QED

Boosting Demand Doesn’t Boost the Economy

Boosting demand is the sine qua non of the Australian Government’s and the Reserve Bank’s (and, if it were in government, the Opposition’s) intended response to the depressed economic conditions, which we and the rest of the world face, having destroyed businesses and livelihoods in the cause of combatting the pandemic. It is an archetypical Keynesian response. Some untutored commentators badge it as Modern Monetary Theory (MMT). It isn’t.

First, dispense with the idea that what we have seen so far by government, in borrowing and spending, is Keynesianism. It is isn’t. Neither Keynes nor any of his followers to the present day constructed a theory based on a premise that one day a government would lockdown its economy. That would have been laughable. Crazy stuff akin to science fiction.

The spending we have seen thus far is relief spending, not Keynesian stimulus spending. Governments here and elsewhere, having closed businesses, had the choice of allowing people to starve or to provide relief. They chose the latter to avoid insurrection. A good thing? Look at it another way. If they had been constitutionally prevented from providing relief, they wouldn’t have acted so absurdly in the first place and we wouldn’t be in this mess. But we are. So, there it is and we have to get on with it.

To understand what economic policies are now best put in place to help economic recovery, a primer on full-employment equilibrium is helpful. Come on, you say, sounds like gobbledegook to me. In reality, it is simple common sense; easy to understand, yet completely missing, it seems, from the economic thinking and toolkit of most treasury and central bank economists.

Imagine an economy performing at its peak. If it were, it is, in fact, at full-employment equilibrium. All available resources are being used to produce a large range of goods and services. The extent and pattern of production among those different goods and services is exactly matched by the extent and pattern of demand (read expenditure from inside and from outside the country) for those same goods and services. Nothing is left unsold. There are no unsatisfied queues.

In real life full-employment equilibrium can never be achieved. But we can get close enough at times. And what gets us close is the price mechanism. Left to themselves market prices constantly adjust to bring unused resources into play and to guide where they can be best deployed. On the other side, those same prices respond to, guide and ration demand (expenditure). No computer can do it, however super. Markets do it. And only markets can do it.

So now, what to do? The answer mainly lies in removing obstacles to prices doing their job. In other words, as President Trump realised, and as President Reagan before him, deregulation is the key. Needing to spend ten years to get a coal mine up and running (Adani) is not a shining example of deregulation. Neither is insisting on building a gas-power plant in a coalfield, the Prime Minister’s last-week brainwave.

Instead, at best, lip service is paid to deregulation. Stimulus spending is the go; usually, for the most part, on geographically spread construction projects here and there. Now, armed with our model of full-employment equilibrium, it is easy to see how misguided is such a policy.

Willy-nilly spending on this or that construction project can only interfere with price signals. In some places, for example, prices of construction materials might go up artificially when they should go down. A wind farm is built or even a gas plant when a coal plant should be built, and would be built if the market were allowed to work. The result: power prices increase for a range of manufacturing industries. They become uncompetitive, go out of business, and move the economy further from full-employment.

The government should continue relief spending while it keeps the economy in paralysis and during a reasonable period thereafter. Beyond that, it should focus on removing impediments to economic adjustments, development and growth. That’s hard work of course. Easier to rely on the Keynesian fallacy; spend money and hope it helps.

Two final points.

Relieving banks of some post-GFC lending constraints is sensible (and deregulatory). Why not, Josh Frydenberg, at the same time, instruct them that their banking licence does not give them license to signal their virtue by discriminating against coal projects or against any legal activity.

Second, stimulus spending, borrowing and keeping interest rates low is none other than the application of Keynesian economics. True MMT is a little more cavalier than Keynesianism but, and this is vital, the essential and novel component of MMT is a government-orchestrated employment buffer scheme. The government employs people nationwide – letting some go when the economy booms and taking some in when the economy stalls. No one is yet proposing this unworkable madness.

2 comments
  • DG

    This brings to mind the NSW government’s desire to get ‘shovel-ready’ projects up and running. But ‘shovel-ready’? Do they think developers are just standing around awaiting the Kafkaesque machinations of the planning law to grind out a result? Is a Development Approval ‘shovel-ready’? No, not by a long shot. The authorities haven’t even started on a complex project yet. Construction Certificate? Nup. What about the torrent of conditions to wade through, seek to negotiate? So, you have a CC? Who else is in the wings with a desire to approve? For an engineering project you can bet there’s some obscure regulator that will demand a survey, an, impact assessment of some kind or a pointless review. Meanwhile the developer has wasted millions on holding charges, design updates, re-financing because the risk has changed…or hasn’t, and maybe, withdrawn. No shovels in sight.

  • Peter Marriott

    Very informative Peter, thank you. Regulations seem to me now to be the big, big, big problem. Of course they never used to seem like that when I was very young and that’s the other big , big problem…I mean of course our politicians seeming to appeal more and more to the very, very young voter. I knew a bit more at 21 than I did at 18 and now it’s those 18 year olds that the Gov. seems to be appealing to more and more, to whom of course regulations sound good. Adani and the environmental regulations are a very good example, but so I think are the banking regulations. Regulations in numbers to appeal to voters should come from the socialist side, not the conservative but now it’s coming from both. I still think it’s wrong that a bank can be fined millions and into the billion for leading money to someone who uses it to do something illegal, when all the collateral , guarantees and business would have shown that it would be a good investment for the bank and it’s shareholders. It’s up to the Police to catch crooks surely, once they’ve committed the crime but the bank should not be held responsible. All this does is stifles investment and lending which we have to have to stimulate and grow our economy surely ?

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