An idiotic idea so bizarrely stupid it defies sense

From this morning’s Oz a story I have just gotten round to now:

The Reserve Bank governor is calling for 3 per cent wages growth across the public sector, apparently to help the rest of us. Ratcheting up public sector pay would damage the economy far more than help it, undermini­ng economic growth, productivity, increasing inequality and further eroding respect for government.

Adam Creighton calls it “a bad idea”, but that is only because he is polite. It is actually an idiotic idea that is so bizarrely stupid that it demands that he explain how it could possibly provide any positive assistance to the economy whatsoever.

How does someone with so little understanding of how an economy works get to make such decisions? But you have to get to the last line of the story to find out why he wants the least productive people in the economy to absorb even more of our productive capabilities:

The Reserve Bank wants higher­ wage growth to boost inflation, which has hovered below its 2-3 per cent target for almost five years. Meeting an arbitrary inflation target is hardly justification to damage the economy and increase inequality further.

He wants the most securely employed people in the country, with the lowest contribution to output, to receive large increases in wages so that the inflation rate can rise even further. It really is infuriating.

So you will know when they lower rates that it was a serious economic mistake

From America, a conclusion which applies here with even more force than there since rates in the US have been rising: Trump’s Keynesian Monetary Policy.

The New York Times reported today on Trump’s advocacy of easy-money Keynesianism.

President Trump on Friday called on the Federal Reserve to cut interest rates and take additional steps to stimulate economic growth… On Friday, he escalated his previous critiques of the Fed by pressing for it to resume the type of stimulus campaign it undertook after the recession to jump-start economic growth. That program, known as quantitative easing, resulted in the Fed buying more than $4 trillion worth of Treasury bonds and mortgage-backed securities as a way to increase the supply of money in the financial system.

criticized these policies under Obama, over and over and over again….

Regardless of whether a politician is a Republican or a Democrat, I don’t like Keynesian fiscal policy and I don’t like Keynesian monetary policy.

Simply stated, the Keynesians are all about artificially boosting consumption, but sustainable growth is only possible with policies that boost production.

Why raising rates is good for production is to modern ears a complete conundrum. Think of this from The ABC:

The RBA concedes it is puzzled by the “tension” between strong jobs growth and a weak economy.

If the jobs data is right, then everything is OK and unemployment will fall, wages will rise and it will be high-fives back in the RBA’s Martin Place redoubt.

If GDP data is right and things are slowing — remember GDP grew at an annualised pace of just 1 per cent in the second half of last year — then a cut is order.

Absolutely incomprehensible to a modern economist is the absence of any relationship between the rate of growth and unemployment. Just as incomprehensible is the possibility that lowering interest rates from the low rates they are presently at might actually do harm and do no good whatsoever at all.

The natural rate of economic ignorance

Having taught modern policy just this week, about inflation targeting and the natural rate of interest, and again while doing it wondering whether such gross stupidity can still persist when it has caused nothing but grief, it was nice to see this in The Australian today, by David Uren, that all is still wrong with the world and economics remains stuck in the same rut it’s been in for thirty years. This is from his article, Stubbornly low inflation tests even RBA’s patience:

When Philip Lowe took up the governorship of the Reserve Bank of Australia a year ago, financial markets were betting he would be cutting rates within six months. Today they are betting he’ll be raising them by May next year.

After Tuesday’s RBA board meeting, Lowe said there would be no change in rates, as he has after every meeting since his first as governor in October last year. . . .

It is as if the economy were stuck in first gear, and the Reserve Bank keeping its foot to the floor is neither making it go any faster nor lifting inflation. Central banking the world over is in ferment as top officials wrestle with the risks created by a decade of ultra-low rates and with their failure to generate the modest inflation required by their formal targets.

The inflation targeting framework that has governed the world of central banking for the past two decades, and that seemed to work so well at taming runaway inflation, is now struggling to deal with price rises chronically undershooting the mandated goals.

The Reserve Bank has been pursuing a target of keeping inflation between 2 per cent and 3 per cent since the early 1990s. The underlying rate of inflation (which strips out volatile movements such as petrol price jumps) has been below 2 per cent since the beginning of last year and the RBA’s projections suggest it doesn’t ­expect a ­return to the desired 2.5 per cent until the middle of the next decade. The same is true the world over, and it is leading central bankers to question whether their explanation of the economy and their impact on it is correct.

In a speech last week, US Federal ­Reserve chairwoman Janet Yellen pondered whether there was a “risk that our framework for understanding inflation dynamics could be misspecified in some fundamental way”. A week earlier, Bank of England governor Mark Carney had claimed globalisation was responsible for weak inflation but said he was not ready to ditch his bank’s inflation target.

The Bank for International Settlements, which is a kind of central bank to the world’s central banks, warns that the inflation targeting framework is fostering a dangerous build-up of risk. Head of its monetary and economic ­department Claudio Borio says central banks must “feel like they have stepped through a mirror”. Having spent their lives struggling to bring inflation down, they now toil to push it up. Where once they feared wage increases, now they urge them on.

Borio challenges the intellectual underpinnings of central banking. For the past century it has been assumed that there is a “natural” (or “neutral”) rate of ­interest that balances the needs of savers and investors. If a central bank sets its policy interest rate below this natural rate, it will ­encourage people to run down their savings and lift spending, pushing inflation higher. If the policy rate is higher than the natural rate, people will save more of their income to take advantage of the higher rates, spending less, and inflation will fall.

The theory runs that while central banks set the short-term rate of interest, long-term bond rates trend ­towards the “natural rate”. But this natural rate of interest is an economists’ hypothesis — it can’t be seen or measured, except by economists’ models. Borio calls it an “abstract, unobservable, model-dependent concept”.

Low interest rates are one of economic theory’s worst ideas ever, a notion once universally understood by all and now understood by none. Economic theory will have to relearn the lessons of the nineteenth century. It is quite quite astonishing to see these errors compound and the undoing of this mess won’t be pleasant. So to the article’s end:

The RBA slashed its cash rate from 4.75 per cent to 1.5 per cent between late 2011 and late last year, triggering a house price boom that pushed up household debts by an average of almost 7 per cent a year.

This week the International Monetary Fund said household debts much above 60 per cent of GDP were a threat to growth and financial stability. The RBA’s measure of the household balance sheet shows debts have soared from 120 per cent of GDP to 137 per cent since 2011, putting them among the highest in the world.

Lowe worries that a small shock could turn into a much lar­ger downturn as households seek to repair their balance sheets. The danger is that debts are already so high that any rise in rates would crunch household spending, while rates are still low enough to make further borrowing attractive. With no path forward, the Reserve Bank is stuck where it is.

As for the theory that explains it all, you could go to Keynes, not The General Theory where he abandoned it all, but to his very orthodox 1930 Treatise on Money where he discussed the natural rate of interest in just the way it had been discussed since the end of the nineteenth century. Or you could go to the last two chapters of my Free Market Economics, whether editions one, two or three, since it is the same message in each.

“Cheap money is not the sustainable path to prosperity”

How fortunate this country is to have Glenn Stevens running the RBA. From todays Australian:

THE government should focus on productivity-boosting reforms rather than rushing to bring the budget to surplus, Reserve Bank governor Glenn Stevens said yesterday.

At the second of his twice-yearly appearances before the House of Representatives economics committee, Mr Stevens suggested further interest rate cuts were unlikely to help lift economic growth.

Mr Stevens said monetary policy was stimulating activity outside the mining industry but weak confidence, the lacklustre pace of reform and a high currency were retarding the growth rate.

‘There are few serious claims that the cost of borrowing per se is holding back growth … monetary policy can’t force spending to occur,” he said in Canberra.

‘Cheap money is not the sustainable path to prosperity.’

Not only is it not the path to prosperity, it is the road to ruin. But like so much else with economic policy, unless one understands how and why these policies work, others won’t be able to repeat them. Just the same with Peter Costello and his near-immaculate management of the Australian economy, 1996-2007, years that coincide with sustained prosperity, rising real incomes and an almost continuous fall in unemployment.

And funny enough, this self same Peter Costello was in the news today as he is about to take on the Chairmanship of the Future Fund, at the moment on a temporary basis. Of course, a great appointment, but this in particular caught my eye:

But Mr Costello . . . said the fund should only pursue investments that deliver a return, playing down suggestions it could be used for nation-building projects.

“Nation-building” projects apparently mean “loss-making” projects, and that’s by definition! You know, the kinds of things Labor specialises in. That is, projects that lose money, make us poorer but give themselves a warm inner glow as they spend our money even faster than we can earn it.

It’s a great pleasure to see a return to sanity, and if it really turns out that both the Paid Parental Scheme and renewable energy targets are to be wound back, things might really start to look up.