Central bank priorities are not the priorities of working people – Bill Mitchell – Modern Monetary Theory

I remember a conversation I had when I was picked up hitch hiking to Melbourne from where I was living down the coast. It was during the 1970s inflationary period, which had morphed into stagflation as a result of deliberate government policy to create unemployment and discipline the wage-price spiral. The driver was a manual worker and during a conversation about the state of the economy (I was studying economics at the time) he said “the government should care about employment because at least then everyone has a job even if prices are rising”. That conversation stuck with me because it summed up what research shows in more sophisticated ways – the costs of inflation are minimal when compared to the devastating costs of unemployment. At present, our policy makers are unwilling to recognise that reality because it is not them that bear the costs.

Two events in the last week indicate that our policy makers have learned nothing in the 50 years since the last inflationary burst.

World Bank restates economic orthodoxy – no progress has been made

First, the World Bank released a paper late last week (September 15, 2022) – Is a Global Recession Imminent?.

The discussion indicates that there is now a “heightened … likelihood of a global recession in the near future”.

Why?

Because:

… many countries are withdrawing monetary and fiscal support. As a result, the global economy is in the midst of one of the most internationally synchronous episodes of monetary and fiscal policy tightening of the past five decades.

Then the orthodoxy sets in:

These policy actions are necessary to contain inflationary pressures, but their mutually compounding effects could produce larger impacts than intended, both in tightening financial conditions and in steepening the growth slowdown.

The World Bank thinks that:

1. “On the demand side, monetary policy must be employed consistently to restore, in a timely manner, price stability” – which means they believe the current inflationary surge (which is abating) is a over-spending problem (demand-side) rather thana supply-side problem.

So, according to that logic, central banks have to push up interest rates and squeeze borrowers, who then cut back spending as some go broke, which then creates unemployment and second-round, spending cuts as incomes vanish.

The logic doesn’t consider the alternative logic that the interest rate hikes drive up business costs and corporations with market power then pass the costs rises on and drive the inflationary surge.

In that latter scenario, and recognising that at present real wages are being cut quite dramatically in some nations (meaning wages are not pushing prices up), then we are not talking about some generalised wage-price spiral (as in the 1970s) but, rather, a massive real income grab by capital.

2. “Fiscal policy needs to prioritize medium-term debt sustainability while providing targeted support to vulnerable groups” – noting the emphasis on “prioritize”.

When we talk about public debt there is no analogue to what we might consider to be ‘sustainable’ in a private debt setting.

A sovereign government that issues its own currency can always meet its liability commitments and its central bank can always keep yields low.

Further, such a government doesn’t even need to issue debt instruments to match its net spending.

That is just a convention.

When an economist says that government must devote its main macroeconomic policy instrument to reducing its debt exposure they never ask the prior question – why is the debt being issued in the first place.

We know why it was issued under the Bretton Woods system – because otherwise the central bank’s responsibility to manage currency liquidity to support the agreed exchange rate parities.

But under the current system of flexible exchange rates (since 1971 in most nations), not such necessity exists.

And we know that the function of debt issuance is really to provide an elaborate form of corporate welfare (to provide a risk free asset they can park their speculative funds to reduce uncertainty).

The financial market lobby successfully pressured governments into maintaining debt issuance and then mounted a massive propaganda exercise to convince the rest of us that it was necessary because the government was like a big household and would run out of money otherwise.

We believed the propaganda and so it goes.

And in doing so, conservatives have a powerful political weapon to scare the public with so that governments have to ‘constrain’ their spending – at least when it relates to helping to reduce poverty and providing public services.

Very little constraint is exercised when it comes to supporting the military-industrial complex or bailing out private corporations in times of crises.

3. “On the supply-side, they need to put in place measures to ease the constraints that confront labor markets, energy markets, and trade networks” – which means the World Bank wants more deregulation and more freedom for corporations to do what they want to prioritise profits over general well-being.

It was this logic that has led to the rise of the gig economy, the loss of job quality and security, the flat wages growth, the massive spike in energy prices and falling service standards and all the rest of it.

It is the logic that has led us into this poly crisis and in no way represents part of the solution.

We should be looking into ways to take back control of the essential services like energy, telecommunications, water supply, transport etc to ensure they serve public interest rather than private profit.

The current supply problems are not due to excessive regulation but are most due to the fact that Covid has devastated workers in key part of the supply chain.

Embarking on policy that cuts employment and squeezes incomes of workers will just make that situation worse.

Australian RBA governor continues to lose the plot

Last Friday (September 16, 2022), the RBA governor and some of his senior staff made their annual appearance before the Federal House of Representatives Standing Committe on Economics to present the central bank’s annual report for 2021.

As background, and I have written about this before, the RBA has been under fire from critics (including myself) for the way they have conducted policy over the last few years.

That criticism though is not uniform.

Most of the critics have been demanding rate hikes well before the Bank started the current hiking period.

I stand, of course, on the other side of that debate – highly critical of the interest rate rises in the face of mainly supply-side price pressures.

The governor Philip Lowe made a point last year of saying that interest rates would probably not rise until 2024 and only when wage pressures were obvious.

We have now had a series of interest rate rises despite the fact that the main wage data continues to show record low wages growth and massive real wage cuts.

The problem for the Bank is that many people, including low income earners, borrowed huge amounts of money to get into the housing market, on the promise from the Bank that rates would not rise any time soon.

So the accusation is that the Bank basically sucked in these borrowers to take out loans, many of which were on the brink of insolvency even at low rates, and those borrowers are now squeezed and many will lose their homes.

The Bank has also been criticised by mainstream economists for introducing their quantitative easing program, which purchased most of the debt issued as part of the fiscal support the Australian government introduced during the pandemic.

The claim is that the expansion was unwarranted and the pandemic was not as bad as first thought.

I disagree with those claims.

These issues framed the appearance of the Governor before the politicians at the House of Representatives Committe.

You can read the full transcript of the event in the – Official Hansard.

In the Governor’s opening statement he acknowledged that:

We are the banker to the Commonwealth government. We operate the official public account and are the government’s main transactional banker, providing banking services to the ATO, Services Australia and many government departments … We are also responsible for the core of Australia’s payment system, which allows money to move from one bank account to another.

We also print the nation’s banknotes.

So really an acknowledgement that the central bank is an instrinsic part of the federal government institutional structure.

But back to the point.

There was pushback from the Committee about the lure the RBA gave borrowers in 2020 and 2021 to borrow heavily on the assumption that rates would not rise until 2024.

The RBA has effectively admitted it made a mistake in making those predictions but appealed to the uncertainty of the situation at the time.

I won’t dwell on that issue.

But then the questions moved onto the monetary/fiscal policy coordination issue.

The Governor had earlier stated that the RBA was less concerned about the impact of the rising interest rates on household spending:

Partly it’s because the saving rate is still high, so people have the ability to smooth through the weaker growth in real income …

This is a familiar story.

Whether you think the saving rate is high or not depends on the perspective taken.

Here is the latest graph from the June-quarter National Accounts which I discussed in this blog post – Australian national accounts – wage share at record low while corporate profits boom – this is not right! (September 7, 2022).

It shows the household saving ratio (% of disposable income) from the June-quarter 1960 to the current period. See also the accompanying table.

We should acknowledge that Australian households currently hold record levels of debt – currently at 187.2 per cent of disposable income and rising.

Back in the full employment days, when governments supported the economy and jobs with continuous fiscal deficits (mostly), households saved significant proportions of their income.

In the neoliberal period, as credit has been rammed down their throats, the saving rate dropped (to negative levels in the lead-up to the GFC).

Hopefully, households are paying off the record levels of debt they are now carrying and improving their financial viability.

The following table shows the impact of the neoliberal era on household saving. These patterns are replicated around the world and expose our economies to the threat of financial crises much more than in pre-neoliberal decades.

The result for the current decade (2020-) is the average from March 2020.

So I would not conclude that the household saving ratio is high.

In historical terms it is about average if we discount the credit binge period that basically led to the GFC.

Moreover, the idea that you squeeze households with higher interest rates and tighter fiscal policy and then hope they keep spending by running down their wealth is not only confused logic but also somewhat venal in intent.

It is confused because the justification for higher interest rates and fiscal austerity is to reduce demand relative to supply to bring down inflation.

But then they claim that households can keep spending by running down their savings.

It is also venal because they know that the higher interest rates fuel the profits of the banks and the wealth of the shareholders who spend less than the lower income workers, who are squeezed by the rate rises.

The RBA governor then made an extraordinary attack on the fiscal position of the government, proving that there is no independence and impartiality of the central bank.

He said:

My main observation on fiscal policy is really a medium-term one. There is significant issue there. At the moment, we’re the closest to full employment we’ve been in 50 years and we’ve got the highest terms of trade ever in Australian history, yet we’ve still got a budget deficit and are projected to have a budget deficit. That’s a significant issue …

Taxes, cutting back and structural reform—we have to do one of those three things, maybe all three of them, if we’re going to pay for the goods and services that the community wants from our governments.

The orthodoxy.

First, the unemployment rate is low for two reasons:

(a) the working age population growth stalled when the external borders were closed during the pandemic.

Migration numbers haven’t yet recovered and when they do the unemployment rate will rise from its current relative low levels.

My current estimate is that the true underlying rate is close to 6 per cent and with the business lobby pushing like mad and the government agreeing – migration numbers will soar in the next year or so.

(b) the fiscal support given to the economy was important and without it the unemployment rate would have soared well behind what actually happened.

So you have to ask yourself – if the current fiscal position supporting the current unemployment rate or is it superfluous?

My answer is obvious – if there is fiscal cuts then the unemployment rate will rise quickly.

Second, that means that the fiscal deficit is serving a functional purpose that advances well-being and trying to impose some ‘natural’ state of fiscal surplus will undermine that purpose.

Given the fact that the external position is unlikely to yield ever larger surpluses, the only way that we could continue to maintain GDP growth at the current levels and support the current unemployment rate with a smaller fiscal deficit would be if the private domestic sector increasingly goes into debt.

Which is the RBA governor’s ‘saving ratio’ argument.

He prefers a world where we rely on households and firms supporting growth through increasing debt and households running down their financial wealth while the public sector cuts services, investment in public infrastructure, hikes taxes and undermines job security tec.

That world has been tried over and over the last several decades and always leads to crisis.

It is unsustainable.

The following graph shows the sectoral balances for Australia from fiscal year 2000-01 to the end of the current forward estimates (2025-26). The black vertical line is when the forecast period in the current fiscal statement begin.

The hard lines are actual and projected.

You can see that given the current terms of trade boom in primary commodities, Australia moved from persistent current account deficit to a small surpluse in 2019-20 and is expected to continue in that state for a while yet (we will assume it lasts until 2025-26).

Should the terms of trade weaken as they will then the situation gets worse than I outline here.

You can see that the external sector situation and the strong fiscal support during the pandemic allowed the private domestic sector (households and firms) to increase its net financial surplus and as a sector stop the accumulation of debt for a time.

However, the fiscal cutbacks as the pandemic eased saw the net financial surplus in the private domestic sector fall.

The dotted lines are what would have happened had the government followed the ideas of the RBA governor and returned to surplus.

The private domestic surplus would vanish and the sector overall would start increasing its debt accumulation again.

But it is unlikely that scenario would play out like that.

What is more likely, and it relates to my point (b) above, is that the fiscal tightening towards a surplus would outpace the capacity of the private domestic sector to continue spending as their savings fell and interest rates rose and the economy would move into recession.

At that point, the fiscal position would remain in deficit as employment fell and tax receipts fell and welfare payments were forced to increased due to the increased number of unemployed.

So we would be left up with diminished private domestic wealth holdings, a ‘bad’ fiscal deficit (associated with higher unemployment rather than relatively low unemployment as is now), and then the terms of trade normalise – and then things get even more unattractive.

Conclusion

The Governor went on further about the ‘national credit card and about how if the government used fiscal policy to help people deal with the cost-of-living pressures that the RBA, itself, was making worse, then the RBA would probably have to hike rates even higher than they plan too.

His statement:

How far the government goes in that direction I don’t know, but I’m not concerned that there’s going to be some change in fiscal policy in the near term that’s going to make our job more difficult.

So think about that conversation I had a long time ago with the kind driver who picked me up hitchhiking when I was a student.

He had his priorities right – the priorities of working people.

Mr Lowe and his gang at the RBA have imposed a rogue set of priorities on the well-being of these people. The challenge is how to wrest power back of this gang.

That is enough for today!

(c) Copyright 2022 William Mitchell. All Rights Reserved.