We have to stop this madness.
The way we use interest rates to control inflation is socially destructive, unfair and inefficient.
Under our current system, when the Reserve Bank finds that there is too much inflation in the economy, it raises interest rates.
By raising rates, it is forcing households with mortgages to hand over more of their money to their banks by way of higher interest payments, so those households have less money to spend at the shops, hence the expected decline in inflation. Will come
But for families stuck in that situation, it seems like a steal of sorts. Why should the banks get more of your money?
Let’s consider an alternative.
If the RBA is going to force households to hand over more of their income during an inflationary episode to prevent them from spending, why shouldn’t households keep that money and later use that money after the inflationary wave has passed? should have access to?
It can go into their retirement accounts, where it can generate returns for those families and build their future wealth.
This way, we will manage inflation with savings and delayed consumption instead of usury.
And savings efforts can be spread more evenly across households (based on each household’s ability to save), rather than the burden of savings falling unevenly on households with mortgages.
It would be a far fairer system.
Why shouldn’t families be allowed to keep the money they earn?
This idea has a long history.
A similar proposal was made by the British economist John Maynard Keynes at the beginning of World War II, when he was thinking of ways to control inflation when all the resources of Britain’s economy were fully employed for the war effort. was being done.
You can find it in his essay How to Pay for the War (1940), where he talks about the economics of compulsory savings.
It is a masterpiece in macroeconomic thought.
Keynes thought deeply about the economics of compulsory savings. (John Maynard Keynes, Essays in Persuasion, Palgrave Macmillan, 2010, p. 369.)
As he argued, in a fully employed wartime economy where everyone able to work would have a job, but where most resources would be directed to the war effort rather than to the supply of normal quantities of consumer goods, people’s Have some disposable income. and accumulated savings.
So how do you prevent people from competing on scarce consumer goods and using their extra income to trigger inflation in the domestic economy?
Keynes said you have two choices.
You can take away people’s ability to spend too much (by raising taxes, or raising interest rates to transfer money from households to banks as financial rent), or you can take away their ability to spend too much. Can postpone (with some kind of mandatory savings).
Keynes said that suspending the spending power of the people would be more appropriate because this would allow workers to keep the money they had worked hard for.
“It is a great advantage for every man to retain possession of the fruits of his labour, even though he should cease to enjoy them. His personal wealth is thus increased,” he wrote.
“That points the way. An appropriate proportion of everyone’s earnings should be in deferred pay.”
As part of his wartime plan, Keynes mandated that each employee have a “deferred pay card” stamped by their employer, which would record the amount of pay to be set aside each pay cycle.
He said that the workers should have the right to choose where their deferred salary would be deposited to generate interest.
“He may choose his Friendly Society, his trade union, or any other body approved for the purposes of health insurance, or failing such preference, the Post Office Savings Bank,” he wrote.
And he hypothesized that, once the war was over, the accumulated savings could be released back to workers “perhaps by a series of instalments” to support consumption through any post-war recession.
It was a brilliant concept.
Even Friedrich Hayek, the Austrian economist who tried to rid the world of Keynes’s influence, said the deferred pay scheme was “ingenious”.
But don’t side-track by talking about it further.
The point is that compulsory savings can be a very effective inflation-management tool.
This is a big part of the reason why Australia’s compulsory retirement plan was introduced in the 1980s and 1990s, helping us to finally stop the inflation that has plagued us since “stagflation” in the 1970s. had harmed the economy.
inequality of the existing system
So why don’t we allow ourselves to think more creatively and consider alternative ways of dealing with inflation?
See the current way of doing things.
Over the past few decades, using fiscal policy (taxes and government spending) to manage inflation has largely gone out of fashion.
Instead, inflation management has been practically the sole preserve of monetary policy (manipulation of interest rates).
But monetary policy is not always the most appropriate tool for combating inflation.
As the RBA noted last week, a recent modeling effort showed that supply shocks are responsible for three-quarters of the increase in inflation in Australia (see graphic).
One model suggests that supply shocks account for about three-quarters of inflation in Australia. (Source: Reserve Bank of Australia, Statement on Monetary Policy, February 2023, p. 67.)
How can the RBA fix those supply shocks by raising interest rates?
As things stand, the main policy lever available to the RBA is interest rates, and it has been raising rates aggressively as inflation rises.
It wants people to stop spending so much, so it is doing what Mr. Keynes thought was unfair.
By forcing households to postpone some of their consumption (by requiring as many households to save as much as possible), this is draining some households’ ability to consume. By raising interest rates (which is transferring money from mortgaged households to banks in the form of financial rent).
Economists are aware of the inequality of the situation.
David Bassani, chief economist at Betashare, says there’s a reason RBA rate hikes have so far failed to curb spending for millions of households.
“Local consumer spending has remained fairly resilient over the past year in the face of interest rate increases, making it easier for business to pass on supply-driven cost increases to final prices,” he wrote on Friday.
“The resilience of consumer spending reflects (so far at least) the tight labor market, the substantial household savings buffers still built up during the pandemic – and perhaps more controversially – the fact that two-thirds of rising interest rates have Households that do not have a mortgage have a direct impact. Tighter monetary policy events tend to be narrowly directed at a subset of households with heavy debt burdens.
“A comprehensive effort to slow economic growth will require more heavy lifting than fiscal policy, although so far this has been missing in action,” he said.
We need more creative inflation-management tools
So where does that leave us?
If we think of Keynes’ “deferred wages” scheme, would a similar idea be useful in an inflationary episode like today?
Australian economist Nicolas Gruen wrote something along these lines over 20 years ago.
In a paper commissioned by the Business Council of Australia in 1999 (strangely enough), Mr Gruen said Australians have adopted the long-term objective of mandatory retirement with a growing pool of savings.
But he said there was no reason why we could not use compulsory super contributions to meet short-term macro-economic stabilization objectives too – for example, by allowing some short-term changes to compulsory super contributions.
“Thus, when macro-economic policy tightening is required, the requirement to contribute to retirement may be increased,” he wrote.
“Conversely, where an economic stimulus is called for, there may be occasions where temporarily reducing the superannuation contribution rate would be an appropriate means.”
If you haven’t heard of him, Mr Gruen is the brother of David Gruen, the head of the Australian Bureau of Statistics.
Martin Wolf, chief economics commentator of the Financial Times, recently said that Nicholls was “the most brilliant economist you’ve never heard of”.
an update on the idea
But fast forward 20 years and another Australian economist, Lachlan Kerwood-McColl, is thinking along similar Keynesian lines to Mr Gruen.
In 2020, he wrote an interesting letter that echoed Mr. Gruen’s views but had its own twist.
Mr Kerwood-McColl said an “adjustable compulsory savings mechanism” would be a very useful inflation-management tool and could take many forms.
But he did not think policy makers should regularly adjust the mandatory super guarantee (which currently stands at 10.5 per cent) to combat inflation.
Instead, he said the RBA might find it extremely helpful to have the power to set aside a small portion of people’s weekly income (as Keynes suggested) in a separate system for compulsory super.
He added that the compulsory savings scheme would be far more effective than the removal of the super savings guarantee as its impact would be more immediate, noting that it would work in a similar way to the first payment of personal income tax.
He added that the RBA’s accumulated savings can be returned to employees in full (as well as any returns from investments) upon retirement.
So in his view the theory is as Keynesian: if the RBA wants to take money from workers to reduce aggregate demand, why not give that money back to workers by giving them extra income for their retirement in their retirement savings? be given, instead of giving it. Bankers as high interest payments?
Compared to the current system, this would spread the national savings effort more evenly across households.
Mr Kerwood-McColl wrote that paper when he was an economist at the Department of Foreign Affairs and Trade, but he has since gone on to work for the ACTU as a senior economist.
I find ideas like this inspiring.
For the past 30 years, the result of relying so heavily on monetary policy to manage inflation (and the economic cycle) has been interest rates getting progressively lower and lower.
By the time the COVID-19 emergency hit, the RBA felt it had little choice but to slash interest rates to near-zero.
We have seen how this has affected house prices.
So, the RBA is now trying to raise rates to more modest levels, while households are in debt up to their eyeballs and property prices have exploded through socially catastrophic levels.
Would interest rates have dropped so low if we had allowed ourselves to have alternative and more creative inflation-management tools?
It is worth considering.
Source: www.abc.net.au
