Look up, we're on the verge of employment greatness

“Visionary” and “inspirational” aren’t words normally used about economists, but they certainly apply to Professor Ross Garnaut, of the University of Melbourne, and to his Thursday dinner speech to the jobs and skills summit. His message to Anthony Albanese is that he’s taken the helm at the worst of times. But, if he can rise to the challenge, he can lead us to the best of times.

Garnaut’s message is in two parts. First, we must stop kidding ourselves about the state of the economy and the budget. Second, we can make the seemingly impossible changes needed to gain all the material and social advantages of economic success.

First, we are kidding ourselves about how well our economy has been performing. It’s true our economy bounced back more quickly from the COVID-19 pandemic recession than did most developed economies - because our stimulus from the budget was bigger and faster.

Since then, however, Garnaut says, “we have looked ordinary in a troubled developed world”.

“We can’t turn the economy back to before the pandemic,” he says. “Even if we could, pre-pandemic conditions aren’t good enough. That’s high unemployment and underemployment and stagnant living standards.”

Recently, our problems have been compounded by the invasion of Ukraine and its disruption of global energy markets. But, unlike the Europeans and most other rich countries, Australian energy companies benefit when gas and coal prices rise.

“We are kidding ourselves if we think no deep wounds will be left in our polity from high coal and gas – and therefore electricity - prices bringing record profits for companies, and substantially lower living standards to most Australians,” he warns.

And “we have to stop kidding ourselves about the budget”. We need unquestionably strong public finances to have low cost of capital, private and public, for our transformation from fossil-fuel loser to Superpower exporter of clean energy and minerals, and to shield us from a disturbed international economy and geo-polity.

We’ve emerged from the pandemic with eye-watering public debt and large budget deficits, when high commodity prices should be driving budget surpluses.

“We talk about [the need for] much higher defence expenditure, but not about higher taxes to pay for it.

“We say we are underproviding for care and underpaying nurses, and underproviding for education and failing to adequately reward our teachers.”

The latest Intergenerational Report tells us that the ratio of over-65s to people of working age will rise by half over the next four decades, bringing higher costs and fewer workers to carry them, he says.

But, “in the face of these immense budget challenges, total federal and state taxation revenue as a share of gross domestic product is 5.7 percentage points lower than the developed-country average”.

Get it? Yet another economics professor telling us taxes must go up – not down.

The budget update issued at the start of this year’s election campaign predicted real wages would decline by 3 per cent over the two years to next June. Treasurer Jim Chalmers’ update three months later increased the decline to 7 per cent.

So, says Garnaut, “the facts have changed, and we should be ready to change our minds”. When we stop kidding ourselves, we’ll recognise the need for policies we now think impossible. That’s Garnaut’s second, more inspiring point.

“Australians accepted change that had been impossible on two earlier occasions when we faced deep problems, and responded with policy reforms that set us up for long periods of prosperity, national confidence and achievement.”

The most recent was the reform era starting in 1983. The first was postwar reconstruction of the economy in the 1940s, which was followed by a quarter of a century of full employment and rising incomes.

Back then, the Curtin and Chifley governments were determined Australians would not return to the high unemployment and economic insecurity of the interwar years.

“The 1945 white paper on full employment was premised on the radical idea that governments should accept responsibility for stimulating spending on goods and services to the extent necessary to sustain full employment ...

“This would achieve the highest possible standards of living for ordinary Australians.”

The Menzies Liberal government’s political success – it stayed in power for 23 years – “was built on full employment, helped by Menzies insulating policy from the influence of political donations to an extent that is shocking today”.

Garnaut says he grew up in a Menzies world of full employment. (So did I, as it happens.)

The authors of the white paper wondered how low the rate of unemployment could fall before it caused high or accelerating inflation. They were surprised to find it fell to below 2 per cent, and stayed there for two decades without a problem.

It’s tempting to think that, with all the problems of controlling inflation and decarbonising the economy, this brush with our glorious past will soon disappear, and we’ll be back to the 5 to 6 per cent unemployment we’ve learnt to think is the best we can do.

But Garnaut’s inspiring vision is that, with the right, seemingly impossible policy changes, we can complete the return to a fully employed economy and stay there, reaping its many material and social benefits.

In the world he and I grew up in, “workers could leave jobs that didn’t suit them and quickly find others – often moving from lower- to higher-productivity firms. Employers put large efforts into training and retraining workers.

“Labour income was secure and could support a loan to buy a house. Businesses that could not afford rising wages closed and released their workers into more productive employment.”

Steadily rising real wages encouraged firms to economise in their use of labour, which lifted productivity.

Sounds worth striving for, to me.

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Welcome to the job, Treasurer. Rather you than me

Very occasionally, some poor misguided letter-writer suggests to my boss that I’d make a better treasurer than the incumbent. I’m flattered, of course, but it’s never been a job I’ve lusted after. Nor do I delude myself I’d be much good at it. And that goes double for the present incumbent, Jim Chalmers.

I wouldn’t want to be in his shoes (especially not with people like that grumpy old bugger Gittins offering a critique of my every move).

When, within days of taking up the job, Chalmers declared the budget situation was “dire”, people thought he was just softening us up. But I suspect it had finally dawned on him (with a little help from his new treasury advisers) just what an unhygienic sandwich he’d promised to eat: the more so because he’d played his own part in making such a meal of it.

Chalmers’ problem comes in two parts. First, he inherited an almighty mess from Scott Morrison and Josh Frydenberg. They hadn’t exactly tidied the place up before leaving.

Justifiably, they’d racked up huge additional government debt to tide us through the worst of the pandemic, and now the economy was growing strongly. But they were still looking at a decade or more of budget deficits continuing to increase the debt.

It was a problem they’d think about when and if they were re-elected. Meanwhile, nothing mattered more that avoiding doing anything that could cost them votes.

All this we knew before the election. What was less obvious were the many stopgap measures they’d used to hold back the growth in government spending, building up a dam that would inevitably burst.

The stopgaps included making oldies wait many months for a homecare package, making people wait months for a visa, keeping the unemployed below the poverty line and thinking of excuses to suspend their payments.

And that’s before you get to the various, hugely expensive problems with the National Disability Insurance Scheme – problems that can’t be solved by telling the disabled to like it or lump it.

The Morrison government’s projections of continuing budget deficits assume those dams will never overflow. Much of the deficit is explained by the continuing cost of the Morrison government’s already legislated stage-three tax cut in July 2024, which the Parliamentary Budget Office now estimates will have added almost a quarter of a trillion dollars to our deficit and debt by 2032-33.

The second element of Chalmers’ budget problem is that, as part of its small-target strategy for finally winning an election, Labor promised never to do anything anyone anywhere would ever dislike.

When it came to the budget, while banging on about our trillion-dollar debt, they painted themselves into a corner by promising not to do what they’d need to do to stop adding to it. Not to rescind the stage-three tax cut, nor do anything else to increase taxes apart from a tax on multinational companies. (Talk about pie in the sky: make the wicked foreigners pay their fair whack and all our problems are solved without any pain.)

In theory, eliminating the budget deficit is easy. Just slash government spending to fit. All you’d have to do is, say, suspend indexation of the age pension, or cut grants to the states’ public hospitals and schools (while taking care not to touch private hospitals and schools).

In practice, making cuts sufficient to fill the gap is politically impossible. It’s true the government is busy reviewing all their predecessor’s spending, looking for waste and extravagance. But all that’s likely to achieve is to make room for their own new spending promises.

As several former top econocrats have told me, what’s needed to eliminate the deficit is to increase tax collections by about 4 per cent of gross domestic product – about $90 billion a year. See what I mean about Labor boxing itself in?

One thing that wasn’t clear before the election was the full extent of our problem with inflation, even though the Reserve Bank did increase interest rates a fraction during the campaign.

It’s made the need to reduce the budget deficit more pressing because the more the government reduces its own stimulus of the economy, the less the Reserve has to increase interest rates to get inflation down.

And the less rates rise, the less the risk that – as has happened so often in the past – the Reserve’s efforts to reduce inflation send us into recession. One of the side-effects of recession would be to increase deficit and debt greatly.

After his “dire” remark, I expected to see Chalmers edging quietly towards a door marked Sorry About That, and preparing a Keynes-like speech about how “when the facts change, I change my promises”.

But so far, he seems still to be painting himself into the corner. Apparently, keeping promises, no matter how ill-judged and overtaken by events, is more important to Labor than managing the economy well or even avoiding becoming a one-term government.

I’d never seen Chalmers and his boss as martyrs to the cause of Unbroken Promises.

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Housing own goal worsens our inflation problem

A key part of the economic response to the pandemic was to rev up the housing industry. It’s boomed and now it’s busting. What’s been achieved? Mainly, a big, self-inflicted addition to our inflation problem.

That, and a lot of recent first-home buyers now getting their fingers burnt. Well done, guys.

It’s not a crime to be wise after the event. Indeed, it’s a crime not to be. As we all know, you learn more from your mistakes than your successes.

We have much to learn from our mishandling of the economic aspects of the pandemic. Because we had no experience of pandemics, our mistake was to treat the lockdowns as though they were just another recession. Turned out they’re very different.

Because downturns in home building and house prices often lead the economy into recession, then a recovery in home building leads it out, the managers of the macroeconomy assumed it would be the same this time.

The federal government offered HomeBuilder grants to people ordering new homes or major alterations. The state governments offered stamp duty concessions to first-home buyers, provided they were buying new homes.

But the doozy was the Reserve Bank’s decisions to cut the official interest rate from 0.75 per cent to 0.1 per cent, and then cut the base rate for 3- and 5-year fixed-rate mortgages.

By the end of last year, according to the Bureau of Statistics, the median house price in Sydney and Melbourne had jumped by more than 40 per cent. In the following quarter, it fell by 7 per cent in Sydney and 10 per cent in Melbourne. By all accounts, it has a lot further to fall.

Turning to building activity, we’ve seen a surge in the number of new private houses commenced per quarter, which jumped by two-thirds over the nine months to June 2021. Then it crashed over the following nine months, to be up only 14 per cent on where it was before the pandemic.

It’s no surprise commencements peaked in June 2021. Applications for the HomeBuilder grant closed 14 days into the quarter.

But to commence building a house is not necessarily to complete it a few months later. The real value of work done on new private houses per quarter rose by just 15 per cent over the nine months to June 2021. Nine months later, it was up 12 per cent on where it was before the pandemic.

For the most part, the home building industry kept working through the two big lockdowns. It seems that, between them, the nation’s macro managers took an industry that was plugging along well enough, revved it up enormously, but didn’t get it building all that many more houses, nor employing many more workers.

Perhaps it soon hit supply constraints – shortages of building materials and suitable labour. I don’t know if the industry was lobbying governments privately for special assistance, or whether it didn’t have to. Maybe pollies, federal and state, just instinctively rushed to its aid.

But I wonder if the builders didn’t particularly want to get much bigger. There are few industries more cyclical than home building. Builders are used to building activity going up and down and prices doing the same.

When demand is weak, they try to keep their team of workers and subbies together by cutting their prices, maybe even to below cost. Then, when demand is strong, they make up for it by charging all the market will bear.

It’s the height of neoclassical naivety to think it never crosses the mind of a “firm” existing outside the pages of a textbook that manipulating supply might be a profitable idea.

So maybe the builders found the thought of increasing their prices more attractive than the thought of building a bigger business to accommodate a temporary, policy-caused surge in demand.

They may have taken a lesson from those property developers with large holdings of undeveloped land on the fringes of big cities. Dr Cameron Murray, a research fellow in the Henry Halloran Trust at Sydney University, has demonstrated that the private land-bankers limit the regular release of land for development in a way that ensures the market’s never flooded and prices just keep rising.

So, back to our inflation problem. Whenever people say the recent huge surge in prices is caused largely by overseas disruptions to supply, which can’t be influenced by anything we do, and will eventually go away, the econocrats always reply that some price rises are the consequence of strong domestic demand.

That’s true. As I wrote last week, it seems clear many of our businesses – big and small – have used the cover of the big rises in the cost of their imported inputs to add a bit for luck as they pass them on to consumers.

But I saved for today the great sore thumb of excess demand adding to the price surge: the price of building a new home (excluding the cost of the land) or major renovations. This accounted for almost a third of the rise in the consumer price index in the June quarter, and jumped by more than 20 per cent over the year to June.

The price of newly built homes has a huge weight of almost 9 per cent in the CPI’s basket of goods and services, making it the highest-weighted single item in the basket. This implies that new house costs have added almost 2 percentage points of the total rise of 6.1 per cent.

When the econocrats worry about the domestic contribution to the price surge, they never admit how much of that problem has been caused by their own mishandling of the pandemic.

Indeed, when people argued that the main thing further cutting interest rates would achieve would be to increase house prices, the Reserve was unrepentant, arguing that raising house prices and demand for housing was one of the main “channels” through which lower rates lead to increased demand.

But the crazy thing is, this strange way of using the cost of a new dwelling to measure the cost of housing for home-buyers – which, I seem to recall, was introduced in 1998 after pressure from the Reserve – exaggerates the true cost for people with mortgages, especially at times like these.

Few people ever buy a new dwelling and, even if they do, rarely pay for it in cash rather borrowing the cost. This is one reason the bureau doesn’t regard the CPI as a good measure of the cost of living, but does publish separate living-cost indexes for certain types of households.

Ben Phillips, of the Centre for Economic Policy Research at the Australian National University, has used the bureau’s living-cost indexes to calculate that about 80 per cent of households had a living cost increase below the CPI’s rise of 6.1 per cent. The median (typical) increase over the past year was 4.7 per cent.

What trouble the econocrats get us into when they use housing as a macro managers’ plaything.

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Fixing inflation isn't hard. Returning to healthy growth is

Despite any impression you’ve gained, fixing inflation isn’t the end game. It’s getting the economy back to strong, non-inflationary growth. But I’m not sure present policies will get us there.

The financial markets and the news media have one big thing in common: they view the economy and its problems one day at a time, which leaves them terribly short-sighted.

Less than two years ago, they thought we were caught in the deepest recession since the 1930s. By the end of last year, they thought the economy had taken off like a rocket. Now they think inflation will destroy us unless we kill it immediately.

For those of us who like to put developments in context, however, life isn’t that disjointed. The day-at-a-time brigade has long forgotten that, before the pandemic arrived, the big problem was what the Americans called “secular stagnation” and I preferred calling a low-growth trap.

In a recent thoughtful and informative speech, Treasury secretary Dr Steven Kennedy observed that the pandemic “followed a period of lacklustre growth and low inflation”. (It was so low the Reserve Bank spent years trying to get inflation up to the target range, but failing. Businesses didn’t want to raise wages – or prices.)

So, Kennedy said, “when assessing the policy decisions made during the pandemic there was an additional consideration for policymakers in wanting to not just return to the pre-pandemic situation, but to surpass it.”

One economist who shares this longer perspective is ANZ Bank’s Richard Yetsenga. He describes the 2010s as our “horrendum decennium” where unemployment and underemployment were relatively high, consumer spending relatively weak and business had plenty of idle production capacity.

He reminds us that real average earnings per worker in 2020 hadn’t budged since 2012. “The resulting weakness in consumer demand meant that ‘need’ – the most critical ingredient [for] business investment – was missing,” he says. “Excess demand, and the resulting lack of production capacity, is a pre-condition of investment.”

See how we were caught in a low-growth trap? Weak growth leads to low business investment, which leads to little productivity improvement, which leads to more weak growth.

During the Dreadful Decade, the prevailing view among policymakers was that high unemployment was preferable to high inflation, which might become entrenched. So, unemployment was left high, to keep inflation low.

Yetsenga says this decision to entrench relatively high unemployment was a mistake. “Unemployment, underemployment and the inequality they contribute to, all affect macroeconomic outcomes [adversely]“.

“Those on higher incomes tend to save more, reducing consumption, but those on lower incomes tend to borrow more. Inequality, in other words, tends to lower economic growth and exacerbate financial vulnerability.”

Even so, Yetsenga is optimistic. The policy response to the pandemic has “changed the baseline” and we’re in the process of escaping the low-growth trap.

Unemployment is at its lowest in five decades and underemployment has fallen significantly. Real consumer spending is 9 per cent above pre-pandemic levels, and businesses’ capacity utilisation has been restored to high levels not seen since before the global financial crisis.

As a result, planned spending on business investment in the year ahead is about the highest in nearly three decades.

Yetsenga says the Reserve would like some of the rise in the rate of inflation to be permanent. “If monetary policy can deliver [annual] inflation of 2.5 per cent over time, rather than the 1.5 to 2 per cent that characterised the pre-pandemic period, it’s not just the rate of inflation that will be different.

“We should expect the ‘real’ side of the economy to have improved as well: more demand, more employment and more investment.”

“The role of wages in sustaining higher inflation is well known, but wage growth doesn’t occur in a vacuum. To employ more people, give more hours to those working part-time, and raise wage growth, business needs to see demand strong enough to pay for the labour.

“Some of the additional labour spend will be passed on to higher selling prices. The need to invest in more labour is likely to go hand-in-hand with more capital investment.”

I think Yetsenga makes some important points. First, the policy of keeping unemployment high so that inflation will be low has come at a price to growth and contributed to the low-growth trap.

Second, inequality isn’t just about fairness. Economists in the international agencies are discovering that it causes lower growth. So, the policy of ignoring high and rising inequality has also contributed to the low-growth trap.

Third, the idea that we can’t get higher economic growth until we get more productivity improvement has got the “direction of causation” the wrong way around. We won’t get much productivity improvement until we bring about more growth.

Despite all this, I don’t share Yetsenga’s optimism that the shock of the pandemic, and the econocrats’ switch to what I call Plan B – to use additional fiscal stimulus in the 2021 budget to get us much closer to full employment, as a last-ditch attempt to get wage rates growing faster than 2 or 2.5 per cent a year – will be sufficient to bust us out of the low-growth trap.

Yetsenga’s emphasis is on boosting household income by making it easier for households to increase their income by supplying more hours of work. He says little about households’ ability to protect and increase their wage income in real terms.

Another consequence of the pandemic period is the collapse of the consensus view that wages should at least rise in line with prices. Real wages should fall only to correct a period when real wage growth has been excessive.

But so panicked have the econocrats and the new Labor government been by a sudden sharp rise in prices (the frightening size of which is owed almost wholly to a coincidence of temporary, overseas supply disruptions) that they’re looking the other way while, according to the Reserve’s latest forecasts, real wages will fall for three calendar years in a row.

Since it’s the easiest and quickest way of getting inflation down, they’re looking the other way while the nation’s employers – government and business - short-change their workers by a cumulative 6.5 per cent.

This makes a mockery of all the happy assurances that, by some magical economic mechanism, improvements in the productivity of labour flow through to workers as increases in their real wage.

Sorry, I won’t believe we’ve escaped the low-growth trap until I see that, as well as employing more workers, businesses are also paying them a reasonable wage.

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We're struggling with inflation because we misread the pandemic

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Treasury boss’s message: higher taxes the cure for debt and deficit

Anthony Albanese and his Treasurer, Dr Jim Chalmers, have inherited many problems that won’t be solved quickly or easily. Nor will they be solved without the new government being willing to persuade voters to accept the sort of tax changes no pollie wants to talk about in an election campaign.

That’s the conclusion I draw from Treasury secretary Dr Steven Kennedy’s belated annual speech to the Australian Business Economists this week.

Election campaigns are times when we hear about all the wonderful things the politicians want to do to improve the public services we get and reduce the taxes we pay. It’s after the election that pollies present the bill.

Especially when the election has changed the government. This wasn’t Chalmers bringing us the bill, it was the waiter reminding us we’d eaten quite a lot and the bill was getting pretty long.

The economic story had “shifted significantly”, Kennedy said. Inflation pressures had emerged faster and more strongly than most people expected. These were likely to persist into next year “at the very least”.

This, of course, is why the Reserve Bank has been raising the official interest rate – to eventually bring inflation back to acceptable levels.

“Interest rates are at near-record low levels and therefore highly accommodative and should normalise”, Kennedy said. In other words, they need to be increased until they’re back to more-normal levels. If so, they have a lot further to go.

But, Kennedy says that “just as fiscal [budgetary] and monetary [interest-rate] policy worked together to respond to the pandemic, they will need to work together in managing the risks to inflation and the economy more broadly”.

Ah yes, the dreaded duo, Debt and Deficit. Not a subject to be dwelt on during election campaigns, but one to return to afterwards. Presenting the bill, remember?

Chalmers is, understandably, anxious to remind us that our trillion-dollar public debt is inherited from his predecessors. What Kennedy does is implicitly confirm that the previous government’s “medium-term fiscal strategy” - to “focus on growing the economy in order to stabilise and reduce debt” - is still the go.

With an important, after-the-election qualification: “a more prudent course would be for the budget to assist more over time”.

How? We’ll get to that. But first, he gave the best explanation I’ve seen of how a government can get on top of a big debt simply by ensuring the economy grows at a faster annual rate than the rate of interest on the debt.

To “get” the explanation you have to accept one proposition that many otherwise sensible people and media commentators can’t get their head around: that the government of a nation is in a radically different position to an individual household.

Households have to repay any money they borrow sooner or later, but governments don’t. That’s because every family gets old and dies, whereas nations are a collection of many millions of households that, though the faces change, goes on forever.

For a nation, what matters is not its ability to repay the debt, but just its ability to afford the interest payments on it. As long as the nation continues to exist, it can re-borrow by issuing a new government bond to replace an old government bond as it falls due for repayment.

Kennedy explained that strong economic growth and interest rates that are low compared with what’s been normal for the past 50 years are likely to ease the burden of the debt. This is by reducing its size not in dollar terms, but relative to the size of the economy, measured by the dollar value of all the goods and services the economy produces annually (nominal gross domestic product) in coming years.

Interest payments add to the amount of debt the nation owes, but growth in the economy (nominal GDP) increases the economy’s capacity to “service” (pay the interest on) that debt. “When the economy grows quicker than the interest payments add to the debt, the debt burden will decrease,” he said.

That’s the basic mechanism all governments in all the rich countries have relied on since World War II to get on top of their debt. It’s what the Morrison government was relying on, and it will be what the Albanese government continues relying on.

But – with Treasury there has to be a but – there was a weakness in the previous government’s strategy: their projections showed the budget remaining in deficit for the next decade and, indeed, the next 40 years.

That means it wasn’t just the interest bill that was adding to the debt each year, it was also the continuing deficits.

“The current projected reduction in the debt [relative] to GDP is unusual in that it is relying solely on favourable growth and interest-rate dynamics [that the average rate of interest on the debt will rise more slowly than the rising rate of interest on the new borrowing because the average government bond takes about seven years to fall due] to reduce the ratio [of debt to GDP],” Kennedy said.

So here’s the post-election But (which, since it’s the same Treasury, would probably have happened even without a change of government): “A more prudent course would be for the budget to assist more, over time,” Kennedy said.

How? By getting the budget deficit down a lot faster than the Liberals were planning to. Maybe even by running budget surpluses for a while – which would involve repaying a bit of the debt.

Sure, but how do you get the deficit down? The government will be reviewing all the spending programs left by the Coalition, looking for savings. But what savings it finds will mainly be used to pay for Labor’s promised new spending.

So the main way to improve the budget balance will be by “raising additional tax revenues”. Kennedy implied that this would be done by reducing businesses’ and households’ tax concessions.

The next three years will be interesting.

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Labor mustn't be panicked into doing something stupid

Who’d want to be the new Treasurer, Dr Jim Chalmers? Certainly, not me. But that won’t stop me giving him a shed-load of free advice. Starting now.

As Chalmers sees it, the economy he’s inherited is in “dire” straits. Everywhere he looks there’s another problem. First, “skyrocketing” inflation.

Second, falling real wages as “a consequence of almost a decade of the deliberate undermining of pay and job security, now coming home to roost in the form of a full-blown cost-of-living crisis”.

And third, a budget “heaving with more than $1 trillion in debt” and worse (though he doesn’t mention it), a budget projected to stay in structural deficit for as far as the eye can see, meaning the debt continues to grow in dollar terms, and falls relative to the growing size of the economy only after a delay, and only slowly.

He could have added a fourth problem: a hostile international economic environment, with a fair risk of the US falling into recession and, worse, a major trading partner – China – that’s mishandling both its response to the pandemic (think more supply-chain disruptions) and its management of the macroeconomy.

Chalmers is, of course, doing what all incoming treasurers (and chief executives) do and laying it on thick. Like Mother Hubbard, he’s discovered the cupboard is bare. Actually, he’s cleaning out the cupboards and finding all the bad stuff his predecessor hid. He’s snapping people out of the campaign fairyland, where government spending can go up while taxes go down and deficits fall.

Even so, his four big problems are real enough – and seem to be getting worse as each week passes. The latest gas crisis is a parting gift from the Liberals, arising from nine years of indecision about how the transition from fossil fuel to renewables should be managed to avoid unexpected mishaps – such as a Russia-caused leap in global fossil fuel prices.

So what should he do? Avoid being panicked by the many partisan ill-wishers and ideological barrow-pushers who would do so. He needs to think carefully about the various problems, the highest priorities, the right order in which to tackle them, their varying degrees of difficulty and urgency, and the way they interrelate - the ways he can kill two birds with one stone, or make choices to fix one problem that make another problem worse.

Chalmers should be wary of conventional thinking about problems that are of unconventional origins. Just as the “coronacession” was unlike an ordinary recession because it was caused by government-imposed restraints on the supply side rather than efforts to curb excessive demand, so he shouldn’t be using demand restraint to try to fix disruptions to supply.

Inflation problems normally arise from an overheated economy leading to excessive wage growth. The standard solution will involve cutting real wages to make labour less expensive. But we’ve had weak real wage growth for a decade.

Those ideologically opposed to fiscal stimulus tell us our stimulus has given us a red hot, inflation-prone economy – as proved by our super-tight labour market. They conveniently forget to mention that the pandemic caused us to ban all imported labour for two years, but that this supply constraint has now been lifted.

If excessive wage growth didn’t cause our high and rising prices, what did? Fiscal stimulus has caused shortages of materials and workers in housing and construction, but most of the price rises have come from external supply constraints caused by the pandemic and the war on Ukraine.

Nothing we could do can fix problems coming from the rest of the world. But we shouldn’t forget that these are once-off price increases. And those import prices will fall at some stage as pandemic disruptions are resolved and the war ends.

It’s not that simple, of course. Why not? Because our businesses don’t seem to have hesitated in passing their increased import costs through to retail prices. That’s the start not of a wage-price spiral, but price-wage spiral. And business and employer groups’ solution to the spiral is simple: allow only a token increase in wages, and inflation will come down in no time.

This is the unspoken doctrine that’s the bastard child of the economic rationalist era: give business whatever it demands and everything in the economy will be wonderful. The business lobby has become so consumed by short-sighted self-interest – so used to getting its own way – that we need a new government with the wisdom and strength to save business from its own folly.

We need a government capable of seeing what business can’t: that wages aren’t just a cost to business and an impost on profits, but also the chief source of income for the 10 million households who are the reason we have an economy and whose spending on the things our businesses produce is what generates their profits in the first place.

Screwing the workers by tolerating ever-falling real wages is a delusional way to increase profits in anything but the short term. The bigger the fall in real wages – and the government can’t stop them falling – the more Labor risks joining the US and China in recession.

This is why, in its worthy desire to keep big business in the tent, the government was wrong to ask the Fair Work Commission to increase award wages by 5.1 per cent only for “low-paid” workers – that is, only about the bottom 12 per cent of workers rather than the bottom 25 per cent.

Do you really think the 88 per cent of workers reliant on bargaining with bosses rather than a commission edict will get anything like a 5 per cent pay rise?

Former Reserve Bank governor Bernie Fraser used to say that any fool could get inflation down – all you had to do was crunch the economy. Is that what business would like? It’s certainly what the financial markets – whose model of our economy is a footnote saying “see America” – want.

As I’m sure the Reserve well understands, we need to get inflation down without causing a recession. And that means being patient about how long it takes. We were below the target range for six years; we can be above it for a few years without the sky falling.

And remember this: if we did fall into recession, the strategy of growing our way out of debt would explode. Not only would the economy be growing more slowly than the debt, the budget’s “automatic stabilisers” would reverse and the deficit would blow out, greatly increasing the debt.

On the other hand, Chalmers should be sceptical of the argument that an additional reason we need to cut the budget deficit ASAP is to reduce the need for interest rates to rise so far. Getting inflation under control is not a big ask – provided we’re patient.

The Reserve’s stated strategy is to shift the stance of monetary policy only from “emergency expansionary” to “neutral”. That is, to take its foot off the accelerator, not to jam on the brakes. This means slowly lifting the official interest rate to about 2.5 per cent, so the medium-term real interest rate is zero.

In theory, at least, this should not cause the economy to contract, nor great pain to most people with mortgages. And it would be a good thing in itself to get rates up to a level remotely approaching normal.

The real challenge for budget policy is to avoid getting us in deeper by proceeding with the stage-three tax cut in its present timing, size and form. It could be rejigged to make it more effective in relieving cost-of-living pressures for people in the bottom half.

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Replacing the misbehaving ScoMo is an easy act for Albo to follow

It is a truth (almost) universally acknowledged by Labor politicians that it’s near impossible to reform from opposition. Be too ambitious, make yourself too big a target, and the government will happily use the many advantages of incumbency to shoot you down.

That’s because all reforms have opponents, and most create losers as well as winners. That’s why, after being reminded of this truth at the 2019 election, Labor made itself as small a target as possible. Part of this was for Anthony Albanese to neutralise most of Scott Morrison’s vote-buying promises by matching them.

Back then, Morrison convinced himself that – apart from having God on his side – his miraculous win was owed to his cunning strategy of painting Labor as the party of tax-and-spend, and the Liberals as the party of lower taxes. He tried repeating the strategy this time.

The first part of his mantra was true enough. The second was bulldust. As independent economist Saul Eslake has demonstrated, in the highest-taxing stakes, the just-departed government runs second only to the Howard government.

Find that hard to believe? You’re forgetting the invisible magic of bracket creep. The loophole in Morrison’s promise not to raise taxes – which Albanese matched – is that it doesn’t include bracket creep. And now that inflation’s back, bracket creep proceeds apace.

Many of the reforms we need – fixing aged care, reversing the squeeze on universities and TAFE, making homeownership affordable, exploiting our chance to become a renewables superpower – would cost big bucks and require greater and changed taxation.

But Albanese’s problem is not just that he’s promised not to increase taxes while making a huge and blatantly unfair cut in income tax in two years’ time, or even that he’s inherited a big budget deficit and huge debt overhang.

That much you see from the budget papers. What you can’t see is the extent to which the Morrison government has been holding back the tide of higher spending by cutting public service jobs, increasing waiting times, cutting NDIS packages and finding excuses to suspend people’s dole payments.

This dam had to burst after the election. And it will do so at just the time when the econocrats are telling Labor the budget deficit must go down, not up.

What was it Paul Keating used to say about excrement sandwiches? Come on down, Albo.

But all is not lost. For a start, on expensive and controversial reforms, Albanese should follow the aforementioned Eslake’s advice and copy John Howard. He got elected in 1996 with a promise to “never, ever” introduce a goods and services tax. So he made an honourable escape by having such a tax fully developed for presentation at the next election.

It was approved – by a whisker. As Eslake reminds us, not since 1931 has any first-term federal government failed to secure a second term.

“Labor needs in its first term to lay the groundwork for a more expansive mandate for its second term,” Eslake recommends.

Next, Labor does have a mandate – both direct and indirect, via the higher votes for the Greens and teal independents – to proceed with climate action, an anti-corruption commission “with teeth”, gender equality, and commitment to the Uluru Statement from the Heart “in full”.

Except for climate action, none of these historic reforms will greatly trouble the budget accountants.

However, as Professor Mark Kenny, of the Australian National University (but formerly of this parish), has helped us see, this election was about something deeper: “The urgent need to rescue longstanding governing norms around transparency, accountability, ministerial standards, trust and honesty and, of course, the viability of the public service.”

Morrison’s approach, he says, was “divide and dither”. “Accountable government, national unity, evidence-based policy, and democratic accountability [whether voters give his performance a tick or a cross] are all on the ballot at this election.”

Let’s get personal. The biggest reason Albanese is now PM is that he’s not Scott Morrison. The biggest policy question in this election, the one almost everyone in the great majority who didn’t vote for the Coalition wholeheartedly endorsed, was: “would you like to see no more of Scotty from marketing?”

It’s simple. The surest way for Albanese to ensure his re-election is to be a better, more likeable PM than that other one.

Just be more truthful, more respectful, more humble, more answerable, more willing to admit your mistakes, more inclusive, more even-handed, more charitable towards the needy, more willing to answer the question, and more protective of Australia’s reputation abroad.

Be less prevaricating, less divisive, less bulldozer-like, less willing to help mates and punish enemies, and less unable to let that five-letter S-word pass your lips unqualified.

I think Albanese’s already got that message. “I want to bring people together and I want to change the way that politics is conducted in this country,” he’s said. Australians have “conflict fatigue”.

Being a saintly prime minister won’t be easy. But think of it this way: conduct-wise, being ScoMo’s successor won’t be a hard act to follow.

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Huge public debt isn’t the worry, it’s continuing budget deficits

There’s an easy way to tell how much someone understands economics: those at panic stations about the huge level of our government debt just don’t get it. But that’s not to say we don’t have a problem with the budget deficit.

Australia’s public debt isn’t high by international standards. It doesn’t have to be repaid by us, our children or anyone else. Since budget surpluses – which do reduce debt – have always been the exception rather than the rule, government debt is invariably “rolled over” (when bonds become due for redemption, they’re simply replaced with new ones).

The time-honoured way governments get on top of their debts is simply to outgrow them. So Treasurer Josh Frydenberg’s plan to reduce the relative importance of the debt by striving for strong economic growth is neither new nor radical.

If the debt panickers took more notice of what’s actually happening, they’d see that this approach is already bearing fruit. The remarkable strength of the economy’s rebound from the coronacession – much of which is owed to the success of the much-criticised JobKeeper scheme – is helping in two ways.

First, it’s causing the budget deficit to fall much quicker than expected, thus reducing the amount we’re adding to the debt in dollar terms. Second, the faster growth in the economy is slowing the growth of the debt in relative terms – that is, relative to the size of the economy that services the debt.

Most of the unexpected improvement in the budget balance has been allowed to stand, with only a small proportion of it used for further stimulus. That’s particularly true of last week’s budget, notwithstanding its blatant vote-buying.

The media have given us an exaggerated impression of the cost of those measures (particularly when you take account of the decision to discontinue the $8 billion-a-year low and middle income tax offset, which most of them failed to notice because there was no press release).

So the biggest burden present and future generations bear from the debt is the interest bill on it. But with interest rates at an unprecedented low, there’s never been a better time to borrow. And though it’s true long-term rates have started rising, they’ll still be unusually low for at least the rest of this decade.

What’s more, the average interest rate payable on the debt rises even more slowly because the higher rate applies only to the small part of the debt that’s being newly borrowed or reborrowed each year.

The budget’s gross interest payments are projected to stay below 1 per cent of gross domestic product until at least 2026. Which, as the independent economist Saul Eslake reminds us, means they’ll stay far lower than they were at any time in the 30 years to 2000. Frightening, eh.

Yet another point to remember is that the Reserve Bank’s resort to “quantitative easing” (buying second-hand bonds with created money) meant that, in effect, more than all the stimulus spending of the past two years was borrowed not from the public, but from another part of government, the central bank. It’s just a book entry.

But though there’s no reason to worry about either the level of the public debt or the interest bill on it, that’s not to say we can go on running budget deficits for another decade at least – which is what the budget papers project will happen “on unchanged policies”.

We had good reason to borrow heavily to protect ourselves from the global financial crisis and the Great Recession of 2008-09, and good reason to borrow heavily to save life and limb during the pandemic.

(The reason the debt continued growing between the two crises, was partly because we kept cutting income tax despite our continuing deficits, but also because economic growth was unusually weak.)

But what we shouldn’t be doing is continuing to run budget deficits after the effect of the temporary stimulus measures has ended. That is, we shouldn’t be running a “structural” deficit because we haven’t been raising enough tax revenue to cover the ordinary (but growing) business of government.

Some economists estimate the structural deficit is roughly $40 billion a year. Treasury’s projections show it falling steadily as a proportion of gross domestic product over the 10 years to 2032-33, but that’s owing to continued growth in the economy plus the no-policy-change assumption that the big tax cut in 2024-25 will be followed by eight years of bracket creep without further tax cuts.

One thing we should have learnt by now is to expect further unexpected major shocks to the economy that require further heavy borrowing. It would be imprudent to add to our debt, and use up borrowing capacity, merely because we didn’t feel like paying our way during the intervals between crises.

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Despite all the hoopla, budget's extra economic stimulus isn't huge

Sensible economists accept that, because they’re determined by politicians, budgets are more about politics than economics. Pre-election budgets are more political than other budgets. And budgets coming before an election a government fears it may lose are wholly politically driven.

Welcome to this week’s budget. But here’s the point: whatever the motivation driving the decisions announced in the budget to increase this or reduce that, all the decisions have an effect on the economy nonetheless.

It’s a budget’s overall effect on the economy that macro-economists care about, not so much the politicians’ motives. So good economic analysis involves leaving the politics to one side while you focus on determining the economic consequences.

A glance at this week’s budget says that, with all its vote-buying giveaways, the budget will impart a huge further stimulus to an economy that was already growing strongly, with unusually low unemployment, but rising inflation.

What on earth are these guys up to, ramping an economy that doesn’t need ramping just to try to buy their re-election? But glances are often misleading, and the story’s more complicated than that.

You can’t judge the “stance” of fiscal (budgetary) policy adopted in a particular budget – whether it will work to expand aggregate (total) demand (spending) in the economy or to contract demand – just by looking at the few of its many “measures” (policy changes) that hit the headlines, while ignoring the other hundred measures it contained.

And, as with many concepts in economics, there are different ways you can measure them, with the different ways giving you somewhat different answers.

The simplest way to judge the stance of policy adopted in a budget – it’s expansionary, contractionary or neither (neutral) – is the way the Reserve Bank does it. You just look at the direction and size of the expected change in the budget balance from the present financial year to the coming year.

Treasurer Josh Frydenberg expects the budget deficit for the year that will end in three months’ time to be $79.8 billion, and the deficit for the coming year, 2022-23, to be slightly smaller at $78 billion.

In an economy as big as ours, that decrease of $1.8 billion is too small to notice. The difference between how much money the budget is expected to take out of the economy in taxes and how much it puts back via government spending is expected to be virtually unchanged.

So, judging it the Reserve’s way, the budget will neither add to aggregate demand (total private plus public spending) nor subtract from it. The stance is neutral.

However, there’s a two-way relationship between the budget and the economy. The budget affects the economy but, by the same token, the economy affects the budget.

The size of the budget’s deficit or surplus is affected by where the economy is in the business cycle. When the economy’s booming, tax collections will be growing strongly, whereas government spending on unemployment benefits will be falling, thus causing a budget deficit to reduce (or a surplus to increase).

On the other hand, when the economy’s dipping into recession, tax collections will be falling and the cost of benefit payments will be rising, thus increasing a deficit (or reducing a surplus).

The Keynesian approach to deciding the stance of policy adopted in a budget is to distinguish between this “cyclical” effect on the budget balance – what the economy’s doing to the budget – and the “structural” effect caused by the government’s explicit decisions.

So, many economists believe that when assessing the stance of a new budget, you should ignore the cyclical component and focus on the change in the structural component – what the government has decided to do to the economy.

You can determine this by looking at what the great budget-expert Chris Richardson, of Deloitte Access Economics, calls “the table of truth”, table 3.3 of budget statement 3 in budget paper 1, page 18 in the PDF (page 86 in the printed version).

The table shows that in the few months since the mid-year budget update last December, the economy has strengthened more than expected - mainly because of the growth in consumer spending and employment but, to a lesser extent, because of the rise in the prices we get for our exports of coal and iron ore.

This means the cyclical component of the budget deficit (what Treasury calls “parameter and other variations”) is now expected to be $28 billion less in the present financial year, and $38 billion less in the budget year, 2022-23.

Adding in the “forward estimates” for three further years to 2025-26, gives a total expected improvement of $143 billion – all of which comes from higher-than-expected tax collections.

So, had the government done nothing in the budget, that’s by how much the string of five budget deficits would have been reduced, relative to what was expected last December.

However, the table also shows that the new policy decisions announced in the budget (and in the few months leading up to it) are expected to reduce that cyclical improvement by $9 billion in the financial year just ending, and $17 billion in the coming year.

These are additions to the expected “structural deficit”. Over the full five years, they should total $39 billion, with more than three-quarters of that total coming from increased government spending.

So, relative to where we expected to be in December, the government’s spending in the budget won’t stop the next five budget deficits – and the government’s debt – being more than $100 billion less.

Even so, judged in Keynesian terms, the government has added to the structural deficit, so the budget is expansionary.

The independent economist Saul Eslake calculates that the budget involves net stimulus equivalent to 0.4 per cent of gross domestic product in the present financial year, and 0.7 per cent in the coming year.

So, he concludes, “the budget does put some additional upward pressure on inflation...but it’s fairly small”.

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Sleight of hand: Frydenberg's disappearing cash trick

If you think this is a going-for-broke, pre-election vote-buying budget aimed squarely at the hip pocket of people worried about the rising cost of living, let me pass on Treasurer Josh Frydenberg’s grateful thanks. That’s just the impression he’s hoping you get.

But it isn’t true. When you read the fine print, you discover that, for most people, most of the cost of the extra help they will soon be getting will later be recouped by an increase in the income tax they pay.

True, low- and middle-income earners will get a one-off increase of $420 in their annual tax offset when they submit their tax return for this financial year (costing the budget more than $4 billion) and pensioners and other welfare recipients will benefit from the one-off $250 payment (costing $1.4 billion) that Mr Frydenberg will ensure hits their bank account before election day.

And every driver will save, thanks to the 22 cents a litre cut in the excise on petrol during the six months to the end of September. Coming at a net cost to the budget of $2.9 billion, it’s not to be sneezed at, even if the usual ups and downs of petrol prices will make it hard for many people to see the saving they’re making.

All this follows the old rule for politicians who put their political survival ahead of the public interest: make sure you look like you’re doing something about whatever is exercising voters’ minds at the minute, even if what you do makes little real difference to the problem.

But Mr Frydenberg has been trickier than that. Without needing to announce it – and hoping no one would notice – he has omitted to continue the low- and middle-income tax offset in the coming financial year.

This is his way of avoiding saying that the 10 million-plus taxpayers earning up to $126,000 a year will have their income tax increased by up to $1080 a year, from July 1. But they won’t feel it for at least a further 12 months, when they discover their tax refund is much smaller than they are used to.

Discontinuing this tax offset will increase tax collections by about $8 billion a year, thereby covering almost all the cost of the three temporary cost-of-living measures announced in the budget.

It’s a point worth remembering when next you hear Scott Morrison repeating his line that the Liberals are the party of lower taxes, whereas his opponents are the party of “tax and spend”.

So this budget is more about moving the budgetary deckchairs between years than significantly changing the government’s finances.

When you go beyond temporary handouts, the budget’s greatest weakness is Mr Frydenberg’s assurance that wage growth in the coming financial year will more than keep up with rising living costs. It is based on nothing more than optimistic forecasts.

The rise in consumer prices will slow from 4.25 per cent in the present financial year to 3 per cent in the coming year. Wages, on the other hand, will grow faster, from 2.75 per cent this year to 3.25 per cent next year.

Should this come to pass – and this government’s record on forecasting wage growth is woeful – it would mean that “real” wages grow by 0.25 per cent in the coming year, which would hardly make up for their expected fall of 1.5 per cent in the present year to the end of June.

If I were deciding my vote based on which side was promising to do more about the cost of living, I wouldn’t be greatly impressed. Whereas Labor is full of plans to speed up wage growth, the budget says nothing about changing wage-fixing arrangements.

The people most disapproving of the temporary cost-of-living relief are those sticking with the Coalition’s now-abandoned fatwa against debt and deficit. To them, reducing the debt must override all other objectives.

This was always based on the misconception that a national government’s finances work the same way a family’s do.

Mr Frydenberg is right in telling us that the best way to get on top of the government’s debt is to outgrow it.

Even so, he should be doing more to reduce the budget deficit in coming years – not because the government’s debt is dangerously high, but to give us greater safety should another global setback come along that yet again requires the government to buy our way out of trouble.

If Liberals were the great economic managers they claim to be, this budget would have included a plan to get started on largely eliminating the budget deficit. That means reducing the deficit by about $40 billion a year.

It didn’t. Which leaves us to wonder whether, should the Coalition be re-elected, its plans to cut government spending and increase taxes will be announced in its next budget, or whether it will continue avoiding unpopular measures and kicking our economic problems down the road.

Labor, on the other hand, is warning that, should it win the election, it will use a second budget to make improvements to this one. Of course, what counts as an improvement changes with the eye of the beholder.

The budget’s increased spending on the training and skills of apprentices and other young workers earns a big tick in my book.

One reason some may see the budget as profligate is its long list of $18 billion-worth of new infrastructure projects – big and small – being added to its much-mentioned record $120 billion infrastructure pipeline.

Many of these projects seem chosen to improve the Coalition’s vote in marginal electorates and few have been checked out and approved by the public service infrastructure experts.

Maybe this is an area where Labor would want to “improve” the list of lucky marginal seats.

But worriers should remember that, after the electioneering  is over, not every project that goes into the massive “pipeline” emerges from the other end. And many take much longer to emerge than the campaigning politician suggested they would.

This budget is not as fiscally responsible as the government would like you to believe when it’s claiming to be the party of good economic management. But nor is it as fiscally irresponsible as it would like you to believe when it is claiming to have fixed your problem with the cost of living.

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The plague hasn’t wounded the economy, but the boom won’t last

The pandemic has caused much pain – physical, financial and psychological – to many people. But what it hasn’t done is any lasting damage to the economy and its ability to support people wanting to earn a living.

That’s clear from this week’s “national accounts” for the three months to the end of December, with the Australian Bureau of Statistics revealing the economy’s production of goods and services – real gross domestic product – rebounding by 3.4 per cent, following the previous quarter’s contraction of 1.9 per cent, caused by the lockdowns in NSW, Victoria and the ACT.

Despite those downs and ups, the economy ended up growing by 4.2 per cent over the course of last year. It was a similar story the previous year, 2020, when despite the nationwide lockdown causing the economy to contract by a massive 6.8 per cent in the June quarter, it began bouncing back the following quarter.

Over the two years of the pandemic, the economy’s ended up 3.4 per cent bigger than it was before the trouble started.

Be under no illusion, however. The economy would not have been able to bounce back so strongly had the federal government not spent such huge sums topping up the incomes of workers and businesses with the JobKeeper wage subsidy, the temporary increase in JobSeeker benefits, special tax breaks for business (including to encourage them to invest in plant and equipment) special incentives for new home-building, and much else. The state governments also spent a lot.

The Reserve Bank also cut interest rates – from next-to-nothing to nothing – and bought a lot of government bonds, but I find it hard to believe this made a big difference, except to house prices and home building.

It’s true that these figures for GDP and its components don’t include the effects of the Omicron wave, which came mainly in the first half of January. But by now it’s pretty clear its effect on the economy was fairly small. Of course, we may not be finished with the Greek alphabet.

None of this is to deny that the pandemic has done lasting damage to some individual workers, businesses and industries. Overall, however, the economy’s in surprisingly good shape. And this is confirmed by turning from the national accounts to the jobs market.

We have 270,000 more people in jobs than we did before the pandemic, and both unemployment and underemployment are at 13-year lows, while the number of job vacancies is at a record high.

This remarkable achievement is partly the consequence of shortages of young, less-skilled workers, caused by our closed border, however. Those shortages will gradually go away now the border’s been reopened.

Unsurprisingly, the detailed figures show that most of the growth during the quarter came from a rebound in the two unlocked states, NSW and Victoria, plus the ACT.

More surprisingly, most of the growth came from a rebound in consumer spending in former lockdown area, which rose by 9.6 per cent, compared with 1.6 per cent in the rest of the country.

The only other positive contribution to growth in the quarter was a rise in the level of business inventories – meaning the rest of the economy was holding it back.

Spending on new housing and alterations fell by 2.2 per cent in the quarter, mainly because of temporary shortages of workers and materials.

The government’s stimulus program has ended, but the industry still has many new houses in the pipeline. However, Thursday’s news of a 28 per cent collapse in the number of new residential building approvals in January makes you wonder how long the housing industry will keep contributing to growth.

Business investment in new equipment and construction also fell during the quarter. Businesses say they’re expecting to increase their spending significantly this year but, as Kieran Davies, of Coolabah Capital, has noted, “companies find it hard to forecast their own investment expenditure”. And the government’s tax incentives won’t last forever.

The jump in consumer spending came despite a fall in households’ disposable income, caused by a decline in assistance from government. Thus, to cover the increased spending, households had to cut their rate of saving during the quarter from almost 20 per cent of their disposable income to 13.6 per cent.

What’s been happening is that households save a huge proportion of their income during lockdowns (because they can’t get out of the house to spend it), but cut their rate of saving when the lockdown ends and spend much more than usual as they catch up on things and services they’ve been waiting to buy.

Even so, a saving rate of 13.6 per cent is about twice the normal rate - meaning households still have a lot of money stashed in bank accounts – more than $200 billion – that they’ll be able to spend in coming months.

Most of this is money they’ve earnt in the normal way, but much of it is also money that’s come to them in special assistance from the government.

It’s mainly because of all this extra money waiting to be spent that the Reserve Bank is forecasting that, after contracting by about 1 per cent in 2020 and growing by 4 per cent in 2021, the economy will grow by a bit more than 4 per cent this year.

Remember, however, that the economy usually grows by only about 2.5 per cent a year. So what looks like booming growth last year and this, is really just catch-up from the temporary effects of lockdowns.

We simply can’t – and won’t – keep growing at the rate of 4 per cent a year. That’s why the Reserve is expecting growth to slow sharply to a more-normal 2 per cent next year, 2023.

Most of the extra money households are holding may have been spent by the end of this year. And the forecast for 2023 assumes we’ll be back to wages growing a bit faster than the cost of living – which has yet to happen.

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Unlike the media, econocrats in no great hurry to raise interest rates

The financial markets and financial press may have convinced themselves we have a serious inflation problem and must hit the interest-rate brakes early and often, but the clear message from our top econocrats is that they aren’t in such a hurry. Their eyes haven’t moved from the prize: seizing this chance to achieve genuine full employment.

Nothing in Treasury secretary Dr Steven Kennedy’s remarks to a Senate committee this week suggested he was anxious about our recent rise in prices, nor hinted that a rise in the official interest rate was imminent.

Indeed, “interest rates are still close to zero and expected to remain historically low for some time,” he said.

What little he said about inflation was that “the effects of COVID on inflation, often characterised as a combination of increased demand for goods [at the expense of demand for services] and supply-side shocks, are still passing through the economy.

“Fortunately, these impacts have been much less pronounced in Australia than in other countries. Nevertheless, the impacts have been felt and headline inflation is currently at an 11-year high.” (Not hard when inflation has been so low for so long.)

It’s true Kennedy also said that “it will not be until we see interest rates rise back to more usual levels that the risks associated with very low interest rates abate”.

But it’s clear he meant it would take years before the Reserve had rates back up to “more usual levels” - such as an official rate of 3, 4 or 5 per cent – not to give a big hint that Commonwealth Bank economists were right in predicting this week that the Reserve would start whacking up the official rate at its first board meeting after the May election.

And he was also making a quite different point. Settle back. Usually, he said, monetary policy (the manipulation of interest rates) is the primary tool with which to manage economic cycles, with fiscal policy (the manipulation of government spending and taxes in the budget) focusing on economic growth and budget stability.

Of course, in this conventional approach fiscal was complementary to monetary policy primarily through the workings of the budget’s “automatic stabilisers” (which cut tax collections and increase the number of dole payments when private sector demand is weak, but do the reverse when private demand is strong).

However, when major shocks to the economy come along, fiscal policy plays a more active role. And shocks to the economy don’t come bigger than the pandemic.

In any case, lockdowns cut the supply of goods and services, whereas monetary policy works to encourage demand – provided there’s plenty of scope to cut interest rates, which there wasn’t because rates were already close to zero.

So fiscal became the dominant policy instrument, with huge increases in government spending – including on the JobKeeper wage subsidy scheme – leading to huge increases in the budget deficit and public debt.

Got that? Now for Kennedy’s big announcement: “This unusual episode of macro-economic policy is now coming to an end.”

From here on, the dominant role will revert to monetary policy, with fiscal policy taking a step back.

Why? Well, partly because monetary policy will be busy for years getting interest rates back to “more usual levels”.

In which case, Kennedy says, “it is important that the withdrawal of fiscal policy support is tapered, as it currently is, to ensure that monetary policy has an opportunity to normalise”. (In the lingo of econocrats, “tapered” means something reduces slowly and steadily, not sharply and suddenly.)

As Kennedy says, the tapered withdrawal of fiscal policy support has already been arranged. That’s because all the government’s stimulus measures were designed to be temporary. So, as those programs wind up, the level of government spending – and the size of the budget deficit – will fall noticeably over the next few financial years.

Which means that what he’s really saying is there should be no additional, discretionary moves to hasten the return to a lower budget deficit. Why not? So monetary policy has an opportunity to “normalise”.

Get it? Over coming years, the Reserve will have to move interest rates up a long way to get them back where they should be – that is, to a level where borrowers have to compensate savers both for the loss of their money’s purchasing-power (that is, for inflation) and for being given the (temporary) use of the savers’ money.

But the Reserve’s scope to do this will be constrained if, while it’s trying to tighten monetary policy, the government’s rapidly tightening fiscal policy.

And Kennedy says there’s “an even more compelling reason” for fiscal policy support for demand not to be withdrawn too abruptly. Which is? “The opportunity to achieve full employment”. The “important opportunity to achieve and sustain full employment.”

No one knows how far unemployment can fall before shortages of labour cause wages to grow at rates that worsen inflation. Which, Kennedy says, suggests we need to exercise “a degree of caution” in tightening both fiscal policy and monetary policy.

All this fits with the remarks Reserve Bank governor Dr Philip Lowe made to a House of Reps committee the week before.

Lowe made it clear most of our inflation problem was temporary, not lasting. Although underlying inflation was 2.6 per cent, for the first time in years, “it is too early to conclude that inflation is sustainably in the target range”.

The Reserve has “scope to wait and see how the data develop and how some of the uncertainties are resolved” – one of which is whether “the stronger labour market [is] going to translate to higher wages”.

“I think it’s worth taking the time to have the uncertainties resolved and trying to secure this low rate of unemployment, which we have not had for 50 years.”

The financial types may be in panic mode over inflation, but it doesn’t sound to me like our top econocrats are in any mood to join them.

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Can we believe the great news on unemployment? Yes and no

Scott Morrison has a great re-election pitch: forget the problems with the pandemic, just look at how well the economy’s going. The rate of unemployment is already down to 4.2 per cent, and his goal is to get it below 4 per cent, the lowest it’s been in 50 years. Wow. What fabulous economic managers the Libs must be. But can you believe unemployment’s that low? Didn’t they fiddle with the figures some time back?

It’s good to be sceptical about the claims politicians make on the economy. Government politicians tend to tell us about the good bits and fail to mention the not-so-good parts of the story. Opposition politicians tend to do the opposite.

But not everything we think we know about the tricks politicians play is true. For instance, many people think they remember that, some years ago, a government changed the definition of unemployment to make the figures look better. They made it so that someone who worked just one hour a week was classed as employed.

This week I’ve had people asking me about this. In my experience, when a Labor government’s boasting about good unemployment figures, Liberal supporters remember Labor fiddled the figures. When, as now, it’s a Liberal government doing the boasting, it’s Labor supporters who remember a Liberal government doing the fiddling.

Which hints at the truth: actually, no government has changed the definition of unemployment. It’s an urban myth which, I suspect, has arisen because people get confused between who’s getting unemployment benefits and who’s unemployed.

The two are related, obviously, but they’re not the same. For instance, you can be unemployed and not get the dole because your spouse is working. On the other hand, single people working a few hours a week wouldn’t be earning enough to make them ineligible for the dole.

Governments can, and do, change the rules about who does or doesn’t get unemployment benefits. But who’s unemployed is measured by a huge monthly sample survey conducted by the independent Australian Bureau of Statistics.

It doesn’t let politicians decide who’s counted as unemployed and who ain’t. Rather, its definitions come from international conventions set by the UN’s International Labour Organisation in Geneva.

So it was the ILO that decided, decades ago, to define anyone doing as little as an hour’s work a week as employed. (I remember talking to an official of the Australian Council of Trade Unions who was an Australian delegate on the sub-committee that, a few years ago, decided to leave that definition unchanged. He vigorously defended the decision.)

Remember, you have to draw the line between being employed or unemployed somewhere – where would you draw it? Five hours work a week? Fifteen? Thirty-five? – and it was set so low ages ago when part-time work was much less common than it is today.

What’s true is not that the unemployment figures have been fudged, but that classing everyone working an hour or more as employed defines unemployment too narrowly. So narrowly as to understate the extent of the problem.

In fact, few people work as little an hour a week. But, though it’s wrong to imagine the only satisfactory jobs are full-time – it suits many students, parents of young children and retirees to work only a few days a week – it’s also true that many people working part-time would prefer more hours.

So for several decades, the bureau has supplemented the official unemployment figures by also publishing the number of people underemployed – those part-timers who’d prefer working work more hours. The latest figures show an unemployment rate of 4.2 per cent, plus an underemployment rate of 6.6 per cent.

Thus it is true the official unemployment rate of 4.2 per cent isn’t as good as it looks. It does understate the proportion of people who aren’t able to find as much work as they want.

And, since we know the proportion of underemployed workers is much higher today that it was 50 years ago, it’s also true that getting back to the lowest unemployment rate in 50 years isn’t likely to be as good as it was 50 years ago.

Even so, it’s quite realistic to expect that, since unemployment is already down to 4.2 per cent, and regardless of who wins the federal election, it won’t be too hard to get the rate down below 4 per cent sometime this year or next.

And whether you hate Morrison – or hate Anthony Albanese – don’t let any smarty pants tell you that will be anything other than a great achievement. If it’s not the best we’ve had the jobs market in 50 years, add in underemployment and it would be the best in maybe 40 years. Unemployment isn’t something you should wish on anyone.

No, the main reason for having reservations is the uncertainty about how long we’ll be able to keep unemployment that low.

We’ve had great success in creating extra jobs in the past year – most of which have been full-time – mainly because the government has responded to the pandemic with massively increased government spending. But the economy may slow if, as all that “fiscal stimulus” runs out, the private sector doesn’t take up the running.

The jobs market has also had a lot of help from an unprecedented (and temporary) source: for two years our borders have been closed to incoming workers. Skilled workers on temporary visas, and overseas students and backpackers doing unskilled and casual jobs.

You’ve heard employers complaining they can’t get workers and that job vacancies are at a far higher level than usual. The consequence is that many older workers who might have been pensioned off, haven’t been. And some of the jobs that haven’t been filled by overseas students and backpackers have gone to local young people.

But now our borders are re-opening to immigrant labour, we’ll see how tight the jobs market stays. I reckon it’ll be a fair while before we get back to the high levels of immigration pre-pandemic.

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Frydenberg right to put full employment ahead of budget repair

It’s hard to feel sympathy for a government that used ignorant scaremongering about the public debt to get elected in 2013, but now doesn’t want to mention the D-word and is being attacked by its own deluded conservatives (plus point-scoring Laborites). Even so, Treasurer Josh Frydenberg has his priorities right in leaving budget repair for later.

It’s noteworthy that the governments’ critics have turned their guns on the likelihood that Scott Morrison will use next year’s pre-election budget to announce yet another one-year extension of the low and middle-income tax offset at a one-off cost to the budget of $8 billion, while studiously ignoring the stronger case for abandoning the stage three tax cut legislated for July 2024, with an ongoing cost of double that.

Stage three is aimed at benefiting higher income-earners. Could this be mere coincidence? Trouble is, as Frydenberg has explained, “we have been working to a clear fiscal [budgetary] strategy to drive the unemployment rate to historically low levels” as we emerge from this great economic shock.

This being so, the only justification for a country with so much debt awarding itself another unfunded tax cut is that most of it will be spent rather than saved and thus hasten our achievement of very low unemployment.

But since households’ rate of saving tends to rise with their income, that makes the cheaper temporary low-and-middle tax cut likely to help much more than the dearer and long-lasting tax cut aimed at higher income-earners.

The belief that cutting tax rates helps by giving people greater incentive to work is an article of (self-interested) faith among high income-earners. And for the Liberal Party. Indeed, Frydenberg repeats this supposed self-evident truth many times a week.

But it’s not based on economic theory, nor supported by empirical evidence. The evidence is that a person’s marginal tax rate (the tax on any extra income they earn) doesn’t greatly affect the work effort of primary earners (mainly, men with full-time jobs) but does affect the work effort of secondary earners – particularly those with young children.

This is why the government’s decision in this year’s budget to greatly reduce the cost of childcare for second and subsequent children should do far more to raise workforce participation than the stage three tax cut ever could. Money well spent.

This, however, doesn’t fit the biases of many of those who profess to be so worried about our high public debt. Their real motive is just to pay less tax, which explains why they think all tax cuts and tax concessions are good, but all government spending is bad. This is economic nonsense.

Leaving aside the self-interest of high income-earners, many conservatives’ concern about our high level of debt is just instinctive. They have a gut feeling that it must be dangerous. They really ought to give the matter more study.

But here’s something even many well well-versed people don’t realise, mainly because it hasn’t suited the politicians and econocrats to tell them: effectively, all the bonds the government has had to issue to cover the huge budget deficits since the pandemic are now held by . . . the Reserve Bank of Australia - which, of course, is owned by the federal government.

So most of the extra interest the feds are paying will find its way back to the budget in the form of higher dividends from the Reserve.

This is not because the Reserve bought the new bonds directly from the government, but because its extensive program of “quantitative easing” – buying second-hand government bonds and paying for them by creating money out of thin air – has amounted to a sum roughly equal to the new bonds sold to the public (mainly to superannuation funds).

But the most important thing to understand is Frydenberg’s repeated statement that the government’s strategy is to “repair the budget by repairing the economy”. This is not just another meaning-free slogan, it’s a statement of fundamental economic truth and political reality.

Governments rarely pay off the debt they incur. Rather, they reborrow to cover their bonds as they fall due, and concentrate on ensuring the economy grows faster than the debt’s growing, thus reducing the debt relative to the size of the economy – and the taxes being paid by the people in the economy.

Which brings us back to where we started: Frydenberg’s strategy of forcing the pace of economic growth to get the rate of unemployment sustainably down to the low 4s or even lower.

This strategy – to keep pushing unemployment down until it’s clear the inflationary pips are squeaking – was first suggested by Professor Ross Garnaut in his book, Reset, and taken up by Peter Martin, of The Conversation website.

It was inspired by the example of the United States which, before the pandemic, got unemployment down to near 3 per cent before wages got moving.

The first point is that there’s nothing better you could do to make the economy bigger (and bigger relative to the public debt) than to ensure more of those who want to work actually get jobs, earning incomes and paying taxes.

Labour lying idle is the worst kind of economic inefficiency.

But the strategy has a deeper objective: to make the market for labour so tight that employers have no option but to increase wages to retain the people they need.

Like all sensible economic managers, Frydenberg’s unspoken concern is the risk that, once the economy has rebounded from the coronacession - with considerable help from temporary fiscal stimulus - it falls back into the “secular stagnation” low-growth trap that the rich countries have been caught in since the global financial crisis.

Our wage growth has stagnated since this government came to power. It’s the most important single cause and consequence of our low growth. Labor will be making hay with this in the election campaign.

Ending wage stagnation is the key to a sustainable return to a healthy rate of economic growth. And given the Coalition’s tribal objection to using regulatory reform to get wages moving, getting unemployment down and tightening the labour market is the right solution to the problem.

Once it has been solved, the budget balance will be improved and the public debt will be less worrying to the unversed. If Frydenberg can get us back to the lowest unemployment since the 1970s, he’ll be up there with Paul Keating as one of our greatest treasurers.

In this column last Monday I overstated the regressiveness of the stage three tax cut. I quoted a summary of the findings of analysis by the Parliamentary Budget Office, but should have checked it. The office’s actual findings are that about two-thirds of the tax cut will go to taxpayers earning $120,000 or more. The highest-earning 20 per cent of taxpayers will receive more than three-quarters of the money. My statement that only a third will go to women remains correct.

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Stop kidding: the 2024 tax cut will be economically irresponsible

It’s a safe bet that, once we’ve seen the mid-year budget update on Thursday, we’ll hear lots of economists and others saying the government should be getting on with budget repair: spending cuts and tax increases.

That’s despite the update being likely to show that the outlook for the budget deficit in the present financial year and the following three years is much better than expected in the budget last May.

It’s also true even though the case for “repairing the budget by repairing the economy” is sound and sensible. The federal public debt may be huge and getting huger, but, measured as a proportion of gross domestic product, the present record low-interest rates on government bonds mean the interest burden on the debt is likely to be lower than we’ve carried in earlier decades.

It’s true, too, that recent extensive stress-testing by the independent Parliamentary Budget Office has confirmed that the present and prospective public debt is sustainable.

It remains the case, however, that both this year’s Intergenerational report and the budget office project no return to budget surplus in the coming decade, or even the next 40 years – “on present policies”.

So, it’s not hard to agree with former Treasury secretary Dr Ken Henry that doing nothing to improve the budget balance is more risky than it should be, too complacent. It leaves us too little room to move when the next recession threatens.

And, indeed, the Morrison government’s revised “medium-term fiscal strategy” requires it to engage in budget repair as soon as the economy’s fully recovered.

But there’s no way Scott Morrison wants to talk about spending cuts and tax increases this side of a close federal election. Nor any way Anthony Albanese wants to say he should be.

Of course, that won’t stop Morrison & Co waxing on about how “economically responsible” the government is – especially compared to that terrible spendthrift Labor rabble. Nor stop Labor pointing to all the taxpayers’ money Morrison has squandered on pork barrelling, and promising an Albanese government would be more “economically responsible”.

But here’s my point. There’s a simple and obvious way both sides could, with one stroke, significantly improve prospective budget balances, and because it would be front-end loaded, disproportionately reduce our prospective public debt over years and decades to come.

There’s no way such a heavily indebted government should go ahead with the already-legislated third stage of tax cuts from July 2024, with a cost to the budget of more than $16 billion a year.

Those tax cuts were announced in the budget of May 2018 and justified on the basis of a mere projection that, in six years’ time, tax collections would exceed the government’s self-imposed ceiling of 23.9 per cent of GDP. That is, the government would be rolling in it.

It was said at the time that it was reckless for the government to commit itself to such an expensive measure so far ahead of time. It was holding the budget a hostage to fortune.

But so certain were Morrison and Josh Frydenberg that the budget was Back in Black that, soon after winning the 2019 election, they doubled down on their bet and insisted the third-stage tax cuts be legislated. Desperately afraid of being “wedged”, Labor went weak-kneed and supported the legislation.

If, at the time, a sceptic had warned that anything could happen between now and 2024 – a once-in-a-century pandemic, even – they’d have been laughed at. But they’d have been right.

Just last week, Finance minister Simon Birmingham righteously attacked his opponents for making election promises that were “wasteful and unfunded” – by which he meant that they would add to the budget deficit.

But the tax cut both sides support is now also “unfunded”. We’ll be borrowing money to give ourselves a tax cut. That’s economically responsible?

It might be different if you could argue that the tax cut would do much to support the recovery, but it wasn’t designed to do that, and it won’t. Stage three is about redistribution, not stimulus and not (genuinely) improved incentives.

The budget office has found that about two-thirds of the money will go to the top 10 per cent of taxpayers, on $150,000 or more. Only a third will go to women. So, the lion’s share will go to those most likely to save it rather than spend it. Higher saving is the last thing we need.

Now, I know what you’re thinking. Get real. There’s no way either side would want to repeal a tax cut, especially just before an election.

Regrettably, that’s true. But, this being so, let’s tolerate no hypocrisy from politicians – or economist urgers on the sidelines – making speeches about “economic responsibility” without being willing to call out this irresponsible tax cut.

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Panicking financial markets could stuff up another global recovery

In economics, there’s not much new under the sun. When I became a journalist in the mid-1970s, the big debate was about which mattered more: inflation or unemployment. You may not realise it, but that’s the great cause of contention today.

With prices having risen surprisingly rapidly this year in the US and Britain – but few other advanced economies – we’re witnessing a battle between people in the financial markets, who fear inflation is back with a vengeance and want interest rates up to get it back under control, and the central banks.

The central bankers see the higher prices as a transitory consequence of the supply and energy disruptions arising from the pandemic. They fear that, once their economies have rebounded from the government-ordered lockdowns and fear-induced reluctance to venture forth, their economies will soon fall back to into the “secular stagnation” or weak-growth trap that gripped the advanced economies for more than a decade following the 2008 global financial crisis until the arrival of the pandemic early last year.

The decade of weak growth involved high rates of saving but low rates of business investment, record low interest rates, weak rates of improvement in the productivity of labour, low wage growth and, not surprisingly, inflation running below the central banks’ target rates. All that spelt adequate supply capacity, but chronically weak demand.

In the months before the arrival of the pandemic, central banks grappled with the puzzle of why economic growth had been so weak for so long – and what they could do about it.

In particular, our Reserve Bank had to ask itself why it had gone year after year forecasting an imminent rise in wage growth, without it ever happening. With such weak growth in real wages – the economy’s chief source of income – it was hardly surprising that consumer spending and growth generally were weak, and that inflation remained well below the Reserve’s target.

Earlier this year, with the economy rebounding so strongly from last year’s nationwide lockdown – but before the Delta setback – the econocrats in the Reserve and Treasury realised that recovering from the coronacession wouldn’t be a problem.

But once all the fiscal stimulus and pent-up consumer spending had been exhausted and the economy returned to its pre-pandemic state, where would the impetus for further growth come from? Certainly not, it seemed, from healthy growth in real wages.

What explained the way we’d finally joined the Americans in their decades-long wage stagnation? And what could central banks do about it? The obvious answer seemed to be to run a much tighter labour market and see if that got wages moving.

Perhaps, as a hangover from the 1970s and ’80s, when the world really did have an inflation problem, we’d continued worrying too much about inflation and not enough about getting the economy back to full employment.

For years we’d been making these fancy theoretical estimates of the NAIRU – the non-accelerating-inflation rate of unemployment; the point to which unemployment could fall before labour shortages caused inflation to take off – but unemployment rates had fallen quite low without the remotest sign of excessive wage growth.

Perhaps we should be less pre-emptive. Stop relying on theoretical estimates and just keep allowing the economy to grow until we had proof that wages really were taking off before we applied the interest-rate brakes.

And perhaps we should base decisions to raise rates on actual evidence of a problem with inflation – including, particularly, evidence of excessive growth in real wages – rather than on mere forecasts of rising inflation.

Our Reserve’s thinking was matched by the US Federal Reserve’s. Chairman Jerome Powell told Congress in July 2019 “we have learned that the economy can sustain much lower unemployment than we thought without troubling levels of inflation.”

Which brings us to this year’s budget, back in May. Although the economy seemed clearly to be rebounding from the coronacession, and debt and deficit were high, Treasurer Josh Frydenberg swore off the disastrous policy of “austerity” (government spending cuts and tax increases) that panicking financial markets had conned the big advanced economies into after the Great Recession, thus crippling their recoveries.

While allowing the assistance measures for the initial lockdown to terminate as planned, the budget announced big spending on childcare and aged care, following a strategy of “repairing the budget by repairing the economy”.

Treasury secretary Dr Steven Kennedy and Reserve governor Dr Philip Lowe made it clear they wanted to keep the economy growing strongly until the unemployment rate was down to the low 4s – something we hadn’t seen for decades – as the best hope of getting some decent growth in real wages.

This is still what the central banks want to see: a new era of much lower unemployment and, as a consequence, much healthier rises in real wages to power a move to stronger economic growth than we saw in the decade before the pandemic.

But now Wall Street is panicking over the surprisingly big price rises caused by the pandemic’s disruption, and has convinced itself inflation’s taking off like a rocket. If the Fed doesn’t act quickly to jack up interest rates, high and rising inflation will become entrenched.

Despite our marked lack of worrying price rises, our financial markets – not known for their independent thinking – have joined the inflation panic, betting that, despite all Lowe says to the contrary, our Reserve will be putting up rates continuously through the second half of next year.

So convinced of this are the market dealers that the (better educated) market economists who service them have begun thinking up more plausible arguments as so why rates may need to move earlier than the Reserve expects. ANZ Bank’s Richard Yetsenga, for instance, fears that if everyone tries to spend all the money they’ve saved during the lockdowns, “rates will need to rise to crimp spending intentions”.

See what’s happening? According to the financial markets, the pandemic has not merely cured a decade of secular stagnation, it’s transported us back to the 1970s and out-of-control inflation. That’s the big threat, and unemployment will have to wait.

Apparently, this dramatic reversal in the economy’s fortunes has occurred without workers getting even one decent pay rise.

There are three obvious weaknesses in this logic. First, globalisation has not made our economy a carbon copy of America’s. Second, there’s a big difference between a lot of one-off price rises and ongoing inflation. If the price rises don’t lead to higher wages, no inflation spiral.

Third, even if the central banks did get a bit worried, they’d start by ending and then reversing “quantitative easing” – creating money from thin air – before they got to raising the official interest rate.

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