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
https://www.theguardian.com/australia-news/2019/mar/26/queensland-to-end-private-jails-experiment-after-scathing-report
and social housing
http://www.newleafcommunities.com.au/


(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.

Job vouchers: a step towards a Jobs Guarantee

It seems quite likely that we will soon see the introduction of a wage subsidy along the lines of that announced by Boris Johnson (himself now testing positive!) in the UK. That is, a payment to employers equal to 70 or 80 per cent of workers’ pre-crisis wages, in return for keeping them on for some period. That would be better than doing nothing beyond what has already been announced, but I have two big problems with it.

First, it is paid to companies rather than workers. The ACTU is touting this as benefit, on the grounds of administrative simplicity, but I suspect that there is lots of potential for abuse through complex corporate structures. Second, it creates essentially arbitrary distinctions between workers. If you happened to work for a company that closes and stays closed, or if you were already unemployed you are out of luck. A final issue (on which opinions may differ) is that the benefit depends on previous salary, rather than being the same for everyone.

I’m thinking about an alternative model. Rather than paying money directly to employers, we should allow recipients of benefits like Newstart to use their benefit as a wage subsidy, either with their current/most recent employer (this would be specific to the pandemic emergency) or with a new employer. This would give workers more freedom and more agency, and could potentially form part of a Jobs Guarantee, which is, I have argued, the natural complement to a Guaranteed Livable Income (the term now being used by advocates of BI/UBI/GMO schemes in Australia). In particular, it could be sustained beyond the current emergency, which is not the case for the wage subsidy ideas.

There are plenty of issues to be addressed in the long run version of the voucher idea, such as the problems of additionality and churning (ensuring that the employer is creating new jobs, rather than replacing existing workers with voucher-holders). But such issues have been addressed in other contexts, with some success.

Crisis and the case for socialism

The coronavirus crisis is very different, at least in its origins, from the Global Financial Crisis. Both differ in crucial respects from other crises in living memory, notably including the Great Depression and World War II, as well a string of severe but not catastrophic crises that have affected the global economy and society. But thinking about them all together brings home the point that major economic crises are quite common events. The crisis of the past took each took between five and ten years to resolve. Even if the current crisis is shorter, we can draw the conclusion that crisis of one kind or another is not an aberration, but a regular occurrence in a complex modern society.

What they have in common is that the result in a need for urgent government action. The greater the capacity and willingness of governments to act to protect society from the economic damage associated with such crises the better, in general, the outcome has been.

The most immediate requirements for dealing with a crisis are a strong and comprehensive welfare state, and strong protections for workers. In the aftermath, we need a substantial economic role for government, including control over infrastructure and financial enterprises and public provision of services like health and education. In short, we need socialism.

(More to come soon!)

How coronavirus will wallop Australia’s economy – and what the government must do

The Guardian has a number of short pieces from economists on the likely economic effects of the coronavirus, and what should be done about it. Here’s mine

The government has finally recognised the correctness of the Rudd government’s response to the GFC

The Australian economy was slowing even before the bushfire catastrophe and the arrival of coronavirus. The economic costs of the bushfires, including damage to property and infrastructure, long-term health effects of smoke exposure and ecosystem destruction were massive, but the main effects on GDP will be felt by the tourism sector. The damage to Australia’s international image from widespread vision of the fires, accompanied by critical commentary to the effect that, as a climate laggard, we have brought this on ourselves, will be long-lasting.

The arrival of the coronavirus, just as the last bushfires were extinguished will have a greater short term impact on economic activity, almost certainly resulting in two or more quarters of negative growth. With an underlying growth rate of 0.5% per quarter, a 5% contraction in the 10% of the economy most exposed to the effects of coronavirus would be sufficient to reduce growth to zero.

It appears that the government has finally recognised the correctness of the Rudd government’s response to the GFC, and will follow that path, with some marginal attempts at product differentiation. It is likely that the effect on the budget balance will be substantially greater than the $10bn currently being discussed, and that the recent decline in the ratio of public debt to GDP will be reversed. In these circumstances, the massive tax cuts for high income earners, legislated for 2024-25 will probably prove unaffordable.

Burning the surplus

Scott Morrison’s total paralysis in the face of the bushfire emergency gave rise to the most convincing excuse for his recent disappearance – he wasn’t doing anything anyway, so why shouldn’t he go?

Part of his problem is that any serious discussion of the problem involves climate change, and even one pull on that thread would risk unravelling the shroud of deception he and the rest of the right are sheltering beneath.

But surely Scotty from Marketing could come up with a campaign that appeared to take action on the bushfires themselves without doing anything about the underlying cause. There’s another factor that hasn’t been mentioned, as far as I can see.

What credibility the government has is tied to its claim that this is the year we will return to surplus for good. The mid-year outlook makes this pretty shaky, projecting a $5 billion surplus this year and $6 billion next year.

The economic impact of the fires is going to be at least as big as that, and the cost of a comprehensive program to respond to them even more. Property damage must be well into the billions (for comparison, the 2011 floods in Queensland were estimated to cost $10 billion), and the loss of business, particularly in tourism, much more than that.

Think of what would be needed for a basic program responding to the new normal (that is, normal, until things get even worse in the future). That includes payment of volunteer firefighters, massive new purchases of firefighting equipment, reequipping the defence forces to make them more useful in emergencies like this, and replacing damaged public infrastructure. It’s obvious that $5 billion a year would be little more than a down payment.

Until this particular element of reality penetrates Scott and Josh’s bubble, nothing serious will be done.