The economic debate 2024 - monetary policy

Neoclassical heritage still has great influence-------. Its latter-day practitioners take refuge in building up more and more elaborate mathematical manipulations and get more and more annoyed at anyone asking them what it is they are supposed to be manipulating.Joan Robinson Economic Philosophy, p. 122

Chart 1

Compiled from RBA Statistical Tables online.

Monetary policy in Australia has come under criticism over recent months. As portrayed in the Chart 1, monetary policy appears impotent and unable to provide stability to an economy experiencing long term decline since 2007. Whilst, monetary policy has followed the CPI curve closely, the GDPr growth curve indicates the underlying economy has been in long term structural decline since the GFC in 2007. Economic dislocation over COVID shows that monetary policy offered no answers. All it could offer was to raise interest rates to address COVID inflationary pressures. Such use of monetary policy would have compounded COVID dislocation.

Post Covid, rising inflation resulted from a combination of income support programs and international supply dislocations. Being a blunt instrument, raising interest rates at a time when the underlying economy was experiencing its worst downturn since the Great Depression would have been counterproductive. This short discussion attempts to explain why monetary policy has become impotent and cannot meet the needs of the modern Australian economy.

The story begins with the election of the Labor Government in 1983 and adoption of Thatcherism based upon supply side economics. In December 1983, the newly elected Labor Treasurer deregulated the Australian Currency which then became the responsibility of the Reserve Bank of Australia. In 1985, monetary targeting was abandoned as monetary flows under the deregulated exchange rate destabilised the domestic demand for money function. In 1988, the RBA assumed the money supply endogenous which meant bank credit determined the domestic money supply. The following equation illustrates the domestic money supply.

Ms = BR + DCE

Ms = Money Supply

BR = Bank Reserves

DCE = Domestic Credit Expansion