RBA Governor Glenn Stevens gave an odd speech in Brisbane yesterday, in which he more-or-less suggested the federal Government should try to offset the demand shock from the end of the mining boom with expanded infrastructure investment, and that now is not the right time for fiscal tightening. The RBA apparently thinks it can’t reduce interest rates further to boost demand, given Sydney’s runaway housing market and also because, in its view, households have already borrowed enough and do not have capacity to go further into debt. So it is up to the Government to step in and boost demand, as business appears unwilling to invest. The Governor’s comments surprised financial markets, as you might expect, given the comments are inconsistent with the consensus view on the operation of monetary and fiscal policies in an open economy with a floating exchange rate, such as Australia’s.
As Tony Makin, among others, has argued vigorously in the past, fiscal policy is typically ineffective in an open economy with a floating exchange rate, and monetary policy is much more potent. According to the textbook model, this is because fiscal stimulus puts upward pressure on domestic interest rates and the exchange rate, crowding out exports (see New evidence stimulus worsened our competitiveness from Makin & Ratnasiri). This is widely recognised and is why macroeconomic stabilisation policy is seen as the role of the RBA. Prior to the floating of the Australian dollar in 1983, it was the Treasury’s responsibility, because, under a fixed exchange rate, it is fiscal policy that is effective, while monetary policy is ineffective.
Oddly, the RBA Governor has gone against this consensus and called for fiscal stimulus from the Federal Government through infrastructure spending. As the Governor himself may have hinted in his remarks, it is possibly too late to do so now, in the context of offsetting the shock from the end of the mining boom, given how long it would take to get projects designed, approved and built. And I don’t think it would be sensible anyway, due to the reason above, and also because it doesn’t seem wise to replace elevated levels of business investment, which were always likely and expected to be temporary, by high levels of government investment, particularly given some of the investment might be in projects of dubious merit. Further, as many commentators have noted, if the Federal Government doesn’t act to repair its Budget now, we run the risk of permanent deficits and, possibly, the loss of our AAA credit rating sometime in the future.
I would suggest Sydney’s overheated property market appears to be the reason for the RBA Governor’s odd remarks, and it is here that the RBA’s attention should be directed. Rather than giving odd and naive advice on fiscal policy, it should investigate the causes of the overheated Sydney market and advise on any regulatory or taxation policy changes that might be desirable.
Finally, I should note I attended the Governor’s speech yesterday as the Secretary of the Queensland branch of the Economic Society of Australia, which organised the lunch at which the Governor spoke. As a Management Committee member, I am very grateful that the Governor agreed to speak at our lunch, which was very well attended. Obviously, views expressed in this post are mine alone, and are not necessarily shared by my fellow Committee members.
I, too, attended Wednesday’s lecture by the Governor and I did not find his speech odd nor did I find him using the forum as an opportunity to give ‘gratuitous advice to the Treasurer’ as has been a common interpretation within the media. His speech reflected an appropriate questioning of the effectiveness of monetary policy in a low interest rate environment and a call for political agreement on how to proceed (in short, it was a call for political leadership and cooperation).
Media instead have focussed on parts of the speech that relay the benefits of considered government spending and which advocate for long-term fiscal planning as calls for 2009-style fiscal stimulus as executed by the Rudd government in the wake of the GFC…and that is not right. He was calling for a plan of action that will help remove uncertainty and inspire investment and growth from multiple sources.
The Governor observed a reality that households are already leveraged and that spending on mining infrastructure was coming to an end and therefore neither would contribute much to accelerate future growth. He did not, however, imply that it was therefore ‘up to the government to step up and boost demand’ as you have asserted above. He merely noted that it would be ‘confidence-enhancing’ if the government could agree on a story about a long-term pipeline of infrastructure projects that could be pursued with appropriate governance in place. He put conditions on the spending, specifically that the projects would ‘earn a return’ which would differentiate them from borrowing money to pay pensions and public servants.
The paper that you have quoted by Makin and Ratnasiri, ‘Competitiveness and government expenditure: The Australian example’ showed that the post GFC spending by the Rudd government was ineffective (even damaging to the Australian economy), but it should not be used to imply that all government spending is inappropriate or ineffective – I think that overstates the conclusions. The Governor was not desperately calling for half-considered ideas to pump dollars into the economy as was practiced in 2009; he was advocating for a pipeline of needed and sustainable infrastructure investments that could add value and help create certainly around future growth. The Governor’s emphasis on ‘priorities & planning’ over ‘dollars spent’ seems to have been overlooked in your analysis and that of many other commentators.
It was useful for Makin and Ratnasiri to both analyse and then criticize the inefficient course of spending which was pursued by the Rudd government in the wake of the GFC because it highlighted the negative impacts of capricious and arbitrary government spending on the Australian economy. The Governor, on the other hand, was calling for increased planning and therefore a series of considered and productive spending initiatives. There is a difference.
The short-termism of politics and political decisions creates a serious threat to the long-term sustainability of the Australian economy. I find it refreshing that the Governor would comment on frameworks for approaching spending not because of his experience with fiscal policy (which you rightly imply is not his area of expertise) but rather because advocating long-term economic planning is simply good business.
Like Gene I attended Wednesday’s event as a representative of the Queensland Branch of the Economic Society of Australia. I appreciate the Governor’s views and his willingness to speak before an Economic Society audience. I also appreciate Gene’s views because he is a knowledgeable and thought provoking economist. My response herein, when juxtaposed to that of Gene, highlights some of the diversity of views represented among committee members of the Queensland Branch of the Economic Society of Australia. As with Gene the views expressed in this post are mine alone, and are not necessarily shared by my fellow Committee members.
Thanks for the comment, Tim. I think Jim gets it right in his comment below that the comments of central bank governors are typically cryptic and open to varying interpretations.
RBA Governors have an amazing talent for skirting around the issues and not being direct in their communication.
So what Mr Stevens was really saying is that interest rate policy is no longer working in stimulating the economy.
Tony Makin might be right about monetary vs. fiscal policy as a generality, but with interest rates so low. the stimulus of any further cuts is very negligible at best.
Absolutely Jim, they definitely have an amazing talent to skirt around issues! Based on his speech and Q&A session it did seem to me he was blaming governments for not spending enough, which given the need to pay down public sector debt across the country struck me as very odd. Also, I found the Governor’s comments about the need for a nicely planned sequence of future infrastructure projects, an infrastructure pipeline, a bit naive. Different observers have been calling for that for decades and it hasn’t happened, and it isn’t going to happen, because it isn’t realistic. Recall Infrastructure Australia, which I recall was supposed to do such a thing, and has clearly failed to do so.