When you are on a good thing, stick to it

I was pleasantly surprised this week when I received a telephone call from a reader wanting to chat about the current state of policy in Australia and the available options. We discussed a range of options and agreed that it didn’t make much sense to cruel the emerging economic growth in Australia while there were 12.1 per cent of available labour resources currently idle (either unemployed or underemployed). With world demand for our exports strong it seemed a perfect opportunity to really eliminate the pool of idle labour and return to full employment – a state that Australia has not been close to since the mid-1970s. The period since that time has been dominated by neo-liberal policy makers who have abandoned the responsibility that was previously vested in our macroeconomic policy arms (RBA and Treasury) to achieve and maintain full employment. We agreed that deliberately restricting growth just as it was gathering pace was a very restricted vision of national potential. The upshot of our discussion was that we agreed that fiscal policy could be targeted to redistribute the growth (to avoid specific sectors from overheating yet maintaining a growth stimulus to other sectors) and that monetary policy was too blunt an instrument to manage this process. But with growth emerging it is a case that policy makers should recite a daily mantra – when you are on a good thing, stick to it – rather than cutting it off at its knees before the benefits have spread widely throughout our nation and its people.

The call came from one Neale Muston. Regular readers might recall that on July 13, 2009 I wrote this blog – D for debt bomb; D for drivel … – which was in response to an article written in the Fairfax media by Neale Muston.

In that article he used alarmist language to argue that the modest growth in debt issued by the Australian government was dangerous. The debt-issuance was part of the Government’s fiscal intervention to combat the growing concern at the time (late 2008 and early 2009) that the financial crisis was morphing into a full-scale real crisis akin to the Great Depression.

The Government’s fears were genuine and well-based and the early intervention has definitely helped the Australian economy withstand the ravages of the crisis that we are still observing in other countries.

Muston had argued that the debt burden would become intolerable and that financial markets would eventually rebel and stop “financing” the government. Further he was concerned that inflation would result from the expansion.

Some 16 months later the world is different and so is Neale Muston’s outlook.

I won’t disclose the contents of our conversation except to say that it was very productive and amicable. In general, we discussed how financial market participants (especially bank economists) become captive to the language and ideology of that milieu and lose insight into what the real world looks like.

So you see every time that the Australian Bureau of Statistics reports some positive news about economic growth, the pavlovian responses of the bank economists are triggered and they call for higher interest rates.

Why? They are totally conditioned by the mainstream economics textbooks and supporting rhetoric that growth equals inflation and monetary policy has to control inflation and that the current inflation targets (2-3 per cent) are appropriate.

They completely overlook the incredible waste that is embodied in a policy framework (inflation-targetting with passive fiscal policy introducing fiscal drag into the expenditure system) which uses labour underutilisation (unemployment and underemployment) as a policy tool to reduce inflation pressures. They never think for one moment (in their public pronouncements) that an employment buffer stock system (that is, a Job Guarantee) might offer better outcomes to a government seeking to achieve price stability.

This group of (influential) commentators accept without question the neo-liberal NAIRU ideology which uses buffer stocks of unemployment (and more recently underemployment) to control inflation irrespective of the waste involved. That waste includes loss of national income in addition to the personal costs that the unemployed (and underemployed) bear in the form of poverty, increased chance of family breakdown, increased likelihood of physical and mental disease, increased alcohol and substance abuse, increased chance of becoming embroiled with the criminal justice system. The social alienation that accompanies unemployment is very damaging.

But the bank economists just react to any economic news that says were are growing – and like mindless parrots they repeat the mantra – rates have to go up because inflation will accelerate.

First, inflation does not have to accelerate when unemployment falls. This is unlikely to occur when you also have high levels of underemployment. We are just about to finalise a paper that shows how traditionally, unemployment has served to discipline wage demands – so slack external to the firm has kept a lid on inflation. But over the last 20 years, “within-firm” slack (underemployment) is increasingly a source of deflationary pressures.

Second, who says that an inflation rate of 2-3 per cent is ideal anyway?

It is only when you escape that “bank economist club” that you start to see that the real world does not operate remotely like the mainstream economics textbooks depict it. Once you become free of the “prison” – broader values and insights become more likely. My conversation with Neale Muston who was previously a bank economist covered these sorts of points.

In the Sydney Morning Herald today (December 10, 2010) Neale Muston wrote an article – Time for Reserve Bank to get off the rate cycle – which examines the current policy framework.

Muston notes that:

There was a time when Reserve Bank monetary policy was determined by a familiar process of statistical analysis, private sector consultation and some old-fashioned crystal ball gazing by the board in order to best fulfil its charter. That is, to ensure currency stability, maintain full employment and promote economic prosperity and welfare for Australians.

The reference to the RBA charter is important and its import has been lost in the recent decades. The Reserve Bank of Australia (RBA) was constituted to pursue full employment and one of its three goals. The functions of the RBA Board are set out in Section 10 of the Reserve Bank Act 1959. Subsection 2 says:

(2) It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia and … will best contribute to:

(a) the stability of the currency of Australia;
(b) the maintenance of full employment in Australia; and
(c) the economic prosperity and welfare of the people of Australia.

The Post-World War II period was marked by governments maintaining levels of demand sufficient to ensure enough jobs were created to meet the demands of the labour force, given labour productivity growth. Governments used a range of fiscal and monetary measures to stabilise the economy in the face of fluctuations in private sector spending.

Unemployment rates were usually below 2 per cent throughout this period and underemployment was non-existent.

The RBA participated in this process as one of the two policy arms of government and worked to balance its broad aims.

In the neo-liberal era, the RBA has become captive of the NAIRU concept and its obsession with natural rates of unemployment. The RBA now conducts monetary policy in Australia to meet an openly published inflation target. It uses its control of the cash rate (market rate on overnight funds) to influence short-term interest rates.

But, significantly, the RBA uses unemployment as a policy tool (to fight inflation) rather than as a policy target. It has joined with the Treasury in abandoning any pretensions to “full employment”. To avoid breaching its “legal charter” it has simply redefined what it means by full employment – now defined in terms of the NAIRU.

I have argued for years that in taking this step, the RBA has ceased to work within its legal charter – it now operates in a way that effectively undermines the capacity of the economy to achieve and maintain full employment.

During the 1990s, when the RBA held interest rates at ridiculously high levels (claiming to be fighting inflation first) I encouraged a group of unemployed citizens to start a class action against the RBA to force their economists to give evidence in a court of law about how they had redefined full employment to become the vacuous and ideologically-charged concept of the NAIRU. The action never eventuated which I think was a shame.

Unlike the usual questions the RBA officials face from a compliant (neo-liberal captured) press about their conduct I could have fed the legal counsel with questions that would have embarassed the RBA and exposed their conduct as being in breach of its legal charter. An opportunity lost!

We can see the way the RBA became captured by the neo-liberals in various statements made in the 1990s and beyond. For example, in September 1996, the Treasurer and Reserve Bank Governor issued the Statement on the Conduct of Monetary Policy, which set out how the RBA was approaching the attainment of its three identified policy goals.

It elaborated the adoption of inflation targeting as the primary policy target. In terms of the priorities, the Statement said (RBA, 1996: 2):

These objectives allow the Reserve Bank to focus on price (currency) stability while taking account of the implications of monetary policy for activity and, therefore, employment in the short term. Price stability is a crucial precondition for sustained growth in economic activity and employment.

The rest of the text emphasised the need to target inflation and inflationary expectations and the complementary role that “disciplined fiscal policy” had to play. There was no discussion about the links between full employment and price stability except that price stability in some way generated full employment even though the former required disciplined monetary and fiscal policy to achieve it.

How does the RBA answer this apparent contradiction? The RBA says that it only has to meet an average inflation target over a business cycle. A senior RBA official said in 1999 that the Bank is sensitive to the state of capacity in the economy when it pursues a change of interest rates aiming at the inflation target:

Consider, for example, a situation in which inflation is regarded as likely to be too high. A rise in interest rates will help to reduce inflation but can also be expected to reduce growth. How far and how quickly interest rates should be raised will depend partly on how the economy is performing at the time. If the economy is operating with very little surplus capacity or is overheating, a fairly rapid rise in interest rates might be called for; if, on the other hand, there is significant surplus capacity in the economy, the appropriate increase in rates might be more gradual. Thus it makes sense for policy to take account of short-run cyclical developments in pursuing the inflation target.

But in the next paragraph, he said that the trade-off between inflation and unemployment is not a long-run concern because, following NAIRU logic, it simply doesn’t exist.

Ultimately the growth performance of the economy is determined by the economy’s innate productive capacity, and it cannot be permanently stimulated by an expansionary monetary policy stance. Any attempt to do so simply results in rising inflation. The Bank’s policy target recognises this point. It allows policy to take a role in stabilising the business cycle but, beyond the length of a cycle, the aim is to limit inflation to the target of 2-3 per cent. In this way, policy can provide a favourable climate for growth in productive capacity, but it does not seek to engineer growth in the longer run by artificially stimulating demand.

The RBA is silent, however, about the stock of long-term unemployed that exists beyond the cycle. The empirical evidence is clear that the economy has not provided enough jobs since the mid-1970s and the conduct of monetary policy has contributed to the malaise. The RBA has forced the unemployed to engage in an involuntary fight against inflation and the fiscal authorities have further worsened the situation with complementary austerity.

This is the theme that Muston is addressing in his Sydney Morning Herald article. He notes that the RBA responded sensibly to the crisis by cutting rates although I might disagree with his assessment that the RBA was correct in holding rates above 3 per cent.

Muston then says “(s)ince those dark days, Australia has emerged with enviable prosperity” and now the RBA has:

… acted to remove monetary stimulus and has taken the official rate back to 4.75 per cent, which, considering where retail rates have settled, is more or less neutral by traditional standards.

We could also debate what a “neutral” monetary policy stance is. Please read my blog – The natural rate of interest is zero! – for more discussion on this point.

But Muston is correct in assessing that:

… we are not in traditional times, and the global economy continues to be adversely aligned towards sustained recovery. Apart from China, which is actively attempting to slow its economy, elsewhere exhibits desperation.

The economic news from around the world is very bleak and with governments actively buying into the neo-liberal (IMF) rhetoric that cutting spending increases spending (the erroneous fiscal austerity story) then it is likely to get worse.

Even in Australia – the so-called miracle economy – the news is far from clear – some good (like yesterday’s Labour Force estimates), some mediocre and some bad (like the fall in construction activity).

Muston says:

The Australian retail sector has performed poorly during this period, mired in perpetual discounting. Housing affordability is near all-time lows as higher borrowing rates and stable house prices create a tremendous barrier to entry. Business and retail borrowers have borne the brunt of banks seeking to beef up margins to pre-crisis levels. Underlying inflation has moved back to the midpoint of the Reserve Bank’s desired 2-3 per cent band, and GDP has most recently floundered, with a surprising negative contribution from net exports.

So these trends would not indicate that both arms of macroeconomic policy – monetary and fiscal – should be simultaneously contracting. But that is what our policy makers are now doing. They are rushing head long into choking the recovery into a state of low growth submission. This is all being driven by some fear that inflation will accelerate some time in the future even though it is moderating at present.

The policy environment is becoming locked into the mindset that growth has to be contained even before it has taken grip and started to perform its most important function – which is to eat into the pool of high labour underutilisation and allow the most disadvantaged workers to enjoy access to income growth and some degree of personal risk management (via savings and income security).

Muston was kind enough to recognise my input into the national debate over a long period of time. He writes that:

Bill Mitchell is a professor of economics at the University of Newcastle, where he heads the Centre of Full Employment and Equity. He has dedicated over 20 years of his career to promoting a better understanding within government and business of the workforce and how it can be best utilised for all concerned.

Mitchell says that on closer inspection of Australian Bureau of Statistics labour force data, 7.2 per cent of Australians were underemployed (as of August). These are full or part-time workers who have the desire or capacity to work longer hours.

In all, about 12.4 per cent are underutilised (unemployed or underemployed), and this represents a wasted national resource.

Ironically, journalists and bank economists regularly cite tight labour conditions as a key need for the Reserve Bank to raise rates; but Mitchell notes that the underemployed on average are available for about 15 hours a week. Available data therefore indicate that Australians would work more if given the chance.

This point pertains to the depiction by the Government (RBA, Treasury and the politicians) and the bank economists and other related media commentators that the Australian economy is close to full capacity.

It almost begs belief that you would characterise an economy as being at or near full capacity when you have 12.1 per cent (as at November quarter estimates released yesterday) of your available labour idle. We are observing participation rates rising which also means we are tapping the hidden unemployed.

The other point to note in this context is that the “full capacity” claims are all predicated on the notion that only the private market determines what labour allocations emerge. I don’t concede that the 12.1 per cent pool of wasted labour cannot be absorbed into productive employment in the “private sector”. That is a myth and whenever private demand for labour rises unemployment and underemployment falls.

We didn’t go close to “testing” the capacity of the labour market to absorb further labour demand growth in the pre-crisis period. The mainstream economists all claimed that in the pre-crisis period we reached full employment – unemployment was at 4 per cent and underemployment about 4.5 per cent. There was no science to that conclusion. We didn’t see how low unemployment and underemployment could go. We had plenty of capacity to absorb more real growth in that period.

The slight rise in inflation in the immediate pre-crisis era had nothing to do with a “tightening” labour market. It was largely the result of higher energy prices and a long drought that pushed up food prices. That is, the inflation pressures were driven by supply-side causes. The last thing you want to do is invoke demand deflation policies to address a supply-side originating cost squeeze. That policy approach just results in stagflation.

But even if the private markets were saturated with nominal demand growth and could not utilise the available labour to expand real production (so the so-called structural unemployment myth), there is a huge pent-up demand in communities across regional Australia for increased provision of personal care services; environmental care services, and other community development services which the private markets will never satisfy.

Appropriately designed and locally offered jobs could go some way to satisfying this pent-up demand while also providing jobs to hundreds of thousands of Australian workers currently idle. This would require the Government to recognise its responsibility to sustain full employment rather than being in denial of that responsibility, which is its current position. In addition, communities would enjoy the value-adding outputs that these jobs would generate. It is called Win-Win!

For more specific information on these opportunities you might like to read our 2008 Report – Creating effective local labour markets: a new framework for regional employment policy – which was the result of a four-year study that involved a national survey of local governments in Australia to assess the potential for public sector job creation.

So either through expanded private activity and/or public sector job creation, there is tremendous scope left for increased employment and income generation in Australia. We are no where near full employment or the limits of (environmentally sustainable) growth.

Muston relates this obvious dislocation between the reality of the labour market and the rhetoric of the conservative economists – to the RBA’s charter and asks:

Whatever happened to the bit in the charter about the Reserve Bank maintaining full employment and prosperity for all? With much of the world experiencing hardship ranging from austerity measures to high unemployment, there is a unique opportunity for Australia to get ahead and raise the standard of living for all. High commodity prices and a mining sector that is expanding capacity should be a cue for the government to realign fiscal policy with measures such as a fair and transparent resource rent tax that will share prosperity.

At the same time it needs to embark on providing affordable housing rather than simply gifting first-home buyer grants that inflate lower tier house prices and do nothing to increase supply.

So it is stupid and seemingly a violation of the RBA’s charter to curtail the growth that is emerging in Australia. It is correct to say that Australia’s location in Asia and our attractiveness to the two big growth centres – India and China – provides us with scope to really push the growth curve out and in doing so, provide wider and better income earning opportunities for our workers – 12.1 per cent of them who are idle at present.

Deliberately putting the brake on now – as a reaction to some “fear” that inflation will accelerate is vandalism and without any vision at all.

Muston also questions why we would be contracting when inflation is around 2.5 per cent when the upper limit of the RBA’s targeting band is 3 per cent. He says that “a slightly higher inflation outcome closer to 3 per cent is a small price to pay in order to cut the underutilisation of labour and provide a level of economic growth that will buffer Australia against a continued gloomy global backdrop where many other central banks are seeking some inflation”.

I wouldn’t even say that there is any “price to pay” in this. The “costs” of a modest rise in inflation are dwarfed (many times over) by the huge daily losses that are involved in maintaining prolonged high labour underutilisation rates. The daily loss on national income alone is huge in the latter situation.

The problem is that once you define the current state as close to full employment you avoid having to face questioning about these losses. Once you say that there is no extra real output that is possible then you define the problem away.

The reality is different. These pronouncements that we are at “full employment” are ideological. We can clearly expand employment and reduce unemployment and underemployment if there is a political will to do so. The current policy makers are largely cowards and hide behind the mainstream obsessions about budget surpluses and inflation-first monetary policy. They rarely face scrutiny because they manage the media and are supported by a phalanx of obsequious commentators.

I fully agree with Neale Muston that:

It is time for the bank and government to use our unique situation as an opportunity to return Australia to full employment, and a good first step is to consider this rate cycle complete.

My conclusion: Neale Muston must have been on one hell of an intellectual journey over the last 16 months. Today’s commentary is a very welcome input into the public debate.

Britain decides to dumb down

I read overnight that Britain is being besieged by rioters protesting about the tripling of fees to enter higher education.

Law of demand: increase price, reduce demand.

In this case, reduced demand means longer term reductions in skill development and resulting productivity losses. It means that potential output will be lower and standards of living will drag behind the levels that could be achieved.

Why? The Government is cutting their net spending. Why? They have forgotten they are a sovereign government which can never be revenue constrained because it is the monopoly issuer of the currency. Mindless in the extreme.

Please read the suite of blogs – Deficit spending 101 – Part 1 – Deficit spending 101 – Part 2 – Deficit spending 101 – Part 3.

Then please read – Fiscal sustainability 101 – Part 1 – Fiscal sustainability 101 – Part 2 – Fiscal sustainability 101 – Part 3

Keynote Address to CofFEE Conference 2010

Last Thursday (December 2, 2010) I gave a talk at the Annual CofFEE Conference outlining the reasons I continue to host the National Conference on Unemployment, despite the main policy agenda and public debate being based on the erroneous notion that Australia is already at or near full capacity.

The following video presents the address I gave in full. It goes for 46:20 minutes.

You can also download the video if that is more convenient – HERE (mp4 format 75 mgbs).

Saturday Quiz

The Saturday Quiz will be back sometime tomorrow – even harder than last week!

That is enough for today!