For the economy, the malaise lies in policy and reporting, writes Matt Zaunmayr.
Another woeful inflation print this past week has finally brought into view the spectre of a Reserve Bank of Australia (RBA) cash rate cut. After a record streak of neutral policy, going back to 2016, the impetus is there now for the central bank to put some stimulus into the economy.
Typically, at this point, the economy would be decelerating from above-trend growth – in wages as well as GDP. Inflation, also would typically have spent a considerable period at least at trend. This however, is nowhere near the case in Australia at the moment.
Inflation has scarcely bothered the RBA’s target range – 2-3 per cent – since even before the last time the cash rate was cut. For the first quarter of 2019, quarter-on-quarter inflation was nought. Meanwhile, wages have been stagnant. Real wages, at times, have gone backwards.
If you listen to the government of the day though, you would be forgiven for thinking that things in the economy are much rosier than you’re currently experiencing. The Liberal party has been spruiking growth and unemployment figures as evidence of its sound fiscal management. The former has been okay and the latter, admittedly by the numbers, has been impressive.
An unemployment figure starting with a 4 and constant monthly new job figures of 20-40,000 are undoubtedly indicators of a traditionally strong economy. The government believes this and for a long time, the RBA and most other economic analysts also believed it.
Even though inflation – the key measure by which the RBA makes its policy decisions – has never really looked like permanently breaking into the target range, the central bank and the market alike have been leaning towards rate hikes for the majority of the time rates have been on hold. They have been convinced of the trajectory of the economy.
Strong employment leads to wage pressure leads to inflation leads to growth says economics 101. Except that it hasn’t. The RBA and the market have slowly come around to this. The RBA seems now to have an easing bias and this has been more than 50 per cent ‘priced in’ by the market – boffin speak for being more likely than unlikely.
Many analysts predict two rate cuts before the end of 2019, which would have the cash rate at 1 per cent. This is historically low for Australia, but looking at other developed countries around the world, still leaves some bullets in the chamber for further monetary stimulus.
So it appears the economy has been through a full cycle then, without there ever being any real, felt benefit to most of the people that are actually in the economy. Why have the experts been so well fooled for the last three years? Because the traditional economic transmission of higher employment to higher wages to higher inflation and higher growth is broken.
This much seems obvious, but why and how? And how can we reconcile this better to analyse the current and future states of the economy.
The why and how
To fully understand how these fissures in the real and analysed economy have developed, it is important to understand how the politics around the economy have evolved since the financial crisis of 2008.
At the time, the Federal Labor government undertook a typically Keynesian response to keep the wheels ticking over. It pumped money into the economy. Fiscal stimulus meant spending on infrastructure to bring jobs and growth into the economy, in spite of the hole in private investment that was caused by the crisis.
Monetary policy was also deployed. The RBA slashed the cash rate by an astonishing 425 basis points between August 2008 and April 2009. A textbook response to try to stimulate investment in the economy via the provision of cheaper lending.
These responses worked. Australia, unlike the rest of the developed world, avoided a recession and continues to do so. The consequences of the policy action though was a ballooning budget deficit, which a cunning Liberal party in opposition knew it could exploit to its advantage.
Thus, what was sensible economic practice at the time was painted as fiscal irresponsibility. When the Liberal party came to power in 2013, it had to respect its own message and get to work on ‘budget repair’. The deficit continued to widen at first but it has been brought back to the point where it is nearly in operating surplus.
There is of course the argument that this is more due to blind luck of high commodity prices and bracket creep than responsible economic management – but that is an argument for another time.
The consequence for the economy has been that the government has been scything away well-paid, publicly funded jobs, preferring a public-private method of infrastructure delivery which squirrels public money into private accounts without the social dividend of a high-paying jobs. Public spending has indeed continued apace, but too often the benefits have been subverted for political or private gain.
At the same time, Australia’s economy has become dominated by the services sector – where employment is poorer-paid and more tenuous. Often, the only way these workers can get a pay rise is through a government mandated minimum wage raise. There’s been buckley’s chance of a meaningful one under this government.
So absent of effective fiscal policy, monetary policy has been left to do the heavy lifting in the economy. It has been trusted to keep the engine well lubricated via cheap lending rates. This creates an illusion in the economy though. Growth rates can easily be stimulated by high demand and surging real asset prices. For a long time in Australia, they were.
The problem with this kind of growth though, is it tends to be dominated by those who can keep getting their hands on the easy money, i.e. those who already have something to leverage. This distorts growth. While the savings of the middle- and low-income earners have evaporated, company profits and shareholder dividends have soared.
That economic growth which we were assured by the experts would filter into wages, has only filtered into the wages of those in the top quartile. This isn’t growth that stimulates the real economy. For that, middle- and low-income earners need to be able to save and purchase in greater quantities. This ability has been eroded.
There is no quick fix for this economic and analytical malaise. The political conversation on the economy is now so narrow and dumbfoundingly spiteful that it isn’t clear whether either side has the ambition or nous to embark on the kind of stimulus that helped drag Australia relatively unscathed through the financial crisis.
Smarter, more accountable fiscal policy is needed. Fiscal policy that is targeted to deliver high-paying jobs for those that need and are qualified for them. This will stimulate spending in the economy and spending begets investment and investment begets more jobs. Then we may see some broader-based health in the economy.
Analysts though, can easily pick up their game in the reporting of the economy. A roaring stock market does not mean the real economy is ship shape. Strong employment figures are a narrow indicator if you don’t look exactly where that employment is. Economic growth is not an indicator of economic health at face value.
The data is there to dig deeper on these numbers and analysts can and should. After years of incorrectly forecasting that strong employment growth will lead to wage growth and economic health it is unsurprising that Australians should feel detached from the data they are being shown.
For its part, the RBA would do well to refocus on its inflation target. Once upon a time it had the gumption to raise or decrease rates by multiple increments at a time. Now, even a slight change of language in the monthly statement causes ripples in financial markets. This has contributed to a clouding of the RBA’s vision. Neutral policy for nearly three years in the face of a constantly undershot inflation rate is beginning to look unjustifiable.
Ultimately though, as discussed above, easing monetary policy can only do so much for the real economy. Unless middle- and low-income earners can get access to better pay, the detachment between economic analysis and the real economy will continue to grow.
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