There's a good case for cutting interest rates ASAP

What a difference a number makes. For weeks, the money market’s macho men had been telling us interest rates needed to rise yet further to ensure inflation would keep falling. But last week, their case went up in smoke and now almost no one thinks the Reserve Bank board will do anything at its two-day meeting starting today.

The weeks of idle speculation came to an end when finally we saw the consumer price index for the June quarter. It showed underlying inflation falling to 3.9 per cent.

So, sighs of relief all round. But why had we allowed these misguided souls to cause us so much angst? Why had their intimations of death and destruction been given so much air time?

Short answer: because we find bad news more interesting than good news. But as last week’s abrupt turnaround reminds us, the bad news ain’t necessarily so. So maybe we should give a hearing to those urging the Reserve to do something nice rather than nasty.

Let me tell you about a briefing note from the economists at the Australian Council of Social Service, who remind the Reserve that its much-remarked “narrow path” to lower inflation without triggering a recession and high unemployment is narrow “because it’s rare for interest rate hikes of this scale and intensity not to trigger a serious economic downturn”.

The peak welfare organisation says the process of reducing demand and lowering inflation is already well under way and, since increases in official interest rates take up to two years to flow through to inflation and unemployment, it has called for the Reserve to start reducing interest rates immediately.

Those who focus on the slowdown in the fall of the inflation rate and conclude there’s a need for further tightening have failed to see how sharply job opportunities and living standards have fallen, even without a recession.

The council examines the data for the two years since the Reserve began increasing interest rates, from June 2022 to June 2024, and it finds a lot more evidence of downturn and pain than you may realise.

For a start, the number of vacancies for entry-level jobs has declined by almost a third. There are an additional 100,000 people unemployed, and almost as many extra people suffering underemployment (unable to find as many hours of work as they want).

If you know employment is still growing, get this: this has occurred only because of stronger growth in publicly funded jobs (particularly under the National Disability Insurance Scheme). The annual number of publicly funded jobs has grown from 210,000 to 326,000, whereas jobs growth in the market sector has collapsed from 321,000 a year to 6000 a year.

If interest rates stay high, jobs in the market sector are likely to decline, but the present growth in publicly funded jobs won’t last.

We have avoided a recession – an economy that’s getting smaller – so far only because of the surprisingly strong bounce-back in immigration since the reopening of our borders. This won’t continue.

But the real value of goods and services produced per person has been falling, meaning that living standards have been falling. Over the two years, average real income per person has fallen by 8 per cent, or about $5000 a year.

According to the council’s calculations, the stage 3 tax cuts, the energy rebate and increased rent allowance for people on pensions or benefits announced in the May budget will restore only about a fifth of this loss of real income to households.

So the macho men’s fear that the budget measures will add to inflation pressure is laughable. And the council doesn’t miss the opportunity to remind us that JobSeeker unemployment benefits remain a miserly $55 a day.

As for the macho men’s fear that a “price-wage spiral” could take off at any moment, the council says average wages have fallen by 2 per cent since June 2022, after adjusting for inflation.

Wages have started rising a fraction faster than inflation, but it will take many moons to make up that gap. Meanwhile, the collapse in consumer spending has been “precipitous”: a fall of 10 per cent in real spending per person since June 2022.

If the Reserve’s renewed commitment to maintaining full employment is to have any meaning, it will need to start cutting the official interest rate ASAP.

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No one's sure what's happening in the economy

Treasury secretary Dr Steven Kennedy let something slip when he addressed a meeting of business economists last week. He said it was too early to say if the economy was back in a more normal period, “perhaps because no one is quite sure what normal is any more”.

This was especially because “unusual economic outcomes are persisting,” he added.

Actually, anyone in his audience could have said the same thing – but they didn’t, perhaps because they lacked the authority of the “secretary to the Treasury”.

No, standard practice among business economists and others in the money market is to make all predictions with an air of great certainty. Forgive my cynicism, but this may be because their certain opinion changes so often.

Often, it changes because something unexpected has happened in the US economy. Many people working in our money market save themselves research and thinking time by assuming our economy is just a delayed echo of whatever’s happening in America.

If Wall Street has decided that America’s return to a low rate of inflation has been delayed by prices becoming “sticky”, rest assured it won’t be long before our prices are judged to have become sticky as well.

But predicting the next move in either economy has become harder than we’re used to. Kennedy noted in his speech that, in recent years, the global economy, including us, had been buffeted by shared shocks, such as a global pandemic, disruptions to the supply of various goods, and war.

One factor I’d add to that list is the increasing incidence of prices being disrupted by the effects of climate change, particularly extreme weather events, but also our belated realisation that building so many houses on the flood plain of rivers wasn’t such a smart idea.

All these many “shocks” to the economy have knocked it from pillar to post, and stopped it behaving as predictably as it used to. But, as we’ll see, not all the shocks have been adverse.

Right now, the change everyone’s trying to predict is the Reserve Bank’s next move in its official interest rate, which most people hope will be downward.

Normally, that would happen just as soon as the Reserve became confident the inflation rate was on its way down into the 2 to 3 per cent target range. And normally, we could be confident the first downward move would be followed by many more.

But since, like Kennedy, the Reserve is not quite sure what normal is, and Reserve governor Michele Bullock says she expects the return to target to be “bumpy”, it may delay cutting rates until inflation is actually in the target zone.

If so, and remembering that monetary policy, that is, interest rates, affects the economy with a “long and variable lag”, the Reserve will be running the risk that it ends up hitting the economy too hard, and causing a “hard landing” aka a recession, in which the rate of unemployment jumps by a lot more than 1 percentage point.

Kennedy was at pains to point out that the rise in the official interest rate of 4.25 percentage points over 18 months is the “sharpest tightening” of the interest-rate screws since inflation targeting was introduced in the early 1990s.

He also reminded us how much help the Reserve’s had from the Albanese government’s fiscal policy, which has been “tightened at a record pace”. Measured as a proportion of gross domestic product, the budget balance has improved by about 7 percentage points since the pandemic trough. Add the states’ budgets and that becomes 7.5 percentage points.

That’s a part of the story those in the money market are inclined to underrate, if not forget entirely. Kennedy reminded them that, since 2021, our combined federal and state budget balance has improved by more than 5 percentage points of GDP. This compares with the advanced economies’ improvement of only about 1.5 percentage points.

So, has our double, fiscal as well as monetary, tightening had much effect in slowing the growth of demand for goods and services and so reducing inflationary pressure?

Well, Kennedy noted that, over the year to December, households’ consumption spending was essentially flat. And consumer spending per person actually fell by more than 2 per cent.

When you remember that consumer spending accounts for more than half total economic activity, this tells us we’ve had huge success in killing off inflationary pressure. And this week, when we see the national accounts for the March quarter, they’re likely to confirm another quarter of very weak demand.

So, everything’s going as we need it to? Well, no, not quite.

Last week we learnt that, according to the new monthly measure of consumer prices, the annual inflation rate has risen a fraction from 3.4 to 3.6 per cent over the four months to April.

“Oh no. What did I tell you? The inflation rate’s stopped falling because prices are “sticky”. It’s not working. Maybe we need to raise interest rates further. Certainly, we must keep them high for months and months yet, just to be certain sure inflation pressure’s abating.”

Well, maybe, but I doubt it. My guess is that a big reason money market-types are so twitchy about the likely success of our efforts to get inflation back under control is the lack of blood on the streets that we’re used to seeing at times like this.

Why isn’t employment falling? Why isn’t unemployment shooting up? Why are we only just now starting to see news of workers being laid off at this place and that?

It’s true. The rate of unemployment got down to 3.5 per cent and, so far, has risen only to 4.1 per cent. Where’s all the blood? Surely, it means we haven’t tightened hard enough and must keep the pain on for much longer?

But get this. What I suspect is secretly worrying the money market-types, is something Kennedy is pleased and proud about.

“One of the achievements of recent years has been sustained low rates of unemployment,” he said last week. “The unemployment rate has averaged 3.7 per cent over the past two years, compared with 5.5 per cent over the five years prior to the pandemic.”

Our employment growth has been stronger than any major advanced economy over the past two years, he said. Employment has grown, even after accounting for population growth.

And we’ve seen significant improvements for those who typically find it harder to find a job. Youth unemployment is 2.6 percentage points lower than it was immediately before the pandemic.

So, what I suspect the money market’s tough guys see as a sign that we haven’t yet experienced enough pain, the boss of Treasury sees as a respect in which all the shocks that have buffeted us in recent times have left us with an economy that now works better than it used to.

And Kennedy has a message for the Reserve Bank and all its urgers in the money market.

“It is important to lock in as many of the labour market gains as we can from recent years. This involves macroeconomic policy aiming to keep employment near its maximum sustainable level consistent with low and stable inflation,” he said.

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How full employment has changed the economy

This may be the first time you’ve watched the managers of the economy using high interest rates and a tighter budget to throttle demand to get inflation down. But if it isn’t your first, have you noticed how much harder they’re finding it to catch the raging bull?

It explains why both the previous and the new Reserve Bank governor have been so twitchy. How, after they seem to have made as many interest rate rises as they thought they needed, they keep coming back for another one.

The economy isn’t working the way it used to. Have you noticed that, although consumer spending stopped dead in the September quarter, and overall growth in the economy slowed to a microscopic 0.2 per cent, there’s been so little weakness in the jobs market?

Although there’s no doubt about how hard most households have been squeezed over the course of this year, how come the rate of unemployment has risen only marginally from 3.5 per cent to a still-far-below-average 3.9 per cent in November?

And if the economy’s been slowing for the whole of this year, how come the budget balance is getting better rather than worse, with Treasurer Jim Chalmers achieving a surplus last financial year and hoping for another in the year to next June?

There are lots of particular things that help explain these surprising results – world commodity prices have stayed high; some parts of the economy change earlier than others – but there’s one, more fundamental factor that towers over all the others: this is the first time in 50 years that we’ve been trying to slow a runaway economy that’s reached anything like full employment.

It turns out that throttling an economy that’s fully employed is much harder to do. Households are more resilient and, after a period when it’s been hard to get hold of all the workers they need, businesses have been far less inclined to add to the slowdown by shedding staff.

Remember that we reached full employment by happy accident. Between the unco-ordinated stimulus of state as well as federal governments, plus the Reserve cutting rates to near-zero, we (like many other rich economies) hit the accelerator far too hard during the pandemic.

This was apparent after the pandemic had eased and before the Morrison government’s final budget in March last year. But there was no way Scott Morrison was going to hit the budget brakes just before an election.

So the econocrats in the Reserve and Treasury resigned themselves to second prize: an unemployment rate much lower than what they were used to and felt comfortable with.

Because the pandemic had also caused us to close our borders and thus block employers’ access to skilled and unskilled immigrant labour, the econocrats got far more than they expected: unemployment so low we hit full employment.

The jobs market is getting less tight, with the number of job vacancies having fallen a long way, but last week’s figures for November showed how strong the labour market remains.

Sure, unemployment rose a fraction to 3.9 per cent, but this is no higher than it was in May last year. And the month saw total employment actually grow, by more than a remarkable 61,000 jobs during the month.

After all this slowing and all this pain, the rate at which people of working age are participating in the labour force by either having a job or actively seeking one has reached a record high.

And almost 65 per cent of the working-age population has a job – a proportion that’s never been higher in Australia’s history.

Employment is still growing strongly, partly because of the rebound in immigration, with foreign students in particular filling part-time job vacancies.

But also, it seems, because more hard-pressed families are trying to make ends meet by taking second jobs. In past downturns, those jobs wouldn’t have been there to be taken.

To force households to spend less, they’re being hit with three sticks. Obviously, by raising mortgage interest rates. Also by employers, taken as a group, raising the wages they pay by less than they’ve raised their prices (have you noticed how Chalmers avoids referring to the cut in real wages by just blaming “inflation”?).

And, third, by the government allowing bracket creep to take a bigger bite out of what pay rises the workers do manage to get.

But there’s another factor that’s been working in the opposite direction, adding to households’ ability to keep spending: over the year to November, the number of people with jobs rose by more than 440,000. That’s a full-employment economy.

All the extra people with jobs pay income tax. All the part-time workers able to get more hours pay more tax. All the people getting second jobs pay more tax. Add the bigger bite out of pay rises, and you see why Chalmers’ budget’s so flush.

But note this: the many benefits of full employment come at a cost – “opportunity cost”. As a coming paper by Matt Saunders and Dr Richard Denniss of the Australia Institute will remind us, “opportunity cost makes it clear that when resources are used for one purpose, they become unavailable for other purposes”.

So when we’re at or close to full employment, any developer, business executive or politician seeking our support for any project because “it will create jobs” should be laughed at. Where will the workers come from to fill the jobs? You’ll have to pinch them from some other employer.

This is especially true when the jobs you want to create are for workers with specialist skills.

According to a federal government report, in October last year there were 83 major resource and energy projects at the committed stage, worth $83 billion. But about two thirds of these were for the development of fossil fuels, including the expansion of nearby ports.

Really? And this at a time when the electricity grid needs urgent reconfiguration as part of our move to a low-carbon economy, but projects are being deferred because you can’t get the workers?

As Saunders and Denniss conclude, “With rapid population growth and the stated need to transform our energy system, the real cost of spending tens of billions of dollars building new gas and coal projects is the lost opportunity to invest in the infrastructure and energy transformation the Australian economy needs.”

I think Jim Chalmers needs to explain the iron law of opportunity cost to his boss. And make sure Climate Change and Energy Minister Chris Bowen’s in the meeting.

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Why it's doubtful we need another interest rate rise

There’s nothing the media likes more than an interest rate rise on Melbourne Cup day. It’s surprising how often it’s happened, and many in the financial markets have convinced themselves that’s what we’ll get next Tuesday. And the good news is that, despite the radical reform of moving to a mere eight board meetings a year, the Reserve Bank has ensured that meetings on cup day will continue.

What I’m not sure of is whether, if we do get a rate rise next week, it will be happening by accident or design. In central banking, getting your timing right is just as important as it is in a comedy routine.

It was no surprise last week when new Reserve Bank governor Michele Bullock used her first big speech to make sure everyone noticed her bulging anti-inflation muscles. “There are risks that could see inflation return to target more slowly than currently forecast,” she warned.

“The board will not hesitate to raise the cash rate further if there is a material upward revision to the outlook for inflation,” she said. She added some qualifications but, predictably, neither the markets nor the media took much notice of them.

Any new governor would have said the same in their first speech. Trouble is, her tough statement about not being willing to return to the 2 to 3 per cent inflation target “more slowly than currently forecast” came just the day before publication of the consumer price index for the September quarter.

And while it showed the annual rate of inflation continuing to fall from its peak of 7.8 per cent at the end of last year to 5.4 per cent nine months later, it also showed the quarterly inflation figure rising from 0.8 per cent to 1.2 per cent.

This was 0.2 percentage points or so higher than the markets – and, they calculate, the Reserve – were expecting. Bingo! Rate rise a dead cert. All the big four banks are laying their bets accordingly.

But the main reason for the slightly higher number was a rise in petrol prices, which contributed 0.25 percentage points of the 1.2 per cent. This rise comes from insufficient supply: the higher world price of oil, forced up the OPEC oil cartel and others trying to increase the price by restricting their supply.

It does not come from excessive Australian demand – which is the one factor the Reserve can moderate by increasing interest rates. Similarly, the next-biggest price increases, for newly-built homes (imported building materials), rents (surge in immigration) and electricity (Ukraine war) aren’t caused by anything a rate rise can fix.

So I think the case for yet another rate rise is weak. As Bullock clearly demonstrated elsewhere in her speech, the Reserve’s single, crude instrument, raising interest rates, delivers most of its punishment to the quarter or so of households with big mortgages.

Too many of these people are really hurting, and the full hurt from rate rises already made has yet to be felt. The economy is slowing, consumer spending is hardly growing, real income per person is falling.

And, as Treasury secretary Dr Steven Kennedy noted in a speech last week, last financial year’s budget surplus of $22 billion shows the budget’s “automatic stabilisers” are working hard to help the Reserve restrain demand – a truth that’s been completely missing from the Reserve’s commentary. That’s gratitude for you.

But if, having thought hard about such a small change to the “outlook for inflation”, Bullock decides a further rate rise isn’t warranted, what are the money market punters (and I do mean people making bets) going to think, considering all her chest-beating? That she speaks big but carries a soft stick?

There are a few things she – and her urgers in the financial markets (most of whom have never in their lives had reason to worry about the cost of living) – need to remember.

First, at this late stage in the game, we really are into fine-tuning. And acting because a revised forecast means we’ll return to target later than we had expected suggests you’ve forgotten what every governor needs always to remember: as with all economists, the Reserve’s forecasts are more likely to be wrong than right.

They can be wrong by a lot or wrong by a little. Worst, they can prove too optimistic or too pessimistic. If your previous forecast was wrong, what makes you so sure your next one will be right? When it comes to forecasts, the person making the actual decisions needs to be the biggest sceptic.

Second, the Reserve’s previous forecast was for inflation to be back to the top of the target range by the first half of 2025. If its latest forecast pushes that out to the second half, what’s so terrible about that? How much extra pain for young people with huge mortgages does that justify?

Ah, says the Reserve, the reason we can’t wait too long to get inflation back to target is that, the longer we leave it, the greater the risk that business’ and workers’ expected rate of inflation rises above the target range.

If that happened, we’d need much higher interest rates and much more pain to get expectations back down to the only range we’ve decided is acceptable.

This is true in principle but, in practice, it’s mere speculation. The fact is, the world’s central bankers have no hard evidence on how long it takes for inflation expectations to adjust – a few years or a few decades.

I’m old enough to remember that when inflation returned, in the late-1960s and early-’70s, it took a decade or two for expectations to adjust. The smarties used to advise youngsters to borrow as much as anyone would lend them. Why? Because real interest rates were negative.

But when a decade or two of tough inflation fighting eventually got expectations down to what became the target range, after the recession of the early ’90s, they’ve shown zero sign of moving for 30 years. Not even during the present inflation surge.

So when nervous-nelly governors decide to err on the safe side, they’re deciding to beat young home buyers even further into the ground. Either sell your house or starve your kids.

Finally, in her answers to questions last week, Bullock implied that the risk of rising inflation expectations was now so great that the Reserve could no longer afford the nicety of distinguishing between supply-side shocks and price rises driven by excessive demand.

Whatever the cause, continuing delay in getting inflation back to target presented such a threat to expectations that rates would have to keep rising regardless.

This means that if our return to target is delayed by supply-side problems – mismatches in the transition to renewable energy, leaps in meat and veg prices caused by extreme weather, or higher oil prices caused by worsening conflict in the Middle East – the home buyers cop it.

In this era of continuing supply shocks, failure to distinguish between the causes of price rises would be a recipe for deep recession. The Reserve’s professed “dual mandate” – full employment – would be out the window.

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How much government spending is wasted? Sorry, don't know yet

Hands up if you think a lot of the money the government spends is wasted. I think a lot of people would agree. But the question’s not as easily answered as you may think.

My guess is that many people’s impression of the amount of waste is exaggerated. When they see what they believe is wasteful spending they notice and remember it, whereas when everything seems to be going as it should, they don’t take note.

And what’s wasteful can be in the eye of the beholder. All the government money that comes my way is well spent, but the money it’s giving to people I don’t know or don’t like – or to causes I don’t care about – that’s waste. Well, maybe, maybe not.

Many people convince themselves governments waste massive amounts, in order to justify their objection to paying more tax, or their resentment of what they already pay.

Remember, no one in government just stands there tearing up banknotes. Some of the money can be spent on, say, fighter planes than don’t work properly, or roads that are rarely used, but almost all the money spent ends up in someone’s hands, not just as a pension or benefit, but as a payment for work they did for the government, either as its employee or the employee of a company that did something for, or sold something to, the government.

The people who get money from the government in this way don’t regard it as a waste. What do they do with it? They spend most of it. And when they do, this generates income for other people. The money goes round and round. It’s rare for government spending to benefit no one.

But that doesn’t mean the money was well spent. That it benefited the people it was supposed to benefit, or that they got as much benefit from it as intended. That can be particularly so when governments don’t just give people cash, but do things for them that are supposed to help them.

When you think of it like that, my guess is that a fair bit of the government’s spending is wasteful. But I can’t tell you how much. Why not? Because even the government doesn’t know.

Why not? Because governments don’t do nearly as much evaluation of their spending as they should. Australian governments have no culture of regularly and rigorously checking to see spending programs are achieving their stated objectives.

But here’s the news. The Albanese government has vowed to change this. In fulfillment of an election promise, it has allocated spending of $10 million over four years to set up the Australian Centre for Evaluation as a unit within Treasury. It’s the baby of assistant treasurer Dr Andrew Leigh.

The centre will improve the number, quality and impact of evaluations across the Australian public service, working together with evaluation units in other departments and agencies. “It will save taxpayers money and make government better,” Leigh says.

It will partner with other departments to conduct evaluations on mutually agreed priority programs. These evaluations will build momentum by helping to build departments’ capabilities and demonstrating the value of better evaluation across the government.

“Building the … public service’s evaluation capability is also an important step towards reducing the over-reliance on [outside] consultants” and cutting spending on them. Using consultants “is expensive and delivers inconsistent results”, Leigh said.

Last week, Leigh announced that the centre’s first evaluation, with the Department of Employment and Workplace Relations, would be of Workplace Australia, the latest name for the network of community and for-profit outfits contracted to provide “employment services” to people having a hard time finding a job.

Leigh says that making sure the Workplace Australia network’s employment services are achieving their stated objective – which is to reduce long-term and “structural” unemployment – is a key part of achieving the government’s commitment to full employment, as outlined in its recent white paper on employment.

Good. Because I’ll be amazed if the evaluation doesn’t find the Workplace Australia program has been a huge waste of money, doing amazingly little to help unemployed people with problems on their way to a decent job.

On one side, bureaucrats have used the tendering system to pay as little as possible for the services the government says it wants to be provided. On the other, the “providers” – even some of the community organisations that seem only in it for the money – have learnt all the ways to tick the boxes and be paid, while doing precious little to help people with problems.

In the era of robo-debt, it didn’t take the providers long to twig that the previous government was happy to pay them for punishing the jobless for minor or manufactured misdemeanours, rather than helping them.

The telltale sign that Workplace Australia was yet another example of the failure of outsourcing – looked good on paper; didn’t work in practice – is the number of times the bureaucrats have tried to fix it by giving it a new name. The old Commonwealth Employment Service became Jobs Services Australia, then the Job Network, then the one-word, lower-case jobactive, then Workforce Australia.

Leigh, a former economics professor, is a great believer in the wider use of the “randomised controlled trials” that the medicos have used so successfully to ensure the procedures and pills they prescribe are “evidence-based”.

This, he hopes, will make the evaluations more accurate in determining what works and what doesn’t.

I have to say there’s a reason that, to date, the evaluation and improvement of spending programs has been half-hearted to non-existent. It’s because ministers and their department heads aren’t keen to have people producing documentary evidence that they aren’t doing their job properly. And the last thing they’d want is for such a report to find its way to the public’s attention.

So Leigh’s is a worthy crusade. Let’s hope he gets somewhere. Actually, if evaluations became a regular thing, and led to regular improvements, ministers and mandarins would have a lot less to fear.

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Chalmers should give the RBA an employment target

My trouble is I’m too nice. I’m too reluctant to tell people when I think they’re not trying hard enough. If I had time over again, I’d be tougher on nice young Treasurer Jim Chalmers and his white paper on employment.

The Albanese government wants to revitalise our resolve to achieve full employment, but didn’t have the courage to put a number where its mouth is and nominate a numerical target for employment.

I’ve been convinced of this by my former colleague, friend and most worrying competitor, Peter Martin, now of the universities’ The Conversation website.

Chalmers says the white paper is “ambitious”, but Martin isn’t convinced. “A clearly ambitious statement would have specified a target for unemployment, ideally one that was a bit of a stretch,” Martin says.

He notes that the Keating government’s Working Nation statement did that in 1994. Released at a time when unemployment was almost 10 per cent, it specified a target unemployment rate of 5 per cent – an ambition that served as a beacon for decades.

With all the progress we’ve made in recent times, getting unemployment down to about 3.5 per cent for more than a year, Martin proposes setting a stretch target of 3 per cent, or even 4 per cent, as an aspiration.

Essentially, his argument for setting a target is that “what gets measured gets done”. And he’s dead right. This is not about economic theory, it’s about the practicalities of not just having ambitions, but making sure you have your best shot at achieving them.

In an ideal world, it would be enough to merely state your ambitions. But in a world of human fallibility, we need to impose on ourselves rules and targets to help us stick to our guns.

The target we’ve had for the rate of inflation – of 2 to 3 per cent, achieved on average over time – which we’ve had since 1996, has been no magic answer, but has been highly effective in leaving everyone in no doubt about whether we were on track or off track, and by how much.

But, as is widely agreed, in the day-to-day management of the economy, we have two objectives, not one: price stability (as measured by the inflation target) and full employment (as not measured by any target).

This lopsidedness leaves us constantly tempted to err on the side of low inflation at the expense of low unemployment. That’s the unspoken message the lack of a numerical target is sending the economic managers, particularly the Reserve Bank. As I’ve written before, this omission may secretly suit the interests of business.

So if the Albanese government’s professed determination to get full employment back up on its pedestal alongside price stability is to be meaningful, it must involve setting two targets, not one.

Last week, one of the nation’s leading labour market economists, Professor Jeff Borland of Melbourne University, joined this debate. He doesn’t agree that the white paper was the right place for the government to nominate a specific numerical target.

But he does believe the managers of the macroeconomy require a numerical target. To achieve what the white paper calls the “maximum sustainable level of employment”, he says, “you need to know what it is”.

Borland accepts the white paper’s criticism of the present way of estimating full employment, the NAIRU, or non-accelerating-inflation rate of unemployment, which “evolves over time, is difficult to measure, and does not capture the full potential of the workforce” – a reference to underemployment and “potential workers”, who want to work but aren’t actively seeking a job, and so aren’t counted in the labour force.

Borland adds another criticism, that “estimation of the NAIRU has become a ‘black box’, making it almost impossible to understand why it is at a particular level at any time.”

So Borland accepts the government’s argument that, rather than relying solely on estimates of the NAIRU, “policymakers need a broad suite of measures to gauge the extent of current underutilisation [of labour]” and whether the labour market is close to the current maximum sustainable level of employment.

This means Borland rejects Martin’s argument that unemployment can stay the measure of full employment because it moves in line with underemployment (having a part-time job, but not as many hours as you want).

“The rate of unemployment is no longer sufficiently informative about labour underutilisation – and labour underutilisation is what we should care about for policymaking,” Borland says.

However, he dismisses the claims of other critics that the new full-employment objective is bad news for keeping inflation under control.

He quotes what the white paper says on the matter. The objective is to “keep employment as close as possible to the current maximum sustainable level of employment that is consistent with low and stable inflation”.

The plain truth is that there has always been much potential for conflict between the goal of price stability and the goal of full employment. Life is full of such conflicts.

And a key teaching of economics is that when you encounter two conflicting but highly desirable objectives, the answer is never to fly to one extreme or the other, as humans are so often tempted to do.

No, economics teaches that what you should do is seek out the best available “trade-off” (combination) between the two, so you end up with as much of each as the circumstances allow.

The point is that making sure we have explicit targets for both is the best way to motivate the economic managers to find the best trade-off available. Both the white paper and the recent independent review of the Reserve Bank’s performance imply that, in recent years, we haven’t been finding the best trade-off between the two.

But there’s still time for Chalmers to nominate a numerical employment target. Although the Reserve’s act requires it to achieve full employment, the review recommended that, in the setting of interest rates, the full-employment objective be raised to the same status as the inflation target.

The place for this to happen is in the imminent “statement on the conduct of monetary policy”, the agreement between the treasurer of the day and the governor that the treasurer has newly appointed.

It was in the first of these agreements, in 1996, between Peter Costello and Ian Macfarlane, that the Howard government accepted the inflation target the Reserve had formulated as the government’s target.

In the upcoming agreement between Chalmers and new governor Michele Bullock, he could ask the Reserve to go away and come up with its own employment target.

But if he wants to be seen by the public as doing his job with diligence and the courage of his convictions, he will ask the new governor to accept an employment target the government has determined as the embodiment of the fine ambitions expressed in its white paper.

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How full employment can coexist with low inflation

Who could be opposed to full employment? No one. Not openly, anyway. But Treasurer Jim Chalmers’ white paper on employment has been badly received by the Business Council and other business lobby groups. And, of course, business’s media cheer squad.

At least since Karl Marx, the left has charged that business likes unemployment to stay high so there’s less upward pressure on wages and workers are more biddable. We know that when, during recessions or lockdowns, bosses announce they’re skipping the annual pay rise, the unions never dare to disagree. Forget the pay rise and keep my job secure.

So you don’t have to swallow all the Marxist claptrap to suspect there may be some truth to the idea that, though businesses hate recessions, they don’t mind a bit of healthy unemployment.

If so, don’t expect them to be greatly enamoured of Labor’s latest resolve to pay more than lip service to the goal of full employment. But, by the same token, don’t be surprised if business happens to find in the full-employment package something they can profess to be terribly worried about.

Talk about speed reading. As is the practice in lobbyist-ridden Canberra, within minutes of the release of the white paper last Monday, the Business Council – like a lot of other business lobby groups – issued a full-page press release singing its agreement with the government’s move. It was all wonderful, and, in fact, just what the council had been calling for in its own recent voluminous report.

Until, suddenly, in the third-last paragraph, we discover the government had got it a bit wrong. Unfortunately, “we believe the federal government’s workplace relations reforms will undermine the objectives set out in the white paper.

“They will return the workplace relations system to an outdated model, unable to meet the expectations of both employees and businesses in the ways they seek to work today. It will risk fossilising industry structures and work practices when we know technology is going to change and people and workplaces need to adapt quickly,” the council says.

“If the government is to achieve the task it has set itself in this white paper, we encourage it to halt the current workplace relations changes and work constructively with business to identify challenges and find solutions that will deliver sustainable real wage increases for Australians.”

Ah, yes. Now we have it. And I’m sure all that would make perfect sense to every chief executive.

No, part of the opposition to the employment white paper comes from paper’s qualification to the definition of full employment as no one being jobless for long: “These should be decent jobs that are secure and fairly paid.”

But another part of the opposition has involved flying to the defence of the NAIRU – the “non-accelerating-inflation rate of unemployment” – which Chalmers now calls the “technical assumption” used by the Reserve Bank and Treasury in their forecasting, as opposed to the broader definition of full employment set out in the white paper.

The Australian Chamber of Commerce and Industry, the biggest employer group, said in its response to the white paper that the government “needs to make it clear that, contrary to trade union understandings, there will be zero impact on the Reserve Bank’s interest rate setting framework, and zero expectation that [it] will be more doveish on inflation”.

Well, not sure about that. Those who take the government’s recommitment to the goal of full employment to be a return to the post-World War II days when full employment was the only goal in the management of the macroeconomy are doomed to disappointment.

But those who happily imagine it will make zero difference are also kidding themselves. As the white paper makes clear, achieving sustained full employment involves “minimising volatility in economic cycles and keeping employment as close as possible to the current maximum level consistent with low and stable inflation”.

It doesn’t mean that, having fallen to about 3.5 per cent, the rate of unemployment must never be allowed to go any higher. No one has abolished the business cycle, nor the need for macro management to smooth the ups and downs in demand as the economy moves through that cycle.

So, the likelihood that, having greatly increased interest rates despite the fall in real wages, we’ll see some rise in unemployment in coming months, won’t prove the white paper was all hot air.

It’s also true, as more sensible business economists have realised, that the improvements in education and training that the white paper envisages could reduce “structural” unemployment, and thus the level of estimates of the NAIRU.

The truth is, economists make lots of calculations and the NAIRU is just one of them. While their calculations can tell them the NAIRU is now higher or lower than it was a few years ago, economists have never been able to tell you just why it’s changed.

The best they’ve ever been able to do is “ex-post” (after the fact) rationalisation. If the NAIRU has fallen, think of something that’s improved. If it’s risen, think of something that’s got worse.

The way the critics have rushed to the defence of the NAIRU, you’d think its magic number was written by God on tablets of stone. It’s just an estimate. And, like all estimates, it can be more reliable or less reliable.

No, what the government’s recommitment to full employment does is put full employment back up there as an economic objective equal in importance to low inflation. There’s always been scope for tension between the two objectives, and this increases that tension.

It says: if you’ve been erring on the side of low inflation, don’t. Try harder to find a better trade-off between the two.

It means the Reserve Bank and Treasury will now be less mindless and more mindful in the way they use the NAIRU to influence forecasts and judgements. But, unlike the critics, I think the Reserve and Treasury have already got that message.

As generator of magic numbers, the NAIRU has two glaring weaknesses. It was designed in an era when most jobs were full-time, so entirely ignores the spare capacity hidden in underemployment.

And, as the Reserve itself has acknowledged, it assumes all price rises are caused by excess demand, when we know that, in recent times, many price rises have come from disruptions to supply. And we know there’ll be more supply-driven pressure on prices from the transition to renewables and other things.

Have you noticed that whenever the Reserve and Treasury tell us their latest estimates of the magic number, they never tell us how much “judgment” they applied to the number that popped out of the model before they announced it?

But if that doesn’t convince you, try this one: the judgements the Reserve Bank makes will be better in future because, for the first time in a quarter of a century, Chalmers has appointed to its board someone who really knows how wages are set in the real world.

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Albanese wants to put full employment back on its throne

Something really important to the management of the economy happened this week: the Albanese government released its white paper on employment. If the government achieves the vision it has laid out, it could be a turning point in how our economy works, one that begins a lasting reduction in the rates of unemployment and underemployment.

This is Labor’s decision to put “full employment” back on its throne as a central objective of macroeconomic policy. Or, as the paper puts it, “placing full employment at the heart of our institutions and policy frameworks”.

For the first 30 years after World War II, the achievement of full employment was the overriding objective for the managers of the economy. This era began in 1945, with the Curtin Labor government issuing a white paper on full employment in Australia. Notice a pattern?

It worked well for 30 years, but fell apart with the arrival of high inflation in the mid-1970s. Since then, the primary concern of macroeconomic management has been to keep inflation low, with the goal of achieving full employment usually given not much more than lip service.

What’s changed has been the way the ups and downs of the pandemic have suddenly returned us to the lowest rate of unemployment in almost 50 years, about 3.5 per cent. But also the lowest rate of underemployment – part-timers who can’t get as many hours of work as they want – in several decades.

At present, we have about the highest proportion of the working-age population participating in the labour market – by having a job or actively seeking one.

This unexpected return to something close to full employment has prompted many people to think we should be trying at lot harder than we have been to keep employment high and unemployment low.

And that’s why the Albanese government has decided to put the goal of full employment back on its throne in the halls of macroeconomic management.

“Macro” means focusing on the economy as a whole. “Micro” means looking at particular bits of the economy, or at particular mechanisms within the economy.

Since World War II, governments have sought to use “fiscal policy” (the budget) and “monetary policy” (interest rates) to “manage” the macroeconomy by smoothing out the ups and downs in demand for (spending on) goods and services – and thus employers’ demand for workers.

If the goal of full employment is now back on centre stage, what does full employment actually mean?

The white paper defines it as where “everyone who wants a job is able to find one without having to search for too long”. But it adds a qualification: the jobs we create should be “decent jobs that are secure and fairly paid”, a requirement many employers won’t like the sound of.

The paper says it wants “sustained” full employment, which means “minimising volatility in economic cycles and keeping employment as close as possible to current maximum level consistent with low and stable inflation”.

So restoring the priority of full employment doesn’t mean ceasing to care about inflation, but does mean that getting serious about full employment will affect the day-to-day management of the macroeconomy.

The paper also says full employment must be “inclusive”: broadening the opportunities for people to take up paid work and lowering the barriers to work created by various forms of discrimination.

But how will the government go about achieving this more inclusive view full employment? Well, one way to answer this is to take the economists’ standard list of the types or causes of unemployment.

“Frictional” unemployment occurs because, at any time, there’ll always be some people moving between jobs or seeking their first job. So frictional employment is inevitable and nothing to worry about.

It occurs because it takes time for someone wanting a job to find someone wanting to give them one. You’d think that with so much advertising of job vacancies, and so much looking for jobs, occurring online, frictional unemployment ought to be lower than it used to be.

“Cyclical” unemployment is caused by downturns in the economy, which reduce employers’ demand for workers with little reduction in the people seeking work. As the paper says, it can be lessened through “effective macroeconomic policy settings”.

That is, to get the economy moving quickly out of a recession and, better, managing to stop it getting into recession in the first place. It’s when people lose their jobs during a prolonged recession – and education-leavers take months to find their first job – that you get a build-up in “long-term” unemployment.

These are the people who needed special, personalised help from the government because the longer they go unemployed, the less an employer wants to take them on. This role used to be played (not particularly well) by the Commonwealth Employment Service, which was replaced by what’s now called Workforce Australia, using often for-profit providers of “employment services” to people with problems.

If you’ve heard anything about robo-debt, it won’t surprise you that it’s become a travesty of what it was supposed to be, with providers gaming the system and gaining the impression the government wants them to punish people rather than help them.

The Albanese government has instituted an inquiry into the present system of government-funded employment services. How seriously it reforms this shemozzle will be a key test of how committed the government is to achieving sustained full employment.

The final type of unemployment is “structural”, caused by a mismatch between the skills a worker possesses and the skills employers are seeking. Sometimes the mismatch is geographic; often it’s caused by the ever-changing structure of industry, as some industries decline and others expand.

This is the hardest cause of unemployment to reduce. But it involves reforming every level of education and committing to retraining and lifelong learning. Again, this will be a key test of whether the government is committed to achieving sustained full employment, not just dreaming about it.

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Labor sets out its alternative to neoliberalism

If, rather than wading through all the things the Albanese government has decided to do, you read what its white paper on employment actually says, you realise a remarkable thing: it reveals a vision of an alternative economy the government wants to take us to.

In recent weeks we’ve seen before our eyes the worst of the economy that several decades of “neoliberalism” – the doctrine that what’s good for big business is best for the rest of us – has brought to us. The rise of the nation’s chief executives as commercial Brahman castes, taking short-cuts to higher profits by chiselling customers and mistreating employees, and seeing themselves as above the law, has left a sour taste.

Treasurer Jim Chalmers and his colleagues want to move from an economy centred on what the bosses want, to one centred on what’s best for the workers. It’s a shift from managing the economy for the few, rather than the many. The great majority of Australia’s households depend on income from wages.

The white paper spells it out from the beginning. “The government’s vision is for a dynamic and inclusive labour market in which everyone has the opportunity for secure, fairly paid work and people, businesses and communities can be beneficiaries of change and thrive. We are working to create more opportunities for more people in more places,” it says.

Our surprise return to our lowest rate of unemployment in almost 50 years – about 3.5 per cent, which we’ve maintained for more than a year – has revived the government’s ambition to pursue a goal we lost sight of in the 1970s, full employment.

The white paper says what the government takes that term to mean in our very different world, and how it will be pursued. Full employment has never meant an unemployment rate of zero. At the very least, there will always be a small proportion of workers moving between jobs or looking for their first job.

The paper announces the government’s definition of the term: it is working to create an economy where “everyone who wants a job is able to find one without having to search for too long”.

That’s a demanding specification. Sometimes unemployment will be high because the economy’s in recession. In normal times, unemployment is high precisely because too many people have gone for months without finding a job.

Some part of unemployment comes from the economy’s ever-changing industry structure, as some industries decline while others expand. This can leave some workers high and dry. They may have skills that some business wants, but that business may be many miles from where they live.

So for the government to commit to people not having to search too long to find a job imposes on it a great responsibility to help those people having problems.

But the government adds an important qualification to the requirement that no one be jobless for long: “These should be decent jobs that are secure and fairly paid.”

All this, it tells us, “is central to a strong economy and a prosperous and inclusive society”.

Just so. The only reason to want a strong economy is for prosperity that’s widely shared among the people who constitute the economy. And a simple truth that was lost in the era of neoliberalism is the value people place on having a job that’s secure.

It’s the peace of mind that comes from knowing that, if you turn up every day, do what you’re told and work hard, you can stop worrying about where your next meal’s coming from.

This can be just as important as how well the job pays, if not more so. But in recent decades we’ve seen the growth of businesses increasing their profits by using casualisation to make jobs less secure and devices such as labour hire and outsourcing to side-step existing wages and conditions.

The white paper says the government’s objective is “sustained and inclusive full employment”.

“Sustained full employment is about minimising volatility in economic cycles and keeping employment as close as possible to the current maximum level consistent with low and stable inflation.

“Inclusive full employment is about broadening opportunities, lowering barriers to work including discrimination, and reducing structural under-utilisation [part-time workers who can’t get as many hours of work as they want] over time to increase the level of employment in our economy.”

The paper says building a strong and skilled workforce “will be fundamental to achieving full employment and productivity growth”. This will require substantial growth in the high-skilled workforce.

“Australia needs an increasingly highly skilled labour force, equipped with the right tools and technology” to maximise gains from the transition to renewable energy, the increased use of artificial intelligence and the growing care economy.

Now, I know what you’re thinking. It would be a much better world to live in. But they’re just words ... just aspirations. True. But by setting it all down so formally, the Albanese government is raising our expectations.

It’s setting a standard for us to judge its performance by – a standard much higher than its predecessors ever set. We must hold Albo to it.

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What's kept us from full employment is a bad idea that won't die

Lurking behind the employment white paper that Treasurer Jim Chalmers will release today is the ugly and ominous figure of NAIRU – the non-accelerating-inflation rate of unemployment. If the Albanese government can’t free itself and its econocrats from the grip of NAIRU, all its fine words about the joys of full employment won’t count for much.

The NAIRU is an idea whose time has passed. It made sense once, but not anymore. The story of how this conventional wisdom came to dominate the thinking of the rich world’s macroeconomists has been told by Queensland University’s Professor John Quiggin.

In the period after World War II, economists decided that the managers of the economy faced a simple choice between inflation and unemployment. Low unemployment came at the cost of high inflation, and vice versa.

This relationship was plotted on something called the Phillips curve, and the economic managers could choose which combination of inflation and unemployment they wanted.

It seemed to work well enough until the mid-1970s, when the developed economies found themselves with high unemployment and high inflation at the same time – “stagflation” – something the Phillips curve said couldn’t happen.

The economists turned to economist Milton Friedman, who’d been arguing that, if inflation persisted long enough, the expectations of workers and businesses would adjust. The inflation rate would become “baked in” as workers and suppliers increased their wages and prices by enough to compensate for inflation, whatever the unemployment rate.

So, after much debate, the economists moved to doing regular calculations of the NAIRU – the lowest rate to which unemployment could fall before shortages of labour pushed up wages and so caused price inflation to take off.

Since the early 1980s, the economic managers have tried to ensure the rate of unemployment stayed above the estimated NAIRU, so inflation would stay low. Should inflation start worsening, central bankers would jump on it quickly by whacking up interest rates.

Why? So that expectations about inflation would stay "anchored". Should they rise, the spiral of rising wages leading to rising prices would push up actual inflation. Then it would be the devil’s own job to get it back down.

If this sound familiar, it should. It’s what the Reserve Bank has been warning about for months.

Trouble is, the theory no longer fits the facts. Inflation has shot up, but because of supply disruptions, plus the pandemic-related budgetary stimulus, not excessive wage growth. And there’s been no sign of a worsening in inflation expectations.

Wages have risen in response to the higher cost of living, but have failed to rise by anything like the rise in prices. Why? Because, seemingly unnoticed by the econocrats, workers’ bargaining power against employers has declined hugely since the 1970s.

Meanwhile, the stimulus took us down to the lowest rate of unemployment in almost 50 years, where it’s stayed for more than a year. It’s well below estimates of the NAIRU, meaning wages should have taken off, but shortage-driven pay rises have been modest.

All of which suggest that the NAIRU is an artifact of a bygone age. As Quiggin says, the absence of a significant increase in wage growth is inconsistent with the NAIRU, which was built around the idea that inflation was driven by growth in wages, passed on as higher prices.

“As a general model of inflation and unemployment, it is woefully deficient,” Quiggin concludes.

Economists have fallen into the habit of using their calculations of an ever-changing NAIRU as their definition of full employment. But it’s now clear that, particularly in recent years, this has led us to accept a rate of unemployment higher than was needed to keep inflation low, thus tolerating a lot of misery for a lot of people.

So if today’s employment white paper is to be our road map back to continuing full employment – if our 3.5 per cent unemployment rate is to be more than a case of ships passing in the night – we must move on from the NAIRU.

A policy brief from the Australian Council of Social Service makes the case for new measures of full employment and for giving full employment equal status with the inflation target in the Reserve Bank’s policy objectives – as recommended by the Reserve Bank review.

The council quotes with approval new Reserve governor Michele Bullock’s definition that “full employment means that people who want a job can find one without having to search for too long”.

But it says another goal could be added, that “people who seek employment but have been excluded (including those unemployed long-term) have a fair chance of securing a job with the right help”.

And it argues that “since an unemployment rate of 3.5 per cent (and an underemployment rate of 6 per cent) has not triggered strong wages growth, this could be used as a full employment benchmark”.

One of the things wrong with the NAIRU was that it was a calculated measure, and it kept changing. As Quiggin notes, it tends to move in line with the actual rate of unemployment.

“When unemployment was high, estimates of NAIRU were high. As it fell, estimates of NAIRU fell, suggesting that how far unemployment could fall was determined by how far unemployment had fallen,” he says.

Which is why, to the extent that econocrats persist with their NAIRU estimates – or the government sets a more fixed target – the council is smart to suggest a test-and-see approach.

Rather than continuing to treat a fallible estimate as though it’s an electrified fence – to be avoided at all cost – you allow actual unemployment to go below the magic number, and see if wages take off. Only when they do, do you gently apply the brakes.

The council reminds us that it’s not enough to merely aspire to full employment, or even specify a number for it. It’s clear that, apart from the ups and downs of the business cycle, what keeps unemployment higher than it should be is long-term unemployment.

Committing to full employment should involve committing to give people who have “had to search too long” special help just as soon as their difficulties become apparent.

This would be a change from paying for-profit providers of government-funded “employment services” to punish them for their moral failings.

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How Philip Lowe was caught on the cusp of history

Outgoing Reserve Bank boss Dr Philip Lowe was our most academically outstanding governor, with the highest ethical standards. And he was a nice person. But if you judge him by his record in keeping inflation within the Reserve’s 2 to 3 per cent target – as some do, but I don’t – he achieved it in just nine of the 84 months he was in charge.

Even so, my guess is that history will be kinder to him than his present critics. I’ve been around long enough to know that, every so often – say, every 30 or 40 years – the economy changes in ways that undermine the economics profession’s conventional wisdom about how the economy works and how it should be managed.

This is what happened in the second half of the 1970s – right at the time I became a journalist – when the advent of “stagflation” caused macroeconomists to switch from a Keynesian preoccupation with full employment and fiscal policy (the budget) to a monetarist preoccupation with inflation and monetary policy (at first, the supply of money; then interest rates).

My point here is that it took economists about a decade of furious debate to complete the shift from the old, failing wisdom to the new, more promising wisdom. I think the ground has shifted again under the economists’ feet, that the macroeconomic fashion is going to swing from monetary policy back to fiscal policy but, as yet, only a few economists have noticed the writing on the wall.

As is his role, Lowe has spent the past 15 months defending the established way of responding to an inflation surge against the criticism of upstarts (including me) refusing to accept the conventional view that TINA prevails – “there is no alternative” way to control inflation than to cut real wages and jack up interest rates.

If I’m right, and economists are in the very early stages of accepting that changes in the structure of the economy have rendered the almost exclusive use of monetary policy for inflation control no longer fit for purpose, then history will look back more sympathetically on Lowe as a man caught by the changing tide, a victim of the economics profession’s then failure to see what everyone these days accepts as obvious.

Final speeches are often occasions when departing leaders feel able to speak more frankly now that they’re free of the responsibilities of office. And Lowe’s “Some Closing Remarks” speech on Thursday made it clear he’d been giving much thought to monetary policy’s continuing fitness for purpose.

His way of putting it in the speech was to say that one of the “fixed points” in his thinking that he had always returned to was that “we are likely to get better outcomes if monetary policy and fiscal policy are well aligned”. Let me give you his elaboration in full.

“My view has long been that if we were designing optimal policy arrangements from scratch, monetary and fiscal policy would both have a role in managing the economic cycle and inflation, and that there would be close coordination,” Lowe said.

“The current global consensus is that monetary policy is the main cyclical policy instrument and should be assigned the job of managing inflation. This is partly because monetary policy is more nimble [it can be changed more quickly and easily than fiscal policy] and is not influenced by political considerations.”

“Raising interest rates and tightening policy can make you very unpopular, as I know all too well. This means that it is easier for an independent central bank to do this than it is for politicians,” he said.

“This assignment of responsibility makes sense and has worked reasonably well. But it doesn’t mean we shouldn’t aspire to something better. Monetary policy is a powerful instrument, but it has its limitations and its effects are felt unevenly across the community.”

“In principle, fiscal policy could provide a stronger helping hand, although this would require some rethinking of the existing policy structure. In particular, it would require making some fiscal instruments more nimble, strengthening the (semi) automatic stabilisers and giving an independent body limited control over some fiscal instruments.”

“Moving in this direction is not straightforward, but some innovative thinking could help us get to a better place,” Lowe said.

“During my term, there have been times where monetary and fiscal policy worked very closely together and, at other times, it would be an exaggeration to say this was the case.”

“The coordination was most effective during the pandemic. During that period, fiscal policy was nimble and the political constraints on its use for stabilisation purposes faded away. And we saw just how powerful it can be when the government and the Reserve Bank work very closely together.”

“There are some broader lessons here and I was disappointed that the recent Reserve Bank Review did not explore them in more depth,” Lowe said.

So was I, especially when two of Australia’s most eminent economists – professors Ross Garnaut and David Vines – made a detailed proposal to the review along the lines Lowe now envisages. (If Vines’ name is unfamiliar, it’s because most of his career was spent at Oxbridge, as the Poms say.)

But no, that would have been far too radical. Much safer to stick to pointing out all the respects in which the Reserve’s way of doing things differed from the practice in other countries – and was therefore wrong.

In question time, Lowe noted that one of the world’s leading macroeconomists, Olivier Blanchard, a former chief economist at the International Monetary Fund (and former teacher of Lowe’s at the Massachusetts Institute of Technology), had proposed that management of the economy be improved by creating new fiscal instruments which would be adjusted semi-automatically, or by a new independent body, within a certain range.

Lowe also acknowledged the way the marked decline over several decades in world real long-term interest rates – the causes of which economists are still debating – had made monetary policy less useful by bringing world nominal interest rates down close to the “zero lower bound”.

How do you cut interest rates to stimulate growth when they’re already close to zero? Short answer: you switch to fiscal policy.

But what other central banks – and, during the pandemic, even our Reserve Bank – have done was resort to unconventional measures, such as reducing longer-term official interest rates by buying up billions of dollars’ worth of second-hand government bonds.

Lowe said he didn’t think this resort to “quantitative easing” was particularly effective, and he’s right. I doubt if history will be kind to QE.

However, there’s one likely respect in which the ground has shifted under the economists’ feet that Lowe – and various academic defenders of the conventional wisdom – has yet to accept: the changed drivers of inflation. It’s not excessive wages any more, it’s excessive profits.

More about all this another day.

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We won't fix inflation while economists stay in denial about causes

Led on by crusading Reserve Bank governors, the nation’s economists are determined to protect us from the scourge of inflation, no matter the cost in jobs lost.

But there’s a black hole in their thinking about the causes of inflation, only some of which must be stamped on. Others can be ignored. Meanwhile, here’s another sermon demanding the government act to raise productivity.

In your naivety, you may think that inflation is caused by businesses putting up their prices. But economists know that’s not the problem. Businesses raise their prices only in response to “market forces”. When demand for their products exceeds the supply, businesses seize the chance to raise their prices.

In your ignorance, you may think they do this out of greed, a desire to increase “shareholder value” at the expense of their customers. But that’s the wrong way to look at it.

In raising their prices, businesses aren’t being opportunistic, they’re only doing what comes naturally, playing their allotted role in allowing the “price mechanism” to bring demand and supply back into balance.

As balance is restored, the price will fall back, pretty much to where it was before. What? You hadn’t noticed? Funny that, neither had I.

No, what causes prices to keep rising at a rapid rate is when the greedy workers and their unions force businesses to increase their wages in line with the rise in the cost of living. Can’t the fools see that this merely perpetuates the rapid rise in prices?

So, what we need to get inflation down quickly is for workers to take it on the chin. They can have a bit of a pay rise – say, 2.5 per cent – but nothing more, especially when there’s been no increase in the productivity of their labour.

This will cut the workers’ real incomes and lower their standard of living, of course, but that can’t be helped. It’s the only way we can make them stop spending as much, so businesses won’t be able to get away with continuing to raise their prices by more than 2.5 per cent.

But cutting real wages probably won’t be enough to stop businesses raising their prices so high, so we’ll need to raise interest rates and really put the squeeze on workers with big mortgages. Sorry, nothing else we could do.

Yet another worry is our return to full employment. If the demand for labour exceeds its supply, that would allow the suppliers of labour – aka workers – to raise their prices – aka wages – and that would never do.

Indeed, our history-based calculations say the unemployment rate has already fallen below the level that causes wage and price inflation to take off. It hasn’t yet, but it will.

But not to worry. As incoming Reserve Bank governor Michele Bullock explained in a speech extolling full employment, the Reserve estimates it should only be necessary to raise the rate of unemployment by 1 percentage point to 4.5 per cent to get inflation back down to where we want it.

What! Cried the punters in stunned amazement. To get inflation down you will knowingly put about 140,000 workers out of work? How could you be so utterly inhuman?

What stunned and amazed the nation’s economists is that anyone should be surprised or offended by this. Don’t they know that’s the way we always do it? And 140,000 job losses would be getting off lightly.

Just so. When, as now, the Reserve Bank and the government accidentally overstimulate the economy, allowing businesses to increase their prices by more than they need to, what we always do to stop businesses raising their prices is bash up their customers until the fall-off in households’ spending – caused partly by people losing their jobs – makes it impossible for businesses to keep increasing their prices.

Problem solved. Standard practice is to put a stop to businesses’ opportunism – their “rent-seeking” as economists say – by bashing up their workers and customers until the businesses desist.

But what never happens is that the level of prices falls back to about where it was before the econocrats stuffed up – as the economists’ price-mechanism theory promises it will.

Why doesn’t the theory work? Because what’s required to make it work is intense competition between many small firms. When one firm decides to raise its prices and fatten its profit margin, the others undercut it and it either pulls its head in or goes out backwards.

In the real world, industries are increasingly dominated by just a few huge firms – firms that have become so mainly by taking over their smaller competitors. This is true in all the rich economies, but none more so than ours.

Economists know that “oligopolies” form because it’s easier for a few big firms to gain a degree of control over the prices they charge (whereas the price-mechanism theory assumes they’re too small to have any control).

The few big players compete on marketing and advertising, and using minor product differentiation, but never on price. When prices rise, they rise together – and rarely come back down.

Economists know all this – it’s knowledge gained and taught by economists – but it’s classed as “microeconomics”, whereas the econocrats seeking to manage the economy and keep inflation low specialise in “macroeconomics”. And they never join the dots – though that’s changing in other countries.

This year the European Central Bank, the International Monetary Fund and the Organisation for Economic Co-operation and Development have delved into the national accounts and determined that rising profit margins explain a high proportion of the recent inflation surge.

But when the Australia Institute replicated this analysis for Australia, both Treasury and the Reserve Bank used dodgy graphs and dubious arguments to dismiss its work as “flawed”.

Entrenched inflation only emerged as a problem in the 1970s. After much debate, the world’s economists decided the problem was caused by powerful unions, whose expectations of continuing high inflation caused a “wage-price spiral”, which could only be broken by using high interest rates to put the economy into recession.

This is the thinking we’ve had full strength from the Reserve for the past year or more. Since the 1970s, however, multiple developments have weakened the unions’ bargaining power, while decades of takeovers have increased our big businesses’ pricing power – without the econocrats noticing.

And despite their unceasing sermons about the need for governments to increase national productivity, it’s never occurred to them that the primary driver of productivity improvement is intense competition between businesses.

The calls by successive heads of the Australian Competition and Consumer Commission for stronger powers to block mergers that would “substantially lessen competition” have gained no support from the Reserve, Treasury or economists generally.

But we won’t fix inflation until we have stronger laws defending competition.

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Beating inflation shouldn't just be left to higher interest rates

Everyone’s heard the surprising news that last financial year’s budget is now expected to run a surplus of about $20 billion, but few have realised the wider implications. They strengthen the case for relying less on interest rates to fight inflation.

But first, the news is a reminder of just how bad economists are at forecasting what will happen to the economy – even in not much more than a year’s time. Which shows that economists don’t know nearly as much about how the economy works as they like to imagine – and like us to believe.

Then-treasurer Josh Frydenberg’s budget in March last year forecast a budget deficit in 2022-23 of $78 billion. By Jim Chalmers’ second go at the budget last October, that became a deficit of about $37 billion.

By the following budget, in May, the best guess had turned into a surplus of $4 billion. And just two months later – and that financial year actually over – the best guess is now a surplus of about $20 billion.

That’s a forecasting turnaround, over the course of only about 15 months, of almost $100 billion, or 4 per cent of gross domestic product.

What did Treasury get so wrong? It grossly underestimated the growth in tax collections. This was partly because it assumed a fall in the prices of our key commodity exports that didn’t happen, thus causing the company tax paid by our miners to be higher than expected.

But mainly because collections of income tax were much higher than expected. The economy grew at close to full capacity, so more people found jobs and many part-time workers got more hours or became full-time.

A huge number of new jobs have been created, almost all of them full-time. Do you realise that a higher proportion of people aged over 15 have paid employment than ever before? The rate of unemployment fell to its lowest in 50 years and many people who’d been unable to find a job for many months finally succeeded.

Obviously, when people find work, they start paying income tax, and stop needing to be paid unemployment benefits. So full employment is excellent news for the budget.

But the rapid rise in the cost of living during the year caused workers to demand and receive higher pay rises, even though those rises generally fell well short of the rise in prices.

So all the people who already had jobs paid more tax, too. But not only that. Our “progressive” income tax scale – where successive slices of your income are taxed at progressively higher rates – means that pay rises are taxed at a higher rate than you paid on your existing income.

Ordinary mortals call this “bracket creep”. Economists call it “fiscal drag”. Either way, the higher rate of tax workers paid on their pay rises also made a bigger-than-expected contribution to income tax collections and the budget balance.

Note that this unexpected move from deficit to surplus in the financial year just past, this underestimation of the strength of tax collections, has implications not only for the size of the government’s debt at June 2023, it has implications for the size of tax collections in the next few years, as well as for the amount of interest we’ll have to pay on that debt this year and every year until it’s repaid (which it won’t be).

In Frydenberg’s budget in March last year, the projected cumulative deficit for the five financial years to June 2026 was just over $300 billion. By the budget in May, this had dropped to $115 billion.

And now that we know last year’s surplus will be about $20 billion, the revised total projected underlying addition to government debt should be well under $100 billion.

Get it? Compared with what we thought less than 16 months ago, the feds’ debt prospects aren’t nearly as bad as we feared. And the size of our “structural” deficit – the size of the deficit that remains after you’ve allowed for the ups and downs of the business cycle – isn’t nearly as big, either.

Which suggests it’s time we had another think about our decision in the late 1970s – along with all the other rich economies – to shift the primary responsibility for managing the macroeconomy from the budget (“fiscal policy”) to the central bank and its interest rates (“monetary policy”).

One of the arguments used by the advocates of this shift was that fiscal policy was no longer effective in stimulating the economy. But our remarkably strong growth since the end of the pandemic lockdowns shows how amazingly effective fiscal policy is.

It’s now clear that fiscal “multipliers” – the extent to which an extra $1 of deficit spending adds to the growth in real GDP – are much higher than we believed them to be.

We know that a big part of the recent leap in prices was caused by shocks to the supply (production) side of the economy arising from the pandemic and the Russia-Ukraine war. But central banks have argued that a second cause was excessive demand (spending), which happened because the stimulus applied to cushion the effect of lockdowns proved far more than needed.

If so, most of that stimulus came from fiscal policy. Our official interest rate was already down to 0.75 per cent before the pandemic began. So, further proof of how powerful fiscal stimulus still is.

But another implication of the $20 billion surplus is that the stimulus wasn’t as great – and its ultimate cost to the budget wasn’t as great – as we initially believed it would be.

In the budget of October 2020, the expected deficit of $214 billion in 2020-21 was overestimated by $80 billion. In the budget of May 2021, the expected deficit of $107 billion in 2021-22 was overestimated by $75 billion. And, as we’ve seen, the deficit for 2022-23 was initially overestimated almost $100 billion.

This says two things: the fiscal stimulus caused the economy to grow much faster than the forecasters expected, even though the ultimate degree of stimulus – and its cost to the budget – was much less than forecasters expect.

Economists know that the budget contains “automatic stabilisers” that limit the private sector’s fall when the economy turns down, but act as a drag on the private sector when the economy’s booming.

We’ve just been reminded that the budget’s stabilisers are working well and have been working to claw back much of the fiscal stimulus, thereby helping to restrain demand and reduce inflation pressure.

Whenever departing Reserve Bank governor Dr Philip Lowe has been reminded of the many drawbacks of using interest rates to manage the economy, his reply has always been: sorry, it’s the only instrument I’ve got.

True. But it’s not the only instrument the government has got. It should break the central bank’s monopoly on macro management and make more use of fiscal policy.

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Enjoy the wonderful land of full employment - while you can

I hope that while you’re complaining about the cost of living, you’re also wallowing in the joys of living in an economy that’s reached the sacred land of “full employment” – being able to provide a job for almost everyone who wants one. This is the first time we’ve seen it in 50 years.

You have to say we’ve achieved it not by design, but as an unexpected consequence of our bumbling attempts to cope with the vicissitudes of the pandemic.

We used interest rates and, more particularly, the budget, to stimulate demand (encourage business and consumer spending) and ended up doing a lot more than we needed to. To the economy managers’ surprise, the rate of unemployment fell rapidly to 3.5 per cent – a level most of them had never seen before and never expected to see.

The sad truth is that, during the half century that the high priests of economics were wandering in the wilderness of joblessness, they lost their faith, and started worshiping the false god Nairu, who whispered in their ears alluring lies about the location they were seeking.

But now the wanderers have stumbled upon the promised land of Full Employment, a land flowing with milk and honey.

So now’s the time for us all to sing hymns of praise to one true god of mammon, Full Employment, in all its beneficence and beauty. And here to be our worship leader is Michele Bullock, deputy governor of the Reserve Bank, who published some new soul music this week.

Bullock says it’s “hard to overstate the importance of achieving full employment. When someone cannot find work, or the hours of work they want, they suffer financially. However, the costs of unemployment and underemployment extend well beyond financial impacts.

“Work provides people with a sense of dignity and purpose. Unemployment – particularly long-term unemployment – can be detrimental to a person’s mental and physical health,” she says.

“The costs of not achieving full employment tend to be borne disproportionately by some groups in the community – the young, those who are less educated, and people on lower incomes and with less wealth.

“In fact, for these groups, improved employment outcomes and opportunities to work more hours are much more important for their living standards than wage increases.”

Early in the pandemic and the imposition of lockdowns, we thought we were in for a regular recession. And “the sobering experience from previous recessions had taught us that these episodes leave long-lasting marks on individuals [called “scarring” by economists], communities and the economy.

“For example, if people stay unemployed for too long, their skills may deteriorate or become obsolete and their prospects for re-engaging in meaningful work may decline. This can result in more people in long-term unemployment or, alternatively, people withdrawing from the workforce,” Bullock says.

But, thanks to all the up-front stimulus, there was no recession and, hence, no scarring. Instead, outcomes in the labour market over the past three years “have consistently exceeded the expectations of the Reserve Bank and other forecasters”.

In fact, the share of the Australian population in employment has never been higher – higher even than in the decades between the end of World War II and the mid-1970s, when full employment became the norm.

Today, the number of Australians in a job has increased by more than 1.1 million since late 2021, and the level of employment is now almost 8 per cent above its pre-pandemic level. Get that.

Almost all the gains in employment since the start of the pandemic have been full-time jobs. Strong demand for labour has enabled many previously part-time employees to move into full-time work. This has pushed the underemployment rate – the proportion of people with jobs, but seeking more hours – down to its lowest since 2008.

Bullock says the people who’ve benefited most from all this are those on lower incomes and with less education. Unemployment has tended to decline more in local areas that had weaker employment to begin with.

Young people – those aged 15 to 24 years – who usually suffer most when recessions occur, have seen their rate of unemployment decline by more than twice the decline in the overall unemployment rate.

Long-term unemployment is defined as being without work for more than a year. Last year, a record number of the long-term unemployed found a job, and fewer gave up looking for one.

What’s more, the risk of not being able to find a job within a year declined significantly. So the rate of long-term unemployment is close to its lowest in decades.

Wow. Now, Bullock’s not exaggerating when she says it’s hard to overstate the many benefits – economic and social – of achieving full employment.

But she’s harder to believe when she assures us that, just because the Reserve has hardly spoken about anything other than the need to reduce inflation for the past year and more: “it does not mean that the other part of our mandate – maintaining full employment – has become any less important.

“Full employment is, and has always been, one of our two objectives.”

Well, I’d love to believe that was true, but both the Reserve’s present rhetoric and behaviour, and its record, make it hard to believe.

The Reserve has had independent control over the day-to-day management of the economy for more than 35 years. For almost all of that time we’ve had low inflation, but only now have we achieved full employment – and only by happy accident.

For most of that time it, like most macroeconomists the world over, has been listening to the siren call of the false god Nairu – aka the “non-accelerating-inflation rate of unemployment” – telling it that “full employment” really means an unemployment rate of 5 per cent or 6 per cent.

If you dispute that, answer me this: how many times in the past 35 years has a Reserve Bank boss been able to make a similar speech to the one Bullock gave this week?

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Maybe Lowe should stay on as governor to clean up any spilt milk

I’ve never liked making free with the R-word until it’s an undeniable reality. Too many journalists refuse to recognise that if enough people in positions of influence predict bad things enough times, their predictions have a tendency to become reality.

But I confess I’m starting to worry that Reserve Bank governor Dr Philip Lowe – a man who, until now, I’ve always regarded as having steady judgment – is pressing harder on the interest-rate brakes than he needs to. And I don’t think I’m the only economy-watcher who shares that fear.

He seems to be seizing on any argument that says he should give the thumbscrews another turn, while ignoring all the arguments that say he’s already done enough. The Fair Work Commission has awarded the people whose wages constitute the bottom 10th of the national wage bill a 5.75 per cent pay rise. Oh, no! Give it another turn.

Employment grew by 76,000 in May and the unemployment rate went down a fraction. Oh, no! Give it another turn.

One of the rules of using interest rates to suppress demand is that they work with “long and variable lags” so that, if you keep tightening until it’s clear you’ve done enough, you’ve already done too much and will crash the economy. But Lowe seems to have forgotten this.

Another thing he seems to have forgotten is that, in times past, we’ve needed a big increase in interest rates to slow a booming economy because the boom has resulted in real wages growing so strongly.

Not this time. This time an unusual feature of the boom has been that real wages have been falling for several years. Do you realise that real labour costs per unit of production are now 6 per cent lower than they were at the end of 2019?

What’s been (conveniently) forgotten is that, in the early days of the pandemic, when we imagined we were in for a severe recession, employers were quick to demand a wage freeze, to which workers readily acquiesced.

Turned out that a couple of lockdowns don’t equal a recession, and employers did fine. But there was no suggestion of a catch-up for the wage freeze that wasn’t needed. Remember this next time you see Lowe banging on about the worrying rise in nominal labour costs per unit.

If Lowe knew more about how wages are fixed in the real world, rather than in economics textbooks, he’d have noticed that the union movement’s failure to talk about the need for a wage catch-up was a sign of its diminished bargaining power.

(He’d also be more conscious that the conventional economic model’s implicit assumption – that the parties to every transaction are of roughly equal bargaining power – doesn’t hold between an employer and an employee. Nor between a big business and a small business, for that matter.)

Then there’s Lowe’s invention of a new doctrine (one previously exclusive to bull-dusting employer groups) that workers need to produce more if they want their wages merely to keep up with inflation.

Lowe professes to be terribly worried about a fall in the productivity of labour in recent quarters but, as The Conversation website’s Peter Martin has reminded us, falling productivity (output per hour worked) is exactly what you’d expect to see at a time when falling unemployment is returning us to full employment.

Employers have preferred to hire more workers rather than buy more labour-saving machines. And, as the econocrats have pointed out, they’re having to hire more of the kinds of workers they usually prefer not to hire – the young, the old and the long-term unemployed.

That is, they’ve had to start hiring the less-productive. This is a bad thing, is it?

One reason I’m shocked by Lowe’s newly invented line that, absent productivity improvement, all wage growth above 2.5 per cent is inflationary, is that I was around in the 1970s when wage growth really was excessive and inflationary. It was to be condemned then; but anyone saying it now has moved the goal posts.

It was then that Treasury made so much fuss about labour costs per unit that the Bureau of Statistics began publishing the figures every quarter – the ones Lowe has been leaning on so heavily.

But when the Australia Institute think tank copied the method used by the European Central Bank (and now by the Organisation for Economic Co-operation and Development) to calculate profits per unit, the econocrats wrote learned treatises saying its method was “flawed”. Apparently, sauce for the wages goose is not sauce for the profits gander.

Speaking of flaws, the flaw in Lowe’s new-found argument that wage rises exceeding 2.5 per cent, but less than the rise in prices, are inflationary ought to be obvious to anyone not blinded by pro-business bias. It doesn’t add to the inflation rate, but it does add to the time it takes for the inflation rate to fall back.

So, what Lowe’s on about is the speed at which inflation is returning to (the now unrealistically low) target range of 2 to 3 per cent. And he’s in such a tearing hurry he’s prepared to risk causing a recession.

Why? Well, what I wonder is whether Lowe’s expectation that his term as governor won’t be renewed in September – so a new governor can make the changes the Reserve Bank review has recommended – is affecting his judgment.

There’s a concept in economics called “revealed preference” which says: judge people not by what they say, but what they do. Lowe says he’s aiming for the “narrow path” to low inflation without a recession.

But what he seems to be aiming for is low inflation come hell or high water. I wonder if he’s decided he prefers not to be remembered as the governor who let inflation get out of control, but left without fixing it.

If, to avoid that fate, he has to be remembered as the guy who plunged the economy into a recession no one thought was needed, then them’s the breaks.

The sad truth about independent central banks is that, if they really stuff up, it’s the elected government that gets blamed. Since there’s no voting for who’s to be governor, there’s no other way voters can register their disaffection.

So, if Lowe continues finding excuses to tighten the monetary screws, don’t be surprised if the Albanese government gets ever less muted in its criticism.

But if I were Treasurer Jim Chalmers, I’d consider postponing the reform of the Reserve’s procedures and extending Lowe’s term, so his mind could be fully focused on achieving the soft landing – or be around to share the blame if he crashes the plane. And help mop up the debris if he fails. This may also stop him acting so uncharacteristically.

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Our big risk: fix inflation, but kiss goodbye to full employment

If you think getting inflation down is our one big economic worry, you have a cockeyed view of economic success. Unless we can get it under control without returning to the 5 to 6 per cent unemployment rate we lived with in recent decades, we’ll have lost our one great gain from the travails of pandemic: our return to full employment.

And if we do lose it, it will demonstrate the great price Australia paid for its decision in the 1980s to join the international fashion and hand the management of its economy over to the central bankers.

There has always been a tricky trade-off between the twin objectives of low inflation and low unemployment. If our return to full employment proves transitory, it will show what we should have known: that handing the economy over to the central bankers and their urgers in the financial markets was asking for inflation to be given priority at the expense of unemployment.

In his customary post-budget speech to economists last Thursday, Treasury secretary Dr Steven Kennedy began by explaining to academic economists why their claim that the budget was inflationary lacked understanding of the intricacies of economics in the real world.

But his strongest message was to remind economists why full employment is a prize not to be lost.

Whereas early in the pandemic it was feared the rate of unemployment would shoot up to 15 per cent and be difficult to get back down, the massive fiscal (budgetary) stimulus let loose saw it rise only to half that, and the remarkable economic rebound saw it fall to its lowest level in almost 50 years.

“This experience is altering our views on full employment,” Kennedy says. “One of the stories of this budget – one that risks being lost – is the virtue of full employment.”

For one thing, near-record low unemployment and a near-record rate of participation in the labour force are adding to demand and to our capacity to supply goods and services.

This time last year, Treasury was expecting a budget deficit of $78 billion in the financial year ending next month. Now it’s expecting a surplus of $4 billion. Various factors explain that improvement, but the greatest is the continuing strength of the labour market.

As I explained last week, this revision has significantly reduced the projected further increase in the public debt and, in consequence, our projected annual interest bill on the debt every year forever. It has thereby significantly reduced our projected "structural" budget deficit although, Kennedy insists, has not eliminated it.

And getting a higher proportion of the working-age population into jobs – and having more of the jobs full-time – improves our prospects for economic growth and prosperity.

There’s no source of economic inefficiency greater than having many people who want to work sitting around doing nothing. And adding to the supply of labour is not, of itself, inflationary.

But let’s not confuse means with ends. The most important benefit of full employment goes not to the budget or even The Economy, but to those people who find the jobs, or increased hours of work, they’ve long been seeking.

Kennedy reminds us that the greatest benefit goes to those who find it hardest to get jobs. While the nationwide unemployment rate has fallen by 1.6 percentage point since before the pandemic, it has fallen by 3.2 percentage points for youth, and by 2.3 percentage points for those with no post-school education.

This is where we get to Kennedy’s observation that recent experience is altering Treasury’s views on full employment.

The obvious question this experience raises is: why have we been willing to settle for unemployment rates of 5 to 6 per cent for so long when, as he acknowledges, “the low rate of unemployment and high levels of participation [in the labour force] have been sustained without generating significant wage pressures”?

Short answer: because economists have allowed themselves to be bamboozled by modelling results. Specifically, by their calculations of the “non-accelerating-inflation rate of unemployment” – the NAIRU.

As Kennedy says, the unemployment rate consistent with both full employment and low and stable inflation isn’t something that can be seen and directly measured. So, as with so many other economic concepts, economists run decades of inflation and unemployment data through a mathematical model which estimates a figure.

Economists have redefined full employment to be the 5 or 6 per cent unemployment rate their models of the NAIRU spit out. They think using such modelling results makes decisions about interest rates more rigorous.

But that’s not true if you let using a model tempt you to turn off your brain and stop thinking about whether the many assumptions the model relies on are realistic, and whether more recent changes in the structure of the economy make results based on averaging the past 30 years misleading.

It’s now pretty clear that, at least in recent years, NAIRU models have been setting the rate too high, thus leading the managers of the economy to accept higher unemployment than they should have.

There are at least three things likely to make those modelling results questionable. One is that, as a Reserve Bank official has revealed, the models assume inflation is caused by excessive demand, whereas much of the latest inflation surge has been caused by disruptions to supply.

Professor Jeff Borland, of Melbourne University, points out that the increasing prevalence of under-employment in recent decades makes the models’ focus on unemployment potentially misleading, as does the increasing rate of participation in the labour force.

Third, unduly low unemployment and job shortages are supposed to lead, in the first instance, to wage inflation, not price inflation. But this turns to a great extent on the bargaining power of unionised labour, which many structural factors – globalisation, technological advance, labour market deregulation and the decline in union membership – have weakened.

If the NAIRU models adequately reflect these structural shifts I’d be amazed.

What is clear is that the Reserve Bank’s understanding of contemporary wage-fixing is abysmal. As yet, it has no one on its board with wage-fixing expertise, its extensive consultations with business leaders exclude union leaders, and Reserve Bank governor Dr Philip Lowe says little or nothing about wage-fixing arrangements.

And this is despite Lowe’s unceasing worry about the risk of a price-wage spiral and an upward shift in inflation expectations. So far, there’s little evidence of either.

Some increase in unemployment is inevitable as we use the squeeze on households’ disposable income to slow demand and thus the rate at which prices are rising.

But if the Reserve’s undue anxiety about wages and expectations leads it to hit the brakes so hard we drop into recession, and full employment disappears over the horizon, it will be because we handed our economy over to the institution least likely to worry about making sure everyone who wants to work gets a job.

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