If I Didn't Have a Hammer

In my last post [https://www.mikeberrywriting.com/mike-berry-blog/2023/1/22/inflation-and-our-discontents] I argued that the recent and continuing rush of the world’s central banks to jack up interest rates in an attempt to get the inflation genie back in the bottle was a mug’s game. It is a policy bereft of intellectual imagination and political courage. In the comment attached to that piece I reproduced a twitter thread from an ex-chief economist of the World Bank who underscored my point that controlling inflation is all about power – who has it and who doesn’t.

Olivier Blanchard pointed out that inflation is tamed with minimum collateral damage when employers, workers and governments broker a deal on wages and prices. Of course, this doesn’t occur in a vacuum. Governments are not neutral arbiters, any more than central banks. These institutions operate within a capitalist system biased towards the collective interest of employers. But – and it’s an important but – tripartite bargaining in good faith (admittedly a big ask after 30 years plus of orthodox theory and policy) ameliorates the normal dynamic of movements in wages and prices when ‘left to the market’ in which significant monopoly and monopsony power is concentrated in the critical sectors of the economy, most notably the financial sector. Amelioration doesn’t mean removal but does mean slowing price increases in a way that allows expectations of the future to readjust without nuclear level fallout – at least until the next outbreak.

Failing reaching agreement central banks are left with the one shot in their armoury, interest rate hikes with the attendant result of enhancing economic inequality and foregoing future rises in living standards on a compounding basis. It has been pointed out if you only have a hammer, every problem looks like a nail. There-is-no-alternative accompanies the exhortations of those who promote the wielding of the hammer. TINA is the last refuge of the scoundrel. (apologies to Dr. Johnson) As I pointed out in my last post, there ARE alternatives open to governments not prepared to abrogate their responsibilities in economic policy and not prepared to see the costs of controlling high inflation concentrated on the backs of those least able to bear the load.

Australia offers a case in point. Post-covid, the federal debt has blown out to a trillion dollars. At the same time, the prospective future costs to federal and state budgets in areas like health, aged and childcare and disability support are increasing rapidly, along with the costs of attacking the multiple threats of climate change baked into current trajectories. Australia also faces the unleashing of income tax cuts in two years, legislated by the recently departed conservative government, that are overwhelmingly focused on benefitting the top five percent of income earners.

What are the alternative tools that governments can use to ‘cool’ the economy? By ‘cool’ is generally meant reduce current aggregate spending by households, firms and governments themselves. Broadly speaking, they fall into three categories. First, increase savings. Second, reduce government spending. Third, raise government revenue. There is, however, a critical factor – time. Some measures work quickly, like pain suffered by a clump on the side of the head administered by a hammer or other blunt instrument. This school of thought believes that pain experienced now will get a positive return quicker. Yes, but try telling that to the person holding his or her ringing ear. If you prefer a different metaphor: quickly yanking out the dangling milk teeth of a child will bring a smile back to its face after the initial yowl.

There is no doubt that raising interest rates in a heavily indebted society will induce an eventual reduction in consumption, private investment, and private savings. Reductions in current savings initially mutes the impact of reduced consumption and investment and thus the cooling effect of higher rates. But as noted, the impact will vary across the economy and society because there are different ratios of current debt to income across households and across businesses. High income households have higher pools of savings to draw down to maintain current spending. The same goes for large corporates with reserves accumulated through their monopoly power and privileged access to capital markets. At the other end, households on their uppers have limited savings and scope to maintain spending. Central banks have relied on private savings built up during the enforced restrictions of Covid to buffer households from the excessive hardships they now inflict. But this buffer is both unevenly distributed and time limited. It is eventually exhausted. With respect to many small and medium-sized businesses, the buffer never existed. Getting through Covid took all their reserves and more by driving up their debt. Particularly at risk are those businesses that fell outside the fiscal support provided by national governments, such as many in sectors like the arts and other areas dominated by the brave sole trader. A very real danger of current Bank policy in countries like Australia is that we will see a gathering storm of chain bankruptcies before the Bank is convinced that inflationary expectations are sufficiently tamed. II is also the case that the cooling effect of reduced private expenditure will be partly offset by the very intervention of the Bank in driving up unemployment, by way of the ‘automatic stabilizers’ in the government budget, encouraging the Bank to go harder: this might be called a Bank-prices spiral.

Housing offers a particularly tricky challenge. (I will reserve for my next post a closer discussion of the housing question since the myriad issues require a separate and more considered treatment going well beyond inflation and in fact is in many advanced countries like my own one of the crowning policy scandals on show. Here, I make a few relevant points.) A large group of households own their houses outright in many advanced economies. They are lightly impacted by rising interest rates, their spending marginally influenced by higher rates on their credit cards and a decline in their paper wealth. Another large group of owner occupiers are paying down variable-rate mortgages and facing escalating monthly repayments. A sub-group (small in comparison to similar cohorts in other countries) are on fixed mortgage rates, many of whom face the imminent reversion of their mortgages to variable rates. Finally, a sizable number (a third in Australia) rent, mostly from private landlords. It is this last group that is most at risk. Skill shortages in the building sector has slowed the growth in the housing stock post-Covid, certainly in my country. Current renters are concentrated in the lower income deciles and face the greatest difficulties in accessing owner occupation, despite (or perhaps because of) marginal, selective government assistance. They face increased competition from households forced out of home ownership and the influx of international migrants, particularly in the major cities. More to the point, falling vacancy rates grant private landlords the market power to gouge higher rents, while further reducing the power of sitting tenants to demand basic repairs and conditions. Landlords are also in a strong position to discriminate against prospective tenants, on racial, gender or other grounds.

Enough has been said to establish that the hammer is indeed a blunt instrument. Are there other tools that would have an immediate impact on current inflation? In the Australian context, one handy though politically fraught expedient would be for the new federal Labor government to rescind or wind back the large flattening of the income tax system that will otherwise kick in in 2025 – that is scotch the sunrise clause that would grant the lion’s share of tax cuts to the top fifth of the population in perpetuity (no sunset here). Not only would that shore up government revenue, but it would also reduce the prospective budget deficits baked into current forward estimates and Reserve Bank calculations on which their inflation forecasts and current interest rate decisions are based. (This is an example mentioned in my last post about the misleading ambiguities built into single figure statistics like the consumer price index.) This would encourage the Bank to pause and begin rate cuts earlier than now lurks in their philosophy.

Other fiscal policies that could ameliorate the uneven fallout of current monetary policy in the immediate term relate to specific ‘cost of living’ relief granted to most at-risk groups. If funded by other selective imposts on, for example, the monopoly profits of large corporations and super wealthy individuals, the expansionary impact across the economy could be minimised.

As always, short term responses to long term challenges are reflexive. What could be done to prevent the recurrence of inflation moral panic? What policy regimes could replace the sole focus on monetary policy and its one blunt instrument? Clearly, one avenue would be to pursue a more genuine competition policy that reined in the ability of large multinational corporations to make prices in their own interests. Genuine tax reform that provided a more secure growing revenue base on which to ameliorate the uneven impacts of monetary policy without slowing the economy and driving up unemployment is, in my view, necessary but would involve a lengthy period of negotiation, refinement and political skill.

Demographic and other forces driving up future federal government spending in the health, care and defence areas will eventually force future governments to increase taxes – but in the long run many people will be dead. Some have suggested radically reforming the determination and execution of macroeconomic policy by creating another independent body to adjust taxes up and down on ‘non-political grounds’, whatever that would mean. But what’s to stop the managers of such a body from adopting the same ‘groupthink’ that prevails at the central bank? Epistocracy or rule by experts is a slippery slope in a democratic society. For all its warts, policymaking by elected officials is the best we have, as long as we the citizens can keep the bastards honest.

Perhaps we should revisit Keynes’ ideas for financing Britain’s involvement in World War II. In his pamphlet, How to Pay for the War, Keynes argued for forced loans by households and bond holders to be returned to them with interest after the war. This was intended to prevent inflation induced by resources shifted to war industries financing the war effort by stealth through inflation raising tax revenue – what tends to be called ‘bracket creep’. As noted earlier, higher saving, forced or voluntary, has the cooling effect on spending sought by policy makers.

It's worth reminding fellow Australians that this Keynesian-type approach has already been tried, twice. In the early years of the Second World War the short-lived Fadden federal government proposed just such a scheme. But as it rivalled the UK’s Truss regime for length of tenure, no such policy was ever consummated. However, in the 1980s a Labor government did introduce a form of forced savings or ‘deferred pay’ by establishing a universal superannuation guarantee scheme, as a measure for securing wage constraint from the trade union movement in inflationary times.

Of course, the main aim of the SGS was to provide for retirement living and to reduce future age pension liabilities. But by a similar means current income could be drawn out of the current spending stream by locking it into short term government bonds or allowing people to boost their superannuation accounts, or a combination of both, but probably with limits so as not to make the current SGS contribute even more to current unconscionable levels of inequality.

There has been much recent heat generated in Australia about whether to allow people to access their super savings early for various reasons, but no consideration has been given to allowing, encouraging, or forcing them to deposit more into their accounts. (I know, this would, under current tax regime overly favour the affluent, thus further reinforcing the case for changing the current regime.) The interest rate on such forced government loans could be discounted to say 50% of the cash rate to minimise the cost to the Budget. Conservatives and tax accountants will scream that they are coming after your money. Yes, it is effectively a tax; after all, it’s intended to take spending out of the economy. But – and it’s a big but ignored by those with a vested interest in not being taxed at all – it’s a tax paid to oneself not the government. Eventually you get the ‘tax’ back with a sweetener to boot – just in time to help the economy recover from the recession inflicted by the central bank’s over-zealous hammering. If inflation moves back into the Bank’s band, you won’t even lose much in real terms. And such a broad scheme would spread the cost of taming the demon beast without heaping the pain on particular sections of the population or locking the economy into a Bank-prices spiral.

I don’t underestimate the difficulties, technical and political of pursuing some of these policy alternatives to Thor’s hammer.  The international constraints posed by interest rate policies in the US and elsewhere do constrain policy makers in smaller over-specialised economies like Australia. I would only say that I see no good reason, in view of the pain inflicted by repeated clumps to the side of the head, not to widen the scope of our imagination with a view to being better prepared next time.

As things stand, the hammer is not ringing out justice and love between my brothers and sisters all over this land (apologies to Peter, Paul and Mary).