myth has the task of giving an historical intention a natural justification, and making contingency appear eternal… in it, things lose the memory that they once were made
(Roland Barthes, 1957)
Since part one, the Reserve Bank of Australia (RBA) has released the minutes of its board meeting: a page of indistinct waffle and blame shifting, disguised as tea leaves, to be read by economics commentators in the business press. The governor has also made a speech to the Australian Business Economists Annual Dinner. That speech contained the following, which has been widely and justly ridiculed:
The second indicator that inflation is being driven by domestic demand is that it is increasingly underpinned by services (Graph 4). Hairdressers and dentists, dining out, sporting and other recreational activities – the prices of all these services are rising strongly
(Bullock, 2023b)
The RBA seems to believe a stiff dose of asceticism is in order for the good of the nation, but for whom? Not for the audience at the Australian Business Economists Annual Dinner, as they are most likely to be “benefiting from rising housing prices, substantial savings buffers and higher interest income” (Bullock, 2023a). Perhaps this audience was more concerned with the price of Roquefort, yet the governor failed to mention our runaway inflation champion – cheese. Would making an example of domestic demand driven cheese inflation be too far beyond parody, and risk exposing the myth that demand is always the cause of inflation? No, it would not. Myth “aims at causing an immediate impression - it does not matter if one is later allowed to see through the myth, its action is assumed to be stronger than the rational explanations which may later belie it” (Barthes, 1957/1991, p. 129). That is why Graph 4, which clearly shows that services price inflation has peaked and is falling, can be baldly presented right after the governor’s “statement of fact” (1957/1991, p. 143).
Inflation has itself become myth, a dragon that must be slain. Inflation is not a thing, or a phenomenon; it is an invention, a term applied to an aggregate basket of prices whose makeup changes from time to time as much due to economic fashions as consumer preferences. For example, in 1997 the RBA requested interest charges be removed from the Consumer Price Index (CPI) because “interest charges as measured tend to distort the signal offered by the CPI of inflationary trends, by incorporating the policy responses to those trends” (Dwyer, 1997, p. 2). In other words, raising interest rates was increasing inflation! How did they propose to fix this? By changing how they measure the CPI – but you still pay. This apparent contradiction is washed away with the knowledge that “Excluding interest charges would in no way distort the outcome over the long run” (1997, p. 2); yet the RBA acts in the short term, responding to a spasm in the September figures that “on a quarterly basis, had picked up slightly” (RBA, 2023). As predicted, we have been spared a xmas rate-rise, since the “monthly CPI indicator for October suggested that inflation is continuing to moderate” (Bullock, 2023c). If we can now suspend disbelief, and assume that equilibrium happens, it may all even out in the long run; but you might not have any teeth when we get there.
Accepting the myth as a statement of fact – inflation is a depoliticised economic indicator – what is the cause of it? The answer is right in front of us, staring back in the words of the governor’s statements and speeches: firms’ pricing decisions. This statement of fact is also built-in to the RBA’s macroeconomic model of Australia, MARTIN, short for “MAcroeconomic Relationships for Targeting Inflation” (Ballantyne et al., 2019, p. 1). We can find, there, apparently logical mathematical expressions for firms’ pricing decisions, but these expressions are always founded upon simplifying assumptions. In common with neoclassical/mainstream economics’ cultural norms, firms’ responsibility for the prices they set is washed away with the following assumption:
In the long run, firms are assumed to set their prices as a fixed mark-up over their input costs. As such, there is a long-run relationship between the price level, nominal unit labour costs and the price of imported consumption goods (Ballantyne et al., 2019, p. 25)
There is a complimentary short run formula, which projects forward from the rate of change in inflation using a time lagged version of itself, inflation expectations, and the difference between unemployment and the NAIRU. The NAIRU is derived from a New Keynesian Phillips curve, which, to be fair, fits the data very well. In other words, it is excellent at predicting the past, but it still cannot predict the future, hence all the uncertainty. In the end, it is little more than a prop for the same underlying assumptions – that firms’ pricing decisions are determined by wages on a mark-up basis. You will notice that there is nothing relating to demand in these formulae. Doing so would require a calculation of effective demand, but that is actual John Maynard Keynes, and is therefore ideologically incompatible with neoliberal “New Keynesian” economics. Nonetheless, the RBA makes a lot of noise about excessive demand in its statements. This amounts to an implied assumption based on assumptions and is a handy stick with which to beat the consumer, but is actually contradicted by MARTIN: in the model it is business investment, and not firms’ pricing decisions, that is driven by demand. There is a clear pattern to these assumptions and public statements. Inflation is always blamed on workers and consumers, even in a clear case of supply disruption, and the cost of inflation and its control is always borne by workers and consumers. What they never say (because, possibly, they can’t see it from inside their neoclassical economic mythology) is that the worker and the consumer are the same person – you. You pay for inflation, and you pay to fix it. The firms whose pricing decisions cause inflation, and their wealthy owners, never pay.
So how are firms’ pricing decisions made? In my experience of writing fees for design services, we would begin with the price then adjust the labour to fit the fees. Ceteris paribus for the size and scope of the job, the price was set based on market rates, the firm’s position in the market, and how much we wanted the job. This anecdotal evidence would, of course, cause any mainstream economist to reject this entire commentary and every argument in it; so, we shall consult business and marketing literature for some more acceptable evidence on how firms set prices.
Here, we see that taking a standard mark-up on costs is “an inappropriate rule of thumb” and a trap for lazy managers to fall into (Doan & Simon, 1996, p. 4). This is because there is a “plethora of internal and external economic political influences that shape a firm’s pricing decisions”, creating many obstacles to effective price-setting (Lancioni, 2005, p. 112). In the book Marketing Management, the marketing process is described as “analyzing market opportunities, researching and selecting target markets, designing marketing strategies, planning marketing programs, and organizing, implementing, and controlling the marketing effort” (Kotler, 2001, p. 50). Estimated costs are an important element in price setting, but this is not as straightforward as economists suggest – many companies pursue the strategy of “targeted costs”, whereby the market position and price are determined first, then deduction of the desired profit margin gives a target cost, on the basis that “Pricing is … an intrinsic element of market-positioning strategy” (Kotler, 2001, pp. 200, 215). In an inflationary environment, firms do face cost pricing pressures that they must respond to, but this is never as straightforward as MARTIN’s lazy management model. Firms may decide to respond by repositioning products, changing designs or differentiating products, cutting costs, or using strategies such as “strategic bundling” (Stremersch & Tellis, 2002). Whichever strategy is chosen, the pricing decision always remains with the firm. The primary influence on that decision is not wages, but market conditions and the actions of other firms.
At this point, a mainstream economist would accuse me of overcomplicating the model in search of “realism”, and assert that their “ideal types are not intended to be descriptive; they are designed to isolate the features that are crucial for a particular problem” (Friedman, 1953, pp. 2, 4). This argument is something of a bait and switch, deflecting discussion away from the assumptions underpinning their ideal type. Regardless, if their model “yields predictions that are good enough for the purpose in hand” (Friedman, 1953, p. 7), it cannot explain why “empirical results suggest that price-based differentiation is not associated with brand performance” (Iyer et al., 2019, p. 26). The obvious retort is built-in to MARTIN already – in the long run. But, according to their own neoclassical theory, in the long run all markets will return to equilibrium anyway, in which case the RBA shouldn’t bother doing anything! History tells us otherwise, as that strategy (or paralysis) was pursued by the US Federal Reserve from 1930 to 1933 – whereby they did nothing as the entire financial system fell apart (Richardson, 2013) – leading to The Great Depression. Clearly there is, and has always been, significant differences between economics’ assumptions about firms’ behaviour, and how business schools actually teach managers to behave. Given that these are often the same people – the RBA board is heavy with business representation, and economics is often a discipline within university business schools – this is a clear indication that what they say and what they do are not the same thing, which brings us back to mythology.
Myth does not deny things, … it gives them a clarity which is not that of an explanation but that of a statement of fact. (Barthes, 1957/1991)
The astute reader may have noticed that interest rates have not been mentioned since the beginning of this article. That is because interest rates do not appear in the formulae for inflation. Rather, interest rates affect demand via indirect “transmission channels” (Ballantyne et al., 2019, p. 34). There is no accepted theory or empirical evidence of how interest rates work. Like excess demand, this is an implicit assumption based on other assumptions, built upon social conventions, and wrapped in the myth of economics. Myth is how we build our reality and understand the world, myth is human. Myth is not “built-in” to MARTIN, or “spun” by the RBA: the entire edifice of economics and its neoliberal ideology is myth. Trapped within their own mythology, it is possible, even likely, that economists and the RBA board believe that they are doing the right thing. It is therefore not possible to state with certainty that the RBA is waging a deliberate campaign to impoverish workers and transfer their wealth to the ownership class – but that is the effect of their actions. That is a bit like saying they believe their own bullshit, and it makes a mockery of economics’ excuse for central bank independence: that government “can’t be trusted”. It is abundantly clear that the RBA (and most economists) have such a tenuous relationship with the lived experience of ordinary people that they can’t be trusted to act in our interest either. So, there should be zero interest. The government bond rate should be set permanently at zero. If the ownership class wants a return, it can invest in something productive, not suck free lazy money from the government and households. The entire RBA board should be dissolved, and replaced with a panel of accountants, whose role will be to ensure that all interbank transactions clear, and all reserve accounts balance. Nothing less, and certainly nothing more.
Reference List
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