The RBA is content to be unconventional but not original
Last week RBA Governor Phil Lowe seemingly dealt a savage blow to proponents of the new economic policy frontier that is Modern Monetary Theory (MMT).
Governor Lowe asserted in his annual Annika Foundation speech that MMT “is not an option under consideration in Australia, nor does it need to be.” This is perhaps not surprising given the conservatism that is such a hallmark of the Reserve Bank - a characteristic that historically has served it reasonably well. However it is arguable that this seems to be too definitive, or perhaps too pre-mature, an edict given the challenges to be faced by policy-makers in a post-Covid economic environment.
The Covid crisis has already pushed the RBA to employ unconventional policy it never thought it would. Despite that reality, the Governor has told us that the RBA is content to push us further into the unconventional, but not into anything remotely original. This seems disappointing given we’ve observed the reduced effectiveness of the RBA’s conventional policy tools and the mixed experience of other economies with more accepted unconventional policies.
Lowe’s critique of MMT arguably falls flat on a number of grounds. Notably he contends that direct financing could induce government spending that may “push inflation up” and increase the level of interest rates. These seem like desirable outcomes for a central bank, that has, like its global counterparts, failed to sustainably hit its inflation target for the better part of half a decade and is at the lower bounds of its own interest rate policy.
His assessment that someone else always pays, and there is no “free lunch” with direct financing is equally true of the policy he advocates; a more traditional government debt which is paid for by current and future taxpayers. While it is true governments can borrow on historically inexpensive terms, two questions remain - will it, given its track record of fiscal conservatism? And should it - given the burden it may place on future generations?
Few economists are devoted disciples of the new world of Modern Monetary Theory, but given the unprecedented economic challenge we currently face and could in time face again, we should not blindly stick to a failed status quo either. Governor Lowe asserts advocates of direct financing do so because they believe conventional monetary policy is “exhausted” and “falling short of its goals”. He is clearly not of this belief. But he has certainly alluded to the reduced effectiveness of monetary policy. And this is evidenced by the RBA falling short of its inflation mandate and the objective of full employment for an extended period of time.
Rather than following other central banks into further ‘acceptable’ unconventional policy that involves massive central bank balance sheet expansion and public sector debt, we owe it to those on the rapidly growing unemployment queue to explore policy options that complement the existing settings - if only given the demands of extraordinary economic circumstances, such as those now.
There is an argument for embracing the original to counter this likes of this current economic shock. Temporary direct financing of government support in times of recession seems appropriate, to provide households and businesses with an adequate and sustained safety net to see them through. The advantage being this would not come at the detriment of government finances, as we observe currently, that would require ongoing future fiscal conservatism (likely to entail taxes being higher and spending being lower than they might otherwise be) for balance sheet repair.
The threat of inflation in a recession would clearly be low given a negative output gap and spare labour market capacity.
There is also a strong argument to provide consistent and sustainable financing of infrastructure. I wrote in the Australian Financial Review back in 2016 about “Helicopter money for Infrastructure” - putting forward the proposal that the central bank could finance necessary projects arrived at by an independent body expediting them to the construction phase. This would underpin jobs and growth in times of crisis, improve productivity outcomes and take pressure off state government balance sheets.
These assets could then be ‘recycled’ to private investors who would readily purchase them and provide funds back to governments.
These proposals would be limited in terms of the quantum of finance, the timing and direction from incumbent governments. Indeed, one of the key drawbacks of MMT concepts, highlighted by Lowe, is that governments get blank cheques for recurrent spending. This is clearly an undesirable outcome.
Conventional fiscal and monetary policies backed by a limited program of MMT may at least provide some additional defence against future downturns and indeed be a part of the solution to break the secular stagnation that grips advanced economies. It seems remiss of policy-makers and economists to not at least explore all options as the economic environment, and the challenges it faces, evolve. Policymakers relying on the models of yesteryear run the risk of continuing to fail to meet their objectives - to the detriment of the nation’s economy and the living standards of its people.
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Alex is IFM Investors’ Chief Economist and has well over a decade of experience in the field. He is responsible for the firm’s economic, financial market and policy analysis and forecasting and is also a member of IFM’s Investment Committee....