Jun 26, 2020
Welcome to Finance and Fury, the Furious Friday edition.
Today is more a Say What Wednesday episode, I need to catch up
on some of your questions and this one fits in nicely. This is a
question I got from Ross about rethinking monetary policy.
“Am currently reading Stephanie Kelton’s book the deficit myth.
As she is a proponent of MMT Explaining her perception of debt
inflation. And the role of government in the way money is
distributed in the economy. As well as the way taxes are used to
incentives behaviour rather than just a means for revenue. She
makes a point that when nearing low unemployment, wages should rise
and then consequentially so should inflation. She argues that the
feds decision of how much slack should be allowed in the economy is
often misguided, and basically says that monetary economist demand
that unemployment is necessary. Which leaves a winners and loses
overview of the overall economy. So to ensure we don’t pay too much
for anything people have to be unemployed. How can this be morally
justified and is the opportunity as she argues to reach full
employment while having our parliament along with the federal
reserve better utilise issued currency and taxation schemes to
manage the rate of inflation so that people aren’t left behind?
As we have seen in the US unemployment was like 4% yet inflation
remained low. How do you explain this phenomenon and is it perhaps
time to rethink monetary policy around the developed world?”
This is a great question – lots to run through
- Role of Governments in the economy – and role of CBs
- The theory of unemployment and if it is necessary or not – and
who the winners and losers are
I am familiar with Stephine’s work – havent read this book but
started seeing her name pop up in researching MMT also following
politics – Bernie sanders economic advisor
At the core of this concept – Theoretical framework in political
economy – called public choice –
- The founder James Buchanan – think about politics without
romance – this means looking at the actual effects of a policy as
opposed of idealistically assuming that we will end up with the
kind of perfect outcomes promised – as they only exist in people’s
imaginations
- No policy is perfect – system is complex – due to it being
complex there is no algorithm or model to predict what will happen
outside of the potential of a first-order effect – Basics flaw of
any policy decision making
- Michael Munger – calls this unicorn Governance – its not enough
to judge a policy or a theory by its intentions – or by what you
hope will be the end result – you might get what you want initially
– but could have bad long term effects –
- Concept of Second-Order Effects – actions have an intended
consequence (outcome) - each consequence has another consequence,
and so on.
- Thing that is forgotten about in Governments – As the second or
third consequences only appear once they leave office
- dominoes—1000 lined up, one tap causes a chain of events to
occur - Once it starts - difficult (if not impossible) to them all
falling down
- For instance, the view of taxes are used to incentivise
behaviour rather than just a means for revenue has been proven to
be ineffective. For example, when they are used to influence
behaviours (like tax incentives for “going green”) and reduce the
incentives for others (e.g., taxes on tobacco and alcohol), the end
result in most cases has created a taxes on the poor.
- Make prices high on those goods – which are disproportionately
spent on by those in lower income brackets – Similar to the alcopop
tax – did it reduce peoples drinking? No people just bought a whole
bottle of vodka
- In addition, the notion of taxes being used to help curb
inflation is a method of indirect pricing controls – has
second-order effects
- Example of price capping – Cap Electricity Prices – outcome is
flat prices (whatever regulators decide)
- First Order – Electricity suppliers set their prices to the cap
price
- Second Order – Electricity supplies (companies) revenues may
decrease – Especially over time with increase in their costs –
(wages, transport costs, inputs into electricity like coal)
- Third Order –- The share values start to decline as investors
flee for fear of limited future potential returns
- Fourth Order - Profits begin to fall for the energy supplies
costs go up but prices are capped
- Fifth Order – Share values begin to plummet – reducing the
capital the company can raise – reducing ‘Capital Expenditure’
- CAPEX – What companies spend on large projects to grow the
company – Energy company – Origins Gladstone pipeline – billions of
dollars spent on upgrading for energy needs – Gas – a lot cleaner
than Coal
- Sixth Order – Companies begin to have to let employees off,
reduce maintenance on the infrastructure, and so on.
- Sounds a bit far-fetched – but it happened in California in the
90s – in RSA - happens across all things
- Rent control in NYC – After WW2 - provide returning veterans
with affordable housing - so city’s housing commission capped rent
prices (with no increases) in certain areas of the city
- law - rent control couldn’t be removed form an apartment unless
the original tenant moved or the building was condemned
- Noble but the cost to maintain properties continued to rise -
landlords couldn’t raise rent prices to compensate for their
increased costs.
- landlords refused to upkeep the property—it was a waste of
money -Financially – better to let the building deteriorate around
the remaining tenants
- over time there was a decline in the quality of property and
eventually supply, as buildings were condemned
- making housing even more expensive — the opposite of the
original intent
- The more complex a system is – the greater the number of
Second-Order Effects
- Consequences can be interrelated or dependent upon each other
in millions of different ways
- Uncertainty guarantees that nobody knows exactly how exactly –
not at the first consequence, or at the 20th.
- Every action has a consequence, and those always have their own
consequences – even if you don’t know they will
- That is what is so dangerous with Government Policy –
Especially those granting Positive Rights, not protecting Negative
Rights
- Approach making changes to a complex system with extreme
caution: what you get may very well be the opposite of what you
expect.
The issue is that at the core of all of this, MMT is assuming
that Governments are now more responsible for the economy
- In my personal views, they haven't been able to manage their
own departments or budgets well due to no market feedbacks along
with a lag in decision making.
- Track record - Any time governments take further control of the
economy – increased regulations - slow decline has been witnessed –
extreme examples –
- Socialism – Complete control – unicorn governance – did it end
up better for the people long term?
- under MMT – not truly socialism – as they don’t take over the
companies that produce- but at the top level they take over the
very cost of money and control of price gains – take over the
disbursement and allocation of money
- The question – will these policy decisions lead to a better
outcome? It assumed that economists and politicians have better
foresight and have better intentions than the individual
- Went through recently the fact that every one of the Feds board
members are multimillionaires based on their asset holdings
- Do they know what is best for the average person? Or what will
make their own portfolios and asset values go up further?
- Policy responses in relation to a statistic are not a good way
to approach this –
Especially when the measurements can be flawed - Gov inflation
stats or unemployment stats shouldn’t be taken at face value – or
policy shouldn’t be built around these – but it is –
- Inflation – CPI measurements - general level of price growth –
- First- it ignored economic innovation and assumed that future
demand does not vary from the historic
- Secondly – it is rife with statistical manipulation - such as
import substitution of goods even though it is meant to measure the
statistical concept of indexing domestic consumer prices
- In western nations that are heavy on importing cheaper goods
overseas – gives the appearance on costs going down –
- Also – doesn’t actually take into account the real price
increase but the increase assuming no difference in products –
called Hedonics -the science of trying to work out how much
product quality has changed and adjusting inflation to
take account of the fact more expensive products are not
just inflation - but due to improved quality
- Example - original iPhone versus the ones now- it would
discount the cameras and additional features as those as product
improvements and reduce the cost to match the base rate cost – even
though people are paying more
- Looking at alternatives – non-governmental statistics that
measure price growth –
- Chapwood index comprised of 500 constant items -shows an
approximate 10% annual rate of price inflation – also Shadowstats
gets a similar 10% approximation
- Therefore - policy of targeting a general level of prices
through broad-based indices such as the CPI has issues in what
these stats actually represent – making policy even less
efficient
- Unemployment - To be included in the unemployment statistics,
you have to have had looked for work and were available to work in
the reference week, or were waiting to start a new job.
- unemployment theory in general works off the basic assumption
that these segments of people are firstly, willing to work in any
role (which a lot of people aren't), but it also doesn’t account
for the fact that in the statistics there are transitional workers
included – if someone is taking a months break before starting
their next job = unemployed
- It can take time to find the right job that people want – so
can take a few months before one comes up
- Beyond the statistical measurement – which is conducted by a
survey - When it comes to this theory of unemployment, monetary
policy does look at the "sweet spot" for unemployment.
- The theory of this is that the labour market will reach a point
where each additional job added does not create enough productivity
to cover its cost, making every successive job after that point
inefficient and detractors to any business (or Government) that
hires them
- Would a business hire someone for $60,000 if it may only help
their productivity by $30,000? No
- Well – why don’t they hire them for $30k? well they might be
allowed to due to award agreements and minimum wages –
- Looking at the morality - The morality of these sorts of
proposals focus on one side, the equality of the economy and think
of it as an aggregate – these stats and theories don’t take
individual choices or freedoms into account
- Could be argued that it is not moral for the Gov to say that
Businesses have to pay $25 per hour for labour
- As what if someone wants and job and would be willing to get
paid $20 p.h. – but the business cant afford $25 p.h. – so that
individual doesn’t get that job and has to keep looking
- There is also the wage inflation theory that comes from an
increasing demand through low unemployment - Ross – point in the
book – need to have unemployed to ensure we don’t pay too much for
anything – and so wages don’t rise
- Going back to the Statistics – a number like 5% assumes that
these people are the always unemployed
- Not the same people month to month though - When looking
further into the 'long term unemployed' (i.e. individuals who have
been looking for work for longer than 52 weeks), this represents
around 15%-25% of those who are unemployed – so if unemployment is
5% - then 1% long term unemployed – so are we experiencing
inflation – cause 1% as long term unemployment is pretty low – but
these are people who can’t find work
- Why might they not be able to find work? But also, why don’t we
see inflation or wage rises? –
- These jobs no longer exist in Australia and goods are imported
from overseas from cheaper labour countries – Could it be that
unemployed people are a by-product of the costs of production being
too high?
- Government regulations – minimum wages and award wages – puts
companies in a tricky spot – small and medium businesses can’t
offshore – but large companies can – and reduce their taxes – so it
creates an unfair playing field
- But through globalisation policies and free trade – this has
created the trade of labour – sending work overseas – holden plant
– based around costs of labour and regulations – had to be
subsidised – in the end failed and all those jobs gone – is it
moral that all those jobs were lost?
- Has there been much real wage growth in a lot of sectors beyond
what is forced by legislation – again – stats are misleading as it
doesn’t take into account individuals in same role for life – but
the average of population
- Assume that it is 3.5% p.a. but has been going down over the
past 30-40 years – whilst goods have been offshored – factor
particularly relevant in the US as to why wages may not rise, is
due to the mobility of labour. For wages to rise, an economy needs
to be isolated but with free trade, or mobility in labour – which a
lot of the models account for- however with free trade of mobility
in labour - the wages tend to average out across nations as well –
if you have 1m legal immigrants coming into a country – who are
willing to work for less – downwards pressure on wages
- Only way to get rid of unemployment fully is to force people to
work in roles provided to them by the government – nobody can leave
or go to another job – as those seeking other jobs are counted as
unemployed
Finally - Claims that Governments can use taxation schemes to
manage the rate of inflation so that people aren’t left behind? And
that US unemployment was 4% but saw no inflation rise -
- Theory of inflation as well – if people have higher wages and
spend this – should also lead to inflation
- One of the reasons for inflation staying low, even with low
unemployment can come down to a number of factors. Firstly,
inflation can take 18 months in general to materialise along with
the issues in measurements of inflation.
- Participation rate – 5% - down to 1% due to 4% no longer
looking
- The supply of a lot of consumer goods, such as electronics,
clothes, etc. through online discounters has reduced the prices of
this component. Hence, there is a natural downwards pressure on
inflation.
- In addition, these theories don't take into account the use of
peoples surplus cashflow, such as repayment of debt (or saving)
instead of spending, which also has a deflationary effect.
- Lets say there is inflation that materialises – how would the
Gov reduce inflation through taxation? Take more money away from
people to spend – so there is less in circulation and reduces the
multiplier effect
Could go on for days about this – but my question to a lot of
these theories is, does monetary policy (i.e. the interest rates)
really either create or destroy jobs? Are Governments responsible
for hiring people to fulfil roles – as that money has to come from
those working outside of the government to cover –
- For me in my business, and for my clients and people I talk to
who own businesses, it is government regulations that are the
inhibiting factor for employment growth. The barries to entry that
governments enforce on companies and the additional costs and
regulations that come with this, reduce employment opportunities
within the small to medium business sector.
- Removing disincentives such as payroll tax may help – where
companies have to pay taxes based on wages –
- Say company paying $2m in wages – in QLD would have to pay
around $55k in tax to Gov for that – if larger company paying $20m
in wages – that is $950k in tax – 4.75% - that could hire more than
10 people
- I definitely think that it is time to rethink monetary policy,
but probably not in the direction of MMT. In my views, MMT involves
too much control over the economy which is part of the structural
issues that the current system faces.
- This comes back to second-order effects in theory compared to
in practice, as with any once forced change in a variable in a
complex system, down the road some unimaged outcome is always
present – MMT sounds like unicorn Governance – appeals to emotion –
in reality – could get 0% unemployment Mao style
- In my view – the rethink needs to be less and not more – The
reasons why we are in this situation is that CBs and Govs already
have a lot of control –
- So they are magically going to solve the economy with more
control? But you never see any mainstream Government economist or
policy maker argue that they need less control – as that puts them
out of the job – self interest rules the day
I don’t have a perfect solution for this – but options in a
future Furious Friday episode – we can look at some alternatives
that have shown practical results
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