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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You can blame Albanese for all our woes - except the cost of living

I try not to be a pollie basher – we get the politicians we deserve – but I can’t remember a time when I’ve been more disillusioned and disheartened by the performance of both major parties. It’s fair to criticise them on every topic except the one that obsesses us: the cost-of-living crisis.

Let’s start with that. For several years, we had prices rising at a rate that was actually lower than the Reserve Bank and economists regarded as healthy: less than 2 per cent a year. But then, in the months before the federal election in May 2022, at which Scott Morrison and crew were tossed out, prices took off.

By the end of that year, consumer prices had risen by almost 8 per cent. As you remember, the Reserve Bank began trying to get inflation back under control the only, crude way it knows: to discourage households from spending so much by using higher interest rates – particularly on home loans – to leave us with less to spend on other things.

Why did the Reserve Bank start raising rates during the election campaign, rather than waiting until it was over? Because it foresaw that a change of government was likely and didn’t want anyone getting the idea that it was the new government that had caused the problem.

By the same token, it’s hard to blame the surge in prices on the Morrison government. Prices took off in all the rich economies for much the same reasons. First, because the pandemic caused major disruption to supply of many goods, and because Russia’s attack on Ukraine disrupted world gas and oil markets.

But second, because the efforts to prop the economy up during the lockdowns – by slashing interest rates almost to zero, and the shedloads of government spending on the JobKeeper scheme, the temporary doubling of unemployment benefits, and on many other things – proved to be wildly excessive. When people started spending all that extra money, demand for goods and services grew faster than businesses’ ability to supply them, so they whacked up their prices.

You could blame this gross miscalculation on Morrison & Co – except that it was the first pandemic the world had seen in a century, the medicos had no idea how bad it would be or how long it would take to develop a vaccine, and like all governments everywhere, our government and its econocrats decided it would be safer to do too much than too little.

Since then, the passing of the international supply disruptions and the Reserve Bank’s many interest-rate increases have succeeded in getting the rate of price increase down a long way. But the bank won’t start cutting interest rates until it’s convinced our return to the 2 to 3 per cent inflation target zone will last.

Despite the unceasing criticism of a largely partisan news media, the Albanese government’s part in helping get inflation back under control has been as good as it’s reasonable to expect.

One reason it’s taking so long is that both the government and the Reserve Bank have been trying to avoid causing a huge rise in unemployment, and in this, they’ve been spectacularly successful. The proportion of the working-age population with jobs is at a record high.

So if it’s not fair to blame Albanese and his ministers for the cost-of-living crisis, why am I so critical and disapproving of the government – not to mention the opposition?

Because on almost every other matter Albanese has touched, he’s done far less than he should have. And in their time on the opposition benches, the Liberals and their Coalition partners have laboured mightily to make themselves more extreme and less electable.

As always, we turned to a new government in 2022 full of hope that it would make a much better fist of dealing with our many problems. And it’s always been true that Albanese and his people knew what needed doing. It’s just that, somewhere along the line, he seems to have lost his bottle.

He’s done a bit to tackle each of our big problems, but with one exception, he’s stopped short of doing nearly enough. Everything gets a lick and a promise.

The one exception has been the government’s significant efforts to reduce job insecurity – to improve the wages and conditions of less-skilled workers – for which we can thank the unions. Under the Labor Party’s constitution, the union movement holds a mortgage over the party and its members of parliament.

On everything else, Albanese seems to live in fear of annoying some interest group somewhere. So he always does something, but never enough. When business and other interest groups lobby the government privately to tone down its planned changes, he invariably obliges.

You can see this in the government’s changes to gambling advertising, Medicare bulk-billing, the adequate taxation of mining and gas, the National Anti-Corruption Commission (no public hearings), the housing crisis, vocational education and training, aged care and so forth.

But on no issue has Albanese failed so badly as on the one most vital to our future: climate change. Sure, he’s shored up the Coalition government’s “safeguard mechanism” and legislated the target of reducing emissions by 43 per cent by 2030. At the same time, however, he’s acted to secure the future of natural gas extraction and authorised expansion of three big coal mines.

It’s as though he’s taking an each-way bet. He seems desperate to stay in office, but has no great plans to govern effectively.

Meanwhile, under Peter Dutton, the Liberals and their pro-mining National Party colleagues have used their time in opposition to make themselves negative, divisive and utterly unworthy to take over from a weak government. Their one substantive policy is to be off with the nuclear fairies.

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How weak competition forces up food prices along the supply chain

By Millie Muroi, Economics Writer

The first most of us see of our groceries is the end product – after all the planting, growing, shipping and packaging has happened. So when we’re hit with a big bill at the checkout, it’s easy to blame supermarkets for the expensive beef, carrot or turnip that ends up on our forks.

We know Coles and Woolies have received raps on their knuckles for their behaviour recently, including alleged false discounts to lure in customers. But it’s not just customers or the competition watchdog dishing out their disdain. And it’s far from just the supermarkets that have pointed questions to answer.

Dr Andrew Leigh, former economics professor and now assistant minister for competition and treasury, has had a deep-dive into the topic. It turns out the list of possible culprits when it comes to the costly lack of competition is longer than just the supermarkets – and it’s our farmers bearing the brunt of it.

Basically, while our household budgets are getting pushed by pricier produce, farmers are getting squeezed. They’re not just facing higher prices when it comes to key ingredients such as fertiliser and machinery, but also higher costs and unfair terms once their produce is ready to be processed, shipped off and sold.

How do we know this? There are a few key signs.

Concentration is one. “Industries with plenty of competitors tend to deliver better prices, more choices and stronger productivity growth,” Leigh said in a speech this week.

The fewer players there are in a market, the less competitive it tends to be. Less competition usually means lower wages, less choice for consumers and less innovation, with dominant businesses able to charge higher prices than they might otherwise be able to, since they don’t have to worry so much about being undercut or fighting to win over customers with bargains.

Analysis by economic research institute e61 last year found all Australian industries were more concentrated than those in the US, especially in mining, finance and utilities, in which the top four firms have more than 60 per cent market share.

Generally, we see a market as “concentrated” if the biggest four firms control one-third or more of it. In 2016, Leigh and his colleague Adam Triggs found more than half of industries in the Australian economy were concentrated markets. Since then, concentration in Australia has become worse.

Farming, though, is surprisingly competitive – at least for most commodities. So why are we still seeing higher prices at the check-out?

Part of it is thanks to supply chain issues, especially during the pandemic, which meant we couldn’t get as many materials and produce from overseas, reducing supply and driving up prices. Then there’s always the temperamental weather, which can dramatically cut harvests.

But it’s a growing domestic issue which is causing headaches for farmers.

Before anything even springs out of the ground or fattens up in a paddock, farmers are dealt a tricky hand. The largest four fertiliser companies, for example, control nearly two-thirds of the market and the top four hardware suppliers control roughly half of the market, according to Leigh’s analysis of data from IBIS World.

From high-tech harvesters to tractors and seeding equipment, machinery is a big cost paid by farmers. That means when there’s a lack of options and farmers aren’t able to shop around as much, their hip-pockets – and ours – are worse off.

If you think that lack of choice is bad, Leigh says it’s even worse when farmers go to repair and service their equipment.

Farming machinery makers have a lot of power – even more than carmakers – thanks to warranties forcing farmers to go to a specific dealer for servicing, and tech restrictions holding farmers back from accessing the parts, manuals and diagnostic software they need to make repairs themselves.

Then there are seeds. From these little things, big costs can grow. One paper from the US Department of Agriculture’s Economic Research Service in 2023 found the seed sector had become more concentrated. Between 1990 and 2020, the average seed price soared 270 per cent, and 463 per cent for genetically modified types.

The huge price increase partly accounts for the fact seeds have become better – for example, GMO varieties which have made farming more productive. But as Leigh points out, “there are not many other industries where the price of a key input has grown five-fold in 30 years.”

But that’s not all. Once the cattle has been raised or the blueberries grown, farmers have little choice or bargaining power when it comes to processing, transporting and selling produce.

When it comes to slaughtering cattle, the top five Australian processors accounted for about 57 per cent of the market in 2017, meaning cattle farmers had little choice in the prices and options they accepted. For fruit and vegetable processing, the biggest four companies hold about one-third of the market.

When the produce is ready to be sent out, farmers have even less choice. Two companies – ANL and Maersk – account for 85 per cent of the shipping freight industry in Australia, and four companies control 64 per cent of the market if farmers want to send things via rail.

Farmers, especially those who produce at a smaller scale, often become the “meat in a market concentration sandwich”. 

Farmers, especially those who produce at a smaller scale, often become the “meat in a market concentration sandwich”. Credit:Louise Kennerley

As Leigh points out, the risk of spoilage further limits viable options available to farmers.

Then there’s the supermarket sector, where Coles and Woolies control about two-thirds of the market – a higher share than every OECD country except New Zealand and Norway.

Concentration at all these points means farmers are at greater risk of facing power imbalances, which show up in things such as unfair contracts, where terms are obviously lopsided. Bigger players in these concentrated industries can generally muscle in with terms which are worse for farmers, such as restricting them from raising issues or selling things at unfairly cheap prices.

All of this not only puts pressure on farmers, but can reduce their ability and incentive to invest in improving their product and the way they do things.

As Leigh puts it, farmers, especially those who produce at a smaller scale, often become the “meat in a market concentration sandwich”.

There’s no easy fix in all this, but preventing too many mergers, where companies combine and gobble each other up to become even bigger, is key to promoting competition.

Of course, bigger companies are not always worse. Their scale can allow them to do things more cheaply. But too little competition can lead to pumped-up prices which flow all the way through from more expensive seeds and fertiliser to the prices charged by supermarkets.

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How supermarkets get away with raising their prices

 By Millie Muroi, Economics Writer, October 4,2024 

If Coles and Woolies wanted to get away with higher prices, they just had to tell us.

Alright, it’s not that simple. But there is a getaway car for any business wanting to keep customers coming – even after pumping up their prices. False discounting? No. Read on.

The high-inflation environment has sucked for a lot of us: growing grocery bills, surging insurance premiums and higher housing costs, to name a few. But the way we’ve perceived price increases – and the way we’ve responded to them – tell us (and businesses) a lot about how and when they can push prices up without getting customers cross.

Behavioural science consultancy Dectech took a look at the most recent spurt of inflation in the UK and how consumers saw – and changed their behaviour in response to – large price rises. They did their own testing, too, to see whether different justifications given for those pesky price hikes could change the way customers responded.

Now, you might expect customers to behave consistently to a price rise, regardless of the justification given for it. After all, an $8 packet of chips is still sucking more money out of your bank account than a $5 packet, regardless of the reason given for it.

But the thing about behavioural economics is that it often pokes holes in the neat economic models and theories we have in place to explain how we act. The law of demand, for example, states that as prices rise, customers buy less. Most economic models wouldn’t account for the fact that this depends on how companies explain those price hikes.

But the effect of the reasoning given for inflation can be more influential than the inflation itself, according to Dectech. An unexplained price rise, or a price rise for a “bad reason” can have a similar effect on customer behaviour as a 16 percentage point higher price rise for a “good reason”.

So, what’s the difference between “good” and “bad” reasons? Basically, it comes down to whether the price increase seems fair. Of course, this all comes down to perception. But one thing which helps to increase customers’ perceived “price fairness” is understanding how the price for a product was determined.

Despite the law of demand, pointing to increased demand for a price rise is a “bad” reason: it has the biggest negative effect on customer satisfaction and eagerness to buy a product. This is especially the case for a sector like telecommunications where the retailer doesn’t really have significant supply constraints.

By contrast, the best way to fend off angry customers is to either blame it on cost increases which “have to” be passed on, or to say the price increase covers extra costs needed for product development. Essentially, it has to be either something out of a business’s control, or aimed at improving the customer’s experience.

The worst thing a business can do is give no reason at all and hope no one notices (or, as Coles and Woolies have allegedly done, hide those price rises beneath false discounts, eroding customers’ trust). A 20 per cent price rise with the explanation that you’re investing in the product has the same effect on sales as a 4 per cent price rise with no explanation.

Even something as vague as “due to recent circumstances” is better than nothing. Did the dog eat your conveyor belt? Or is it because of a global supply shock? Who knows – but it works because at least the business is showing the decency to own the price increase. Openness and honesty count for something.

Time-poor and lazy

It also depends on the sector. Dectech’s study found raising prices “to invest in the product” worked especially well for the grocery and airline sectors – at least in the UK. Why? “People want to see better ready-made meals and new aeroplanes,” the authors said.

We also know humans aren’t big fans of change. We’re creatures of habit, often preferring to stick to routine or with what we know. Independent Australian economic research institute e61’s economist Matt Elias took a peek into consumer bank transactions linked to store locations and found there was a “persistent degree of inertia” when it comes to our supermarket choices.

Chances are, even if you have multiple options, you stick with one of the big two: Coles or Woolworths. It’s hard to pinpoint why, but Elias says it could reflect the fact that comparing prices between supermarkets can be tricky: there are so many items which are changing in price from week to week.

Consumers are also time-poor and – let’s face it – lazy. How often do you pull up the websites or catalogues of the major supermarkets to optimise your shopping? Probably not as much as you should or could.

Fluffy handcuffs

Brand loyalty can trap consumers, and unfortunately, it can reduce competition, handing more market power to big companies such as Coles and Woolworths. Why? Because when customers refuse to shop around, there’s less pressure on businesses to offer the best prices.

One way to combat this, Elias says, is to set up a government-supported digital price comparison platform, similar to the websites and apps we have to compare fuel prices. When these systems have been set up overseas, they’ve resulted in lower prices.

Loyalty cards or reward apps can worsen customers’ inertia, acting like fluffy handcuffs. They lock in consumers who would otherwise be more inclined to shop around for the best deal by offering enticing rewards for being faithful. Why cut prices when your customers are busy spending at your store to rack up points?

While economists like to assume people are perfect bargain-hunters, helping to keep companies on their toes and prices in check, the reality is blurrier. From inertia to justifications and loyalty cards, our behaviour is shaped by more than price. Being aware of some of what makes us tick (or sit back) can help businesses make money – but it can also help us save it.

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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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Why the Reserve Bank thinks it's too soon to cut interest rates

By Millie Muroi, Economics Writer 

When the Reserve Bank’s second-in-command – recently appointed deputy governor Andrew Hauser – took shots at his closest observers this week, he ruffled plenty of feathers.

“It’s a world of winners and losers, gurus and charlatans, geniuses and buffoons,” he proclaimed. Then he wagged a finger at those confidently commentating from the sidelines on the direction of the economy. “It’s a dangerous game,” he warned.

We know economists – including those at the Reserve Bank – are notoriously bad at knowing exactly what we (and therefore the economy) will do. So, why was Hauser so mad at those confidently making their own calls?

Brash statements made by the media, government and economists have real-world consequences. People often rely on that information to make decisions, from taking out mortgages to negotiating wages.

“What about Phil Lowe?” you may ask. Didn’t the former RBA governor promise in 2021 that interest rates would not go up until 2024? Well, sort of. It was actually couched in caveats which many people glossed over.

The Reserve Bank generally treads carefully because the words of its bosses can shift behaviour: a hidden weapon beyond its interest rate-setting superpower.

RBA governor Michele Bullock often declares she is “not providing forward guidance” when fielding questions from journalists trying to get a steer on interest rates. But last week, she gave the closest thing to guidance in a while: people’s expectation for rate cuts in the next six months doesn’t align with the RBA board’s feeling, she said. At least, “not at the moment.”

In doing so, Bullock flexed the bank’s hidden bicep. She signalled for all of us to rein in our expectations of a rate cut and, she would have hoped, our inflation expectations.

This is important because what people believe can become reality. If we expect inflation to stay high, this belief can feed into the wages we ask for, and the prices businesses charge.

That’s not to say the Reserve Bank doesn’t believe its own thinking. The only medicine it can explicitly prescribe is the level of interest rates, but the central bank busies itself with a lot of data gathering, discussions and number crunching to diagnose the state of the economy.

Core to the Reserve’s thinking is its observation that, collectively, we are consuming more than we can produce for an extended period of time. Sure, young people and mortgage holders have been tightening their belts as housing costs surge. But that’s been more than offset by older, affluent Australians splurging on things such as travel, by population growth and by government spending.

Now, the government has bones to pick with any suggestion that its spending is contributing to inflation. And Government Services Minister Bill Shorten this week trashed RBA chief economist Sarah Hunter’s assessment that the economy is “running a little bit too hot”.

However, it is important to note Hunter’s view isn’t necessarily that Australians are doing too well, or that the economy is bubbling along. It’s more a reflection of the limited spare capacity we have to cater for the spending – however little or much of it we may be doing.

We’re spending “too much” mostly by comparison to the limited resources we have to keep up with it: the people making our coffee in the morning and machines they use to brew it for us, for example.

Unless we become more productive, making more with the things we already have, the more we strain people and machines to meet our demands, and the pricier things will be to produce.

Productivity is especially difficult to improve for sectors such as hospitality, which rely heavily on people rather than machines (there’s only so many ways your barista can brew a coffee faster and better). And it’s why services inflation is proving so much more stubborn than goods inflation.

How does the Reserve Bank know how much spare capacity we have (and therefore how much pressure we might expect on prices)? It looks at something called the output gap: the difference between how much we’re producing and how much we could produce without putting too much pressure on prices.

Heaven for the Reserve Bank would be an output gap of zero. Any lower means we’re not using our resources as intensively as we could – including people who want to work, but can’t find jobs, or machines sitting idle.

Any higher, and we’re using our resources too intensively. This can be OK for a short period, but as workers demand higher wages, machines are run into the ground and businesses compete for a shrinking pool of resources, prices rise. For the past few years, this is the state the Reserve Bank thinks our economy has been in.

Measuring the output gap is tricky. We can’t really see it, and our capacity can change over time as our population changes, or we find better ways to do things. So, how does the RBA measure it?

How much the economy is producing is measured through statistics such as Gross Domestic Product. The trickier task is pinning down how much the economy could produce without adding to inflation. To do this, the Reserve Bank uses economic models which spit out results based on things such as what’s happened in the past and the data plugged into them: relatively straightforward numbers such as population, as well as educated assumptions about other factors influencing the economy.

The bank also asks businesses about their capacity usage through surveys and by chatting with them through its liaison program. Then, there’s also the inflation figure itself.

While the output gap is just one gauge, it is given considerable weight in the Reserve Bank’s decisions. So far, the gap is narrowing, the bank says, but it’s likely we’re still pushing our resources past the ideal level to pull inflation back into line.

There’s not much the central bank can do to increase potential output, or capacity, in the economy, which is why it is instead focusing on weakening our demand, or spending.

While a rate cut now would be like an iron infusion for an anaemic economy, help preserve jobs, and bring mortgage holders relief, the bank is clearly on the warpath against its public enemy number one: inflation.

Keep in mind, though, no one is perfect. The Reserve Bank is careful to stress that the output gap, like most of its other measures, is “subject to considerable uncertainty.”

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One reason for our inflation problem: weak merger law

Nothing excites the business section of this august organ more than news of another merger between two public companies. “Merger” is the polite word for it; usually the more accurate word is “takeover”.

So, is the dominant firm offering a good price for the firm being acquired? And should the shareholders in the dominant firm be pleased or worried about the deal? Will it benefit them, or just the company executives who organised it? A bigger company equals higher salaries and bonuses, no?

The financial press tends to regard takeovers as all good fun. Part of the thrills and spills or living and investing in a capitalist economy. But such mergers change the shape of the economy that provides us with our living. Do they make the economy better or worse?

According to the Albanese government’s Assistant Minister for Competition Dr Andrew Leigh, a former economics professor, some mergers improve the economy, whereas some worsen it.

As he explained in a speech this week, mergers are part of the market mechanism that allows financial capital to go where it’s most needed and will do most good to the consumers, workers and savers who make up an economy.

Most mergers are a healthy way for firms to achieve economies of scale and scope, and to access new resources, technology and expertise, Leigh says.

But mergers can do serious economic harm when firms are motivated by a desire to squeeze competitors out of the market and so capture a larger share of the particular market.

So “the small number of proposed mergers that raise competition concerns warrant close scrutiny” to see whether they should be allowed to proceed, he says.

The point is that, according to economic theory, the main thing ensuring ordinary people benefit from living and working in a capitalist economy is strong competition between the profit-making businesses providing our goods and services, which limits their ability to charge excessive prices and make excessive profits.

Competition obliges businesses to pass on to customers much of the savings they make from using improved technology to increase their economies of scale, while preserving the quality of service provided to their customers.

Similarly, competition between a reasonable number of alternative employers is needed to ensure their workers are fairly paid.

This is why laws controlling mergers are one of the main pillars of policy to keep competition between firms effective, along with prohibitions on the forming of cartels and other collusion between supposedly rival firms, and the misuse of “market power” – the power to keep prices above the competitive level.

Leigh says merger law is unique among those pillars because it’s the preventative medicine of competition law. While the other pillars deal with anticompetitive practices that are already being used, it deals with the likely effect of future anticompetitive actions the merger could make possible.

Fine. Trouble is, reformers have been batting for about 50 years to get effective restrictions on the ability of Australian companies to proceed with mergers designed to limit competition and enjoy excessive pricing power.

Leigh notes that a less-competitive market can add to the cost of doing business, and reduce the incentives and opportunities to invest, grow and innovate. For consumers, a less competitive market leads to higher prices, less choice, and lower growth in wages.

Big companies have resisted previous reforms – sometimes as represented by the (big) Business Council – sometimes, when Labor’s been in power, by big unions in bed with their big employers.

But now the Albanese government is making another attempt to get decent control over mergers that are expected to worsen competition.

And not before time. The challenge in Australia is to name more than a handful of industries not dominated by a few big firms.

Academic research Leigh has been associated with has shown that monopoly power worsens inequality by transferring resources from consumers to shareholders. He found evidence that market concentration – a few firms with a big share of the market – had worsened.

As well, profit margins had worsened and “monopsony hiring power” – few employers in an industry – was a problem in many industries.

After the Albanese government’s election in 2022, Treasurer Jim Chalmers and Leigh set up a Competition Taskforce within the Treasury focused on advising the government on actionable reforms to create a more dynamic and productive economy.

The taskforce’s top priority was to reform our merger laws. Consultations with industries said our piecemeal merger process was unfit for a modern economy and lagged best practice in other countries.

We were one of only three developed countries with a system of notifying proposed mergers that was merely voluntary. The Australian Competition and Consumer Commission (ACCC) complained about inadequate notification of proposed mergers, insufficient public information about the mergers, “a reactive, adversarial approach from some businesses” and limited opportunity to present evidence of likely economic harm arising from a particular merger.

In April this year, Chalmers and Leigh announced what they said were “the most significant reforms to merger rules in almost 50 years”. They would reduce three ways of reviewing merger proposals to a single, mandatory but streamlined path to approval, run by the ACCC.

For merger proposals above a monetary threshold or market-concentration threshold, this means those which would create, strengthen or entrench substantial market power will be identified and stopped. But those consistent with our national economic interest will be fast-tracked.

Challenges to the commission’s decisions will be the responsibility of an Australian Competition Tribunal, made up of a Federal Court judge, an economist and a business leader.

This should make it easier for the majority of mergers to be approved quickly, so the commission can focus on the minority that are a worry on competition grounds.

It’s the great number of our industries dominated by just a few firms that makes us especially susceptible to the inflation surge we’re still struggling to get back under control.

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Cost-of-living crisis? Why only some of us are feeling the pinch

If you believe the opinion polls, we’re all groaning under the weight of the cost-of-living crisis. And Treasurer Jim Chalmers confirms we’ve all been “under the pump”. But it’s not that simple. Some of us are doing it a lot tougher than others. And some of us are actually ahead on the deal.

In any case, where did the living-cost crisis come from? That bit’s simple. The economy’s been on a rollercoaster for the past four and a half years. COVID and the lockdowns may seem a distant memory, but almost everything that’s happened in the economy since the end of 2019 has been the direct or indirect consequence of the pandemic.

The surge in consumer prices that began in early 2022 stemmed from a combination of temporary disruptions to supply caused by the pandemic, and excess demand for goods and services as people spent the money they’d earned but couldn’t spend during the lockdowns.

The tax cuts that began this month had been planned for six years, but Chalmers changed their intended shape radically to help people most affected by the cost of living. They mean that, by the end of this year, overall living standards should be just a little up on where they were five years ago.

Just as the media focus on bad news more than good news, so you and I focus more on what’s been happening to the cost of living than what’s been happening to our after-tax income. But it’s the difference between the two – our standard of living – that matters most.

Two economists at the Australian National University’s Centre for Social Policy Research, Associate Professor Ben Phillips and Professor Matthew Gray, have been crunching the numbers, and their results may surprise you.

They’ve examined the change in our standard of living since the end of 2019, and included a forecast up to the end of this year, to take account of the latest tax cuts and changes in the May budget.

Lumping all households together, they find that we did quite well in 2020 and 2021 as the Reserve Bank cut interest rates and governments spent billions on such things as the JobKeeper scheme and temporary doubling of JobSeeker unemployment benefits. But then living standards fell sharply in 2022 as consumer prices took off and housing costs rose. Living standards fell a little further last year, taking them to 0.6 per cent lower than they were before COVID arrived.

The authors estimate that, this year, the tax cuts and continuing pay rises will lift living standards to a princely 1.6 per cent above what they were in December 2019.

But those national averages conceal much variation. When the authors ranked all households by their disposable income, then divided them into five “quintiles”, the poorest 20 per cent are expected to end the five years with their living standard 3.5 per cent higher.

Huh? They did well partly because their pensions and benefits are indexed to inflation.

At the same time, the top 20 per cent of households are expected to be 2.7 per cent ahead. Why? Partly because they did well on their investments.

So it’s the middle 60 per cent of households that have been hit the hardest by the cost of living. The second lowest 20 per cent barely broke even, while the middle and upper-middle quintiles suffered a fall in their living standards.

But now we get to the pointy bit. Why did the middle do so much worse than the rest? Because that’s where you find most of the people with mortgages. Turns out all those households with mortgages are expected to see their living standards fall by 5.6 per cent over the five years to December 2024.

What about renters? Their living standards should rise by 2.9 per cent over the period. Huh? How could that be? It’s true that shortages of rental accommodation have caused rents to rise hugely this year and last. But much of that can be seen as catch-up for the lockdown-caused falls in rents in 2020 and 2021, and the small increases in 2022.

If you’re sitting down, I’ll tell you that the living standards of people who own their homes outright are expected to rise by … 8.5 per cent.

But here’s an even bigger shock: if you divide all the households by their main source of income, those in the “other” category – that is, not reliant on either wages or pensions – should see their standard of living rise by what the authors call “an astounding 15.8 per cent”.

Penny dropped yet? Yes, we’re talking about the group that always has its hand out for a handout to thank it for being too well-off to get the age pension: the self-described, so-called self-funded retirees.

But while you’re feeling sorry for all those poor souls (whose company I’ll be joining one day), spare a kick for the economists who, several decades ago, had the bright idea of using only interest rates to control inflation. They must have had a fairness bypass.

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OECD’s message to our inflation warriors: calm down, she’ll be right

Last week a bunch of international public servants in Paris launched a rocket that landed in Sydney’s Martin Place, near the Reserve Bank’s head office and the centre of our financial markets. It carried a message we should already know. Australia has a big problem with real wages: they’re too low. In which case, why are you guys so anxious about continuing high inflation?

The Organisation for Economic Co-operation and Development’s annual Employment Outlook says Australia’s real wages in May this year are still 4.8 per cent lower than they were in December 2019, just before the pandemic.

This is one of the largest drops among OECD countries. It compares with real falls of 2 per cent in Germany and Japan, and 0.8 per cent in the United States. Real wages have risen by 2.4 per cent in Canada and 3.1 per cent in Britain.

The organisation observes that, “as real wages are [now] recovering some of the lost ground, profits are beginning to buffer some of the increase in labour costs. In many countries, there is room for profits to absorb further wage increases, especially as there are no signs of a price-wage spiral”.

Just so. But this isn’t something you’re allowed to say out loud in Martin Place. When the Australia Institute copied various overseas authorities in calculating the contribution that rising profits had made to our rising prices, it was dismissed by the Reserve Bank and the financial press.

Apparently, it’s OK for the Reserve to say it must increase interest rates because demand is growing faster than supply and adding to inflation, but it’s not OK to say that businesses have used the opportunity to raise their prices and this has increased their profits.

No, in the Reserve’s eyes, the problem with prices soaring way above its inflation target has never been greedy bosses, but always the risk of greedy workers using their industrial muscle to prevent their real wages from falling and thus causing a price-wage spiral that perpetuates high inflation.

It was a worry that anyone who knew anything about the changed power balance between employers and workers and their unions – anyone who wasn’t still living in the 1970s – could never have entertained.

For many years, the Reserve Bank benefited greatly from having a senior union official appointed to its board along with the many business people. But John Howard soon put a stop to that.

Since then, the Reserve has had to fall back on the primitive understanding of how labour markets work that you gain from a degree in neoclassical economics. Fortunately, since last year the board has included Iain Ross, former president of the Fair Work Commission.

The Reserve’s great sense of urgency in getting the inflation rate back down since it began raising interest rates in May 2022 has been driven by two worries about wages. First, when excessive monetary and budgetary stimulus caused the post-lockdown economy to boom while our borders were closed to imported labour, it worried that shortages of skilled and even unskilled labour would cause wages to leap as employers sought to bid workers away from other firms.

Although job vacancies more than doubled, reaching a peak in May 2022, annual wage growth had risen no higher than 4.2 per cent in December last year, even though consumer price inflation had peaked at 7.8 per cent a year earlier.

So, though no one’s bothered to mention it, our first period of acute labour shortages in decades hardly caused a ripple. It’s probably fair to say, however, that had the shortages not occurred, wages would have fallen even further behind prices than they did.

The Reserve’s second reason for feeling a sense of urgency in getting inflation back down to the target range is its fear that, should we leave it too long, inflation expectations may rise, causing actual inflation to move to a permanently higher level.

Indeed, the signs that our return to target will be slow have been used by the Reserve’s urgers in the financial markets to call for another rate rise or two. Apparently, every week’s delay in getting inflation down could see inflation expectations jump.

But this is mere pop psychology. Even if the nation’s workers and unions were to expect that inflation will stay high, they lack the industrial muscle to raise wage rates accordingly. If you didn’t already know that, our outsized fall in real wages should be all the proof you need.

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It's slowing the spin doctors' spin that keeps me busy

Do you remember former prime minister John Howard’s ringing declaration that “we will decide who comes to this country and the circumstances in which they come”? It played a big part in helping him win the 2001 federal election. But it’s only true in part.

The job of economic commentators like me is supposed to be telling people about what’s happening in the economy and adding to readers’ understanding of how the economy works.

But the more our politicians rely on spin doctors to manipulate the media and give voters a version of the truth designed always to portray the boss in the most favourable light, the more time I have to spend making sure our readers aren’t being misled by some pollie’s silken words.

These days, I even have to make sure our readers aren’t being led astray by the economics profession. For the first time in many years, I’ve found myself explaining to critical academic economists that I’m a member of the journos’ union, not the economists’ union.

Like many professions, economists are hugely defensive. And they like to imagine my job is to help defend the profession against its many critics. Sorry, I’m one of the critics.

My job is to advise this masthead’s readers on how much of what economists say they should believe, and how much they should question.

It’s not that economists are deliberately misleading, more that they like to skirt around the parts of their belief system that ordinary people find hard to swallow.

And then there’s the increasing tendency for news outlets to pick sides between the two big parties, and adjust their reporting accordingly. My job is to live up this masthead’s motto: Independent. Always.

So, back to Howard’s heroic pronouncement. It’s certainly true that “we” – the federal government – decide the circumstances in which people may come to Australia. If you turn up without a visa, you’ll be turned away no matter how desperate your circumstances. If you come by boat, your chances of being let in are low.

But if you come by plane, with a visa that says you’ll be studying something at some dodgy private college when, in truth, you’re just after a job in a rich country, in you come. If we’ve known about this dodge, it’s only in the past few weeks that we’ve decided to stop it.

No, the problem is, if you take Howard’s defiant statement to mean that we control how many people come to this country, then that’s not true. We decide the kinds of people we’ll accept, but not how many.

There are no caps because, for many years, both parties have believed in taking as many suitable immigrants as possible. It’s just because the post-COVID surge in immigration – particularly overseas students – has coincided with the coming federal election that the pollies are suddenly talking about limiting student visas.

But remember, the politicians have form. Knowing many voters have reservations about immigration, they talk tough on immigration during election campaigns, but go soft once our attention has moved on, and it’s all got too hard.

It’s a similar thing with Anthony Albanese’s Future Made in Australia plan. Polling shows it’s been hugely popular with voters. But that’s because they’ve been misled by a clever slogan. It was designed to imply a return to the days when we tried to make for ourselves all the manufactured goods we needed.

But, as I’ve written, deep in last month’s budget papers was the news that we’d be doing a bit of that, but not much. It’s just a great slogan.

On another matter, have you noticed Treasurer Jim Chalmers’ dissembling on how he feels our pain from the cost-of-living crisis, which is why he’s trying so hard to get inflation down?

What he doesn’t want us thinking about is that, at this stage, most of the pain people are feeling is coming not from higher prices, but from the Reserve Bank’s 4.25 percentage-point increase in interest rates.

Get it? The pain’s coming from the cure, not the disease. The rise in interest rates has been brought about by the independent central bank, not the elected government, of course. But when Chalmers boasts about achieving two successive years of budget surplus, he’s hoping you won’t realise that those surpluses are adding to the pain households are suffering, particularly from the increase in bracket creep.

And, while I’m at it, many people object to businesses raising their prices simply because they can, not because their costs have increased. This they refer to disapprovingly as “gouging”.

But few economists would use that word. Why not? Because they believe it’s right and proper for businesses to charge as much as they can get away with.

Why? Because they think it’s part of the way that market forces automatically correct a situation where the demand for some item exceeds its supply. In textbooks, it’s called “rationing by price”.

Rather than the seller allowing themselves to run out of an item, they sell what’s left to the highest bidders. What could be better than that?

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Treasury tells all: how the housing market is so stuffed up

Would you believe that our ever-rising house prices are a sign there’s something badly wrong with our housing market? Would you believe our housing arrangements are worse than in the other rich countries?

Well, I would when that’s what Treasury is admitting in the annual sermon it tacks onto the budget papers. This year it’s about meeting our housing “challenge”.

In a well-functioning economy, its industries can respond to the increase in demand for their good or service by increasing their supply without much delay. Of course, it takes a lot longer to build a new house or apartment than it does to churn out more ice-creams or haircuts.

But, even so, our housing industry has been too slow to respond to the increased demand for housing. This comes from our rising population which, thanks to continuing high levels of immigration, has grown faster than most of the other rich countries.

Figures from the Organisation for Economic Co-operation and Development, a group of mainly advanced economies, show that our number of dwellings per 1000 people increased only from 403 to 420 between 2011 and 2022. This compared poorly with most other countries.

In 2011, our level of housing supply was just 92 per cent of the OECD average. And by 2022 it had fallen to 90 per cent. This was behind countries such as Canada, the United States and England.

Our completions of new private dwellings reached a peak of more than 200,000 a year in 2018-19 but have since fallen to about 160,000 a year. This has left us with an acute shortage of properties available to buy or rent.

Nationwide, the number of homes being offered for sale has fallen since 2015, while the number offered for rent has been falling since early 2020.

Speaking of renting, Treasury says the rental market is considered to be in balance – meaning renters have little trouble finding a place and landlords have little trouble finding a tenant – when the vacancy rate is about 3 per cent. In cities such as Sydney and Melbourne it’s now down to about 0.5 per cent. Ouch.

Not surprisingly, when demand grows faster than supply can keep up with, prices rise. The rise in the cost of newly built homes, and the cost of renting, have contributed significantly to the general cost-of-living crisis.

So, why has our housing industry become so slow to respond to increased demand? Treasury says the causes are “multifaceted, complex and affect all stages of the housing construction process, including all levels of government and industry”.

One way to improve the market’s response to greater demand is to accelerate the construction process. But Treasury says that completion times for apartments, townhouses and detached houses actually worsened by 39 per cent, 34 per cent and 42 per cent respectively over the 10 years to June 2023.

Calculations (or, if you want to sound more scientific, “modelling”) by a federal government agency says that, over the next six years, the nation’s existing unmet demand will never be satisfied unless completion times are speeded up. In six years’ time, we’ll still have a backlog of about 39,000 dwellings.

Treasury says the expectation that churning out homes faster will help to lower house prices is supported by empirical research. One study found that those OECD countries that built more housing over the 15 years to 2015 experienced lower real growth in house prices.

Another study showed that adding an extra 50,000 homes a year for a decade could reduce house prices by up to 20 per cent.

So, what can be done to increase the housing industry’s annual output? Treasury says planning and zoning restrictions can limit the speed at which land is made available.

Delays in approving development applications by local councils can be excessive. I think councils and government departments are monopolists and, like all monopolists, they take advantage of the lack of competition.

Private sector monopolists whack up their prices and don’t worry about the quality of the service they provide. Public monopolists make you jump through hoops that aren’t strictly necessary, and they fix your problem in their own good time.

I wonder whether, over all these years, those outfits have ever had much pressure on them to lift their game. If that changed, I’m sure we could get more homes built per year.

Treasury says average times for the approval of development applications vary by state, with Victoria and NSW experiencing the longest waiting times early this month of 144 and 114 days, respectively.

It shouldn’t surprise you that Treasury wants housing to be delivered in well-located areas where the demand is greatest.

Dense development in the “missing middle” of major cities, where households can reside closer to jobs in areas with higher quality amenities and infrastructure, has been limited by planning and zoning restrictions and slow release of infill land, Treasury says.

Global supply constraints and price shocks on imported building materials associated with the pandemic have added to the cost of construction, driving up the price of newly built homes. Although prices aren’t rising as fast as they were, they haven’t fallen back.

Shortages of building labour have also increased the prices of newly built homes and slowed the pace of construction. The growth in non-dwelling construction activity has drawn labour away from home building. The productivity of labour in construction has not improved since the early 2000s.

The industry blames these shortages on the drop-off in rates of skilled migration during the pandemic. But I wonder if the deeper problem is that the former ready availability of imported labour tempted the industry to save money by failing to train as many apprentices as they should have.

So, what’s the Albanese government doing about this mess? It’s finally grasped the nettle and is spending big – $32 billion, including $6 billion in this month’s budget – to “address historical underinvest in the housing system” and build 1.2 million new, well-located homes. We’ll see how they go.

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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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Let's stop using interest rates to throttle people with mortgages

What this country needs at a time like this is economists who can be objective, who’re willing to think outside the box, and who are disinterested – who think like they don’t have a dog in this fight.

On Friday, Reserve Bank governor Michele Bullock, with her lieutenants, made her first appearance as governor before the House of Reps economics committee.

See if you can find the logical flaw in this statement she made: “The [Reserve’s] board understands that the rise in interest rates has put additional pressure on the households that have mortgages. But the alternative of lower interest rates and high inflation for a prolonged period would be even worse for these households, as well as all the households without mortgages.”

Sorry, that’s just Bullock doing her Maggie TINA Thatcher impression, mindlessly repeating the assertion that “There Is No Alternative”. Nonsense. There are various alternatives, and if economists were doing their duty by the country, they’d be talking about them, evaluating them and proposing them.

What’s true is that the Reserve has no alternative to using interest rates to slow demand. Some economists can be forgiven for being too young to know that we didn’t always rely mainly on interest rates to fight inflation, just as we didn’t always allow the central bank to dominate the management of the economy.

These were policy changes we – and the rest of the rich world – made in the early 1980s because we thought they’d be an improvement. In principle, now we’re more aware of the drawbacks of giving the central bank dominion over macroeconomic management, there’s no reason we can’t decide to do something else.

In practice, however, don’t hold your breath waiting for the Reserve to advocate making it share its power with another authority. Nor expect the reform push to be led by economists working in industries such as banking and the financial markets, which benefit from their close relations with the central bank.

What those with eyes should have seen in recent years is that relying so heavily on an instrument as blunt as interest rates is both inequitable and inefficient. It squeezes the third of households with mortgages – or the even smaller proportion with big mortgages – while hitting the remaining two-thirds or more only indirectly.

It’s largely by chance that the Reserve’s need to jam on the demand brakes has coincided with the worst shortage of rental accommodation in ages, thereby spreading the squeeze to another third of households. Had this not happened, the Reserve would have needed to bash up home buyers even more brutally than it has.

Clearly, it would be both fairer – and thus more politically palatable – and more effective to use an instrument that directly affected a much higher proportion of households. This should mean the screws wouldn’t have to be tightened so much, another advantage.

One obvious alternative tool would be to temporarily move the rate of the goods and services tax up (or, at other times, down) a percentage point or two.

Another alternative, one I like, is to divide compulsory employer superannuation contributions into a part permanently set at 11 per cent, and a part that could be varied temporarily between plus several percentage points and minus several points.

This would leave workers less able to keep spending (or more able to spend), as the managers of demand required to stabilise both inflation and unemployment.

Its great attraction is that it involves the government temporarily fiddling with people’s ability to spend, without actually taking any money from them. Surely, this would be the least politically painful way to manage demand.

Experience with central-bank dominance has shown us one big advantage: the economic car has been driven markedly better when the brake and the accelerator are controlled by econocrats independent of the elected government.

But this simply means we’d have to set up an independent authority to control all the instruments of macro management, whether monetary or fiscal.

Not all our economists have been too stuck in the mud of orthodoxy to think these new thoughts. They were canvased by professors Ross Garnaut and David Vines in their submission to the Reserve Bank inquiry – which, predictably, was brushed aside by a panel of economists anxious to stay inside the box.

A century ago, Australians were proud of the way we showed the world better ways of doing things, such as the secret ballot and votes for women. These days, our economists are dedicated followers of international fashion.

This means the country that should be leading the way to better tools to manage demand will wait until it becomes fashionable overseas. Why should we be first? Because our unusual practice of having mainly variable-rate home loans means our use of the interest-rate tool bites a lot harder and faster, thus making our monetary policy a lot blunter than theirs.

Economists may not fret much about how badly some punters are hurting as the economic managers rapidly correct the consequences of their gross miscalculations – the Reserve played a big part in the excessive stimulus during the COVID lockdowns – but one day the politicians who carry the can politically for these miscalculations will revolt against the arrogance of their economic gurus.

Reserve Bank governors – and, in earlier times, Treasury secretaries – privately congratulate themselves for being the last backstop protecting the nation against inflation. When no one else cares, they do. When no one else will impose a cost of living crisis on spendthrift consumers, they will.

Don’t you believe it. If they cared as much as they think they do, they’d care a lot more about effective competition policy. But when the economists leading the Australian Competition and Consumer Commission – Allan Fels and later, Rod Sims – were battling to get more power to reject anticompetitive mergers, they got precious little support from their fellow economists.

While the (Big) Business Council was lobbying privately to retain the laxity, backed up on the other side by a few Labor-Party-powerful unions that had done sweetheart deals with their big employers, the Reserve and Treasury were missing in action.

The people at the bottom of the inflation cliff boast about the diligence of their ambulance service, while doing nothing to help the people at the top of the cliff trying to erect a better safety fence.

If you were looking for examples of oligopolies with pricing power, you could start with the big four banks. If you were looking for examples of “regulatory capture” – where the bureaucrats supposed to be regulating an industry in the public interest get sweet-talked into going easy – you could start with the Reserve and banking (with Treasury not far behind).

In the natural conflict between the goals of financial stability and effective competition, the Reserve long ago decided we’d worry about competition later.

But the more concentrated we allow our industries to become, the more often the Reserve will have to struggle to control inflation surges, and the harder it will need to bash home-buyers on the head.

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You can (partly) blame cost-of-living crisis on greedy businesses

The nation’s economists and economist-run authorities such as the Reserve Bank have not covered themselves in glory in the present inflationary episode. They’ve shown a lack of intellectual rigor, an unwillingness to re-examine their long-held views, and a lack of compassion for the many ordinary families who, in the Reserve’s zeal to fix inflation the blunt way, have been squeezed till their pips squeak.

There’s nothing new about surges of inflation. Often in the past they’ve been caused by excessive wage growth, where economists have been free with their condemnation of greedy workers. But this one came at a time when wage growth was weak and barely keeping up with prices.

What economists in other countries wondered was whether, this time, excessive growth in profits might be part of the story. Separate research by the Organisation for Economic Co-operation and Development, the International Monetary Fund, the Bank for International Settlements, the European Commission, the European Central Bank, the US Federal Reserve and the Bank of England suggested there was some truth to the idea.

But if the Reserve or our Treasury shared that curiosity, there’s been little sign of it. Rather, when the Australia Institute replicated the European Central Bank’s methodology with Australian data and found profit growth did help explain our inflation rate, the Reserve sought to refute it with a dodgy graph, while Treasury dismissed it as “misleading” and “flawed”.

One leading economist who has been on the ball, however, is Professor Allan Fels, a former chair of the Australian Competition and Consumer Commission, whose experience of competition and pricing issues goes back to the year before I became a journalist.

In his report this week on price gouging and unfair pricing practices, commissioned by the Australian Council of Trade Unions, he concluded that “business pricing has added significantly to inflation in recent times”.

Fels says his report is “fully independent” of the ACTU, which did not try to influence him. Considering his authority in this area, I have no trouble believing it.

“ ‘Profit push’ or ‘sellers’ inflation’ has occurred against a background of high corporate concentration and is reflected in the surge of corporate profits and the rise in the profit share of gross domestic product,” he finds.

“Claims that the rise in profit share in Australia is explained by mining do not hold up. The profit share excluding mining has risen and [in any case,] energy and other prices associated with mining have been a very significant contributor to Australian inflation,” he says.

Fels says there has been much discussion about inflation and its causes – including monetary policy and fiscal policy, international factors, wages, supply chain disruption and war, but “hardly any discussion that looks at actual prices charged to consumers, the processes by which they are set, the profit margins and their possible contribution to inflation”.

His underlying message is that there are too many industries in Australia which are dominated by just a few huge companies – too many “oligopolies” – which limits competition and gives those companies the ability to influence the prices they can charge.

“Not only are many consumers overcharged continuously, but ‘profit push’ pricing has added significantly to inflation in recent times,” he says, nominating specifically supermarkets, banks, airlines and providers of electricity.

Fels says, “some of Australia’s largest businesses, often [those selling such necessities that customers aren’t much deterred by price rises], are maintaining or increasing margins in response to the global inflationary episode”.

He identifies eight “exploitative business pricing practices” – tricks – that enable the extraction of extra dollars from consumers in a way that wouldn’t be possible in markets that were competitive, properly informed, and that enabled overcharged customers to switch easily from one business to another.

First, “loyalty taxes” set initial prices low and then sharply increase them in later years when customers can’t easily detect, question, or renegotiate them, and where the “transaction costs” of changing to another firm are high. This trick can be found in banking, insurance, electricity and gas.

Second, “loyalty schemes” are often low-cost means of retaining and exploiting consumers by providing them with low-value rewards of dubious benefit.

Third, “drip pricing” occurs when firms advertise only part of a product’s price and reveal other costs as the customer continues through the purchasing process. This trick is spreading in relation to airlines, accommodation, entertainment, pre-paid phone charges, credit cards and other things.

Fourth, “excuse-flation” occurs when general inflation provides camouflage for businesses to raise prices without justification. This has been more prevalent recently. As the inflation rate starts falling, excessive inflation expectations and further cost increases can be built in to prices.

Fifth, “confusion pricing” involves confusing customers with myriad complex price structures and plans, making it difficult to compare prices and so dulling price competition. This is occurring increasingly in mobile phone plans and financial or maintenance service contracts.

Sixth, asymmetric or “rockets and feathers” pricing is a big deal now the rate of inflation is falling. When a firm’s costs rise, prices go up like a rocket; when its costs fall, prices drift down slowly like a feather.

Fels says this trick can be very profitable for businesses. The banks have long been guilty of this stunt, yet I can’t remember a Reserve Bank governor ever calling it out.

Seventh, “algorithmic pricing” is where firms use algorithms to change prices automatically in response to what their competitors are doing. Fels wonders whether this reduces price competition and is analogous to the way now-illegal cartel pricing worked.

Finally, “price discrimination” involves charging different customers different prices for the same product, according to what the firm deduces a particular customer is “willing to pay”. The less competition firms face, the easier it is for them to play this game.

That so few economists and econocrats have been willing to think about these issues doesn’t speak well of their profession’s integrity. If they won’t speak out about businesses’ failings, why should we trust what they do tell us?

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Are the supermarket twins too keen to raise their prices?

The cost-of-living crisis has left many convinced the two big supermarket chains – known to some as Colesworth – have been “price gouging” – raising their prices without justification. “Gouging” is a rude, pejorative phrase that would never cross an economist’s lips (nor mine), but economic theory does say that, when an industry is dominated by just a few huge companies, this will give them the power to manipulate prices to their own advantage.

But anecdotes and even economic theory are one thing, hard evidence is another. And knowing what to do about it is a third. So it’s good that last Friday, Treasurer Jim Chalmers launched a full inquiry into supermarket prices by the Australian Competition and Consumer Commission. Chalmers said this was “about making our supermarkets as competitive as they can be so Australians get the best prices possible”.

The inquiry, which will take a year, will include an examination of online shopping, the effects of loyalty programs and how advances in technology are affecting competition.

The competition watchdog’s chair, Gina Cass-Gottlieb, said the commission will use its compulsory information-gathering powers to collect financial details from the supermarket giants.

The government has also commissioned a former Labor minister and economist, Dr Craig Emerson, to review the effectiveness of the “food and grocery code of conduct”, introduced in 2015 to stop the big supermarkets from using their buying power to extract unreasonably low prices from their suppliers, particularly farmers.

The code is voluntary and has no way of punishing bad behaviour, so hasn’t worked well. It’s drawn few complaints from suppliers, probably because they’re afraid of retaliation by Colesworth. Only if it’s made compulsory and given teeth is it likely to improve the farmers’ lot.

Our groceries market is one of the most concentrated in the developed world. Woolworths has 37 per cent of the market and Coles has 28 per cent, leaving Aldi with 10 per cent and Metcash (wholesaler to IGA stores) with 7 per cent. So our two giants’ combined share of 65 per cent compares with Britain’s top two’s share of 43 per cent. In the United States, the four largest chains make up just 34 per cent of the market.

While we wait for the competition watchdog’s report, what do we know about the chains’ behaviour?

The report of an unofficial inquiry into price gouging and unfair pricing practices, commissioned by the ACTU from a former competition commission chair, Professor Allan Fels, will be published on Wednesday.

But we know from a letter Fels sent to Chalmers last month what it will say about supermarkets. Fels said the inquiry had been inundated with concerns from experts and regular Australians alike on the prices set by the chains.

Fels found that neither Coles nor Woolworths suffered declines in profit during the pandemic because their services had been deemed essential. Since then, however, both have increased their profit margins, thanks to weak competition and their ability to delay passing on any cost reductions.

Fels noted that high prices, including co-ordinated price increases between the two, aren’t actually prohibited by competition law, except where there is unlawful communication or agreement between the firms. (Which, of course, doesn’t prohibit tacit collusion.)

Duopolies have a mutual incentive not to decrease prices where possible, Fels said, particularly on those goods whose prices are closely watched by customers.

“There has not been a price war between the major supermarkets in some years,” he said. This contrasts with the British experience, where Tesco and Sainsbury’s entered an aggressive price war with Aldi.

Here, the entrance of Aldi has been helped by outlawing the ability of the big two to do deals with shopping centre owners preventing rival supermarkets from setting up. Fels said he shared the watchdog’s concern about the big two’s ability to limit competition by engaging in “land banking” – hoarding supermarket sites, so rival companies can’t get a foothold.

Fels worries also about the giants playing “rockets and feathers”. When their costs rise, their prices go up like a rocket, but when their costs fall, their prices drift slowly down like a feather.

Fels found that, as prices have increased, consumers had noticed again and again that once-normal prices were being advertised back to shoppers as “special”.

He quoted one submission to his inquiry asserting that, until August 2022, Coles and Woolies sold a 200-gram jar of Timms coffee for $8. Then Coles increased the shelf price to $12.70 before, a couple of weeks later, reducing the price to $10.70 with a tag saying “was $12.70 per bottle, now ‘down, down!’.”

Another submission asserted that Devondale cheese had gone from $5 to $10 in recent months, but had then been on “special” for $10.

Cass-Gottlieb has said the commission was “carefully looking” at claims that some discounts amounted to deceptive conduct. She also said it was concerned by “was, now pricing”, which might be outlawed.

If all the pain of the cost-of-living crisis at last prompts this government to get tough with the game-playing supermarkets, it will be some consolation.

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With luck, we’ll escape recession next year, but it will feel like one

What we’ve come to call the “cost-of-living crisis” has made this an unusually tough year for many people as they struggle to make ends meet. It’s likely to get worse rather than better next year. Which won’t help Anthony Albanese’s chances of being comfortably returned to government in early 2025.

Everyone hates rapidly rising prices and demands the government do something. But I’m not sure everyone understands the paradoxical nature of the usual ways central banks and governments go about fixing the problem. They make it worse to make it make better.

In a market economy, when our demand for goods and services exceeds the economy’s ability to supply them, businesses solve the problem by putting up their prices. The economic managers then seek to weaken our demand by squeezing households’ finances so that they can’t spend as much.

As our spending weakens, firms are less able to keep raising their prices without losing sales.

The main way the Reserve Bank puts the squeeze on household spending is by engineering a rise in mortgage interest payments, leaving people with less money to spend on everything else.

A shortage of rental housing has allowed landlords to make big rent increases. Employers have helped the squeeze by ensuring they raise wages by less than they’ve raised their prices. And Treasurer Jim Chalmers has helped by allowing bracket creep to take a bigger tax bite out of wage increases.

All this is why so many people have been feeling the financial heat this year. But even if there are no more interest rate rises to come, the existing pressures are still working their way through the economy, with little sign of relief.

Consumer prices rose by 7.8 per cent over the year to last December, but the annual rate of increase slowed to 5.4 per cent in September. That’s still well above the Reserve’s target of 2 per cent to 3 per cent.

If the Reserve has accidentally hit the economy harder than intended, we could slip into recession next year, causing a big jump in the number of people out of a job, and thus hitting them much harder.

But with any luck, it won’t come to that. And the crazy-lazy way the media define recession – a fall in real gross domestic product in two successive quarters – means that growth in the population may conceal the hip-pocket pain many people are feeling.

Consider the case of someone on the very modest wage of $45,000 a year in September 2021. If their wage rose in line with the wage price index, it would have risen by $3300 to $48,300 in September this year.

However, bracket creep, plus the discontinuation of the low and middle income tax offset, raised the average rate of income tax they pay from 9.8¢ in the dollar to 14.2¢. So their tax bill would have grown by $2460.

Now allow for the rise in consumer prices over the two years, and the purchasing power of their disposable income has fallen by about $5290, meaning their “real” disposable income is $4450 a year less than it used to be.

Can you imagine that person being terribly happy with the way their finances have fared under the Albanese government? My guess is, there’ll be growing disaffection with Labor as next year progresses.

To help him win last year’s federal election, Albanese made Labor a “small target” by promising very little change, including no change to the stage three income tax cuts, legislated long before the pandemic, to start in July next year.

His game plan had been to spend his first term being steady and sensible, keeping his promises and being an “economically responsible” government. This would get him re-elected with an increased majority and able to implement needed but controversial reforms.

But, through no great fault of his own, he’s had to grapple with the worst surge in the cost of living in decades. If there’s a low-pain way to get inflation back under control, I’ve yet to hear about it.

The trouble set in well before the change of government, and the Reserve Bank began its long series of interest rate rises during the election campaign.

My guess is that Albanese’s hopes of storming back to power at an election due by May 2025 are dashed. But it’s hard to see Peter Dutton winning the election unless he can win back the Liberal heartland seats that went to the teals, which seems doubtful.

So, it’s not hard to see Albanese losing seats and reduced to minority government, dependent on the support of the Greens and teals.

There is, however, one thing he could do to cheer up many voters: rejig the coming tax cuts so the lion’s share of the $25 billion they’ll cost the budget goes not to the high-income taxpayers who’ve had the least trouble coping with living costs, but to those on lower incomes who’ve the most.

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Why your income tax refund is so much less than last year's

The political hardheads in Canberra are convinced much of the resounding No vote in the Voice referendum is a message from voters that they want the Albanese government fully focused on the cost of living crisis – which is really hurting – not wasting time on lesser issues.

I suspect they’re right. But if so, it’s the consequence of years of training by politicians on both sides that we should vote out of naked self-interest, not for what would be best for the country.

So, as the government switches to moving-right-along mode, expect to hear a lot from Anthony Albanese and Treasurer Jim Chalmers on how much they feel our pain and the (not so) many things they’ve done to ease the pain.

If that pain gets a lot worse – or just if the cries of anguish get a lot louder – expect to see the government doing more. If the Reserve Bank has miscalculated and, rather than just slowing to a crawl, the economy starts going backwards, expect to see the two of them spending, big time.

There’s no denying that, for most of us – though by no means everyone (see footnote) – it’s become a weekly struggle to make ends meet. Paradoxically, this is partly because of the post-lockdowns surge in many prices and partly because of the Reserve Bank’s efforts to stop prices rising so fast by ramping up interest rates.

Mortgage interest rates at present are not high by past standards. Two factors explain the pain from mortgages. First, thanks to higher house prices, the size of loans is much bigger than it used to be.

Second, after lowering interest rates to rock bottom during the lockdowns, the Reserve unexpectedly raised them by a huge 4 percentage points within just 13 months.

Households with big home loans, roughly a quarter of all households, have had their belts tightened unmercifully. Less usually, the third of households that rent have seen their rents rise by 10 per cent in the past 18 months; more than that in Sydney and some other capital cities (but not Melbourne, according to Australian Bureau of Statistics figures).

To this, add the big rises in the cost of petrol, electricity and gas, home insurance, overseas travel and various other things. Most people’s wages have not kept up with the rise in prices.

So yes, the cost of living crisis is no media exaggeration. And Albanese and Chalmers are full of empathy on all the elements I’ve listed. But there’s one other contribution to the crisis that many people will have stumbled across without understanding what was hitting them.

It’s below the radar because Albanese and Chalmers do not want to talk about it. Nor does the ever-critical opposition. As a consequence, most of the media have not woken up to it – with the notable exception of this august organ.

But according to Dr Ann Kayis-Kumar, a tax lawyer at the University of NSW, one of the most Googled questions in Australia in recent times is “Why do I suddenly owe tax this year?” A related question would be, why is my tax refund so much smaller than last year’s?

I’ll tell you (and not for the first time). Preparing for former treasurer Josh Frydenberg’s last budget, just before the election in May 2022, the Morrison government decided to increase the “low and middle income tax offset” (dubbed the LAMIngTOn) from $1080 to $1500, but not to continue it in the 2022-23 financial year.

Frydenberg made much of the increase, but governments that decide not to do things aren’t required to announce the fact. So Frydenberg didn’t. And Chalmers, watching on, said nothing.

The tax offset was a badly designed measure and all the insiders were pleased to see the end of it. I was too but, as a journalist, felt it was my job to tell the people affected what the politicians didn’t want them to know: that, in effect, their income tax in 2022-23 would be increased by up to $1500 for the year.

The 10 million taxpayers affected have been getting the unexpected news in just the past three months or so, after submitting their tax returns and discovering their refund was much less than last year’s, or had even turned into a small debt to the Tax Office.

The full tax offset went to those earning between $48,000 and $90,000 a year, which was most of the 10 million. Our friendly tax lawyer notes that the median taxable income in 2020-21 was $62,600, leaving $90,000 well above the middle.

Disclosure: Having paid off my house decades ago, and being highly paid (as are politicians), I haven’t felt any cost of living pain. Which makes me think that, when the people who are feeling much pain see Albo and Jimbo giving people like me a long-planned $9000-a-year tax cut next July, while they get chicken-feed, they might be just a teensy weensy bit angry.

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