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14 July 2000 A critical issue behind interest rates: How the Reserve Bank constitutes economic nationalityThe Peace of Westphalia of 1648 that ended the Thirty Years War established the legal basis of the modern nation state. It is also the legal origin of the one-state-one-currency principle. That principle was never tightly adhered to, but it was a key symbolic statement of national monetary sovereignty. From it followed the capacity of each nation state to exercise its own national monetary policy. Based on this principle, the Australian state could use the price or quantity of Australian dollars to regulate economic activity in Australia. But as finance has globalised in the last three decades, there has been a growing detachment between national money and the national economy. Australian dollars circulate extensively outside Australia. Accordingly, the exchange rate on the Australian dollar can reflect all sorts of influences, and is only partially responsive to Australian state policy. Conversely, interest rate adjustments impact not just on the level of economic activity in Australia but also on the world’s demand for Australian dollars, and thereby on the price of the dollar. The management of the Australian dollar and Australian dollar interest rates in their international role as part of global finance may not be always compatible with the more traditional management of interest rates and the dollar as national monetary policy. So a basic question arises: by what means, in this post-Westphalian world of global finance, does the nation state constitute the nation as an economic unit? Posed another way, what is the policy adjustment mechanism by which Australia, as a constituted economic unit, adapts to changing global conditions? It would once have been said that interest rates manage the domestic economy and the exchange rate secures global adjustment. But the separation between the ‘domestic’ and the ‘international’ has broken down. With national currencies circulating globally, interest rates are not ‘domestic’ and the exchange rate is not ‘external’. There is now no clear solution to the monetary mechanism of national adjustment.
Instead, I want to argue that wages have become the ‘safe bet’ of monetary policy and are being advocated as the mechanism to adjust national economic activity in Australia. Unlike finance, labour is largely internationally immobile. Its immobility makes it the easy target of policy. If national inflation is too high it must be due to wages. If Australian industry is losing competitiveness it must be due to high wages and low labour productivity. And because wage levels in Australia are discrete from wage levels elsewhere, the policy works! Labour is an effective adjustment mechanism. It matters not whether wages are indeed the source of inflation - wage cuts will provide a cure. Nor does it matter what social consequences might ensue. The strategy is not new—in the nineteenth century, with finance globally integrated under the Gold Standard, wages were the adjustment mechanism to address a national trade imbalance. But at that time the mechanism wasn’t clearly articulated. Balance of payments data didn’t exist and labour didn’t have the vote. There was no effective resistance to the strategy. In Australia since the 1980s the role of wages as the adjustment mechanism has become increasingly apparent. It was therefore a surprise when non-wage factors started to cause inflation in the first half of 2000. The global adjustment mechanism came under pressure. If wages were not the cause of inflation, and inflation was impacting on the exchange rate, how would the RBA undertake the national adjustment process? Interest rates had to rise, but the nominated adjustment mechanism thereby came under challenge. THE INCREASESAustralia has seen four recent central bank-induced interest rate rises - a total of 125 basis points (one and one quarter percent) over 6 months to the beginning of May. The fact of rises is not surprising and the size of the rises not extraordinary. More surprising is the rationale for the rises. The following table shows the justifications nominated in the Reserve Bank of Australia (RBA) media releases that accompanied each of the policy announcements. The differentiation of global and national follows the Bank’s own presentation style.
Global growth, oil prices and wages are pretty standard fare in explanations of interest rate rises and falls (although I will consider the wages bogey shortly). Noticeable has been the shift in rationale away from these so-called ‘real’ economy factors towards financial factors themselves: consumer credit growth, asset price growth, interest and inflation rates elsewhere in the world and the exchange rate. Moreover, within these financial variables, the shift in emphasis has been from domestic to international factors such as the exchange rate and interest rate relativities between Australia and (especially) the USA.
Indeed, so important have these international financial factors become that the financial markets themselves become an important variable. In its April statement the Bank observes that the fall in the value of the Australian dollar (AUD) “reflects an assessment by market participants” about Australian policy settings. When perceptions of financial market players become a rationale for policy settings, we are in a very different world to that of the economics textbooks. So the question is, how is national adjustment being managed? On the surface, it would appear that the exchange rate is the adjustment mechanism, but at a closer reading, perhaps not. The following analysis looks at the RBA’s stated rationales as a means to explore the discourse it has constructed in handling the relation between wages, interest rates and the exchange rate. THE EXCHANGE RATEThe RBA claims that “the level of exchange rate is not an end in itself, but is important insofar as it can affect future inflation” (April 5). That is consistent with its agenda to target a zone for inflation and to use other policy instruments, such as the exchange rate, to achieve that inflationary target. The supposed logic is as follows: a falling dollar is inflationary (because import prices increase, and that flows through to general price increases) and the RBA wants to stop inflation. Therefore it wants to stop the dollar falling. To stop the dollar falling, the RBA increases interest rates on Australian dollars, leading to an increase in global demand for Australian dollars. The claim that the level of the exchange rate is being used for domestic purposes is at odds with established Bank policy. The official position has been that ‘the market’ should determine the overall level for the dollar. The exchange rate should be the mechanism that adjusts economic activity in Australia to the global system and the Bank intervenes in the foreign exchange market only to reduce volatility, not to affect the dollar’s longer-term level. So that established approach has recently been overruled, with the dollar’s value now in the domestic anti-inflationary armoury. Accordingly, the RBA has to answer a difficult question: what is the correct value for the AUD? Or, to put the same question slightly differently, what portion of Australia’s inflationary pressure should be absorbed by state-promoted exchange rate adjustments, and what portion by other variables (such as wages)? An inevitable consequence of the RBA seeking to manage the level of the dollar is that domestic interest rates become part of the adjustment mechanism. An increase in the US interest rate will cause a fall in the Australian dollar, because funds managers will shift assets from the Australian to the US dollar. Hence if US interest rates go up, do Australian interest rates follow, or will the Australian dollar fall? The RBA statements highlight the post-Westphalian dilemma: are interest rates used as a domestic policy tool to regulate the level of economic activity within Australia, or as a global tool, to support a particular exchange rate?
The RBA stared this dilemma in the face. The May 3 statement was explicit in nominating world interest rates, and particularly events in the US as critical to the RBA decision to increase interest rates. By late in May, with an increase in US rates, opinion was divided as to whether Australian interest rates should follow. The RBA said no. The exchange rate fell dramatically. Interest rates stayed in the service of domestic policy and the exchange rate provided the adjustment mechanism, but it was a close call. WAGESWages have long been regarded by the RBA as the primary cause of inflation, and wage data have consistently features prominently in RBA statements on monetary policy [1]. This view has seen much of the Bank’s in-house research focusing on the labour market, the Bank adopting strong stands in favour of labour market (so-called) deregulation [2]. So as interest rates have gone up, it is not surprising to see the Bank looking to wages as a causal factor. It is an automatic response. The table below shows the reference to wages in each of the four statements
This labour market evidence look like a pretty limp inflationary threat. February’s and April’s unrealised portents of wage growth were watered down by May to a guess that something that could occur in the next year or two. Such ‘evidence’ cannot be nominated to explain interest rate rises for other than the dogmatic view that wages are, despite the evidence, the ‘real’ source of inflation.
In the current environment the RBA’s connection between wages and inflation is a beat-up. Indeed for wage earners generally, RBA data points to credit-funded expenditure, not wages per se, as the source of concern for inflation. RBA data show that credit for house buying and bank margin lending to fund share purchases are the central concerns (RBA May 2000:16) [3]. As wage earners’ credit exposure grows, interest rate increases directly reduce household consumption levels. Monetary policy itself then appears as the singular pervasive pressure for wage increases as workers attempt to retain their current consumption expenditure! Such an untenable situation is just part of the bizarre world of credit-funded subsistence, and a signal of how directly monetary policy impacts on the living standards of workers. CONCLUSIONThe RBA maintains an air of authority and assurance. But financial processes are not under state control. These are globally integrated, market-driven processes, and any one central bank has but a limited capacity to affect a desired outcome. And as domestic and global requirements can be in conflict, it is unclear what a desired policy outcome is, anyway. The RBA has been in a process of international strategising to hold exchange rates up and inflation rates down. The tool of international battle is interest rates. At the moment, it is possible to rationalise that internationally driven interest rate agenda as domestically appropriate. It won’t always be thus. But beneath it all is the politics of who carries the burden for national economic adjustment. When the credit-driven increase in asset prices slows we can expect wages to be rediscovered as the bogey of inflation, and the preferred national adjustment mechanism. Wages are, after all, the most nationally determined of all prices. They are the politically easy adjustment mechanism, associated with populist rhetoric about Australians ‘living beyond their means’. And the Reserve Bank will be able to claim that it has had on-going concern for mounting wage levels in Australia. But will labour stay as passive and unheard as it did under the Gold Standard? The Federal Government has certainly been working to secure that outcome, and the Reserve Bank is counting on it. ENDNOTES1. It warrants noting in this regard just how far the finance sector has moved into the production of labour market data. The recent RBA Semi-Annual Statement on Monetary Policy (May 2000) treats ANZ Bank, NAB and ACCI-Westpac data on the same footing as ABS and Department of Employment and Workplace Relations survey data. There is no suggestion on my part that the private institutions’ data are other than thorough, but it is interesting to see that the institutions that provide data which inform RBA deliberations are also the primary speculators on the outcome of those deliberations. Shane Warne and Mark Waugh giving pitch reports seems a parallel. [Back] 2. Refer to any recent speech of the Governor reviewing the successes of the Australian economy: labour market deregulation features prominently. [Back] 3. That popular home and share ownership are central to the current government’s vision should not go unnoticed! [Back] REFERENCESReserve Bank of Australia Media Release No. 1999-11, 3 November 1999 http://www.rba.gov.au/media/mr_99_11.html Reserve Bank of Australia Media Release No. 2000-03, 2 February 2000 http://www.rba.gov.au/media/mr_00_03.html Reserve Bank of Australia Media Release No. 2000-08, 5 April 2000 http://www.rba.gov.au/media/mr_00_08.pdf Reserve Bank of Australia Media Release No. 2000-11, 3 May 2000 http://www.rba.gov.au/media/mr_00_11.pdf Reserve Bank of Australia Semi-Annual Statement on Monetary Policy, May 2000 http://www.rba.gov.au/bulletin/bu_may00/bu_0500_01.pdf Dick Bryan is Associate Professor and Head of Political Economy in the School of Economics and Political Science, University of Sydney. He is the author, most recently, of The Global Economy in Australia (with Michael Rafferty). View other articles by Dick Bryan:
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