We should stop using a blunt instrument to manage the economy

In the economy, as in life, it helps a lot if you learn from your mistakes. Or, if you’re in public life, from the mistakes of your predecessors.

Accordingly, the caning that former Reserve Bank governor Dr Philip Lowe got for his assurance that interest rates wouldn’t rise before 2024 does much to explain why his successor, Michele Bullock, has been so persistently cagey about the future of rates.

Even as she’s announced a decision that the official cash rate was to be left unchanged, she’s warned that it may need to rise in future. And indeed, that the case for raising it had been seriously considered.

But last week, with the herd sniffing in the wind the smell of rate cuts, she took her life in her hands and got a lot more specific – though not before muttering the incantation that she was not providing “forward guidance” (that was the crime Lowe was convicted of).

In a carefully rehearsed line, she said that a “near-term reduction in the cash rate does not align with the board’s current thinking”. Oh yes, and what does “near term” mean? The next six months, she said.

“Current” thinking. Get it? In other words, that thinking could change over, say, the next six months. Especially because, as she repeated, the board’s decisions would depend on what the economic indicators were telling it. And, as she keeps saying, “the outlook remains highly uncertain”.

It’s clear many people aren’t convinced the board’s thinking against cutting rates will stay unchanged for the next six months. Because the financial markets are so heavily into betting, their predictions are almost always based on what they expect the Reserve will do.

But there are plenty of other, simpler souls, whose emphasis is on what they believe the Reserve should do to ensure it avoids the recession it says it wants to avoid.

The other point about learning from your mistakes and adventures is the familiar problem that those who were around at the time of lesson-learning pass on, handing over to people who weren’t around to have learnt.

This is what worries me as the Reserve ploughs on, determined to ensure the inflation rate returns to the centre of its target range within a time that the Reserve itself judges to be the maximum time acceptable. This determination seems to be regardless of the source of the forces that are slowing the return to mid-target and making it “bumpy”.

When the Reserve was granted operational independence by the elected government in the mid-1990s, its bosses at the time understood a truth I’m not sure their successors still understand. When you’re not free of the politicians, you can leave the politics to them. But when you are free of them, you have to do your own politics.

Now, I’ve been a great supporter of central bank independence. It’s been one experiment that time has shown to be a big improvement on leaving interest rates to the pollies. But we, and the central bankers, must understand that central bank independence is an uneasy fit with democracy.

We now have a situation where the central bank has the most control over whether the economy is plunged into severe recession, but the only people the voters can punish for this are not the central bankers, but the government of the day.

So, to get specific, if the Reserve Bank decides inflation can’t be fixed without a recession or, more likely, miscalculates and leaves interest rates too high for too long, it won’t be Michele Bullock that voters punish, it will be Anthony Albanese and his government.

Guess what? Should that happen, Labor is likely to be angry and vengeful. And, as Bullock’s predecessors understood, should government pass to the Liberals, their strongest emotion is likely not to be gratitude, but a determination that the Reserve won’t be allowed to trip them up the way it tripped up Labor.

With independent central banks being the long-established convention throughout the developed world, would any government of ours be game to strip the Reserve of its independence? Probably not.

But politicians have other, less noticeable ways of bringing independent institutions to heel. The usual way – practised by the previous federal government with the Administrative Appeals Tribunal and the Fair Work Commission, and by Donald Trump with the US Supreme Court – is to stack appointments to the board with people who share the government’s predispositions.

So there will be a way for the politicians to pass the voters’ punishment on to the Reserve should it stuff up. This is why it does have to do its own politics.

And there’s another, far more positive way that could be used to clip the Reserve’s wings. This episode of tightening, much more than any previous episode since the day-to-day management of the macroeconomy was handed over to the Reserve in the 1980s, has revealed just how unfair and ineffective it is to make the manipulation of interest rates the dominant instrument for managing the strength of demand.

As research by Associate Professor Ben Phillips of the Australian National University has confirmed, the much-lamented cost-of-living crisis has been imposed on households with big mortgages far more than on any other households.

When you take account of the way rents actually fell during the lockdowns, renters haven’t been hard hit, while those who own their homes outright have been laughing. People on pensions or the dole have been protected by indexation.

So the reliance on interest rates to reduce demand is hugely unfair. But it’s also lacking in effectiveness. All of us have contributed to the excessive demand for goods and services, but only the minority of us with big mortgages have been pressed directly to pull back our spending.

This is why our management of the macroeconomy needs reform. We need another, much broader-based instrument that could be used as well as, or in place of, interest rates. Temporary changes in the rate of the goods and services tax are one possibility, but I’m attracted to the idea of temporary changes to the rate of compulsory superannuation contributions.

The two instruments – one interest rates, and the other budgetary – could be controlled by a new independent authority.

Despite all the Reserve’s apologies for having just a single, blunt tool and all the hardship it causes home buyers, we’ll wait a long time before it suggests sharing its power with a rival independent authority.

As well, the banks have ways of ensuring they benefit from rising interest rates, while financial markets want to keep betting at Reserve Bank race days.

So I’m tempted by the thought that only if the Reserve stuffs up and causes a severe recession are we likely to see the reform to macroeconomic management we so badly need.

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How the budget was hijacked by a $300 cherry on the top

Talk about small things amusing small minds. It looked like a textbook-perfect exercise in budget media management by Anthony Albanese’s spin doctors. Until it blew up in the boss’s face. Trouble is, it wasn’t just the tabloid minds that got side-tracked. So did the supposed financial experts.

Budget nights are highly stage-managed affairs, as the spinners ensure all the mainstream media are focused on the bit the boss has decided will get the budget a favourable initial reception.

You pre-announce – or “drop” to a compliant journo – almost all the budget’s measures, big or small, nice or nasty. This time they even revealed the exact size of the old year’s surplus. But you hold back one juicy morsel, knowing the media’s obsession with what’s “old” and what’s “new” will guarantee it leads every home page.

I call it the cherry on the top. And this time it was the $300 energy rebate going to all households. A prize for everyone (except the pensioners, who last year got $500) and proof positive that Jim Chalmers feels their cost-of-living pain. (It would have been much better to announce the rejig of the stage 3 tax cuts, of course, but Albo had to play that card early, to help with a dicey byelection.)

How were the spinners to know the punters would be incensed when they realised it would even be going to Gina Rinehart? And get this: if a billionaire owned, say, 10 investment properties, they’d be getting 11 lots of $300. Outrageous.

The way some tabloids tell it, the punters were so offended they were rioting in the streets, demanding Chalmers stick their $300 up his jumper. It was the Beatles returning their MBEs.

Why wasn’t the rebate means tested? Perfectly good reason: because that would have been more trouble and expense than it was worth. Don’t bother mentioning: because, apart from being a popular giveaway, the rebate’s other purpose was to help reduce the consumer price index by 0.5 of a percentage point, and means testing it would have reduced the reduction.

How so many shock jocks and journos could get so steamed up about such a small thing is hard to explain. But what’s much harder to explain is why so many otherwise sensible economists got so steamed up about the wickedness and counterproductive wrongheadedness of it.

I think it’s a perfectly sensible device to hasten progress in getting inflation down to the target zone, and by no means the first time governments have used it. The temporary energy rebate will cost $3.5 billion over two years and the continuing increase in the Commonwealth rent allowance for people on social security will cost $880 million over its first two years.

So while it’s true that increased government spending adds to inflationary pressure, to argue furiously about $4.4 billion in an economy worth $2.7 trillion a year shows the lack of something the late great econocrat Aussie Holmes said every economist needed: “a sense of the relative magnitudes”. It’s chicken feed.

But the financial experts’ righteous indignation about what they see as an inflationary attempt to fudge the inflation figures seemed to utterly distort their evaluation of the budget and its effect on the macroeconomy.

The budget was a “short-term shameless vote-buying exercise” in which Labor abandoned all pretence of fiscal responsibility and went on a massive spending spree. The budget’s return to surplus had been abandoned, leaving us with deficits as far as the eye could see. We now had a permanent “structural deficit”. The hyperbole flowed like wine.

It’s true that the policy decisions announced in the budget are expected to add $24 billion to budget deficits over the next four years. But if, as the financial experts assert, getting inflation down ASAP is the only thing we should be worrying about, then it’s really what’s added in the coming year that matters most. Which reduces the size of Chalmers’ crimes to less than $10 billion.

It’s true, too, that the expected change in the budget balance from a $9 billion surplus in the financial year just ending, to a deficit of $28 billion in the coming year, is a turnaround of more than $37 billion. Clearly, and despite Chalmers’ denials, this changes the “stance” of fiscal policy from restrictive to expansionary.

But the financial experts seem to have concluded this development can be explained only by a massive blowout in government spending. Wrong. It’s mainly explained by the $23-billion-a-year cost of the stage 3 tax cuts.

Perhaps they were misled by the budget’s Table of Truth (budget statement 3, page 87) which, like everything in economics, has its limitations. The tax cuts don’t rate a mention. Why not? Because they’ve been government policy since 2018, and so have been hidden deep in the budget’s “forward estimates” for six years.

But whatever its main cause, surely this shift to expansionary fiscal policy puts the kybosh on getting inflation back down to the target range? Well, it would if shifts in the stance of the macroeconomic policy instruments were capable of turning the economy on a sixpence.

Unfortunately, the first rule of using interest rates to slow down or speed up the economy is that this “monetary policy” works with a “long and variable lag”.

The financial experts seem to have forgotten that managing the strength of demand – and fixing inflation without crashing the economy – is all about getting your timing right.

So is predicting the consequences of a policy change. Two years of highly restrictive monetary and fiscal policies won’t be instantly reversed by a switch to expansionary fiscal policy. As the new boss of the Grattan Institute, Aruna Sathanapally, has wisely noted, at the heart of the budget is the sad truth that the economy is weak, which is one reason inflation will fall.

The inflation rate peaked at just under 8 per cent at the end of 2022. By March this year it had fallen to 3.6 per cent. To me, that’s not a million miles from the Reserve Bank’s target range of 2 per cent to 3 per cent.

But the financial experts seem to have convinced themselves there’s a lot of heavy lifting to go. They even quote one brave soul saying the Reserve will need two more rate rises. I think it’s more likely we’ll get down to the target in the coming financial year, and that the move to expansionary fiscal policy will prove well-timed to help reverse engines and ensure the Reserve achieves its promised soft landing.

Chalmers’ decision to use the $300 rebate to reduce the consumer price index directly by 0.5 of a percentage point adds to my confidence. It’s particularly sensible if, as the financial experts have convinced themselves, the inflation rate’s fall is now “sticky”.

Those dismissing this decline as merely “technical” display their ignorance of how wages and prices are set outside the pages of a textbook. To everyone but economists, the CPI is the inflation rate. It’s built into many commercial contracts and budget measures.

It’s a safe bet this device will cause the Fair Work Commission’s annual increase in minimum award wage rates – affecting the bottom quarter of the workforce – to be about 0.5 of a percentage point lower than otherwise. And do you really think employers won’t take the opportunity to reduce wage rises accordingly? I doubt they’re that generous.

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Budget's message: maybe we'll pull off the softest of soft landings

When normal people think about the economy, most think about the trouble they’re having with the cost of living. But when economists think about it, what surprises them is how well the economy’s travelling.

It’s been going through huge ups and downs since COVID arrived in early 2020. By 2022, it was booming and the rate of unemployment had fallen to 3.5 per cent, its lowest in almost 50 years. Meaning we’d returned to full employment for the first time in five decades.

Trouble was, like the other rich economies, prices had begun shooting up. The annual rate of inflation reached a peak of almost 8 per cent by the end of 2022.

The managers of the economy know what to do when the economy’s growing too fast and inflation’s too high. The central bank increases interest rates to squeeze households’ cash flows and discourage them from spending so much.

The Reserve Bank started raising the official “cash” interest rate in May 2022, just before the federal election. It kept on raising rates and, by November last year, had increased the cash rate 13 times, taking it from 0.1 per cent to 4.35 per cent.

While this was happening, Treasurer Jim Chalmers was using his budget – known to economists as “fiscal policy” – to help the Reserve’s “monetary policy” to increase the squeeze on households’ own budgets, reducing their demand for goods and services.

Why? Because, when businesses’ sales are booming, they take the chance to whack up their prices. When their sales aren’t all that brisk, they’re much less keen to try it on.

The government’s tax collections have been growing strongly because many more people had jobs, or moved from part-time to full-time, and because higher inflation meant workers were getting bigger pay rises.

As well, iron ore prices stayed high, meaning our mining companies paid more tax than expected.

Chalmers tried hard to “bank” – avoid spending – all the extra revenue. So, whereas his budget ran a deficit of $32 billion in the year to June 2022, in the following year it switched to a surplus of $22 billion, and in the year that ends next month, 2023-24, he’s expecting another surplus, this time of $9 billion.

So, for the last two years, Chalmers’ budget has been taking more money out of the economy in taxes than it’s been putting back in government spending, thus making it harder for households to keep spending.

Guess what? It’s working. Total spending by consumers hardly increased over the year to December 2023. And the rate of inflation has fallen to 3.6 per cent in the year to March. That’s getting a lot closer to the Reserve’s target of 2 to 3 per cent.

The Reserve’s rate rises have been the biggest and fastest we’ve seen. Wages haven’t risen as fast as prices have and, largely by coincidence, a shortage of rental accommodation has allowed big increases in rents.

And on top of all that you’ve got the budget’s switch from deficits to surpluses. Much of this has been caused by bracket creep – wage rises causing workers to pay a higher average rate of income tax, often because they’ve been pushed into a higher tax bracket.

Bracket creep is usually portrayed as a bad thing, but economists call it “fiscal drag” and think of it as good. It acts as one of the budget’s main “automatic stabilisers”, helping to slow the economy down when it’s growing too quickly and causing higher inflation.

The Reserve keeps saying it wants to get inflation back under control without causing a recession. But put together all these factors squeezing household budgets, and you see why people like me have worried that we might end up with a hard landing.

Which brings us to this week’s budget. The big news is that in the coming financial year the budget is expected swing from this year’s surplus of $9 billion to a deficit of $28 billion.

This is a turnaround of more than $37 billion, equivalent to a big 1.3 per cent of annual gross domestic product. So, whereas for the past two financial years the “stance” of fiscal policy has been “contractionary” (acting to slow the economy), it will now be quite strongly “expansionary” (acting to speed it up).

Some people who should know better have taken this turnaround to have been caused by a massive increase in government spending. They’ve forgotten that by far the biggest cause is the stage 3 tax cuts, which will reduce tax collections by $23 billion a year.

The same people worry that this switch in policy will cause the economy to grow strongly, stop the inflation rate continuing to fall and maybe start it rising again. But I think they’ve forgotten how weak the economy is, how much downward pressure is still in the system, and how long it takes for a change in the stance of policy to turn the economy around.

Treasury’s forecasts say the economy (real GDP) will have grown by only 1.75 per cent in the financial year just ending, will speed up only a little in the coming year and not get back to average growth of about 2.5 per cent until 2026-27.

So, the rate of inflation will continue falling and should be back into the target range by this December. All this would mean that, from its low of 3.5 per cent – which had risen to 4.1 per cent by last month – the rate of unemployment is predicted to go no higher than 4.5 per cent.

That would be lower than the 5.2 per cent it was before the pandemic, and a world away from the peak of about 11 per cent in our last big recession, in the early 1990s.

So maybe, just maybe, we’ll have fixed inflation and achieved the softest of soft landings. Treasury’s forecasting record is far from perfect, to put it politely, but it is looking possible – provided we don’t do something stupid.

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Budget will make us better off now, but worse off later

It’s said you can tell a government’s true priorities from what it does in its budget. If so, the top priority of Anthony Albanese’s government is not to have any priorities.

Rather than focusing on fixing the most pressing of our many problems, his preference is to be seen doing a little to alleviate all of them. In this budget, (almost) every voter wins a prize.

Certainly, every powerful interest group gets something to placate it. Of course, when you’re handing out so many prizes, most of them aren’t all that big.

Unfortunately, it’s a strategy that works better politically – where every vote counts – than economically, where sticking to what you’re good at brings better returns.

Fortunately, however, this budget has been “back-end loaded”. Most of what’s likely to be wasteful spending will come sometime in the next 10 years. Most of the budgetary cost of the sensible decisions starts from the first day of the new financial year, in just seven weeks’ time.

So let’s start with the good half of the budget, and leave the bad stuff for later.

By far the greatest political pressure on the government is to ease the intense cost-of-living pressure that so many people are feeling. Since most of the pressure has been caused by rapidly rising prices, this is also the government’s most immediate economic problem.

The trouble for Treasurer Jim Chalmers is that the standard remedy for rapid inflation involves making the pressure worse to make it better. You use higher interest rates and a bigger tax bite out of people’s pay rises to make it harder for households to keep spending, which stops businesses from raising their prices as much.

This explains Chalmers’ repeated but contradictory statement that he wants to ease the cost of living without weakening the efforts – by the Reserve Bank and his own budget surpluses – to get inflation down.

But this is where Albanese’s predilection for the each-way bet actually makes sense. Chalmers has found a way to do the seemingly impossible: ease living pressures a bit, while weakening the inflation fight only a bit.

He’s done this, first, by introducing a $300 power-bill rebate for all households, increasing the rent allowance paid to people receiving welfare benefits, and freezing the cost of prescriptions for two years.

This not only helps those people; it also reduces the rise in the consumer price index somewhat. And this, in turn, brings closer the day when the Reserve Bank starts cutting interest rates.

But second, by his rejig of the stage 3 tax cuts. This may be old news, but it’s by far the biggest measure in the budget. Most wage earners will realise how big it is – and how much it helps – when it increases their take-home pay at the start of July.

Albanese and Chalmers took a tax cut the previous government had intended to be of real benefit only to those on incomes well above the average, and changed it to ensure all taxpayers got something.

See? Everyone gets a prize. Everyone on incomes below about $150,000 a year gets more; everyone above that gets less than first intended. As a measure to ease living costs, it’s now far more effective.

Why won’t this $23 billion-a-year tax cut weaken the inflation fight? Because it has been government policy since 2018. It’s likely effect on households’ spending has been built into the Reserve Bank’s decisions to raise interest rates 13 times. Good stuff.

But it’s when we turn to the longer-term Future Made in Australia plans that you see the folly of Albanese’s efforts to stay friends with every interest group on every side.

By far the most important task Albanese must accomplish to secure our economic future is to achieve a smooth transition from fossil fuels to renewables – most of it done by 2030 – without blackouts and avoidable jumps in the cost of electricity.

But, more than that, he must ensure our continuing income from exports by establishing new green, further-processing industries exploiting our new-found strength of being among the world’s cheapest producers of renewable energy. This can be what will keep us prosperous when the world stops buying our fossil fuels.

The government spending needed to get these green industries started is included in the Future Made in Australia project. Trouble is, so is money for a lot of crazy ideas, such as setting up in competition with China as a producer of solar panels.

Albanese’s problem is he wants to say yes to everyone and everything, not just stick to the main chance. He’s saying he can turn us into a renewable energy superpower with one hand while, with the other, he lets the gas industry steam on to 2050 and beyond.

This does not fill me with confidence in the Albanese government’s capability. Quite the reverse.

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The economy is just the means to an end. So, is it working?

We spend a lot of time hearing, reading and arguing about The Economy, and we’ll be doing a lot more of all that after we’ve seen Tuesday night’s federal budget.

But while we’re waiting, let’s take a moment to make sure we know what we’re talking about. What’s the economy for? How does it work? What does it do? Who owns it? Who runs it?

Why am I suddenly so deep and meaningful? Because Dr Shane Oliver, AMP’s chief economist, has written a note saying the economy doesn’t seem to be giving us what we want.

As individuals, it’s easy to think of the economy as something that’s outside ourselves, something that does things to us, over which we have little control.

As individuals, that’s true. But if you take us altogether, it’s not true. Why not? Because if you took all the people out of the economy, there wouldn’t be an economy. What’s more, you wouldn’t need one.

You’d be left with a lot of homes and other buildings, roads, cars and machines that had been abandoned, were just sitting there and so were worthless.

So, in that sense, the economy belongs to all of us because it is us. It’s most of us getting up each morning, going to work and earning a living, and all of us spending what’s been earnt.

Most of us have paid work, some of us do unpaid work, while some of us are still getting an education and others are too old or sick to work. But all of us consume.

So don’t think of the economy as high finance beyond your understanding. It’s actually as basic as you can get. This is why it’s important to remember the economy is just a means to an end.

At its most elemental, the end we’re seeking is for the economy to provide us with food, clothing and shelter, plus a few luxuries. But all of us want to do more than barely subsist. We want our lives to bring us enjoyment.

Economists say we want all our earning and spending to bring us “utility”. A better word would be satisfaction. But it’s no stretch to say what we want from our lives is happiness. And it’s on happiness that Oliver finds we aren’t doing as well as we should be.

All this is why the best way to think about the economy is that it belongs to all of us. Legally, however, most of the capital – whether physical or financial – is owned by companies, big and small. So most of us are employed by companies.

Where does government fit in? Apart from employing a lot of workers, it owns most of the roads and other public infrastructure. It makes the laws that limit what businesses (and the rest of us) are permitted to do and the way we do it.

Governments discourage some business activities and – as we’ve seen with the Albanese government’s recent announcements – seek to encourage others.

But the central bank also uses its control over short-term interest rates to “manage” the strength of the private sector’s total demand for goods and services, encouraging it when unemployment is high, and – as now – discouraging it when inflation is high.

As well, the federal government uses its budget – government spending on one side, taxes on the other – to discourage or encourage private demand. Hence, all the fuss next week.

But how are we, and other rich countries, going in our efforts to use our economic activity – earning and spending – to keep us happy and getting happier? Not well, according to Oliver’s research.

For Australia, he finds that, though our real annual gross domestic product per person has increased fairly steadily over the past 20 years, the average score we give ourselves on our satisfaction with our lives (as surveyed by the World Happiness Report) has actually been falling over the same period.

It’s a similar story for the United States, where its real GDP per person has risen steadily since 1946, while the proportion of Americans describing themselves as “very happy” has fallen slowly over most of that period.

In particular, he finds that younger people in the US, Canada, Australia and New Zealand are the least happy age group. This is a major change from 20 years ago.

Why is this happening? We can all have our own theories, but I think the big mistake many of us – and certainly, most economists – make is to focus on improving our material standard of living: using our increasing income to buy bigger and better things. Homes, cars, smartphones, whatever.

Trouble is, our materialism puts us on a “hedonic treadmill”. We think buying a bit more stuff will make us happier and, at first, it does. But pretty soon the thrill wears off – we get used to our higher standard of living – and tell ourselves it’s actually the next new thing that will make us happy.

Many people use their pursuit of promotions and higher income to make them happier by raising their social status. But this, too, is a step up you can get used to. And, in any case, it’s a zero-sum game. If passing you on the status ladder makes me happier, why won’t being passed by me make you less happy?

Actually, as I explained in a book I wrote some years back, there’s a lot of evidence that what’s better at giving us lasting satisfaction is the quality of our relationships with partners, family and friends. Beats just buying more stuff or getting a promotion.

And while it’s true that the economy, and our small role in it, can be seen as just a means to an end, it turns out that “extrinsic” benefits – such as wanting to earn money because of the nice things it buys – aren’t as satisfying as “intrinsic” benefits: such as finding a job you enjoy doing, not just do for the money it brings.

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RBA will decide how long the economy's slump lasts

The media are always setting “tests” that the government – or the opposition – must pass to stay on top of its game. But this year, it’s the Reserve Bank facing a big test: will it crash the economy in its efforts to get inflation down?

There’s a trick, however: when the Reserve stuffs up, it doesn’t pay the price, the elected government does. This asymmetry is the downside of the modern fashion of allowing central banks to be independent of the elected government. Everything’s fine until the econocrats get it badly wrong.

It’s clear from last week’s national accounts that the economy has slowed to stalling speed. It could easily slip into recession – especially as defined by the lightweight two-successive-quarters-of-negative-growth brigade – or, more likely, just go for a period in which the population keeps growing but the economy, the real gross domestic product, doesn’t, and causes unemployment to keep rising.

Because interest rates affect the economy with a lag, the trick to successful central banking is to get your timing right. If you don’t take your foot off the brake until you see a sign saying “inflation: 2.5 per cent”, you’re bound to run off the road.

So now’s the time to think hard about lifting your foot and, to mix the metaphor, ensuring the landing is soft rather than hard.

Here’s a tip for Reserve Bank governor Michele Bullock. If you get it wrong and cause the Albanese government to be tossed out in a year or so’s time, two adverse consequences for the Reserve would follow.

First, it would be decades before the Labor Party ever trusted the Reserve again. Second, the incoming Dutton government wouldn’t feel a shred of secret gratitude to the Reserve for helping it to an undeserved win. Rather, it would think: we must make sure those bastards in Martin Place aren’t able to trip us up like they did Labor.

Last week’s national accounts told us just what we should have expected. They showed that real GDP – the nation’s total production of goods and services – grew by a negligible 0.2 per cent over the three months to the end of December.

This meant the economy grew by 1.5 per cent over the course of 2023. If that looks sort of OK, it isn’t. Get this: over the past five quarters, the percentage rate of growth has been 0.8, 0.6, 0.5, 0.3 and 0.2. How’s that for a predictable result?

Now you know why, just before the figures were released, Treasurer Jim Chalmers warned that we could see a small negative. It’s a warning we can expect to hear again this year.

If you ignore the short-lived, lockdown-caused recession of 2020, 1.5 per cent is the weakest growth in 23 years.

But it’s actually worse than it looks. What measly growth we did get was more than accounted for by the rapid, post-COVID growth in our population. GDP per person fell in all four quarters of last year.

So whereas real GDP grew by 1.5 per cent, GDP per person fell by 1 per cent. We’ve been in a “per-person recession” for a year.

It’s not hard to see where the weaker growth in overall GDP is coming from. Consumer spending makes up more than half of GDP, and it grew by a mere 0.1 per cent in both the December quarter and the year.

At a time when immigration is surging, and it’s almost impossible to find rental accommodation, spending on the building of new homes fell by more than 3 per cent over the year.

Of course, this slowdown is happening not by accident, but by design. Demand for goods and services had been growing faster than the economy’s ability to supply them, permitting businesses of all kinds to whack up their prices and leaving us with a high rate of inflation.

Economists – super-smart though they consider themselves to be – have been able to think of no better way to stop businesses exploiting this opportunity to profit at the expense of their customers than to knock Australia’s households on the head, so they can no longer spend as much.

For the past several decades, we’ve done this mainly by putting up interest rates, so people with mortgages were so tightly pressed they had no choice but to cut their spending. The Reserve began doing this during the election campaign in May 2022, and did it again 12 more times, with the last increase as recently as last November.

It would be wrong, however, to give the Reserve all the credit – or the blame – for the 12 months of slowdown we’ve seen. It’s had help from many quarters. First is the remarkable rise in rents, the chief cause of which is an acute shortage of rental accommodation, affecting roughly a third of households.

Next are the nation’s businesses which, in their zeal to limit inflation, have raised their wages by about 4.5 percentage points less than they’ve raised their prices. Talk about sacrifice.

And finally, there’s the federal government, which has done its bit by restraining its spending and allowing bracket creep to claw back a fair bit of the inflation-caused growth in wage rates. As a consequence, the budget has swung from deficit to surplus, thereby helping to restrain aggregate demand.

It’s the help the Reserve has had from so many sources that risks causing it to underestimate the vigour with which spending is now being restrained. It’s far from the only boy standing on the burning deck.

Last week some were criticising the Reserve for popping up in November, after doing nothing for five months, and giving the interest-rate screws another turn while, as we now know, the economy was still roaring along at the rate of 0.2 per cent a quarter.

The critics are forgetting the politics of economics. That isolated tightening was probably the new governor signalling to the world that she was no pushover when it came to the Reserve’s sacred duty to protect us from inflation.

In any case, a rate rise of a mere 0.25 per cent isn’t much in the scheme of things. It’s possible that quite a few hard-pressed home buyers felt the extra pain. But when did anyone ever worry about them and their pain? It was the central bankers’ duty to sacrifice them to the economy’s greater good – namely, preventing the nation’s profit-happy chief executives from doing what comes naturally to all good oligopolists.

The looming stage 3 tax cuts should give a great boost to the economy, of course, provided seriously rattled families don’t choose to save rather than spend them.

What matters most, however, is by how much unemployment and underemployment rise before the economy resumes firing on all cylinders. So far, the rate of unemployment has risen to 4.1 per cent from its low of 3.5 per cent in February last year.

By recent standards, that’s still an exceptionally low level, and a modest increase in the rate. But for a more definitive assessment, come back this time next year.

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Chalmers finds a better way to get inflation down: fix the budget

There’s an important point to learn from this week’s mid-(financial)-year’s budget update: in the economy, as in life, there’s more than one way to skin a cat.

The big news is that, after turning last year’s previously expected budget deficit into a surplus of $22 billion – our first surplus in 15 years – Treasurer Jim Chalmers is now expecting this financial year’s budget deficit to be $1.1 billion, not the $13.9 billion he was expecting at budget time seven months’ ago.

Now, though $1.1 billion is an unimaginably huge sum to you and me, in an economy of our size it’s a drop in the ocean. Compared with gross domestic product – the nominal value of all the goods and services we expect to produce in 2023-24 – it rounds to 0.0 per cent.

So, for practical purposes, it would be a balanced budget. And as Chalmers says, it’s “within striking distance” of another budget surplus.

This means that, compared with the prospects for the budget we were told about before the federal election in May last year, Chalmers and Finance Minister Katy Gallagher have made huge strides in reducing the government’s “debt and deficit”. Yay!

But here’s the point. We live in the age of “central bankism”, where we’ve convinced ourselves that pretty much the only way to steer the economy between the Scylla of high inflation and the Charybdis of high unemployment is to whack interest rates up or down, AKA monetary policy.

It ain’t true. Which means Chalmers may be right to avoid including in the budget update any further measures to relieve cost-of-living pressures and, rather, give top priority to improving the budget balance, thereby increasing the downward pressure on inflation.

The fact is, we’ve always had two tools or instruments the managers of the economy can use to smooth its path through the ups and downs of the business cycle, avoiding both high unemployment and high inflation. One is monetary policy – the manipulation of interest rates – but the other is fiscal policy, the manipulation of government spending and taxation via the budget.

This year we’ve been reminded how unsatisfactory interest rates are as a way of trying to slow inflation. Monetary policy puts people with big mortgages through the wringer, but lets the rest of us off lightly. This is both unfair and inefficient.

Which is why we should make much more use of the budget to fight inflation. That’s what Chalmers is doing. The more we use the budget, the less the Reserve Bank needs to raise interest rates. This spreads the pain more evenly – to the two-thirds of households that don’t have mortgages – which should be both fairer and more effective.

Starting at the beginning, in a market economy prices are set by the interaction of supply and demand: how much producers and distributors want to be paid to sell you their goods and services, versus how much consumers are willing and able to pay for them.

The rapid rise in consumer prices we saw last year came partly from disruptions to supply caused by the pandemic and the Ukraine war. There’s nothing higher interest rates can do to fix supply problems and, in any case, they’re gradually going away.

But another cause of the jump in prices was strong demand for goods and services, arising from all the stimulus the federal and state governments applied during the pandemic, not to mention the Reserve’s near-zero interest rates.

Since few people were out of job for long, this excessive stimulus left many workers and small business people with lots to spend. And when demand exceeded supply, businesses did what came naturally and raised their prices.

How do you counter demand-driven inflation? By making it much harder for people to keep spending so strongly. Greatly increasing how much people have to pay on their mortgages each month leaves them with much less to spend on other things.

Then, as demand for their products falls back, businesses stop increasing their prices and may even start offering discounts.

But governments can achieve the same squeeze on households by stopping their budgets putting more money into the economy than they’re taking out in taxes. When they run budget surpluses by taking more tax out of the economy than they put back in government spending, they squeeze households even tighter.

So that’s the logic Chalmers is following in eliminating the budget deficit and aiming for surpluses to keep downward pressure on prices. This has the secondary benefit of getting the government’s finances back in shape.

But how has the budget balance improved so much while Chalmers has been in charge? Not so much by anything he’s done as by what he hasn’t.

The government’s tax collections have grown much more strongly than anyone expected. Chalmers and his boss, Anthony Albanese, have resisted the temptation to spend much of this extra moolah.

The prices of our commodity exports have stayed high, causing mining companies to pay more tax. And the economy has grown more strongly than expected, allowing other businesses to raise their prices, increase their profits and pay more tax.

More people have got jobs and paid tax on their wages, while higher consumer prices have meant bigger wage rises for existing workers, pushing them into higher tax brackets.

This is the budget’s “automatic stabilisers” responding to strong growth in the economy by increasing tax collections and improving the budget balance, which acts as a brake on strong demand for goods and services.

There’s just one problem. Chalmers has joined the anti-inflation drive very late in the piece. The Reserve has already raised interest rates a long way, with much of the dampening effect still to flow through and weaken demand to the point where inflation pressure falls back to the 2 per cent to 3 per cent target.

We just have to hope that, between Reserve governor Michele Bullock’s monetary tightening and Chalmers’ fiscal tightening, they haven’t hit the economy much harder than they needed to.

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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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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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Business cries poor on wages, even as profits mount

Don’t believe anyone – not even a governor of the Reserve Bank – trying to tell you the Fair Work Commission’s decision to increase minimum award wages by 5.75 per cent is anything other than good news for the lowest-paid quarter of wage earners.

Because they are so low paid, and mainly part-time, these people account for only about 11 per cent of the nation’s total wage bill. So, as the commission says, the pay rise “will make only a modest contribution to total wages growth in 2023-24 and will consequently not cause or contribute to any wage-spiral”.

But that’s not the impression you’d get from all the wailing and gnashing of teeth by the main employer group, the Australian Chamber of Commerce and Industry. It claims “an arbitrary increase of this magnitude consigns Australia to high inflation, mounting interest rates and fewer jobs”.

These are the sort of dramatics we get from the Canberra-based employers’ lobby before and after every annual wage review. They lay it on so thick I doubt anyone much believes them.

But it’s worse than that. In the age-old struggle between labour and capital – wages and profits – most economists have decided long ago whose side they’re on, and long ago lost sight of how one-eyed they’ve become.

For a start, many of the talking heads you see on telly work for big businesses. They’re never going to be caught saying nice things about pay rises.

Econocrats working for conservative governments have to watch what they say. And parts of the media have business plans that say: pick a lucrative market segment, then tell ’em what they want to hear.

In my experience, there’s never any shortage of experts willing to fly to the defence of the rich and powerful, in the hope that some of the money comes their way.

But I confess to being shocked in recent times by the way the present Reserve Bank governor, Dr Philip Lowe, has been so willing to take sides. The way he preaches restraint to ordinary workers struggling to cope with the cost of living, but never urges businesses to show restraint in the enthusiasm with which they’ve been whacking up their prices.

It’s true that Lowe has a board that’s been stacked with business people, but that’s been true for all his predecessors, and they were never so openly partisan.

When businesses take advantage of the excessively strong demand that Lowe himself helped to create, that’s just business doing what comes naturally, and must never be questioned, even in an economy characterised by so much oligopoly – big companies with the power to influence the prices they charge.

But when employees unite to demand pay rises at least sufficient to cover the rising cost of living, this is quite illegitimate and to be condemned. The more so when a government agency such as the Fair Work Commission acts to protect the incomes of the poorest workers.

On Friday, the commission set out what has long been the rule for fair and efficient division of the spoils of the market system between labour and capital: “In the medium to long term, it is desirable that modern award minimum wages maintain their real value and increase in line with the trend rate of national productivity growth”.

In other words, wage rises don’t add to inflation unless their growth exceeding inflation exceeds the nationwide (not the particular business’) trend (that is, over a run of years, not just the last couple) rate of growth in the productivity of labour (production per hour worked).

But last week, in his appearance before a Senate committee, Lowe was twisting the rule to suit his case, setting nominal (before taking account of inflation) unit labour costs (labour costs adjusted for productivity improvement) not real unit labour costs as the appropriate measure.

He told the senators that growth in labour costs per unit of 3 or 4 per cent a year was adding to inflation because the past few years had seen no growth in the productivity of labour (which, of course, is the fault of the government, not the businesses doing the production).

This is dishonest. What he was implying was that wage growth should not bear any relationship to what’s happening to prices at the time. Wage growth should be capped at 2.5 per cent a year every year, come hell or high water.

Without any productivity improvement, any wage growth exceeding 2.5 per cent was inflationary. Should the nation’s businesses choose to raise their prices by more than 2.5 per cent, what was best for the economy was for the workers’ wages to fall in real terms.

Now, Lowe is a very smart man, and I’m sure he doesn’t actually believe anything so silly. Like the employer groups, he’s cooked up a convenient argument to help him achieve his KPIs. He sees the inflation rate as his key performance indicator.

He’s got to get it down to the 2 to 3 per cent target range, and get it down quick. He ain’t too worried what shortcuts he takes or who gets hurt in the process.

When he claims that, absent productivity improvement, wage rises far lower than the rate of inflation are themselves inflationary, what he really means is that they make it harder for him to achieve his KPIs.

Clearly, the wage rise that would help him get the inflation rate down fastest is a wage rise of zero. It would plunge the economy into recession, and businesses would have a lot more trouble finding customers, but who cares about that?

It’s not true that sub-inflation-rate pay rises add to inflation. What is true is that the bigger the sub-inflation rise, the longer it takes to get inflation down. But he doesn’t like to say that.

Why’s he in such a hurry he’s happy for ordinary workers to suffer? Because he lies awake at night worrying that, if it takes too long to get inflation down, inflation expectations will rise and a price-wage spiral will become entrenched.

Does Treasury secretary Dr Steven Kennedy also lie awake? Doesn’t seem to. He told the senators last week that “there are no signs of a wage-price spiral developing and medium-term inflation expectations remain well anchored”.

If ever there was a general fighting the last war, it’s Lowe.

Meanwhile, please don’t say business profits seem to be going fine. It may be true, but please don’t say it. Business doesn’t like you saying such offensive things, and business’ media cheer squad goes ape.

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What they don't tell you about how the budget works

Now we have some space, there are things I should tell you that there’s never time for on budget night. If you don’t know these things, the media can unwittingly mislead you, and the government spin doctors can knowingly mislead you.

A budget’s just a plan for how much income you’re expecting in the coming period, and what you want to spend it on. Governments have budgets and so do businesses and families.

You may think you know a lot about budgeting and that all you need is common sense, but the federal government’s budget ain’t like any other budget you’ve known.

Where people go wrong is assuming the government’s budget is the same as their own household budget, only much bigger. Families budget so they don’t end up spending more than they earn.

But governments often spend more than they raise in taxes – run at a “deficit” – and only occasionally spend less than they raise – run a “surplus”. When they run deficits, they borrow to cover it; when occasionally they run a surplus, they can pay back a bit of it.

Governments can borrow, and keep borrowing, in a way families can’t. Why? Because they can’t go broke. When they run short of money, they can do what no family can do: order all the other families to give them money. It’s called taxation.

And national governments can go one step further and print their own money. Money is just a piece of plasticky stuff that’s worth, say, $50. Why is it worth $50? For no reason other than that the government says it is, and everyone believes it.

Actually, these days the government doesn’t print money so much as create it out of thin air, by crediting bank accounts. This is done not by the government itself, but by a bank the government owns: the Reserve Bank. It created hundreds of billions during the pandemic (although now the Reserve is making the government gradually pay it back, by actually borrowing the money).

Everyone knows that whatever you borrow has to be paid back. What’s more, you have to keep paying interest on the debt until it is paid back. Parents know they have to get any home loan paid back before they retire.

The trouble with a family is that eventually it dies. The kids grow up and start families of their own, then mum and dad pop off. But governments don’t die. The nation’s government acts on behalf of all the families in the country. There are always some families dying, but always others taking their place.

This is why families have to pay back their debts, but governments don’t – and often choose not to. Because governments go on and on, the main way they get on top of their debts is by waiting for the economy to outgrow them, so the size of their debt declines relative to the size of the economy.

Remember, unless you add to it, a debt is a fixed dollar amount, whereas the size of the economy – gross domestic product – grows with inflation and “real” economic growth.

The final thing making government budgets different from family budgets is that a particular family’s budget is too small to have any noticeable effect on the economy, whereas the federal budget is so big – about a quarter the size of the economy – that changes the government makes in its spending and taxing plans can have a big effect on an individual family’s budget and indeed, many families’ budgets.

But it also works the other way: what happens to one family won’t have a noticeable effect on the budget, but what happens to many families – say, everyone’s getting bigger pay rises, or many families are cutting back because they’re having trouble coping with the cost of living – certainly will affect the budget.

What common sense doesn’t tell you is that there’s a two-way relationship between the budget and the economy. The budget can affect the economy, but the economy can affect the budget.

Whenever a treasurer announces on budget night that he (one day we’ll get a she) is expecting the budget deficit to turn into a surplus, the media usually assume this must be because of something he’s done.

Possibly, but it’s more likely to be because of something the economy did. In this month’s budget, it’s because the economy’s been growing strongly, leading families and companies to earn more income and pay more tax on it.

Because many in the media imagine the government’s budget is the same as a family’s budget, they assume that budget deficits are always a bad thing and surpluses a good thing.

Not necessarily. If the budget was in surplus during a recession, that would be a bad thing because it would mean that, by raising more in taxes than it was spending, the budget would be making life even harder for families.

Only when the economy’s growing too fast and adding to inflation pressure is it good to have the budget in surplus and so helping to slow things down. And deficits are a good thing when the economy’s in recession because this means that, by spending more than it’s raising in taxes, the budget’s helping to prop up the economy.

But not to worry. When the economy goes into recession, the budget tends to go into deficit – or an existing deficit gets bigger – automatically. Why? Because people pay less tax and the government has to pay unemployment benefits to more people. Economists call this the budget’s “automatic stabilisers”.

Hidden away in the budget papers you find Treasurer Jim Chalmers quietly admitting he has no intention of trying to pay off the big public debt he inherited. His “overarching goal” is to “reduce gross debt as a share of the economy over time”.

Finally, for a family, a $4 billion surplus is an unimaginably huge sum of money. But for a federal government, it’s petty cash.

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Chalmers and Lowe: good cop, bad cop on the inflation beat

Have you noticed? There’s a contradiction at the heart of Treasurer Jim Chalmers’ budget. Is it helping or harming inflation?

Both Chalmers and Reserve Bank governor Dr Philip Lowe are agreed that our top priority must be to get the rate of inflation down. That’s fine. Everybody hates the way prices have been shooting up. The cost of living has become impossible. Do something!

But while Lowe seems to be just making it all worse, jacking up mortgage interest rates higher and higher, nice Mr Chalmers is using his budget to take a bit of the pressure off, helping with electricity bills, cutting prescription costs and so on.

It’s as though Lowe is the arsonist, sneaking round the bush to start more fires, while Chalmers is the Salvos, turning up at the scene to give the tired firefighters a kind word, a pie and a cup of tea.

Is that how you see it? That’s the way Chalmers wants you to see it, and Lowe knows full well it’s his job to be Mr Nasty at times like this.

But what on earth’s going on? Has the world gone crazy? No, it’s just the usual dance between brutal economics on one hand, and always-here-to-help politics on the other.

Let’s start from scratch. Why do we have an inflation problem? Because, for the past 18 months or so, the prices of the things we buy have been shooting up, rising much faster than our wages, causing the cost of living to become tough for many people.

Why have prices been rising so rapidly? Partly because the COVID-19 pandemic and Russia’s attack on Ukraine caused international shortages of building materials, cars, computer chips and fossil fuels. But also because the massive increase in our governments’ payments during the pandemic left us cashed up and spending big on locally made goods and services.

When the suppliers of the stuff we buy can’t keep up with our demand for it, they raise their prices. The media may call this “price gouging”, but economists believe it’s what happens naturally in a market economy – and should happen because the higher price gives the suppliers an incentive to produce more. When they do, the price will come down.

When inflation takes off like this, what can the managers of the economy do to stop prices rising so fast? They can do nothing to magically increase supply; that takes time. But what they can do is reduce demand – discourage us from spending so much.

How? This is where it gets nasty. By squeezing households’ finances so hard they have to cut their spending. Once demand for the stuff they’re selling falls back, businesses are much less keen to raise their prices.

At present, households are being squeezed from all directions. The main way is that wages aren’t keeping up with the rise in prices. As well, more of the wage rises people are getting is being eaten up by income tax, thanks to “bracket creep”.

And the fall in house prices means home-owning households aren’t feeling as wealthy as they were.

All that’s before you get to Mr Nasty, raising the interest rates paid by people with mortgages, which is particularly tough on young home owners, with more recent, much bigger mortgages.

(You may wonder if this extra pressure on, say, only about 20 per cent of all households is either fair or the most effective way to get total household spending to slow. And you may be right, but you’d be way ahead of the world’s economists, who think the way they’ve always done it is the only way they could do it.)

But what part is the budget – “fiscal policy” – supposed to play in all this? It should be helping put the squeeze on, not reducing it. Now do you see why some are questioning whether Chalmers’ $14.6 billion “cost-of-living relief package” will help or hinder the cause of lower inflation?

The budget balance shows whether government spending is putting more money into the economy, and its households, than it’s taking out in taxes. If so, the budget’s running a deficit. If it’s taking more money out than it’s put back in, the budget’s running a surplus.

The way the Reserve Bank judges whether the budget is increasing the squeeze on households, or easing it, is to look at the size and direction of the expected change in budget balance from one year to the next.

The budget papers show the budget balance is planned to change from an actual deficit of $32 billion last financial year, 2021-22, to an expected surplus of $4 billion in this financial year, ending next month.

That’s an expected tightening of $36 billion, equivalent to 1.6 per cent of the size of the whole economy, gross domestic product.

No doubt such a change is adding a big squeeze to household incomes. But then the budget balance is expected to worsen in the coming financial year, 2023-24, to a deficit of $14 billion. That’s an easing of pressure on households’ finances equivalent to 0.7 per cent of GDP.

Put the two years together, however, and its clear the budget will still be putting a lot of squeeze on households – on top of all the other squeeze coming from elsewhere.

Somewhere in there is most of Chalmers’ $14.6 billion relief package. As a matter of arithmetic, it’s undeniably true that, had the package – which, by the way, is expected to reduce the consumer price index by 0.75 percentage points – not happened, the squeeze would be, say, $10 billion tighter than it’s now expected to be.

But there’s no way, looking at that – and all the other sources of squeeze – the Reserve will be saying, gosh, Chalmers is adding to inflation pressure, so we’d better raise rates further.

Chalmers has said the “stance” of fiscal policy adopted in the budget is “broadly neutral”. Not quite. So, I’ll say the nasty word Mr Nice Guy doesn’t want to: the stance is “mildly contractionary”.

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How budget spin doctors manipulate our first impressions

These days, federal budgets are just as much marketing and media management exercises as they are financial and economic documents. That’s because the spin doctors’ role has become central to the way Canberra works. This is just as true under Labor as the Coalition. Media management is a characteristic of government by the two-party duopoly.

Budgets are actually the management plan for controling the government’s spending and tax-raising over the coming financial year. Because you can’t do a budget without first making guesses about what will be happening in the economy at the time, the budget documents contain detailed economic forecasts and commentary about what it has supposed will happen.

These forecasts are taken very seriously on budget night, but rarely referred to again. That’s because this era of dominant “monetary policy” (manipulation of interest rates), conducted by an independent central bank, means it’s the Reserve Bank’s forecasts that matter.

We’ve had those already, on Friday. The financial markets care more about the Reserve’s opinions than the government’s because they’re always trying to guess what the central bank will do to interest rates. What’s more, the RBA revises its forecasts quarterly, so the budget forecasts soon become outdated.

All this means the government’s forecasts can’t be very different from the Reserve’s. Differ by more than half a percentage point, and you get headlines about a split between Treasury and the central bank. Nothing the econocrats hate more (even though there’s unceasing rivalry between the two outfits).

A separate question is what effect the budget, and particularly the new measures it contains, will have on the economy: on gross domestic product, inflation and unemployment. Now that the macroeconomic fashion (aka “best practice”) dictates that the management of demand be left to the central bank – except in emergencies, such as the pandemic – the budget papers will contain little discussion of this.

But the inescapable fact remains that, the federal budget being so big relative to the economy, everything it does affects economic growth. That’s true whether the economic effects were intended or are the unintended consequence of politically driven decisions. All budget measures are political but, equally, all have economic consequences.

At this time of year, many people say they don’t know why the government is bothering to hold a budget when it has already announced the changes it’s making. Well, not quite.

What’s true is that, these days, budgets – and the days leading up to them – are highly stage-managed by the spin doctors. These people are based in the PMO – prime minister’s office – with extension into every minister’s office, via the minister’s press secretary. All paid for by the taxpayer, naturally.

The spin doctors’ job is to use the “mainstream media” to convey to voters an unduly favourable view of the government and the things it’s doing. They do this by exploiting the foibles of journalists and their editors.

Hence, the common trick of releasing potentially embarrassing information late on a Friday, when it’s less likely to make the bulletin. The hope is that, by Monday, the under-reported story is passed over as “old”.

The spinners have the great advantage of a near monopoly over news about what the government is doing. Much of this news is put into press releases, but much is held for selective release to journalists and outlets that are in favour with the government. Write a piece like this one and don’t expect to be popular.

In the olden days, many budget “leaks” really were leaks, the product of journalists talking to bureaucrats and putting two and one together to make four. These days, bureaucrats are forbidden to speak to journos, so most budget leaks have come from the spin doctors, intended to soften us up for what’s to come.

Sometimes, something – say, that the government has decided to increase the JobKeeper payment only for the over-55s – is leaked to just one or two news outlets to “run it up the flagpole and see who salutes”. If it goes over well enough, it will happen. If there’s a big adverse reaction it may never be heard of again.

Any bad news is usually officially announced ahead of the budget, so it won’t spoil the budget’s reception on the night. Lots of small but nice decisions will be announced early, so they don’t get overlooked on the night.

But, particularly if there has been a big pre-announced unpopular measure, the spinners will save some nice, un-foreshadowed hip-pocket measure for unveiling on the night. This, being the only major budget measure that’s “new”, will dominate the media’s reporting. I call it the cherry on top.

As a former treasurer, John Kerin, demonstrated in 1991 – much to the disapproval of Paul Keating - there is no genuine need for reporters to be locked up and allowed to see the budget papers well before the treasurer delivers his speech at 7.30pm, immediately after the ABC evening news.

But the budget “lockup” persists to this day because of its great media-management advantages. It’s of much benefit to have the treasurer’s made-for-telly (that is, full of spin) budget speech broadcast in prime time, rather than after lunch. (The smaller disadvantage is that the ABC gives the leader of the opposition – not the shadow treasurer – right of reply, at the same time on Thursday night.)

The other advantage of a lockup is that letting journalists out so late in the day gives them little time to ask independent experts what they thought of the budget. Rather, they’ve spent six hours locked up with Treasury heavies. (I remember one saying to me, long ago: “Not much there to criticise, eh?” )

This media manipulation usually ensures the media’s first impressions are more favourable to the government than they should be, getting the budget off to a good start with the voters. Only on day two do the interest groups finish combing through the fine print and finding the carefully hidden nasties.

All pretty grubby, but true.

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RBA review attacks the groupthink of others, but not its own

With more time to think about it, it’s clear the review of the Reserve Bank is not the sweeping blockbuster shake-up overhaul we were told it was. Even if all its recommendations are accepted, ordinary borrowers and savers won’t discern any difference in the way interest rates go up and down. But to those who work at the Reserve, and the small army of people who make a lucrative living second-guessing its decisions, the proposed “modest improvements” are a big deal.

Ostensibly, they’re aimed at getting the Reserve up to “world best practice”. But that’s just a spin doctor’s term for doing things the same way everyone else does them. Where’s the evidence that the conventional wisdom is sure to be “best practice”?

It’s also a way of concealing the colonial cringe. Because the rich world’s financial markets are now so highly integrated, with the biggest rich country’s Wall Street setting the lead, most people in our financial market think that if we’re not doing it the way the US Federal Reserve does it, we’re obviously doing it wrong.

This inferiority complex is reinforced because, for the past 30 years, most other central banks have conformed to the US Fed’s ways – even the world’s best colony-conscious country, Britain, has switched to the Fed’s way.

So, what is the Fed’s way? To have interest rates set by a special committee of outside experts, meeting eight times a year not monthly, with each member employed part-time and getting lots of research assistance.

The monetary policy committee should hold a press conference after every meeting and each member should give at least one speech a year on the topic.

To be fair, the Reserve’s Americanisation was pre-ordained by Treasurer Jim Chalmers’ terms of reference and his decision to have the inquiry led by Carolyn Wilkins, a former Bank of Canada heavy and now Bank of England heavy.

Of course, just because we do things differently to the others doesn’t guarantee we’re doing it better, any more than it means we’ve been doing it worse. I’d say our performance over the past 30 years – since the introduction of inflation targeting – has seen a few missteps, but been at least as good as any of the others.

And if the American way is “best practice”, how come the Fed’s been so heavily criticised for being slow to respond to the inflation surge?

But let’s be frank. The review’s big criticism of the Reserve is that it’s too insular, too inward looking and inbred. Except when one Treasury man got the job, governors are always promoted internally. The present governor joined the bank from high school. External appointments to senior economic jobs are rare.

As the review’s critique implies, the Reserve is a one-man band. The governor’s word is law, with limited tolerance for debate. He runs as much of the show as he chooses to, leaving the boring bits to his deputy.

It suits the governor to have a board stacked with business people because, not being economists, their doubts are easily dismissed. Employees would never disagree with the boss in front of the board, and any reservations the Treasury secretary may have would be raised in private.

There always used to be a union leader on the board, but he was let go as part of John Howard’s efforts to delegitimise the union movement which, in his eyes, was in league with his Labor opponents.

This does much to explain the present governor’s ignorance of labour-market realities. Dr Philip Lowe bangs on unceasingly about wages, but excludes unions from the Reserve’s extensive consultations with business and even welfare groups. I don’t remember hearing that swearword “union” ever pass his lips.

There’s always been an academic economist on the board, but they’re in no position seriously to take on the establishment. The board rarely if ever votes on anything. Rather, the chairman-governor “sums up the feeling of the meeting”.

Note, the Reserve has worked this way for the four decades I’ve been watching it. But it does seem to have become more insular and, as the review charges, more subject to “groupthink”, under Lowe.

The inquiry heard from young ex-Reserve economists saying they’d been warned that expressing doubt about the house line would harm their promotion prospects. I’ve been hearing that lately, too.

It’s madness for the Reserve to recruit the cream of each year’s graduating economists, then tell ’em not to speak unless spoken to. And what a way to train the next governor but three.

So, bring an end to groupthink inside the Reserve? Of course. Get a more vigorous debate around the board table before deciding on rates? Sure.

But here’s the joke. While rightly criticising the Reserve for encouraging groupthink, the report is itself a giant case of groupthink. It accepts unquestioningly the conventional wisdom of recent decades that there’s really only one way you could possibly manage the economy through the ups and downs of the business cycle, and that’s by manipulating interest rates.

Any role for “fiscal policy” – changing taxes and government spending? Didn’t think of that but, no, not really. Just make sure it doesn’t get in the way of the central bank.

We’ve fiddled with interest rates so much we’ve got them down to zero. Should we stop? Gosh no. Just think of some way to keep going. The review accepts that the central banks’ misadventure into “unconventional monetary policy” – UMP – which it sanctifies as “additional monetary policy tools”, is now part of “best practice”.

Really? Competitive currency devaluations are the way to fix the global economy’s ills? Can you hear yourselves?

Apparently, slowing the growth in spending by directly punishing the small proportion of households young and foolish enough to load themselves up with mortgage debt is “best practice”.

No, it’s not. It’s just a sign that the review committee is so caught up by global groupthink that it has never thought there might be a better way.

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