Another first Tuesday of the month, another 50-point interest rate hike from the Reserve Bank. It “will help bring inflation back to target and create a more sustainable balance of demand and supply in the Australian economy”, governor Philip Lowe says.
As has been noted over and over again, one of the big drivers of the current bout of inflation are external forces or those beyond the control of Australian policymakers — Vladimir Putin’s invasion of Ukraine causing global energy prices to spike, most particularly, but food prices have been affected by both the war and floods caused by the climate emergency.
The Reserve Bank’s response to that is basically “bad luck, we don’t care what’s causing inflation, we’re going to smash demand with rate rises” — with the goal of that being “more sustainable balance of demand and supply in the Australian economy”. The beatings will continue, in other words, until morale plunges to a low enough level that people are too scared to spend.
Then inflation will fall back to 2-3% and we’ll be able to once again have the Great Moderation that characterised most of the two decades before the pandemic.
But like many hopes of returning to the pre-pandemic world, what happens if that’s impossible?
The RBA’s thinking on the relationship between monetary policy and inflation is based on some core assumptions about policymakers and policy: that economies will continue to operate in relative stability, and that policymakers have the ability — if not always the will — to address structural problems that might drive up inflation. The occasional shock might disrupt markets — the financial crisis; a war; a major terrorist incident such as 9/11 — but economies will revert to stability. That was especially the case once the world became unipolar after the collapse of the Soviet Union. The US stood unchallenged geopolitically.
How much do those assumptions apply now? Russia has emerged as a malignant global actor and military and cyber threat. China is increasingly belligerent and confident in its ability to damage those who oppose its will. There’s already one major war going on in Ukraine; there are fears of a bigger one over Taiwan. Neither are particularly amenable to direct control by Western politicians.
Indeed, part of Western policymakers’ response to Russia, and to China in the event it invades Taiwan, is inflationary: sanctions.
Sanctions disrupt trade and investment and push up prices, which is why they horrify neoliberals who’d rather states didn’t go in for all that stuff about human rights and standing up to tyranny. They’ve certainly disrupted global energy markets, with the Putin regime blaming sanctions for what will be the permanent shut-off of Russian gas from Europe.
Trade and financial sanctions have grown steadily in importance in recent decades, particularly as US control of the world financial system has tightened, enabling the US to cut off the flow of money both to companies and countries. They are now a frontline weapon in international relations between major powers — far more so than in the 1990s, when sanctions were for tinpot regimes like Saddam Hussein’s.
Sanctions complement a growing reaction against globalisation (among consumers, and the companies they influence, and politicians too) and an increasing desire in Western countries for greater supply chain control. The pandemic has shown the disadvantages of long international supply chains. The result is increasing onshoring of manufacturing of certain items deemed “strategic” or “sovereign”. Much of this is crass protectionism and looking after industry mates dressed up in the language of supply chain resilience, but it’s real enough to push up prices as manufacturing moves away from the lowest cost centres in developing countries or developed countries with long-term expertise.
At least the inflationary impacts of sanctions and onshoring are within the control of policymakers, and fit the ’90s paradigm of policymaking. But three bigger threats are beyond the short- or even medium-term control of policymakers: climate change, pandemics and the growing shortage of workers.
All will be growing problems for the rest of our lives. Our worker shortage, created by lower-than-usual immigration and a lack of foreign students and holidaymakers as a result of the pandemic, is just a preview of what will happen for the rest of the century: workers will become fewer and ever more valuable around the world.
As major countries like China and the US age, the problem will become more acute. Sourcing immigrants will become a ferocious battle between developed countries trying to attract as many workers as possible (which is why Australia should be launching an emigration campaign in Europe this coming winter to lure well-educated, highly skilled Europeans to move to Australia where the weather is warm and the energy bills much lower).
Increasing impacts of disease will also play a role. Even among a vaccinated population, COVID continues to wreak havoc on workforces. At least policymakers will be better prepared for when, not if, the next pandemic arrives, but the timing and severity is a lottery, as is the capacity of vaccines to quickly deal with a new virus.
At least we have certainty about climate change: we’ve already failed to prevent significant and damaging climate change and continuing inaction will make a bad situation worse. Floods, droughts and extreme weather will become a much more common part of economic cycles, pushing food and energy prices up, disrupting core markets like insurance and pressuring budgets with greater infrastructure and recovery spending. The only upside is that the more rapidly we can decarbonise, the more rapidly we can abandon inherently energy sources that will be increasingly inflationary and volatile — coal and gas.
How does the RBA cope in a world where multiple external sources of inflation are beyond the immediate control of policymakers, where inflationary pressures are a constant, revolving mix of threats, not transitional phenomena? Does it persist with its 1990s “I have only one tool and it’s a hammer” approach of always bludgeoning demand? Does it keep playing what will increasingly look like whack-a-mole with interest rates? Or does it look for ways to adjust to the post-pandemic world?
The world has changed. The next 30 years will be a lot more difficult than the past 30. Even for central bankers.
If the Government wants to deal with inflation by cutting back on demand, they could push the tax rate up on high income earners and business. This would take steam out of the economy at that level but leave interest rates and the little people who pay mortgages in the real economy alone. It would not strike at new investment and would increase tax revenue that could be used to fund infrastructure and social projects in the real economy.
This is simply using Keynesian thinking to slow demand in a way that does not hurt investment and ordinary householders and also produces a bottom line for the budget.
This is fairly basic idea that has never been put in the public realm as far as I am aware. This is because free market economists and the Reserve Bank who employs them are never going to support taxation policies that are equitable and address the issues of wealth inequality.
Imagination is defined by self interest in the governing classes.
It is still a good idea, though.
If you read your MMT, you’ll see that inflation comes from printing more money than the economy needs (queue covid relief measures), and the cure comes from taking that money out of circulation, mostly through taxation. Increasing taxes is the correct response, irrespective of what theory you use to justify it. Government policy (the budget) allows a great deal of flexibility in how that happens, and whom it inconveniences.
That’s not exactly the best MMT-informed explanation of inflation . . .
MMT-informed economists generally say that inflation is a result of competition for the limited real resources that are available in the economy – this is generalised from the classical demand/supply relationship, as well as incorporating actual real world constraints. It’s definitely /not/ something that can be described as “printing more money than the economy needs” – if you squint that description /might/ resemble reality, but it’s not very useful, because it doesn’t get to the heart of the problem: competition over control of limited real resources, competition which in a capitalist economy manifests as /price/ competition.
Taxation can help manage that competition by reducing the capacity for some portion of the population to participate – take enough of their money away that they can’t afford to win the competition by spending more than other people. Or it can just blanket reduce demand to a level where supply can keep up without issues.
The RBA’s use of interest rates is basically the same as the blanket taxation approach – take money out of the hands of a large portion of the population, thereby reducing demand everywhere. This is one of the main reasons for central bank independence – it allows governments to avoid taking the blame for that kind of blanket demand reduction, which they might otherwise have to implement in the form of explicit taxes.
As you say, governments have far larger toolboxes than they generally admit – taxation is only part of it, they also have the capacity to spend, to build infrastructure to support productive capacity, or even to build productive capacity themselves. They also have the capacity to explicitly /restrict/ or manage demand or supply – rationing is a dirty word, but only because no one’s willing to talk about how price competition for limited real resources is rationing based on capacity spend. Rationing based on need rather than on wealth might not be such a bad idea sometimes, particularly in times of crisis.
The world is a lot more complex than the economists at the RBA or in Treasury or wherever are able to reason about usefully, and until that’s recognised and corrected governments and other national institutions are going to keep making stupid decisions.
The phenomenon that has no name in Australian economic and finance, tax increases that can fund actual public services, and also increases in the SCG Superannuation Contribution Guarantee, used for the same effect in ’80s).
Further, targeted reform e.g. removing all subsidies on property ownership/investment, and direct action on any other sector experiencing non-organic price inflation.
The discussion has an amazingly short attention span. Wasn’t much more than six months ago that the problem wasn’t a shortage of workers, but what all of the out-of-work citizens were going to do when the AIs made their jobs redundant. Universal Basic Income was the hot topic. Wasn’t much more than six months ago that the problem wasn’t ever-increasing energy prices, but how to support stranded assets and infrastructure as “free” renewable energy inevitably drove energy prices down. What could we do with all that supposed surplus energy?
Unfortunately six months ago the future of the climate was just about as dire, so that part hasn’t changed.
This government wont do whats needed for the same reason the previous one didnt, they are owned by the status quo, billionaures and big business, including the fossil fuel people. The common folk can suck it up.
That comment nibbles at the heart of the matter. There’s a saying frequently used these days… “the pub test.” It refers to down-home, common sense opinion—untainted by the sophisticated BS language of the elites—that is seen to cut through to the heart of a matter. Here’s some ‘pub test’ input; the greater wage- and salary-earning population of this nation understand the contemporary fiscal challenges facing our Federal government, and they would look more favourably on the need for tax rates to rise (or at least not to be reduced) if they could see that the cohort at the high-end of town was paying its share. The current situation in that regard is nothing short of an obscenity.
The underlying assumption of the RBA seems to be that the demand side of the equation is causing the lift in inflation when, in reality, it is the supply side (multi-nationals) that is pushing up prices. So, the RBA punishes the people who already are having difficulty paying bills and putting food on the table rather than attending tho the real cause (which is probably outside their jurisdiction or capacity to influence).
“Our worker shortage, created by lower-than-usual immigration and a lack of foreign students and holidaymakers as a result of the pandemic, is just a preview of what will happen for the rest of the century: workers will become fewer and ever more
valuable around the world.”
Again I have to say, what are you on? You are kidding aren’t you? Workers becoming more valuable when they are enduring wage rises well below inflation? You have said it all in this sentence. Foreign students and working holiday makers. This has been the best thing for the country. Wages would be sky high now were it not for the fact that strikes are illegal and the wage fixing system is faulty and weak. Automation will see the need for fewer workers over time. This worker shortage will be short lived and workers are ill-equipped to take advantage of this and make hay while the sun shines so to speak.