In a recent op-ed, Paul Keating accused the Reserve Bank of ‘indolence’ and an unwillingness to help ‘shoulder the load’ in the current economic emergency. With its interest rate lever no longer effective, the RBA should be directly funding the government, he argued. Put bluntly, it should write a blank cheque for the ‘mountainous sums’ of money that needed to be spent. The unemployed, those who have lost their retirement savings and an under-pressure government deserve no less.
Is Keating right? Is the RBA sitting on its hands during the current crisis? The short answer, of course, is no. The Bank has cut the cash rate to its current historically low level of 0.25 per cent. And as Keating himself points out, it backed this up with a commitment to buy government debt on secondary markets and provide cheap funding for the banks.
Indeed, rather than sticking to an outmoded playbook, the RBA has done exactly the opposite. In common with the major central banks overseas, it has embraced the unorthodox. It has switched from traditional monetary policy to the provision of fiscal support, exactly what Keating, and those spruiking Modern Monetary Theory, want. Yes, the RBA is purchasing bonds on the open market rather than directly from the government (a less seemly thing to do), but the end result is the same. Excess debt is hoovered up with electronically created money, removing any upward pressure on interest rates or short-term need to raise taxes.
The RBA and other central banks know full well what they are doing. Since their traditional lever (manipulation of short term interest rates) has not been working for some time, the only way they can hope to influence economic activity is by getting into the fiscal policy game. Expansionary fiscal policy used to be frowned upon by central bankers, but now (according to RBA Governor Philip Lowe) it’s a national imperative.
Unconventional monetary policy (rock bottom or negative short-term interest rates and large-scale bond purchases) is not new, however. Adopted by the Fed and the European Central Bank after the 2008 economic crisis, its track record has been questionable at best.
It has signally failed in its main objective: to stimulate investment, spur growth and lift inflation back to target levels. Economists have spent the past decade debating why this has been the case, but remain none the wiser. The grab bag of explanations (globalisation, the rise of the digital economy, population ageing, the drying up of investment opportunities) which has been offered has been unconvincing, suggesting a discipline in crisis.
And it has had serious negative side-effects. Asset values (housing and equities) have gone through the roof, exacerbating inequality and undermining support for the market economic system. Financial intermediation has been adversely affected (since the interest differentials banks make money from have been squeezed). And millions of savers have had their incomes drop, forcing them to save more or invest in risky securities.
So, even before the pandemic hit, the wisdom and effectiveness of unconventional monetary policy were being questioned. Critics included Ian Macfarlane, the respected former governor of the RBA, and Peter Costello. In 2019, the latter compared it to the Hotel California. ‘You can check out any time you like, but you can never leave’, he quipped. A reference to the financial market jitters that emerge any time central banks signal their intention to pull back from it.
But with the virus upon us, global central banks have doubled down on this policy experiment. While the lead was taken by the Fed and other majors, the RBA followed suit.
Stepping back then, Keating’s article is not about monetary policy. It’s a call for turbo-charged fiscal policy, or in his phrase ‘mountainous sums’ of spending, to get us out of our hole. An echo of Keynes’ idea that you spend your way out of depressions. Is this the way forward? Is this the elixir that we are looking for?
I have my doubts. The recession we are experiencing is a highly unusual one. It was triggered not by a financial panic or collapsing demand (the scenario Keynes and his contemporary followers have in mind), but rather government-imposed shutdowns of large parts of the economy. It hit us, in other words, on the supply side.
When supply is constrained, when large swathes of the economy are closed down or only able to operate at reduced capacity (due to social distancing), you can pump demand up all you like but it will have little positive effect. You are attacking a symptom of the problem, not the cause. (This should not be read as a rejection of income support for people and businesses caught up in the pandemic. This is not stimulus or welfare, but legitimate compensation for damage caused by health policy decisions).
True, supply conditions may well improve (although many businesses will no longer be viable), leaving demand as a potential problem. But will this be because people lack money? With the government and the RBA backing big deficits for the foreseeable future (indeed, until the rate of unemployment returns to six per cent), that is unlikely to be the case. No, the risks we face are likely to be more psychological than financial. We see this now, in fact. With generous support on offer, many families and businesses are not cash-poor. Understandably, they are opting to save rather than spend this windfall. This is a hedge against a highly uncertain future. What will the virus look like next year? How effective will any vaccine be? What will trigger-happy governments, particularly at the state level, do once infection rates rise again? What happens when short-term payments from governments are phased out?
No one knows the answer. We are sailing in uncharted waters, with events beyond the immediate control of anyone. So the worry is that this uncertainty, and the dulled animal spirits it gives rise to, can easily become entrenched.
We have seen this before. In these circumstances, policy circuit breakers will have little effect. Our economic models do not take this into account. For them, a dose of stimulus always works. The offered carrot unfailingly elicits the hoped-for Pavlovian reaction from households and businesses. If Keating’s RBA piece was wrong and self-serving, he was right about one thing. His observation that central bankers, both here and overseas, are regarded as ‘exalted priests’ who are uniquely wise and knowledgeable was spot-on. This is not a healthy attitude in a democracy. Better to see them as mortal and flawed like the rest of us. Doing their best, to be sure, but in the ‘fog’ of the pandemic and without their traditional tools, necessarily feeling their way.
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