What Should Gordon Brown Do Now?
What Should Gordon Brown Do Now?
Bryan Gould Writes The PM’s Next Speech
“The local election results and the opinion polls convey a pointed message _ that my government and I have for the time being lost the confidence of our supporters. We cannot deny the reality that the next election may be a step too far for a government completing its third term.
To accept this is oddly liberating. It means that, instead of focusing exclusively on trying to win an election, I can now concentrate on delivering _ for the two years that remain of this term _ the best government this country can have. History may judge that I failed as an election-winner; my term as Prime Minister might yet deliver the verdict that I did the job well.
To achieve this, I must first clear away the baggage that I inherited. I will, for example, lance the boil of the Iraq invasion by setting up an independent commission to establish how and why that came about. This will signal a return to the ethical foreign policy advocated by Robin Cook; we will, for example, finance the return to their homeland of those displaced when the US military base on Diego Garcia was established.
I will cut by half the number of media advisers employed by the government, with the intention of showing that our message is about real issues, rather than spin. And I have learnt and will apply the lesson that a government that ignores its supporters for the sake of pleasing its opponents will end up being disliked by everyone.
I will ensure that my government maintains unity and cohesion by taking careful account of what my MPs and those who elected them are telling me. I will recognise in advance those issues – such as the removal of the 10p tax band or the 42-day detention period – where a broad consensus looks impossible to achieve. Where there is a consensus, my colleagues will be expected to abide by it.
I will review those policies – even the sacred cows – that have failed to deliver. I am not convinced, for example, that academy schools have succeeded or that we have even applied the right criteria for evaluating them.
Because I believe that my government should be accountable for its own economic policy, I will reconsider whether it is right to contract that policy out to an “independent” central bank, and re-evaluate the advantages of restoring the main elements of economic policy to the arena of public debate and democratic process. My goal is a sustainable economy that delivers better standards of living, employment and public services to ordinary people, rather than inflated bonuses to those who create no new wealth but manipulate existing assets to their own advantage.
I will return to my basic political instincts – those that brought me into Labour politics in the first place. I regard as unacceptable the rapid growth in inequality in this country. We cannot expect people to take pride in their country and to work hard for its success if they do not share in the benefits that success will bring.
While I believe that a properly functioning market is irreplaceable, I do not accept that the market is infallible. It must be regulated and supplemented if it is to deliver acceptable outcomes to everyone. There is, in other words, an important role for public services in a modern economy. My government will give them priority over the next two years.
The next election is in the lap of the gods – or, more prosaically, in the hands of the voters, as it should be. Between now and then, you will see less, not more, of me on your television screens. I will be concentrating instead on leading a competent, caring and effective government.”
This piece was published in the online New Statesman on 18 April 2008
Beaches – for Cars or People?
The following article appeared in the New Zealand Herald on 11 January.
“The Kiwi beach holiday used to be about picnics, sunburn, surf and games on the sand. Today, it is increasingly about the internal combustion engine.
In 2008, cars, motor bikes, quad bikes and all sorts of motorised vehicles are a dominant presence on our beaches. And if land-based motorisation is not enough, there are always the motor boats and jet skis to add to the jollity.
The traditional beachgoers now need to have their wits about them. The danger to swimmers and sunbathers, picnickers and walkers, is constantly there, and can easily become real, as recent well-publicised events have shown. Small children and dogs are particularly at risk.
Our beaches offer in many cases the kind of flat open space that can be hard to find elsewhere. Little wonder that the eyes of drivers, who have chafed under the constraints of the Road Code and a growing volume of traffic on our roads, light up when they see the chance of opening the throttle.
But it is not just the threat to life and limb from speeding vehicles that has grown. As our beaches have been transformed into race tracks and test beds, the beach environment suffers as well. The motorised holidaymakers will return to their everyday lives oblivious of the damage done to the habitats of rare nesting birds or of vulnerable native plants.
And then there are the various forms of pollution that come inevitably in the wake of the internal combustion engine. The peaceful enjoyment of a beautiful beach can be ruined for hundreds by the noisy exhaust of a single motor bike doing wheelies on the wet sand all afternoon.
Hearing is not the only sense to be assaulted. I recall snoozing under a pohutukawa tree one afternoon, listening to the rustle and rumble of the sea, when I suddenly realised what it was in my nostrils. It was the smell of diesel, the first indication that a large four-wheel-drive vehicle was approaching and the last thing one expected to smell on a pristine beach.
And then there is the visual pollution – the rutted tyre marks disfiguring the sand and making walking difficult, the rows of parked vehicles at the water’s edge looking more like an urban car park than a beautiful part of our once-beautiful country.
I should make it clear that it is not the fisherman looking for the best surfcasting spot who is in my sights. I regret that it seems necessary to use vehicles for such a purpose, but I recognise that fishing is a legitimate, pleasurable and traditional leisure activity on our beaches, and that the careful use of a vehicle should be accepted as a reasonable balance between the interests of fishers and of other beach users.
The people I object to are those who seem to have lost the use of their legs. I know of a beach where a car park has been thoughtfully provided just metres from the sand and less than a hundred metres from the water’s edge. Drivers regularly by-pass the car park, drive their vehicles on to the sand and up to the water’s edge, before getting out to swim or picnic or play games on the beach.
It is almost as though they have become so enamoured of their vehicle, so dependent on it, that it has become such an integral part of their lives, that they cannot bear to be more than a few metres from it. So much for the outdoor life!
I have even less sympathy for those who have no regard for other beach-users but are determined to inflict their vehicle noise, danger, smell, environmental damage and all on everyone else. Or for those who ignore an easily available road route for getting from A to B in favour of a short-cut along a populated beach.
In vain do local authorities put up notices proclaiming that vehicles are forbidden on the beach. The proclamation, we are told, is unenforceable. The police solemnly intone the mantra that the beach is regarded for legal purposes as a highway; but, if this is the case, how is that so many unlicensed vehicles and drivers are being allowed to destroy our beaches? A change in the law is long overdue.
There can be no bright side to the tragic accident in Northland this summer. But, while it will be of no comfort to the bereaved family, it may awaken us to the damage we are doing to ourselves through carelessly allowing what Mrs Thatcher once described as “our great motor car culture” to harm the beautiful and vulnerable environment in which we are privileged to live.
A Brown Study
The following article by Bryan Gould appeared in the Sunday Telegraph on 21 September
The first two months must have been very heaven. The long-awaited prize had been grasped. Opposition from both within and without had faded away. A long period at Number Ten seemed assured.
The voters seemed to like the new leader. They liked his plain-speaking and the absence of spin. They liked his re-statement of basic values and his robust defence of the national interest. Most of all, they liked the fact that he was not Tony Blair.
So, one month later, how have we arrived at the 7% Conservative lead in today’s poll? Is Gordon Brown on track to join the ranks of those Prime Ministers who were never granted an electoral mandate because they fell at the first electoral hurdle?
The first and partial answer is that it may be premature to ask these questions. The “Brown bounce” was always going to be short-lived. There was always going to be an audible thud as the polls came back to earth. What matters now is what will happen over the next eighteen months, and the current volatility of the polls (something to which David Cameron is himself no stranger) tells us little that we need to know.
None of this means that Gordon has not compounded his problems by making avoidable errors. He has lacked a sure touch in presenting policy and in Parliament. He has appeared to contradict his declared distaste of spin. And he made a serious mistake in handling the issue of an early election – a mistake that suggests that there is behind the appearance of iron resolve a much less certain political calculator.
A more confident leader might well have gone for the kill in the period leading up to the conference season. He could have argued with some justice that he was unwilling to serve for long without a full mandate for a Brown premiership, and that the voters deserved the chance to say whether they wanted him or not. He could have launched an election campaign from the top of the “Brown bounce”. And he could have denied David Cameron the chance to make a life-saving conference speech.
But to concentrate on these immediate mistakes does not explain the speed and scale of the decline in Gordon Brown’s standing. There are other, deeper factors at work – contextual elements that, unlike those with a short life, such as a conference speech or a mistake in presentation, are likely to influence events for some time to come.
First, there were always going to be elements of the poison chalice about Tony Blair’s legacy to Gordon Brown. We should not forget (and nor should the Blairites) that Tony left office, not because he wanted to, but because his party saw him increasingly as an electoral liability. Glad of a change, intrigued by a new face (or at least a familiar face in a new context), the voters were always going to recall before too long that Gordon had been a centrally important figure in the Blair government. Its failings were his as well.
Gordon knew this, too, but foreknowledge made the problem no easier to resolve. He could go just so far in drawing a line under the Blair legacy, and trying to distance himself from its more unpopular aspects. If he went too far, he would provoke several unwelcome responses.
The first would be the predictable question – if you were at odds with this or that policy, why did you not say so at the time? More damagingly, a break with the Blair record in government would prompt a damaging counter-attack from the still powerful guardians of the New Labour project.
And so it has turned out, and in a much shorter time than even Gordon’s enemies must have planned or hoped for. No sooner had Blairite spokespeople like Peter Mandelson declared that their long-nurtured hostility to a Brown premiership had ended than hostilities were resumed – and with a vengeance.
The all-too familiar off-the-record briefing is suddenly in full swing. Unnamed “insiders” warn darkly that they always knew that Gordon’s personal and political deficiencies meant that he would falter sooner rather than later. For the first time in years, we are now made privy to leaks from around the Cabinet table, designed to show that Gordon’s colleagues are unhappy. Blairite ex-Ministers proclaim their readiness, in effect, to campaign against the new leader. As we know, the voters hate to see division and infighting – and they look like getting it in spades.
Why has this happened? It is partly a matter of personal pay-back. The price is being paid for those brooding years at the Treasury, when the hint of an anti-Blair conspiracy was often in the air. But it may also be that there are issues of real political substance in play. The Blair government drew its strength only reluctantly from its democratic mandate, still less from the Labour party. Its main pillars of support were always Washington and the Murdoch press.
Any change of policy that Gordon Brown may wish to make would cause him real problems if it provoked an adverse reaction from these powerful allies. So, even a phased withdrawal from Iraq may be seen as unacceptable. Even the most careful hint of a slight move to the left, or at least towards traditional Labour values, might ring some alarm bells. The Blairite counter-attack may not be made in the interests of its front-men alone.
As it is, there is no quick victory – just the long haul. But the long haul – like the electoral arithmetic – may work to Gordon Brown’s advantage. He has time to get the balance right between acknowledging and distancing himself from the Blair legacy. He has time to confound his internal enemies by using the power of patronage and reminding his party of the electorate’s intolerance of disunity. He has time for the voters to understand and value his sterling qualities, and to turn his quintessential Britishness and love of his country to political advantage.
Above all, he has time to stop paying so much attention to “advisers” and to trust his own judgment. Today’s poll means that the campaign for the next election is only just beginning.
Bryan Gould
15 October 2007
Rogue Markets
While the economy burns – the conflagration fuelled by the mounting failures of monetary policy – some politicians prefer to fiddle. The Opposition promise us several weeks of focus on David Benson-Pope and the minutiae of what they hope will turn into a minor scandal. In the meantime, all they can offer on the burning issue of the day is the view that there is nothing to be done but sit back and wait for the worst to happen.
National’s Finance spokesperson, Bill English, should have been a World War One general. His is exactly the mindset that committed thousands of soldiers to the trenches and refused to countenance any alternative. Like so many politicians, he prefers to chase a short-term political gain – by hoping to embarrass the government of the day – rather than address the real long-term issues. So committed is he to this view that he would oppose not only any new thinking but the very idea of discussing the issues at all.
The refusal to contemplate any economic policy option other than one that is demonstrably failing is, in other words, to take a political rather than an economic stance. There are those on the right who believe with religious fervour that markets are always right and that government intervention, however urgent the need for it may seem, will always be counter-productive. Those who venture to disagree, and who challenge what is now established as the current orthodoxy, are labelled as extremists.
But those rigidly adhering to that orthodoxy and refusing to budge in the face of mounting evidence are the real extremists. The adherents of Rogernomics and the denizens of the Business Roundtable have rightly been dismissed from the nation’s counsels on most issues, but they maintain their inviolable position as the guardians of economic policy rectitude because they have sold us on the ludicrous idea that the market must be obeyed, whatever its failings, when it comes to macro-economic policy. No one is allowed to question the dangerously ill-founded assumption that the only issue that matters is inflation, and that it can only be controlled by a single unelected official given a single ineffective and potentially destructive instrument and unchallengeable powers to use it.
The view that the market must always prevail is of recent origin and has never before been given an extended trial in practice. Hitherto, it has usually been seen as the preserve of extremists. It was only when international capital was freed to roam the world at will and thereby escaped the political constraints of what we used to call democracy that we have been brainwashed into accepting that there is no alternative to such an extreme view.
What is astonishing is that so many of those who claim to be representing business can be heard parroting the same dangerous nonsense. As they watch the policies they profess to support destroying their businesses before their very eyes, we can only conclude that this is a remarkable triumph of political obscurantism over economic rationality.
Markets are like elephants – immensely powerful, and valuable. We would all be hugely worse off without both of them. There is nothing else as effective at doing their job. But they work best when they are constructive, disciplined and working well with other factors.
From time to time, an elephant will override these considerations, throw off the shackles and run amok. A rogue elephant can do enormous damage.
So, too, with markets. A rogue market can be immensely destructive. To allow a rogue market – or elephant – not only to carry on doing that damage, but to give it priority over all other considerations, is to take an irrational and extreme view which can be justified only by prejudice and not by argument.
Yet that is where we now are. Only someone with a closed mind could fail to see that our current monetary policy is not only failing in its purpose but is doing great damage to our economic prospects. Any serious politician – especially one with a realistic hope of exercising power – should be joining in the search for better options.
Bryan Gould
24 July 2007.
Submission to Select Committee Inquiry Into Monetary Policy
SUBMISSION FROM BRYAN GOULD TO THE
FINANCE AND EXPENDITURE SELECT COMMITTEE’S
INQUIRY INTO THE FUTURE MONETARY POLICY FRAMEWORK
Introduction
1. The Select Committee is to be congratulated on undertaking this inquiry. Concern has been mounting over recent months about the impact of current monetary policy. That concern has been expressed by a wide range of observers, including the Governor of the Reserve Bank himself (initially, in a speech in South America in 2006), the Minister of Finance, spokespeople for the major productive industries, and a substantial majority of those who usually comment on the performance of the New Zealand economy. It is entirely appropriate and opportune that the Select Committee should reflect the breadth and depth of this concern by conducting a full inquiry into the changes that might – and perhaps should – be made in the current policy stance.
2. The recent actions of the Reserve Bank in intervening in the foreign exchange markets show not only that the Governor has begun to look beyond his usual range of policy instruments but also demonstrate an increasing lack of confidence – both on his part and on that of others – in the efficacy of current monetary policy. As I will argue later, a high – not to say appreciating and over-valued – exchange rate has been an important element in current counter-inflationary policy; to intervene to restrain its rise is to counteract one of the main elements of the current strategy and to undermine one of its principal and intended impacts.
3. New Zealand has often been prepared to lead the world in challenging current orthodoxy. The recent expressions of concern and the holding of this inquiry suggest that we are again taking a lead – this time, in recognising the limitations of monetarist orthodoxy and actively seeking other policy options to supplement or in some cases replace some of the instruments of monetary policy. Where we now go, other countries may well follow.
4. In seeking those other options, it is important to recognise that all policy measures bring with them downsides and uncertainties. What is being sought is not perfection, but measures and a policy framework which will be more effective and less damaging and which will overcome – at least in part – the limitations and drawbacks of the current policy stance.
How Monetary Policy Is Supposed To Operate
5. Monetarist theory suggests that monetary policy offers a painless, effective, and value-free method of controlling inflation. Inflation can only occur, so the theory says, if the quantity of money in the economy is allowed to increase. Inflation can therefore be controlled by controlling the growth in the money supply. The current monetary policy framework shows that our policy-makers have bought into this apparently simple proposition. Experience shows, however, that it is not as straightforward as it seems; it takes no account, for example, of differing rates of velocity of circulation or differing rates of demand for money, and it reflects an essentially static and often retrospective view of how the economy operates.
6. The real problems begin, however, when the attempt is made to control the money supply. It used to be thought that policy-makers could act directly on this issue – first, by defining money for policy purposes and then pursuing measures to control the quantity of money that was available. Money (and particularly those forms of money that owe their existence to the creation of credit) turned out, however, to be a slippery concept. It proved impossible to fix a definition of the money supply which would remain useful, since new forms of money that fall outside a given definition would inevitably develop. In the end, monetary policy no longer depends on defining money but rests rather on controlling the speed and direction of changes in the money supply by altering the price of money (however defined) through fixing interest rates.
7. Raising interest rates (which is the usual monetarist response to increasing inflationary pressures) is intended to restrain inflation by deterring borrowing through raising its cost. In principle, this should work, and in the past has done so, at least to some degree. There is also a second-order consequence of raising interest rates which is also intended to have a counter-inflationary effect. Higher domestic interest rates will – all things being equal – attract an inflow of short-term money (“hot money”) from overseas. That increased demand for the currency will raise its value (providing, incidentally, a further attraction to foreign investors); the higher currency will then further restrain inflation by restricting the profitability of economic activity at the margins, and – by reducing the price of imports – exercise a downward pressure on all prices in the internationally traded goods sector, both at home and overseas.
8. These counter-inflationary effects are predicted by monetarist theory to have little or no impact on the real (as opposed to the financial) economy. Any changes in the inflation rate or in the value of the currency brought about by monetary measures are assumed to have only a temporary or marginal effect on the real economy, which will rapidly adjust to the new conditions; and since it matters little to the real economy, policy-makers may as well choose a low or nil rate of inflation which – it is assumed – will encourage confidence and therefore investment.
9. The relatively simple business of fixing the price of money is said to be a technical task which can be safely entrusted to technicians (that is, bankers) who – unlike politicians – it is hoped can be relied on to make objective and non self-interested decisions about interest rates. Again, the current monetary policy framework shows that policy-makers are happy to comply with this simple view by entrusting the battle against inflation to a single official with a single goal and a single instrument for achieving it. The validity of this view is now very much open to question. Moreover, very few seem to have noticed that the consequence of this approach is that the major – indeed, only – macro-economic decisions are thereby removed from the democratic arena and are made by unaccountable officials. Very few, either, understand that the effect of excluding elected governments from macro-economic policy is to leave most important decisions to the market – and the global market at that – so that government intervention is precluded.
Why Has Interest Rate Policy Done So Much Damage?
10. The comforting assumption that the real (or productive) economy is unaffected by high interest rates has been contradicted by experience. In the end, raising interest rates is just another way of deflating the economy, and all experience shows that deflation is inimical to growth, investment and productivity. In deflationary conditions, elements of production are by definition taken out of use. While out of use, they increasingly lose their value. Plant and equipment become obsolete, the unemployed lose skills, and market share is forfeited to competitors, never to be regained. Once the economy adjusts at a lower level of activity to the loss of those productive elements, further deflation will be needed to maintain the counter-inflationary effect – the very reverse of the virtuous cycle of growth and productivity that policy-makers seek.
11. The deliberately destructive effect of high interest rates is an essential element in the current counter-inflationary strategy. Its destructiveness is exacerbated by the fact that it is the only instrument available. The Governor of the Reserve Bank is given almost exclusive control over macro-economic policy but is allowed only one single indicator and goal – the inflation rate – and one single instrument – interest rates – for achieving that goal. Macro-economic policy is dangerously founded on an excessively narrow view of how and for what purpose it should operate, but its impact is damagingly wide. However obvious a particular inflationary factor might be, however narrowly and precisely its causes may be identified, the single crude instrument of interest rates is trundled out and has its destructive effect across the whole economy. So, a high rate of asset inflation in, let us say, the Auckland housing market will prompt an interest rate hike that depresses incomes and activity across the whole productive and wealth-creating sector.
Why Is Using The Exchange Rate As A Counter-Inflationary Instrument Such A Bad Idea?
12. One deliberate counter-inflationary effect of higher interest rates, as we have seen, is to promote an appreciation in the value of the currency. The theory (particularly as developed by a school of economists called the International Monetarists) is that this provides the elusive “transmission mechanism” between controlling the money supply and bearing down on inflation, and that it does so by compelling domestic prices to fall in line with cheaper imports.
13. As with so much of monetarist theory, the reality is somewhat different. The use of the exchange rate to combat inflation means that it can no longer do its proper job of clearing the market at a price which will enable us to balance our trade and to develop our economy in ways which will encourage us to enlarge our areas of comparative advantage. And, although there will always be siren voices to say that cheap imports are a boon, that foreign travel is made cheaper, and that we should not try to compete on price, the damage to our productive economy from an over-valued exchange rate is now widely understood. Even so, the calamitous effect of the constant reality (and threat) of over-valuation is usually understated.
14. The exchange rate converts all domestic costs, including labour costs, into international prices. The immediate effect of a rise in the exchange rate is to raise all costs and to force those selling into international markets (including our own) either to hold prices stable (expressed in a foreign currency) and accept a consequent reduction in margins, or to maintain prices in New Zealand dollars and suffer a fall in market share. The most likely outcome is a combination of both. With declining profits as a result of lower margins and sales, the first impact is on the ability of the producer to pay wages, and invest in new capacity. In some cases, as we have seen, the squeeze is so acute that companies either fail or move offshore.
15. The second-order effect (on the assumption that the enterprise survives at all) is that the producer generates less income and is therefore less able to invest in new product development, buying new equipment, skill training of the workforce, developing new markets, after-sales service and so on – all those expensive elements that go to make up non-price competitiveness. The quality of New Zealand products falls behind those of other countries that do invest in these vital areas, making it even less possible for New Zealand producers to surmount the disadvantage of declining price-competitiveness – and all this, very often, against the background of ill-informed advice that they should not try to compete on price, but concentrate on quality!
16. In the long run, the constant or regularly recurring reality (and threat) of over-valuation of the currency is so harmful to investment and confidence that there is actually a change in the culture. As a country, we cease to be interested in making new wealth, because it is just too hard. We concentrate instead on manipulating existing wealth and on creating higher values in existing assets like housing. Our best brains go into the professions or domestic industries like retailing, where there is less threat from international competition, and shy away from the internationally traded sector, where the real prospects for growth lie. Anyone who does succeed in productive industry either goes overseas or sells the business to overseas owners. It is hard to think of a strategy that is more certain to frustrate the government’s stated goals of encouraging enterprise, investment and productivity.
Why Are Interest Rates No Longer Effective To Control Inflation?
17. Much of the damage caused by monetary policy might be excused if it actually succeeded in controlling inflation. Increasingly, however, we are handicapping ourselves severely in terms of our international competitiveness in the interests of trying to control inflation with a blunt instrument that no longer works. Indeed, there are grounds for thinking that higher interest rates and a higher exchange rate might actually make inflation worse.
18. An obvious first point is that interest rates actually raise prices rather than lower them. It is assumed that higher interest rates will reduce economic activity (and prices) by making borrowing more expensive. But what if the higher costs produced by raising interest rates are simply absorbed into the cost and price structure, with the result that everyone goes on as before, but at a higher level of costs and prices and therefore of inflation? This is just what might be expected of an economy where price competitiveness has become a chimera, where wealth is made by manipulation rather than improved productivity, and where the emphasis is heavily and increasingly on consumption rather than investment. That seems to be, unfortunately, exactly our situation as a consequence of current policy settings.
19. This is particularly true of the housing market. Much has been made of the high proportion of homeowners with fixed interest mortgages. This may well be significant in explaining the short-term ineffectiveness of higher interest rates in damping down the housing market, but there may also be a somewhat longer-term effect. Homeowners have now lived with constantly rising interest rates for some time now, and the housing market has continued to boom. They are now enured to small interest rate increases, and believe that more expensive mortgages are just another cost increase which will be easily absorbed into the cost structure and will be offset by continued capital appreciation. Indeed, by increasing the replacement cost of existing housing, the effect of higher financing costs may well be inflationary.
20. In any case, what else are New Zealand investors to do, when the returns from productive industry are so uncertain and the housing market offers by far the best chance of a capital gain? It is little use lecturing them for failing to save. Economics is a behavioural science and people will respond to the economic realities they find.
21. One such economic reality is the constant invitation to spend and consume provided by a New Zealand dollar which currently buys 15% more than it should. Why should the consumer invest or save when over-valuation makes imports so cheap? Again, a government that urges a change in behaviour should look to its own role in setting the current pattern.
Why Have We Persisted So Long With Failed Policies?
22. We now find ourselves in a policy cul-de-sac. The high interest rates that are our chosen instrument for controlling inflation are not doing the job but they are pushing up the value of the dollar. The over-valued currency and the consequent loss of competitiveness produce an unsustainable current account deficit – now at or near record levels. In order to finance that deficit (which is made worse by high interest payments to overseas lenders of “hot money” and by repatriated profits as more and more of New Zealand’s productive industry is sold overseas), we have to attract yet more short-term money. This requires even more excessively high interest rates which is where we started and which makes any further circuit of this particular vicious circle look like a counsel of despair.
23. Why, then, have we persisted so long with what is manifestly failing in its purpose and which could only have the desired effect at the expense of crippling what remains of our economy? The answer is that monetarism is a political doctrine rather than a prescription for effective economic policy. An illuminating light is cast on this issue in a paper written for the Reserve Bank by a leading American monetarist economist, Professor Laurence Ball, when he was a Visiting Fellow at Victoria University in 1996. In his paper, “A Proposal for the Next Macroeconomic Reform”, Professor Ball asks why we rely so much on monetary policy which is, he says (quoting Milton Friedman), notorious for the “long and variable lags” in its effects, and is poorly focused in that its adverse consequences are particularly felt by the productive sector. The answer he gives is instructive. The preference for monetary policy as opposed to other measures is not because it is effective, which it is not. It is that monetary policy has been handed over to officials who are immune to political pressures. Professor Ball seemed unconcerned about the undemocratic nature of this reasoning.
What Is Now To Be Done?
24. The foregoing recital of the deficiencies of the current monetary framework demonstrates the urgency of making a proper evaluation of other options. Our inquiry is into improvements that might be made rather than a search for perfection. A failure to find the ideal should not excuse us from settling for something better. There are several steps that could be taken to improve the efficacy of our counter-inflationary strategy and to do so while mitigating the worst of the adverse effects of current policy.
Fiscal Policy
25. The most important step that could be taken is to widen the instruments available to policy-makers in their efforts to control inflation. Principal among these is the use of fiscal policy – taxation and public spending. There is ample evidence that – as Professor Ball conceded in his 1996 study – fiscal policy is more effective than monetary policy as a counter-inflationary weapon. It is quicker-acting and more easily focused. For these reasons, it is able to deal directly with inflationary pressures without causing anything like as much collateral and unintended damage to the rest of the economy.
26. The argument is not that fiscal policy should replace monetary policy altogether. It is rather that fiscal policy should be used as an important supplement to monetary policy and that the two strands of policy should be properly integrated and made consistent with each other. The use of fiscal policy would mean that the excesses and inappropriateness of monetary measures could be mitigated.
27. The major argument against the use of fiscal measures – as Professor Ball pointed out – is not that they are ineffective but that past experience has shown that politicians cannot be relied upon to use them appropriately. They will, it is argued, defer a tightening of fiscal policy, or unwisely loosen it, if this suits the electoral timetable. This argument, it should be noted, can also apply to monetary policy. Politicians are not averse to escaping responsibility for dealing with inflation, by handing it over to officials, if that means that they will not then be blamed for the outcomes. Governments will usually welcome, too, some degree of exchange rate over-valuation, since it will produce a short-term “feel-good” factor by providing a temporary and unsustainable boost to living standards. This is a particular issue in New Zealand with its short election cycle.
28. The objection to the irresponsible use of, or failure to use, fiscal policy by politicians is in any case easily overcome. The provisions of the Fiscal Responsibility Act, by ensuring that fiscal policy is properly explained and debated both in Parliament and, as a consequence, in the media, already make it difficult for politicians to avoid their responsibilities. As a consequence, New Zealand governments have taken a very cautious approach to fiscal policy over recent years, and a decision to treat it as a more important counter-inflationary tool would very much heighten this parliamentary and public attention. The continued use of the Fiscal Responsibility Act very much removes the political objection to the use of fiscal policy and leaves us free to evaluate its use on purely economic grounds.
29. An increased number of available counter-inflationary instruments would have a further and very important and beneficial consequence. It would offer the opportunity to widen at the same time the objectives of macro-economic policy. The use of fiscal policy and other measures in addition to monetary policy would allow – indeed, virtually require – policy-makers to consider other economic goals as well as the single narrow goal of inflation. This would be a very important step forward. It would not mean that a lower priority should be given to inflation, but it would allow issues such as full employment, the level of public services, the competitiveness of our productive industries, – indeed, the whole range of macro-economic issues – to enter the policy picture.
30. With a wider range of counter-inflationary instruments available and a wider range of goals as the proper purposes of macro-economic policy, it would of course no longer be possible or even appropriate to hand responsibility for such policy over to a single unelected official. The Minister of Finance – in Parliament – would have to resume responsibility for macro-economic policy. This would not only be a considerable step forward in the effectiveness of the policy but it would also mean a major advance in restoring proper democratic control and debate over the most important decisions taken in the economic policy arena.
Selective Credit Controls
31. Once the decision was taken to end the dangerous reliance on monetary policy as the sole counter-inflationary instrument, the way would be clear to use other weapons and to target them for maximum effectiveness. What is clear is that the major inflationary factor in our current economic situation has been the rising level of bank lending, often made for the purposes of buying residential property; private sector credit has risen nearly sixfold over the past twenty years. Rather than disadvantage the whole economy in a vain attempt to deal with this problem, it would be more sensible to act directly on the issue by requiring the banks to tighten their levels of lending and the purposes for which they lend. This is not technically a difficult exercise. The banks would not like it but they cannot expect the rest of us to bear the burden for resolving a problem for which they are largely responsible. One of the advantages, incidentally, of an inquiry of this sort is the opportunity it provides to hear advice from sources other than the usual range of economists from the banking sector.
Action On The Housing Market
32. A further and related step would be to act directly on the housing market. A number of measures have been contemplated – a mortgage interest rate levy, a capital gains tax on second homes, changes to tax relief in respect of properties bought to let – and, while all have their disadvantages and of course their opponents, it is not beyond the wit of policymakers to identify measures that would – perhaps even if applied only in the short term – take the heat out of an overheated housing market. This would “knock the top off” the inflation problem – again, without burdening the rest of the economy unduly.
Encouraging Saving
33. Much has been made of the failure of New Zealanders to save, and particularly to invest in the New Zealand economy. As suggested above, this behaviour is no more than should be expected from the current policy settings. New Zealanders are provided with every incentive to spend, particularly on imports and on housing, but with little reason to save and invest. A scheme such as KiwiSaver is very much to be welcomed, in that it promises to remove some of the spending power from the economy in the short term (thereby fulfilling some of the purposes of a tightening of fiscal policy) and it also offers the possibility of increased investment in the New Zealand economy; its effectiveness, however, would be greatly extended if it was working with the grain of economic policy rather than against it. The changes to macro-economic policy suggested above would greatly increase the efficacy of KiwiSaver and similar schemes.
Other Issues
34. An increased emphasis on macro-economic policy, as recommended here, would allow a significant change in the general approach to inflation and other economic issues. Monetarist theory takes an essentially static view of a given economy. It assumes that each economy has a naturally occurring requirement for money and that any increase in the money supply above that level must be inflationary. The emphasis (in theory, if not in practice), is therefore always on restriction. Little account is taken of the propensity to grow and expand (and therefore to require more money) which efficient economies constantly demonstrate. This is surely selling short the power of a market-based economy to improve its performance under the right macro-economic conditions and demonstrates a priority given to the interests of asset-holders as opposed to new wealth creators. Supporters of monetarism as an economic policy doctrine may be surprised to hear that they demonstrate no faith in the dynamism of the market, but that is the reality of our current situation.
35. An economy where credit for investment (as opposed to consumption and housing) was relatively inexpensive and available, where the exchange rate was monitored to preserve and improve competitiveness, and where incentives were provided for investment and productivity gains, would be one which not only freed itself from many of the current burdens (including the ticking time bomb of an unsustainable current account deficit) but which optimised its counter-inflationary strategy by encouraging growth, investment and efficiency gains and thereby garnered the benefits to inflation of falling unit costs – the very reverse of the deflationary orientation of current policy. To put the same point a different way, an economy which was encouraged by the macro-economic context to deploy its creative energy in expanding capacity, improving productivity and increasing export competitiveness would help to avoid the build-up of the inflationary pressures we currently suffer in our constrained domestic economy.
36. Domestic policy along these lines could be accompanied by lending support to international action to damp down exchange rate volatility (which has been at least as damaging to the New Zealand economy as the much-lambasted “stop-go” cycle of demand management policy) and to require more responsible international investment. There is an increasing level of international support for such action, and no shortage of proposals, from people as diverse as Joseph Stiglitz, George Soros and Paul Krugman. New Zealand, which has taken greater risks than any other advanced country in throwing itself upon the mercy of an international free-for-all, would have much to gain if international currency and investment markets operated on a more structured and less volatile basis.
Conclusion
37. We should not doubt that this inquiry and the concerns that prompted it signal an end to the simple certainties that interest rates are the only instrument we need to control inflation, that this is the only purpose of macro-economic policy and that the task should be the sole prerogative of an unelected official. We have much to gain from establishing a wider base for macro-economic policy, with a wider range of goals and a wider range of instruments. This short paper can do little more than sketch out some of the possibilities if we once have the courage to challenge current orthodoxy. The deficiencies of that orthodoxy are now all too apparent. We should no longer close our minds to those other possibilities. I hope to have provided a few signposts to some of the ways forward.
Bryan Gould
17 July 2007