I was getting tired, not to mention angry, at all those economists who said that governments don’t make any difference to interest rate levels, so it was a relief to hear Frank Gelber from BIS Shrapnel on ABC Radio news today.
There is no reference to it on the ABC website, so I can’t link and I have to rely on my memory, so forgive me if I’m not 100 percent accurate. What he said was that both parties were promising to spend such large amounts of money that they would fuel unsustainable growth in the economy. This would result in wage push inflation, housing interest rates would hit 10% in 2006, and we would see the housing crash we thought we were having now.
I’m not an uncritical fan of BIS Shrapnel, as I seem to remember them forecasting five of the last three recessions, but on this forecast they are more likely right than not. Low tariffs and floating exchange rates mean wage push inflation is much less likely than in the 70s and 80s, but excess spending always has a reckoning.
The thing is, both sides of politics at the highest levels (although not necessarily that much further down the hierarchy), know that the government spending inherent in the present fiscal settings (and supercharged by the campaign promises of both sides with more to come), will have adverse repercussions, but there is a conspiracy of silence on the issue.
Robert Manne, writing in The Age analyses the ethics of lying. While he concedes that at times it may be O.K. he concludes “There are …no situations in which politicians are entitled to tell blatant lies simply to be re-elected.” In this he fails to understand the real imperatives underlying most political lies. Most politicians lie either because electors expect them to, or because they know that if they do not their opponent will lie about the same issue, and as a result of their truthfulness they will lose to an untruthful opponent.
The issue of interest rates is a good example of this. Most of us know that governments cannot spend ever increasing amounts of money without it having an impact on interest rates amongst other things, but it is a truth we deny to ourselves. We would not thank a politician with our vote, except in times of national crisis, such as 1975, for telling us the truth. So politicians lie to us about economic policies.
Then, having both made that lie, they are bound even more deeply in because, in a version of the prisoner’s dilemma, they know that if they suddenly have an epiphany of truth and recant, their opponent will win. In this situation politicians end up balancing on the one hand their truthfulness against, on the other hand, the awful possibilities of what their opponent being in power might mean for the country. Who is in power may itself have a moral dimension, and lying to attain that end might not only be justifiable to a politician, but in a sense, demanded by the electorate.
September 07, 2004 | Graham
Governments do affect interest rates – economist!
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The Emperors Both have No Clothes
Well, Labor’s tax package has been released, and it looks very attractive, as Chris Sheil discusses here. Will it be enough to get Latham’s campaign back on track? Certainly, Howard is doing his level best to keep derailing Latham’s loco,…
Comment by Troppo Armadillo — September 7, 2004 @ 4:51 pm
It would be silly to say that governments have no effect on interest rates. But it’s equally silly to say that the likely difference in deficits between Labor and the Liberals, say $7 billion or 1 per cent of GDP either way depending on your view, will have a noticeable effect.
Comment by John Quiggin — September 7, 2004 @ 7:08 pm
Yeah, well I didn’t say the latter, so I escape the charge of silliness. What I have argued is that governments do make a difference and that the Labor record over the last 30 years is worse than that of the Liberals. It doesn’t guarantee that it will be in the next 30 years, but voters won’t be thinking about the next 30, they’ll be thinking about the last 30, making Howard’s line a potent persuader.
In your view, what percentage of GDP makes for a significant effect, and are there any studies that try to correlate magnitude of expenditure with magnitude of interest rate hikes, and if so, what are the results?
Comment by Graham Young — September 7, 2004 @ 10:19 pm
Graham
I must say I haven’t read your arguments in favour of the Howard propaganda line that Labor leads to higher interest rates. That’s probably fortunate. Leaving aside the Whitlam government (which only just creeps into the last 30 years anyway), it’s really quite silly to argue about the Hawke/Keating period. It was a period of revolutionary deregulation, when the politicians, Treasury and the Reserve Bank were learning how to effectively manipulate the reduced number of economic levers they had at their disposal. That they left interest rates too low for too long for fear of provoking a deep recession in the wake of the 1988 stock market crash is beyond argument, as is the fact that they lifted rates too far and too fast thereafter and engineered a recession we really wouldn’t have needed to have had they been more experienced ar running a deregulated economy.
But I really don’t think anyone including you could honestly assert that the Coalition would have done anything substantially different had it been in power through that period (except that they may well not have had the guts to deregulate in the first place).
The bottom line is that the 1980s don’t tell us anything meaningful about Labor’s likely economic performance in government today. The period 1992-96 gives a much more accurate idea, and is essentially indistinguishable from the Howard government era.
Of course, that doesn’t mean it isn’t a smart strategy for Howard to run. Some people might well be frightened by it, but we all know it’s a dishonest propaganda line without any substantive merit. But then, as you so persusasively argue, honesty is a problematic concept in politics. And the practice of politics is (sadly) largely amoral anyway – whatever it takes. So if some people might conceivably be persuaded to believe that Labor is a larger risk of presiding over higher interest rates, then however spurious the argument, it will be advanced. If that’s all you were arguing, I agree. If you were arguing that the claim had any substantive validity, you’re on much shakier ground.
Comment by Ken Parish — September 7, 2004 @ 10:56 pm
Graham, of course governments can affect interest rates. The point is that government spending and interest rates are not economic identitites. To the contrary, under the right conditions, government spending can enhance productivity, taking pressure off demand, inflation and thus rates. If you wish to see the mathematical proof, check out this paper, which runs the algebra in the context of public debt.
Comment by cs — September 8, 2004 @ 1:03 am
Of course government spending can affect interest rates, as can lots of things. On the other hand, government spending under the right conditions can also enhance productivity, relieving pressure on demand, inflation and hence rates. The point is that there is a (complex) relationship between spending and rates, not an identity. If you want to check the sums, they’re in the url paper below in the context of a discussion of public debt.
http://evatt.org.au/publications/papers/64.html
Comment by cs — September 8, 2004 @ 1:40 am
Sorry about double post – didn’t realise your comments ran in reverse order.
Comment by cs — September 8, 2004 @ 1:41 am
The ABC News link to Frank Gelber is:
http://www.abc.net.au/news/newsitems/200409/s1193924.htm
Comment by Guido — September 8, 2004 @ 1:56 pm
Thanks for the link Guido. Seems my memory is pretty good.
Chris, I checked out the algebra, and I don’t think that’s quite what it says. I should preface this by saying that I’m not a believer in zero public sector debt per se, but there is a relationship between government borrowing and interest rates which Professor Aspromorgous acknowledges in the paper when he says “One cost might be a tighter primary budget balance, depending on the relationship between g and i. It may be noted also that higher D* might feed back upon and raise i.” D* is the trend in public debt to GDP and i is the interest rate of government borrowings.
Higher borrowing only gives you higher real growth if you can find investments that return you more than the cost of borrowing and which are higher than the totality of people living in the country could realising deploying the same assets differently. As you say, it’s a complex relationship.
Comment by Graham Young — September 8, 2004 @ 2:30 pm
I think we are in furious agreement, but FWIW, Prof Tony’s key statement challenges the government’s assumptions:
“there are not likely to be any smooth continuous functions linking D (debt, but you take this as government spending generally for the sake of the algebra and the argument) and i (interest rates), as employed in the appendix to the government’s discussion paper.”
i.e. as I say, they are not identities. But we agree, the relationship is not direct, but complex.
Comment by cs — September 8, 2004 @ 7:25 pm
I should point out that the national private sector debt eclipses the Federal public sector debt by an order of magnitude — too much interest in importing European whitegoods in the community, apparently. Have to start digging that iron ore out of the ground a lot faster and shipping it outta here…
The Federal public sector debt is really only an indicator of how well the govt is managing its own affairs, not the nation’s. High unemployment and concomitant payments tends to ratchet it up, as does bloated and unnecessary govt.
BIS Shrapnel reports always seem to me to reflect the vested interests of developers and the property market – never seen them as too impartial or reliable. Somewhat like listening to the REI for an account of how to house citizens responsibly — they really just don’t care.
Comment by Sean Reynolds — September 15, 2004 @ 2:36 pm