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November 20, 2008
In his speech to the CEDA annual dinner Glenn Stevens, the governor of the Reserve Bank, is pretty optimistic. Even though we face difficult circumstances there is no need to worry really. The economic authorities and regulators have things are in hand by the economic authorities and regulators. All we need to really worry about is worrying about how bad things are. Confidence is what is needed, not gloomy talk.
After reading the speech I had the impression that we live in parallel universes. What has happened in the financial world has been catastrophic and its effects on the Australian economy are likely to cause is a recession and a rise in unemployment. Yet Stevens, whilst acknowledging systemic collapse, continues to think in terms of normal business cycles and the markets automatic stabilisers. Referring to the financial crisis Stevens says that:
a good deal has been done already towards addressing the financial problems themselves. These measures cannot avert a significant slowing in the global economy – it is fairly clear that a recession in the major country group, the G7, is under way. That, in turn, means that credit losses will be incurred by the lenders in those countries as typically happens in a business cycle downturn. But the measures averted, in my judgment, potential systemic collapses that would have had massive repercussions throughout the world. That leaves an international business cycle event to be addressed. So what are the ingredients for doing that?
The worst is over, in other words. Now it's just a matter of a business cycle to sort out. And its easily done. Stevens says that the fall in commodity prices has increased the scope for many central banks to reduce interest rates and for fiscal expansion that passes the ‘good policy’ test. Stevens does not mention an active labour policy (training,wage subsidies, direct job creation), nor say what the good policy test is, other than "worthwhile public investment."
"Worthwhile" is not unpacked. Presumably, it means nation-building infrastructure projects as opposed to tax cuts for the rich, bailing out NSW, or concreting river beds in the Murray-Darling Basin. Does "worthwhile" exclude the recent grants to local government? If not, then what sort of nation-building infrastructure project? Does it include an active labour market policy for unemployed workers?
Stevens adds that it is not realistic to assume that regulators and central bankers will always have the wisdom and prescience, or even the scope, to deploy their few instruments such as to ensure that an ideal combination of financial stability and high growth can be achieved consistently. Note the "ideal combination of financial stability and high growth". There is no mention of policy reform to shift the Australian economy to a low carbon one. Shouldn't a principal policy intervention be to place a price on carbon to support changes on both the consumption and production sides and to encourage necessary investment in R&D and the takeup by business?
On Stevens account, as it stands, we can have high growth coupled with environmental destruction on a massive scale. He qualifies this by saying that policy-makers and regulators both here and abroad will need to stand ready to act promptly to provide any necessary support for the financial system and sustainable economic activity, without saying what sustainable economic growth is. It is not obvious that "sustainable" would include seeking a lower level of emissions or active labour market measures.
Stevens goes on to celebrate the market in terms of the recent shift to greater regulation:
the genius of the market economic system is that so much of the risk that is prudently taken, much of the time, turns out to reward the risk-taker, and indeed all of us, with the profitable deployment of capital, jobs, more choice, higher productivity and better living standards .
But he does not mention that greenhouse gas emissions are a classic example of an external cost that is a result of market failure. Both the producers and the consumers ignore any costs caused by the greenhouse gas emissions as they add to the stock of greenhouse gases.
Stevens concludes his speech thus:
given the underlying strengths of the economy, about the biggest mistake we could make would be to talk ourselves into unnecessary economic weakness. Yes, the situation is serious. But, as I suspect CEDA members know well, the long-run prospects for the Australian economy have not deteriorated to the extent that might be suggested by the extent of some of the gloomy talk that is around. If businesses remain focused on the long-term opportunities; if markets and commentators do the same; if banks remain willing to lend on reasonable terms for good proposals; if governments are able to so order their affairs as to continue supporting worthwhile – and I emphasise worthwhile – public investment (even if that involves some prudent borrowing); then Australia will come through the present period.
The biggest mistake is not tackling climate change in a resolute way. It is talking ourselves into unnecessary economic weakness! My opinion of the Reserve Bank sinks lower after reading that "soothing upbeat" speech.
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the interpretation in the mainstream press is that the Reserve Bank has given the green light to take the budget into deficit to foster demand and protect the Australian economy from the deepening financial downturn.