In this episode of the Australia Together Podcast on Substack I read Parts 12 and 13 of Chapter 2 of my latest book, The Public Interest Economy: the path to wellbeing, security and sustainable consumption in a democratised Australian economy.
Chapter 2 is called Deploying money so that it can make Australians safe. It describes how Australia’s macroeconomic policy and governance arrangements can be reformed so that in future all Australians can be assured of their prosperity through the achievement of both full employment and price stability.
In these final sections of Chapter 2, I set out the arrangement of economic governance in Australia that is the most appropriate for a nation where money is issued by government fiat. The implication is that when in any economy the currency is issued by fiat, there is little if any utility to relying primarily on monetary policy to control any aspect of the economy, including prices.
Prioritising monetary policy is a largely ineffective strategy either for stabilising inflation or achieving full employment. In fact, the Reserve Bank of Australia has been largely unsuccessful in keeping inflation within its target band of 2-3%.
The proof of this is that in the 35 years since the RBA began using interest rate adjustments to control inflation, it has failed to maintain inflation within its target band of 2-3% for almost 70% of that time. Inflation has been within the target range of 2-3% in only 46 (or 33%) of the 141 quarters in that period. Based on the evidence, monetary policy is comparatively ineffective for controlling inflation. Fiscal policy is far better suited to that purpose and this is comprehended in Rule 1 of functional finance.
Additionally, deprioritising fiscal policy is highly injurious to both the economy and the welfare and wellbeing of people. Fiscal restraint does more harm than good and this has been proven in the facts about the decline of the health and wellbeing of Australians shown in earlier parts of Chapter 2.
The proposed solution
To correct the imbalance in macroeconomic policy in Australia, I suggest that macroeconomic policy should be conducted in a newly integrated system and be led by the Treasury, not the Reserve Bank. This would end the split that currently exists between the Treasury and the Reserve Bank where the Treasury leads on fiscal policy decisions and the bank makes all monetary policy decisions with no influence being permissible by the elected government. This disintegration is at best inefficient and at worst financially harmful to Australians – a fact which is most notably evident in the growth of poverty and inequality in Australia.
For guidance as to how this integrated macroeconomic system should be steadily conducted on a daily basis, I suggest that a new board should be created within the Treasury to oversee the implementation of integrated fiscal and monetary policy in accordance with the rules of functional finance. Those rules are straightforward:
Rule 1 – prescribes the adjustment of total spending (by everybody in the economy, including the government) in order to eliminate both unemployment and inflation, using government spending when total spending is too low and taxation when total spending is too high.
Rule 2 – prescribes the adjustment of public holdings of money and of government bonds, by government borrowing or debt repayment, in order to achieve the rate of interest which results in the most desirable level of investment.
Rule 3 – prescribes the printing, hoarding or destruction of money as needed for carrying out the first two parts of the program.[1]
[1] Abba P. Lerner, Roosevelt College, Functional Finance and the Federal Debt, Social Research, February 1943, reprinted in 1955 by the American Economic Association.
Effective implementation of integrated macroeconomic policy will require the following reorganisation of the macroeconomic governance arrangements in Australia. They should be reorganised so as to:
give the Treasury full use and control of Rule 1 of functional finance to achieve full employment and thereby manage inflation; and
oblige the Treasury and the RBA to act in a fully integrated economic governance system in applying Rules 2 and 3, with the provisos that:
none of the rules can be used in such a way as to permit austerity (ever), and
decisions on monetary policy, including cash rates, be driven not by reference to a target inflation band but by the need to achieve the rate of interest which results in the most desirable level of investment within the whole economy.
The most desirable level of investment within the economy will be the level that results in full employment. Full employment is in this arrangement more likely to equate to an unemployment rate of between 0.5% and 1%, as pertained in the post-war boom period. It will not equate to the reserve bank’s preferred NAIRU (a supposed “non-accelerating inflation rate of unemployment”) which is usually above 4%. A target cash rate band in the order of 2-3% is the most likely to result in a sustained unemployment rate of 1% or less.
There is no reason why the RBA should not investigate the benefits that may arise from replacing its inflation target of 2-3% with a cash rate target of 2-3%. In fact it would make a lot of sense if the bank and the government paused to consider the facts about inflation and whether the prescription they have favoured for it since the 1990s actually works. In its most hurtful form – where the monetary policy board hits the poor and workers with high interest rates – the prescription doesn’t actually reduce inflation. It adds to the price of everything. It causes a rise in the cost of living – because, make no mistake, those interest rate increases flow through to everything we need to buy for our health and safety, not just to mortgages. High interest rates also cause a simultaneous rise in unemployment – so that fewer people have incomes that help them cope with the price increases the bank has caused. Raising interest rates reduces demand – sure – but it does so by raising prices and lowering employment and wages. This is about as perverse as economic management can get – the cure is worse than the ill.
An important qualifier about effective functional finance
A notable feature of the suggested reform is a ban on austerity (public spending cuts). Earlier parts of Chapter 2 expand on why austerity must not be permitted in applications of functional finance. Prohibiting austerity is extremely important if Australia’s consumption patterns are to be switched towards the more environmentally and economically sustainable forms of spending – that is, spending on what I have called “industries of wellbeing” but which others have called “the foundational economy.” This reform is likely to significantly increase the chance of achieving full employment in a sustainable industrial composition. It is also more likely to deliver real wage growth.
In functional finance, stabilisation of the economy and price stability are achieved by synchronous implementation of all three of its rules, with the qualifier that Rule 1 should not be used in such a way as to permit governments to reduce spending on the essentials for our wellbeing. Neither the economy nor those who live within it need that, and it’s why Rule 3 is there. Rule 3 is a failsafe alleviating the government from ever having to resort to austerity. This is the great advantage of the Australian government’s choice to become a sovereign fiat currency issuer. It is a gift that enables not just everyone’s survival but their survival in a permanent state of prosperity. And there is no reason (even in politics) why, having granted us the gift, the government should take it back again by misapplying the three rules.
If functional finance is to assist a government to achieve an economy that supports people, then it must be implemented in such a way as to prevent governments resorting to spending cuts on the essentials of our wellbeing. Governments that can issue currency by fiat absolutely do not need to do that.
A detailed explication of “effective functional finance” is provided in Chapter 4.
The effect of integrating macroeconomic policy under the Treasury
The suggested reforms amount to a replacement of the current macroeconomic management system, which seeks to control inflation by increasing unemployment and suppressing wages, with a new system in which that trade-off is not necessary. With functional finance, we don’t need to sacrifice the chance of employment in order to control inflation.
Functional finance lets fiscal policy do the work of controlling inflation without increasing unemployment. More specifically, functional finance favours using tax instead of interest rates to control inflation. In an era of fiat currency issues, this is the only sensible and fair system for stabilising Australia’s economy.
As long as Australia’s government continues to be a fiat currency issuer it will make no sense whatsoever to make the job of workers in the macroeconomic engine room harder by assigning a responsibility to the RBA that it can’t meet – because it doesn’t have the most effective tools – and simultaneously cramping the workers in Treasury in the use of the more effective tools.
What are the chances of implementing functional finance?
Governments may pose political barriers to these reforms. But there are no technical barriers. It is not difficult to use functional finance. Any competent economic manager can use it.
However, successful implementation will require establishment of a new basis for trust between governments and electors. It will require a genuinely democratised economy where the people of Australia set down in writing:
their objectives for their economy – what they want it to achieve for them; and
the principles for fair decision making on taxation, government spending, and the design and regulation of the wider economy.
This will require the establishment of what is called a National Accord on Wealth, Welfare and Wellbeing and adoption of a new system of longer term economic and financial planning called National Integrated Planning & Reporting.
Chapter 3 begins to expand on these vital instruments.
Quick views of how functional finance works
For a readily accessible summary of the policy orientation of functional finance and how it would benefit Australia’s economy if Reserve Bank independence was reduced, see Extracts from The Public Interest Economy, particularly:
Table 1 – Key takeaways for macroeconomic policy and governance reform.
Box 1A – The rules of functional finance.
Box 1B – The most effective macroeconomic governance arrangement using functional finance.
Table 5 – which shows the prevailing economic policy orientation under neoliberalism in Australia and the alternative policy orientation necessary for a public interest economy.
Listen to a full reading of The Public Interest Economy
You’ll be able to listen to a complete reading of The Public Interest Economy in weekly instalments.
If you wish to keep reading, the full book has already been published and is available on Kindle here. The paperback is available for mail-order here or click on the picture below. Or visit the Australian Community Futures Planning website to purchase The Public Interest Economy at https://austcfp.com.au/publications#public-interest-economy
Stay in touch for the next episode
Next Episode: Chapter 3: A framework for trust in a democratised Australian economy – Introduction.
Useful insights into The Public Interest Economy
Click on the picture to listen to a radio interview with Bronwyn Kelly about The Public Interest Economy.
