Monetary policy is not effective in dealing with a pandemic – it must support active fiscal policy

It’s Wednesday and I have now settled back into my office after being stuck away from home for 9 weeks as a result of border closures between Victoria and NSW. So I am reverting back to the usual Wednesday pattern of limited writing, although today, the topic is worthy of some extended narrative. Before we get to the swamp blues music segment, I am analysing a speech made by the RBA governor yesterday on the role of monetary policy during a pandemic, whether low interest rates are driving house prices too high, and, what should be done about that. The conclusion is that he supports better use of fiscal policy – sustaining supportive fiscal deficits and dealing with the distortions that are contributing to high housing prices, via amendments to taxation (eliminating incentives for high income earners to buy multiple properties) and public infrastructure policies (more social housing).

Speech by RBA governor illustrates what fiscal and monetary policy do

Yesterday (September 14, 2021), the RBA governor presented a speech to the Anika Foundation – Delta, the Economy and Monetary Policy.

Much of the media attention has been on the projections for the economy, in which the RBA is suggesting that the “has delayed – but not derailed – the recovery of the Australian economy.”

I am guessing that this prediction is fairly sound.

We saw after the big infection wave (mostly in Victoria) last year how quickly the economy recovered. This was mostly due to the tight lockdowns that put a cap on the infections and allowed us to open up fairly quickly in a Covid free state.

I think the evidence from 2020 was clear – there was no trade-off between the economy and the health control.

Early on in the outbreak, the ‘free market’ clan were urging the governments of Australia (federal and state) not to impose lockdowns because they claimed the economy would suffer enduring impacts, which were more costly than allowing people to die. Effectively, that was their message.

They were proven wrong.

The 2021 experience is a little different because the conservative NSW government believed some of that ‘free market’ nonsense and maintained lax quarantine practices and then failed to lockdown hard and quickly enough when the predictable breach from their slack quarantine regime occurred.

Since then the debate has changed to vaccinate rather than suppress.

But, given their penchant for a ‘freedom day’, I am sure the economy will start to recover in the fourth quarter somewhat even as the death rates rise.

However, there is one major difference between this year and last year.

This graph is reproduced from the RBA Bulletin article (June 17, 2021) – COVID-19 Stimulus Payments and the Reserve Bank’s Transactional Banking Services – authored by Jiawen Chen and Kristin Langwasser.

The transition in the fiscal position between last year and this year and beyond is very stark.

Last year, the Federal government spent more than $A90 billion on the JobKeeper wage subsidies (see the red columns) and abandoned that program at the end of March 2021.

This year, and the estimates are somewhat imprecise because it is hard putting the information together from a range of sources, the stimulus the federal level is putting in the system is around $A6 billion.

The yellow bars will be a little different to the graph this year, given the extended lockdowns in NSW and Victoria, that began after the paper was published. Those state governments will be putting in more than the authors would have estimated.

The point is that the federal government is seriously undermining any hope of a rapid recovery.

But it gets darker than that.

The current record virus infections in Sydney, and, now, Melbourne (as a result of leakage from Sydney) are located in the working class, migrant suburbs of the west (Sydney and Melbourne), south-west (Sydney) and north-west (Melbourne).

These workers are typically low-paid and often work in the supply chain sectors and the essential services sector such as cleaning etc.

They are typically workers who will have multiple jobs out of sheer economic need.

Last year, the wage subsidy protected them to a degree and the bonus paid on the unemployment benefit also helped those that did not retain a relationship with their employer (which is what JobKeeper was designed to achieve).

As a result of that protection, these workers were not driven by desperation to go to work when sick or go to work in general.

Now, with all that protection withdrawn, and paltry emergency payments the only assistance on offer, these workers, by necessity, are being forced to disregard their health concerns and go into dangerous work places and mix with the community in dangerous ways.

Result? The virus is continuing to spread.

Last year, the lockdowns worked because the workers who were most vulnerable (and ordinarily unable to ‘work from home’) were protected during the lockdowns and could ‘stay at home’.

This year, no such security is being offered and the results are obvious.

Whether the federal government, which ideologically was against the lockdowns imposed by the states (under their constitutional powers), is now using this fiscal weapon to force the ‘living with Covid’ narrative – a narrative that pleases their pals in the airline industry, in the clubs and bar industry, etc is unknown.

They might just be driven by a stupid ‘sound’ finance mentality.

Either way, the result is a disaster and we are now a relatively high infection rate country after enjoying more than 12 months Covid free.

When we relaxed the lockdown from a zero infection position, it was obvious that people rushed out and spent again and the result was predictable – strong growth.

This time, as the RBA governor noted:

Another source of uncertainty is how Australians will respond to the easing of restrictions, given that the easing is likely to take place with COVID-19 still circulating in the community. This is quite different from our earlier experience, when the number of cases was close to zero, and there was a very quick bounce-back. Whether the same will be the case this time remains to be seen.

I, for one, will be adopting a very cautious approach once the governments relax the lockdown.

The vaccine is not foolproof and the virus will run through the vaccinated population and we do not know yet what that means.

So, I suspect that caution will generalise, except maybe in the younger population.

He later got onto housing prices, which is really the issue that I want to highlight here.

Australian house prices have surged since the pandemic – up 19 per cent.

Regional land prices (outside of the big cities) have gone up much more than that as professional workers who can ‘work from home’ are seeking to change their lives by moving to regions that allow them to escape the city but maintain a relatively short commute to their main office base should they need to.

He said:

… some analysts have suggested we might lift the cash rate to cool the property market. I want to be clear that this is not on our agenda. While it is true that higher interest rates would, all else equal, see lower housing prices, they would also mean fewer jobs and lower wages growth. This is a poor trade-off in the current circumstances.

That is not to say that there aren’t public policy issues to be addressed here …

More broadly, society-wide concerns about the level of housing prices are not best addressed through increasing interest rates and curbs on lending. While monetary policy is contributing to higher housing prices at the moment, the way to address these concerns is through the structural factors that influence the value of the land upon which our dwellings are built. The factors include: the design of our taxation and social security systems; planning and zoning restrictions; the type of dwellings that are built; and the nature of our transportation networks. These are all obviously areas outside the domain of monetary policy and the central bank.

So quite clearly he is pointing to a failure of fiscal policy and infrastructure policy here.

The tax system (negative gearing) rewards those with high incomes and wealth if they accumulate multiple residences, which then drives up prices because it inflates demand.

The fiscal mindset towards achieving surpluses has starved low income workers of access to affordable ‘social’ housing. Australia has a deficit of around half a million residences at present in this category.

Low-income workers have to compete with those who are better off and have access to more credit and frequently spend too much – which also pushed prices up.

So the inflated demand for housing coming from the tax system distortion pushes up against a deliberately restricted supply (from the surplus obsession).

That is all down to government not the central bank.

Low interest rates would benefit low income workers if the supply of housing was increased as a result of a properly thought out social housing construction initiative.

The construction stimulus would help workers in that industry and the increased availability of affordable housing would provide opportunities for those on low pay to have secure housing and a chance to accumulate some modest wealth before retirement.

Win-win.

So the RBA governor is correct in pushing against the call for higher interest rates.

Those calls often come from those with a vested interest in having higher rates – the banks, those on lucrative fixed income flows, etc.

It is far better to keep rates low and then use fiscal policy to ensure the structural rigidities that are driving housing prices to ridiculous levels are sorted out.

Finally, the RBA governor talked about the QE program.

I will follow up on this topic next week, because I read a very interesting ECB discussion paper this morning which provides further analysis on this question.

But, for now, the RBA governor made it clear that is government bond buying program would continue and has been very beneficial in a number of ways:

… keeping funding costs and lending rates low across the economy; ensuring that the financial system is very liquid; supporting household and business balance sheets; and contributing to an exchange rate that is lower than it would be otherwise. It is through these transmission mechanisms that our policies are supporting, and will continue to support, the recovery of the Australian economy over the months ahead.

They are clearly going to maintain the program until at least February 2022.

The RBA recognises that:

1. There is no inflation threat on the horizon.

2. The RBA has an important role to complement fiscal policy stimulus, which they acknowledge “is the more effective policy instrument in responding to the Delta outbreak. This is because fiscal policy can use the public balance sheet to offset the hit to private incomes during the lockdowns.”

3. Conversely, “In contrast, monetary policy works mainly on the demand side and the effects on income are felt with a lag; realistically, there is little we can do to offset the hit to demand in the September and December quarters. ”

4. They have now “hold around 35 per cent of the Australian Government bonds on issue and 18 per cent of the state and territory bonds” which represents “a substantial and ongoing degree of support to the economic recovery”.

How?

By subverting any chance that the bond markets can push up yields using the pretext that the fiscal deficits are too high.

This way, the RBA keeps yields low and spurious arguments about ‘increasing cost of government spending’ etc, which are wrong in principle anyway, are not able to surface and distort the policy debate.

Everyone can see that the relatively large fiscal stimulus over the last two years (notwithstanding the reduction this year) has been injected at a time when inflation is low and bond yields are very low.

They are learning that the central bank can always control yields on government debt including driving them into negative territory.

They are learning that the narratives about government debt and yields and crowding out etc – all important myths that are used to restrain government spending and maintain unemployment rates at elevated levels are false.

So that is a good outcome from the shift by the RBA towards QE.

They are directly funding deficits – even if they claim otherwise – and the people can see the sky is still over our heads.

Music – Lazy Lester

This is what I have been listening to while working this morning.

Yesterday, I featured the post minimalism of Max Richter. Today we go to Louisiana and bring the not very well-known singer and harmonica player – Lazy Lester – to the fore.

Lazy Lester could sing, play guitar really well and feature on harmonica. In the 1950s, he was one of the founders of what has become known as the – Swamp Blues – which is a Louisiana variant that combines the traditional delta blues and R&B with – Cajun and Zydeco – influences.

Lots of shuffle patterns, with reverb and tremelo on guitars and very clean and sparse drumming.

And who took the form up in the 1960s? The Rolling Stones, Kinks and Yardbirds brought the sound to the White audience in Britain and beyond.

Appearing on guitar on this 2001 album – Blues Stop Knockin’ – is – Jimmy Vaughan

The track today is ‘Sad City Blues’ and the feature players are:

1. Derek O’Brien – resident guitarist at – Antone Records – in Austin, Texas.

2. Sue Foley – guitar.

3. Sarah Brown – house bass player at Antone’s Blues Club.

4. Gene Taylor – piano. He died earlier this year in Austin during a cold snap and he was unable to afford heating in his home.

That is enough for today!

(c) Copyright 2021 William Mitchell. All Rights Reserved.