Welcome to Finance and Fury, the Furious Friday edition. Today we’re look at if economic data really means anything.

I was thinking – and do any of these numbers really matters to you? Or even to me?

  1. Think about this – talk about a lot of the metrics – GDP, Inflation, employment statistics
    1. As an economy – would you prefer to have high GDP – or having your disposable income increase?
    2. Employment statistics – or having the ability to find a good well-paying job
    3. Inflation measurement – or have the ability to save and be rewarded in interest income?
  2. Thought about this for a while – most of these numbers mean nothing for the average person –
  3. But unfortunately they have an indirect effect on our lives – What dictates economic policy – fiscal or monetary – GDP or employment stats aren’t what matters to the average person – but the setting of interest rates and having a targeted inflation policy does have a real world effect on people

First – Issue with these stats and measurements – done by the ABS

  1. Employment – You have employed, unemployed and not in the workforce – what makes someone employed? Working for 1 hour a week –
    1. Unemployed – if you don’t have a job, but you actively looked for one in the past 4 weeks, and can start work in less than a week –
    2. Not in the labour force – don’t have a job, couldn’t have started in the last week, not looking for work or starting a job in the next 4 weeks – if I ceased working now –
    3. ABS website – The Labour Force Survey is based on a multi-stage area sample of private dwellings (currently approximately 26,000 houses, flats, etc.), a list sample of non-private dwellings (hotels, motels, etc.), and covers approximately 0.32% of the civilian population of Australia aged 15 years and over. Sampling error occurs because a sample, rather than the entire population, is surveyed.
  2. Inflation – The Consumer Price Index (CPI) measures quarterly changes in the price of a ‘basket’ of goods and services which account for a high proportion of expenditure by the CPI population group
    1. What is in the basket 11 groups – Food and non-alcoholic beverages, Alcohol and tobacco, Clothing and footwear, Housing, Furnishings, household equipment and services, Health, Transport, Communication, Recreation and culture, Education, Insurance and financial services.
    2. These price movements collected from – The Household Expenditure Survey (HES) is used to update the weights in the years that it is available – The HES provides the most comprehensive data on household expenditure. The HES is a sample of just under 8,000 metropolitan households. Data are collected using a diary of personal expenditures in which residents aged 15 years and older record their expenditure over a two-week period.
    3. The cost of housing is measured as the price of a new home (excluding land). Mortgage interest payments are excluded – not a true reflection of cost of living
  3. GDP – Any economics textbook will admit that GDP is flawed when it comes to measuring production in an economy – (doesn’t include black market, and is very hard to measure accurately) –
    1. The majority of the estimates in the quarterly national accounts are based on the results of sample surveys –
  4. Think about all of these stats – So many people to keep track of – relies on data collection –
    1. Relies on surveys and naturally has sampling errors –
    2. Inflation is similar – survey of respondents in their purchases in the basket of goods – non-response and sampling 8,000 households out of the 8.5m households in Australia – 0.094%
    3. This is how it is done though – and state there is a 95% confidence interval – the issue is there is not a great way of measuring these statistics – too many people – too much variation – but monetary and fiscal policy makers need this data to make their decisions –
  5. Which is the problem – the need to try and control the economy – using Fiscal and monetary policies- but there is no great feedback loop on data –
    1. Feedback loop in important in decision making – example – touch a hot pan – you get burnt straight away – and you know it as your pain receptors fire instantaneously – you learn to not touch the pan again when it is hot
      1. Smaller business- make a decision to change products or services, charge different price – get an almost instant feedback – did it work or not? Make take a month or two to really see – but then a small company can pivot and has a wide range of actions that it can take –
      2. Government or CB level – change one policy – no idea if it has worked or not – as this is at the macro level where you have 1m other inputs – it is just to have assumed to have worked – and if it didn’t – just do more of the same thing – there is not really any pivoting – think about a ship changing course – small boat relatively quick – behemoth cruise ship – not as easy to do a 180 if you about to hit a dock
  • Almost like touching a hot pan and not having your pain receptors firing until months or years later – might not have any skin left by that point

Regardless – this is how the RBA – The Reserve Bank of Australia’s – central bank that conducts monetary policy

  1. Their Purpose – providing stability in the financial system and promoting efficiency and competition in the payments system – indirect functions through having an inflation target
  2. What Is the Inflation Target? Officially: “keep annual consumer price inflation between 2-3% on average, over time”.
    1. measure of inflation is the percentage change in the Consumer Price Index (CPI)
    2. Run through this in previous ep – ABS gathers data on the price change between a basket of goods – fuel, eggs, building materials, etc. – aims to capture goods and services that households buy
  3. Why they need this – An inflation target provides the framework to monetary policy decisions –
    1. guides a central bank’s in its management of the economy – original purpose of CBs was to be the bank of last resort – not control the economy
    2. meant to help with Direct functions: issues Australia’s banknotes and provides banking services to the Australian Government –
    3. So theories emerged – being more active in putting money into the economy by central banks and spending decisions by governments can boost the economy –
    4. So in the 60s Gov spending made up about 10% of GDP, consumption has stayed the same, 34% was investment
      1. Today – Gov spending is about 18.5% and investment down to 24%
      2. More government spending – giving out more consumption – make our GDP growth better? GDP growth has gone down over the past decade – almost no variation anymore – Gov spending has to come from somewhere – Tax or Deficit (i.e. more debt through issuing bonds) –
  • The assumption is the spending is efficient – but centrally planned spending has been proven to be fairly wasteful – Investment has declined – gov spending has gone up –

Trying to set the data and manipulate it – controlling it rather than letting the economy to its own device

  1. So whilst these measures of inflation, GDP, employment, etc don’t directly matter to us as a population – the policies that come out of these do have a direct effect on our lives – as the policy decisions made by those in control over the economy affect our taxes, savings rates, etc.
  2. They also skew individual and business decision making – as when Data is used as a target – it ceases to be useful
    1. Origins of this concept date back to an RBA paper from 1975 – this was where a thing called Goodhart’s laworiginated – from economist Charles Goodhart – talked about this 6 or so months ago –
    2. Officially phrased as “When a measure becomes a target, it ceases to be a good measure.” 
    3. Especially when applied in economics – based on the economic idea of rational expectations
    4. entities who are aware of a system – rewards and punishments – will aim to optimise their actions to achieve their desired results
      1. g. employees whose performance in a company is measured by some known quantitative measure (cars sold in a month etc.) will attempt to optimize with respect to that measure regardless of whether or not their behaviour is profit-maximizing – Sell all the cars at $100 – looks good for your performance but sends the company bankrupt – now your performance doesn’t matter as you don’t have a job
      2. Example of central planning (top down) policy – similar to socialism where measurement by weight in output leads to massive unusable nails – like Soviet Union
  1. For central banks – also occurs when individuals and investors know the policy decisions and then take actions that that can result in different outcomes on the target
    1. Example – signals from banks to lower interest – may increase prices of assets or be a bad sign for the economy = People may invest or start saving = less spending to policy to control inflation results in opposite direction –
    2. Individuals adapt – homoecnomicus doesn’t exist – the rational man that economic modelling relies upon
    3. Goodhart’s law explains – when a feature of the economy is picked as an indicator of the economy, then it inexorably ceases to function as that indicator because people start to game it – but relies on everyone being rational
      1. Rational – depends on knowing how to act in response – most people don’t except those who know how to
    4. Big part of the widening wealth gaps (not income inequality) – I think it is between those in the past 25 years – or at least benefited through rising house prices and markets
  2. When the target is set – central banks aim to achieve the inflation rates regardless of consequences – They are set on their path to get back to 2.5% inflation while keeping economic stability –
    1. No secrets when it comes to how central banks are likely to respond – look at the trend – they ever increase their intervention into the economy to control it – all in an effort to hit their precious inflation target – to keep banks (central and commercial) and governments both happy
  1. What will they do To achieve it – requires total control and increased monetary control and intervention into markets – when they don’t get the desired result as projected – more control and intervention is needed – central banks think of themselves as all powerful –
  2. While original statement of Goodhart’s law fast saw light when Charles delivered it to a conference in July 1975 to the RBA
    1. General phrase – “When a measure becomes a target, it ceases to be a good measure.” 
    2. But the original formulation was: Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes
    3. has profound implications for the selection of high-level targets in organizations – across both risk and reward.
    4. Any statistical relationship will break down when used for policy purposes – These aim to try and control peoples behaviour
  3. But this creates a situation where if a lot of these Central bank policies cannot be unwound without creating a market collapse –
  4. Central banks are focusing on inflation – but money printing has resulted in inflation of asset prices – not in consumer economy – no real business growth (despite markets going up) – limited wage growth and affordability issues – bit of a mess
    1. Situation where the policy response is to lower interest rates to try to boost CPI through increased ability to spend more and businesses can increase how much they sell for – i.e. basket of goods goes up – but doesn’t work as the printed money never ends up in the equation, as velocity of spending is needed- if the money is in the financial system through sinking money into investments – then velocity of that under current model and measurement system – velocity is non-existent on those funds
  5. Governments are focusing on employment and GDP – so to reduce unemployment hire more people in the public sector – even if long term the budget cant afford it – or spend more money on government consumption to try and boost GDP

In summary –

  1. The data collected in the first place doesn’t give a good picture of the economy – to the average person the mean nothing anyway – might hear about it on the news –
  2. But when the savings rates they can earn go away, or house prices are unaffordable – these are issues that matter to them

Thank you for listening to today’s episode. If you want to get in contact you can do so here: http://financeandfury.com.au/contact/

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