, central banks, and economists helps sustain the power and influence of large banks.
  2. Financial deregulation in the US and weak Dodd Frank reforms failed to address issues like too-big-to-fail banks and accountability.
  3. Quantitative easing policies after the financial crisis disproportionately benefited wealthy asset holders over others.  
  4. There is a need for more diverse public and non-profit financial institutions focused on social missions over profits.
  5. Crypto poses risks if it infects the core banking system or continues high-carbon polluting practices.

Links relevant to the conversation

Gerald Epstein’s book Busting the Bankers’ Club: Finance for the Rest of Us

https://www.amazon.com/Busting-Bankers-Club-Finance-Rest/dp/0520385640

Working paper co-authored by Prof. Epstein “Did Quantitative Easing Increase Income Inequality?”

https://www.ineteconomics.org/research/research-papers/did-quantitative-easing-increase-income-inequality

Transcript: From Jekyll to Hyde: Exploring the Dual Nature of Finance | The Bankers’ Club w/ Prof. Gerald Epstein  – EP226

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.

Gerald Epstein  00:04

There’s a phenomenon in the US. The political scientists talk about this called capture that is that the regulatory agencies that are supposed to be regulating the industry, artefact captured by the industry and tend to operate, often in the in the interests of the industry.

Gene Tunny  00:29

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 shownotes relevant information. Now on to the show. Hello, thanks for tuning into the show. My guest this episode is Professor Gerald Epstein. He’s professor of economics at the University of Massachusetts Amherst, and he’s co director of the Political Economy Research Institute. We discuss his new book busting the bankers club published by the University of California Press. It’s a great book demonstrating Professor Epstein’s deep knowledge of the US financial system. I thoroughly recommend it. So if you enjoyed this conversation, please consider buying a copy. I’ll put a link to it in the show notes. As always, please get in touch. If you have any thoughts on this episode, guest suggestions or ideas for how I can improve the show. You’ll find my contact details in the show notes. Right? Oh, we’d better get into it. I hope you enjoy my conversation with Professor Gerald Epstein. Professor Gerald Epstein, welcome

01:53

to the programme.

Gerald Epstein  01:54

Thanks so much for having me. Excellent. Gerald,

Gene Tunny  01:57

look, I’m really grateful for you appearing on the show to talk about your new book busting the bankers club finance for the rest of us. To start off with, could you tell us what is the bankers club?

Gerald Epstein  02:12

So the bankers Club is a group of allies, very powerful allies that support the banks and the financial Titans more generally. And the reason that’s important is because the banks in the United States in the book is mostly about the United States, but I think it’s true in many other places. They’re not very popular, people don’t like banks very much as a whole. I have my students look at a bunch of American movies about banks, they say, please find me a movie that has a favourable gives a favourable impression of the banks and, and they really can’t find them. So in the popular culture, you know, banks aren’t very popular, but they’re incredibly powerful. They’re in powerful politically, they’re powerful economically. And this is, despite the fact that we have these prices that the financial institutions seem to create every 10 years or so. And so the question is, how do they remain so powerful? And my answer is that it’s the bankers club is this group of allies that support the banks politically, economically, and helps them sustain their both economic and political power? And so I go into some detail discussion of various components or various groups within the bankers club,

Gene Tunny  03:37

broad and who are they? I mean, are you able to give some examples?

Gerald Epstein  03:42

She, of course, so there’s some usual suspects as you is what anybody would think about. So they’re the banks themselves and by banks, in this context, I mean, the mega banks, like Chase Manhattan Bank and Bank of America and the large banks, then the major hedge funds and private equity firms, and the large asset management firms. So we’re talking about mega finance more generally. So, of course, they’re the head of the club, but they get politicians to help them out, then that’s well known in the US and in other countries, and they get politicians to help them out by giving them campaign contributions by offering them good, lucrative jobs when they get out of the legislature. And in a variety of ways. They find finance friendly politicians, that will help them with legislation and so forth. So that’s kind of well known in many countries. Perhaps less well known is that the our central bank, Federal Reserve Board, is what I call the chairman of the club. The central bank, is historically Since it was founded in 1914, has been a big supporter of the banks. Partly this is for structural reasons that is, they rely on the banks, when they make their monetary policy they operate to the banks that interest rates, they expect the banks to pass these interest rate changes, up or down, depending on whether they’re fighting inflation or trying to get the economy going. So they have a kind of an intimate relationship with the banks. But what it also means, however, is that they tend to see the world through what I call finance coloured glasses. And so they tend to see the world the same way the bankers do. And more than that, they help out the banks in very significant ways. And we can see that most clearly in two areas. One is when they bail out the banks, like we have this great financial crisis of 2007 2008, and the Federal Reserve along with the US Treasury, but in trillions of dollars that keep the big bankers operating. But they also do it with regulation. That is they the Federal Reserve, and I think is true in many other countries, tends to really push for fairly flexible, and even very easy forms of regulation on the banks. And I’m very reluctant to put on very tough regulations on them. So we have politicians, the Federal Reserve, and then we have regulatory agencies, in the United States, we have various regulatory agencies that are in charge of regulating the banks. And there’s a phenomenon in the US, the political scientists talk about this called capture that is that the regulatory agencies that are supposed to be regulating the industry, artefact captured by the industry and tend to operate often in the in the interests of the industry. And once again, this is a process that goes on with financial regulation, the SEC, the OCC and other financial regulators we have, and I’m sure you have some in Australia. And we have the same revolving door processes that we have with the Fed. And then there are a couple of other groups that maybe are less well known. One is lawyers, many lawyers work for, for banks, they, they when they’re working in the regulatory agencies or in Congress, they help fashion regulation and and, and regulate and laws that help the banks. And they actually help write laws that are very bank friendly. And so we have a whole group of lawyers that are that are involved. non financial corporations, you think that one thing that I started during the Great Depression when this books my book starts talking about in talking about the Great Depression, and the New Deal financial regulation put into place by Franklin Delano Roosevelt and his administration. At that time, the big companies like us steel and the big industrial companies, they kind of parted way with the banks, the banks had helped crash the economy. And the big industrial companies said, Look, we need a new path. And they supported a lot of the financial regulation, like the Glass Steagall Act that separated for a commercial from industrial banks. But these days, our biggest corporations are very supportive of the banks, they don’t want to regulate finance. And so there many of them are members of the bankers club, too. And finally, I have to admit my own profession, economists, were very many of us are very me, but many are loyal members of the bankers club, become stuck with economic theories that say low regulation is best for society. Markets are efficient. They work better on their own, and this all works in the interests of the banks.

Gene Tunny  08:58

Yeah, yeah. Okay. Look, yeah, I think there’s definitely scope for discussion about the appropriate regulation of banks. That’s right. And we might get into that a little bit later. I’m just thinking about, you know, some of the people involved, I mean, often you hear their accusations levied against people like, was it Robert Rubin. And then Larry Summers, who were the treasury secretaries in the Clinton administration. That’s right. Is there a was there a concern that they were perhaps too close to, to the banks and that yes, yeah. Yeah.

Gerald Epstein  09:35

So Larry Summers, Robert Rubin. Alan Greenspan. They are, you know, golden members of the bankers club, all of them. The major deep financial deregulation that happened in the United States that kind of took apart the New Deal, structure of financial regulation. It happened. First, slowly building up. But then it really happened with the Big Bang. under President Clinton, who was a Democrat with the advice of Robert Rubin, who was chair of Goldman Sachs, and then city city Corp. Alan Greenspan, who was a libertarian, he was a follower of the philosopher Ayn Rand. And he was head of the Federal Reserve. And Larry Summers, who was a was was a very good economist, but somehow found himself kind of, as part of his part of the bankers club. And that was, that’s what really led us down the path to the great financial crisis. And to the problems we’re still having with banking. Yes,

Gene Tunny  10:39

yeah. It’s interesting, this idea the bank is clogged because it reminds me in Australia here, I mean, we’ve had successive treasury secretaries, that’s the head of the cabinet. First and responsible the Treasury is called the treasurer, that we’ve have successive treasury secretaries who have gone on to be the chairman of a bank. And I think for years that was seen as a pretty sort of cushy job. And it was until like, we had David Morgan who became head of Westpac, and then my old boss, Ken Henry ended up head of NAB, but for Ken ended up getting grilled at the Royal Commission into banking, and I don’t think he ever expected that that because we had a whole bunch of bad behaviour. Yeah, the bank’s due to a guest lacks oversight by our Prudential regulator. So absolutely. Same kind of thing. Yeah, yeah. Okay, so I think you’ve, you’ve given us a good description of the bankers club. What’s your case? Can you state your case, please, Professor Epstein, as to why the bankers club should be busted? Well,

Gerald Epstein  11:51

yeah, the title of the book is busting the bankers club finance for the rest of us. And the problem with the system as it is, is that our, our financial system has been has become incredibly bloated. It’s much too much too large. It uses way too many of our financial and human resources, it sucks in some of the best and the brightest of our young people, I can tell you, from my classes here at the University of Massachusetts, when I teach classes, a lot of our best and brightest students want to go into finance and banking. And they want to go in to the mega banks. And you know, the really the really lucrative ones. And there’s a whole literature, which I registered my built on, which is called too much finance. It’s an economics literature, which shows that its financial sectors get too large relative to the size of their economies. And this is a cross national study, that after a while, they’re they’re too big, or they’re structured inappropriately, or they’re doing negative things in the economy. And they actually contribute, after a certain point to lower economic growth, lower national income. And there’s something about having a bloated, an excessively large and complex financial system, which really harms everybody. So that’s, that’s one problem. But we have that’s just one of the problems. Another problem is that it’s bad for democracy that is, you know, Australia’s democracy, the United States is trying to risk to remain a democracy. And the idea is that it’s one person, one vote. But the process I’ve described, where the, these large institutions of powerful institutions are able to, by essentially legislation, regulatory practices that benefit them at the expense of the rest of society. That’s a major problem. But it’s, it’s even worse than that in the United States, because people understand that, that the whole process is unfair. When we had the great financial crisis, the Federal Reserve the Treasury, the government, and this was under both W Bush and Obama bailed out the banks. But they didn’t bail out the people, people lost their homes, people’s jobs were lost. And this made many Americans, understandably, very angry. And I think this turn to this very anti government kind of politics in the United States. That started with the so called Deep party at that time. And it’s now morphed into very, very extreme right wing populism that we had, that has kind of organised around and been organised by Donald Trump. Really stems I think, from this sense that our system is not fair. And so yeah, well understand that it’s not democratic. And I think it’s really poisoning our politics.

Gene Tunny  15:06

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

Female speaker  15:12

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, www dot adept economics.com.au. We’d love to hear from you.

Gene Tunny  15:41

Now back to the show. Well, I think this idea of this, too much finance literature, I’m gonna have to have a look at it or a closer look, I’ve seen some of it, I think. I mean, obviously, we need banks. Okay. I mean, we’re not necessarily any banks, because banks do play an important role in providing credit and supporting businesses. I mean, you asked most bankers, they will think they’re adding value to society. What are the activities where there’s this so called too much finance? I mean, how, like, what how does that manifest? Yeah,

Gerald Epstein  16:18

excellent question. Well, I start off my book with a chapter called the Jekyll and Hyde finance. It builds on this idea from the Robert Louis Stevenson story, which some some of your listeners might have heard of, this very upstanding doctor, Mr. Dr. Jekyll, who was a pillar of the community and really supported the committee and did all kinds of things with it. But we had another base hidden inside of him, this Mr. Hyde, who was who was a criminal, and murderous, and so forth. And, and these different phases of this one entity would show itself depending on on the conditions. So our financial system is kind of like that, you’re absolutely right. We need a financial system that works for the everybody that works for the economy, we need to be able to finance people’s retirement be able to finance people’s ability to buy homes, we need to finance credit for businesses to invest in new plant and equipment. And the list goes on and on and on. The problem is that our current financial system in the United States, which I call roaring banking, it’s kind of comes from the bill boring banking idea of the 1950s and 60s that was very regulated, and morphed into roaring banking as a result of this deregulation, it led this financial markets and these big financial institutions to engage in more speculation taking on more and more risks, to invest in speculative bets and derivatives and other kinds of speculative activity. Yeah, and it resulted in them taking on much more risk, which allowed them to increase the profits and wages, going to the major investors, and to those at the top, without, at the same time, investing a lot in in new plant and equipment for businesses and so forth. In the United States. Many big corporations do not rely on the banks or even the financial markets for their major investments, they get most of the financing from the major investments from their own retained earnings, their own profits. And so it raises the question, well, what are these these big banks, hedge funds, private equity funds, what are they really doing? And many of them are not really supporting the real needs of the economy. In the United States, we have a lot of smaller banks and community banks. And they’re the ones who are much more likely to give home mortgages to give to lend to small businesses, and so forth. And the problem is, in the United States, we have a particular system, your system is different in Australia, what we have is these very speculative mega banks that are driving out to smaller banks. Part of the reason that happens is that when there’s a financial crisis, our government has a too big to fail policy. That means if you’re a really big bang, chances are you’re gonna get bailed out by the government. Whereas if you’re a mid sized or smaller bank, and you get in trouble, you’re not going to get bailed out or you’re gonna go bankrupt or get merged into another bank. And so depositors and investors don’t feel that safe, putting their money in the smaller banks. They Put them in the big banks as well. So the cost of capital for the smaller and community banks is higher, because of the too big to fail subsidy that the big banks get. So it’s an unfair competition. And it’s not a one of the things that I propose in the book is a set of policies that help make this competition, more level more, more fair, so that we have a whole variety of financial institutions that provide the needed services, as you said, that our economy needs. Okay.

Gene Tunny  20:36

Now, in your book, you talk about issues with mortgage backed securities, I suppose one of the things that people, you know, they were most critical of some of these major investment banks was there, you know, they’d be packaging up, or creating these mortgage backed securities and then selling them around the world. But at the same time, I forget which firm it was, but was one of the banks betting against products that was actually selling or one arm of Goldman Sachs. Yeah, Goldman Sachs was one of them. Yeah. So it’s, it’s,

Gerald Epstein  21:09

you know, it’s not really taking care of your clients. And it’s really betting against your own clients. And that’s kind of one example of a behaviour that this all allowed. Yes. Yeah.

21:23

And another. Another good point I think you make in the book.

Gene Tunny  21:29

And this gets to the fact that you argue that the Federal Reserve is at the head of the bankers club, you talk about the impact on of quantitative easing and the the adverse, or the unfair impacts of that. Could you elaborate on that, please? Professor Epstein.

Gerald Epstein  21:47

Yeah. So when the great financial crisis hit Central, the Federal Reserve and other central banks, were trying to revive the economy, understandably, that’s what they should have been doing. Interest rates were already in almost zero. So they wanted to come up with another tool to put liquidity in the in the economy and reduce the cost of investment, cost of capital and so forth, while helping to sustain the banks that were in trouble. So they engaged in what’s called quantitative easing. They put liquidity in the economy by buying up not just government securities, which is the typical way that they do open market operations. But they bought up asset backed securities, mortgage backed securities, this kind of thing from banks, which ended up increasing the value of these assets, which helped the banks because they had these, these assets on their balance sheets were which were not worth very much. So it helped the banks. But the the idea is that it was there hoping that it would also lower the cost of capital to borrowers and investors, and then to generate more employment, and so forth. So my graduate students, and I looked at whether what the impact was in the United States. So there could have been, there was this asset in value increase, which increases the wealth of asset holders, the banks and others, there was cost of capital mechanism that would have possibly lowered the cost for homeowners and others who were borrowing money. And then there was the impact on the interest rates that the consumers get on their savings in banks and banks. So we had a various impacts going in opposite directions, the asset value increase, we’re going to help the wealthy people because they’re the ones who have all the assets, reducing the cost of capital, would help those homeowners who needed to get their mortgage cost down. And the lowering of interest on savings might have hurt middle class and working class people because they hold their money in savings in the bank. So we have these different possible impacts. So we tried to figure out what the net effect was. And what we found was that in the case of the United States, during this period, the main impact was on increasing the wealth of the wealthy, that the other impacts were relatively modest. So there have been other studies of quantitative easing in other countries during this period, and most of them find something similar that it had a relatively small impact on employment and cost of capital for borrowing and a much bigger impact on the value of assets which helped primarily the wealthy. There’s some counter studies, but most of them go in that direction. Now. It’s not necessarily the case. But we weren’t arguing that the Fed was trying to do that, per se. I I think they would have liked to have seen the economy get going more. But that was the impact of the policy that they pursued.

Gene Tunny  25:05

Yeah, yeah. Okay. Why was Dodd Frank? So there were there were some changes to legislation, post financial crisis. So as a result of the financial crisis, why were they insufficient. So Dodd Frank in particular,

Gerald Epstein  25:22

right, so what what really needed to happen after the financial crisis, in my view, and in the view of other others who were looking for some big changes, first of all, these mega banks, Goldman Sachs, the Bank of America, and so forth, they’ve gotten too big to fail, too big to manage. Oftentimes, the people at the top didn’t really understand what the heck they were doing. The big jail that is, the government didn’t even put any of these people who ended up taking on fraudulent activity, they never made them have any consequences at all. So they were just too big. And so there were proposals during the Dodd Frank process, to shut down these big banks that one was to implement a new Glass Steagall Act, which was kind of a modern version of the separating commercial and investment bank, another was putting an asset cap on these banks to try to get them into a size that couldn’t run the economy that can be managed better, and so forth. That was never put on the table. Another thing that the some of us argued for, were consequences for the bad behaviour of the decision makers or the wrong decision makers. When these Goldman Sachs was selling these securities to their clients and betting against them. And then they they made a lot of bonuses and profits, and then the bank threatened to collapse. They didn’t have to give back their salaries, they didn’t have to give back their bonuses, they were able to take the money and run, there were attempts to put in so called law backs into the Dodd Frank legislation. So that we didn’t have moral hazard that is, so we didn’t have a situation where people didn’t have to pay the consequences of their bad behaviour. That was never really put in as in in a significant way. There were conflicts of interest all over the place, including with credit rating agencies, we had the credit rating agencies that were rating the securities, the asset backed securities and so forth, that were full of really dicey mortgages, they rated them leave parts of them triple A, which is this, which is the same as the US government securities, triple A ratings. And why? Well, because the investment banks demand that they rate them triple A, the veteran banks paid the rating agencies, if they didn’t rate them, triple A, then the investment banks would take their business elsewhere to another rating agency. So there are all these kinds of conflicts of interest. They weren’t really dealt with either the list could go on. We needed more regulation for derivatives, derivatives are relatively unregulated. And again, there wasn’t much done there is Well, the question is why? Why wasn’t there better regulation? And the answer is bankers club. Dodd and Frank were both very weak members of they had very kind of weak backbone for really taking the banks on both Republicans and Democrats in the Senate and the House of Representatives. Many of them were were on the take from the banks. Tim Geithner, who was Treasury Secretary, Larry Summers, we talked about before Ben Bernanke, head of the Fed, they didn’t really want to shake up the financial system. They just wanted to get it back up and running again. So the bankers club really did a number on Dodd Frank. Now, there were a few things that were done, and they were good, but they weren’t enough.

Gene Tunny  29:08

Yeah, okay. Okay. And did Trump do anything when he was in office?

Gerald Epstein  29:12

Yeah, Trump’s an interesting story. He ran on a platform when he was running against Hillary Clinton, a very populous platform, who said, All the banks are terrible. They really messed everybody up. Probably Clinton makes money from the banks as she terrible. I’m really going to do a number on the banks. But then when he was elected, he immediately put a bunch of Goldman Sachs people in his administration. And he appointed people to try to dismantle the Dodd Frank Act. And among the things that they did was to raise the size that banks could get before they were subjected to special capital requirements or liquidity requirements. The so called mid size banks, were set free to kind of do what they want and The result of that is we had the Silicon Valley Bank that went under, in 2023. Because they were a bank that had been subject to special reg regulation. Under Trump, they were, they were let go and not have had to be subject to this regulation. And they got in trouble. In the end, the government had to bail out the financial markets again. So the question is, you know, what would trump do if he got into power? Again, you know, it’s probably going to be a similar story, where he’s going to rail against the wealthy and the banks and so forth. But chances are, they’ll do more of the same and it will be kind of this the supreme member of the bankers club if he ever gets back into office. Okay. Do

Gene Tunny  30:43

you see a greater role for publicly owned financial institutions?

Gerald Epstein  30:47

I do. And so it’s time I think, to raise the point of about the others theme in my book, I talk a lot about the bankers club. But I also talk a lot about group I call the club of busters. That is, there are many legislators like Elizabeth Warren and others in our in our government, there are activists, there are economists and lawyers and regulators, who really do want to try to do the right thing. They really do want to try to regulate the financial institutions properly, and are pushing for legislation and regulation to do so Gary Gensler, for example, the head of the SEC, really wants to regulate crypto very strictly, as an example, is giving the crypto people a lot of headaches. He’s a member, he’s what I call a club buster. And what we need, I think, not only tighter regulations, and this is what most people argue for, but we need a whole ecology a whole set of public financial institutions. Now by public, I don’t necessarily mean government owned. But what I mean is financial institutions that have a public orientation, that is making the maximum profits is not their only goal. It’s not their goal. They have missions, public mission, social missions. So some of them can be owned by the government. And the United States, we have some community banks, state banks, and so forth. There are many government owned banks around around the world, but they can also be public private partnerships. They can even be privately owned, nonprofit, non nonprofit nonprofits, who have a social mission. We need many more of these financial institutions to provide low cost mortgages, and loans for small businesses, investment in deprived communities that need more investment, help with transition to a greener economy, at the local level, and the regional level. So we need what I call banks without bankers, that is, banks who don’t have typical bankers in them, they have to have skilled people, technically competent people. But for whom maximising profits is not the main goal. And in the United States, we have a very active public banking movement of activists around the country pushing for public banks of various kinds. Their major obstacles, like once again, is the bankers club who was trying to prevent them from from succeeding, but they’re, they’re these bank posted this quote, officers are working very hard.

Gene Tunny  33:29

Gotcha. Okay, I’ll have to look into that public banking movement. That’s interesting. I like your point that, look, it doesn’t necessarily have to be publicly owned, because like where I’m coming from, as in Australia, we’ve had some, we had some really colossal state bank collapses in the late 80s, early 90s, tri continental state bank of Victoria, and Bank of SA South Australia, if I remember correctly, so we’ve got a bit of a, an aversion to publicly owned banks here, because of the risks to the balance sheets. I liked how you describe that. And I think I’ll have to look more into that at public banking movement. It looks interesting. The one concern I would have is, is there a concern? Is there a risk that maybe, maybe they’re too cautious or they’re not innovative enough? Have you thought about that? Right?

Gerald Epstein  34:16

So, you know, there’s, there is an upside and a downside. As a graduate student, I study the cyclical behaviour of publicly oriented banks in different countries relative to the purely private for profit banks. And what we found was that they were much less cyclical that is they went up much less than the upside and went down much less on the downside. So it’s can be a stabilising force in the economy. But I think what you’re going to getting errors don’t we need some you know, real risk takers and people who are really good, willing to go out on the limb with some some crazy but maybe great ideas. Take the risks and we Absolutely do need that in a dynamic economy. The problem is, what we don’t want is the government backstopping that we don’t want the government saying, you when you gain, you lose, we pay. We don’t want a kind of lemon socialism. So, yes, we need a risk takers, and and they have to pay the consequences if it doesn’t work out. Yeah,

Gene Tunny  35:24

yeah. Yeah, that’s a good point. I mean, that was one of the points that came up during the financial crisis that they were privatising the profits, but socialising the losses. So exactly. That’s a that’s a good point. Right. Okay. Well, to finish up, we might, I might ask you about crypto because in your book, you talk about Jekyll and Hyde. You write just as finance, as both Dr. Jekyll and Mr. Hyde face crypto has a bit of a Dracula quality as well. Could you tell us more about that, please.

Gerald Epstein  35:56

So if anybody who’s followed crypto or invest in it, they know, they know that there was a big bubble and Bitcoin and other cryptocurrencies and 2122. But there was the so called crypto winter, and when the crypto values just, you know, collapsed, and then there are all kinds of scandals with sand bank and freeze in jail and several the other main crypto people are in are subject to criminal investigation, or maybe are in jail. So it seemed like around that time, the crypto was dead. But like the vampires you stick across in them, and they somehow, you know, they revive and now crypto I think, has has had a revival. It’s still trying to push ahead. And there are a lot of crypto friendly legislative leaders in the US and in other countries. And so it’s like, yeah, we all thought it was was dead, but it’s risen from the dead. And my view on crypto, is that again, it’s fine. It’s like, it’s fine if people want to mess with it, you know, in line and death, you know, gamble with it, and so forth. But we can’t let it do two things, one, either of two things. One is infect core banking system. Once we have crypto infecting the core banking system, we’re back to where we were in 2007 2008, when these exotic asset backed securities and collateralized debt obligations, and so forth, infected the very core of the banking system. So when they collapse, they threaten to bring down the banking system with it. As long as it’s a marginal thing. Have fun with it, I suppose, as long as people are aware of the the downsides, but there’s another problem. Most crypto is very carbon intensive, the crypto mining, it’s very bad for our environment, we have this, this existential threat of climate change. And the way crypto mining is done in most cases, not all cases now. It’s really adding as much carbon to the atmosphere as a small country like Iceland or some other country. So I think that has to be taxed. And if crypto can still you know, give some thrills to the its investors in a safe way without destroying the environment. Okay, go for it. But let’s not let it ruin the environment. And it let’s not let it infect our our core banking system. Yeah, very good points.

Gene Tunny  38:27

Okay. Professor Epstein, any final points? Before we wrap up? I think this has been a great conversation. And I did enjoy reading your book. And I’m going to recommend it. And I’ll put the link in the show notes. Any final points before we wrap up?

Gerald Epstein  38:42

Yeah, the final point is that was one of the things that’s kind of obvious from our conversation, my book is, is almost entirely about the United States. So whatever, if these processes happen elsewhere, it will happen in a different way. There have been people doing work in similar kinds of work in other countries, we have Nicholas Shaxson, who’s done interesting work in in England, and we have Jim Stamford, who you might know who is then actually work in Australia and Canada. So I don’t claim that this is a universal process. But But I do hope that other people explore some of these ideas in their particular countries in particular environments to see what’s similar and what’s different.

Gene Tunny  39:21

Absolutely. Okay. Professor Gerald Epstein, thanks so much for your time. I really enjoyed the conversation.

Gerald Epstein  39:26

Thank you very much.

Gene Tunny  39:29

Right. Oh, 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 economics explore.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 So listening, I hope you can join me again next week

40:16

thank you for listening. We hope you enjoyed the episode. For more content like this where to begin your own podcasting journey, head on over to obsidian-productions.com

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.

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Podcast episode

Reagan’s Budget Boss David Stockman on Trump’s Economic Policies – EP224

Economics Explored host Gene Tunny speaks with David Stockman, who was President Reagan’s first director of the Office of Management and Budget. Stockman discusses his new book, “Trump’s War on Capitalism,” and shares his frank and fearless commentary on the former president’s economic policies. In his foreword to the book, Robert F. Kennedy Jr wrote, “Stockman has become one of the nation’s most steadfast and eloquent crusaders against the corrupt merger of state and corporate power.”

Please get in touch with us 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 Podcast and Spotify.

What’s covered in EP224

  • Trump and capitalism. (0:04)
  • Trump’s fiscal and monetary policies. (4:41)
  • Government spending and lockdowns during the Trump presidency. (10:04)
  • Trump’s handling of the COVID-19 pandemic and its economic impact. (15:06)
  • COVID-19 response and blame game. (20:05)
  • US economy under Trump, job growth, and performance. (25:51)
  • Economic growth and tax cuts during Trump’s administration. (30:10)
  • Monetary policy and inflation during Trump’s presidency. (36:26)
  • Corruption in US government and military spending. (41:56)
  • Alan Greenspan’s legacy and economic challenges. (49:54)

Takeaways

  1. David Stockman argues that while Trump portrayed himself as a capitalist, his fiscal and monetary policies like large tax cuts, increased spending and pressure on the Fed to keep rates low were reckless and a threat to capitalism.
  2. According to Stockman, the data shows the US economy was not in its strongest position ever pre-COVID, as Trump claimed, with key metrics like GDP growth, job growth and investment lower under Trump compared with some previous presidents.
  3. Stockman believes Trump bears responsibility for the unprecedented pandemic spending and deficits, as he could have resisted lockdowns but instead endorsed huge stimulus packages.
  4. Stockman views Trump as the worst president for sound money policy due to his pressure on the Fed to keep rates low.

Links relevant to the conversation

Amazon page for Trump’s War on Capitalism:

https://www.amazon.com/Trumps-War-Capitalism-David-Stockman/dp/1510779329

William Greider’s famous 1981 Atlantic article “The Education of David Stockman”:https://www.theatlantic.com/magazine/archive/1981/12/the-education-of-david-stockman/305760/

Transcript: Reagan’s Budget Boss David Stockman on Trump’s Economic Policies – EP224

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.

David Stockman  00:04

He’s campaigned against the Fed, but he wants an easier fed, okay, I want to read the Wall Street doesn’t like totally different I want a Fed that’s proven that pursues sound money policy Trump wants a fed that prints even more money than the flood we already have.

Gene Tunny  00:28

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. My guest this episode is David Stockman, who was President Reagan’s first director of the Office of Management and Budget. Prior to the Reagan administration, he had served as a congressman. And after he left the administration, he had a career in private equity in business. David has a new book out titled Trump’s war on capitalism, and I was delighted to speak with him about it. David is a frank and fearless commentator, and I was never left wondering what he really thought about the former President’s economic policies. Indeed, David has a long history of Frank commentary. He first became famous for some frank remarks he made in 1981, to journalist William Greider about the Reagan administration’s budget strategy is also tangled with Paul Krugman, among other prominent commentators in the US. I really enjoyed this conversation with David and I hope you do too. Regardless of whether you agree with him or not, I think you have to respect his ability to argue his points. And he will demonstrates that ability in this conversation. I get the sense he is incredibly resilient as he’s copped a lot of criticism over the years, he’s had to make a multimillion dollar legal settlement with the SEC. He’s even a defender of criminal charges, they did end up being dropped by the SEC, I should note, all of this is to say that he’s had a very interesting career and life experience. And he’s someone worth hearing from, in my view. Now, David expresses some very thought provoking views in this episode, and I expect you’ll have some thoughts on what he says and you may have some thoughts on some of the things I say. So please get in touch and let me know your own thoughts. My contact details are in the show notes as our links related to the book and about David Righto. We’d better go into the episode. I hope you enjoy my conversation with David Stockman about Trump’s war on capitalism. David Stockman thanks for joining me on the programme.

David Stockman  02:46

Very happy to be with you got a lot to talk about here, I think. Absolutely.

Gene Tunny  02:50

Well, you’ve written a very provocative book a very, very in depth book looking at the policies of the former President Donald Trump and prospects for a new term if the minute is looking very possible that Donald Trump could be in the White House again next year. So your book is called Trump’s war on capitalism. Now, this is, this is interesting because too many of us, Donald Trump is the exemplar of the American capitalist. And yet you argue that he is undertaking a war on capitalism. And even more strongly, well, strongly. You argue that is a clear and present danger to capitalist prosperity. Could you explain David, how do you how can we reconcile these things? I mean, Donald Trump does seem to be the exemplar of a capitalist, but yet he’s a threat to capitalism. How do we reconcile these facts?

David Stockman  03:58

Well, those are great questions. I don’t think really, he’s an exemplar of capitalism. And we can get into that. I think he’s an exemplar of getting lucky when the Fed created so much inflation and asset prices and made debt so cheap that if you were a speculator, in New York City, real estate or elsewhere, you possibly made a lot of book, wealth, but I don’t think it was capitalist genius behind it. That’s the first point. The second point is that his policies were really almost anti capitalist in some common sense notion of conservative economics. To have a healthy capitalist economy. You need three things. One, fiscal rectitude, you can’t be running up the public debt, spending like there’s no tomorrow and having the government grow and mushroom and impinge in every direction on the economy. You can’t have easy money and a central A bank that is flooding the system. With cheap credit and excess liquidity, you can’t have a government that is really anti free market, which is what, you know, trade protectionism is all about. And he’s the biggest protectionist in the White House. You know, since I don’t know Hoover set, and Smoot Hawley in 1931. So all of his policies were really in the wrong direction. Now, I do concede in the book, that the one abiding virtue that Donald Trump has is he’s got all the right enemies, okay. The establishment hates him, The New York Times The Washington Post, CNN, The Washington, what I call you, in a party establishment, the leadership and the long standing careerist of both parties can’t stand him. But basically, it’s because he’s an outsider is because he’s unwilling to conform, and he’s pretty obnoxious, and unpredictable. That’s why they’re against him. The point of the book, though, is none of his power. And his policies were wrong, even if he had the right enemies. And nothing that he did help the economy or addressed, the huge long term problems we have of a runaway public debt of a government is way too big and too costly and too intrusive. And especially at the heart of the matter, a central bank that is out, it’s a rogue Central Bank, it’s out of control. And yet Trump was constantly on their case, demanding even easier money, lower interest rates, even more, you know, of the same that got us into, you know, the huge bubbles and troubles that came from them. So, the point of my book was to say he had a chance he’s got her four year record we can look at it is terrible, it offers nothing in terms of remediation of our great problems and putting us in a different direction for the future. So, you know, don’t waste the opportunity. And you know, that’s about where I come out.

Gene Tunny  07:13

Right. Okay. So you write about what you call the Donald’s reckless fiscal and monetary policy. So we might talk about fiscal first. Now, among other things, you talk about the most grotesque act of fiscal malfeasance in American history. So that was something that Trump was associated with you argue? Are you talking about the the big tax cut the Trump tax cut in 2017? Is that Is that something you see as as reckless,

David Stockman  07:44

and that’s part of it, but I’m looking at the overall picture, and the data, the big top line data on spending and borrowing on the public debt. Now, let’s just take it down to the core metric, which is the public debt. I mean, if you’re running huge deficits and spending, far beyond your willingness or ability to tax, it comes out in the public debt. When Trump became president in round terms, that public debt was about 20 trillion. When he left it was 28. That’s 8 trillion of growth, a trillion of debt, public debt. In four years, you let me ask the question, when did when did we get the first 8 trillion of public debt? And how long did it take us to get there? The answer is in two or three, it took us 216 years 43 presidents to rack up a trillion in debt. He did it in four years. That’s kind of the bottom line. It puts it in perspective, in terms of how big the air was. If we look at other more conventional measures, you get the same picture, the average deficit to GDP and that’s another good ratio, you know, how big is the deficit or surplus relative to the national economy? It will the deficit average two and a half percent of GDP for all the presidents from the early 50s through 2016. The deficit under Trump’s four years average 9% of GDP, almost four times more than it had been the average going back for. If you look at spending, I think that’s important. And again, let’s take the inflation out of the picture and looked at it in inflation adjusted for real terms real spending. Trump average 7% per year during his tenure, for instance, big spending Obama right before him was 2% per year in real terms. Reagan when I was there was 3% per year. In real terms, the average was two and a half. So again, Trump was you know, three times, in some cases four times more In terms of the growth rate of spending then haven’t heard historically. So you know, if when you go through those kinds of measures, and then of course, it all culminated, I just want to put this last point. And in 2020, when he made the huge mistake of shutting down, locking down the economy based on very bad advice from some very bad doctors that worked for the federal government, if he had any principles about, you know, property rights and personal liberty and constitutional due process, he never would have ordered a lockdown to the economy. But in any event, he did that in 2020. And as a result of that, we had just an explosion of spending to bail out the economy that the government had ordered to close. And I’m talking about the 2 trillion worth of stimulus measures that were passed with his urging, you know, with his support in 11 days, I mean, this was an $800 800 page, I mean, Bill that contain 2.2 trillion, where the so called Cares Act, you know, banned unemployment insurance benefits, that checks 200 million households, massive amounts of money to education, health, other institutions. The point is, they passed 2.2 trillion in spending and 11 days, nobody read the 800 pages. And that was just the warm up. He then, you know, insisted on the second stimulus or COVID Relief bill in December that he signed right before he left, that was another 2 trillion. And it paved the way for the last 2 trillion that Biden put on top of it, when he came in, basically to implement an extension of all of the freebies and free stuff and giveaways that Trump had put into place during 2020. Well, the reason I’m dwelling on this is it added up to $6.5 trillion of spending, almost sight unseen in terms of legislative review, and scrutiny, it happened in 12 months, march 2020, to march 2021. And that in itself was equal to 150% of the pre existing budget. In other words, in 12 months, they passed the emergency spending that was 1.5 times bigger than the entire federal budget, defence, Social Security, interest payments, student aid and all the rest of it. This is how far it was out of control. And he was sitting in the Oval Office with a veto pen in his hand, theoretically, but obviously, his stubby little fingers never gotten here, the veto pen, he didn’t veto anywhere in either he waved it on. And so therefore, you have to blame him for the most outrageous edge Regis outbreak of fiscal madness that we’ve ever seen in peacetime or wartime in this country. And when you prove that’s where, you know, that’s where you come out that you know, as his record is undeniable, the facts are all there. Why in the world, the Magga fans and Republicans or the Republican rank and file, want him to have another chance is really beyond me. But I wrote this book test, just in case someone cares about, you know, the reality and about the facts, that if they do put him back in, they’re probably going to put him on the ticket. And if the country puts him back in the Oval Office, there is no, it should be no confusion about what you’re getting, you’re getting a worse, you’re getting a exacerbated case of all the problems that we have already today. Rod,

Gene Tunny  14:05

okay. In terms of that spending, I thought that was interesting. You compare the growth rate of spending under Trump versus other presidents, including Reagan. And I was surprised it was. Yeah, there was that stark difference that’s due to that, that pandemic stimulus is that that, you know, one and a half times the budget that was approved in whatever, 11 days or however many, there was an extraordinary fact you mentioned there. Now, one thing I’d like to ask you about because I’m in Australia, so I’m less familiar with exactly what happened in the States than I am here. I mean, I’ve seen it, you know, I saw all the commentary and but you said that you blame Trump for the lock downs or partly, you blame Trump for the lock downs. i The impression I got was he was king piny against the lock downs. Am I wrong on that? I thought it was done by the states.

David Stockman  15:06

No, but yeah, it’s a great question. But if you go back and look at the calendar, the Tick Tock day by day, week by week, it’s very evident that another reason why Trump is on Fit is that he doesn’t have any principles. He doesn’t have any guiding philosophy, he flies by the seat of his ample britches, and whatever seems to strike is fancy at any moment in time, he goes with me because he’s so damn arrogant, that he doesn’t even begin to understand what he doesn’t know. And basically, when it comes to economics in the world, and governing a $26 trillion economy, he knows very little that maybe he sees basically ignorant. So when when the COVID came along for a few days, he was saying, Well, you know, the flu every year to X number of people, 38,000 50,000 people succumb to the flu one way or another, we’re used to this very, what’s the crisis, six days later, as a result of a lot of pressure that came into the Oval Office led by, you know, his son in law, Jared Kushner, bringing in a couple of scientists who wanted a chance to really exercise some power, I convinced him that it was not only not the flu, but it was something like the Black Plague, and that every all stops had to be pulled out. And that’s on the 16th of March, he gave this speech, you know, two weeks to flatten the curve and turn Dr. Fauci and Dr. Burks and the rest of that crowd of Mal practising doctors loose on the country. And before we know it, the entire economy was on its knees and I got data in the book that lays out how severe this was. Two measures, I think, give you a dramatic a pretty dramatic indication of the hammer that Donald Trump brought down on the US economy and therefore the world economy at the end of the day, on March 16, when he authorised you know, two weeks to flatten the curve and turn the CDC loose on daily economic life. First in the second quarter, when it hit that was ground zero of the lockdown second quarter 2020 GDP in the United States declined at a 34% annualised rate, what does that mean? Well, in the worst recession that we’ve had in the post war period, which is the Great Recession, you know, in 208, the annualised the redonk, fall in GDP was 8% during the worst quarter, okay, the worst quarter was 8%. And in the second quarter of 2020, because of the government ordered lockdown, not some kind of cyclical, you know, tumble of the economy, the government ordered the Trumpler lockdown, GDP declined at a 32% rate just, you know, startling, you know, on precedent. Now, the other measure I use a lot in the book is if you look where it hit the hardest lockdowns, it was obviously in my I call the social interaction venues, restaurants, bars, sports, arenas, gyms, malls and the rest of it. in that arena, that area of the economy in the BLS statistics, Labour department’s statistics is called leisure and hospitality as you know, all those industries are in that grew in April 2020, which is ground zero, the heart of the lockdown hours worked in the leisure and hospitality sectors declined by 56%. Compared to the previous month, half of the employment half of the out and not just headcount answer people but actually hours worked, disappeared. Now how big is a 56% decline in employment in that core sector of the economy? Well, it’s so big that it reduced the actual working level. In other words, the hours work the number of people on the pay pay clock to a level not seen since the spring of 1979. In other words, it rolled back the clock 43 years in terms of the slow and steady and relentless growth that occurred in that sector. Are was wiped out in 30 days and it’s taken years to recover. And we’re still not back to where we were in February 2020. So the lock downs are fading, you know, because as time passes things that seemed pretty bad, right at the moment they were happening suddenly, you know, see maybe not so bad, but the lock downs were dramatic. Yeah, they were, you know, the biggest, you know, Thunderbolts to hit the economy. I think it ever at least in the United States, so, he that was the consequence of Trump. swivelling on a dime from nothing to worry about to the sky is falling. And then And here’s where I really put the pin the tale of the donkey, so to speak. He created this thing called the White House Coronavirus, Task Force. And it met day after day and they had a big press conference. At the end of the day. It was like a reality show from the White House Press Room day after day in which Fauci was up there. Burks was up there, and it Hance Vice President Pence and others. And they just scared the living daylights out of the country, even as all of these orders from the public health departments were being implemented at the urging of the CDC and the White House. So this, this whole lockdown catastrophe, was born, bred and perpetuated from the Oval Office, and I go by the famous aphorism you might not be as an Australian might not be aware of it. But Harry Truman, famous president, you know, at the end of World War after World War Two, and had this had this slogan on his desk that said, the buck stops here. In other words, I am going to take responsibility for what happens? Well, in this case, the buck stops with Trump on the whole disaster of the COVID response to pandemic response to lock downs, the damage that it did to the economy and the costs that were generated in terms of borrowing and deficits and the public debt, you know, all of it, you have to ultimately put on his doorstep. Because if he had stuck to his guns, listen to this, this is unbelievable. If he had stuck to his guns of March 11, when he said, you know, this will be handled in the normal way. We’re used to these, you know, viruses coming along, and we can handle it. If he had stayed with that position. None of this disaster would have happened, right? It wasn’t the virus that caused the economy to plunge into a black hole. It was the lockdowns.

Gene Tunny  23:08

Right, just on the what Trump could have done. I think this is an interesting perspective. And it’s Yeah, I think this is probably this might be the perspective that gets you the most pushback or reaction. I think it’s an interesting proposition. What I’m interested in is whether like, say Trump just said, Okay, we’ll ignore the we think there’s a minor virus. I’m not saying necessarily it is. Let’s say Trump says that. Could he have actually directed the states? Could he have directed? Who was at Andrew Cuomo and Gavin Newsom to open up? Could he have done anything? Did he have the levers to be able to do that? Yes.

David Stockman  23:50

Because they responded, I don’t think they were sitting there in Albany, New York, where Cuomo was where Sacramento and said, hey, you know, this, these reports, we’re getting sound like this is a pretty terrible virus. We’re gonna start systematically closing bars and restaurants and malls. And they were doing that in response to the guidelines, the recommendations, and the pressure from the CDC, which was the federal government, and it was controlled, obviously, by Trump, and the CDC and in turn was responding to the White House Coronavirus Task Force, which was being run by Fauci, which was being run by dance is as delegated by Trump. So it was all coming right out of the oval office there. They wouldn’t. I don’t think and I’ve been in politics since the 1960s in America. So I think maybe my judgement is not totally bad. But I’m absolutely certain that without the imprimatur without the urging without all the hysteria, coming from Fauci in that White House Task Force, these people would have not, they wouldn’t have stuck their neck out and closed down their economy, because every one of them was creating political problems for themselves. It wasn’t you know that this was like some great winning political opportunity. Let’s close down all the gyms and in the state, like they did New Jersey and New York, and let’s shut down the malls and let’s put the restaurants out of business. They’re sitting there saying, Yeah, this would be some real good politics for us and forced that the governors weren’t saying that. They were doing it all ultimately, because they were being pressured. They were being encouraged by the federal government and particularly by the Trump White House.

Gene Tunny  25:51

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

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Gene Tunny  26:26

Now back to the show. crass now about one of the things that President Trump would claim was that he had the greatest economy ever the economy was in the strongest position ever. And then it was the virus that COVID that came along and, and wrecked everything. But you, you actually question that you don’t think that the US economy was the greatest economy ever pre COVID? What What’s your what is your analysis? Show you there? You haven’t What do you conclude there?

David Stockman  27:00

Yeah, good question. I don’t question it myself. The data proves it. In other words, I just did a lot of research and served up the data that comes out of the statistical mills of the US government. And you can measure it seven different ways. And you get the same answer. But let’s start with real growth. After all, that’s the big, you know, summary metric for economic performance and health. And real growth of the economy was grew at 1.5%. During Trump’s four years, the lowest rate of any presidential term, going back to Harry Truman, again, to 1950, the average over that entire period, no, nine presidents 11 business cycles during that period, recessions and recoveries, we had a couple of wars during that period, we had any number of crises. So in other words, what we’re talking about here is the long term trend performance of the US economy from 1954 to 2016. Right before Trump got in it averaged 3.04% Or double the growth that occurred during the Trump period. So you can on that on that summary, you can’t make that statistic go away. That’s that’s the major the whole ball of wax. And his growth rate was half of the norm. It was a third, basically, of the highest performance with Kennedy Johnson was 5%. It was maybe 40% of what I remember during the Reagan period, when the growth rate was 3.5%. So the idea that he kept Tweety and keeps to this very day complaint, you know, talking about the great Magga economy that he brought the greatest economy ever is totally refuted contradicted by the facts. Now that’s one of them. We can look at job growth. And of course, the answer there is pretty interesting. He’s the only president since Herbert Hoover, in which there was no job growth. You’d never know that from listening to Donald Trump’s boisterous speeches, but the fact is, when he took office in January 2017, there were 145 point 5 million jobs, non farm jobs in the US when he left office in January 2021. There were 142.5 in other words, the job shrunk by 3 million jobs during his term nothing like that ever had before every other president, there’s more jobs than when they start, not because of their virtue. Do necessary or are there policy is because a capitalist economy unless it’s really thwarted, tends to expand and grow and create more jobs. Trump was the exception. Now you can say, Well, again, it was the lock downs, and it was the spring of 1920 20 catastrophe. But even if you take that out of the picture, and you look at Trump and pretend his, his administration handed in February 2020, which is, you know, the month before the COVID, the pandemic hit, he averaged 145,000 new jobs a month, in that period, until the eve of the COVID, or pandemic hit to the economy. Obama had 215,000. So he was a third shorter than Obama. And Obama was considered pretty bad. If you look at overall employment growth, even taking the pandemic period out, the growth rate under Trump was about 1.4%. And it average two and a half percent in the decades and decades before. In finally, I think the, the, you know, the bottom line measure of economic health. And, you know, the this standard of living on Main Street, you know, for the broad middle class is really per capita, GDP, real GDP per capita, if it’s rising, that means the living standards are rising. And if it’s not, you have a problem. But the average again, during the 60 years post war was 2.5%. And during Trump’s period, it was 1%. In other words, the growth rate was, you know, barely two fifths of the normal rate on this basic metric, which is real GDP per capita. So when we can look at other things to the savings rate collapsed during his administration, despite the big tax cut, we haven’t gone into in detail yet. But despite that, investment growth was lower during the Trump period, than in any other administration going back again to 1950. So, you know, when you ask the question, Where’s the proof? Is it in the pudding? The answer is no. There’s there’s no proof whatsoever of his boast. You know, about the greatest economy ever. So what I say in the book, is it wasn’t the greatest economy ever. It was really the greatest con job ever. Right.

Gene Tunny  32:47

Okay. So on the tax cut, you mentioned the tax cut before you mentioned that this didn’t. In your view, it didn’t lead to, you know, a, an economic surge or surge in investment. And can you explain what happened with that tax cut? And where did you where did the money go? You talk about that in the book?

David Stockman  33:10

Sure. Well, if you want to look at the tax cut, you have it was clearly skewed to encouraging reinvestment by business, both corporations and, you know, individual proprietors. That’s why the corporate rate went down from 28 and 21. Why they put in the equivalent 20% deduction for unincorporated businesses. Now in Aw that cost 1.7 trillion over the first 10 years in revenue loss. And that was supposed to then, you know, cause a surge of investment. But if I look at the investment rate, by that I mean, real investment in the business sector, in the five years before the tax cut became effective in 2018. It was actually well higher than the growth rate in the next five years after the tax cut took effect. So if you spend $1.7 trillion that you don’t have, because it was all deficit, finance, they didn’t cut spending to pay for the revenue loss, and you get not no gain at all, but actually a worse trend performance in real terms, inflation adjusted terms, then you have to ask, how could you possibly justify that if you were borrowing money for a huge rate of return? You might argue, well, let’s let’s try that. But if the rate of return is even smaller than what was already built in, it’s dubious now where the money went them because clearly, corporations and individual proprietors paid a lot less in taxes. The answer is into a record surge in stock buybacks, and in corporate m&a deals and in other forms of, you know, leverage recaps and so forth other forms of financial engineering that basically flow money to Wall Street and to the top of the economic ladder, because that’s where all the stock is owned. In other words, 93% of the stock in the United States is probably true in Australia as well, I’m not sure. But 93% is owned by the top 10% of households, and bout 48% is owned by the top 1%. So if you have a huge corporate tax cut 1.7 trillion, that produces no gains in investment and therefore, future growth and job creation, but instead ends up being flushed back into Wall Street, you know, in the form of stock buybacks and other financial engineering, which then flows to the very top of the income scale. You know, you’ve got a double bad, okay, you added to the debt that the whole public is going to be paying service charges interest on forever, and you put the money, you took the money out of the economy and Senate, to the top of to the very wealthy and to the most affluent people next. Oh, sense. Raw.

Gene Tunny  36:27

Okay. I’d like to ask you about a go back to this point you made in the book about the Donald’s reckless fiscal and monetary policies being doubly bad. We’ve talked about the fiscal policies, what were his monetary policy? So monetary policy is handled by the Federal Reserve, isn’t it? What’s what’s, what was Trump’s role there?

David Stockman  36:49

Okay, though, that’s, again, another important topic. As far as I’m concerned, the number one, number two, and number three policy problems in the United States today, and the world is the Fed and the other central banks, they’re out of control, they’re printing presses have been running red hot. For decades and decades, one measure that I think is startling, if you take all the central banks of the world and add their balance sheets together, in 20, in the year 2000, it was 3 trillion. Now, why is it important to take the balance sheets, look, because that’s just a measure of how much money they printed? Okay, you know, when they print money, they buy assets and put it on the balance sheet. That’s a good simple metric to measure how much money they’re printing, it was 3 trillion at the turn of the century is 44 trillion today. All right. So in barely two decades, they have, you know, they’ve just flooded the world financial system, you know, with freshly minted credit, that, you know, ultimately created bubbles and inflation of every time. So the question then is, what about Fed policy? Now, given that backdrop, and my point is yes, in nominally, the Fed is independent, and they make their own decisions. But my quarrel with Trump is twofold. One, he made enormous put enormous public pressure on them, you know, practically week after week, to lower interest rates, and to make money even easier than it already was. So he was making the wrong advice. And secondly, he was doing it at a time in the business cycle, when it was desperately important for monetary policy to be normalised. I never agreed with all the huge money printing that Bernanke undertook in 208209 to 10. But you know, people argued it was an emergency, it was a one time thing, and even Bernanke himself, said in 2011, we’re out of the woods now. And we’re going to normalise the balance sheet, and we’re going to shrink it back to something reasonable, because it was 900 billion when the, you know, great financial crisis started struck the Wall Street meltdown in September 208. And by the peak it was 4.4 trillion. And, you know, everybody agreed that it needed to be normalised and interest rates were being held practically to zero for years and years and years, and I document a lot of this in the book, and that they needed to normalise as well, because when you make money dirt cheap, you’re just inviting speculation on Wall Street and you’re inviting Congress to spend money it doesn’t have because it’s so cheap to borrow down in Washington. So it was time for normalisation the Fed was trying to To do that by slowly raising rates, and by getting out of the Qt business and actually our QE business and actually shrinking its balance sheet they had initiated before Trump got through something called Qt quantitative tightening, and they were slowly trying to shrink the balance sheet back, just like Bernanke had promised they would. And Trump was constantly on their case, not to do either. And as a result of that the Fed just kept interest rates at zero. It kept the balance sheet, massively, bloated, still around $4 trillion. And that paved the way for the huge inflationary mourning after that we had in 2020 2021 and up into the present. So it the timing of the cycles screamed out because we were well into the recovery, the longest recovery in history. It was it screamed out for normalisation get back to something that was sustainable. And Trump was pounding the table, you know, day after day, don’t you dare do it. And even you know, leaking to the press that he was investigating whether he could fire Powell or whether he could, you know, clean house at the Fed and so forth. So therefore, when it comes to something as fundamentally important as sound money, Trump is the worst president and I say this advisedly, that we ever had the very worst, you know, far worse than Jimmy Carter far worse than Lyndon Johnson. Far worse, as far as I’ve studied it, than FDR, he may be even William Jennings Bryan if he had been elected president. So you, that’s another big black mark on the record.

Gene Tunny  41:56

Okay. You don’t blame Richard Nixon for taking us out of Bretton Woods. off the gold standard? Yeah,

David Stockman  42:04

no, I do. Yeah. And I’m I don’t know how I missed that one. But he was he was he was even worse than Richard Nixon and Tim was bad enough. Right.

Gene Tunny  42:14

Okay. Okay. That’s a it’s a Yeah, that’s a lot. I think your discussion of the Fed and fed policies, it’s definitely worth reading. So thanks for that. David. One last thing. In the foreword to the book by you’ve got Robert F. Kennedy, Jr. He says that you’re a crusader against the corrupt merger of state and corporate power in the US. Is that? Is that? Is that how you see yourself? And like, How bad is it in the States? I mean, you’ll see here the talk about the swamp and you hear about the power of lobbyists and all of that, and, and the corruption. I mean, how bad is it, in your view in the US at the moment?

David Stockman  42:59

I think it’s, I think is terrible, because the two worst things we have going are the military industrial complex, this massively bloated defence budget, and the pretentions of Washington that were the hegemony of the world with bases all over, will forever wars all over it interventions everywhere. That is due to the capture of policy by the military industrial complex, that’s corporate power, merging with government power, that’s the first one. The second one is the Fed is a rogue institution that is basically captive of Wall Street. That’s why they keep you know, printing money like they have been doing for decades now. And, you know, that’s exactly what Robert Kennedy is talking about there as well. Total capture of government institutions, in one case, the national security apparatus, in the second case, the basic Central Bank, by private interests, and it leads to some very, very bad outcomes, both domestically and internationally.

Gene Tunny  44:11

Gotcha. These are things that these are things that Trump himself has been campaigning against, hasn’t he or he made he these are things that he uses in his

David Stockman  44:22

arguments. Yes. And no, that is a good point. He’s not campaigning against the Fed. He’s campaigned against the Fed, but he wants an easier fit, okay. I want to send a Wall Street doesn’t like it’s totally different. I want a Fed that’s proven that pursues sound money, but obviously Trump wants a fed that prints even more money than the flood we already have. When it comes to defence is weird. He talks about America First he talks about, you know, NATO should pay its fair share of the tab and all that. But when he got in, he inherited a defence budget of 600 billion which was already way too big bloated, beyond anywhere. Rational need, and he took it up date other than 50 billion. In other words, he never saw a request from the defence department from, from the generals for money that he didn’t like that he wasn’t ready to embrace lock, stock and barrel. Now, why was that? Well, because Trump fancies himself as the greatest negotiator to ever come down the pike. I guess he learned that in the Queen’s as a real estate developer in his early life. And if he hasn’t, you know, an $850 billion defence budget behind him, even if it’s a big waste unnecessary. He thinks he’s accomplished something. But he’s so wrong. Because when you give the defence department and national security apparatus and all those agencies, all that money, they use it to buy political support. That’s right. You know, they use it, basically to perpetuate their missions, their manpower, their budget levels, and so forth. So, you know, Trump isn’t very smart. To tell you the truth, when it comes to how the world works. You know, he may have been a street smart gambler from Queens and got lucky in the real estate business. But he’s never studied. He’s lazy. He’s uninformed. He’s impetuous. He’s fairly dangerous.

Gene Tunny  46:27

Okay. Brought up Wow, man, this is, yeah, it’s been a real. A really great conversation, David, and very, very forthright. And I expect you’ll get a lot of reactions to your book for sure. I suppose one thing I’d like to ask before I leave. So you’re someone that you’ve, you’ve worked, you’ve been in Congress, you’ve been a representative, and you’ve also you’re a director of the Office of Management and Budget, management and budget in the Reagan administration. Correct. What was what was that? Like? I mean, what I mean, that’s, that’s a celebrated administration. I mean, obviously, one of your most distinguished or famous presidents and, you know, lots of really good people in that administration. What was it like on the ground working in it? Well,

David Stockman  47:18

it was a pretty exciting time, at least an effort was made to try to contain the behemoth that it build up on the banks of the Potomac. And it’s interesting to note that when Reagan was sworn in, in January 1981, I became budget director, the first thing we had to do, because we inherited this mess from Jimmy Carter, was to raise the national debt limit above a trillion dollars for the first time, we didn’t have any choice. But where are we today? Go public debt is 34 trillion. And we were struggling with one and we thought, you know, it was a world was going to come to an end. That’s how far things have drifted. Now, of course, the economy is three times bigger, but the public debt is 34 times bigger. So you know, it’s. And then during that period, we had our ups and downs. But at the end of the day, only some minor progress was made in shrinking the size of the federal budget, we cut taxes deeply. We were going to cut spending to match the tax cuts, the spending cuts didn’t happen, because the Republicans really, were not willing to walk the plank in Congress. And because defence spending, got totally out of control and ate up all the savings that we were getting domestically. So essentially, the fiscal calamity that the country is struggling with still today, and the Trump made infinitely worse, originated in the early 1980s, not by purpose, not by intention. But, you know, by the result of the political and policy battles that occurred in the Reagan era, but the one thing that was different is we had Volcker as chairman of the Fed. Volker was the last of the sound money Fed chairman. And he said, You know, I’m not going to finance the federal deficit. You guys want to run up the ready, then you’re going to fund it honestly, in the bond pits, interest rates are going to go up and it’ll be on your watch. And so he did bring inflation to heal, but he was the last of them and in fact, he was so unpopular with the Republican politicians who ran Reagan You know, by the end Reagan wasn’t with it that much of the last two years. They convinced him to not reappoint Volcker and put it Alan Greenspan instead. And, you know, the rest is history. Greenspan was a disaster.

Gene Tunny  49:53

Yes, I mean, he he certainly is his legacy initially After he retired he was seen as the the maestro, but then the financial crisis and there’s been a big reassessment of Greenspan’s legacy since then for sure, absolutely. I might have to cover that on a future show because it’s Yeah, it is a it’s a you know, there’s a lot of history a lot of to go over there. But then Stockman has been terrific. I really enjoyed talking about your new book. I think it’s an important book. It’s, it’s thought provoking. I expect it will be controversial and will should there should be prominent in the the upcoming debate over the rest of this year. So thanks so much for for participating. I’ll put a link in the show notes to your book. Is there anything you’d like to say to wrap up?

David Stockman  50:47

Well, I think we’ve covered a lot of good ground. But I think the answer is, you know, people really need to look beyond the headlines and what the mainstream media is telling you or what the politicians are boasting about, and get a grasp on the facts because we’ve got some pretty difficult economic times to grapple with as we go forward.

Gene Tunny  51:10

So David Stockman thanks so much for your time, really enjoyed it.

David Stockman  51:14

Very good. Thank you.

Gene Tunny  51:18

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 economics explore.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 outlets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

52:05

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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.

Categories
Podcast episode

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

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 was then checked over by a real human, Tim Hughes from Adept Economics, to pick out any howlers that otters might have missed. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:06

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host Gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory, evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show.

Hello, thanks for tuning in to the show. In this episode, I chat with one of my colleagues at the Centre for Independent Studies, Peter Kurti. Peter is director of the Culture Prosperity and Civil Society programme at CIS. He is also Adjunct Associate Professor of Law at the University of Notre Dame Australia. Peter has written a great paper for CIS on the role of experts in government. The paper is titled “Authority, Expertise and Democracy – Should Those Who Know Best Rule The Rest of Us?” In the paper, Peter asked how society should best use experts in public policymaking and he provides some very useful tips. This is a really important issue given how much we rely on experts. At different times, experts have wielded a lot of power. Dr. Anthony Fauci in public health and Jay Powell in monetary policy come to mind. When does it make sense to delegate power to experts? What are the relevant considerations? Peter Kurti provides some great advice in his latest paper, which we talk about in this episode. Okay, let’s get into it. I hope you enjoy my conversation with Peter Kurti.

Peter Kurti, thanks for joining me on the programme.


Peter Kurti  01:59

Thanks, Gene. Great to be with you.


Gene Tunny  02:02

Very good Peter. You’ve recently had a new paper published by the 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 ceded 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 turf them out at the next election. And we can turf out individual members of parliament at 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, 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 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 Peter?


Peter Kurti  05:18

In Covid 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 uneasy 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 but 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. This is 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 are, 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, is 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 Gene, 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, you know I’m 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’d 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 tradies 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 worse 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 that 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. You talk 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, is this 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 I 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 Pabst who talks about the the fact that he 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 Pabst 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 citizens of 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 tre.., 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 I 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 do decision-makers do when there is a situation of of that of that dissent I 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 just 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 bai., 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 deter 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 in Australia 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 or they didn’t show that they were weighing up pros and cons, whereas they 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 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?


Peter Kurti  22:16

Yes it does! 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 nearest was in Queensland, but it’s qui… You can edit this bit out Tweed Heads, Tweed Heads in New South Wales isn’t it?. Yeah. She needed to get across the border. And Palaszczuk said famously, or notoriously that Queensland hospitals are for 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 colonies, and I would d.., former colonies, and I thought that even our sense of national cohesiveness has, has has gone. 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 Dominic Perrottet came into office, the first thing he did was reduce 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 Perrottet 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 from Queensland to 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 this is really good I think this is 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 and 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 at 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 all, 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 the 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 it 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 hurriedly 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, to an extent, 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 there’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 blithely 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, would’ve allowed 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 need 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. 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

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


Female speaker  29:51

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Gene Tunny  30:20

Now back 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, I 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 a cultural contour is something that 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 medical experience was something 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 it 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 off label. 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, I don’t know I mean 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 too.

Peter Kurti  34:18

I agree, I agree.

Gene Tunny  34:20

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, well it’s out of the stable 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 dissent, 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, but 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, you note 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 Koppl, who of course, develops as you’ve mentioned, public choice theory, but really, information choice theory. Koppl 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 Koppl 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 Koppl 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 injust, 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 although 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 that Koppl cites and I think it’s a it’s an interesting one that we 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 Koppl. Did you, was he in the public choice school?


Peter Kurti  40:09

No, he is, it’s Roger Koppl he’s actually it’s finance and financial management. He teaches, he teaches, 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?


Peter Kurti  40:26

Yes I think he is, 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 give in 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, and 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 not, not, 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, Monetary Policy Board that’s it, 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, a 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 inflationary target. It 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 cite it 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 it’s 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 ICAC 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 but 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. Where 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 is Peter Tulip, Chief Economist at Centre for Independent Studies, and Peter’s 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, it’s possibly worth doing the experiment. But one of the things I would point out too 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 Peter for so he’s read this. And he knows what I’m, what I’m saying.


Gene Tunny  48:00

Very good. 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 Alesina 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 too.


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 tre.., the chancellor, the Treasurer, Gordon Brown, declared the independence of the Bank of England, that had needed to happen long ago. And I mean, Australia had 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 it’s 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 that I 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 Schudson talks about, we need to work out the length of the leash on which we keep experts, it can’t be too short, otherwise they won’t be able to do their job, but it 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 too 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 a return to government control.


Gene Tunny  51:20

Oh, no, no, no, not at all. I read that section, I thought 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 what was it, thinking about, was it accountability?

Peter Kurti  52:37

Institutional integrity I’ve called it.

Gene Tunny  52:40

Institutional integrity. Very good. That’s great. Peter Kurti thanks so much for your time. I’ve 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 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.


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.

Categories
Podcast episode

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

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 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.


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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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Podcast episode

The Greedflation hypothesis – EP186

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

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

What’s covered in EP186

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

Links relevant to the conversation

Greedflation articles:

Blaming inflation on greedy business is a populist cop out

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

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

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

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

price hikes 

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

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

Inflation is being amplified by firms with market power  

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

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

UK windfall profits tax:

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

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

RBA on sources of inflation in Australia:

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

Charts:

Australian bank deposits

Australian money supply (M3)

Transcript:
The Greedflation hypothesis – EP186

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

Gene Tunny  00:00

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

Arturo Espinoza Bocangel  01:12

I’m very happy to be here.

Gene Tunny  01:14

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

Arturo Espinoza Bocangel  02:05

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

Gene Tunny  02:11

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

Arturo Espinoza Bocangel  08:26

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

Gene Tunny  09:04

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

Arturo Espinoza Bocangel  10:25

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

Gene Tunny  10:36

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

Arturo Espinoza Bocangel  10:42

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

Gene Tunny  11:05

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

Arturo Espinoza Bocangel  16:15

Exactly if the concentration, right,

Gene Tunny  16:19

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

Arturo Espinoza Bocangel  17:20

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

Gene Tunny  17:35

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

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Gene Tunny  21:03

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

Arturo Espinoza Bocangel  21:55

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

Gene Tunny  22:00

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

Arturo Espinoza Bocangel  28:09

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

Gene Tunny  29:03

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

Arturo Espinoza Bocangel  34:37

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

Gene Tunny  34:43

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

35:30

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Credits

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.

Categories
Podcast episode

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

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

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

You can listen to the episode via the embedded player below or via podcasting apps including Google 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

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

Gene Tunny  00:06

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

Darren Brady Nelson  01:46

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

Gene Tunny  01:48

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

Darren Brady Nelson  02:21

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

Gene Tunny  04:29

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

Darren Brady Nelson  04:45

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

Gene Tunny  07:19

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

Darren Brady Nelson  08:24

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

Gene Tunny  10:00

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

Darren Brady Nelson  10:05

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

Gene Tunny  12:20

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

Darren Brady Nelson  12:25

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

Gene Tunny  13:38

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

Darren Brady Nelson  14:15

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

Gene Tunny  16:45

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

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Gene Tunny  17:20

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

Darren Brady Nelson  18:18

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

Gene Tunny  21:08

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

Darren Brady Nelson  21:18

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

Gene Tunny  24:55

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

Darren Brady Nelson  25:44

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

Gene Tunny  26:26

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

Darren Brady Nelson  27:16

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

Gene Tunny  28:54

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

Darren Brady Nelson  29:27

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

Gene Tunny  30:42

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

Darren Brady Nelson  31:15

Thank you for having me.

Gene Tunny  31:26

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

41:26

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Credits

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Categories
Podcast episode

Normalization of interest rates & monetary policy – EP173

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

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

You can listen to the episode via the embedded player below or via podcasting apps including Google 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

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

Gene Tunny  00:00

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

Arturo Espinoza Bocangel  02:58

Hi Gene, it’s my pleasure to be here.

Gene Tunny  03:01

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

Arturo Espinoza Bocangel  05:51

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

Gene Tunny  05:59

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

Arturo Espinoza Bocangel  10:28

Between two and 3%. Yeah,

Gene Tunny  10:31

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

Arturo Espinoza Bocangel  17:01

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

Gene Tunny  17:21

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

Arturo Espinoza Bocangel  18:43

and depending on what loan.

Gene Tunny  18:46

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

Arturo Espinoza Bocangel  21:42

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

Gene Tunny  22:07

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

Female speaker  23:31

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  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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