Populist economics

The Sydney Tele yesterday had a front page screamer about Glenn Stevens, Governor of the Reserve Bank – Is this man Australia’s most useless? There were two main parts to the critique. First, that the Reserve Bank should be stopping the banks from raising interest rates beyond the official cash rate;

“it is a key part of his job as Reserve Bank governor to use official interest rates as a guide for the major banks as to what they should charge on mortgages.”

And the other slam was at the governor for suggesting that the government raise taxes rather than lowering them;

THE nation’s most powerful economic figure has committed a double betrayal of working families … saying taxes could be increased.

While one could argue with the Governor’s interpretation of the economy, the Governor is doing exactly what the Reserve Bank’s charter, clarified by a statement on monetary policy (1996, jointly issued by the then Governor and Peter Costello, then Treasurer) says it should.

The framework for the operation of monetary policy is set out in the Reserve Bank Act 1959 which requires the Board to conduct monetary policy in a way that, in the Board’s opinion, will best contribute to the objectives of:

  1. the stability of the currency of Australia;
  2. the maintenance of full employment in Australia; and
  3. the economic prosperity and welfare of the people of Australia.

The first two objectives lead to the third, and ultimate, objective of monetary policy and indeed economic policy as a whole. These objectives allow the Reserve Bank to focus on price (currency) stability while taking account of the implications of monetary policy for activity and, therefore, employment in the short term. Price stability is a crucial precondition for sustained growth in economic activity and employment.

Both the Bank and the Government agree on the importance of low inflation and low inflation expectations. These assist businesses in making sound investment decisions, underpin the creation of new and secure jobs, protect the savings of Australians and preserve the value of the currency.

In pursuing the goal of medium term price stability the Reserve Bank has adopted the objective of keeping underlying inflation between 2 and 3 per cent, on average, over the cycle. This formulation allows for the natural short run variation in underlying inflation over the cycle while preserving a clearly identifiable benchmark performance over time.

Nowhere does the charter (section 10(2) of the Reserve Bank Act) or the clarifying statement say that the Reserve Bank has any responsibility for individual banks’ pricing policies – particularly in the context of an increase in their costs (the banks are all putting their prices up because their costs of funds on the international market has increased substantially).

And, whether you like it or not, the Reserve Bank’s inflation objective (stability of the currency) comes above maintenance of full employment and the econmic prosperity and wealth of the people of Australia.

In suggesting that taxes should be increased, and supporting the banks’ increases in interest rates charged to their customers, the Reserve Bank governor is supporting actions that might reduce spending in the economy. Given that the Australian economy as a whole is getting overheated (at least by some measures), and inflation is definitely outside the 2-3% band, the Reserve Bank is doing its job by suggesting measures that might reduce demand, and hence inflation.

If the banks are able to completely pass on their increases in costs to their customers, by increasing their interest rates, then the problem is inadequate competition. That’s the job of the ACCC, and the government, not the Reserve Bank.

It’s too much to expect the Tele to publish nuanced economic analysis on its front page. But it does annoy me when such a nominally right wing paper publishes such populist economic claptrap.

Update: Possum comitatus and Mark from Larvatus Prodeo don’t much like the article either.

  3 comments for “Populist economics

  1. April 11, 2008 at 9:25 pm

    When I was teaching economics at uni I used to collect these stories to show students.

  2. June 10, 2008 at 6:01 am

    We don’t want to reduce spending in the economy. And if we did we’d want to reduce government spending. Certainly not by tax increases which would be immensely wasteful and destructive. The populist economics has it right and Glenn Stevens has lost the plot. The money supply has been collapsing since December and the collapse continued in April. I’m not complaining about his handling of things prior to December but now he’s lost the plot.

    The economists look at the wrong metrics. GDP doesn’t include GROSS INVESTMENT and so is totally inadequate for quarter-to-quarter comparisons. There can be little doubt that business-to-business spending is collapsing.

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