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Economic commentators still clueless about the recession
Gerard Jackson
The latest Australian Industry Group performance of manufacturing index report began with the statement: "Manufacturing activity fell for a seventh month in a row in December". And still our economic commentators are at a loss as to what this really means. They shouldn't be. The report is telling us that Australia is in recession and has been for some months. The report found all of its 12 sectors were not only contracting but had fallen below 50. In other words, the sectors showed negative growth. We should not be surprised, therefore, to find that capacity utilisation had dropped to its lowest level 1992.
Falling back on the fallacy that consumption drives the economy, the authors assert that the contraction simply "reflects slower consumer demand". If this were so then we should expect consumer demand to start falling first and continue to fall followed by a continuous fall in manufacturing output. But this clearly did not happen.
If one reflects on the matter it should become apparent that if our economic commentators were right about falling consumption causing a manufacturing recession then not only must the sequence in which the stages of production contract follow a strict order (first consumption contracts, then the next stage of production and so on) but consumption must also be highly variable. That this is not so is made clear by the following chart showing consumption to be highly stable compared with business investment and housing expenditure1
Obviously the interest rate was the guilty party. At the same time that the demand for housing dived manufacturing investment also fell. We find that short term interest rates also rose as did the cash rate which reached 6.25 per cent in August 2000 before steadily falling until December 2001. I think it needs to be noted that prime rates2 started to rise in September 1999, peaking in September 2000 and then falling until March 2002 after which they began to rise again.
Unfortunately there are no mathematical relationships in economics. This means that economics is qualitative and not quantitive, despite the obvious importance of statistics. Therefore, as a rule, we should not draw immediate conclusions from statistical data. The Phillips curve is a sorry example of what when economists rely on a correlations for their conclusions instead of economic reasoning.
What matters here is not whether there is a correlation — not matter how weak or strong — between interest rates and business contractions but whether economic logic is able to lay bare and explain the processes at work. I said earlier that the idea that falling consumption is what causes manufacturing to contract and hence investment spending to drop is totally wrong. A good Keynesian could argue that Keynes fingered the volatility of investment as the real perpetrator, arguing that
if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die;—though fears of loss may have a basis no more reasonable than hopes of profit had before. (John Maynard Keynes, The General Theory of Employment, Interest and Money,Macmillan, St Martin’s Press for the Royal Economic Society, 1973 p. 162).
My basic point is that this explains nothing. As the Austrian stress, the real problem is the manipulation of interest rates by the central banks and how this affects the production structure and relative prices. It is the manipulation of interest — and this alone — that is at the root of the business cycle. Even where the central bank manages to maintain a constant interest rate boom and bust are sure to follow if the rate is still below the market rate. Moreover, the final phase of the boom creates a situation where the yield curve becomes negative even when the central bank has not tightened monetary policy.
Being only able to think in terms of monetary factors instead of real factors when it comes to the yield curve, mainstream economists find themselves unable to account for this phenomenon. Because of this fact the authors of the Australian Industry Group PMI find themselves lamely blaming consumption for the depressed state of manufacturing. Sad to say, the rest of the economic commentariat are no better.
1. Although housing is a consumption good its cost makes it sensitive to interest rate changes.
2. "In the January [2008] RBA Bulletin, the prime rate was ceased in favour of a 'weighted average interest rate on credit outstanding'. The reason the RBA changed the statistic is that 'the large business variable indicator rate … is no longer representative of large businesses’ funding costs'. The new interest rate is reflective of the cost of servicing loans, on all debt outstanding".
Gerard Jackson is Brookesnews' economics editor
BrookesNews.Com
Monday 5 January 2009
It should have been obvious to our economic commentariat that falling consumption was not the culprit. The huge drop in housing that occurred in 2000 is striking a refutation of the consumption thesis. The standard variable home loan interest rate was 6.5 per cent in June 1999. In the following July it rose to 6.55 per cent, peaking at 8.05 per cent in August where it remained until January 2001 after which it fell.
Source: Westpac.
* Adjusted for Telstra's privatisation and for second-hand asset transfers
between the private and other sectors.