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April 06, 2005

Gruen on economic policy

We are at what economists call the turning point of an economic cycle. Hence the need to match economic policies to particular circumstances.If you miss the match up things could turn real bad.

In addressing this issue, and the skill required to do it Nicholas Gruen refers back to 1989-1993 period. This period, he says, highlights the way economic policies were not matched to circumstances. It stands in marked contrast to the golden age of economic management of 1983-1987 where policies were so matched.

On the 1989-1993 period Nicolas says:

"Our loss of improvisational élan can be dated to 1989 when we faced a ballooning current account deficit and rising inflationary pressures - déjà vu anyone? We turned to monetary policy - déjà vu anyone? The problem was, as we knew at the time, tighter monetary policy was not only a blunt instrument, carrying the risk of misjudgment and recession, but its short-term benefits came with counter productive long-term costs."

We ended up with high interest rates of around 17% to stifle the boom. Giving us the recession we had to have sent many people to the wall. That recession does not stand for heroic leadership: it signifies a disastrous policy call.

Gruen says that an alternative option to slow consumption would have been to require workers to pay some small share of their wages into their newly established superannuation funds. It was rejected.

He connects the economic situation of the 1989-1993 period to the one now:

"So here we are again. Our once yawning current account deficit is now coming to resemble lockjaw. The labour market is tightening, with skills shortages emerging as they were in 1989. And in the absence of action by the Government, the Reserve Bank considers that it’s being forced to slow the economy with the wrong instrument - higher interest rates. Exports have stalled and, though mineral exports will lift soon, our dollar is already overvalued."

This time around the Reserve Bank is being more cautious with using that blunt monetary instrument. Commentary is mixed: see John Quiggin and Ambit Gambit

So what action can the Government take?

Gruen advocates increasing compulsory superannuation: this would have the effect of decreasing consumption, increasing savings, lowering the cost of capital and the exchange rate, and therefore lifting exports.It would certainly address the too much consumption and too little saving syndrome in Australia.

That still leaves us the skills shortage and the bundle of government polices that cut back on education, training and on research and development assistance. Is there not a need to shift government spending priorities away from the election bribes and towards more investment in skills, infrastructure? Do we not also need better incentives to move from people from welfare to work?

And what do we do about the current account deficit lockjaw? Continue to rely on the rapid industrialisation of China, which has increased global demand for oil and other forms of energy and for various minerals, pushing up their world prices, to rescue us? We need to supplement being a quarry for foreign miners with an industry policy.

What about all the investment in new infrastructure that is required? Should we do away with the dumb Department of Finance logic of budget surpluses in all situations and begin to borrow to invest?

Posted by Gary Sauer-Thompson at April 6, 2005 12:31 PM

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