‘Four bullets left’ to save economy

 

A weird thing happened a little while ago. A joint press appearance featuring the Treasurer, who is aiming for a surplus, and the independent RBA Governor, who has been slashing interest rates.

The appearance was seemingly designed to give the impression the pair are on the same page about how the economy was going.

They emphasised what they agreed on. But behind the scenes, it's not so clear they agree about the trajectory of the economy - are we on the brink of sunny days or disaster? It's also not clear who needs to step in to save it if the latter scenario comes true.

WHO BOOSTS?

The RBA been hinting that it wouldn't mind a bit of help in boosting the economy. It is nearly out of ammunition.

The RBA cuts interest rates, as we know, and it cuts them 0.25 percentage points at a time. When interest rates were at 1.5 per cent it had six bullets left. In June they fired a bullet and rates went down to 1.25 per cent. In July, they fired another one and interest rates went down to 1 per cent.

There's four left, before monetary policy has rates at zero and they have to move to weird new options this country has never seen before, like negative rates of quantitative easing.

It makes some sense, that instead of using up your last conventional ammunition you might ask for a bit of assistance. Treasurer Josh Frydenberg can use fiscal policy - spending and tax cuts - to boost the economy.

RBA Governor Philip Lowe (left) meeting with Treasurer Josh Frydenberg last week. Picture: The Australian Pool, David Geraghty/AAP
RBA Governor Philip Lowe (left) meeting with Treasurer Josh Frydenberg last week. Picture: The Australian Pool, David Geraghty/AAP

Indeed RBA Governor Philip Lowe has been asking for a bit more of that consistently in recent times, using language that - for an RBA Governor - counts as strong.

"There are certain downsides from relying just on monetary policy … as a country, we should also be looking at other options to reduce unemployment," Mr Lowe said in early June.

"One option is fiscal policy, including through spending on infrastructure," he said in late June.

In early July he said, "Over recent times I have been drawing attention to the fact that, as a nation, there are options other than monetary easing for putting us on a better path."

He repeated his call for infrastructure spending and fiscal support.

A week after that last comment he showed up at the press appearance, which came following a meeting between the pair. What happened at the meeting is hard to know - but this week the Treasurer was optimistic about the discussion.

"The meeting I had with the Governor and senior Treasury officials last week was very productive and constructive. We discussed issues relating to the domestic economic outlook," Mr Frydenberg said.

WHERE DOES THE RBA FIT?

The RBA is part of government, but independent of the elected officials. The reason for keeping it independent is because it controls interest rates. If politicians controlled interest rates they would promise rate cuts before every election. Who could resist?

The Reserve Bank of Australia is fast running out of options. Picture: Bianca De Marchi/AAP
The Reserve Bank of Australia is fast running out of options. Picture: Bianca De Marchi/AAP

That would eventually cause inflation to zoom out of control, because if you cut interest rates when the economy is strong, the economy can "overheat" and start producing not just growth but also inflation.

That's what the RBA is doing every month when it fiddles with interest rates - trying to make sure we get the healthiest possible economy without high inflation. (At the moment inflation is just 1.3 per cent, which is very low, so they have cut interest rates.)

Independent central banks are arguably one of the great inventions of the last century, responsible for the moderate level of inflation we've enjoyed in the last two decades, well below the rapid price rises of the 1970s. Their advice is valued because of their independence and it can be wise for a Treasurer to take it.

THE PRESS APPEARANCE

The press appearance itself didn't have much content. Both the RBA Governor and the Treasurer said a few things. They both announced they agreed the economy was growing. Which is literally true - it grew 1.8 per cent over the last year - although they didn't mention how unimpressive that is.

"We both agreed that the fundamentals of the Australian economy remain sound. Australia is in its 28th year of consecutive economic growth," Mr Frydenberg.

"I agree 100 per cent with you that the Australian economy is growing and the fundamentals are strong," Mr Lowe said.

Lowe and Frydenberg were keen to show they were singing from the same hymn book. Picture: David Geraghty/AAP/The Australian
Lowe and Frydenberg were keen to show they were singing from the same hymn book. Picture: David Geraghty/AAP/The Australian

The statements are clearly designed to give the impression the Treasurer and RBA are aligned - but they don't cut to the heart of the issue, which is whether the Treasurer should give things an extra boost.

THE ECONOMY

The RBA is doing what it can to make the economy grow and cut the unemployment rate to 4.5 per cent. The Treasurer, meanwhile, is hellbent on getting a surplus, that magical prize.

As he focuses on his dream of a balanced budget, the economy is sputtering along. The latest unemployment figures show the economy added just 500 net new jobs in June. Australia's population grows by around 33,000 new Australians a month, so we need to add around 20,000 new jobs a month just to stand still - 500 is not enough.

Unemployment is at 5.2 per cent, and underemployment is 8.2 per cent, both well above the level that would make the labour market "tight" and lead to wage rises.

There's a strong argument that the RBA Governor is right to tell the Treasurer to pull his finger out. After all, it's only the Treasurer who can spend money to make the economy surge.

It's only the elected politicians who can change laws to make the economy's growth easier.

The Government, to be fair, is doing something. It has promised a $1080 tax offset to middle income earners, which you get after you do your tax return. That's a good example of how the government can get more money out into the economy and prop up spending. It has also made some vague promises to cut red tape for business.

But if you look at the data, you have to ask if it's enough. The unemployment rate fell to 5 per cent earlier this year, as the next graph shows. That was good. But when we needed it to fall to 4.5 per cent, it did the opposite and started going back up.

After a small drop, unemployment is rising again. Picture: Supplied
After a small drop, unemployment is rising again. Picture: Supplied

If the unemployment rate keeps rising, we will need to make sure that we do more to stop it. And that might mean the Treasurer has to listen to the independent central bank.

Jason Murphy is an economist. He is the author of the new book Incentivology. Continue the conversation @jasemurphy



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