The Governor of the RBA appeared before the House of Representatives Standing Committee on Economics yesterday (December 18, 2013). He told the Committee that the economic growth that we experienced leading up to the crisis in 2008 was unlikely to be repeated but his assessment was largely ideological in nature – in the sense that he implicitly eschewed a fundamental re-appraisal of the policy structures in the economy and the way in which national income is distributed. He thus rejected (tacitly) a return to fiscal activism claiming the public “debt dynamic” militated against that. He admitted the limits of monetary policy as an expansionary force. And he implicitly ignored the fact that the on-going failure of real wages to keep track of productivity growth meant that if household consumption expenditure was to grow it would see a return to increasing private debt to unsustainable levels, as occurred in the decade leading up to the crisis. He acknowledged that households were much more cautious now given the heavy debt levels they were carrying but didn’t acknowledge that this meant that the fiscal surpluses of that era were also unsustainable and that deficits were needed to offset the drain from the external deficits and the cautiousness of the private domestic sector. The journalists thus published all the wrong headlines and stories and the public is none the wiser. We remain locked into a neo-liberal option set that will deliver sub-trend growth and rising unemployment. The Governor even had the audacity to say that the unemployment rate (at 5.8 per cent) was low by historical standards, which in itself is false (depending on where history starts) and ignores the fact that our broad labour wastage exceeds 15 per cent of the willing labour force at present.
The – Full Transcript – of the hearing is interesting in many ways.
First, for all those who think a central bank in a currency-issuing nation can go broke this is what the Governor said:
There are central banks that run without capital; there are central banks that have negative capital. They can still do their job in terms of issuing currency, running monetary policy and so on, but I think the better approach and the one that we have always had in Australia is to explicitly hold capital in the central bank against the risks that the central bank, by virtue of its job, accepts on behalf of the nation.
Later on (Page 9) he said in relation to the Reserve Bank Reserve Fund being empty:
The scenario you paint, in which the cupboard is so-called bare, is one that we gave thought to … The advice from the accounting professionals and the auditors was that the bank carries on in that world and, as I said, there are central banks who have negative capital, but I do not think it is a good look. I think that in that world there is the risk of uninformed commentary suggesting the RBA is broke or something, which would not be true but would not be helpful in sustaining the credibility of our institution … [if the fund did become negative] … We would come to work every day and do our jobs — the institution does not get wound up or something — but I am concerned about the perception that that may create. That is why I think the balance always ought to be positive—a strong number.
Perception rather than reality.
He was talking about the decision by the Treasurer to inject $A8.8 billion into the Reserve Bank Reserve Fund recently. This injection was just a political stunt. As a once off increase in the government deficit it will allow the new government to boast next year how much fiscal shift (reducing the deficit) it has been able to achieve – and what responsible managers they are.
Total fluff and deceit.
But the message of the Governor was clear – a central bank can operate perfectly well with negative capital. After all, it is not a private business subject to rules of solvency. A central bank in a currency-issuing nation can never become insolvent.
Get over that one and there are only a few more myth hurdles left.
As an aside, the Governor also revealed that the injection “has not actually happened yet — it has been announced — but the intention is that there will be a grant to the bank before the end of the financial year”. He then explained how the Treasurer cannot actually put money into the fund.
Instead, the Treasurer will agree that the RBA will retain profits this financial year which will be retained in the Reserve Bank Reserve Fund. Which makes the rise in the deficit attributable to this item announced in the – in this context look rather deceptive to say the least.
In the MYEFO (Page 35) we read:
… a grant payment of $8.8 billion to the Reserve Bank of Australia (RBA) to increase the RBA’s capital reserve and strengthen the RBA’s financial position
Box 3.1 (Page 37) elaborates further:
The Government has therefore decided, following consultation with the Reserve Bank Governor, to provide a one-off $8.8 billion grant to the RBA to strengthen its financial position.
It appears from the RBA Governor’s testimony that there is no such grant. A grant means that the Government is bestowing funds on the RBA when in fact it is merely foreshadowing that it will not take out a certain amount as dividends.
To further underline the deceit, the extraction of dividends each year is not automatic but subject to negotiation between the RBA Board and the Treasury.
From the perspective of the flow of funds, this announcement doesn’t actually mean the Government is increasing spending.
The information provided by the Governor also qualify my statement on Tuesday in the blog – The deficit is undermining our welfare – because it is too low! – that “The Treasury actually borrowed from the private sector an equivalent amount to that which was put back in the Reserve Bank Reserve Fund (RBRF)”.
The correct statement is that depending on the timing of the retained earnings the government might actually inject the $A8.8 billion in on June 30, 2014 and then get paid back by the RBA when it works out its retained earnings policy in August. As the Governor said “they will not be borrowing it for very long”.
The conclusion I drew doesn’t alter though – nonsensical accounting gymnastics to score political points.
The Governor also made the assessment of where the Australian economy was at:
Nearly six years on, where do we stand? We have an economy which, although growing at a rate that none of us feel is quite as good as we want, is 12 or 13 per cent bigger than it was then. Our banking system is probably stronger today than it was then. We have an unemployment rate higher than it was then, but, really, by historical standards, by our standards and by the standards of many other countries, it is still pretty low. We have a record of macroeconomic success in that period that, in all modesty, I would say many other countries wish they had. It is certainly true we have a build-up of government debt, and that is a medium-term challenge for us to address.
First, the economy avoided the worst of the crisis because the previous government took the bold step to introduce a massive and early fiscal stimulus. That saved the economy.
Second, the withdrawal of that stimulus has led to growth faltering.
Third, the Australian unemployment rate is high by historical standards. The following graph shows the aggregate unemployment rate from 1861 to 2013. The 2013 value is averaged to November 2013.
The Governor’s assessment depends on where you start history and the events you take into account. Certainly when the neo-liberal period is compared to the full-employment period (1945 to 1975 approx), the recent unemployment rates are high by historical standards.
And I should add that now underemployment is over 7.5 per cent and prior to 1991, it was around 0.5-1.0 per cent only.
The point is that the public debate gets locked into narrow historical epochs and what appears normal then is abnormal when we take a longer-term perspective.
This locked-in mentality also narrows our appreciation of the available macroeconomic tools that we can use to alter the “market outcomes” in our favour. The Governor told the Committee that the “debt dynamic” prevented any significant fiscal action and so monetary policy had to do all the work.
That is simply asserting ideology not fact. I turn to that later.
Fourth, the “build-up of government debt” is irrelevant and presents no medium-term challenge. It should be ignored. Even within the RBA’s own endorsement of the latest Basel III capital adequacy regulations there will not be enough government debt for banks to hold to satisfy the requirements.
Basel III will see an increased demand for government paper not less. It is likely that in certain nations including Australia there will not be enough government debt!
Please read my blogs – New central bank initiative shows governments are not financially constrained and Banks might be forced to buy government bonds … and Lending is capital- not reserve-constrained – for more discussion on this point.
The Governor was asked about the future by a Committee member and he made what I thought was the most extraordinary comment that should have been further scrutinised and analysed in the mainstream media (Page 22):
We do know no really at all, but it is pretty hard to foresee a return to the kind of world we had from the mid- 1990s up to about 2006: a world of such apparent predictability and stability. We already look back on it — it preceded in my time as governor; my timing was not good here — as a golden period, to which I do not think we are going to be able to return any time soon.
It is highly desirable that we do not see a return to that kind of world. It was characterised by:
1. Fiscal policy activism being eschewed in favour of the less effective monetary policy so growth was lower overall and labour wastage higher. The population was indoctrinated (brain-washed) into believing that government deficits were bad even though for almost 85 per cent of the years before the 1990s, governments had run more or less continuous deficits without the sky falling in.
The latest manifestation of this is that we think fiscal austerity is good for us – strong medicine!
2. Increased financial and labour market deregulation which redistributed national income away from wages towards profits and handed over real resources to enrich the bankers and speculators. They used this windfall as gambling chips in a mad betting frenzy that culminated in the Global Financial Crisis.
3. Deregulation allowed real wages growth to lag significantly behind labour productivity (an atypical historical event) which meant that households had to increasingly access credit (borrow) to maintain growth in consumption.
4. The Australian government was only able to run surpluses for 10 out of the 11 years between 1996 and 2007 because growth was being driven by the massive credit explosion that allowed the financial markets to boom and left households with record levels of debt relative to disposable income.
5. Governments abandoned their commitment to full employment and this manifested in the labour underutilisation remaining at 9.6 per cent at the height of the last cycle – which was the best we could do.
6. Income and wealth inequality rose and we know that rising inequality is causally related to slower growth.
So going back to that is not anything that we would hope for. You will see the ideological slant in the Governor’s language when he calls this a “golden period”.
It was the period that established the conditions for the crash. Central bankers and treasury officials continually were in denial during this period but it was obvious to anyone who understood what was happening that a major crash was looming.
The reality is that households and firms are reluctant to return to the days of credit bingeing. The Governor acknowledge in his evidence that:
The cash rate is the lowest for 50 years; many borrowing rates are similarly at the low end of historical experience; banks generally are willing to lend. It is still a bit difficult in certain areas to get loans, but, by and large, they are willing to lend and in fact they are lamenting that there is not more demand for credit … we can lead the horse to water, so to speak …
Which tells us that the private domestic sector is now more cautious about debt and that means the rate of growth of spending will be more subdued.
There is no likelihood that the external sector will be a positive contributor in net terms to aggregate demand in the coming decade. Indeed, projections out to 2015-16 tell us that the deficits will be of the order of 3.75 to 4 per cent of GDP.
With the private domestic sector probably not willing to bridge that gap, then to maintain real GDP growth at its current poor level will require the government deficit to be at least 2-3 per cent of GDP. To push the economy back to trend growth and to start reducing the labour wastage will require larger deficits.
The Governor told the Committee:
It is certainly true, as you say, that a number of countries have what you could term very aggressive monetary policies — their interest rates are at or near zero; their central banks have expanded the balance sheet quite aggressively — and that is a process that continues in a couple of cases. But they are doing that because of the growth being so anaemic and because they felt, I think, that they needed to do whatever they could to support growth, and the more so if the fiscal side does not have the same degree of flexibility to be expansionary because of debt dynamic, so that puts more pressure on monetary policy.
This is the debate that has to be had before we will refind economic prosperity.
He just assumes there is a “debt dynamic” that is a real constraint. It is merely a political constraint that has been created because none of these officials will break out of the neo-liberal paradigm and admit that the public debt issue is a non-issue.
Sure enough in the Eurozone, the public debt is a problem because the government use a foreign currency. Even then the ECB could render the situation benign and fund as much growth in aggregate demand as is needed.
The point is that while we do not want to return to the pre-crisis behaviour the alternative is not to accept sub-standard growth and mass unemployment of obscene levels.
We can do something about it. Governments can run larger deficits again to fund the private domestic debt reductions (through saving via income growth).
We can reregulate financial markets and force speculators to behave in ways that advance the public interest.
We can redistribute national income to reduce income inequality and provide households with a growth source without recourse to increasing debt.
We can stop free trade and only permit fair trade.
We can afford to introduce strict environmental rules.
We can … if we want to. The most of us though have been brainwashed into accepting the TINA model and cannot see that we control the economy not the other way around.
Meanwhile the elites continue their plunder.
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.