Economics of Murder in Mississippi

I got the new non-fiction book by John Safran for Christmas. Murder in Mississippi. It was a quick read and a good one.

The premise: Safran knows a white supremacist in Mississippi – when the guy gets murdered he heads over to write a true crime book. The story only gets better from there.

Now.

Perhaps I’ve been overs-sensitised to costs by working for the Australian Financial Review (“BYO phone”, “travel by bus”, “we’ve run out of pens”). But throughout the book, Safran incurs big expenses that left me wondering if he, or Penguin, were going to actually make money on the book.

Let’s have a look:

Expense 1. Travel. Jackson is halfway between Dallas and Atlanta, or if you like, halfway between Miami and Denver. Today, the cheapest flights Melbourne – Mississippi are $1642.

Expense 2. Living. When he moves into the Sleep Inn and Suites in Jackson Mississippi, they are brand new and the carpet, which he says “feels like minigolf astroturf,” squeaks. Its advertised price is now $79/night.

Safran writes that he stayed in Jackson from winter to summer. Penguin claims “Over six months, Safran got deeper and deeper into the South.” During that time, Safran also went off to other parts of America to make some TV.

He also stayed at the Ashford Place apartments (circa $1000/month.)  If we assume he spent 6 weeks in the first motel and 10 weeks in the second one, that’s around $6000 on accommodation. I’m budgeting $50 a day for food and drink, for four months. That’s $6000 on food.

[Running total $1642 + 6000 + $6000 = $13642]

Expense 3. Car hire. Unavoidable. Jackson’s public transport situation is the sort of unholy tangle that would make Jarrett “Human Transit” Walker apoplectic. Four months of the cheapest Hertz car on monthly booking adds up to $4000. Plus, say another $1000 for gas? (Mississippi gas prices are almost the lowest in the US, equivalent to $A0.897/L)

[Running total $1642 + $6000 + $6000 + $4000 + $1000 = $18642]

Expense 4. Bribing the incarcerated.

This is the one that really caught my eye. The book includes a series of trips to Walmart where Safran buys phone cards for the murderer. He also delivers some other goods on his behalf. I won’t spoil the book by telling you what they are.

At one point the murderer asks for $2500 and Safran says “I can’t give you $2500. I don’t have much money left.”

Click here to see the murderer’s facebook profile (friends include one J.Safran!).

Assuming the items mentioned in the book are everything, that’s around $2650.

[Running total $1642 + $6000 + $6000 + $4000 + $1000 +$2650 = $21292] 

So. Twenty-Two Thousand Dollars. Quite the bill.

It is probably more than he budgeted. The book reveals he didn’t expect to spend so long in Jackson. He’s barely been in the place a few weeks when the expected trial is delayed.

murder in M

Safran is a big name as these things go, and I guess he was spending an advance he got from Penguin.

Instagram reveals that around the time the book was launched, Safran visited a whole heap of bookstores and posed for photographs with the proprietors. He did shows in Melbourne and Sydney to promote the thing.

Penguin is working hard to sell the book. There’s even been posters up around the place, as though his book was a rock act coming to town.

As author Ian Irvine explains here: “The promotional budget for your book is, generally, directly related to the size of the advance.”

Advances vary a great deal.

Melbourne internet publishing impresario Mel Campbell got $5000 for her book Out of Shape. Flinders University student Hannah Kent got over $1,000,000 for a two book deal, after writing one about an execution in Iceland. (!)

Safran is probably in the middle. I’d guess his advance is around $60,000. It is his first book and he’s got no form as a writer. On the other hand he is a publicity machine, especially among those who would buy non-fiction.

If I am right, that means he made $38,000. He could make more if and when the royalties cover the cost of the advance.

But he had to take time off from his radio show. Even if he got a $100,000 advance, and pocketed a large chunk of it, missed wages are a major cost of the book.

(Money would be scant compensation for hanging out in Jackson, which seems like the worst of what’s bad about America.When I dragged and dropped the orange Street View man onto a random corner of inner-city Jackson, I found myself on a huge roundabout with multi-lane roads in all directions, and no buildings in sight except a church.)

Quantification and snark aside, the book is pretty terrific, and I am insanely jealous. You have to invest to make something like that happen.

As his friend Lally Katz says to him in an email at the start of the book:  “What an exciting thing to do. You’d have such a great and sometimes dangerous adventure.”

Here’s the real economics of it all. A true adventure like that is scarce and therefore valuable. Of course it is worth it. Getting paid to adventure is every man’s dream. Speaking of which, The Economics of a Great and Sometimes Dangerous Adventure sounds like a book people would read. Any publishers reading who feel like commissioning that title?

People before what kind of profit?

Profit may be the most emotive and most disagreed-on word in the modern political lexicon.

Screen Shot 2014-01-25 at 3.09.41 pm

For some people, it conjures up a deep positive energy. It’s the lacquer of success that tells you your life has not been in vain, a thank you message from the universe.

For others, it’s a totem of greed. It’s the fuel barbarians pour onto the  bodies of the civilised before they burn them all, throw back their heads and howl as the smoke covers the moon.

Both can be right.

Whether you drive a Rolls Royce or a 1990 Subaru with a bumper sticker that says People Before Profit, you need to know this.

There’s two types of profit.

Economic profit (bad), and accounting profit (fine).

(for more: 1 2 3 )

Let me explain.

Accounting profit is what a business makes after it has paid all its staff, all its bills, but before it pays the people who put the money into the business. People who funded the business to start up need a little bit of sugar to keep their money in there instead of putting it in the bank.

Imagine a small business person who delivers things you buy on the internet. She buys a van, putting $30,000 into the business. If that money was put in the bank and got 5 per cent return it would make $1500. So the small business needs to make at least $1500 in accounting profit, on top of paying wages and bills, to compensate the person who funded the business.

That accounting profit is necessary for the business to run. If there’s no accounting profit, the delivery business will shut down, as the delivery woman realises she should sell the van, put the money in the bank, and work for someone else.

(In reality she should be looking for slightly more than $1500 in accounting profit, to help compensate her for the risk of running a business, which is much higher than plonking your cash in a government-guaranteed deposit.)

So, accounting profit is necessary for businesses to exist. The alternative is the business shutting down.

When you see Woolworths Limited reporting a before-tax profit of $3.4 billion on sales of $58.5 billion, some of that is the accounting profit necessary for the share to be worth anything at all.

But some of it might be economic profit. Let’s go back a step.

Us economists think accountants are simpletons. We like to think about opportunity cost.  We think that you should measure your ‘profits’ against the next best use of your money. So economic profit is not the little bit extra you need to pay back the person who funded the business. Economic profit is extra on top of that. If you make a lot of economic profit, something has gone wrong.

Some businesses make enough money that their owners don’t just get a nice 5 per cent return on their investment. They make enough that it rains cash. That’s often economic profit, and it’s a bad sign.

Unfortunately, it’s not always clear if a company’s profit is simple accounting profit or the extra economic profit.  When an company reports profit, it includes some that is necessary to cover the cost of capital, and the gravy.

PROFITLESS

Here’s the thing: under the assumption of perfectly competitive markets, there should be no economic profit in the long run. Businesses should make enough to cover their cost of capital and not any more.

It’s only during deviations from perfect competition, or when market failures creep in that economic profit can occur. Sometimes firms can create economic profit for themselves by behaving in an anti-competitive way. They have an incentive to do that, which is why we have to have competition law.

The most obvious market failure is market power. If a company is part of an oligopoly, or worse a duopoly (Hi Woolworths), or worst of all, a monopoly, then economic profit can be expected to ensue.

CBAThis is why we can be fairly sure the profits of Australia’s big four banks are not simple accounting profits. They operate in a protected space under the four pillars policy.

Australians think there is far more bank competition than there really is.

Of course banks should make enough to compensate the people that own the capital that allows the bank run. But should they make more?

Commonwealth Bank, Australia’s biggest, made $7.7 billion in profit last year.

The value of the Commonwealth Bank is $120 billion at time of writing. It was, at least until recently, in the top ten biggest banks in the world by value, even though it is not in the top ten by assets.

Any industry where all the competitors are making  extra profit on less assets should ring alarm bells. There is almsot certainly economic profit being made, and it is being made at the expense of the customers.

IS THERE NOTHING WE CAN DO?

I’m glad you asked.

A tax design idea is floating around – currently out of favour – called allowance for corporate equity. It is gentle to accounting profits, and starts to snarl and salivate when economic profits are made. As the name implies, it would allow profits to cover the cost of equity [that’s the money the owner put in, or the $30,000 van in the example above]. After that, taxes rise.

Another way of putting that same idea is to say ‘take the mining super-profit tax and apply it across all industries.’

Here’s an excerpt from the Fairfax press, quoting one of my old lecturers, John Freebairn.

“At the tax summit, Melbourne University’s John Freebairn, a former research director of the Business Council, said Australia’s super-profits tax rate might be ”more towards 40 or 50 per cent”. It would only be paid by companies earning ”monopolistic-type rent”. ”And let’s rub it into the banks,” he added. ”They seem to make much higher returns than anyone else.””

But that would not be popular. It’s one reason Wayne Swan ran from the Allowance for corporate equity idea when it had a brief resurgence a few years ago.

But recognising the difference between the types of profit is crucial for anyone who wants to make a difference to society. Tax policy makers know better than anyone else that companies making a super profit are probably managing it at the expense of the consumer. We should not stint from hitting them with extra tax.

How this blog is going

This blog is going gangbusters!

Here’s a chart of readership the first time I launched the blog, in 2009 vs this time around.

Screen Shot 2014-03-03 at 2.40.38 pm

You can see that with improved social media reach, improved writing skills and a more focused set of topics, I’m now doing a better job.

I’ve obliterated my record for most hits in one day twice (when the Guardian printed my story during January, sending waves of traffic in; then again when I wrote this wildly popular story about Bunnings ) . As 2014 picks up, I’m hopeful blog traffic will continue to surge.

Compared to the Fin Review, I’m pretty sure my least-read stories are getting more attention, although the best-read ones are still probably falling short of the impact I used to have in a national newspaper.

My only complaint so far is a notable decline in the number of comments per visitor compared to 2009/10. There’s thousands of you – please comment more! Plenty of the feedback comes via facebook, twitter, etc, but I’d really like this to be more of a forum.

$?

People sometimes ask me how much money I make from this blog. To which I answer: “The blog is an absolute delight. I love it.”

It is possible to host ads on websites. I am aware of that. Wordpress has an opt-in program called WordAds that I could share the upside of.

Is it worth it? Here’s a quote from their blog.

“We now have more than 10 thousand sites running WordAds with around 1 billion ad impressions per month, and we will be paying out around $1 million to WordAds publishers in 2013.

There’s enough information to make the upside clear:

When a billion ad impressions earn bloggers a million dollars, each ad impression is worth one-thousandth of a cent, on average. WordPress is not as generous as Blogspot.

When ten thousand sites get a million dollars between them, the average blog gets $100 a year. And the distribution will be a classic long tail scenario.

I read about a site that got 30,000 views in three weeks and made $2.39. Let’s just say I’m still building up to getting 30,000 views in three weeks.

So that’s why this blog has no ads – it’s not worth annoying you, dear reader! And you are important to me.

That’s all I wanted to say. Thanks a lot for reading. I intend to keep writing, every day. If you can do one thing for me, it’s to tell your friends about this blog!

Politicians – peddlers of pain. Why not make it plain?

Change that doesn’t involve pain is not political. It is administrative change.

Politics without pain is not politics at all. Change without pain requires no hard choices, no leadership, and no leaders.

Dress up administration as leadership, people will disrespect you. Pretend reform produces only winners and you’ll be unable to be true to your word. Say “this won’t hurt a bit” and people will soon learn to not trust you.

Politicians who aspire to be more than mere administrators must not flinch in the face of pain. They must be conversant in it. They must know that being a leader means being a dealer of pain.

Does the surgeon tremble when he picks up the scalpel? Does the coach worry that the players must be tired? Does the kindergarten teacher flinch at using the naughty corner?

Not if they know their job. So politicians too must be prepared to make scars, see sweat, deal with temper-tantrums.

Perceptions of injustice, angry placards, people weeping for a way of life lost and letters to the editor. These are the products of good leadership.

And I’m not talking about hurting foreigners. Asylum seekers and would-have-been aid recipients. That’s fish in a barrel stuff. Rookie stuff. Leadership means a willingness to rile your own.

Being willing to deal in political pain requires seeing over the horizon even when the voters can’t. Lead well enough for long enough, and the balance will show through.

Here are some examples of politicians being afraid to dish out hurt – beneficial hurt – to their constituents and stakeholders.

  • The absence of congestion charges and user-charges on the road system.
  • The lack of GST on education and health.
  • The failure to increase the tax on the abundant profits of the mining sector as ore prices rose.
  • The loopholes in the taxation system that allow trusts to operate and remove billions from within the ATO’s reach.
  • Urban planning rules that preserve certain suburbs in sepia tone.

Politicians need to step back and understand their job. Rather than trying to make changes that don’t hurt, or making changes that do hurt but pretending they don’t, they ought to make pain their friend. They are pain-makers.

When you lie about the way reform hurts, you undermine the case for reform. A simple headline that says “pensioners to be worse off” can end your reform.  But if you introduce a reform by emphasising that it hurts, that headline doesn’t have the same effect.

I’m not advocating pain for pain’s sake. I just want good policy to be able to be discussed openly. Pain and all.

If we know politicians are pain-makers, we will be more respectful and careful in selecting them. Fewer flighty weirdos. More hard-thinking, fair-minded squares.

Because a good politician, like a good coach, is one that makes us want pain. A communicator that fills each billowing twinge with the reason for it.

In other fields of endeavour we love and respect hard-liners who remind us nothing good comes cheaply. Why do we elect politicians that pledge to coddle?

Politics is ripe for cracking open, ripe for genuine innovation. The homogeny of ideas and approaches is stifling. The acceptance of the limits placed on politicians is stifling. But this stifling period in democracy will end.

When it does, it could be via a politician that does not shy from pain. I’d like the next Prime Minister to also adopt the title Minister for Pain. PM-MP. Put the issue front and centre. Make it clear that this is a government that won’t lie about the connection between hurt and improvement.

The canine financier’s terrible faux pas.

Let me tell you about the time I met a pet lender in a public van. It’s a story about a public transport ride, but it’s also a story about rich and poor, and the amazing eye-opening effect of travel.

The pet lender was white, well-dressed, fit-looking, perhaps in his mid-40s. He was happy and exceedingly confident, wherein lay his downfall. He owned a company that offered loans so people that can’t afford a pet can get a pet. 

It was in a van, but I mentioned that already. And it was in America. Of course.

I was in Vail, Colorado. I did it on the cheap. A crappy apartment far from the glitz and glamour of the centre of town, plus free lift tickets I swindled from the resort. Vail was charming and delightful and really I loved it. But some of the people you met there were as different from at home as the people in any far-flung corner of the world

The story I want to tell comes when we are leaving Vail. We needed to get from the town to the airport and we booked a van called Colorado Mountain Express.

We get in the huge American vehicle and there’s your typical mountain town shuttle van driver – addled and with a dream-catcher hanging rom the rear-view mirror. She natters with us as we drive to our next pick-up.

At some nice-looking condominiums far from where we had stayed, a single man gets on board and engages my companion and me in conversation. 

He immediately strikes me as prototypically USA. Perhaps a scion of a great dynasty, or perhaps born outside Belgrade. Either way, his warm greeting, perfect teeth, intense eye contact and open-ness with information tells us we are in the presence of the American Dream . 

“I make loans on lots of things.” he tells us. “For example pets,”

“Pardon?”

“If people want to buy a pure-bred dog, that can cost up to $3000, you know. We make finance available.”

We are incredulous. The mountain landscapes speed past, but for sheer American-ness, everything pales in comparison to hearing about this man’s company and its contribution to the American Economy.

The man reveals, when pressed, that the loans generally have an interest rate of 40 per cent, and maximum three-year terms. But many of them are not repaid.

“Obviously we don’t repossess the dogs in that case,” he says.

Having recently come into possession of a dog, I am quite aware that the main cost of canine acquisition and care comes on the care side. They are not free to run. The fact that people who couldn’t afford dogs would buy dogs strikes me as quite shocking. I put that to the man.

“I know,” he says. “It’s a really bad financial decision.” He seems to show a moment of genuine care for these people. But in retrospect, interest payments on pomeranians, pugs and poodles were funding his powder skiing, so any concern was a mere surface appearance.

The market for pet loans was only part of his business that also loaned for furniture and some complicated scheme with real-estate agents who would get an advance on settlement of homes they had sold.

Somewhere along the way our van-driver pulls over for another passenger to climb on board. She is blonde and immaculately coiffed, emerges from a lodging still more glamorous than the last one and takes the only available seat, next to the pet financier.

“I am tired,” she announces by way of introduction.

“You can lay your head in my lap,” says the pet financier with a smile.

In retrospect, that was it. You can’t say that to someone you’ve just met. It’s wildly inappropriate. So inappropriate that noone acknowledges it and she just moves on to another topic.

Anyway, over the next several hours of van travel, the garrulous pet financier gives up on chatting to the Aussies, and instead focuses his laser-like attention on the supposedly weary ice queen.

We listened intently as they chatted lifestyles of the rich and famous. Names were dropped.

“I’m flying out next week on my buddy’s private jet,” pet financier says. Twice. He is fairly subtle about it though, especially compared to his initial foray. He really does seem to have her rapt attention. They have plenty in common.

I begin to wonder if she perhaps hadn’t heard his initial lap comment. Perhaps I had misheard it? Or perhaps such a statement was de rigueur among the one percent?

Eventually, though, we near our destination. Pet man needs to close the deal.

“So I’m in town here for a few more days,” he says. “Are you?”

“Yes, I am,” she replies.

“it would be fun to catch up.” He pauses, but she’s apparently going to make him say it.

“Can you give me your phone number and we can organise a night to perhaps see each other?”

Literally 60cm away, in the back of this van, my companion and I are holding our breaths. It’s like a Bold and the Beautiful cliff-hanger come to life. What will happen next?

“No, I don’t think that would be appropriate,” she says.

We cheer silently. Hurrah!

“Okay, fine. I understand,” says the pet financier, head held high. He affects a mighty confident tone of voice in the face of crushing public rejection and my respect for him goes straight back up.

We had to get out of the van and carry on with our lives.

There’s no epilogue where we find out what happened to these two characters, whether perhaps she finds him hit by a bus on a street corner a few days later, nurses him back to health and they go on to devote their lives to ending world hunger. 

But it is a story that has stuck with me, not just because the rich are lending to the poor to buy dogs they can’t afford, but because of the way travel can open your eyes, and how it is always the people you meet, no matter how normal they seem, that will give you the memories that last.

Guest Post: Sabrina Lau Texier on making transportation policy in an environment of public distrust

Sabrina Lau Texier is a transportation planner who has worked in Toronto, New York City and Vancouver. She attended the University of Melbourne in 2003. The opinions expressed here are those of the author and do not necessarily represent the opinions of TransLink. 

Vancouver City
Source: City of Vancouver, 31 Jan 2014

I moved from New York City to Vancouver a year and a half ago. I landed a job in a great organization that is admired from afar for its proactive approach to linking land use planning and provision of transportation, including public transit, major roads, bridges and cycling. But I’ve learned the hard way just to tell people my occupation and not name my employer. If I say the dreaded T-word (okay, it’s TransLink) I get an earful from the surprisingly strong anti-transit crowd in this town.(1) However, TransLink’s damaged brand is not just tough for me, it’s tough for making good policy.

Making policy is not quite the same as advocating for it. I’ve found it easier to advocate (or denigrate) from a distance, often with an air of righteous indignation; however, bearing the weight of public dissatisfaction has been a different beast.

We are, in the words of a former premier, the city “that mostly got it right”. In my metropolitan area, as in many others, we have reached a tipping point on traffic congestion. Millennials defer getting a driver’s license (2,3) transit access is a new requisite for commercial real estate (4) and the installation of complete streets for all modes of travel is becoming (already is?) the new normal (5,6) With growing demand for improved transportation options, agencies everywhere are struggling to come up with funds to maintain and expand services.

Vancouver rapid transit map
Source: http://www.evergreenline.gov.bc.ca/documents/Maps_Graphics/Transit_Map.jpg

Partly in response to a persistent public perception of gross mismanagement, my agency has been through two government audits in 2012 alone, and both have found that the system has the best funding formula in Canada, and that “the organization is well run and manages its costs”(7). However, implementation of all suggested efficiencies (including cutting low-performing routes) will not be enough to meet the future transit expansion needs of Metro Vancouver. The provincial government has called for a referendum on this issue by Spring 2015.

“The line between democracy by plebiscites and mob rule is very thin.” – Anne Golden(8), speaking about the upcoming transportation referendum, Jan 2014

The referendum question has yet to be set, but how do you create the message on an issue as complex, multi-faceted and far-reaching as future transportation funding? How do you reach a population that is so disillusioned with your organization, that they prefer to view the referendum as a vote on the agency itself, rather than the larger issues (9). Failure to pass this referendum has its own opportunity costs (10), but the importance of funding transportation expansion is lost as public attention is directed to how much money is spent on office coffee. The province has taken the politically-safe approach of asking taxpayers to decide if they would like further taxes to pay for transit. They have not asked taxpayers if they agree with funding recent road and bridge expansion, oil pipelines, or a coal terminal.

We are entering into this referendum woefully unequipped to succeed. At the best of times, making an argument for transit/cycling/walking is going against a 50-yr+ status quo attitude of “the car is king”. However, investments in transit infrastructure benefit more than the riders themselves. The regional economy, goods movement, personal mobility, job opportunities, and healthy communities require planning and funding of alternate transportation options. We can make many sound scholarly arguments, but it is often preaching to the converted.

“When trust is broken between the government and the governed, it’s almost impossible to generate support for public policy changes even when the proposals are right.” – Anne Golden, Jan 2014

The public has very little trust in my organization, and the media caters to this. Transit decisions, big and small, are routinely lambasted and misrepresented, with major omissions that compromise balanced reporting. There is scant awareness that the agency is also responsible for roads, bridges, goods movement, air care testing for vehicles, and pedestrian and cycling infrastructure. It is an easy news story to cater to the strong public appetite for taking potshots at the region’s punching bag. There is the sense that merely having a transit pass is the equivalent of an advanced degree in transit planning, and everyone feels they could have made a better decision.

It would be easy to put my head down, hide amongst the thousands of employees at my organization, and tell individuals in social settings that I wasn’t responsible for their particular grievance. Yet I am proud of the work that my city, my region, and my transportation authority have accomplished. I want it to succeed in the future. I worked in NYC for 5 of its most formative years in the transformation of its streets from auto-dominated through-routes to celebrations of public spaces, and I know how good news stories are borne of years of blood, sweat and tears. When one looks up from the battle, and takes a step back, it is possible to be reminded of what the fight is really for.

“I know the RBA sets interest rates but I’m embarrassed to ask why.” An explainer

“I know the RBA sets interest rates but I’m embarrassed to ask why.”

Someone said this to me at a party recently. In trying to explain interest rate policy by shouting over Daft Punk I achieved simultaneous pedagogical and social failure.

This setting, I hope, is a more appropriate place to provide the answer.

The Really Simple Version:

Interest rates are the brakes on inflation (price rises). When the RBA changes interest rates, they are trying to control inflation.

Higher interest rates slow inflation down.

If you notice the price of a sandwich keeps going up, the Reserve Bank is probably getting worried about high inflation. The RBA watches price rises by looking at the consumer price inflation data. If inflation is getting too high they will raise interest rates.

Lower interest rates speed inflation up.

On the other hand, if shops are having big sales that suggests prices are falling. The RBA is probably worried about low inflation. It might cut interest rates.

The RBA’s job is to keep consumer price inflation between 2 per cent and 3 per cent, annually. If price rises are above 3 per cent, they will raise interest rates. If price rises are below 2 per cent they will cut interest rates.

How does that work?

High interest rates slow down spending.

  • For people: If interest rates go up, it makes sense to put more money in the bank, not spend it.
  • For companies: If interest rates go up, you won’t borrow money to build a new factory. You’ll try to pay back your loans.

Low interest rates do the opposite.

  • For people: If interest rates go down, it makes sense to take your deposits out of the bank and spend them.
  • For companies: If interest rates go down, you can borrow to build a new factory.

Spending matters because the rate of spending affects the way companies set prices. If items are not selling, companies will put them on discount. If they are selling out, they may even put up prices.

This is the basic lesson. The RBA is controlling interest rates, to affect spending, to affect inflation.

The fairly simple reason we care about inflation:

Too much inflation can be bad – it means the money you have saved buys less and less.

But we don’t aim for no more price rises ever – because price rises can be good.  Inflation can be good because it CAUSES spending. I know we just said spending causes inflation. But it works both ways. Think about this:

If inflation is high, your money is losing value, so it makes sense to spend it. If $100,000 will buy you a Mercedes today, but it will cost $105,000 next year, it makes sense to spend the money now. That spending will pump up the economy.

If inflation is low, however, it makes more sense to save your money. Of course, if everyone saves, the economy suffers.

i.e. The way people react to inflation (spending/saving) is important to economic growth.

The RBA tries to balance the speed of the economy so we get the right amount of spending and saving to keep the economy growing. Inflation is kept between 2 and 3 per cent, because we’ve decided that is a good range to keep spending and saving in balance.

Why do we care about growth? Growth affects unemployment, and thereby people’s health and happiness. That’s why the newspapers pay so much attention to it.

Advanced class: How does the RBA control interest rates?

The RBA doesn’t set your bank account interest. And it doesn’t set your home loan rate. So what is it controlling?

The one market that rules them all.

The overnight cash market is the shortest-term loan in the market. Big banks borrow in there for just a few hours.

Because you can make a year-long loan out of 365 overnight loans, targeting the overnight loan market affects all other loan markets.

So the RBA gets in there and plays. It literally buys and sells money in that market so that the interest rate does not deviate from the publicly announced official cash rate (at present 2.5 per cent).

(Interest rates are the price of a loan, so increasing supply of money in that market lowers interest rates, decreasing supply raises interest rates).

The RBA is damn good at getting the overnight cash rate to match the target rate.

#winning
#winning

PhD level: Does the RBA have to balance unemployment against interest rates?

In the United States, their Reserve Bank (the Fed) has what they call a dual mandate:

“maximum employment, stable prices”

In Australia, the RBA technically has a triple mandate.

The Reserve Bank Act 1959 says it must act to ensure:

  1. the stability of the currency of Australia;
  2. the maintenance of full employment in Australia; and
  3. the economic prosperity and welfare of the people of Australia.

But that has basically been waived. A statement is agreed between the Treasurer and the Governor of the RBA after each election, agreeing that the bank should focus most on inflation when setting monetary policy:

“…allow the Reserve Bank Board to focus on price (currency) stability, which is a crucial precondition for long-term economic growth and employment, while taking account of the implications of monetary policy for activity and levels of employment in the short term.”

Why not focus on employment too?

Back in the day, economists thought  you could have low unemployment if you were willing to pump up the economy enough to have high inflation. Now we know this is not true.

You get a short term bump in employment under high inflation because the wages are not actually worth as much as the workers thought they would be. Workers aren’t dumb though, so once they re-calibrate their inflation expectations, they stop being willing to work for those crappy wages.

That means solely focusing on inflation is the surest way to promote low unemployment.

That’s the end of the lesson on interest rates! I hope it was helpful. Now you can nod wisely when Alan Kohler does the finance news.