Is it time to rethink monetary policy? A question from Ross.

Welcome to Finance and Fury, the Furious Friday edition.

Today is more a Say What Wednesday episode, I need to catch up on some of your questions and this one fits in nicely. This is a question I got from Ross about rethinking monetary policy.

“Am currently reading Stephanie Kelton’s book the deficit myth. As she is a proponent of MMT Explaining her perception of debt inflation. And the role of government in the way money is distributed in the economy. As well as the way taxes are used to incentives behaviour rather than just a means for revenue. She makes a point that when nearing low unemployment, wages should rise and then consequentially so should inflation. She argues that the feds decision of how much slack should be allowed in the economy is often misguided, and basically says that monetary economist demand that unemployment is necessary. Which leaves a winners and loses overview of the overall economy. So to ensure we don’t pay too much for anything people have to be unemployed. How can this be morally justified and is the opportunity as she argues to reach full employment while having our parliament along with the federal reserve better utilise issued currency and taxation schemes to manage the rate of inflation so that people aren’t left behind?

As we have seen in the US unemployment was like 4% yet inflation remained low. How do you explain this phenomenon and is it perhaps time to rethink monetary policy around the developed world?”

This is a great question – lots to run through

Role of Governments in the economy – and role of CBs The theory of unemployment and if it is necessary or not – and who the winners and losers are

I am familiar with Stephine’s work – havent read this book but started seeing her name pop up in researching MMT also following politics – Bernie sanders economic advisor 

At the core of this concept – Theoretical framework in political economy – called public choice –

The founder James Buchanan – think about politics without romance – this means looking at the actual effects of a policy as opposed of idealistically assuming that we will end up with the kind of perfect outcomes promised – as they only exist in people’s imaginations No policy is perfect – system is complex – due to it being complex there is no algorithm or model to predict what will happen outside of the potential of a first-order effect – Basics flaw of any policy decision making Michael Munger – calls this unicorn Governance – its not enough to judge a policy or a theory by its intentions – or by what you hope will be the end result – you might get what you want initially – but could have bad long term effects – Concept of Second-Order Effects – actions have an intended consequence (outcome) - each consequence has another consequence, and so on. Thing that is forgotten about in Governments – As the second or third consequences only appear once they leave office dominoes—1000 lined up, one tap causes a chain of events to occur - Once it starts - difficult (if not impossible) to them all falling down For instance, the view of taxes are used to incentivise behaviour rather than just a means for revenue has been proven to be ineffective. For example, when they are used to influence behaviours (like tax incentives for “going green”) and reduce the incentives for others (e.g., taxes on tobacco and alcohol), the end result in most cases has created a taxes on the poor. Make prices high on those goods – which are disproportionately spent on by those in lower income brackets – Similar to the alcopop tax – did it reduce peoples drinking? No people just bought a whole bottle of vodka In addition, the notion of taxes being used to help curb inflation is a method of indirect pricing controls – has second-order effects Example of price capping – Cap Electricity Prices – outcome is flat prices (whatever regulators decide) First Order – Electricity suppliers set their prices to the cap price Second Order – Electricity supplies (companies) revenues may decrease – Especially over time with increase in their costs – (wages, transport costs, inputs into electricity like coal) Third Order –- The share values start to decline as investors flee for fear of limited future potential returns Fourth Order - Profits begin to fall for the energy supplies costs go up but prices are capped Fifth Order – Share values begin to plummet – reducing the capital the company can raise – reducing ‘Capital Expenditure’ CAPEX – What companies spend on large projects to grow the company – Energy company – Origins Gladstone pipeline – billions of dollars spent on upgrading for energy needs – Gas – a lot cleaner than Coal Sixth Order – Companies begin to have to let employees off, reduce maintenance on the infrastructure, and so on. Sounds a bit far-fetched – but it happened in California in the 90s – in RSA - happens across all things Rent control in NYC – After WW2 - provide returning veterans with affordable housing - so city’s housing commission capped rent prices (with no increases) in certain areas of the city law - rent control couldn’t be removed form an apartment unless the original tenant moved or the building was condemned Noble but the cost to maintain properties continued to rise - landlords couldn’t raise rent prices to compensate for their increased costs. landlords refused to upkeep the property—it was a waste of money -Financially – better to let the building deteriorate around the remaining tenants over time there was a decline in the quality of property and eventually supply, as buildings were condemned making housing even more expensive — the opposite of the original intent The more complex a system is – the greater the number of Second-Order Effects Consequences can be interrelated or dependent upon each other in millions of different ways Uncertainty guarantees that nobody knows exactly how exactly – not at the first consequence, or at the 20th. Every action has a consequence, and those always have their own consequences – even if you don’t know they will That is what is so dangerous with Government Policy – Especially those granting Positive Rights, not protecting Negative Rights Approach making changes to a complex system with extreme caution: what you get may very well be the opposite of what you expect.

 

The issue is that at the core of all of this, MMT is assuming that Governments are now more responsible for the economy

In my personal views, they haven't been able to manage their own departments or budgets well due to no market feedbacks along with a lag in decision making. Track record - Any time governments take further control of the economy – increased regulations - slow decline has been witnessed – extreme examples – Socialism – Complete control – unicorn governance – did it end up better for the people long term? under MMT – not truly socialism – as they don’t take over the companies that produce- but at the top level they take over the very cost of money and control of price gains – take over the disbursement and allocation of money The question – will these policy decisions lead to a better outcome? It assumed that economists and politicians have better foresight and have better intentions than the individual Went through recently the fact that every one of the Feds board members are multimillionaires based on their asset holdings Do they know what is best for the average person? Or what will make their own portfolios and asset values go up further? Policy responses in relation to a statistic are not a good way to approach this –

Especially when the measurements can be flawed - Gov inflation stats or unemployment stats shouldn’t be taken at face value – or policy shouldn’t be built around these – but it is –

Inflation – CPI measurements - general level of price growth – First- it ignored economic innovation and assumed that future demand does not vary from the historic Secondly – it is rife with statistical manipulation - such as import substitution of goods even though it is meant to measure the statistical concept of indexing domestic consumer prices In western nations that are heavy on importing cheaper goods overseas – gives the appearance on costs going down – Also – doesn’t actually take into account the real price increase but the increase assuming no difference in products – called Hedonics -the science of trying to work out how much product quality has changed and adjusting inflation to take account of the fact more expensive products are not just inflation - but due to improved quality Example - original iPhone versus the ones now- it would discount the cameras and additional features as those as product improvements and reduce the cost to match the base rate cost – even though people are paying more Looking at alternatives – non-governmental statistics that measure price growth – Chapwood index comprised of 500 constant items -shows an approximate 10% annual rate of price inflation – also Shadowstats gets a similar 10% approximation Therefore - policy of targeting a general level of prices through broad-based indices such as the CPI has issues in what these stats actually represent – making policy even less efficient Unemployment - To be included in the unemployment statistics, you have to have had looked for work and were available to work in the reference week, or were waiting to start a new job. unemployment theory in general works off the basic assumption that these segments of people are firstly, willing to work in any role (which a lot of people aren't), but it also doesn’t account for the fact that in the statistics there are transitional workers included – if someone is taking a months break before starting their next job = unemployed It can take time to find the right job that people want – so can take a few months before one comes up Beyond the statistical measurement – which is conducted by a survey - When it comes to this theory of unemployment, monetary policy does look at the "sweet spot" for unemployment. The theory of this is that the labour market will reach a point where each additional job added does not create enough productivity to cover its cost, making every successive job after that point inefficient and detractors to any business (or Government) that hires them Would a business hire someone for $60,000 if it may only help their productivity by $30,000? No Well – why don’t they hire them for $30k? well they might be allowed to due to award agreements and minimum wages – Looking at the morality - The morality of these sorts of proposals focus on one side, the equality of the economy and think of it as an aggregate – these stats and theories don’t take individual choices or freedoms into account Could be argued that it is not moral for the Gov to say that Businesses have to pay $25 per hour for labour As what if someone wants and job and would be willing to get paid $20 p.h. – but the business cant afford $25 p.h. – so that individual doesn’t get that job and has to keep looking There is also the wage inflation theory that comes from an increasing demand through low unemployment - Ross – point in the book – need to have unemployed to ensure we don’t pay too much for anything – and so wages don’t rise Going back to the Statistics – a number like 5% assumes that these people are the always unemployed Not the same people month to month though - When looking further into the 'long term unemployed' (i.e. individuals who have been looking for work for longer than 52 weeks), this represents around 15%-25% of those who are unemployed – so if unemployment is 5% - then 1% long term unemployed – so are we experiencing inflation – cause 1% as long term unemployment is pretty low – but these are people who can’t find work Why might they not be able to find work? But also, why don’t we see inflation or wage rises? – These jobs no longer exist in Australia and goods are imported from overseas from cheaper labour countries – Could it be that unemployed people are a by-product of the costs of production being too high? Government regulations – minimum wages and award wages – puts companies in a tricky spot – small and medium businesses can’t offshore – but large companies can – and reduce their taxes – so it creates an unfair playing field But through globalisation policies and free trade – this has created the trade of labour – sending work overseas – holden plant – based around costs of labour and regulations – had to be subsidised – in the end failed and all those jobs gone – is it moral that all those jobs were lost? Has there been much real wage growth in a lot of sectors beyond what is forced by legislation – again – stats are misleading as it doesn’t take into account individuals in same role for life – but the average of population Assume that it is 3.5% p.a. but has been going down over the past 30-40 years – whilst goods have been offshored – factor particularly relevant in the US as to why wages may not rise, is due to the mobility of labour. For wages to rise, an economy needs to be isolated but with free trade, or mobility in labour – which a lot of the models account for- however with free trade of mobility in labour - the wages tend to average out across nations as well – if you have 1m legal immigrants coming into a country – who are willing to work for less – downwards pressure on wages Only way to get rid of unemployment fully is to force people to work in roles provided to them by the government – nobody can leave or go to another job – as those seeking other jobs are counted as unemployed

Finally - Claims that Governments can use taxation schemes to manage the rate of inflation so that people aren’t left behind? And that US unemployment was 4% but saw no inflation rise -

Theory of inflation as well – if people have higher wages and spend this – should also lead to inflation One of the reasons for inflation staying low, even with low unemployment can come down to a number of factors. Firstly, inflation can take 18 months in general to materialise along with the issues in measurements of inflation. Participation rate – 5% - down to 1% due to 4% no longer looking The supply of a lot of consumer goods, such as electronics, clothes, etc. through online discounters has reduced the prices of this component. Hence, there is a natural downwards pressure on inflation. In addition, these theories don't take into account the use of peoples surplus cashflow, such as repayment of debt (or saving) instead of spending, which also has a deflationary effect. Lets say there is inflation that materialises – how would the Gov reduce inflation through taxation? Take more money away from people to spend – so there is less in circulation and reduces the multiplier effect

 

Could go on for days about this – but my question to a lot of these theories is, does monetary policy (i.e. the interest rates) really either create or destroy jobs? Are Governments responsible for hiring people to fulfil roles – as that money has to come from those working outside of the government to cover –

For me in my business, and for my clients and people I talk to who own businesses, it is government regulations that are the inhibiting factor for employment growth. The barries to entry that governments enforce on companies and the additional costs and regulations that come with this, reduce employment opportunities within the small to medium business sector. Removing disincentives such as payroll tax may help – where companies have to pay taxes based on wages – Say company paying $2m in wages – in QLD would have to pay around $55k in tax to Gov for that – if larger company paying $20m in wages – that is $950k in tax – 4.75% - that could hire more than 10 people I definitely think that it is time to rethink monetary policy, but probably not in the direction of MMT. In my views, MMT involves too much control over the economy which is part of the structural issues that the current system faces. This comes back to second-order effects in theory compared to in practice, as with any once forced change in a variable in a complex system, down the road some unimaged outcome is always present – MMT sounds like unicorn Governance – appeals to emotion – in reality – could get 0% unemployment Mao style In my view – the rethink needs to be less and not more – The reasons why we are in this situation is that CBs and Govs already have a lot of control – So they are magically going to solve the economy with more control? But you never see any mainstream Government economist or policy maker argue that they need less control – as that puts them out of the job – self interest rules the day

I don’t have a perfect solution for this – but options in a future Furious Friday episode – we can look at some alternatives that have shown practical results

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