Gilding the budget lily: Labor brings in the creative accountants

This month’s budget is not as profligate as its critics claim, but nor is it the deficit-disappearing, penny-pinching budget it was tricked up to be.

When ministerial staffers use words to gild the fiscal lily, it’s called spin doctoring. When the government’s bureaucrats show the treasurer and, more particularly, the finance minister how to do it with numbers, it’s called creative accounting.

So, never fear, Jim Chalmers and Katy Gallagher didn’t need to pay PwC a motza to explain how to make the budget seem better than it was.

No, not the way the former NSW Coalition government paid KPMG to show it how to make its budget balance look better by moving the state’s trains off-budget. Nor has the same firm been paid by another part of the state government to write a report on why it was a bad idea.

There was something a bit odd about the media’s treatment of Chalmers’ second budget. Because the budget’s purpose is to reveal the government’s plans for taxing and spending in the coming financial year, the media give all their attention to the budget balance for the coming year.

Which, this time, is expected to be a deficit of $14 billion, rising to $35 billion the following year, with the budget projected to stay in deficit through to at least 2033-34.

Usually, the media ignore the estimated budget balance in the present financial year, which will end on June 30. It’s “old”. But not this year. This time, a surplus of $4 billion is expected.

Once the media got wind of a surplus, they lost interest in anything else. A surplus! First surplus in 15 years! What an achievement. And after being in power for only a year. How could you get more convincing proof of Labor’s skill as a manager of government finances?

Now, let’s be clear. The expected surplus is perfectly believable, and not the product of creative accounting. But it is the media displaying their economic ignorance.

For a start, in a budget of $630 billion a year, in an economy of $2600 billion a year, a surplus of a mere $4 billion is nothing to get excited about. It’s really a balanced budget, just as much as a deficit of $4 billion would be near enough to a balanced budget.

More significantly, the notion that any treasurer, no matter how wonderful, could turn an expected deficit of $78 billion into a surplus of $4 billion in the space of a year is fanciful. If any pollie should get the credit for it, it would have to be Chalmers’ Liberal predecessor, Josh Frydenberg.

Only he had enough time to do the things capable of helping produce such a result. With the benefit of hindsight, what Frydenberg did was greatly overstimulate the economy, adding to a surge in inflation as well as causing the unemployment rate to fall to 3.5 per cent so workers and businesses paid a lot more income tax.

Another way to look at it is that, had Treasury been better at forecasting, Frydenberg could have forecast a return to budget balance in his last budget.

But this didn’t stop Chalmers and his spin doctors from claiming the credit for himself. Consider this from the budget papers: “The improved fiscal outlook since October largely reflects government decisions to return tax upgrades to budget.”

Talk about twisting the truth. Chalmers wants to take all the credit because, confronted with an unexpected surge in tax collections of $88 billion, he only spent a bit of it.

But, surely, it was the silly media that made all the fuss about the surplus, not that nice young Mr Chalmers. Well, that’s certainly what his spin doctors want you to think – all the adulation came from the crowd.

But they were subtly pushing an easily distracted media in a favourable direction. Consider this. The usual practice in the construction of budget tables is to highlight the coming “budget year”. Not this time. This time it was the old year that got highlighted. So, the $4 billion surplus was shown in bold type, not the $14 billion deficit.

(By the way, as The Australian Financial Review has reported, had Frydenberg’s $690 million [yes, million] deficit in 2018-19 – the one that presaged all the Libs’ happy election talk about “back in black” – been calculated using the same accounting rules under which Chalmers’ surplus was calculated, it would have been a surplus of $7 billion. But no, this isn’t a fiddle, either. The decision to change the rules was made, in prospect, many years earlier by some finance minister named Penny Wong.)

Now we get to the creative accounting, which the Centre for Independent Studies’ Robert Carling, a former NSW Treasury officer, has pointed out. The budget papers make much of the claim that “the government’s spending restraint has limited real [note the real] payments growth to an average 0.6 per cent over five years from 2022-23 to 2026-27”.

Wow. Now that’s what I call restraint. What an achievement. Elsewhere in the papers we’re told that this compares with real average spending growth of about 4 per cent in the eight years before the global financial crisis, and 2.2 per cent over the eight years before the pandemic.

Wow. What restraint the Albanese government is showing. Except that pollies usually quote budget figures over the four years of the budget year plus three years of “forward estimates”. So, why is the 0.6 per cent an average over five years?

Because the extra year includes in the sum the pre-budget year ending in a month. And, purely by chance, real government spending in 2022-23 is expected to fall by 4.3 per cent.

By contrast, real spending in the coming year will grow by 3.7 per cent. Then comes projected annual real growth of 0.6 per cent, 1.9 per cent and 1 per cent.

Why the huge fall this year? Partly, I suspect, because of the effect of temporary pandemic spending programs coming to an end. But also because the indexation of various spending programs was lagging the huge rise in the consumer price index, which is the inflation measure used to calculate the “real” change.

What’s worth remembering from this little fiddle is: never trust calculations of average spending growth into the future. The first year will be close to the truth, but the projections for subsequent years will always be way too low because they’re based on the assumption of unchanged policies, whereas it’s certain that spending plans will have grown by the time we get there.

The first treasurer to con me with this averaging trick was Chalmers’ former boss, Wayne Swan. But Swan got his comeuppance by making himself a laughing-stock when he treated Treasury’s forecasts of future budget surpluses as in the bag. Turned out they weren’t.

The assumptions that policies won’t change and that targets will always be achieved are the reason the budget papers’ “medium-term” projections of deficits and debt 10 years into an unknowable future shouldn’t be taken seriously.

In both sense of the word, they are calculated to mislead.

Read more >>

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Read more >>

The cost of living isn't as high as we've been told

So, as we learnt the day after the budget, the cost of living leapt by 7.3 per cent over the past year, right? Wrong. Last week we were told it’s gone up no more than 6.7 per cent for employees, and 6.4 per cent for pensioners and others on benefits.

The 7.3 per cent came from the Australian Bureau of Statistics, and was the rise in the consumer price index over the year to the end of September. The other figures also came from the bureau, and were for the rise in the “living cost index” over the same period for certain types of households.

Why weren’t you told about the second lot? Because the media wanted to avoid confusing you – and because they were better news rather than worse.

Huh? What’s going on? We’re used to using the consumer price index (CPI) as a measure of the cost of living. But the bureau knows it’s not. So, a week later, it always issues its living-cost indexes for key household types – which the media always ignore.

Usually, the differences from the CPI aren’t big enough to worry about. But now they are. Why? Because mortgage interest rates are increasing rapidly. And mortgage interest charges are the main difference between the two measures.

Before late-1998, the CPI measured the housing costs of owner-occupiers according to the interest they paid on their mortgages. But this was changed at the behest of the Reserve Bank, which didn’t want its measure of inflation to go up every time it raised interest rates to get inflation down.

So, since then, the bureau has measured owner-occupiers’ housing costs by taking the price of building a new house or unit. This doesn’t make much sense, since not many people buy a newly built home each quarter. Many of us have never bought a newly built home.

This is why the bureau also calculates separate cost of living indexes, using the same prices as the CPI, but restoring mortgage interest charges, as well as giving the prices different weights to take account of the differing spending patterns of particular household types, such as age pensioners.

New dwelling prices rose by almost 21 per cent over the year to September, meaning they accounted for a quarter of the 7.3 per cent rise in the CPI. By contrast, the mortgage interest charges paid by employee households rose by more than 23 per cent, but contributed only 12 per cent (0.8 percentage points) of the 6.7 per cent rise in their total costs.

Get it? Since mortgage interest charges are a more accurate guide to the costs of owner-occupiers than new-home prices are, the CPI is significantly overstating the rise in the living costs of everyone, from employees to people on social security (and the self-proclaimed “self-funded” retirees, for that matter).

This is a sliver of good news about the extent of cost-of-living pressure on households. It’s better news for people on indexed pensions and benefits: they’ll get what amounts to a small real increase.

But it raises an obvious question: why on earth has the cost of newly built homes shot up by 21 per cent over the past year? After all, this has added hugely to the Reserve Bank’s need to fight inflation by raising interest rates, to the tune of 2.75 percentage points so far.

It’s true the pandemic has caused shortages of imported building materials, but the real blame is down to the economic mangers’ appalling own goal in using grants, tax breaks and cuts in interest rates to rev up the home building industry far beyond its capacity to expand.

It got a huge pipeline of unfilled orders and whacked up its prices, adding no less than a quarter to our soaring inflation rate. Well done, guys.

This raises a less obvious question: federal and state governments were spending unprecedented billions to hold the economy together during the pandemic and its lockdowns. With the official interest rate already down to 0.75 per cent without doing much good, was it really necessary to cut the rate to 0.1 per cent and engage in all that unconventional money creation?

It makes a good case for the new view that, while monetary policy works well when you want to slow demand, it doesn’t work well when you wish to speed it up. Especially when rates are already so low and households already so heavily indebted.

This is something those reviewing the Reserve Bank should be considering.

Read more >>

Labor will struggle with deficit and debt until it raises taxes

There’s something strange about last week’s federal budget. It reveals remarkably quick progress in getting the budget deficit down to nearly nothing. But then it sees the deficit going back up again. Which shows that, as my former fellow economics editor Tim Colebatch has put it, Rome wasn’t built in one budget.

Let’s look at the figures before explaining how they came about. The previous, Coalition government finally got the budget back to balance in the last full financial year before the arrival of the pandemic, 2018-19.

The government’s big spending and tax breaks in response to COVID’s arrival in the second half of the following year, 2019-20, saw the budget back in deficit to the tune of $85 billion. Next year’s deficit was even higher at $134 billion.

But in the year that ended soon after the change of government in May, 2021-22, the deficit fell to just $32 billion. And in last week’s second go at the budget for this year, 2022-23, the deficit is expected to be little changed at $37 billion – which would be $41 billion less than what Scott Morrison was expecting at the time of the election six months ago.

But the changes in these dollar figures don’t tell us much as comparing the size of the deficit with the size of the economy (nominal gross domestic product) in the same year. Judging it this way allows for the effect of inflation and for growth in the population.

So, relative to GDP, the budget deficit has gone from zero in 2018-19, to 4.3 per cent, then a peak of 6.5 per cent in 2020-21, then crashed down to just 1.4 per cent last financial year. This year’s deficit is now expected to be little changed at 1.5 per cent.

We all know why the deficit blew out the way it did, but why did it come back down so quickly?

Three main reasons. The biggest is that it happened by design. All the pandemic-related measures were temporary. As soon as possible, they were ended.

But also: the rise in world fossil fuel prices caused by the war in Europe produced a huge surge tax collections from our mining companies. Last week’s budget announced the new government’s decision to use almost all of this windfall to reduce the deficit.

And last week we learnt the government had also decided to keep a very tight rein on government spending. It introduced all the new spending programs it promised at the election, but cut back the previous government’s programs to largely cover the cost of the new ones.

Its frugality had one objective: to help the Reserve Bank reduce inflation by first using higher interest rates to reduce people’s demand for goods and services.

Keeping the deficit low for another year has, Treasurer Jim Chalmers said this week, changed the “stance” of fiscal (budgetary) policy to “broadly neutral” - neither expansionary nor contractionary. Which, he’s sure to be hoping, will mean the Reserve has to raise interest rates by less than would have.

Another benefit of his decision not to spend the tax windfall, Chalmers said this week, is that by June next year, the government’s gross debt will be $50 billion lower than it would have been. And, according to Treasury’s calculations, this reduction means a saving of $47 billion on interest payments over the decade to 2033.

Great. Wonderful. Except for the strange bit: two years after this financial year, the budget deficit is expected to have gone back up to $51 billion, or 2 per cent of GDP.

What’s more, the budget’s “medium-term projections” foresee the deficit stuck at about 2 per cent each year – or $50 billion in today’s dollars – for the following eight years to 2032-33.

In the first budget for this year, just before the election, the deficit was projected to have fallen slowly to 0.7 per cent of GDP by 2033. Now, no progress is expected. Which means, of course, that the amount of public debt we end up with will be higher than expected during the election campaign.

The gross public debt is now not expected to reach a plateau, of about 47 per cent of GDP, until the first few years of the 2030s.

So, if the budget deficits last year and this are so much better than we were expecting just seven months ago, why on earth are the last eight years of the medium term now expected to be significantly worse?

Three main reasons. First, because a new actuarial assessment of the future cost of the National Disability Insurance Scheme (NDIS) shows the cost growing much faster than previously thought.

Second, because, with world interest rates having risen so much this year, the interest bill on the public debt is now projected to be much bigger over the coming decade.

Third, because the previous government based its projections on the assumption that the productivity of labour would improve at the quite unrealistic average rate of 1.5 per cent a year, but Chalmers has cut this to a more realistic 1.2 per cent. This change reduces government revenue by more than it reduces government spending.

What this exercise reveals is that the “persistent structural deficit” earlier projections told us to expect, will actually be worse than we were told. The deficit won’t go away but, on present policies, will stay too high every year for as far as the eye can see.

Fortunately, Chalmers freely admits that present policies will have to be changed. “While this budget has begun the critical task of budget repair, further work will be required in future budgets to rebuild fiscal buffers [ready for the next recession] and manage growing cost pressures”.

He repeated this week his view that, as a country, we need to “have a conversation about what we can afford and what we can’t” - his way of breaking it gently that, if the structural deficit is to be removed, taxes will have to rise.

Read more >>

Memo RBA board: Time to stop digging in deeper on interest rates

If, as seems likely, the combined might of the advanced economies’ central banks pushes the world into recession, the biggest risk isn’t that they’ll drag us down too, but that our Reserve Bank will raise our own interest rates too far.

That’s the message to us – and everyone else – from the International Monetary Fund’s repeated warnings about the unexpected consequences of “synchronised tighten” by the big economies – America, Europe and, in its own way, China, all jamming on the brakes at the same time.

Synchronised macro-policy shifts are a relatively new problem in our more globalised world economy. Until the global financial crisis of 2008, world recessions tended to roll from one country to the next. Since then, everyone tends to start contracting – or stimulating – at the same time.

When you were stimulating while your trading partners weren’t, much of your stimulus would “leak” to their economies, via your higher imports. But, as we learnt in the fight to counter the Great Recession, when everyone’s stimulating together, your leakage to them is offset by their leakage to you, thus making your stimulus stronger than you were expecting.

The fund’s warning is that we’re now about to learn that the same thing happens in reverse when everyone’s hitting the brakes – budgetary as well as monetary – together. Synchronisation will make your efforts to restrain demand (spending on goods and services) more potent than you were expecting.

So the fund’s message to us is: when you’re judging how high interest rates have to go to get inflation heading back down to the target, err on of side to doing too little.

But there are four other factors saying the Reserve should be wary of pushing rates higher. The first is Treasurer Jim Chalmers’ confirmation in last week’s budget that the “stance” of his fiscal policy has also switched from expansionary to restrictive, and so is now adding to the restraint coming from tighter monetary policy.

Chalmers has cut back the Coalition’s spending programs to make room for Labor’s new spending plans, while “banking” the temporary surge in tax revenue arising from the war-caused jump in world energy prices, and the success of the Coalition’s efforts to return us to full employment.

As a result, the budget deficit has fallen from a peak of $134 billion (equivalent to 6.5 per cent of gross domestic product) in 2020-21, to $32 billion (1.4 per cent) in the year to this June. The present financial year should see that progress largely retained, with the deficit rising only a little.

What’s more, the government’s already acting on its intention to force our greedy gas producers to raise their prices by a lot less than has been assumed in the budget’s inflation forecasts.

Second, the Reserve’s efforts to reduce aggregate (total) demand by using the higher cost of borrowing to reduce domestic demand, will be added to by the other central banks’ efforts to reduce our “net external demand” (exports minus imports).

What’s more, the expected further big fall in house prices will help reduce domestic demand by making home owners feel a lot less well-off than they were (the “wealth effect”).

Third – and this is a big point – the restrictive effect of the Reserve’s higher interest rates will be massively reinforced by the “cost-of-living squeeze” (aka the huge fall in real wages). Comparing the wage price index with the consumer price index, real wages fell by 2 per cent over the year to June 2021, and by an unbelievable 3.5 per cent to June this year.

Now the budget’s predicting a further fall of 2 per cent to June next year, with only the tiniest gain by June 2024.

This is an unprecedented blow to households’ income. It just about guarantees an imminent return to weak consumer spending. And it’s a much bigger blow than the big advanced economies have suffered, suggesting our central bank should be going easier on rate rises than theirs.

The final factor saying the Reserve should be wary of pushing rates higher is “lags”. As top international economist Olivier Blanchard reminded us in a recent Twitter thread, monetary policy affects the inflation rate with a variable delay of maybe six to 18 months.

This says you should stop tightening about a year before you see any hard evidence that inflation has peaked and started falling. Wait for that evidence, and you’re certain to have hit the economy too hard, causing the recession we didn’t have to have.

But to stop tightening before the money market know-alls think you should takes great courage.

Read more >>

Monetary policy is no longer fit for purpose

It’s an outstanding feature of the modern economy: the multitude of people who could do a far better job of running interest rates than the fool they’ve got doing it at the moment. Welcome to the inquiry into the performance of the Reserve Bank.

One small problem. About half governor Dr Philip Lowe’s critics complain he was too slow putting rates down, while the other half say he was too slow putting them up. Since interest rates are a cost to borrowers but income to savers, it’s hardly surprising that, whichever way the Reserve jumps, many will be complaining.

To be clear, it’s always a good idea to review regularly the performance of an institution with as much power over our lives as the central bank.

But equally, the inquiry needs to focus on the right question. Some critics just want someone to agree with them that the Reserve could have done a better job in recent years. Others – particularly academics specialising in monetary economics – want to argue about the mechanics.

Should we change the monetary target? Since the Reserve’s procedures aren’t identical to the US Federal Reserve’s, doesn’t that mean we’re doing it wrong? Why stack the Reserve’s board with business worthies when it would make much better decisions if you stacked it with academic experts like me and my mates?

Leaving aside those who just care about how much interest they’re paying or receiving, most of those who were pushing for the inquiry have a vested interest in monetary policy continuing to be the dominant instrument used in the year-to-year management of demand. They need monetary policy to stay dominant because their living depends on it.

But monetary policy’s role in the “policy mix” is the most important question. Just as much of the pomp and pageantry we’ve been watching isn’t as ancient as many monarchists imagine, monetary policy has been the main instrument used to manage demand only since the late 1970s.

Before then, fiscal (budgetary) policy was dominant, with monetary policy an afterthought, and the central bank a vassal of Treasury. The switch made sense then, but does it still?

And even then, we got off on the wrong foot, starting by trying to control the supply of money, which didn’t work. We didn’t switch the focus to controlling interest rates until the early ’80s. The inflation target came in the mid-90s, and it wasn’t until 1997 that the Reserve’s independence from the elected government was formalised.

It would be nice to imagine we’re gradually closing in on the one right way to manage the economy, but this would be a delusion. History tells us we keep changing the way we do it to better fit the particular problems of the era. Indeed, it wasn’t until the late 1940s that everyone agreed there was a macroeconomy that needed managing.

The two main “arms” of macro management (we abandoned the third arm, exchange rate policy, in 1983 when maintaining a fixed exchange rate became impossible) have different strengths and weakness.

The great advantage of monetary policy is that the econocrats who run it can ignore the electoral cycle. It can also be adjusted quickly and easily. But after acknowledging that, it’s otherwise inferior to fiscal policy. It can’t be targeted at particular regions or industries, and it takes longer to do what you need it to – with the notable exception of house prices.

Our present problem of sudden, high inflation – caused by disruptions to the supply (production) side of the economy being exacerbated by an overstimulated demand (spending) side – well demonstrates the bluntness, crudeness and unfairness of monetary policy.

This raises two questions. Did we need to use both arms of policy to respond to the pandemic? And how much of our present excess demand can be attributed to monetary policy?

The econocrats defend what, with hindsight, was clearly too much stimulus, by saying they didn’t know how much economic disruption the pandemic would cause, the medicos initially led them to believe it could be much worse than it turned out to be and, anyway, it’s better to err on the side of doing too much than too little.

But none of that says we had to overdo it on both barrels. With the official interest rate already down to 0.75 per cent before the virus arrived, it was clear the Reserve was almost out of ammo. I imagined it would have little more to contribute, leaving fiscal policy to do all the heavy lifting. As it did.

But no, the Reserve rode to the rescue as though it was the only knight that could find a horse. It slashed rates to near zero, offered cheap loans to the banks and, before long, joined the bigger central banks in buying government bonds with created money, to lower longer-term interest rates.

At the time, I wondered whether this was just institutional turf protection. It was the Reserve’s job to be the chief demand manager, and it wasn’t going to sit out the biggest crisis in ages just because it had run out of ammo. We’ll find something we can make into bullets.

Looking back, I suspect the Reserve’s determination not to be left out of the party has added greatly to our new problem and to the pain it’s inflicting on us to fix the problem. When you boil it down, one of the main “channels” through which monetary policy influences demand is by interfering in the cost of housing.

The Reserve is right to say interest rates aren’t the primary cause of high house prices, but because monetary policy is such a one-trick pony, it can only ignore all the pain it inflicts by causing prices to soar when it cuts rates and fall when it raises them.

Between the two arms, they’ve revved up the housing industry, only now to be hitting the brakes. They’ve caused surprisingly few extra homes to be built, but pushed up the price of new homes by 20 per cent, adding 1.8 percentage points to the 6.1 per cent inflation rate.

According to Professor Simon Wren-Lewis, of Oxford, the old consensus among academics that monetary policy should take the lead in demand management, has been replaced by one where interest rates are the favoured instrument to deal with inflation – as now – but fiscal policy should be the main weapon used to fight recessions. Or lockdowns.

Point is, had we followed that rule during the pandemic, we’d now have a much smaller inflation problem. Something the inquiry should ponder. And whether resorting to “unconventional measures” was ever a smart idea.

Read more >>

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.

Read more >>

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.

Read more >>

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.

Read more >>

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.

Read more >>

Our inflation problem isn't a big one - unless we overreact

I can’t remember a time when the arguments of all those bank and business economists claiming “the inflation genie is well and truly out of the bottle” and demanding the Reserve Bank raise interest rates immediately and repeatedly have been so unconvincing.

At base, their problem is their unstated assumption that the era of globalisation means all the advanced economies have identical problems for the same reasons and at the same time.

If America has runaway inflation because successive presidents have applied budgetary stimulus worth a massive 25 per cent of gross domestic product at the same time as millions of workers have withdrawn from the workforce, Britain’s withdrawal from the European Union is causing havoc, and Europe’s problem is particularly acute because of its dependence on Russian oil and gas, we must be the same.

Business economists have put most of their energy into convincing themselves our problem is the same as everyone else’s, rather than thinking hard about how our circumstances differ from theirs and how that should affect the way we respond.

There’s also been a panicked response to a huge number – inflation of 5 per cent! – that says, “don’t think about what caused it, just act”. And since every other central bank has already started raising rates, what’s wrong with our stupid Reserve?

Too many economists have switched their brains to automatic pilot. We know from our experience of the 1970s and ’80s how inflationary episodes arise – from excessive demand and soaring wages – and we know the only answer is to jack up interest rates until you accidentally put the economy into recession. You have to get unemployment back up.

That stereotype doesn’t fit the peculiar circumstances behind this rise in prices, nor does it fit the way globalisation, skill-biased technological change, the deregulation of centralised wage-fixing and the huge decline in union membership have stripped employees of their former bargaining power.

The first thing to understand is that our price rises have come predominantly from shocks to supply: the various supply-chain disruptions caused by the pandemic, the war on Ukraine’s effect on oil and gas prices, and climate change’s effect on meat prices.

Various economists are arguing that price rises have been “broadly based” so as to show that price rises are now “demand-driven”, but the main reason so many prices have risen is that there have been so many different supply shocks coming at the same time, with so many indirect effects, ranging from transport costs to fertiliser and food.

Two thirds of the quarterly increase in prices came from four items. In order of effect on the index: cost of new dwellings (up 5.7 per cent), fuel prices (11 per cent), university fees (6.3 per cent) and food (2.8 per cent).

Of those, only new dwelling prices can be attributed mainly to strong demand, coming from the now-ended HomeBuilder stimulus measure. The rise in uni fees was a decision of the Morrison government.

America’s economy is “overheating”, but ours isn’t. It’s true our jobs market is very tight, and that much of this strength is owed to our now-discontinued stimulus measures.

But, paradoxically, the economics profession’s ideological commitment to growth by immigration has blinded it to the obvious: job vacancies are at record levels also because of another pandemic-related supply constraint: our economy has been closed to all imported labour (and we even sent a fair bit of it back home). This constraint has already been lifted.

The thing about supply shocks is that they’re once-only and not permanent. So, left to its own devices, without further shocks the rate of price increase should fall back over time. Petrol and diesel prices, for instance, have already fallen a bit but, in any case, won’t keep rising by 35 per cent a year year-after-year.

It’s sloppy thinking to think a rise in prices equals inflation. The public can be forgiven such a basic error, but professional economists can’t. A true inflation problem arises only when the rise in prices is generalised and is ongoing. That is, when it’s kept going by a wage-price spiral.

When a huge rise in prices, from whatever source, leads to an equally huge – or huger – rise in wages, which prompts a further round of price rises. That’s inflation.

In their panic, business economists have assumed that the loss of employee bargaining power we’ve observed in most of the years since the global financial crisis, which has done so much to confound the econocrats’ wage and growth forecasts, and caused inflation to fall short of the Reserve’s target range for six years in a row, has suddenly been transformed. Union militance is back!

Really? I’m sure employees and what remains of their unions will be asking for pay rises of at least 5 per cent this year, but how many will get anything like that much? They’ll all be on strike until they do, you reckon?

They’re safe to get more than the 2.3 per cent they got in the year to December, according to the wage price index, but the greatest likelihood is that real wages will continue to fall. And the cure for that is to raise interest rates, is it?

It is true that, if wages rose in line with prices, we would have an inflation problem, but how likely is that?

There’s been much concern about stopping a rise in “inflation expectations”, but this thinking involves a two-stage process: in expectation of higher inflation, businesses raise their prices. And in expectation of higher inflation, unions raise their wage demands.

All the sabre-rattling we’ve seen by the top retailers and their employer-equivalent of union bosses – so breathlessly reported by the media – suggests they’re increasingly confident they can get away with big price rises. But how much success individual employees and unionised workers have in realising their expectations remains to be seen.

Perhaps in this more inflation-conscious environment, employers will be a lot more generous – more caring and sharing – than they have been in the past decade. Perhaps.

The Reserve is under immense pressure from the financial markets, the bank and business economists, the media, the actions of other central banks and even the International Monetary Fund to start raising interest rates.

It will, with little delay. It must be seen to act. But whether it’s at panic stations with the media and the business economists is doubtful. And you don’t have to believe the inflation genie is out of the bottle to see that the need for interest rates to be at near-zero emergency levels has passed.

As BetaShares’ David Bassanese has predicted, the Reserve will be “not actively trying to slow the economy, but rather [will] begin the process of interest-rate normalisation now that the COVID emergency has passed”. Moving to “quantitative tightening” will be part of that process.

Read more >>

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”.

Read more >>

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.

Read more >>

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.

Read more >>

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.

Read more >>

When judging recessions, depth matters more than length

With the publication this week of the latest “national accounts”, our situation is now clear: we’re not in recession, yet we are – but, in a sense, not really.

Confused? It’s simple when you know. One thing we do know is that the economy – as measured by real gross domestic product – will have contracted significantly in the present quarter, covering the three months to the end of September.

At this stage, the smart money is predicting a contraction – a fall in the production and purchase of goods and services – of “two-point-something” per cent, although there are business economists who think the fall could be as much as 4 per cent.

Recessions are periods when people cut their spending sharply, causing businesses to cut their production of goods and services and lay off workers. It’s mainly because so many people lose their jobs that recessions are something to be feared. But also, a lot of businesses go broke.

This means no one should need economists to tell them if we are or aren’t in recession. If you can’t tell it from all the newly closed shops as you walk down the main street, you should know from what’s happening to the employment of yourself, your family and friends. Failing that, you should know it from all the gloomy stories you see and hear on the media.

Have you heard, by chance, that NSW, Victoria and now Canberra are back in lockdown, leaving some workers with no work to do, and the rest of us unable to spend nearly as much as usual because we’re confined to our homes? You have? Then you know we’re in recession.

When the first, national lockdown began in late March last year, real GDP contracted by 7 per cent in the June quarter. That was the deepest recession we’ve had since the Great Depression of the 1930s.

But it was also the shortest recession we’ve had because, once the lockdown was lifted, the economy – both consumer spending and employment - immediately began bouncing back. As the Australian Bureau of Statistics revealed this week, the bounce-back continued in the June quarter of this year, which saw real GDP growing by a strong 0.7 per cent, leaving the level of GDP up 1.6 per cent on its pre-pandemic level.

All clear so far? The confusion arises only in the minds of those people silly enough to let the media convince them that, despite all the walking and looking and quacking they see before their eyes, a recession’s not a recession unless you have two consecutive quarters of contraction in GDP.

The size of the contraction is of no consequence, apparently, nor would be two or more quarters of contraction that weren’t consecutive. This is nonsense.

As my colleague Jessica Irvine has explained, this “rule” is repeated ad nauseam by the media, but has no status in economics. It’s a crude rule of thumb that’s frequently misleading. It’s in no way the “official” definition of recession.

But the consecutive-quarter rule is so deeply ingrained that it causes needless debate and uncertainty. Some business economists convinced themselves that this week’s figure for growth in the June quarter could be a small negative.

Oh, gosh! Since we know the present quarter will be a negative, that means we could be in another recession. Quick, get out the R-word posters.

But no. June quarter growth proved stronger than expected. Treasurer Josh Frydenberg couldn’t resist the temptation to declare there’d been no “double-dip recession”. Thank God!

But wait. The lockdowns could easily continue beyond the end of this month and into the December quarter. So we could have a second negative quarter on the way. Quick, bring back the posters and start writing the double-dip speech.

Sorry, this is not only silly, it’s got the arithmetic wrong. When the economy goes from growth to lockdown, you get a negative. But when, in the follow quarter, the economy merely stays in lockdown you get zero growth, not another fall.

The present lockdowns apply to a bit over half the economy. So, if the other half continues to grow, we will get a positive change in GDP during the quarter.

What’s more, if the lockdowns end sometime before the end of December, we’ll get a bounce-back in growth in that half of the economy, as everyone rushes out to start buying the things they were prevented from buying during the lockdown.

That’s what happened last time the lockdown ended; it’s safe to happen this time too. So it’s hard to see how we could get a second quarter of “negative growth” in the three months to New Year’s Eve.

We’ll learn what the figure was in early March, in good time for the federal election. Stand by for Frydenberg’s triumphant declaration that we’ve avoided a double-dip recession for a second time. He’ll turn the media’s consecutive-quarters bulldust back on them, and spin a story of great success.

But this will literally be non-sense. He’ll take a contraction in the September quarter of, say, 2 to 4 per cent – as big as the contractions that caused the recessions of the mid-1970s, the early 1980s and the early 1990s – and pretend it doesn’t count, simply because that massive contraction was concentrated in one quarter rather than spread over two.

He’ll con us into accepting that the depth of a slump doesn’t matter, just its length. More nonsense.

But there remains a respect in which, like the first dip, the second isn’t really a recession. What we had last year and are in the middle of right now aren’t recessions in the normal sense.

They’re artificial recessions deliberately brought about by governments to minimise the loss of life from the pandemic. They thus involve a degree of monetary assistance to workers and businesses unknown to normal recessions. This means they don’t take years to go away, but disappear in six months or so because of the speed with which the economy bounces back when the lockdown ends.

Read more >>

The economy’s job is to serve our good health

What a tough, tricky world we live in. There we were, starting to think the pandemic – for us, at least – was pretty much over bar the jabbing, when along came a new and more contagious variant and knocked our confident complacency for six. It’s now clearer that getting free of the virus will be messier, more expensive and take longer than we’d hoped.

It’s natural to be impatient to see the end of this terrible episode in the nation’s life, but no one’s been more impatient to see the end of restrictions than Scott Morrison and the business lobby groups.

We should worry less about any continuing small risks and more about getting the economy working normally again, we were told. Why do those appalling premiers keep closing state borders? Don’t they understand how it disrupts businesses?

One theory that’s been blown away is the tribal notion that continuing problems keeping a lid on the virus were limited to dictatorial Labor states, not “gold standard” Liberal states. We’ve been reminded of what pride so often causes us to forget: success is invariably a combination of competence and luck.

Luck was running against Victoria, now it’s NSW’s turn. NSW did do better on contact tracing, but along came a variant that could spread faster than the best contact-tracing system could keep up with.

The nation’s macro-economists learnt some years ago that the best response to a recession is to “go early, go hard”. That’s something the exponential spread of viruses means epidemiologists have long understood.

The sad truth is, no matter how long NSW’s present lockdown needs to last before the virus is back under control, Premier Gladys Berejiklian’s critics are certain to say she waited too long and didn’t go hard enough.

And they’ll be right. If there’s ever a possibility of starting even a day earlier, it’s always right.

Is it a bad thing to want to limit the economic disruption caused by our fight against the virus? Of course not. But it’s a tricky choice. You don’t want to act unnecessarily, but the longer you take to realise you must act, the more disruption you end up causing.

Berejiklian’s problem is that she was being held up as the national pin-up girl of governments’ ability to cope with the crisis while minimising economic disruption.

The economy is merely a means – a vital means – to the end of human wellbeing. Health is also a means to achieving human wellbeing. But good health is so big a part of wellbeing it’s almost an end in itself. And prosperity isn’t much good to you if you’re dead.

So, as surveys show, most economists get what it seems many business people (and certainly, their lobby groups and media cheer squad) don’t get: in any seeming conflict, health trumps economics.

It’s also a matter of solving problems in the best order. Just as a war takes priority over material living standards, so does a major threat to our health. Fix the health problem, then get back to worrying about the economy.

To put it yet another way, “the economy” exists to serve the interests of the people who make it up; we don’t exist to serve the economy.

The people who want to exalt “the economy” tend to be those using “the economy” to disguise their pursuit of their own immediate interests, not the interests of everyone. “Keep my business going; if that means a few people die, well, I’m pretty sure I won’t be among ’em.”

Some economists estimate that the NSW lockdown will cost the economy (gross domestic product) about $1 billion a week. But don’t take that back-of-an-envelope figure too seriously. For a start, it’s not huge in a national economy producing goods and services worth about $2000 billion a year.

In any case, it’s misleading for two reasons. First, can you imagine what would be happening in the economy had St Gladys (or, before her, Dictator Dan) done nothing while the virus raged about us, getting ever worse?

Most of us would be in what Professor Richard Holden of the University of NSW calls “self-lockdown”. Which would itself be a great cost to the economy – not to mention the angst over the lack of leadership.

So don’t confuse the cost of the virus with the cost of the government’s efforts to limit its spread by doing the lockdown properly.

Second, remember that the economy rebounded remarkably quickly and strongly after the earlier lockdowns, making up much of the lost ground. Of course, the exceptional degree of income support for workers and businesses provided by the federal government does much to account for the strength of the rebound.

Which is why it’s good to see the federal-state assistance package announced on Tuesday, even though its cut-price version of JobKeeper, while being better than was provided to Victoria recently, isn’t as generous as it should have been.

Like Berejiklian, Morrison is still adjusting to his newly reduced circumstances.

Read more >>