I travelled to the US and UK to discuss my ideas on monetary policy with some of the best economic minds in the world, including former World Bank chief economist Joseph Stiglitz, Harvard academic Jeffrey Frankel and IMF chief economist Olivier Blanchard.
I believe Stiglitz is one of the great living thinkers in the world and so I was looking forward to seeing him again. It’s not often you get the opportunity to canvas views with a Noble Prize recipient.
Stiglitz’s views on life and economics really are holistic. While we started on monetary policy, we soon moved on to inequality and more general economic issues that concern him.
I was not surprised he thought inflation targeting and central bank practices have been deeply flawed, as he has published his views previously.
The following excerpts from his chapter of In the Wake of the Crisis (2012), IMF book which I referred to yesterday:
“The crisis has brought home something that should have been recognised even before the crisis: managing inflation is not an end in itself but a means to an end. The end is a more stable economy – not just price stability but real stability – and an economy that is growing faster in a sustainable way. We ought to be concerned about how the economy affects ordinary individuals. And here, employment and wages are critical.
The perspective that low and stable inflation leads to a stable real economy and fast economic growth was never supported by economic theory or evidence yet it became the main tenet of central bank doctrine. This idea has been destroyed by the crisis – and it ought to have been…….Focusing on inflation has diverted attention away from something that was far more important, the far larger, first-order consequences of financial instability. Indeed the price misalignments (from inflation) were not even of second-order importance. They were more like a tenth order of significance relative to the losses resulting from the (GFC)…. . The crisis has shown that financial stability is far more important than price stability.
The idea that inflation targeting will lead to financial stability or that focusing only on price and financial stability is sufficient for maintaining a low output gap and stable and robust growth is fundamentally flawed. (In extreme cases, where the issue is not 3, 4 or 5 per cent inflation but more like 10 per cent inflation, central banks must focus on inflation as well…)
He emphasised something I read in his latest book The Price of Inequality (2012). He said those who pushed inflation targeting tended to have an ideological commitment to limited government. They wrongly believe this always leads to economic efficiency and optimal growth. They are just about blind to the morality of inequality. Stiglitz thinks inflation targeting was born as much of political philosophy as economics. Milton Friedman is the example he used. I mentioned the Frederick Hayek school of thought, which is similar.
For those who think monetary policy has not had other associated political objectives in New Zealand, remember that Dr Don Brash is a Hayek disciple. I am wary of ideologues. Dr Brash’s fervour and personal belief in the righteousness of his own views was so strong that he politicised the ostensibly non-political role of the Reserve Bank including by negotiating a safe place in parliament via the National Party list while he was still governor.
It is not hard to see who the winners have been in New Zealand through our focus on inflation targeting, with some asset classes profiting from the capital flows which have contributed to house and farm price inflation to the detriment of many of our exports. How have we allowed ourselves to persist so long with a singular focus on the consumer price index while ignoring effects on a cost centre which is such a big part in most people’s budgets – the cost of housing. To allow housing costs to run away while we focus on the price of bread and clothes has never made sense to me. Neither has it made sense to allow the Reserve Bank to have no responsibility for effects on our exchange rate, current account deficit and rising net international liabilities.
The primacy of inflation targeting which New Zealand has required the Reserve Bank to pursue has, in my view, contributed to our protracted current account deficit, asset bubbles, low growth, rising private indebtedness and low productivity growth. Stiglitz has no doubt inflation targeting has failed to achieve economic stability, or maximise sustainable growth, and has contributed to inequality.
As attractive as the simplicity of inflation targeting may have been, it hasn’t worked to put New Zealand, the USA, or the UK, or most European economies in a strong place.
Stiglitz said Friedman and others of similar political ideology, had previously favoured the gold standard, and when that did not hold up, sought refuge in monetarist control of the money supply. When that narrow tool also failed, they moved to something a little more complicated – but still narrow – inflation targeting.
He said inflation targeting always suffered from fundamental limitations, including the fact that it reacted to some supply shocks in a pro-cyclical manner, was blind to asset price bubbles and credit growth, and that the Treasury Bill Rate and the lending rate where only loosely coupled. He said these limitations were and are fundamental, and “still have not been unambiguously owned up to”.
He wanted to move on to inequality, and we did.
His doctoral thesis at MIT was on inequality, its evolution over time, and its consequences for macroeconomic behaviour and especially growth.
Stiglitz got his Nobel Prize in Economics for his work showing that inefficient economic outcomes are not limited to what were previously thought to be rare instances of market failures, and are much more widespread. Markets are not always efficient, for lots of reasons. He proved that government interventions, including taxes, can and should be used to improve the economy.
He finds it ironic that the very time he was proving the economic case for government interventions, the political mood was for smaller government, based in part on the mistaken believe that markets would work better only if the government withdrew.
History of the two decades, when this ideology had ascendency, shows it did not work as well as what went before.
The message in his latest book is that the economy needs to work for ordinary people. He laments the disproportionate control achieved politically, and the economic rents extracted, by the most wealthy vested interests.
His book on inequality explains why “our economic system is failing for most Americans, why inequality is growing to the extent it is, and what the consequences are. The underlying thesis is that we are paying a high price for our inequality – an economic system that is less stable and less efficient, with less growth”. He says economic rents extracted by the top 1% are eroding the living standards of the majority, that values in society are being seriously eroded and that the control of political and economic institutions by a small minority imperils democracy.
He sees similarities between the fall of unfair regimes in North Africa and Arab states with the complaints of the 99% or the occupy movements that took the streets in developed countries 2011.
The message from Stiglitz is similar to Paul Krugman’s; to that of Pickett and Wilkinson in The Spirit Level; and to Tony Judt’s in “Ill fares the land (to hastening ills a prey, where wealth accumulates and men decay)”. Similar to the analysis in Hacker and Pierson’s Winner-Take-All-Politics: How Washington Made the Rich Richer – And Turned Its Back on the Middle Class. All books he quotes, which I am pleased to have read too.
His main concern now is inequality. He shows how this is both unfair, worsening and causes all but the very wealthy to be worse off (and threatens the stability of their long term interests too).
On New Zealand’s circumstance, over the last three decades the increase in the Gini co-efficient (which measures high incomes as a factor of low incomes) has risen at a higher rate than in most other countries. Had we started out as unequal as the USA, we would be worse than them by now.
We talked about the need to tax all forms of economic income fairly. He is attracted to the Gareth Morgan idea of a capital tax at say 2%, as being fairer and more economically efficient than a realisation based capital gains tax. He dislikes the many tax exemptions that persist in the USA for those already wealthy.
The need for an economy that provides jobs and incomes leads back to the work of Swedish economist Goran Roos, which I spoke about before I left. Macroeconomic settings are fundamentally important, but microeconomic levers must be considered as well. Roos is coming to the Labour Party conference in November, which will add another dimension to Labour’s consideration of where we want to lead New Zealand.
Joseph Stiglitz has an interest in New Zealand. He respects our public investments in our health and education systems, our freedom from corruption, and of course our principled stance in refusing to participate in the war in Iraq.
Let’s hope we can get him back down to New Zealand again in the future to help us steer our way back to the prosperous economy and fairer society we once enjoyed.
It is time for me to get back to New Zealand and to advocate for the changes I know we need for that future.
It has been gratifying to meet with leading thinkers in economics and find their thinking in so many ways aligns with current Labour economic policies. We are interconnected globally, and what we do in New Zealand is of interest to others.
I have been inspired by the meetings on this trip, and am grateful for the open and helpful way in which those we have met have given of their time and expertise.