What Philip Lowe Simply Refuses to Acknowledge

I see Philip Lowe is likely for the chop. Once the powers that be start making snide remarks about you, the jig is up.  Once Anthony Albanese in one of his fly-in visits makes fun of your untoward interest rate prediction your successor has been lined up. Postulating aloud that rates would be unlikely to rise before 2024 was monumentally silly, it must be said. Is it a hanging offence? Maybe.  People and financial institutions were undoubtedly led astray. Of course, the RBA board as a whole was complicit. Still, Lowe, as the top guy has to take the responsibility. Applies generally, unless you’re in the Australian Army, that is.

That all said, I hope Lowe survives. I knew him professionally at one stage, closing on two decades ago now. He’s a sound chap. As good as they’ll get and less likely to err in the future, I would think. Incidentally, this doesn’t mean I think that he’s good at his principal job, containing inflation. I listened to his long speech after the latest interest rate decision. He talked about inflation mainly, and about wages, the budget, aggregate supply and aggregate demand.

Hello!What is aggregate supply and aggregate demand? Well, you’ll need to read John Maynard Keynes’s General Theory to get a good handle on them. I wouldn’t bother, it’s a turgid read, and they are useless concepts that have led economists and central bankers down the garden path ever since 1936.

Not once in his speech did Lowe mention the money supply. Extraordinary, in a speech principally about inflation and trying to tame it! I needed to get away halfway through the questions he fielded. Nothing there either, so far as I heard. To be clear, inflation is a monetary phenomenon. An appreciable and persistent rise in the general level of prices has its counterpart in an appreciable and persistent fall in the value of money. Inflation is too much money chasing too few goods, as it is often put in common or garden terms.

It is plainly misguided to talk about inflation without talking about the money supply. It shows how far down the Keynesian rabbit hole the RBA’s economists have gone. Keynes largely ignored the influence of money because he assumed that the demand for money behaved like a “will-o’-the-wisp” and was indeterminate. He was wrong, as Milton Friedman later showed.

Inflation comes about when increases in the money supply exceed the growth in the production of goods and services. The money supply in Australia and elsewhere grew very strongly during the COVID lockdowns. Governments spent lavishly. The RBA and other central banks monetized the spending by buying government bonds.

What to do when the inflation genie is out of the bottle?Turn to Friedman. Slowly and gradually rein in the rate of growth of the money supply until it is growing at about the pace of real economic growth; or, in keeping with latest theory of keeping inflation to between 2 and 3 percent, to two or three percentage points above the pace of real economic growth. Don’t try to dampen things down too suddenly or too fast. To paraphrase Friedman, this will cause unnecessary economic misery. I wonder whether the RBA is now on course to produce such misery.

I think we would, or should, have more confidence if the we knew that the RBA is closely monitoring the money supply and its drivers — government deficit spending and bank lending. As it is, when the Governor can make a major speech about inflation and not mention the money supply, all bets are off.

To the end of April M1 money (notes and coin in circulation plus at-call bank deposits), which I think provides the best guide to the current state of affairs, though admittedly that’s a judgment call, had fallen by 3 percent over the year. That, it seems to me, is a warning sign that monetary tightening is going at too fast a pace. The RBA would have later figures. Is it focusing on them? That’s the question.

Hopefully, the Bank totally discounts the latest inflation number. Leave that to the imbecilic press and to financial economists who earn their keep as talking heads. It is irrelevant. Historical and full of noise. The money supply is the key variable, Bring its rate of growth down gradually and inflation will start to fall, and without necessarily sending the economy into a tailspin.

By the way, if I don’t think Philip Lowe knows what he’s doing on the monetary policy front, why do I think he should be kept on? Simple, the chances of any replacement eschewing Keynesianism and understanding economics is slim to zero. Better the bloke we know, informed by his misstep.