Memo to RBA: If wages growth isn't the problem, what is?

 I can’t help wondering if the Reserve Bank isn’t misreading the economy. And it seems I’m not alone.

When you’re seeking to manage the economy through its ups and downs, it’s critically important to diagnose its problems correctly. If you’ve misread the symptoms, you can make things worse rather than better. Or, for instance, you can single out citizens who had the temerity to borrow heavily to buy their home and subject them to needless punishment.

Last week, several things made me start wondering if the Reserve needs a rethink. The first was a paper by America’s highly regarded Brookings Institution, that I should have got onto in August.

The world’s central banks – including ours – have concluded that this unexpected burst of inflation is explained partly by temporary disruption to the supply of goods caused by the pandemic (and Russia’s attack on Ukraine), and partly by excessive demand following the authorities’ excessive economic stimulus to counter the lockdowns.

Sorry, not true says the Brookings study, which looked at new data.

“The vast majority of the COVID-19 inflation surge is accounted for by supply-linked factors, especially a rise in company [profit] margins that followed severe delivery delays at the height of the pandemic. Demand-linked factors, notably indicators of labour market overheating, play almost no role.

“As a result, the argument that policy stimulus was excessive is weak,” the study says. And, since company profit margins have yet to return to their previous level, this suggests the inflation rate has yet to fall as the effects of the pandemic continue to unwind. If so, the US Federal Reserve may have overtightened.

Now, all that refers to the US economy and may not apply to ours. May not, but I doubt it.

Despite four successive quarters in which the economy’s rate of growth in “aggregate demand” has been very weak, our Reserve is delaying a reduction in interest rates because, it says, the level of demand is still higher than the level of supply. If so, the rate of inflation may not keep falling, or may even start rising.

How does the Reserve know the level of supply is too low? Mainly by looking at the measure of idle capacity in the jobs market – aka the rate of unemployment.

So, when we saw the figures for October last week, and they showed unemployment still stuck at an exceptionally low 4.1 per cent, no higher than it was in January, it wasn’t surprising that many concluded the Reserve wasn’t likely to start cutting the official interest rate until May next year.

But hang on. One good measure of the job market’s ability to supply more labour as required is the “participation rate” – the proportion of the working-age population willing to participate in the paid labour force by either having a job or actively seeking one.

Now, the econocrats have been predicting that the ageing of the population would cause the “part rate” to start falling for at least the past 20 years. But in that time, it has kept going up rather than down, and is now higher than ever. Last week’s figures show it’s risen by a strong 0.5 percentage points to 67.2 per cent over just the past year.

So where’s the evidence the economy’s reached the end of its capacity to supply more workers?

My guess is that all the Reserve’s unaccustomed talk about the level of supply being too low relative to demand is just a way for it to avoid admitting that its judgment about when to start cutting interest rates is still – as it has been for all macroeconomists for the past 40 years – heavily reliant on its calculation of the present NAIRU: the “non-accelerating-inflation rate of unemployment”, which is the lowest the unemployment rate can fall before shortages of labour cause wage inflation to start going back up.

I think the Reserve’s reluctance to cut is driven by its (undisclosed) calculation that the NAIRU is well above 4.1 per cent. But earlier this month, Treasury secretary Dr Steven Kennedy told a parliamentary committee that, though such calculations are “uncertain”, Treasury estimates that the NAIRU is “around 4.25 per cent, close to the current rate of unemployment”.

Another thing we learnt last week was that a key measure of the rate at which wages are rising, the wage price index, rose by 0.8 per cent during the September quarter, causing the annual rate to fall from 4.1 per cent to 3.5 per cent.

According to Adam Boyton and other economists at the ANZ Bank, this caused the six-month annualised rate of wages growth to be unchanged at 3.2 per cent. “Wages growth has slowed across awards, enterprise bargaining agreements and individual agreements, pointing to a broad-based slowdown,” they said.

This – combined with the lack of increase in the rate of unemployment over the past year, and allowing for the delay before what’s happening to unemployment affects wage rates – has led these economists to conclude the NAIRU is closer to 3.75 per cent.

Finally, Westpac chief economist Dr Luci Ellis noted last week that another measure of wages pressure, the cost of labour per unit (which takes account of changes in the productivity of workers), has fallen from an annualised rate of 7 per cent to 3.5 per cent in just the six months to September.

She said that even if the annual improvement in the productivity of labour averages a touch below 1 per cent, which would be worse than our recent performance, annual wages growth averaging 3.2 per cent – as it has for the past three quarters – is “well and truly consistent with inflation averaging 2.5 per cent or below”.

Get what all this says? Ever since the Reserve began raising interest rates in May 2022, it has worried about the possibility of excessive growth in wages keeping inflation above the Reserve’s target zone. In all that time, and particularly now, it’s shown absolutely no sign of doing so. Neither shortages of labour nor the (much reduced) power of the unions has caused a problem.

The Reserve needs to lose its hang-up about wages and think harder about the need to ease the pain on innocent bystanders.

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If there's no 'price gouging' how come interest rates are so high?

The nation’s economists have a dirty little secret. They all believe that what the punters denigrate as “price gouging” is actually a good thing, part of the mechanism by which a market economy returns to “equilibrium” (balance) after it’s been hit by an inflationary shock.

But they have a visceral hatred of terms such as “price gouging” and “profiteering”, and are always producing graphs and calculations purporting to prove that the recent surge in inflation – the worst in about 40 years – has produced no increase in company profits.

What they don’t seem to have noticed, however – or maybe are hoping none of us have noticed – is that you can’t argue that demand has been growing stronger than supply and so causing price increases, thus justifying using higher interest rates to slow down demand, and at the same time claim there’s no evidence that profits have risen.

Sorry, guys. You can’t have it both ways. If you claim there’s been no noticeable rise in profits, you’re contradicting the Reserve Bank’s main justification for its 13 increases in the official interest rate since May 2022. (Which is funny, considering the Reserve has been prominent among those seeking to deny that profits have risen.)

That main justification has been that much of the worsening in the rate of price increases has been caused by “excessive demand”, thus necessitating higher interest rates to discourage us from spending so much.

But how exactly does excessive demand lead to higher prices? It’s simple. When there are more people wanting to buy my product than I and my suppliers can keep up with, I could leave the price I’m charging unchanged, in which case it won’t be long before my shelves are empty, and I have nothing to sell.

That’s not the way it works in practice, however, nor the way it works in economic theory. I take advantage of strong demand to raise the price at which I’m selling the item. Why do I do this? Because, like all business people, I’m trying to maximise my profit.

The higher price means I won’t be selling my stock as fast as I was – so it will take longer for my shelves to empty – but I’ll still be better off.

Economists say that when demand exceeds supply, the stuff still available has to be rationed, one way or another. One way to ration supply is simply to keep selling at an unchanged price until everything is sold. After that, everyone who comes later misses out.

But when the seller raises their price, economists call this “rationing by [higher] price”. They believe this is always the better solution to the rationing problem because it does so in a way that uses the “market mechanism” to fix the problem.

The higher price encourages would-be buyers to reduce their demand – by wasting less of the product, or finding a cheaper substitute – while encouraging suppliers to produce more of the now-more-profitable product.

So because the higher price reduces demand while increasing the supply, the price mechanism causes the price of the item to fall back towards what it first was. Brilliant. Another win for market forces.

But this means a (possibly temporary) rise in prices is an essential part of the price mechanism. So a consequent rise in profits is also an inevitable part of the mechanism.

It’s gone out of fashion but, long ago, economists would say there were two causes of inflation: “cost-push” and “demand-pull”.

Sometimes firms raise their prices because they’re passing on the higher costs they’re paying for their inputs. At other times they’re raising their prices simply because the high demand for their product allows them to.

We now know from the work of behavioural economists that ordinary consumers accept it’s OK for businesses to raise their prices because of their higher costs. But they regard raising your prices just because shortages in supply let you get away with it as exploitative. (The classic example is charging more for umbrellas on rainy days.)

This dual, supply caused and demand-caused, explanation for inflation fits well with the Reserve’s analysis of the origins of the great surge in prices – in all the developed economies – in late 2021 and 2022.

Part of it was from disruptions to supply caused mainly by the COVID-19 pandemic, but also the Ukraine war, which pushed up the cost of building materials, various manufactured goods, shipping and oil and gas. But part of it was caused by the excessive stimulus applied to the economy by governments and central banks during the pandemic and its lockdowns, which had caused the demand for goods and services to run ahead of the economy’s ability to produce them.

Increasing interest rates can do nothing to increase supply, and the end of the lockdowns would see supply gradually return to normal, the Reserve reasoned. But higher rates could dampen the excess demand caused by all the extra government spending and rock-bottom interest rates that was applied to ensure the lockdowns didn’t lead to a lasting recession.

See how this analysis is undermined by claims there’s no sign of firms earning higher profits in the post-pandemic period? It implies that there’s no sign of excess demand, suggesting the surge in prices must have come only from supply disruptions and other cost increases.

In which case, the justification for maintaining high interest rates is greatly weakened. It implies that demand hasn’t been growing excessively and, rather than waiting for the supply problems to resolve themselves, we’re going to batter down demand to fit.

If so, that would be a very painful solution to a temporary problem. And, unlike the inflation problem we suffered in the 1970s, there’s no way this inflation surge can be blamed on excessive growth in wage costs.

Real wage growth had been weak long before the pandemic arrived. And in 2020, many workers were persuaded to skip an annual wage rise in the belief that we’d entered a lasting recession. As we subsequently discovered, government handouts to business meant many businesses sailed through the pandemic with few scratches.

Why so many economists want us to believe that, despite decades of increased market concentration – more industries dominated by just a few huge firms – and despite excessive monetary and budgetary stimulus, profits never increase, I’m blowed if I know.

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Creative destruction: Even pandemics have their upside

There’s nothing new about pandemics. Over the centuries, they’ve killed millions upon millions. But economic historians are discovering they can also have benefits for those who live to tell the tale. Take the Black Death of the 14th century.

In October 1347, ships arrived in Messina, Sicily, carrying Genoese merchants coming from Kaffa in Crimea. They also carried a deadly new disease. Over the next five years, the Black Death spread across Europe and the Middle East, killing between 30 and 50 per cent of the population.

What happened after that is traced in a recent study, The Economic Impact of the Black Death, by three American academics, Remi Jedwab, Noel Johnson and Mark Koyama, and summarised by Timothy Taylor in his popular blog, the Conversable Economist.

The immediate consequences of all the deaths were severe disruptions of agriculture and trade between cities. There were shortages of goods and shortages of workers, so those who did survive had to be paid well. This will ring a bell: with shortages of supply but strong demand, inflation took off.

In England, the Statute of Labourers, passed in 1349, imposed caps on wages. It was highly effective during the 1350s, but less so after that. Similar restrictions were imposed elsewhere in Europe.

Over the next few decades, after economies had adjusted to the worst of the disruptions, the continuing shortage of workers resulted in many rural labourers moving to the cities, which had vacant houses as well as jobs. Farmers had to pay a lot to keep their workers, so real wages had grown substantially by the end of the century.

Since many noblemen had died, the distribution of income became less unequal. Ordinary people could afford better clothing. So, many countries passed “sumptuary” laws under which only the nobility were allowed to wear silk, gold buttons or certain colours. Nor could the punters serve two meat courses at dinner.

Sumptuary laws were an attempt by elites to repress status competition from below.

The authors say the economic effects of the Black Death interacted with changes in social and cultural institutions – accepted beliefs about how people should behave. Serfdom went into decline in Western Europe because of the fewer labourers available.

People became even more inclined to marry later and so have fewer children. Stronger, more cohesive states emerged and the political power of the church was weakened.

It’s widely believed that all these developments played a role in the economic rise of Europe, particularly north-western Europe.

Taylor notes that one of the great puzzles of world economic history is the Great Divergence - the way the economies of Europe began to grow significantly faster than the economies of Asia and the Middle East, which had previously been the world leaders.

This divergence began soon after the Black Death.

“Of course, many factors were at work. But ironically, one contributor seems to have been the disruptions in economic, social and political patterns caused by the Black Death,” he concludes.

Fortunately, advances in medical science mean our pandemic has cost the lives of a much smaller proportion of the population. And believe it or not, advances in economic understanding mean governments have known what to do to limit the economic fallout – even if we didn’t see the inflation coming.

Governments knew to spare no taxpayer expense in funding drug companies to develop effective vaccines and medicines in record time.

One consequence of our greater understanding of what to do may be that this pandemic won’t alter the course of world economic history the way the Black Death did.

Even so, it’s still far too soon to be sure what the wider economic consequences will be. Changing China’s economic future is one possibility. Come back in 50 years and whoever’s doing my job will tell you.

Even at this early stage, however, it’s clear the pandemic has led to changes in our behaviour. Necessity’s been the mother of invention. Or rather, it’s obliged us to get on with exploiting benefits from the digital revolution we’d been hesitating over.

Who knew it was so easy and so attractive for people to work from home – with a fair bit of the saving in commuting time going into working longer. And these days many more of us know the convenience of shopping online – and the downside of sending back clothes that don’t fit.

Doctors were holding back on exploiting the benefits of telehealth, but no more. Prescriptions are now just another thing on your phone. And I doubt if the number of business flights between Sydney and Melbourne will ever recover.

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We're struggling with inflation because we misread the pandemic

It’s an understandable error – and I’m as guilty of it as anyone – but it’s now clear governments and their econocrats misunderstood and mishandled the pandemic from the start. Trouble is, they’re now misreading the pandemic’s inflation phase at the risk of a recession.

The amateurish way governments, central banks and economists have sought to respond to the pandemic is understandable because this is the first pandemic the world’s experienced in 100 years.

But it’s important we understand what we’ve got wrong, so we don’t compound our errors in the inflation phase, and so we’ll know how to handle the next pandemic - which will surely arrive in a lot less than 100 years.

In a nutshell, what we’ve done wrong is to treat the pandemic as though it’s a problem with the demand (or spending) side of the economy, when it’s always been a problem with the supply (or production) side.

We’ve done so because the whole theory and practice of “managing” the macroeconomy has always focused on “demand management”.

We’re trying to smooth the economy’s path through the ups and downs of the business cycle, so as to achieve low unemployment on one hand and low inflation on the other.

When demand (spending by households, businesses and governments) is too weak, thus increasing unemployment, we “stimulate” it by cutting interest rates, cutting taxes or increasing government spending. When demand is too strong, thus adding to inflation, we slow it down by raising interest rates, increasing taxes or cutting government spending.

When the pandemic arrived in early 2020, we sought to limit the spread of the virus by closing our borders to travel, ordering many businesses to close their doors and ordering people to leave their homes as little as possible, including by working or studying from home.

So, the economy is rolling on normally until governments suddenly order us to lock down. Obviously, this will involve many people losing their jobs and many businesses losing sales. It will be a government-ordered recession.

Since it’s government-ordered, however, governments know they have an obligation to provide workers and businesses with income to offset their losses. Fearing a prolonged recession, governments spend huge sums and the Reserve Bank cuts the official interest rate to almost zero.

Get it? This was a government-ordered restriction of the supply of goods and services, but governments responded as though it was just a standard recession where demand had fallen below the economy’s capacity to produce goods and services and needed an almighty boost to get it back up and running.

The rate of unemployment shot up to 7.5 per cent, but the national lockdown was lifted after only a month or two. As soon it was, everyone – most of whom had lost little in the way of income – started spending like mad, trying to catch up.

Unemployment started falling rapidly and – particularly because the pandemic had closed our borders to all “imported labour” for two years – ended up falling to its lowest rate since 1974.

So, everything in the garden’s now lovely until, suddenly, we find inflation shooting up to 6.1 per cent and headed higher.

What do we do? What we always do: start jacking up interest rates to discourage borrowing and spending. When demand for goods and services runs faster than business’s capacity to supply them, this puts upward pressure on prices. But when demand weakens, this puts downward pressure on prices.

One small problem. The basic cause of our higher prices isn’t excess demand, it’s a fall in supply. The main cause is disruption to the supply of many goods, caused by the pandemic. To this is added the reduced supply of oil and gas and foodstuffs caused by Russia’s attack on Ukraine. At home, meat and vegetable prices are way up because of the end of the drought and then all the flooding.

Get it? Once again, we’ve taken a problem on the supply side of the economy and tried to fix it as though it’s a problem with demand.

Because the pandemic-caused disruptions to supply are temporary, the Ukraine war will end eventually, and production of meat and veg will recover until climate change’s next blow, we’re talking essentially about prices that won’t keep rising quarter after quarter and eventually should fall back. So surely, we should all just be patient and wait for prices to return to normal.

Why then are the financial markets and the econocrats so worried that prices will keep rising, we’ll be caught up in a “wage-price spiral” and the inflation rate will stay far too high?

Short answer: because of our original error in deciding that a temporary government-ordered partial cessation of supply should be treated like the usual recession, where demand is flat on its back and needs massive stimulus if the recession isn’t to drag on for years.

If we’d only known, disruptions to supply were an inevitable occurrence as the pandemic eased. What no one foresaw was everyone cooped up in their homes, still receiving plenty of income, but unable to spend it on anything that involved leaving home.

It was the advent of the internet that allowed so many of us to keep working or studying from home. And it was the internet that allowed us to keep spending, but on goods rather than services. It’s the huge temporary switch from buying services to buying goods that’s done so much to cause shortages in the supply of many goods.

But it’s our misdiagnosis of the “coronacession” – propping up workers and industries far more than they needed to be – that’s left us with demand so strong it’s too easy for businesses to get away with slipping in price increases that have nothing to do with supply shortages.

Now all we need to complete our error is to overreact to the price rises and tighten up so hard we really do have an old-style recession.

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Inflation: small problem, so don't hit with sledgehammer

It’s an old expression, but a good one: out of the frying pan, into the fire. Less than two years ago we were told that, after having escaped recession for almost 30 years, the pandemic and our efforts to stop the virus spreading had plunged us into the deepest recession in almost a century.

Only a few months later we were told that, thanks to the massive sums that governments had spent protecting the incomes of workers and businesses during the lockdowns, the economy had “bounced back” from the recession and was growing more strongly than it had been before the pandemic arrived.

No sooner had the rate of unemployment leapt to 7.5 per cent than it began falling rapidly and is now, we learnt a fortnight ago, down to 3.5 per cent – its lowest since 1974.

You little beauty. At last, the economy’s going fine and we can get on with our lives without a care.

But, no. Suddenly, out of nowhere, a new and terrible problem has emerged. The rate of inflation is soaring. It’s sure to have done more soaring when we see the latest figures on Wednesday morning.

So worrying is soaring inflation that the Reserve Bank is having to jack up interest rates as fast as possible to stop the soaring. It’s such a worry, many in the financial markets believe, that it may prove necessary to put interest rates up so high they cause ... a recession.

Really? No, not really. There’s much talk of recession – and this week we’re likely to hear claims that the US has entered it – but if we go into recession just a few years after the last one, it will be because the Reserve Bank has been panicked into hitting the interest-rate brakes far harder than warranted.

As you know, since the mid-1990s the power to influence interest rates has shifted from the elected politicians to the unelected econocrats at our central bank. A convention has been established that government ministers must never comment on what the Reserve should or shouldn’t be doing about interest rates.

So last week Anthony Albanese, still on his PM’s P-plates, got into trouble for saying the Reserve’s bosses “need to be careful that they don’t overreach”.

Well, he shouldn’t be saying it, but there’s nothing to stop me saying it – because it needs to be said. The Reserve is under huge pressure from the financial markets to keep jacking up rates, but it must hold its nerve and do no more than necessary.

It’s important to understand that prices have risen a lot in all the advanced economies. They’ve risen not primarily for the usual reason – because economies have been “overheating”, with the demand for goods and services overtaking businesses’ ability to supply them – but for the less common reason that the pandemic has led to bottlenecks and other disruptions to supply.

To this main, pandemic problem has been added the effect of Russia’s invasion of Ukraine on oil and gas, and wheat and other foodstuffs.

The point is that these are essentially once-off price rises. Prices won’t keep rising for these reasons and, eventually, the supply disruptions will be solved and the Ukraine attack will end. Locally, the supply of meat and vegetables will get back to normal – until the next drought and flooding.

Increasing interest rates – which all the rich countries’ central banks are doing – can do nothing to end supply disruptions caused by the pandemic, end the Ukraine war or stop climate change.

All higher rates can do is reduce households’ ability to spend – particularly those households with big, recently acquired mortgages, and those facing higher rent.

The Reserve keeps reminding us that – because most of us were able to keep working, but not spending as much, during the lockdowns – households now have an extra $260 billion in bank accounts. But much of this is in mortgage redraw and offset accounts, and will be rapidly eaten up by higher interest rates.

Of course, the higher prices we’re paying for petrol, electricity, gas and food will themselves reduce our ability to spend on other things, independent of what’s happening to interest rates. It would be a different matter if we were all getting wage rises big enough to cover those price rises, but it’s clear we won’t be.

The main part of the inflation problem that's of our own making is the rise in the prices of newly built homes and building materials. This was caused by the combination of lower interest rates and special grants to home buyers hugely overstretching the housing industry. But higher interest rates and falling house prices will end that.

So, while it’s true we do need to get the official interest rate up from its lockdown emergency level of virtually zero to “more normal levels” of “at least 2.5 per cent”, it’s equally clear we don’t need to go any higher to ensure the inflation rate eventually falls back to the Reserve’s 2 to 3 per cent target range.

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The cost of living is soaring, but raising interest rates won't help

This week removed any doubt that the cost of living is the dominant issue in this election campaign. We got official confirmation that the many people complaining about rising prices are, to coin a phrase, right on the money.

Now the Reserve Bank is under immense pressure to begin increasing interest rates at its board meeting on Tuesday. If it does so, this will add to the cost pressures facing many consumers, making the cost of living an even bigger issue politically.

But were it to wait for the latest information on wages that it will get three days before the election – which it really ought to – then increase rates in early June, it will be accused of choosing its timing to help the Coalition. And rightly so.

As Reserve Bank governor Dr Philip Lowe’s predecessor, Glenn Stevens, argued convincingly when he increased the official interest rate just before the 2007 election, which saw John Howard thrown out of office, the only way for the Reserve to be apolitical is for it to do what it believes the economy needs without regard to what’s happening politically.

Speaking of politics, The Conversation’s Peter Martin has used the ABC’s Vote Compass – a questionnaire which, among other things, asks respondents to name the issue of most concern to them – to show that, at the 2016 election, only 3 per cent picked “cost of living”.

At the 2019 election, it was only 4 per cent. At this election, however, 13 per cent of voters have picked it, making it the respondents’ second biggest concern, behind only climate change. (Which should be biggest. But that’s for another day.)

After this week, it’s probably more than 13 per cent.

This week the Australian Bureau of Statistics released figures showing the consumer price index rose by 2.1 per cent during the three months to the end of March, and by 5.1 per cent over the year to March.

Strictly speaking, the CPI is a measure of consumer prices rather than the cost of living, but it’s near enough. So this “headline” figure is the right one for people concerned about living costs. It’s the highest annual rate for two decades.

But it can be affected by extreme prices changes that don’t represent the general price pressures on the economy, so “for policy purposes” (that is, for its decisions about changing the official interest rate) the Reserve focuses on a measure of “underlying” inflation called the “trimmed mean”.

This excludes the 15 per cent of prices that rose the most during the quarter and the 15 per cent of prices that rose the least or fell.

By this measure, prices rose by 1.4 per cent during the quarter and by 3.7 per cent over the year. This is the highest it’s been since 2009, and well above the Reserve’s 2 to 3 per cent target range.

It’s standard behaviour for incumbent politicians to claim the credit for anything good that happens in the economy during their term, regardless of whether they’re entitled to.

So it’s only rough justice for opposition politicians to blame the government for anything bad that happens – which is just what Labor’s been doing this week.

But Scott Morrison and Josh Frydenberg have been arguing furiously that the leap in most prices has had nothing to do with them. And I think there’s a lot of truth to their claim.

Let’s look at the particular prices that do most to explain the March quarter jump in living costs. The biggest was a 5.7 per cent rise in the cost of newly built houses and units.

This has been caused by shortages of certain imported building materials due to pandemic-related disruptions to supply, worsened by a surge in demand for new homes arising from the authorities’ efforts to counter the “coronacession” by cutting interest rates and using HomeBuilder grants to keep the building industry moving.

Next in importance in explaining the surging cost of living is an 11 per cent rise in the cost of petrol and diesel fuel, caused by Russia’s war on Ukraine. These prices are up 35 per cent over the year to March.

The higher world oil price has also raised fresh food prices by increasing the cost of fertiliser, as well as increasing the cost of transporting many goods. The pandemic has temporarily increased the cost of international shipping.

Third in importance this quarter is a 6.3 per cent increase in university fees caused by a federal government decision last year.

Add in the 12 per cent annual rise in beef and lamb prices caused by graziers’ restocking following the end of the drought and you see that most of the rise in living costs so far comes from factors far beyond the government’s control.

So, are Morrison and Frydenberg off the hook on rising living costs? No. People feel the pain of rising prices more acutely when their wage rises haven’t been keeping up, let alone getting ahead.

In a well-managed economy, workers’ wages rise a little faster than prices. This hasn’t been happening, particularly in the past two years or so, and the government has made no attempt to rectify the problem.

Raising interest rates can do nothing to fix all the problems we’ve noted on the supply-side of the economy. The only thing it can do is dampen the demand for goods and services by increasing the cost of borrowing and by leaving those people with mortgages with less disposable income to spend.

Which is an economist’s way of saying what everybody knows: that higher interest rates add to the living costs of the third of households paying off a home loan. Those who’ve taken on loans in recent years will feel it most.

Of course, all those people living off their savings will be cheering the return to rising interest rates. But from an economy-wide perspective, the winners are far outweighed by the losers.

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Why prime ministers do have to hold a hose (and much else)

If we don’t have another setback on the COVID front between now and May, it seems likely Scott Morrison will escape having his various fumbles in handling the pandemic loom large in the federal election campaign. Even so, the coronavirus was a stark reminder of how much the running of this nation is down to the premiers, not the Prime Minister.

The premiers took full advantage of this opportunity to raise their political profiles. And they’re likely to stay more assertive for years to come.

We’ve all lived all our lives with Australia’s federal system of government. We all know it doesn’t work so well. We long ago tired of the eternal bickering, buck-passing, duck-shoving and cost-shifting between the two levels of government. But just as we’re “learning to live with COVID”, so we long ago got used to living with a dysfunctional federation.

Does a nation of 25 million people really need one federal, six state and two territory governments? Well, if you were starting with a clean sheet of paper, you wouldn’t design it that way.

But we’ve never had a clean sheet. Back in the 1890s, we began with six self-governing colonies. They would never have agreed to dissolve themselves in to one national government. And, today, it’s not just that all those premiers and state parliamentarians wouldn’t want to give up their well-paid jobs.

The Australian mainland is such a big island, and its people are so widely spread around its coastal edge, I doubt if voters in any state would choose to be ruled henceforth solely from distant Canberra.

But the states being immovable, efforts by various prime ministers to make the system work better have had little success.

The pandemic has reminded us that our constitution grants to the states, not the feds, ultimate responsibility for most of the things we expect governments to do for us: healthcare, education, transport, law and order, housing, community services and the environment. Only the states and territories had the constitutional power to order lockdowns or close state borders.

But the problem isn’t just constitutional. It’s also economic. It’s what economists call “vertical fiscal imbalance”. Over the years – and with much help from rulings of the High Court – the feds have accreted to themselves most of the power to levy taxes.

See the problem? The feds raise most of the tax revenue, whereas the states have most of the responsibility for spending it.

Economists think the federation would work better if there was a closer alignment between each level’s spending responsibilities and its tax-raising capacity. But prime ministers haven’t been keen to hand over their taxing powers.

The bigger problem with VFI, as the aficionados call it, isn’t economic, it’s political: the feds cop the blame for levying nasty taxes; the states get the credit for lots of lovely spending. The states love it, the feds hate it.

Related to this is a truth that seems to come as a shock to prime ministers. The feds run defence and foreign affairs and customs and trade. Apart from that, they raise taxes and write cheques – to the premiers, universities, chemists and bulk-billing doctors, pensioners and people on unemployment benefits.

What the feds don’t do much of is deliver programs on the ground, whereas that’s the main thing the states do. Run hospitals and schools, build highways, fight bushfires and clean up after floods.

Turns out that when the feds do try to deliver programs on the ground – put pink batts in ceilings; roll out vaccines across the land – they stuff it up.

In all this you have the hidden explanation for some of Morrison’s coronafumbles.

Despite him setting up the national cabinet – and doing most of the on-camera talking after each meeting – it turned out that most of the credit for our success in handling the pandemic went to the premiers, not him. “What? Even though the feds were picking up almost all the tab?”

Apart from the feds’ failure to order enough vaccines early enough, it seems clear Morrison decided to deliver them through an essentially federal distribution chain of GPs and pharmacists, in the hope this would yield him more of the credit.

That’s how the rollout became a stroll out. It was slow and unfamiliar. Only when the feds admitted defeat and started distributing vaccines through the experts – the states’ public hospitals and mass-vaccination hubs – did things speed up.

I suspect other hold-ups – in replacing JobKeeper; in distributing rapid antigen test kits – came because the feds and states fell to arguing over how the bill should be divvied up. “Why am I paying when you’ll be getting all the credit?”

Morrison said what he did about hoses because bushfires are a state responsibility. Constitutionally, correct; politically, incorrect. He’s had to learn the hard way that if a state problem affects more than one state – or just gets too big for the state to cope with – it becomes a federal problem in the minds of voters.

If you can’t hold a hose, just bring your chequebook.

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Problems abound, but we could yet emerge as winners

As we begin to lift our heads and look beyond the lockdown, it’s easy to see the many other problems we face. It’s possible to view those problems with fear and disheartenment – and it suits the interests of many groups to play on our fears.

But it’s almost as easy to see Australia as still a lucky country, with a populace that’s confident, resourceful, committed to the “fair go” and capable of co-operating to convert our problems into opportunities to flourish.

The keys to making life in Australia better rather than worse are to face up to all the change being forced upon us, and to unite in finding solutions that share both the costs and the benefits as fairly as possible.

Ideally, we’d have a political leader who offered us a more united, optimistic and confident vision of the path to a better world, but the sad truth is the two main parties are locked in a race to the bottom that we can’t even be sure they’d like to escape.

In reviewing our problems, let’s start with the pandemic. There’s a risk that we’ve opened up too soon, that our hospitals are overwhelmed and death rates rise unacceptably, forcing the premiers to backtrack.

But it’s only a risk and, assuming it doesn’t happen, I think we can be confident the economy will bounce back strongly and quickly, as it did last year. It won’t be quite as strong as last year because the feds haven’t splashed around nearly as much money as last time.

Even so, most households have saved a lot of their incomes and, as we saw last year, will spend much of the increase over coming months.

At a global level, the risk is that the pandemic continues for years more, as long delays in vaccinating everyone in the poor countries allow new variants to emerge. That the rich countries, having hogged all the vaccines, then lose interest in the topic.

Our first post-pandemic problem is that the economy will rebound only to the plodding rate of growth we were achieving before the plague arrived. Like the other rich countries, our rate of improvement in productivity – production per worker – is anaemic.

Our business people are going through a phase where the only way they can think of to increase profits is to use every tactic to keep wage rises as low as possible. The penny is yet to drop that, since wages are their customers’ chief source of income, this is not a winning formula.

Other problems abound: ever-rising house prices that can’t keep rising forever; adjusting to the ageing of the population and the growing demand for aged care; continuing digital disruption, with all its benefits to users but upheaval in affected industries; handling the growing assertiveness of China, while still taking advantage of being part of the global economy’s fastest-growing region; and the less tangible but no less worrying problem of the breakdown of trust in Australian and global institutions and relationships.

All that’s before we get to our biggest problem – responding to climate change – which, with the Glasgow conference starting in less than two weeks, is also our most pressing challenge.

No issue better illustrates the lesson that, if we want to be on top of our problems rather than crushed by them, we must face up to inevitable changes being forced on us by forces we don’t control.

We must stand up to powerful interests – our coal, oil and gas industries, in this case – hoping to stave off the evil hour as long as possible. They’ll protect their own interests at our expense for as long as we let them. We must be suspicious of political parties accepting donations from these urgers.

We must resist the blandishments of populist politicians – yes you, Tony Abbott – promising to save us from sky-high power costs (we got them anyway) because we can just let the whole thing slide.

Now we have the farmers-turned-miners National Party holding themselves out as champions of the put-upon regions and using their veto over adoption of the net zero emissions target to extort money from the Liberals.

People in the regions, we’re told, bitterly resent Liberal city slickers sitting pretty while imposing all the costs of adjustment on the bush.

This conveniently ignores two points. First, farmers are the biggest losers from climate change and the biggest winners from successful global action to limit further global warming.

Second, as Scott Morrison rightly says, coal mining jobs in NSW and Queensland will decline as other countries reduce their own emissions by ceasing to buy our coal and gas. But acting to get on with making Australia a renewable energy superpower – including by exporting hydrogen, clean steel and clean aluminium – will create many new skilled manufacturing jobs – all of them in the regions.

But only if we stop thinking and acting like losers, and do what it takes to be winners in the new, decarbonised world.

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Blame the lockdown on business urgers trying to wish the virus away

I’ve yet to see any of the perpetrators – Liberal tribal mythmakers, industry lobby groups and business’ media cheer squad – admit to their part in the humbling of that “gold standard” virus fighter, NSW premier Gladys Berejiklian (a woman I quite like).

All those business people feeling the pain of NSW’s protracted lockdown – which seems not to be getting anywhere, with no end in sight – have no one to blame but the short-sighted, self-centred urgers on their own side.

The great “learning” from our earlier struggles to control the coronavirus – particularly Victorian premier Daniel Andrews’ struggles this time last year – was the wisdom of the medicos’ advice that the exponential nature of pandemics meant the best strategy was to go early, go hard.

The economic modelling Treasury did to accompany the Doherty Institute’s epidemiological modelling confirmed this wisdom. “Continuing to minimise the number of COVID-19 cases, by taking early and strong action in response to outbreaks of the Delta variant, is consistently more [economically] cost-effective than allowing higher levels of community transmission, which ultimately requires longer and more costly lockdowns,” Treasury concluded.

Another relevant “learning” – drawn by Treasury from economic studies overseas – is that, should governments not impose lockdowns, many anxious people will significantly curtail their economic activity of their own accord. The assumption that it’s the government’s lockdown, not the virus’s threat to people’s health, that does all the economic damage is fallacious.

Yet going early and strong is just what Berejiklian failed to do. Why? Because of all the pressure she was under from her own side to be a true Liberal and control the problem without resorting to lockdowns or border closures.

That pressure started at the top with Scott Morrison and his ministers, but was eagerly pursued by the business lobbies and business’ media cheer squad. In his efforts to score points off Andrews, no one worked harder than Treasurer Josh Frydenberg to propagate the mythology that only Labor premiers were so dictatorial and disregarding of business wellbeing as to lockdown and close state borders at the first sneeze, whereas Liberal premiers knew how to get results with superior testing and contact tracing.

To be fair, it’s clear Labor’s Mark McGowan in Western Australia and Annastacia Palaszczuk in Queensland, both with state elections coming up, were well aware of the votes to be reaped by gratifying their locals’ xenophobic tendencies towards possibly plague-ridden people from “over East” or “down South”.

But the fact remains that with Sydney and Melbourne being the country’s two main international gateways, it’s been eminently sensible for the other premiers to protect their states from infection by closing their borders. Yet they’ve been subject to continuing abuse from the national press.

And in view of the medical experts’ consistent advice, the pressure to which all the premiers have been subjected over lockdowns and borders amounts to trying to wish the virus away. “Don’t worry about contagion, just keep business open and making money.”

This is hardly enlightened self-interest. It’s short-termism at its worst. It’s wilfully disregarding the greater good. “Ignore the interests of other ‘stakeholders’ – even the consumers I hope will still be able to buy my product in the months ahead – I’m just gunna keep pushing my own self-interest.”

The nation’s business people don’t need me to tell them our politicians – including those purporting to represent the business side - can be trusted to favour their own survival at the next election over the prospects for businesses long beyond the election.

But I do wonder whether business people understand the potential for conflict between their interests and those of others anxious to take up the cudgels on their behalf – for the small fee.

The industry lobby groups work in the national capital representing the interests of member businesses around the country. No doubt much of what they do isn’t highly visible and doesn’t lead to spectacular results.

Much of their communication with members would be via the media, where they need to be seen as tireless champions of their members’ interests, shouting louder than rival interest groups. Just to be noticed by the media they’d need to be hardline.

An ability to see the other side’s viewpoint – or the government’s difficulty in balancing conflicting objectives - wouldn’t be career-enhancing. Like the pollies themselves, they’d worry more about appearances and impressions than about making all things work together for the ultimate good of their members.

The self-appointed media business cheer squad is operating on a business model that sees telling people what they want to hear as more rewarding than telling them what they need to know. Commercially, they may be right. But, as you may have gathered, it’s not the way I do business.

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Our leaders would do better if their followers were thinking harder

Much has been said about the failures of Scott Morrison, Daniel Andrews and Gladys Berejiklian in our never-ending struggle to keep on top of the coronavirus. But just this once, let’s shift the spotlight from our fallible leaders to the performance of those they lead. I think we ourselves could be doing a better job of it.

There is, after all, much truth in the saying that we get the politicians we deserve. When we think we’re entitled to have good government served up to us on a plate, we’ve lost sight of the truth that well-functioning democracies require diligent citizens, not just honest and smart politicians.

Perhaps our biggest complaint has been that our leaders and experts keep changing their tune. Why can’t we be told simply and clearly what’s required of us? Why can’t the pollies decide what they want and stick to it?

It’s as though they’re making it up as they go along, chopping and changing when they realise they’ve taken another wrong turn. Hopeless.

Let me tell you the shocking truth: they are making it up. But if you were thinking harder you’d realise that’s all they can do. As Morrison rightly says, a new virus doesn’t come with an instruction manual.

Our political leaders are relying heavily on epidemiologists and other medical experts because pollies have so little knowledge and experience of pandemics. The medicos know a lot about viruses, epidemics, vaccination and immunology, but at the start they knew little about the characteristics of this particular virus.

They were forced to make assumptions about those characteristics but, as they’ve realised those assumptions were wrong, they’ve changed them.

At the start they thought the virus was spread in big droplets landing on surfaces within one or two metres, whereas now they think it’s more like smoke. Without strong ventilation, it builds up in the air. This explains much of the early uncertainty about whether masks were a good idea.

The medicos have relied on the findings of the limited studies available, but when bigger and better studies have come along with different findings, they’ve updated their views.

As I don’t think Keynes actually said, “When the facts change, I change my mind. What do you do, sir?” Or, as he did say, “It is better to be roughly right than precisely wrong.”

Those people carrying on about how confusing it all is and how incompetent our leaders are reveal their own intellectual laziness: their reluctance to think through complex, nuanced, ever-changing problems when they’d prefer to be back watching carefully choreographed “reality” television. And their ignorance of how science works, slowly groping towards an ever-changing best guess at the truth.

The media’s new-found interest in public health means formerly obscure academics have become TV stars and any boffin who disagrees with what the government’s doing about X gets an op-ed article to air their dissent.

You could say this is adding to the confusion, but it’s science proceeding the way science does. It’s academics doing what academics do – eternally arguing among themselves.

It’s tempting to tell them “not in front of the children”, but when you remember how lacking our leaders are in competence, openness and accountability, the last thing our democracy needs is for experts to keep their critique of government policies to themselves.

You might have thought that a bunch of media-innocent scientists and a news media devoted to highlighting the exceptional over the typical, seeking out controversy and not always untempted by the sensational, would make an explosive combination.

But for the most part, the media have been on their best behaviour, favouring their audience’s need for accurate, trustworthy information. That brings us to the Australian Technical Advisory Group on Immunisation, and its ever-changing recommendation on who should be receiving the AstraZeneca vaccine now it’s been found to carry a very rare risk of blood clotting.

The advice has changed partly because circumstances have changed, but mainly because the original advice led to considerable vaccine hesitancy at a time when the vaccine rollout is way behind, we have Greater Sydney in lockdown and loads of AstraZeneca is going begging while little of the alternative Pfizer vaccine is available.

The advisory group has been criticised, but I think it was a narrowly constituted group, which gave narrow advice when what the government needed – and should have sought from elsewhere – was advice taking account of a broader range of factors.

The public’s huge reaction against the vaccine is unwarranted and unfortunate at such a time. AstraZeneca is less risky than taking aspirin. But when the media gave such attention to the clotting risk, the overreaction wasn’t surprising.

Responsible reporters can say “very rare” as many times as they like but, as our science reporter Liam Mannix has explained, humans are notoriously bad at giving minuscule probabilities the weight they deserve.

The saver may be that, as highly social animals, when people see so many of their friends lining up to “bare their arms”, their hesitancy may evaporate. It’s a strange, messy world we live in.

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Don’t be surprised if the economy surprises on the downside

The economy has been on a roller-coaster since the virus arrived early last year, dipping one minute, soaring the next. Now, with the Delta variant putting Sydney and Melbourne back in lockdown, we’re in the middle of another dip. But as you hang on, remember this: what goes down must come up.

When governments order many businesses to close their doors, and us to leave our homes as little as possible, it’s hardly surprising that economic activity takes a dive. What did surprise us was the way the economy bounced back up the moment the lockdown was eased.

We rushed out of our houses and started spending like mad. Not that we weren’t spending whatever we could while locked down. Another surprise was the way the presence of the internet changed what would otherwise have happened.

Apart from allowing most people with desk jobs to work from home, and talk face to face to people in other cities without getting on a plane, it allowed us to keep spending: ordering groceries and takeaways online, consulting doctors over the phone – I thought receptionists were there to stop you getting through to the great personage – buying exercise equipment and stuff to get on with fixing up the back bedroom.

As I keep having to remind myself, only God knows what the future holds – and He’s not letting on. But it’s part of the human condition to be insatiably desperate to know what happens next. We keep searching the world for the one person who might be able to tell us.

Since even the experts can’t be sure what will happen, they base their predictions on the hope that what happens this time will be much the same as what usually happens. Experts are people who remember last time better than we do.

But that way of predicting the future hasn’t worked this time. The epidemiologists – and all the related -ologists we hardly knew existed – know a lot about viruses but, at the start, little about the particular characteristics of this one. Their predictions have kept changing as they’ve had more to go on.

Last year’s recession was the fifth of my career (counting the global financial crisis, which I do). I thought that knowledge put me so far ahead of the game I was an expert expert. Wrong.

Ordinary recessions happen because the people managing the economy stuff up. The economy takes well over a year to unravel, then three or four years to wind back up. But this recession was completely different, having been knowingly brought about by governments, for health reasons. When at last they let us go back to business, however, that’s just what we did.

The initial, nationwide lockdown caused the economy’s production of goods and services (gross domestic product) to dive by an unprecedented 7 per cent in just the three months to the end of June last year. But then the economy bounced back by 3.5 per cent in the September quarter and a further 3.2 per cent in the December quarter after Victoria’s delayed release from lockdown.

In the period before the Delta strain sent Sydney back into humbling lockdown, GDP was ahead of what it was at the end of 2019. Total employment was also ahead, while the rate of unemployment was actually a little lower.

Since the present September quarter has two months left to run, and Sydney’s lockdown rolls on even though Melbourne’s has ended, it’s too early to be confident by how much GDP will fall but, depending on how long Sydney’s drags on, it’s likely to be a fall of less than 1 per cent or somewhat more than 1 per cent. However bad, a lot less than last time.

As for the December quarter – and barring some new outbreak, say a new letter in the Greek alphabet – it’s likely to show expansion rather than contraction. Victoria will be growing, NSW will be in bounce-back mode as soon as the lockdown ends, and the rest of Australia will be doing its normal thing.

So all those silly people desperate for a chance to repeat the R-word aren’t likely to get the excuse they imagine they need.

Another major respect in which coronacessions differ from normal recessions is that politicians can’t consciously decide to stop the economy without at the same time providing generous assistance to all the workers and businesses this will harm. Normally, the assistance comes much later and is less generous.

Despite cries for the return of JobKeeper, the arrangements Scott Morrison has hammered out with Gladys Berejiklian and Dan Andrews are, by and large, a good substitute for the measures used the first time around.

The other thing to remember is that the economy is in much better shape now than at the end of 2019. Households have more money in the bank, the housing market is booming, profits are up and businesses are complaining about staff shortages.

Not such a bad time to cope with a setback. It won’t be the end of the world.

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