As the treasurer lauds supply-side economics, a once-controversial recovery theory is gaining traction.This is the essence of modern monetary theory – that government budgeting is nothing like household or business budgeting, for the simple reason that government can create money.
Philip Lowe and Australia’s economy
He has told Australian workers they should demand higher pay from their employers and told employers, including Australia’s governments, they should give it.
In speech after speech, he has urged governments – state and federal – to invest much more in building infrastructure and to do it quickly. And told his political masters to move on structural reform of the economy. He has even ventured into the contentious area of welfare payments, suggesting boosting the dole as a means of stimulating the economy.
Has Australia ever had a Reserve Bank governor as public and as publicly opinionated as Philip Lowe?
Bob Gregory, AO, emeritus professor at the Research School of Economics at the Australian National University, can’t think of one and his memory goes back a long way. It’s been 50 years since Gregory started teaching economics at the ANU. From 1985, he spent a decade on the RBA board.
“It’s unusual,” he says of Lowe’s approach. “The public nature of it is very unusual.”
But then, these are unusual times. In the 1990s, when Gregory was at the RBA, the bank set a target rate for inflation of 2 to 3 per cent – originally meant to keep inflation down. When the economy was running too fast, it would apply the brakes by increasing interest rates. When things were too slow it would lower them.
Now, though, the brakes are almost all the way off in Australia. The official cash rate is at 1 per cent. Across much of the world, they are fully off. And still economies are not responding as they once did.
“If the economy goes really bad,” says Gregory, “… then interest rate reductions are not really going to fix it, because rates are already so low that you won’t see much response.
“Hence those statements [by Lowe] about infrastructure and so on. What he’s saying [to government and business] is ‘you guys are going to have to do it’.”
Philip Lowe is far from the only central banker sounding a warning, says independent economist Saul Eslake.
“Plenty of central banks now are saying to their governments – in different ways and to different degrees – that monetary policy has reached the limits of what it can do; fiscal policy [government spending and tax policy] should be doing more,” he says.
But there is pushback from governments.
“Germany, for example, has had one quarter of negative growth and may be coming to the end of a second negative quarter, yet the government is reluctant to increase spending on infrastructure, but the government is insistent on returning its budget to surplus,” says Eslake. “It’s become a source of contention.”
Eslake says the debate in Australia has been “fairly polite”. “In marked contrast to some others, the United States in particular, where [the chair of the Federal Reserve] Jay Powell has been elevated to enemy-of-the-people status by Trump,” he says.
The US president tweeted about Powell last month, saying: “My only question is, who is our bigger enemy, Jay Powell or Chairman Xi?” This week, he called the Federal Reserve board “boneheads” and demanded they immediately cut interest rates to “ZERO, or less”.
It’s unlikely Lowe is piping up because he wants the public attention or the glowing media profiles, or a fight with the government. Instead, he shares the concern other central bankers and influential economists have about where their economies are headed, and about their declining capacity to influence that direction.
“He is very low key,” says John Hewson, former Liberal Party leader and economics professor, who taught Lowe at the University of New South Wales. “He is not a seeker of publicity for its own sake, not about the status of the job.”
The RBA governor’s backstory is a classic of great achievement from modest beginnings. He was a country boy from Cootamundra who joined the bank straight out of high school, in a humble clerical role, while putting himself through university. Hewson oversaw Lowe’s honours thesis at UNSW.
“He was the best student I ever had in all the years I taught,” says Hewson. It’s a big statement, considering Hewson also taught other high achievers, including former Treasury head Ken Henry. “I fought for him to get not only first-class honours but also the university medal,” says the former Liberal leader.
From there, Lowe went on to do his doctorate at the Massachusetts Institute of Technology, under the supervision of arguably the pre-eminent contemporary economist, Nobel prize winner and New York Times economics correspondent Paul Krugman.
But Lowe is not without his critics: notably Labor’s Andrew Leigh, one of Australia’s most prolific and highly regarded economists, a professor at ANU before entering politics. Leigh went for Lowe in a big way last month during the RBA’s appearance before the house of representatives economics committee.
Leigh argued the bank had failed by not reducing interest rates further, sooner, in response to the early signs of a slowing economy. The argument involved abstruse economic theories and models, but Leigh’s point was clear – if the RBA had acted when the housing market first started to go bad a couple of years ago, there would be more people in work, earning better wages.
“That’s 20,000 Australians who were not in work as a result of that decision [not to cut earlier],” said Leigh. “That’s a pretty significant cost to the economy … Wouldn’t you agree that unemployment could be lower, and would have been lower, had you chosen to cut as housing prices fell?”
Lowe conceded the bank had got it wrong with its predictions of employment growth. “Should we have cut interest rates earlier? Only time will tell there, and people have their different views on that,” he offered, a little tamely.
A number of other economists take a similar view – even Hewson, although he directs his criticism at the RBA as an institution, rather than at its leader.
“Over the last couple of decades, I’ve written a lot about this,” says Hewson. “One feature of the Reserve Bank under various governors is an inclination to put interest rates up fast, and hold them up, often at too high a level, for too long.”
Hewson also notes an inclination in the Morrison government to constrain the independence of the bank – as part of a general effort to make the public service “more responsive” to government.
Treasurer Josh Frydenberg has floated a changing in the agreement between himself and Lowe that governs the relationship between the bank and the government, requiring the bank to formally explain itself if it fails to hit its inflation target, as happens in Britain and some other countries.
Bruce Preston, professor of economics at Melbourne University, approves. Others question the need for such change. Hewson reckons it is an effort to “set the bank up as the fall guy”.
Says Eslake: “Australia’s RBA has always interpreted its target fairly flexibly, I would say rationally. The targets are not holy writ.”
The more concerning issue, going forward, is that interest rates seem to have lost their power as a tool to manage the economy.
“If you plotted rates over the last 20 to 30 years,” Preston tells The Saturday Paper, “you would see the rise in boom times and fall in recessions, but the peak rates at each boom has been lower.
“Interest rates have become progressively lower. And all of these central banks are concerned about having limited room to move.”
Worse, low rates can have perverse consequences, as Lowe noted recently in a speech to a gathering of central bankers in Jackson Hole, Wyoming. In times of “elevated uncertainty”, such as we have now around the world, “we can’t be confident that changes in monetary conditions will have the normal effect,” he said. “… Relying on monetary policy risks further increases in asset prices in a slowing economy, which is an uncomfortable combination.”
And sure enough, that is what appears to be happening in Australia. In the wake of the RBA’s historic rate cuts, consumer spending and business investment haven’t really moved. Housing prices, though, have taken off. It is early days, but things don’t look good.
The problem is the same everywhere. Even where rates are now below zero, even where banks have resorted to unconventional measures such as quantitative easing. The benefits tend to flow into assets, such as houses, or to the sharemarket, rather than into real productive activity. The people with money just sit on it.
This week Rob Kapito, head of the world’s largest money manager BlackRock, gave an interview to the Nine media in which he estimated there is more than $A73 trillion in cash sitting idle around the world due to a lack of investment opportunities and weak returns.
A number of serious economists are now predicting a US and global recession next year. One of the most respected and prescient of those is New York University’s Nouriel Roubini, who has previously advised the Clinton White House, the International Monetary Fund, the World Bank and the US Fed, and he predicted the global financial crisis well in advance. Roubini warns further the crisis would not be averted “even if the US Federal Reserve and other major central banks pursue aggressive monetary easing”.
What is the solution, then?
In his speech at Jackson Hole, Philip Lowe again suggested it was time to pull on the “fiscal lever”. Though he conceded this was difficult in many countries because of the high level of debt – not an issue for Australia – or “difficulties in generating the political consensus about what should be done”, which is an issue here.
“A third potential lever is structural reforms that encourage firms to expand, invest, innovate and hire people,” said Lowe.
This is probably the “best lever”, he said. “But it, too, is hard to move or is stuck in many countries.”
Lowe did not mention Australia specifically. But this week, Ken Henry put it rather more bluntly in a speech that detailed a long list of government policy failures, and lamented a decade of lost opportunity for reform, and refusal by government to heed expert advice.
But not even the experts agree on what to do. It’s not like the 1980s or ’90s, when there was broad consensus on what needed to happen, as the outgoing head of the Department of the Prime Minister, Martin Parkinson, acknowledged in his valedictory speech a couple of weeks ago.
“Future public servants will have a much more difficult time than I ever had in navigating these and other questions – and continuing to provide frank and fearless advice while doing so.
“Today, there is no such consensus on what reform looks like,” Parkinson said. “Some of the economics we now need is not even in the textbooks.”
This article was first published in the print edition of The Saturday Paper on Sep 14, 2019 as "Lowe tidings".
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