The Eurozone, the US, Japan and the UK are all suffering prolonged economic stagnation. [You can see how serious it is in the US here.] It is sensible to suggest that they are doing something (or perhaps many things) wrong and need to change policy.
What is not sensible is ignoring a developed world economy that has conspicuously not suffered any of the economic stagnation problems that have hit the major developed economies. Indeed, has not had a recession (in the sense of two quarters of economic contraction) since 1991. That sailed through the Great Recession and Global Financial Crisis (aka GFC) with barely a ripple. Whose current problems are not of economic stagnation but of maintaining economic balance when one part of the economy is doing much better than another.
That country is Australia. Yes, it is true that the surge in commodity demand (centred on China) has been a boon to the Australian economy (well, to the commodity exporting States; the resultant surge in the value of the $A has been a problem for the tourism-and-goods exporting States—the commodity boom has been a distinctly mixed blessing). But Australia had also managed to avoid recession even when its terms of trade (the ratio of the price of what it sells to the price of what it buys) were in long-term decline and when commodity prices dropped dramatically at the onset of the Great Recession. Indeed, the fall in Australia’s exports as a % of GDP was worse than the US’s.
Yet the Australian success gets mostly ignored. A classic example is Raghuram Rajan’s recent piece in Foreign Affairs. (Non-gated version here [pdf].) Much of what he has to say about the desirability for supply-side reforms is sensible. Indeed, much of what he advocates Australia has already done; which makes the failure to mention what should be the poster-polity for what he is advocating all the more of a glaring failure.
The problem with mentioning Australia is that it does not conform to the stories that Rajan and others want to tell about what went wrong. Rajan essentially ignores monetary policy, both in the commonly offered solutions to economic stagnation (fiscal stimulus and even-lower interest rates: interest rates are a very limited way of looking at monetary policy) and in diagnosing why the economic stagnation descended. So Rajan writes:
today’s economic troubles are not simply the result of inadequate demand but the result, equally, of a distorted supply side.
Australia has done a lot of supply-side reforms, so perhaps it can be ignored. Except Rajan goes on to say:
For decades before the financial crisis in 2008, advanced economies were losing their ability to grow by making useful things. But they needed to somehow replace the jobs that had been lost to technology and foreign competition and to pay for the pensions and health care of their aging populations. So in an effort to pump up growth, governments spent more than they could afford and promoted easy credit to get households to do the same. The growth that these countries engineered, with its dependence on borrowing, proved unsustainable.
Does anyone really think Australia just magically averted such structural problems, that its economy is somehow profoundly different from other developed countries? Given its per capita GDP growth has been respectable but not outstanding. In particular, while its public finances were much sounder, with public debt reduced to very low levels, enthusiastic embrace of private debt meant that the total level of indebtedness was and is comparable to other developed countries.
The story that Rajan wants to tell is that:
the common thread was that debt-fueled growth was unsustainable.
Except, apparently, in Australia. Australia ran a mildly higher inflation rate than the US during the “Great Moderation”, so its monetary policy was more “lax” than “easy money-easy credit” US.
Rajan is claiming that low interest rates are an “easy credit” policy: but credit is a supply-and-demand process. Yes, low interest rates make credit cheap to buy but it also reduces the return on providing it. Something is missing in this story; that a lot of capital was looking for safe havens. Many developing economies might be vigorously growing, but they have also been significantly failing to satisfy the demand for safer assets. Said demand therefore flowed into developed countries: including Australia, which continues to run the substantial current account deficits it has for 50 years (i.e. be a net importer of capital). So, the “too much debt/easy credit” story of sin Rajan (and others) want to tell just does not work if you include Australia.
It is true that Australian financial institutions were not much affected by the GFC and that Australian housing prices have not crashed (yet). The former is, in part, because of superior prudential regulation. This includes the Australian banking trade-off where the “four pillars” (NAB, Westpac, ANZ, CBA) have some level of protection in return for strong prudential oversight. Conversely, the American banking sector is far more fragmented, due to regulatory blocks on inter-state branching. Comparison with the performance of both the Canadian and the Australian banking sectors suggests that this regulated fragmentation has not been a social positive. (The much-discussed separation of investment and deposit banking is much less important.) But the GFC does not explain the Great Recession. On the contrary, a failure of monetary policy both aggravated the GFC and created the Great Recession; as was also true for the Great Depression [pdf].
So, despite “lax” monetary policy, fairly standard levels of indebtedness and a considerable export shock, Australian demand (and so income) did not collapse. Which meant debt remained manageable. Why?
The simple answer is: because our central bank is not mad (unlike other central banks). The RBA looks like a standard inflation-targeting central bank. Except it does not have a fixed inflation target, it has an explicit average-over-the-business-cycle target. Which means that, if output falls, the money supply does not have to follow output down. On the contrary, counteracting monetary stimulus “smooths out the bumps”. The effect is not merely to anchor price expectations, but to anchor income expectations as well. We did not end up in the situation where people are nervous about their income expectations but confident in their price expectations (i.e. the future-swap-value-of-money), which then encourages people to hold onto their money, which leads to less transactions and so less income (income being someone else’s spending; i.e. price x transactions), which increases concerns about income, leading to a downward spiral in transactions. Low interest rates are not a sign of “easy” money; they are generally a sign of “tight” money; of money being expected to retain—or even increase—its average swap values. (Inflation expectations in the US are currently very low while cash flow uncertainty can have, unsurprisingly, a significantly negative impact on corporate investment and employment.)
The RBA is also an example of the Australian ability to “do” bureaucracy. It has a clear policy focus, set out in a public letter of agreement between the Governor and the Treasurer, and a strong organisational identity that extends to deliberately investing in developing the skills and experience of its staff.
Rajan wants to tell a structural story for an economic downturn. Certainly, one understands the temptation of a crisis: “oh look, a crisis!, now I can get my favourite reforms through”. But that does not make it sound economics. On the contrary, there simply is no necessary trade-off between dealing with short-run level-of-economic-activity problems and fixing long-term structural problems. (And something that is clear enough to a high school student, however scarily smart, should probably be clear to a full professor.)
If income collapses, debt becomes much harder to manage. If your income does not collapse, you are much less likely to have a debt-management problem. Yes, lots of developed countries are having debt-management problems. But that is not because they were strikingly more indebted than Australia (even if their public debt levels are higher). It is because spending, and so income, did collapse.
Rajan’s penchant for false dichotomies does not just manifest in short-term/long-term trade-off claims, it also extends to excluding policy possibilities:
The way out of the crisis cannot be still more borrowing and spending, especially if the spending does not build lasting assets that will help future generations pay off the debts that they will be saddled with.
Someone’s future liabilities are also someone else’s future income (which is why debt defaults worry folk so; yes, it eliminates someone’s liabilities but it also eliminates someone else’s assets: this also increases your risk premium for any future borrowing). But, leaving that aside, there can be spending without borrowing: that is the joy of monetary stimulus. Yes, the fiscal multiplier is a measure of central bank incompetence. Yes, the monetary authority “moves last”. But, if it is competent, it chooses to move in ways that do not create catastrophic collapses in spending and so income. If people have more confidence in their future income prospects, they will spend. And, if they spend, income goes up and debt becomes much more manageable.
Yes, it would be a good idea if developed countries reformed their public sectors, if they abolished regulations that protect incumbents and retard economic activity, if they got their debt levels under control. All things Australia has done (but, in some areas—notably its land use permit raj’s—not enough). But neither the Great Recession nor the Global Financial Crisis would have been anywhere near as severe if the US, the UK and the Eurozone had had central banks as competent and accountable as the RBA. If they now became as competent and accountable as the RBA, economic recovery would occur much quicker and unemployment would fall much faster. The alleviation of utterly unnecessary human misery would be worth it all on its own. And structural reform could be sold as providing benefits, not simply sharing pain. Pain that, moreover, will not get folk spending again: for that, you have to change their expectations in positive ways. Which central banks can do more thoroughly, and far more cheaply, than anyone else. All it takes is to be as competent, and as accountable, as the RBA.
It is very, very necessary that folk start using the A-word, and considering the example it provides, a lot more.
