RBA governor denying history and evidence to make political points

Today, the Australian Treasurer is out in force telling us that the fiscal situation is dire and that they have to start making cutbacks. Meanwhile in the real world, the unemployment rate continues to rise, businesses continue to fail, and the lowest paid workers, are being forced to continue working in dangerous health situations because they cannot ‘afford’ to stay at home like the better paid workers and protect their health. Its doesn’t bear scrutiny. My research centre released an updated report this week that also bears on the situation. The current fiscal stimulus is probably, at least $A100 billion short of where it should be, yet the government is announcing cuts. It will not turn out well. Meanwhile, across town, the Reserve Bank governor has been trying to deny the RBA has the currency capacity to allow the Treasury to keep spending without issuing debt. Already, the Labor party are making political points out of the rising public debt, which just makes them unelectable really, rather than savvy. The RBA governor’s intervention also just proved he is prepared to deny history and evidence to make political points, which had the other consequence of demonstrating how lacking in ‘independence’ the central bank is from the political process. And so it goes on.

Lukenomics casts its expert eye over Modern Monetary Theory (MMT)

A few weeks ago, I was sent a script for an upcoming comedy segment and asked to give input. The first iteration was already terrific and after a few more iterations, it was in great shape – representing Modern Monetary Theory (MMT) faithfully and pointedly.

I was pleased to have been given the chance to advice the writers so they did not misrepresent MMT. Not often that happens. I really respected that.

The segment by comedian – Luke McGregor – was aired last night (July 22, 2020) on the ABC program – The Weekly with Charlie Pickering.

He calls his segment – Lukenomics – and uses it to explain economics things in an amusing but clear way.

Last night, he covered MMT and I saw the script that had been worked on over a few weeks come to life. That alone was an interesting thing for me.

But Luke’s depiction of our work was great and I hope that he will make some cameo appearances in the future for MMTed.

Here is the segment:

Maybe the Treasurer and RBA governor should have been watching

Today, the Federal Treasurer is unveiling his fiscal update.

Already the Opposition Labor treasury spokesperson has been on TV all morning embarrassing himself and effectively demonstrating why the Labor Party are unelectable.

He was raving on about the government ‘crashing’ through some debt ceiling (“half-a-trillion dollars”) and “racking up debt” and all the rest of his ridiculous ranting.

Who is advising this guy? Neoliberal central!

I will analyse the Treasurer’s data next week when I have had time to study it and do some calculations of my own.

In the media release (July 23, 2020) – Economic and Fiscal Update – we learn that:

1. The fiscal balance will rise to an “$85.8 billion deficit in 2019-20 and a $184.5 billion deficit in 2020-21.”

2. “The fiscal measures are also estimated to have lowered the peak of the unemployment rate by around 5 percentage points.”

3. “real GDP is forecast to have fallen sharply in the June quarter by 7 per cent.”

4. “around 709,000 jobs were lost across the country in the June quarter.”

5. “The unemployment rate is forecast to peak at around 9¼ per cent in the December quarter …”

In other statements, the Treasurer said that:

… the government’s actions have saved 700,000 jobs.

Now do some arithmetic.

They will spend around $A70 billion on the JobKeeper wage subsidy program over a 6 month period. Initially, the Treasury claimed that it would be the difference between the unemployment rate rising to 10 per cent rather than 15 per cent.

5 percentage points, which is the figure reaffirmed by today’s statement amounts to around 585 thousand jobs given the current labour force.

Even if the interventions have saved 700 thousand (today’s Treasury estimate) that doesn’t seem like a good deal to me.

On Monday (July 20, 2020), the Centre of Full Employment and Equity (CofFEE), our research centre released our latest technical report – Investing in a Job Guarantee – which was written by myself and Martin Watts.

We used our CofFEE macroeconomic simulation model to explore the impacts on public and private employment of a Job Guarantee program designed to reduce the unemployment rate from 10 per cent to 4 per cent?

The Job Guarantee wage would be equal to the current federal minimum wage.

Using very conservative productivity assumptions, we found that the scale of annual GDP (income) loss resulting from the unemployment rate being at 10 per cent rather than 4 per cent ranges from $95,404 million (if all workers were absorbed in the retail trade sector) to $201,384 million (if the workers had average non-mining productivity).

That range on a daily basis would be $261.4 million (5 per cent 2019 GDP) to 551.7 million (10.6 per cent of 2019 GDP).

The following tables summarise the employment and output impacts (Table 2) and the fiscal investment parameters (Table 3). Note that these numbers are for an estimation period of 12 months.

The probable outcome would be that investment confidence would be stimulated by the higher employment and output and that the non-government sector would start adding jobs at a faster pace and reducing the pool of workers within the Job Guarantee pool fairly quickly.

Even if the losses are at the lower end of this sort of range, the quantum is very large and represent huge deadweight losses that are never recovered, and losses of some degree accumulate every day that unemployment remains above 4 per cent.

We also did not take into account the massive personal and community losses that accompany the narrow economic (income) losses.

It is obvious that a 6-percentage point reduction in unemployment would deliver substantial net benefits to the nation.

We also concluded that the net investment required by the federal government is clearly within its fiscal capacity and compares well, in terms of dollar returns, to other stimulus measures that the government has introduced.

Further, the program provides a pathway for the nation to end its dependence on welfare payments and the pernicious ‘unemployment’ industry that ‘manages’ the unemployment through a never-ending cycle of punishment and failed outcomes.

The point is that for a net investment of $A51.7 billion over 12 months, the federal government could create 1.24 million jobs, 200 thousand of them in the private sector and the rest in the Job Guarantee sector.

Compare that to the Treasurer’s stated outcomes above – at least $A70 billion to save 700 thousand jobs but still leave around 10 per cent of the willing labour force jobless.

Doesn’t bear comparison.

We presented a paper to the Prime Minister’s office late last week making the case for a Job Guarantee. It probably went in the bin, which means we will pursue our strategy more broadly now.

Yesterday, as part of a suite of fiscal announcements leading up to today’s grand statement, the Government has also announced it is cutting back on the fiscal stimulus it introduced in March.

It is reducing the rate of the JobKeeper wage subsidy and cutting back on the special supplement to the unemployment benefit (JobSeeker).

What responsible government would cut spending when unemployment is elevated levels and rising, underemployment has gone through the roof, and businesses are failing at an accelerating rate as this disaster continues?

Answer: No responsible government would.

Reality: the Australian government is already telling us that it must cutback to save the ‘budget’.

The only thing this will achieve is worsening unemployment (and the increased scarring that goes with long-term unemployment), more failed businesses, mortgage defaults, and a long period of lost income earning opportunities.

The heightened uncertainty about the health issues is reaching dangerous levels in Australia as various commentators start to hint that the Melbourne situation is now out of control and the virus will multiply throughout the regions and across into other states.

The last thing we need now is the worsen that sense of fear by the government withdrawing its life support from the economy.

I have estimated the stimulus was already about $A100-120 billion short of what was required.

Cutting back an inadequate first intervention just magnifies the initial error.

Enter the Reserve Bank governor.

On Tuesday (July 21, 2020), the RBA governor Philip Lowe gave an address to the Anika Foundation entitled – COVID-19, the Labour Market and Public Sector Balance Sheets.

The Anika Foundation supports “research into adolescent depression and suicide”.

I won’t draw any parallels on that front.

The Governor’s speech was held out in the conservative financial media as a rebuttal of MMT.

I saw it more as a demonstration of how political the RBA has become, which, of course, blows the story about it being independent out of the water.

His analysis of the labour market was accurate although I am not as optimistic as he was in terms of his statement that “Fortunately, we have now turned the corner”.

I think that this was probably written before the full import of the Victorian virus second wave was understood.

The renewed Victorian lockdown will retard progress significantly and this is especially important in relation to the observation made by the Governor that:

… many firms … were able to keep many of their employees over recent months because they had a pipeline of work to complete. But as new orders have declined, this pipeline is drying up. If it is not replaced soon, hours worked in these businesses will decline further …

Investment and employment decisions are forward-looking. Firms will not invest in new capital if they are not sure there will be increased sales in the future, when the capital is in place and ready to produce goods and services.

This is why the Federal government should be spending up now to foster new orders to keep the ‘orders pipelines’ full.

The Governor informed his audience that:

1. The “Reserve Bank’s balance sheet has increased from around $180 billion prior to the pandemic to around $280 billion today and further increases are expected over coming months”

2. Among other things, it has “used its balance sheet to purchase $50 billion of government bonds” – which has controlled yields in the targetted maturities.

He claimed this was “viewed as credible by market participants” (what other choice have the ‘participants’ got – the RBA has the power not them).

3. “There is also a broad understanding that the RBA is prepared to use its balance sheet in whatever quantity is needed to maintain the target.” In other words, it will keep interest rates (and bond yields) where it wants and will use its currency capacity to achieve that objective, irrespective of what the ‘market participants’ might desire.

And at this point, the Governor became political and defensive.

He said:

I would now like to address one idea for the use of the central bank’s balance sheet that I sometimes hear – that is, we should use it to create money to finance the government. A variant on this idea is that the central bank should just deposit money in every bank account in the country – this is sometimes known as ‘helicopter money’ because, before we had an electronic payments system the idea was that banknotes could simply be dropped by helicopter.

For some, this idea is seen as a way of avoiding financing constraints – it is seen as holding out the offer of a free lunch of sorts. The central bank, unlike any other institution, is able to create money and the resource cost of creating that money is negligible. So the argument goes, if the government needs money to stimulate the economy, the central bank should simply create it in the public interest.

The reality, though, is there is no free lunch. The tab always has to be paid and it is paid out of taxes and government revenues in one form or another. I would like to explain why.


He said the RBA just credits bank accounts to facilitate government spending. The offsetting asset might be an “IOU from the government to be paid in the future”.

Right pocket of government issuing IOUs to the left pocket!

So how is this not a free lunch?

Enter the inflation bogey – the government spending causes inflation “perhaps to a very high level” – which is a tax on the community. The “spending is just paid for in a different way”.

What if there is no inflation? Think about Japan over three decades. Think about almost everywhere else in the last decade.

What if the RBA pushed up interest rates to fight the inflation? Notice his example, all requires the inflation bogey, to trigger the steps.

Well there is no inflation tax, but other taxes have to rise to pay back the IOU (and interest) to the RBA.

Remember right and left pocket.

Then what happens, he asks, if the IOU was just written off?

Well then the RBA would incur “losses” (left pocket marking down numbers because the right pocket had marked down numbers), the government would not earn any ‘dividends’ from the RBA (left pocket not sending numbers to the right pocket) and the RBA might have to be recapitalised because it was making losses.

All which he claimed would have to be “funded through tax revenue”.

The RBA is not a private corporation. It could function forever with no ‘capital’ and nothing significant would change. The emergence of a ‘loss’ for a private corporation is a problem because the shareholders have to cover the gap.

An accounting ‘loss’ recorded by the RBA is rather meaningless. Numbers that can be altered at will and no-one would care less.

The Governor then tried to deny history:

It certainly is possible for the central bank to change when and how the spending is paid for, but it is not possible to put aside the government’s budget constraint permanently. Where countries have, in the past, sought to put aside this constraint the result has been high inflation.

There is no ‘government budget constraint’. The term has no meaning for a government that issues its own currency.

The RBA is a creature of government. It is part of government. The Australian government can always purchase whatever is for sale in AUDs and has the legislative capacity to instruct the RBA to permanently facilitate that via its balance sheet.

And then we might ask the Governor to explain the Japanese history since 1990 in a sentence.

The Bank of Japan has effectively been funding the Japanese government by buying Japanese government bonds in large quantities – zero interest rates, negative yields on long-term debt and deflation rather than inflation.

And what of the ECB since 2010 – same story.

And the Federal Reserve in the US at various times – same story.

And the Bank of England at various times – same story.

It is a plain untruth for the Governor to say that accelerating inflation is an inevitable consequence of central banks purchasing government debt in large volumes, which is the same thing, functionally, as the governments not issuing any debt in the first place.

And a little bit of Australian history would not go astray.

I have written before about the significant changes that occurred in Australia in the mid-1980s, when the government shifted from a ‘tap’ system of bond issuance to the current ‘auction’ system.

See the blog posts:

1. Why do currency-issuing governments issue debt? – Part 1 (June 1, 2020).

2. Why do currency-issuing governments issue debt? – Part 2 (June 2, 2020).

3. Direct central bank purchases of government debt (October 2, 2014).

This RBA Bulleting article from November 1993 also bears on the topic – The Separation of Debt Management and Monetary Policy.

Note that the framing of this article is all in the mainstream context that the federal government was financially constrained. But read it for the institutional arrangements it describes.

Essentially, before 1979:

… primary issues of Commonwealth Government securities (CGS) were through ‘cash loans’ or ‘tap’ issues in which securities were offered at pre-determined rates of interest, and the authorities accepted whatever sales occurred at that rate …

When the Commonwealth Government did not sell sufficient debt to finance its deficit, the shortfall was made up by borrowing from the Reserve Bank.

In effect, the RBA would accept “Treasury bills, which were short-term discount securities carrying a fixed discount rate of 1 per cent”.

These bills were also used to fund “finance lags in revenue encountered by State governments” and to “make intra-governmental transfers” between government departments.

The government pockets were very busy recording numbers, adding and subtracting and this all kept the accountants busy.

Between 1950 and 1980, the RBA held various proportions of the total Australian government debt on issue as shown by the following graph.

There was no relationship (coincident or lagged) between these holdings and the inflation rate or tax rates.

In other words, the RBA was already doing what the RBA governor considers to be taboo.

The reason they shifted to the auction system was because the government embraced the Monetarist view that fiscal policy discretion should be discouraged and monetary policy should be elevated to a dominant position.

It was easier to conduct daily liquidity management with the auction system, where the government allows the private bond dealers set the yields.

It was an ideological shift, which was then ‘justified’ with the fictions about inflation, no free lunch, tax burdens and the rest of it.

It was designed to take aggregate policy discretion away from the elected representatives of the people.

It was also at the time when governments abandoned their full employment pledge and instead started to use unemployment as a policy tool (to discipline inflation) rather than a policy pledge.

As I noted in Tuesday’s blog post – An old central banker trying to come to terms with MMT – not quite getting there (July 21, 2020) – when I quoted Alan Blinder:

There is neither theoretical nor statistical support for the popular notion that inflation has a built-in tendency to accelerate. As rational individuals, we do not volunteer for a lobotomy to cure a head cold. Yet, as a collectivity, we routinely prescribe the economic equivalent of lobotomy (high unemployment) as a cure for the inflationary cold. Why?

Anyway, the reality that the RBA governor wants to suppress encircles him – Japan, the US, ECB in Europe, Bank of England etc.

Someone said to me the other day that the RBA will never adopt that sort of monetary leadership because it is a ‘very conservative institution that has the respect of the financial markets’.

So, we are meant to sit around while a few million people cannot work, because the RBA is being preciously ‘very conservative’.

At some point, the citizens will understand all this and demand that the government force the RBA to do what the Reserve Bank Act of 1959 says it should – and one of those legislative responsibilities is to foster full employment.

I was also told that if the RBA ever did just credit bank accounts on behalf of government then the ‘markets’ would lose confidence and respect for it. To which I wondered – so what?

Its a stacked deck in favour of financial capital and the top-end-of-town. The house has to crumble for us to make progress.


Congratulations to Luke McGregor for his wonderful sketch last night.

And, I have a segment on ABC’s special report on today’s fiscal statement tonight where I go into all this.

That is enough for today!

(c) Copyright 2020 William Mitchell. All Rights Reserved.