A how-to guide to economic policy

For any single business, higher demand, all other things being equal, makes them more money and can often lead to an increase in the number of employees.

For an entire economy, higher demand has no bearing either on real incomes or on the level of employment.

This is straightforward and for me anyway, as obvious as the morning sun. It is the conclusion that comes from a proposition that now goes by the name Say’s Law.

There have been many examples in history where Say’s Law was shown to be an absolute truth in an economy where cuts to public spending led to an increase in output. There have been even more where attempts to raise an economy from recession through increased public spending – through an increase in aggregate demand – have been abject failures. No stimulus in history has ever succeeded in pulling an economy out of recession, NOT A SINGLE ONE! The sad story since the GFC is the most recent, but there have been lots. Every single one made economic conditions worse.

On the other hand, we had the Peter Costello/John Howard years from 1996 to 2007 of the best economic management ever seen, possibly anywhere. Not only did we balance the budget for years on end, we ended up with zero national debt! Because of the idiocies of modern economic theory, even though this was done right there before our eyes, bad theory remains. Modern macro is economic poison, but it’s often lots of fun for both governments and the people who they spend the money on. And for everyone else, it looks sensible since higher demand must create higher levels of production. In reality, it is higher levels of production that allow for an increase in demand. That is why we are so much richer than a century ago. We produce more so that we can demand more.

We were reminded of all this here: John Howard and Peter Costello urge PM to keep building budget surplus.

John Howard and Peter Costello have urged the Morrison government not to squander the budget surplus on a short-term stimulus, while doubting whether monetary policy is still a useful economic instrument given the reduction in interest rates to historic lows.

“The government is absolutely right to be returning the budget to surplus and I think it’s right to anchor­ its fiscal policy to producing surpluses over the next four years,” Mr Costello, the nation’s longest-serving treasurer, told The Australian.

Treasury is filled with people who have no idea why this is the way to prosperity. Reserve Bank as well. A bit more here:

As forecasts for economic growth, household consumption and wages have been downgraded, and $21.6bn wiped from future surpluses, Mr Costello said he doubted whether monetary policy was still a useful economic lever.

“Monetary policy has run out of puff,” he said. “Once you get interes­t rates at near-zero levels, whether they’re at 0.75 per cent, 0.5 per cent, 0.25 per cent, it just doesn’t matter, it’s lost its power as an economic instrument and that is why when the Reserve Bank cut rates during the course of (last) year it had no discernible effect.”

Low interest rates are the other side of the Keynesian economic model, a disastrous shambles of a policy, which inevitably puts money into the hands of many more people who will not earn a productive return on investment relative to the proportion of borrowers who will do so if rates are higher. Interest rates are near zero everywhere and no economy has found low rates of any benefit. Only value-adding investment can raise living standards. High levels of public spending and low rates of interest will not do that, just as they never have.

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10 Responses to A how-to guide to economic policy

  1. Steve Kates:

    Low interest rates are the other side of the Keynesian economic model, a disastrous shambles of a policy, which inevitably puts money into the hands of many more people who will not earn a productive return on investment relative to the proportion of borrowers who will do so if rates are higher. Interest rates are near zero everywhere and no economy has found low rates of any benefit. Only value-adding investment can raise living standards. High levels of public spending and low rates of interest will not do that, just as they never have.

    I’ve said this an several occasions, but it seems to not generate any discussion, which seems odd to me. But maybe I’m on the economists scroll – on – by list.
    “The concept and practice of negative interest rates is similar to an all pervading stench in ones house – it is a hint that there is something horribly wrong somewhere and it should lead one to at least a search for what is causing the smell. But our Intellectual and Political Classes are determined to sprinkle more incense around, lay more expensive carpet over the source of the olfactory discomfort, and deny the existence of any hint something may be amiss.”
    (From the Book of Winston, second reprint when I can gather the funds for another ream of paper and another ink cartridge for my printer.) 🙂

    Put more simply:
    “The existence of a concept as ludicrous as negative interest rates is the system trying to draw your attention to the fact that there is something dreadfully wrong somewhere.”

  2. rich

    I saw an ABC article on how a surplus “hurts” the economy because more is not spent on “public services”, as if government spending is what maintains the standard of living. If such is the case, why not print unlimited money and then buy everyone everything? The claim that NMT advocates make doesn’t pass the straight face test.

  3. Tom

    Modern macro is economic poison, but it’s often lots of fun for both governments and the people who they spend the money on. And for everyone else, it looks sensible since higher demand must create higher levels of production. In reality, it is higher levels of production that allow for an increase in demand. That is why we are so much richer than a century ago. We produce more so that we can demand more.

    That is not only the key to macroeconomics that works, but crucial to building individual businesses: new products create demand.

    The reasons Australia is becoming such an economic basket case, after the mining boom in this century’s first decade are a) Treasury and RBA are full of Keynesians who believe that government spending creates demand; b) the primary objective of all political administrations in the past century has been to grow government and its burden on taxpayers and the economy.

    You’d think Morrison would have learned something from his trip to America last year, but he has learned nothing. Getting government off people’s backs and out of their pockets has been the foundation of American reforms since 2016, which is producing GDP growth of 3-4%, compared with the roaring recession in Australia, due to the ever-growing strangulation of the economy by government red tape and compliance.

  4. John A

    Winston Smith #3278025, posted on January 2, 2020, at 10:24 am

    Put more simply:
    “The existence of a concept as ludicrous as negative interest rates is the system trying to draw your attention to the fact that there is something dreadfully wrong somewhere ELSE.”

    T,FTFY

  5. RobK

    “Monetary policy has run out of puff,” he said. “Once you get interes­t rates at near-zero levels, whether they’re at 0.75 per cent, 0.5 per cent, 0.25 per cent, it just doesn’t matter, it’s lost its power as an economic instrument and that is why when the Reserve Bank cut rates during the course of (last) year it had no discernible effect.”
    This I’ve always seen as a truism, even as a mere layman. The only people who can cut a profit from a few points of a percent are those into bulk arbitrage.

  6. Trax

    High levels of public spending and low rates of interest will not do that, just as they never have.

    Low rates will eat into our future prosperity, it is not just of no benefit but negative. Most businesses will take on debt only where there is likely future earnings to justify said debt. When there are low interest rates they will rightly think there will be low productivity growth and low returns if any for the extra risk.
    In contrast the consumers who take on the debt do so against their wages, where they wrongly believe they will remain employed and increase their earnings. Consuming instead of investing means lower productivity, means lower future employment and more manual lower wages, on average.

  7. IainC

    For any single business, higher demand, all other things being equal, makes them more money and can often lead to an increase in the number of employees.
    For an entire economy, higher demand has no bearing either on real incomes or on the level of employment.

    I’m not an economist, as you’ll soon tell. In economics or its measured web of numbers re the economy, is there any difference in practice whether, if you have $10 to spend, you buy something that was $20 and is now $10 due to decreased demand for that item, or something that was $5 and is now $10 due to increased demand for that item? I can see for the individual businesses that there is a big change in fortunes up or down, but is this factor picked up at all in the economy’s numbers?

  8. Iampeter

    On the other hand, we had the Peter Costello/John Howard years from 1996 to 2007 of the best economic management ever seen, possibly anywhere.

    Doubtful. More likely the good years were a consequence of the liberal policies of the preceding Labor governments of Hawke and Keating who were the closest thing to “Right-Wing” governments we’ve ever had.
    Just like the bust years under Rudd/Gillard/Rudd through to today were a consequence of the gross mismanagement of leftists like Costello/Howard who turned Australia into a Green/welfare state.

    So you’ve pretty much got it as wrong as possible, but this is to be expected from “classic economists” who support things like “trade wars” and “tariffs” and “Trump.”

    Steve-Everything-Backwards-Kates.

  9. rich

    I’m not an economist, as you’ll soon tell. In economics or its measured web of numbers re the economy, is there any difference in practice whether, if you have $10 to spend, you buy something that was $20 and is now $10 due to decreased demand for that item, or something that was $5 and is now $10 due to increased demand for that item? I can see for the individual businesses that there is a big change in fortunes up or down, but is this factor picked up at all in the economy’s numbers?

    It’s not just about the individual prices spent for an item fluctuating. There are three pieces that need to work in tandem: 1) a producer producers a good 2) a consumer purchases that good or capital 3) price is used to signify the demand for 1. Unless you have all 3 the picture is incomplete, such as your question focusing on just price. 1) is a great proxy (amount of value/capital produced) but you need 2/3 to qualify whether what was produced was actually useful.

    By the way, Government cannot produce 1 because it has to coerce money to fund the production through taxation. A parasite cannot live without a host, hence anything it produces is parasitically zero sum. A government may produce “useful infrastructure” such as a “road”… the question then becomes could taxpayers have bought something more useful than a road given both the resources required to build the road (and no profit mechanism to moderate how elaborate such a road would be), and whether taxpayers could have better spent the money on other things.

  10. Doubtful. More likely the good years were a consequence of the liberal policies of the preceding Labor governments of Hawke and Keating who were the closest thing to “Right-Wing” governments we’ve ever had.

    Except the mountains of debt and massive sop to the unions vis a vis compulsory superannuation.

    Keating got microeconomics somewhat correct, Costello got macroeconomics & labour markets somewhat correct.

    Anyway, we’re heading to the freeway to economic misery, ala negative real interest rates, however, those with an ability to receive loan funding are in an enviable position, much like the boomers who mortgaged in the mid-late 1970s and paid off their loans before, during or just after the 1983 recession.

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