This is a simple story about current US events. Lulled by continuing, uninterrupted prosperity US citizens spent too much – the last 10 years have been a credit-driven spending frenzy. Now it is payback time and because many asset prices (housing and stocks) remain high the potential for a severe prolonged contraction is there.
If there is a recession it might be much more severe than those in 1990/91 and 2001. Joseph Stiglitz is one of the economists on the left of politics who commands my upmost respect. He agrees that the downturn might be long and deep and favours a fiscal response with strong short-term as well as longer-term impacts. Strengthening unemployment insurance, supporting State budgets and limiting foreclosures on mortgages should have decent sort of short-run effects in strengthening the US economy as overspent consumers cut back.
While most of us have been focusing on the inflation bogy and making public expenditure cuts, Fred Argy has been thinking about a fiscal expansion program for Australia if we move into a recession because of US developments. He wants short-term stimuli but also, like the good old leftie Laborite that he is, Fred wants to upgrade ‘public infrastructure’. He might even be right in this – it is certainly sensible to think of contingency plans. These fiscal plans will be important if the real risk of an inexperienced Labor Party damaging the economy with policy bravado actions in the short-run are realised and a monetary overreaction drives a highly leveraged Australian economy into a downward spiral.
But the shocker inflation number of 3.6% announced a few days ago – the highest annual inflation rate for 16 years - poses real dilemmas for the Labor Party and the RBA. Should the RBA raise interest rates further to constrain demand or should it pay most attention to the effects of a possible US recession on the Australian economy which might in fact eventually call for a rates easing? Dealing with inflation offers few short-term benefits and costly impacts on security markets but significant longer term benefits in terms of avoiding the need for a major monetary contraction that will tip the economy into recession.
I think it is important to diagnose the source of the current inflationary impulse and to make sure that wage increases do not feedback by turning once-and-for-all-price increases into ongoing inflation. That is going to be difficult to do in a government most of whose front bench are economic illiterates and ex-trade union officials.
Are these right wing fantasies? What does the new ACTU Secretary Lawrence say? According to The Australian today ACTU secretary Jeff Lawrence insisted that an increase in living costs had to be considered in wage claims. Mr Lawrence said ....there was no evidence that wage increases were causing inflation and in a decentralised enterprise bargaining system and negotiations will take place and all the parties will look at the various factors, and increases in the cost of living is clearly one of them. Inflationary pressures are the ‘result of international pressures and the failure of the previous government. Clearly, workers and unions are entitled to take that into account’.
The situation is ominous. Wage demands may not have caused the recent price increases but they can initiate ongoing inflation. The objective of interest rate increases is to dampen demand. There is no case for compensating workers for fuel and food price increases since these increases represent real additional costs to nthe economy.
Seeking wage catch-up in this situation was the reason for the last period of Labor Party-induced stagflation and there is the potential for a repeat particularly if the Labor Party drones pick away at the decentralised wage system to ensure the survival of their major funders, the unions.