In an address to the Australian Industry Group yesterday, Deputy Governor of the Reserve Bank Philip Lowe made a number of interesting remarks regarding recent monetary policy and the difficulties experienced by some sectors, such as manufacturing.
Lowe’s focus was on two prominent features of the recent economic landscape: the historically high value of the Australian dollar; and the increasing household saving ratio of the last eight to 10 years.
Arguably these two factors – at least considered in isolation - have been a drag on the growth of the economy; the high Australian dollar hitting parts of manufacturing hard; while a more thrifty household sector has had a negative impact on retail.
Interestingly though, Lowe finds a silver lining in this story and in making his case is really suggesting that this was part of an inevitable structural change which would have had to have been confronted, one way or another.
In essence Lowe’s argument is that in the absence of the drag on growth in manufacturing from the high exchange rate and the sluggish consumer spending the economy “it is highly likely that the economy would have overheated and that we would have had substantially higher inflation and substantially higher interest rates ”.
And if there had have been higher inflation then, so the argument goes, the exchange rate would have been higher in real terms, with a given nominal value of the currency. In other words, even if the value of the dollar in terms of other currencies had not been historically high, higher inflation would have made our exports more expensive and imports relatively cheaper. The dollar would still be higher in other words in real terms.
Our manufacturers would have been hit one way or another, in this view. Moreover, if the inflation was outside of the desired RBA range, the RBA would have pushed up interest rates, doubling the pain for trade-sensitive (non-mining) sectors with the added effect of deterring investment demand across the economy.
Perhaps this is not so much a silver lining as an argument to the effect that attributing key problems in the Australian economy to the value of the dollar and sluggish consumer spending may be somewhat superficial. These features may simply be masking deeper matters associated with structural change.
The silver lining for the Deputy Governor is rather that the lower interest rates which the RBA has felt able to sustain will begin to generate a positive influence on investment. As well, Lowe maintains, the high value of the dollar will have generated changes in manufacturing which lead to greater efficiencies and productivity improvement.
Personally, however, I have some concerns about the kind of argument Lowe is advancing and the inferences which might be drawn from it.
Setting aside doubts about the assertion that had the dollar been lower inflation would have been higher, with the economy overheating, the Deputy Governor’s argument does make one wonder about the priority given to inflation in modern macroeconomic policy.
With 5.4% unemployment, some might argue, whether a higher inflation rate is something worth trading off against a reduction in unemployment.
The traditional view, and the one I suspect lurking behind Lowe’s argument, is that the economy is always tending in the long-run towards a situation where the only unemployed are those voluntarily unemployed or else those without the necessary skills for available jobs. In this view stimulating the economy will do little to cure that kind of unemployment and would only overheat the labour market.
However even if one rejects such a proposition – and there is ground in my view to do so – this is more than a Reserve Bank problem. It goes to the issue of assigning monetary policy the task of trying to control two things simultaneously - inflation and unemployment - especially when government, except in emergencies, is too fearful to make use of fiscal policy in a counter-cyclical manner.
One other aspect of Lowe’s argument worth remarking on is the reference to the manufacturing firms for example improving “their internal processes and address[ing] inefficiencies”. One may well argue, as Lowe does, that the high dollar has focused attention in trade-exposed industries on areas in which they have quality advantage.
My fear however is where this kind of pressure on sectors of the Australian economy might be used solely to focus on efficiencies in one area in particular – labour.
It will be unfortunate if this kind of economic pressure results solely in a race to the bottom in terms of wages and conditions as a means of improving competitiveness, instead of taking the high road via quality investment and innovation.