MMT bad faith.

MMT advocates don’t seem to appreciate the risks in giving politicians responsibility for managing inflation, and they engage in the same sort of supply-side voodoo as tax cut-obsessed Republicans.

It seems to me more and more that advocates of MMT (or Modern Monetary Theory) may not be debating in good faith.

To be sure, this doesn’t apply to all – in fact, the reason I learnt about MMT at all was because I stumbled upon a conversation on the topic on Twitter, and several individuals were kind enough to engage with me very much in good faith.

But there does appear to be a segment of this movement that is not interested in whether MMT can be implemented feasibly, which leads me to believe that they’re just looking for an excuse to drastically increase spending on their chosen pet projects, without caring how it is accommodated (note I didn’t say ‘afforded’ or ‘paid for’ given the fact that MMT states the limits of government spending aren’t what the government can afford, but what the economy’s real productive capacity can accommodate).

The first reason for my accusation is that very few MMT advocates seem to highlight the potential disaster of trusting politicians with responsibility over inflation, rather than a semi-independent central bank. MMT does indeed point out that fiscal policy (taxes) is the intended tool to control inflation (even if not to ‘pay for’ government spending) but very few worry that whenever politicians have been given that power, they’re not good at wielding it. Tax policy is simply too slow to react to inflationary pressures (or lack thereof). Sometimes politicians are simply too afraid of the voter reaction if they change taxes one way or the other.

I’ve suggested some sort of independent fiscal authority with control over the choice and implementation of infrastructure projects, and maybe a direct link to the printing press (if not indirectly through simply a share of the government budget). This would leave the determination of any output gap and the proper cost-benefit analysis of infrastructure projects out of the hands of politically-motivated individuals. But it’s not an idea I see discussed frequently.

So this is my first concern with many MMT-advocates – they don’t seem to appreciate the entire purpose of outsourcing monetary policy to the experts of an independent central bank in the first place.

My second concern, in the case of the ‘Green New Deal’ debate in the US, is the suggestion (explicitly not implicitly) that the additional spending on environmental protection will create entire new industries and economic activity, thereby absorbing all the extra spending without it translating into inflation.

Again, this is a risky proposition to trust politicians to ‘pick winners’. Governments have attempted this kind of industrial policy all over the world with very mixed success. Sure, South Korea’s auto manufacturing industry did well with government support, as did the US’s manufacturing industry in the 19th century. But there are just as many examples (if not more) of abject failure (see South America – and I’m not even talking about Venezuela’s fiasco, I’m talking about countries like Argentina throughout the 20th century).

This is the kind of supply-side voodoo Republicans employed to pass their tax cuts – that they’d generate enough economic activity to pay for themselves. They didn’t. They were just used mainly for executive bonuses and stock buybacks. They haven’t even generated much new real investment.

To be sure, there *are* lots of good projects the US could undertake – even just repairing their crumbling infrastructure – that could literally ‘pay for themselves’ through increased economic activity. But if MMT is to be the new status quo, we need a way to ensure that once the ‘low hanging fruit’ productive projects are exhausted, politicians don’t keep printing money to finance lesser projects that do, in fact, just result in inflation.

So this is my second concern – how easy it would be for a government to pick the wrong industries resulting in all that additional money translating not into new economic activity, but plain old inflation.

MMT is philosophically interesting and is indeed a clever way of looking at how the world works. And it arguably arose (or at least came to greater prominence) as a legitimate antidote to the ill-advised government austerity movements that followed the GFC. But unless its advocates talk more about how it is to be implemented, accusations of bad faith – along with comparisons to countries like Venezuela – will continue.

It’s good for taxes to be progressive. But it’s more important that they can’t be avoided.

There’s been a lot of talk recently (particularly out of the US) about increasing taxes on the wealthy – Elizabeth Warren has proposed a wealth tax of 2 per cent for assets over $50 million and 3 per cent for assets over $1 billion. Alexandria Ocasio Cortez (AOC) has proposed a top marginal income tax rate of 70 per cent for incomes over $10 million. Bernie Sanders wants to lower the threshold for the estate tax and make it more progressive.

On the face of it, there is a good argument for countries like the US collecting and redistributing more tax than they currently do. I've written before that there is a good inverse relationship between tax collection and inequality. Countries in the OECD with the highest tax revenue as a percentage of GDP (e.g. Norway, Denmark) tend to be the best at keeping inequality low while still maintaining some of the strongest free market economies. On the other hand, countries like the US with one of the lowest levels of tax revenue as a percentage of GDP and also one of the strongest free market economies have among the highest levels of inequality.

What is the best way to raise tax revenue though? Income taxes? Wealth taxes? Corporate taxes? Consumption taxes?

Warren, AOC and Sanders seem to think the first two. I think they're also considering a reversal of Trump’s corporate tax cuts. And it makes sense. Income and wealth taxes can be progressive, with the richest people paying higher rates. Consumption taxes disproportionately affect the poor who spend a higher proportion of their income on goods and services than the wealthy. The same applies to flat corporate tax rates and small vs. large businesses.

So I can understand why Warren, AOC and Sanders picked these taxes.

Unfortunately, income, wealth and corporate taxes are rife with avoidance. Wealthy individuals and companies have the means to use every form of accounting trickery to avoid actually paying these taxes. Shifting profits overseas to avoid corporate taxes. Minimising your official income with every imaginable deduction to avoid income taxes. Even wealth and property taxes can disproportionately affect the middle class because the wealthy tend to hold most of their wealth in shares rather than houses and therefore, avoid such taxes. It’s not easy to enforce these taxes.

This is why, according to a recent article by Bloomberg, the OECD countries that are able to raise the most tax revenue as a percentage of GDP are the ones with the *least* progressive tax systems – economies that rely proportionately more on consumption taxes (e.g. Denmark, Finland). The US on the other hand, has very little reliance on consumption taxes.

As mentioned above, consumption taxes disproportionately affect the poor, but are much harder for the rich to avoid. They also have the added advantage of not discouraging work (like income taxes can) or investment (like corporate taxes can).

Consequently, these countries are able to raise much more tax revenue, and then undertake much more income redistribution to offset the disproportionate impact on the poor – social welfare, infrastructure, education, health care, paid vacations, paid parental leave, child care, all provided by the State to greater extents than in the US.

This redistribution can also include much more targeted exemptions for specific items or activities society wants to encourage above others. This can include fruit and vegetables, health care and, in Australia, possibly new home building. Given the barriers that existed to new home building for much of the 21st century, the affordability crisis that developed, the sudden influx of supply (especially apartments) and the subsequent risk (though not expectation) of a deep and protracted correction, this is not something of which we’d like a repeat episode. Even if such sudden new taxes don’t discourage investment, extra incentives for new home building are still a good idea given our history.

The IMF too, in their latest assessment of the Australian economy, recommended a shift away from less efficient taxes like stamp duties to more efficient ones like consumption taxes (our GST) and land taxes.

This does not mean all taxes need to be consumption taxes but a greater reliance on them seems wise. If high tax collections are the best way to minimise inequality – thereby helping people into the Australian dream of home ownership – while retaining a strong free market, then the taxes that are most difficult to avoid are surely the preferred option over more progressive, but easier-to-avoid, taxes – even if it involves the extra step of greater redistribution.

Redistribution is not a dirty word after all – it’s literally the one and only job of government.

Interest rate speculation pushed into overdrive.

Australia’s economic fundamentals are still strong.
But the local housing downturn, the global trade war, increasing international borrowing costs, a slowing EU, structural issues in China, and general instability all threaten to derail both global and local economic momentum.
The risks are asymmetric to the downside – the RBA should pre-empt them by dropping interest rates this year. The costs of not doing so are potentially much larger.

 

Death, taxes and cash rate speculation – these are universal constants. But in recent months, speculation about the direction of the Reserve Bank of Australia’s (RBA) cash rate have pushed this speculation into overdrive (at least amongst us economists).

The RBA – for many months now – has very clearly been signaling that its next cash rate move will likely be upwards. Many players in the industry agree, speculating some time in 2020 for the next rise.

There are good reasons for this upwards cash rate broadcasting.

Australia is continuing its approach towards 30 years of uninterrupted economic growth. Growth recently returned to trend following the mining and resources fallout, supported by strong home building activity and public infrastructure spending. The labour force continues to strengthen too, with unemployment back down to 5.0 per cent.

We are also being supported by a buoyant global economy. The US is experiencing one of its longest economic recoveries on record. China continues to generate economic growth rates beyond the dreams of any developed country. And advanced economies have driven strong global economic growth in recent years.

It is in spite of – or perhaps *because* of – this strong performance that there is increasing nervousness about the future. A number of prominent pundits have broken from the herd and begun canvassing the idea that the next move could actually be a cut. These concerns mainly surround two perceived risks – a global shock and a major local housing correction.

The IMF has just revised down its forecasts for global growth in the next couple of years; the trade war between the US and China (and perhaps the EU too) threatens to derail global momentum; recent negative economic data out of both the EU and China have raised concerns; and ongoing insular, nationalistic and anti-globalisation sentiments surrounding not just Trump’s America, but also Brexit, the Italian budget situation, recent French riots, and many other regions, threaten in the short term to shock the economic outlook, and over the longer term unwind decades of wealth generation, poverty reduction and international cooperation and stability.

Closer to home, Australia has its own ‘Moloch and Mammon’ on the horizon. Since their respective 2017 peaks, dwelling prices in Sydney have declined by 11.1 per cent to December 2018, and by 7.2 per cent in Melbourne. Nationally, prices are down by 5.2 per cent. The November housing finance figures showed that the number of loans by banks for the construction of a new home fell by 2 per cent in the month of November to be 9 per cent lower than the previous year. The change in the housing cycle had a direct impact on the flow of new residential building work entering the pipeline and creates a risk that the change in housing wealth may cause households to reduce consumption expenditure.

The continuing housing market downturn has thus far not resulted in a significant wealth effect on household consumption. The largest price declines have been at the top end of the price spectrum – households that are less sensitive to changes in wealth and therefore, less likely to significantly cut back on consumption. But this is not a forgone conclusion and while we have long been anticipating a housing downturn (five years of housing construction completed in just four years couldn’t be sustained indefinitely), and ongoing population growth will continue to absorb housing supply, there is still ongoing uncertainty about the downturn’s true length and depth.

Record household debt levels have not yet caused households to tighten their belts and there are few concerns from the RBA about debt serviceability with mortgage arrears remaining low. But wage growth has only just begun to tick upwards from is recent sluggishness and is definitely not guaranteed to continue that way. Combined with structural issues like ageing populations and low productivity growth, wage growth could continue to struggle, putting pressure of heavily-indebted household budgets and increasing their vulnerability to increasing borrowing costs.

Slower global growth will slow the pace of interest rate normalisation around the world but the combination of APRA’s tighter lending standards for investors and interest-only lending and the Royal Commission into the financial industry have acted to tighten local finance conditions not just for investors, but also owner-occupiers (even though APRA’s caps have since been removed). The time it takes to gain approval for a loan has blown out from around two weeks to over two months. And we saw just last week that NAB increased interest rates independently of the RBA and other commercial banks, citing these increasing costs of finance. When the impact of the findings from the Royal Commission become apparent, plus Labor’s proposed changes to negative gearing and capital gains tax, it could be the trigger to a steeper property market decline and the thus far-absent wealth effect on the broader economy.

Perhaps most important to Australia – as has been the case for the last 20 years – is the fate of China’s economy, our single greatest export market. There too, significant amounts of debt have been accumulating. China’s massive ‘pump-priming’ following the GFC averted a significant downturn. But it unfortunately also shifted huge amounts of resources away from potentially productive and innovative private sector uses back into government infrastructure and programs, unfortunately derailing their transition from an investment-led to a more sustainable consumption-led economy.

Recent slower economic growth and other worrying data out of our behemoth neighbor to the north poses the question – do they still have the will and the means to carry themselves through the next downturn? To be fair, people have been talking about Chinese imbalances and slowdowns for a couple of decades now, and China has continued to defy expectations. Even the GFC couldn’t knock them over. Policy makers and regulators have also been attempting to address some of these imbalances for a while now. But these predictions only need to be right once. And doesn’t the fact that these imbalances haven’t disappeared (and have actually got worse) add *more* weight to the argument for every year China keeps kicking the can down the road, not less?

Furthermore, the international trade war – even though escalation is still forecast to cost the global economy only in the low single digit percentages of GDP – could represent the trigger for some of China’s more significant imbalances to reveal themselves.

 

These are a lot of national and international factors that could turn against Australia in the near future. Hence the recent boom in RBA cash rate speculation.

Monetary policy is supposed to be proactive, not reactive. The US provides a good case study of this during the GFC. It was real-time feedback from financial institutions around the country rather than deterioration in official statistics that revealed the sudden liquidity emergency being faced and triggered the unprecedented response from Ben Bernanke and the Federal Reserve.

In Europe on the other hand, they did wait for longer and actually initially increased interest rates because they were more concerned about inflationary pressures than the financial crisis that had already begun. Consequently, the pain that followed was much greater than in the US.

Our own RBA Governor Philip Lowe – generally seen in the industry as a rather conservative figure – would arguably need a significant new development to occur to consider not just delaying any future increases, but actually dropping the cash rate from its current record low 1.5 per cent.

What then would need to happen for the RBA to reverse its long-broadcasted position that the next cash rate move will be upwards? A sudden deterioration in official economic indicators? Unemployment to jump up over 6 per cent? Inflation to fall below 1.5 per cent? Economic growth to turn negative? An influx of panic from their business liaison program?

There is a lot that could go wrong in the near future for Australia and the world.

Notwithstanding one (or more) of the above potential global shocks, I am only predicting a manageable slowdown in the Australian economy, rather than a drastic correction or recession. But I do think this will be a valid justification for the RBA to drop interest rates this year. They no longer have to concern themselves with overheating the property market. In fact, the combination of tighter credit conditions, the imminent impact of the Royal Commission’s findings and increasing global borrowing costs means it may be very irresponsible not to drop interest rates further. The risks are asymmetric – much larger to the downside than the upside. Why not drop rates?

The RBA may suffer a bit of embarrassment if they suddenly change their position. But policy makers need to be willing to consider rapid reversals of position if the worst should happen. By the time it shows up in the official data, it could be too late.