Age of disruption casts doubt on power of rate hikes

Ron Bewley


January 5, 2018

In Samuel Beckett’s play Waiting for Godot, the title character is much anticipated but never arrives. Could inflation, of both wages and prices, be our economic Godot?

Central banks around the world have been waiting for signs of inflation before they begin to raise interest rates from emergency to neutral levels. Except for a glimmer of hope in the UK, Canada and New Zealand, inflation has been anemic at best. Yet co-ordinated global economic growth is starting to bubble under. Even the latest 2.8 per cent for Australia posted just before Christmas is a fraction above trend. US growth, at 3.3 per cent, is running well.

So why is there a disconnect between economic growth and the labour market, on the one hand, and price and wage inflation on the other?

Messy metrics

To start with, there is a massive measurement problem. Take consumer price inflation; statistical offices around the world typically produce a single representative number for it by averaging price changes for a basket of goods and services. But the pace at which technologies are emerging and becoming obsolete is skewing such metrics.

Last month, for example, I bought a new monochrome laser printer for $68 and that included a toner cartridge worth almost the same amount! In the early 1990s, my first laser printer cost me about $3500. There is no perceptible difference in the quality of the printed pages. My latest laptop cost me about $1600, and it is tremendously more powerful in so many ways than the first one I bought in 1989 for $16,000. And my first return economy trip to London in 1978 cost $1300 or about 10 per cent of my then pre-tax income. I could now pick up a similar ticket for well under $2000!

We could all cite so many examples. Technology is advancing rapidly, making so many goods and services much, much cheaper. So rapid is the change there is little point in companies raising prices in between introducing new models. In the 1990s, I did a number of consultancies for companies facing the now-defunct Prices Surveillance Authority. Certain companies producing ‘necessities’ were required to apply to the authority if they wished to increase prices. I recall one company telling me that they didn’t bother increasing prices, they just launched a ‘new’ similar brand at a higher price. The print on the packaging was about the biggest change in some cases. How does the Australian Bureau of Statistics cope with these problems?

Not only are price changes for individual goods and services difficult to interpret, the way in which consumers allocate their total expenditure is undergoing increasingly frequent shifts. So while price inflation figures are reported every quarter, they do not have the same meaning they did in even recent times.

The wage inflation story is similarly difficult to work out. Individuals are often getting lower inflation increases but workers are also shifting industries. These shifts often move people into lower-paying jobs so it looks like there is no wage increase, on average.

In short, the notion of having one number for price or wage inflation is becoming largely irrelevant. As a result, simplistic macroeconomics based on the ‘representative consumer’ in a country with one good, etc, is no longer enough to guide economic policy.

As a first step, the Reserve Bank needs to acknowledge the measurement problem by cutting the inflation target band from the current 2 per cent to 3 per cent range to, say, 1 per cent to 2 per cent, and placing more emphasis on economic growth and the labour market than on wage and price inflation.

If we look at the US, with the unemployment rate at 4.1 per cent and growth at 3.3 per cent, it can take a few more rate rises in stride. On the other hand, with the Australian unemployment rate at 5.4 per cent and growth at 2.8 per cent, a rate cut might be welcomed.

The real problem comes when economists eventually realise simplistic models have stopped working. A rate increase is unlikely to stop a new high tech company going for growth opportunities, anymore than a rate cut helps a fading industry invest in a future that is being disrupted.

And as central banks appear to become ineffective in controlling their economies, will investors lose confidence in the system? For nearly 10 years, there has been collectively little action by the central banks of developed economies. They arguably saved the world in 2008 by injecting stimulus but they have done little since.

“A pack of Nobel Prize-winning economists gave Donald Trump and his policy plans the thumbs-down on Friday, with one [Joseph Stiglitz] saying the president-elect’s programs could lead to a deep recession,” Bloomberg reported a year ago. They were wrong, too – unless they want to keep the door open until the US inevitably has another recession.

In my opinion, by and large, equity markets still make a good investment but the worm will turn one day. I am keeping an ear open to any chatter about loss of confidence in central banks’ ability to control their economies. If I get wind of that, I might hedge my bets.

TOPICS:   inflation,  Reserve Bank of Australia (RBA),  TECHNOLOGY