Dump inflation targeting

Yesterday, I pointed out that the first instalment of the rescue package could be financed by cancelling the Stage 3 income tax cuts legislated for 2024-25. Today, the same suggestion is on the front page of the SMH. Morrison is apparently resisting the idea, but that can’t last long.

Trying to keep one day ahead, I’ve turned my mind to how the Reserve Bank should operate during and after the crisis. The first step is to abandon inflation targeting once and for all. The policy of using small interest rate adjustments to keep inflation in a range of 2-3 per cent made sense in the policy context of the (spurious) Great Moderation, when the target appeared consistent with maintaining unemployment at a stable level of 5 per cent or so, assumed to be the lowest the economy could sustain.

That all fell to pieces with the GFC. Inflation targeting, which did nothing to stop asset price bubbles, was a significant contributor to the crisis. Various ideas to address this problem were floated, but it ended up in the too-hard basket.

In the aftermath of the GFC, most central banks pushed their key interest rates down to zero. Even where this didn’t happen, as in Australia, inflation remained persistently below the target range, a problem that hadn’t been contemplated when the policy was first introduced in the 1990s, and the big concern was a resurgence of the inflation of the 1970s and 1980s.

It’s now obvious that we will never return to a world where inflation targeting makes sense. But what should replace it?

The first step should be a re-ordering of the Reserve Bank’s objectives to focus primarily on full employment rather than price stability. One way to implement this would be to target the level and growth rate of nominal income. My suggested target would be a 7 per cent rate of nominal growth, ideally made up of 3 per cent real growth* and 4 per cent inflation. The idea of the nominal target is that, if real growth falls below the target, the Reserve Bank loosens monetary policy and accepts higher inflation.

A 7 per cent growth rate would imply a doubling of nominal income over a decade. That in turn means that if we end the crisis with, say, debt equal to 60 per cent of national income, and balance the budget (on average) after that, the debt to income ration would fall to 30 per cent by 2030.

  • In the longer term we should be looking at taking the benefits of technological growth in the form of more leisure rather than more output. But I haven’t had time to do the analysis on that.

Renationalisation in Australia

I got a message from a student asking about examples of renationalisation in Australia. Here’s my response

There hasn’t been much explicit renationalisation of business enterprises in Australia. What we have seen is

(a) Public private partnerships (PPPs) being wound up and returned to the public sector. As well as Port Macquarie, some others are mentioned herehttps://grattan.edu.au/news/public-private-hospital-partnerships-are-risky-business/
and here on private prisons
and social housing

(b) The government has also re-entered areas of business it had previously privatised. The most important example is the NBN, but there is also the big Tesla battery in SA  https://hornsdalepowerreserve.com.au/ and other interventions by the state government there. The Federal governments proposed Snowy 2.0 is another example

How to pay for the rescue

I was asked by a journalist about the long-term fiscal effects of the government response to the crisis. Here’s what I said

 In simple accounting terms the cost of the intervention so far can mostly be offset simply by cancelling the Stage 3 tax cuts legislated in advance for 2024-25 (this also happened when the Keating Labor government legislated for future tax cuts in the 1990s). These are projected to cost $95 billion over the five years to 2029-30
so the saving would easily offset the crisis intervention over 10 years.

That’s assuming that the crisis ends quickly and everything returns to the way it was before. I think we will end up with a substantially larger role for government, and therefore a permanent increase in the public sector share of national income, which means higher taxes.

Border deflection

Another recent piece, this time in Inside Story. Opening paras

Supporters of ethnonationalist and anti-immigrant sentiment have been quick to seize on the Covid-19 pandemic as evidence against what they call “open borders,” by which they mean any relaxation of the stringent controls that prohibit international migration by anyone who falls outside a tightly defined set of categories, each subject to numerical limits. The underlying idea is that foreigners who don’t look or think like us are all potential carriers of infection, and that we can keep ourselves safe by excluding them.

The reality is quite different. The vast majority of Australia Covid-19 cases acquired overseas had a recent history of travel to Europe or the Americas, or arrived on cruise ships such as the Ruby Princess. Hardly any (in fact none, as far as I can determine) were new migrants to Australia.

What should the post-coronavirus economy look like?

The New Daily asked me to write a bit on the question “What should/will the post-coronavirus economy look like?

Here’s what I sent

The Covid crisis has demonstrated the inadequacy of crucial aspects of our social and economic system, particularly relating to employment and unemployment.  Before the resurgence of neoliberalism in the 1970s, Australian governments accepted responsibility for maintaining full employment, and provided support for all those unable to engage in paid work, whether through age, disability or unemployment on an equal basis.  The full employment goal was not always achieved, but it remained central to public policy.  

Over the period since the 1970s, government has passed the responsibility for economic management to the Reserve Bank and required a primary focus on low inflation. The treatment of benefit recipients, except the old, has been steadily less generous and more punitive. Meanwhile governments have focused obsessively on largely meaningless measures of budget balance.

The failures of this approach have been evident for years, but it has taken the Covid crisis to lead to any change. Within a matter of weeks, dogmas that have been in place for decades have been abandoned.

The most important requirement for the post-coronavirus is that we should not attempt to return to a pre-crisis ’normality’ that was unsustainable in almost every respect: social, economic and environmental. Rather, the income support measures adopted in response to the crisis should be maintained, and the government should accept the maintenance of full employment as its core economic responsibility.