Monetary offset in Australia
Stephen Kirchner quotes from Treasurer Wayne Swan’s briefing notes from August 8, 2008:
There are three broad considerations the Government would need to keep in mind in taking a decision to engage in discretionary [fiscal] action:
– The Reserve Bank through its control over interest rates, determines the overall level of aggregate demand in the economy, and the Bank would likely take account of any fiscal stimulus in its monetary decisions – that is, more spending would keep interest rates higher than otherwise…
The bottom line is that in the event of a shallow downturn, discretionary [fiscal] action may not achieve any noticeable outcomes in terms of growth and unemployment, but would leave rates higher, erode the [budget] surplus and put at risk the Government’s fiscal credibility.
These costs of course need to be weighed against the potential political costs of being seen to do nothing…
Then Stephen comments:
Needless to say, the ‘political costs’ argument won in the end, with the first discretionary fiscal stimulus announced in October 2008.
Because rates have never been at zero in Australia, I presume Paul Krugman would agree with Stephen and I on this point. Perhaps someone can search to see if Krugman commented on Australian policy.
Tags:
14. August 2014 at 11:49
http://krugman.blogs.nytimes.com/?s=australia
That’s the URL for a search on Kruman’s blog for Australia. 16 mentions over fewer posts over the past 6 years. Most of the mentions happen with respect to the fact that Australia has run an account deficit for about forever. A few mentions to the fact that Australia is just about the only advanced country that hasn’t fallen into a liquidity trap but no actual comment about why that may be.
14. August 2014 at 12:23
I remember Joseph Stiglitz in 2009 or so, attributing the benign situation in australia to fiscal stimulus.
As you might know, Stiglitz is also pushing for some time now that monetary policy in the us should be tightened.
14. August 2014 at 12:56
Thanks Joseph.
Sven, Yes, Stiglitz’s views on money are very different from Krugman’s.
14. August 2014 at 13:39
Scott,
The position that monetary offset nullifies the benefits of fiscal stimulus seems to be based on an assumption that the monetary authority reacts to private and public financial/investment decisions in this rational context and acts appropriately. Given your belief in the Fed’s overly tight money policy at the start of the recession and continued tight monetary policy being causes of insufficient growth I am having a tough time reconciling the two. One argument states the Fed isn’t reacting appropriately to changes in economic activity (public or private) and one states that it will of course offset fiscal with an appropriate monetary response. Am I missing the delineation? Is it your stance that they only adequately tighten to offset expected economic activity and don’t loosen appropriately?
If you are the government and they see economic activity faltering but you don’t expect the monetary authority to go far enough do you think they should act or not?
14. August 2014 at 15:40
I think Swan is talking about the fiscal stimulus itself raising interest rates, rather than the stimulus being counteracted by a rate-raising RBA; that would seem to be more in line with how he thinks about economics (more traditional Keynesianism).
Interesting to see him tell the barefaced truth about what he expected from his flagship policy from the outset, though.
14. August 2014 at 18:36
Chase, This is a very complex issue, and I have many very lengthy blog posts discussing all the angles. You said:
“If you are the government and they see economic activity faltering but you don’t expect the monetary authority to go far enough do you think they should act or not?”
No, the short answer is because even if the central bank is inept, I see no reason to assume they would not offset the effects of fiscal policy. It’s true if they are inept in a highly specific way then fiscal stimulus can work, but as we saw in 2013 they don’t seem to be inept in that particular way.
Saturos, How is what you said consistent with this paragraph:
“The Reserve Bank through its control over interest rates, determines the overall level of aggregate demand in the economy, and the Bank would likely take account of any fiscal stimulus in its monetary decisions – that is, more spending would keep interest rates higher than otherwise…”
Especially the third line of that paragraph.
14. August 2014 at 19:28
BTW and well worth mentioning is that Australia’s central bank targets an inflation “band” of between 2 and 3 percent. While I much prefer Market Monetarism, a mildly higher inflation-rate band as a central bank target is perhaps worth considering.
I do not know how they measure inflation in Australia and so do not know if their inflation band is much more accommodative due to measurement considerations. But is it is worth noting that evidently the Australian public is fine with a 2 to 3 percent inflation band. Are Americans so different?
14. August 2014 at 20:57
Benjamin, the RBA’s target refers to headline inflation, but the RBA most closely watches core measures and frequently ‘looks through’ temporary impacts such as the introduction of the GST, the carbon tax and the recent AUD depreciation.
14. August 2014 at 21:09
Ah, I suppose the word “keep” makes it sound more like the Bank is doing it than the Treasury. Perhaps.
15. August 2014 at 03:06
If it is wrong for those of us on this blog to take people’s money against their will to spend on ourselves, and if it is wrong for us to counterfeit money to spend on ourselves, even if doing so could increase the number of labor hours devoted to projects in line with our wants and desires care of our spending, why is it not wrong for those with badges who call themselves government to do this?
15. August 2014 at 03:14
“in the event of a shallow downturn, discretionary [fiscal] action may not achieve any noticeable outcomes in terms of growth and unemployment, but would leave rates higher”
Why would discretionary fiscal policy leave rates higher if it had no effect on growth and unemployment?
He seems to be assuming that the central bank would want the economy to remain in a recession.
15. August 2014 at 03:30
I’d like to echo Rajat: it goes deeper than the headline numbers on their acceptable inflation band. They have a good attitude about inflation in general.
Also, if you look at the evolution of their inflation rate and their rate target, it looks like they will hit the ZLB one of these days if the rest of the world doesn’t figure something out soon. I’m sure they will still do fine, though, they seem to understand that their job is to prevent recessions, not assure the world that the recessions would have been worse without them.
15. August 2014 at 03:36
MF,
the obvious answer would be that they’re not taking people’s money against their will or counterfeiting money.
15. August 2014 at 04:11
Nick and Rajat: thanks for your replies. Actually my question goes even deeper in that there are different ways to measure inflation. Perhaps the Australian method of measuring inflation comes out with a result 1-2 percent lower than the American method.
My real hope is that a central bank with an inflation band could mimic the policy choices that a market monetarist central bank would make.
15. August 2014 at 04:49
Scott not sure how to look at this. We have had pretty good federal deficits since 1980, and a secular decline in interest rates. Total government expenditures (state & local) have grown at a pretty good clip, though the annual rate has been in a secular decline. In the end we have short rates near zero, and long rates are historically low against a fiscal policy that includes persistent federal deficits, and growing government spending. Should we look at the real rate of change?
So rates are higher than otherwise with the fiscal policy? Just Does not feel that way, and government spending adds to NGDP.
http://research.stlouisfed.org/fred2/graph/?g=HNc
15. August 2014 at 05:17
Chase,
If I understand correctly, the offset argument means that fiscal stimulus is only likely to be effective if (1) the central bank actually wants to increase the money supply by more than it is accomplishing, but won’t because of political or perceived practicality concerns; or (2) for some reason, the central bank is completely indifferent to effects of fiscal policy on the money supply.
Both of those are pretty specific and unlikely, so you have to guard against people who want fiscal stimulus to be effective and therefore assume one of them to be true.
15. August 2014 at 06:19
Benjamin,
International comparisons of CPI are a bit above my level. I think Australia includes new home prices in CPI instead of imputing rent, but I don’t see how it would cause systematically lower reads.
The way they build up the basket and select the means for price movement seem to allow for a fair amount of substitution: (http://www.abs.gov.au/ausstats/abs@.nsf/mf/6440.0)
15. August 2014 at 08:13
Matt, the graph you link to is accounting, not economics. Here’s another accounting relationship:
GDP = GDI = C + Taxes + Gross Savings (including depreciation)
Can I presume that you believe higher taxes or higher saving would boost GDP, because they are a component of GDP?
I do agree one issue, deficits have very little impact on interest rates.
15. August 2014 at 09:53
Nick—thanks for the link. Yes, it would be a serious undertaking to compare one nation’s econometric methods against another’s. In the USA it may be even the PCE deflator overstates inflation, due to rapid evolution of hoods and services.
15. August 2014 at 10:12
Scott, did not mean to reference accounting. Just curious about the statement that “fiscal action would leave rates higher, erode the [budget] surplus and put at risk the Government’s fiscal credibility”.
Japan and the US have had growing government budgets, deficits, and debt – but rates are near zero at the short end, and low longer term rates. That chart was just to show the rate of growth of total US government expenditures, and broke out federal.
So we agree that deficits have little impact, but what about fiscal spending growth?
15. August 2014 at 11:54
Matt, Fiscal spending growth has relatively little impact on interest rates. Not zero, but the effects are swamped by other factors like NGDP growth.
17. August 2014 at 23:21
Not only did they know it would happen, it in fact did happen. I’m too lazy to do it again, but a couple of years back I dug out the budget papers showing the fiscal splash and a chart of RBA decisions and you could see the RBA respond when the Govt went big on the spending. From memory the tightening started in 2009.
In fact I’m not that lazy so here is a link
http://australianpolitics.com/topics/rba/interest-rates-since-1990
You can see the tightening round that started in Oct 2009
and this
http://www.budget.gov.au/2008-09/content/uefo/html/part_2.htm
18. August 2014 at 04:26
Thanks Peter.