Keith Rankin's Thursday Column
Cullen v. Brash
27 June 2002
Former Reserve Bank governor Don Brash's entry into politics has given Finance Minister Michael Cullen a windfall opportunity to criticise the management of monetary policy. Hitherto, at least since 1989, Finance Ministers had been expected to stoically wear the policy actions of the nation's most influential (yet unelected) policymaker.
Macroeconomic policy is essentially about the management of the overall spending of New Zealand households, firms and the government. The preferred stance of the present government is neutral, meaning that there should be no overall stimulus or dampening of spending. The Finance Minister has control over fiscal policy, and the Reserve Bank governor has control over monetary policy. So neither person can ensure that the overall policy is neutral, though each can act to neutralise the actions of the other.
The Labour-Alliance government's preferred balance is to have a firm fiscal policy and an easy monetary policy. Indeed this is the form of neutrality generally preferred by leftish governments, who would rather have relatively high taxes and relatively low interest rates. Left-wing voters are more likely to be debtors, and are much less likely to be substantial creditors than are right-wing voters. Further, low interest rates favour new the businesses which threaten the established capitalist hierarchy. High interest rates, on the other hand, are tacitly favoured by well-established businesses, because high interest rates are a barrier to new competition.
High taxes are most opposed (and avoided) by well-established capitalists whose disposable incomes are boosted by the relative absence of interest costs. On the other hand, newly established businesses which have yet to turn a substantial profit are comparatively less affected by high taxes.
Right of centre governments tend to favour an easy fiscal policy (read "tax cuts") that is balanced by a firm monetary policy. This policy combination has obvious appeal to the established capitalist classes. Cuts to the top tax rate ensure that the lion's share of the gains are paid to the richest 10 percent (and especially the richest 5%) of the owners of New Zealand's resources. (It is of course possible to devise tax cuts in the form of tax credits that do not favour the rich; unfortunately the chance of such a tax policy this year or next is probably about the same as the chance that Saudi Arabia had of winning the soccer World Cup.)
Does macroeconomic policy need to be, in the main, neutral? Why can it not always be used to test the boundaries of what is possible?
At the moment Dr Cullen's concern is that the overall policy stance is too firm and rapidly getting more restrictive. The Reserve Bank is not playing Cullen's game. Cullen, himself, wants to be tight. (That is, he wants his fiscal policy to be tight.) But the Reserve Bank also wants to play tight, a trend restarted by Brash at the beginning of this year. This monetary tightness constitutes a challenge to Cullen to loosen fiscal policy. Now that Brash is no longer governor, his fiscal agenda no longer needs to be expressed covertly. Dr Brash wants tax cuts. (Contrast his 'official' view in 1996 when he acted to neutralise the expenditure stimulus of the Birch pre-election tax cuts.) We can assume that the Reserve Bank sans Brash would be more than happy to accommodate tax cuts.
For the meantime both are playing "chicken". The Minister of Finance and the Reserve Bank are challenging each other to loosen up while wanting to be seen as fiscally and monetarily "responsible", noting that 'responsible' is a euphemism for 'parsimony', for being stingy. Cullen can hardly criticise Brash for being too tight, given that he himself has delivered a miserly budget just last month.
There is an obvious way out for Cullen. He can loosen up, but not by cutting taxes. The government can spend more. Net of this year's increment to the new pension fund, there is a projected surplus of over $1.5 billion. He could retain and recruit a lot of school teachers with that. And he could invest in a public knowledge economy; an economy which might just be able to employ our most creative and able graduates.
But no. Michael Cullen believes (or says he believes) that he needs to maintain a tight fiscal policy in order to prevent interest rates from rising.
What does Cullen believe interest rates would be if he had opted to spend that $1.5 billion? Interest rates are now determined by monetary policy, not by the size of the government's deficit or surplus. Can we really be sure that Rod Carr, the acting Governor of the Reserve bank, would tighten monetary policy (ie by more than he is already tightening) if the projected budget surplus had been smaller than it in fact was?
What if both government and household spending rise together? The short answer is that we do not know what the limits to sustainable economic growth in New Zealand are until we test those limits by raising our spending and reducing our rate of saving.
I believe that now is a good time to test those limits. That means we could do with an overall expansionary stance to macroeconomic policy; a simultaneous easing of both monetary and fiscal policy. In the 1990s, both the United States and Australia showed that sustained high levels of aggregate demand did not necessarily generate inflation. Instead, it generated productivity gains. That could have happened here too. But we were too timid - ie too much Brash but not brash enough - to allow ourselves to find out what would happen if a general and sustained increase of spending was allowed to happen.
If Dr Cullen is disingenuous today, then Dr Brash is even more so. Brash continues to claim that (i) high global inflation was the cause of the slow growth of the 1974-84 period, (ii) that the possibility of high inflation must always be opposed with a tight monetary high interest policy, and (iii) that high inflation would be an inevitable outcome of any sustained bout of spending growth.
Re (iii), we know from other countries' experiences in the 1990s that increased spending growth is at least as likely to raise productivity growth as to lead to an unacceptable level of inflation. Further, other strange things happen when rising spending leads to rising incomes. One is the choice to trade household income for more household leisure. A policy of more spending can actually result in a medium-term outcome of less household spending, more leisure and higher productivity.
Re (i), Don Brash, for a social scientist, is unscientific in his methodology. (He is less scientific, for example, than the practitioners of alternative medicine whom the medical establishment condemn in the strongest possible terms for being unscientific.) Brash is guilty of both data-mining and misconstruing what is no more than a simple correlation. Data mining is selecting a set of dates which produce the correlation he is looking for to make his pre-determined point. Having established his correlation between high inflation and slow growth, he jumps to the conclusion that the high inflation must have caused the slow growth. In fact, it is much more plausible to assume that the slow growth was the cause of the high inflation. Alternatively, the correlation could be completely spurious; ie coincidental. This is always likely with mined data. A final possibility is that some other unidentified cause (or causes) were (in 1974-84) simultaneously generating high global inflation and inhibiting world economic growth. An example of such a possible cause of both is policy-induced high interest rates.
In my judgement, the high global inflation of the 1974-84 period was a symptom rather than a cause of economic unwellness. Our experience of that time does not justify the raising of interest rates today.
Dr Brash's very simplistic statements about inflation fail to make even the most basic distinction between demand-inflation (a symptom of unsustainable growth) and cost-inflation. (Cost inflation can be a result of rising costs such as policy-driven interest rates, wages that grow more rapidly than productivity for reasons unrelated to market demand, adverse climatic change, depletion of easily-mined raw materials, or rising 'transaction costs' such as insurance premiums.).
A tight macroeconomic policy - be it dominated by Brash-style monetary tightness or Cullen-style fiscal rectitude - is only appropriate when it is clear that expenditure growth really is unsustainable. That presumption has never been tested in New Zealand. The really serious bouts of inflation that endured throughout the 1980s in New Zealand were in fact cost inflation. At no time from 1976 to 1989 could it be said that New Zealanders were spending (or attempting to spend) in excess of what New Zealanders were capable of producing.
To cure cost-inflation (otherwise known as "stagflation") by raising interest rates is about as stupid as using petrol to extinguish a fire. Similarly, running a high budget surplus at a time when public schools and hospitals are losing trained staff because of inadequate remuneration is just as silly.
© 2002Keith Rankin
published on Scoop at www.scoop.co.nz/stories/HL0206/S00165.htm
postscript (4 July 2002): On Interest Rate Hike
The Acting Governor of the Reserve Bank, while once again raising the Official Cash Rate as an act of further tightening monetary policy (see www.scoop.co.nz/mason/stories/HL0207/S00014.htm), notes that ongoing increases are less likely than he had expected in May.
The suggestion is that short-term interest rates will stabilise at around 6 percent. The main reason given by Dr Carr for his less hawkish outlook was that the exchange rate had risen faster than the Reserve Bank had anticipated. The second reason given was the shaky international outlook.
This is the first monetary policy statement since the budget. Yet at no stage did Dr Carr suggest that the Minister of Finance's (Michael Cullen) overtly tight fiscal policy had anything to do with the softer tone of Dr Carr's media statement.
Remember that Dr Cullen had claimed that fiscal policy had to be tight to keep a lid on interest rates.
Yesterday's statement suggests that Cullen's harsh fiscal policy makes not a jot of difference to interest rates.
published on Scoop at www.scoop.co.nz/stories/HL0207/S00025.htm
© 2002 Keith Rankin
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