More policy confusion and conflict from Xenophon

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By Leith van Onselen

Senator Nick Xenophon has co-written an article today arguing that the RBA should abandon its 2%-3% inflation target in favour of a 5% nominal GDP growth target. From The Age:

Wages are growing at recessionary levels, profits for small and medium-sized businesses are flat and the budget deficit constrains government spending.

Overall, Australia’s “nominal” growth rate – the growth in actual money in our pockets – has fallen from 7 per cent per annum in the decade before the GFC to only 2 per cent today.

Part of this so-called “income recession” is a hangover from the end of the mining boom…

The inflation target means the RBA can ignore our crashing national income growth, acting only when inflation is low.

But many components of the CPI used to measure inflation – like health insurance, school fees, utilities, cigarettes and alcohol – virtually never fall, no matter what state the economy is in.

A better option would be for the RBA to target a reasonable rate of growth in Australia’s nominal GDP…

Stronger growth in nominal GDP would provide workers and businesses with greater means to pay their debts, hire more staff and invest in new plant and equipment.

Instead of grinding along at 2 per cent, the RBA could target nominal GDP growth of 5 per cent – safely below the unsustainable rate before the GFC, but enough to speed up the transition from mining to value-added manufacturing and services.

Economic growth will rise, unemployment will fall and the budget balance will look a lot healthier.

Xenophon makes some reasonable points. The crash in Australia’s terms-of-trade has caused nominal GDP to plunge, along with national income:

ScreenHunter_14544 Aug. 22 08.39
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And a nominal GDP target of 5% looks like a reasonable goal that is not too hot nor too cold.

That said, the RBA does already appear to take nominal GDP into account when it sets monetary policy. As shown in the next chart, there is a strong correlation between changes in the cash rate and changes in nominal GDP:

ScreenHunter_14545 Aug. 22 08.43
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Whereas the association between changes in the cash rate and changes in underlying inflation appears similar:

ScreenHunter_14546 Aug. 22 08.44

Thus, this whole debate is a non-issue: the RBA is already targeting nominal GDP, just not explicitly.

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There are also question marks about whether monetary policy is all that effective in boosting the real economy anyway? Without commensurate support from macro-prudential and fiscal policies, any change in interest rates is likely to manifest in financial asset and housing values, providing little real and long lasting stimulus to jobs and growth.

If Xenophon genuinely wants to boost productivity, jobs and growth, and ‘save manufacturing’, then he must seek to kill Australia’s non-productive housing obsession.

It is this housing obsession that has inflated the cost of land and housing, thus placing upward pressure on wages and rents and making Australian industry less competitiveness.

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It is Australia’s housing obsession that has seen lending shift away from productive businesses:

ScreenHunter_14389 Aug. 05 11.36

And it is this housing obsession that has encouraged excessive capital inflow, thus inflating the Australian dollar and making trade exposed manufacturing less competitive.

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Yet to date Xenophon has vigorously defended the housing bubble by:

We also know that Xenophon is conflicted by his own significant property holdings.

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It’s time for the real Mr Xenophon to stand up. If he really cares about “speed[ing] up the transition from mining to value-added manufacturing and services” then he cannot support Australia’s distortionary housing policies that are misdirecting investment and lending away from productive businesses, as well as killing Australian competitiveness by raising the dollar and input costs like the price of land.

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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.