We have to stop this insanity.
The way we use interest rates to control inflation is socially destructive, unfairand inefficient.
Under our current system, whenthe Reserve Bank thinks there’s too much inflation in the economy, it lifts interest rates.
By lifting rates, it's forcinghouseholds with mortgages to hand over more of their money to their banks, via higher interest payments, sothose households have less money to spend at the shops so inflation will hopefully fall.
But for households caught in that situation, it feels like a form of stealing. Why should banks get more of your money?
Let's consider an alternative.
If the RBA is going toforce households to hand over more of their income during an inflationary episode to stop them spending,whyshouldn't households get to keep that money and have access to it later, once the inflationary wave has passed?
It could go into their superannuation accounts, where it could generate returns for those households and build their future wealth.
That way, we'd manageinflation with savings and delayed consumption, rather than usury.
And the saving effort could be spread more evenly across households (depending on eachhousehold's ability to save), rather than the saving burden falling disproportionately on households with mortgages.
It would be a much fairersystem.
Why shouldn't households be allowed to keep the money they've earned?
This kind of idea has a long history.
British economist John Maynard Keynes made a similar proposal at the beginning of World War II, when he was thinking of ways to control inflation when allof the resources in Britain's economy were going to be fully employed for the war effort.
You can find itin his essayHow to Pay for the War (1940), where he talksabout the economics of compulsory saving.
It's a masterpiece in macroeconomic thinking.
As he argued, ina fully-employedwartime economy where everyone who is capable of working will have a job, but where most resources will be directed towards the war effort rather than supplying the usual amount of consumer goods, people will have some disposable income and accumulated savings.
So howdo you stop people from using their excess income to compete over scarce consumer goods and triggering inflation in the domestic economy?
Keynessaid you'd havetwo options.
You could eliminate peoples' ability to spendtoo much (by raising taxes, or by lifting interest rates to transfer money from households to banks as a financial rent), or you could postponetheir ability to spend too much (with mandated savings of some kind).
Keynes said it would be much fairer to postponepeoples' ability to spend because it would allow workersto keep the money they'dworked hard for.
"For each individual it is a great advantage to retain the rights over the fruits of his labour even though he must put off the enjoyment of them. His personal wealth is thus increased," he wrote.
"This suggests to us the way out. A suitable proportion of each man's earnings must take the form of deferred pay."
Under his wartime plan, Keynessaid each worker ought to have a "Deferred Pay Card," stamped by their employer, which would recordthe amount of pay that would bequarantined each pay cycle.
He said workers should have the right to choose where their deferred pay would be deposited to start generating interest.
"He might choose his Friendly Society, his trade union, or any other body approved for the purposes of health insurance; or, failing such preference, the Post Office Savings Bank," he wrote.
And he envisaged that, once the war was over, the accumulated savings could be released back to workers "probably by a series of instalments" to support consumption through any post-war slump.
It wasa brilliant concept.
Even Friedrich Hayek, the Austrian economist who tried to rid the world of Keynes's influence,said thedeferred pay plan was "ingenious".
But let's not get side-tracked by talking about it further.
The point is, compulsory savingcan be a very effective inflation-management tool.
It's a big part of the reason why Australia's mandatory superannuation scheme was introduced in the 1980s and 1990s, to help usfinally contain the inflation that had plagued our economy since "stagflation" in the 1970s.
The inequity of the current system
Sowhy don't we allow ourselves to think more creatively and consider alternative ways to tackle inflation?
Look at the current way of doing things.
For the last few decades, it's been very unfashionable to use fiscal policy (taxesand government spending) to manage inflation.
Instead, inflation management has practically been the sole preserve of monetary policy (manipulatinginterest rates).
But monetary policy isn't always the most suitable tool to tackleinflation.
As the RBA notedlast week, a recent modelling effort showed thatsupply shocks accounted forthree-quarters of the pick-up in inflation in Australia (see the graphic).
How can the RBA fix thosesupply shocks by lifting interest rates?
As things stand, the main policy lever available to the RBA is interest rates, and with inflation surging that's why it's been lifting rates aggressively.
It wants people to stop spending so much, so it's doing the thing Mr Keynes thought was unfair.
Rather than getting households to postpone some of their consumption (by mandating more saving from as many households as possible), it'seliminating some households' ability to consumemoreby raising interest rates (which is transferring money from mortgaged households to banks as a financial rent).
Economists are aware of the inequity of the situation.
David Bassanese, the chief economist at BetaShares, says there's a reason why the RBA's rate hikes have failed to stop millions of households spending so far.
"Local consumer spending has remained fairly resilient over the past year in the face of interest rate increases,making it easier for business to pass on supply-driven cost increases through to final prices," hewrote on Friday.
"The resilience of consumer spending (so far at least) reflects the tight labour market, a still substantial household saving buffer built up during the pandemic — and perhaps more controversially — the fact that rising interest rates have less direct effect on the two-thirds of households that don't have a mortgage.The incidence of tighter monetary policy is narrowly directed to a subset of households with heavy debt burdens.
"For a broader effort in slowing economic growth, more heavy lifting would need to come from fiscal policy, though so far it's been missing in action," he said.
We need more creative inflation-management tools
So where does that leave us?
If we think back to Keynes's "deferred pay" scheme, would a similar idea be useful in an inflationary episode like today's?
Australian economist Nicholas Gruen wrote something along these lines over 20 years ago.
In a 1999 papercommissioned by the Business Council of Australia (weirdly enough), Mr Gruen said Australians had embraced the long-term objectives of compulsory superannuation, with its rising pool of savings.
But he said there was no reason why we couldn't use compulsory super contributions to meet short-term macro-economic stabilisation objectives too — forexample, by allowing some short-term variation in compulsory super contributions.
"Thus, when macro-economic policy required tightening, the requirement to contribute to superannuation could be increased," he wrote.
"By contrast, where economic stimulus is called for, there may be occasions where temporarily lowering the superannuation contribution rate would be an appropriate instrument."
If you haven't heard of him, Mr Gruen is the brother of David Gruen, the head of the Australian Bureau of Statistics.
Martin Wolf, the Financial Times's chief economics commentator, recently said Nicholas was "the most brilliant economist you've never heard of".
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An update on the idea
But fast forward 20 yearsand another Australian economist, Lachlan Kerwood-McCall, hasbeen thinking along similar Keynesian lines as Mr Gruen.
In 2020, he wrote an interesting paper that echoed Mr Gruen's thoughts but had its own twist.
MrKerwood-McCall said an "adjustable compulsory savings mechanism" would be a very useful inflation-management tooland it could take a number of forms.
But hedidn't think policymakers should be regularly adjusting the compulsory super guarantee (which is currently 10.5 per cent) to combat inflation.
Instead, he said the RBA might find it extremely helpful to have the power to quarantine a small portion of people's weekly income (as Keynes suggested), in a separate system to compulsory super.
He said the mandated savings scheme would be far more effective thanlifting the super savings guarantee because its impact would be more immediate, given it would work similarly to a before-pay pay-as-you-go personal income tax.
He said the RBA's quarantined savings could be returned to workers in full(plus any returns from investment) upon retirement.
Sohis idea has the same principleas Keynes: if the RBA wants to take money off workers to reduce aggregate demand, why not give that money back to workers by putting it in their retirement savings as additional income for their retirement, rather than giving it to bankers in the form of higher interest payments?
Compared to the current system, thatwould see the national saving effort spread more evenly across households.
MrKerwood-McCall wrote that paper when he was an economist at the Department of Foreign Affairs and Trade, but he's since gone to work for the ACTU as a senior economist.
I find these types of ideas inspiring.
For the last 30 years, aconsequenceof relying so heavily onmonetary policy to manage inflation (and the economic cycle) has been that interest rates have progressively become lower and lower.
By the time the COVID-19 emergency came around, the RBA felt it had little choice butto cut interestrates to near-zero.
We've seen what that did to house prices.
So, the RBA is now trying to lift rates to more normal levels while households are indebted up to their eyeballs and property prices have burst through socially destructive levels.
Would interest rates have fallen so low to begin with ifwe'd allowed ourselves to have alternative and more creative inflation-management tools?
It's worth thinking about.
