Shortly afterwards the American economy was declared to be in recession. Although we in Australia are facing the same phenomenon, our economic pundits are once again demonstrating that they have learnt absolutely nothing from the US experience. In fact, I now doubt that these economic Solons are capable of learning anything.

Glenn Stevens' defended his monetary policy as the equivalent of "changing lanes on the freeway" in that changing rates to alter the course of economy is like steering a car while changing the speed in one direction or another. Far be it from me to condemn the use of analogies but Stevens' is plain asinine and reveals an utter ignorance of monetary theory, the nature of economic growth and the vital role that interest plays in allocating capital through time. An ignorance that is shared by the economic commentariat of which McCrann is a prominent member.

One cannot know what is really going on with the economy unless one accepts the fact that there exists a production structure the shape of which can be distorted by artificially lowering interest rates which then expands the money supply. Eventually this manipulation results in recession when the central bank is finally forced to slap on the monetary brakes. However, the emergence of a recession is not uniform nor does it first make itself felt in consumer spending.

The latter crucial to the debate because the belief that consumer spending drives the economy is the oldest and most dangerous of economic fallacies. McCrann states — and the rest of the economic commentariat would agree with him — that because inflation-adjusted consumer spending, including spending on housing, has probably gone negative this could see an economic downturn led by NSW. While McCrann is right to point to the incompetence and economic stupidity of the NSW Labor Government (the Liberal Party Opposition is just as bad) he is wrong to blame them for any recession, though they must bear the responsibility of making it worse.

It's an unfortunate fact that McCrann and the rest of his colleagues are unable to fit together the pieces that form our current economic puzzle. Because of this their view of the economy is fractured and their economic thinking deeply and dangerously flawed, as evidenced by their focus on consumption at the expense of aggregate economic activity.

Irrespective of what they have been taught total spending greatly exceeds GDP. This is because spending on goods between stages of production are not included in the national accounts. An absurdity that the likes of McCrann have never noticed. Once this omission is taken into consideration consumer spending as a percentage of total spending drops to about one-third. The ramifications of this fact are of enormous importance.

Let's now examine two vital parts of our economic puzzle. First, the Australian Industry Group's manufacturing Index for August revealed that "manufacturing activity fell for a third consecutive month in August. . . [while] manufacturing employment fell for the sixth consecutive month". Second, UBS chief economist Scott Haslem calculated that, excluding NSW, the unemployment rate had fallen to 3.7 per cent while NSW's unemployment rate rose to 4.9 per cent. ABN Amro senior economist Felicity Emmett "noted the fall in jobless was inexplicably concentrated among teenagers*".

The Australian Industry Group's Index clearly showed manufacturing contracting before consumer spending fell. This is exactly the same pattern that emerged at the tail-end of the Clinton boom. Moreover, the national fall in unemployment is largely due to consumer spending, as was the case with the Clinton recession. What we found is that the Clinton boom came to an end once manufacturing output and jobs began to contract, even as aggregate unemployment continued to fall. This now seems to be the case in Australia.

We can now see that rising unemployment in NSW is mainly due to contractionary forces emerging in manufacturing. The same thing can now be expected to happen in Victoria. As for WA and Queensland, employment in these states has been bolstered by the minerals boom. This is an external factor that can do nothing to prevent a recession once it takes hold in the higher stages of production.

At this point an observation by Fritz Machlup would be in order:

. . monetary factors cause the [business] cycle but real phenomena constitute it, Essays on Hayek, Routledge, Kegan Paul 1977, p. 23).

*There is nothing at all inexplicable in the circumstances about a fall in the teenage unemployment rate. Economists are supposed to know that labour will be employed up to the point where the 'gross wage' (the total cost of hiring labour) equals the marginal value of the worker's product. One of the effects of a monetary expansion — as Keynes well knew — is to lower the wage rate relative to the value of the labourer's product thereby raising the demand for labour.

Gerard Jackson is Brookesnews' economics editor

Subscribe to BrookesNews Bulletin