From Professor Warwick McKibbin at the AFR today :
Per capita income growth has stalled over the year. This has direct implications for the budget with revenue importantly affected by weak nominal GDP growth. Second, with a stalling in income growth real demand may slow in coming quarters, which will impact on GDP growth over time…Some argue that a doom and gloom scenario is inevitable and call on the Reserve Bank to bring down the value of the Australian dollar. This is misguided since it implies even lower interest rates, causing even greater distortions in the domestic economy that would likely end in a significant misallocation of capital and asset price bubbles.
…The adjustment that would be helpful under the current deterioration in the terms of trade is a depreciation of the real exchange rate. The real exchange rate is the nominal exchange rate adjusted by foreign prices relative to domestic prices. Since the floating of the exchange rate in 1983, the nominal exchange rate did a large part of the adjustment to shocks so policymakers and politicians didn’t have to do much to achieve a reasonable economic outcome.
…Given Australian policy can do little to affect world prices, the answer lies in engineering a real depreciation by reducing domestic prices. Prices can fall by raising productivity and by reducing the other costs of producing goods and services such as wages, regulatory costs, energy costs and capital costs.
Productivity growth is difficult for governments to engineer. One clear source is through well-targeted infrastructure investment that has been through a rigorous cost-benefit analysis.
However, most productivity gains come from a large number of small actions throughout the economy. An example is the car-sharing service, Uber, which allows the existing stock of motor vehicles to be used more intensively, which is productivity boosting.
MB agrees on everything here with one exception. Nobody in the economic market place of ideas is arguing for lower interest rates to lower the dollar. Everyone that is arguing for the use of monetary policy to accelerate the real exchange rate depreciation – in conjunction with Professor Mckibbin’s other measures – is doing so on the basis that macroprudential policies be installed to prevent any further asset price inflation while interest rates are cut.
That doesn’t mean the arguments in favour of MP wouldn’t have challenges but let’s take them on their merits, not dispense with them using straw men. Professor McKibbin’s intellect would be most useful in working them through, no?
One other point in favour of the use monetary policy with MP tools to kick along the real exchange rate adjustment is implicit in Professor McKibbin’s own alternative. He argues that politicians need to get their arses into gear to manage an internal deflation, while outlining precisely why they are incapable of doing so: they are bloody hopeless.
The argument for infrastructure spending is severely undermined for the same reason, with the Government on a clear path to spend without the rigorous cost/benefit analysis Professor McKibbin insists upon.
The nation needs your full attention, Professor McKibbin!
