Question for voters: Which party do I want deciding wages policy?

The craziest thing about this election is that we’re into the last week of the campaign without anyone much bothering to mention the word “wages”. Really? We’re too obsessed by the cost-of-living crisis to have any interest is what has happened, and will happen, to our wages?

Is it possible our voters could be so detached from reality that they don’t see the link between prices and wages? It reminds me of the person who voted for Trump because “prices went up, and they’ve never come back down”.

That’s right, sir, the general level of consumer prices goes up and rarely falls back. That’s why it’s nice to see your wage rising in line with the rise in prices, or even a bit faster than prices. If that’s what happens, you don’t have a lot to complain about.

Is it possible some people think the government can do something about rising prices but has nothing to do with wages?

Actually, the proportion of workers who are members of a union has fallen so far – to 13 per cent – that many workers may feel they have no say in what happens to their wage, and neither does the government. The boss increases your pay occasionally if she feels like it.

The fact is, the cost of living is always high on ordinary people’s list of complaints. But it became a particular concern in 2022 because of the huge surge in prices caused by the pandemic. The annual rate of increase in prices got to about 8 per cent, but is now back down to the 2 to 3 per cent range we’ve become used to.

Trouble is, wages didn’t rise as much as prices did and, to make matters worse, in its efforts to get the inflation rate down, the Reserve Bank caused interest rates on home loans to rise by more than 4 percentage points. As well, “bracket creep” took an extra bite out of workers’ after-tax pay.

That’s what explains the voters’ obsession with the cost of living. But the surge in prices was set in train before the Albanese government won the last election in May 2022. So the real questions are: what has this government done about it, and would a change of government improve the prospects for the cost of living?

We can learn a lot from a new research paper by one of the nation’s top labour-market economists, Professor David Peetz, of Griffith University and the Australia Institute’s Centre for Future Work.

Peetz finds that, despite a fall in “real” wages (that is, after allowing for price rises) during the COVID pandemic and the subsequent surge in prices, by December 2024, real wages had recovered to be equal to what they were at the end of 2011.

Two things to note. First, this is wages before taking account of income tax. Real after-tax wages would not have recovered to their level 13 years earlier, because of the bracket creep made greater by the price surge.

Second, over those 13 years, the productivity of labour improved by 15 per cent. So none of the benefit of that improvement was shared with workers – contrary to the assurances of businesspeople, politicians and economists that, by some magic process, productivity automatically increases real wages.

Sorry, there’s nothing automatic about it. If workers don’t have the bargaining power to insist on their fair share of the spoils, employers don’t pass it on.

What labour-market economists understand, but most economists (including Reserve Bank boffins) keep forgetting, is that wage rates are determined not simply by the balance of supply and demand for labour, but also by the employees’ bargaining power relative to the employers’ bargaining power.

Peetz’s examination of 16 factors that influence or indicate power in the jobs market shows that “almost all economic and labour market trends in the past half century have reduced workers’ power”.

To be precise, he finds that 14 of the 16 factors indicate reduced workers’ bargaining power.

Here’s a list of the 14 – reduced union membership, a reduced proportion of workers whose wages are bargained collectively by unions, fewer days lost through strikes, the advent of the gig economy, businesses’ increased use of labour-hire companies, increased casual employment, fewer workers changing jobs, increased outsourcing of work, industries dominated by fewer firms, more issuing of temporary visas to foreign workers, use of non-compete clauses in employment contracts, increased franchising of businesses, increased importance of share-market capital, and increased competition from low-wage imports.

The two factors indicating increased workers’ power are the gradual decline in the gender pay gap and the fall in the rate of unemployment since 2010, although it’s been creeping up since 2023.

Peetz sees the influence of this overall decline in workers’ bargaining power in figures for the average annualised wage increases under new enterprise agreements. They gradually declined from about 3.5 per cent in 2014 to 2.5 per cent by 2022.

But in the two years since then, the average reached a peak of 4.8 per cent, and was higher in every quarter than it was in any quarter between December 2014 and December 2022.

Why the improvement? Peetz argues it’s because of the change in government industrial relations policy since the election of the Albanese government in mid-2022.

Whether voters know it or not, the federal government does influence the size of wage rises via its regulation of the wage-fixing rules. It can shift the balance of bargaining power between employees and employers. Under the Howard and subsequent Coalition governments it was shifted in favour of employers; under the Albanese Labor government it’s been shifted back in favour of employees and their unions.

And whether voters know it or not, the many hundreds of minimum wage rates set out in industrial awards – covering about the bottom quarter of workers – are increased on July 1 every year by an amount determined by the Fair Work Commission.

The federal government can influence these decisions by urging the commission to be generous or stingy. I’ll leave it to you to guess which side of politics likes to see bigger increases, and which prefers smaller.

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Dutton almost promised to fix bracket creep. Here's why he didn't

By MILLIE MUROI, Economics Writer

Taxes are a necessary evil – which is why neither side of politics is willing to sign themselves up to the best way to keep them in check.

While most of us acknowledge the merits, you’ll be hard-pressed to find anyone jumping for joy when they find out their tax bill is growing.

The one you’re probably most familiar with is personal income tax – a chunk of your income scooped out from your salary every pay cycle. Luckily for politicians, it’s not often that they need – or choose – to raise them.

That’s because the tax system is designed in a way that “naturally” fattens the amount of tax raked in by the government every year. You’re paying more in tax this year? “Not our fault,” they can shrug. It’s simply the way things are.

As you know, we pay bigger tax rates within higher tax brackets (slices of our income) with the amount of our income determining which rates – and ultimately, how much tax – we pay. While your income usually climbs each year, those tax brackets and rates don’t budge automatically.

When the growth of your pay packet is faster than the rise in consumer prices (such as the price of the champagne you might crack open after a pay rise), it’s not so bad. But when your pay isn’t keeping up with inflation, your tax bill still increases, leaving you doubly worse off.

This extra tax you pay is called “bracket creep”.

If we let it march on unchecked, by 2031, the average full-time worker is on track to get bumped from the 30 per cent tax bracket to the 37 per cent tax bracket, regardless of whether their wages, in “real terms” (after allowing for inflation) are going backwards, forwards, or sideways.

So, why is no politician on the crusade against bracket creep?

To be fair to Opposition Leader Peter Dutton, he had one of the best ideas in this broadly uninspiring election campaign: change the system. “Bracket creep, as we know, is a killer in the economy,” he declared in an interview this month, adding a worthy note of urgency: indexing (or raising tax brackets in line with inflation) needs to be introduced – quickly.

How quickly, exactly? Well, this is where his sensible idea seems to fade into a vague mist of political fantasies. First, we’ll have to “get the budget into a position where we can index the brackets”, he clarified at a later press conference on his campaign.

That’s about as clear a caveat as mud. What is that magical budget position? A budget surplus? By how much? And with the budget now, under Labor, forecast to remain in deficit for the next decade, it’ll be more than just the average worker being pushed into that 37 per cent tax bracket by the time the budget is back in balance. But if the Coalition (if elected) makes some deep cuts to spending, gets gifted some unexpected jumps in the tax on income from mineral exports, or rakes in significantly more money from other taxes, perhaps then.

But with plenty of policy costings yet to be released just a week out from election day, how are we to know if the Coalition has a coherent plan to get the budget – and apparently the country – “Back on Track”?

Dutton also labelled his idea an “aspiration” rather than actual policy, just about giving it a final kiss goodbye in the graveyard of good ideas. I can “aspire” to kick a goal for the Matildas once I get myself into a position where I can do that. I’ll leave the judgment to you on how likely that is.

Labor’s stance is not promising either. Prime Minister Anthony Albanese hasn’t even expressed a nice, fluffy goal when it comes to indexing income tax brackets. Instead, he has made a fairly safe tax promise: Labor will generously gift us taxpayers 1¢-in-the-dollar tax cuts in 2025-26 and 2026-27 for the lowest slice of our income that we pay tax on. That works out to be a saving of about $5 a week in the first year, and $10 a week the year after.

Sure, that compensates for some of the additional tax we’ll pay from bracket creep. But it’s not a lot, and it doesn’t stop the root problem: the growing number of workers who will be pushed into higher tax brackets in the years ahead.

All we seem to see from either side of politics is this kind of tinkering around the edges. Or, it’s temporary measures such as the Coalition’s low-and-middle-income tax offset in 2018, which gave a tax saving up to $1080 for people earning up to $126,000 a year (until 2022) and their promise this election of a $1200 “cost-of-living tax offset” for Australians earning up to $144,000.

It makes you think bracket creep is a problem neither side of politics really wants to solve – and you’d be right.

Have you ever noticed politicians are always announcing tax cuts, but never tax increases? They can thank bracket creep.

It’s a villain that allows whoever is in government to play the hero: “Look at these wonderful tax cuts and relief we’re offering!” It’s a bit like a doctor ignoring the preventative measures their patient could take, instead offering temporary or tiny relief through various medicines that simply alleviate the symptoms.

Bracket creep is also an excellent revenue driver for the government: a way for them to increase their tax take every year without lifting a finger. Not only does the government of the day get to wave offsets and tax relief around as if these things are a big favour to punters – they avoid having to put their name to the unpopular decision of increasing taxes.

Permanently tying the level of tax brackets to inflation also commits future governments to more budget discipline. If they don’t sufficiently limit the growth in government spending, they can’t rely on the quiet power of bracket creep to boost their coffers.

For now, it looks like neither side has the guts to end the sugar hit they get from bracket creep – all at the cost to workers’ pay packets. Getting tax “Back on Track” has a nice ring to it. If only Dutton had the guts to go with it.

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Are you better off now? That's Dutton's trick question

For most people, the simple answer to Peter Dutton’s repeated question – are you better off today than you were three years ago? – is “no, I’m not”. But if Dutton can convince us this is the key question we need to answer in this election, he’ll have conned us into giving him an easy run into government.

Why? Because it’s the wrong question. It’s the question of a high-pressure salesman. A question that makes the problem seem a lot simpler than it is. A question for people who don’t like using their brain.

And it’s a question that points us away from the right question, which is: which of the two sides seems more likely to advance the nation’s interests in the coming three years?

Economists have a concept called “sunk costs” – money (or time) that you’ve spent, and you can’t unspend. Economics teaches an obvious lesson: you can’t change the past, so forget it and focus on what you can change, the future.

But, since it’s become such a central issue in this election, let’s dissect Dutton’s magic question. For a start, it’s completely self-centred. Focus on what’s happened to you and your family and forget about what’s happened to anyone else.

Similarly, the implication is to focus on the monetary side of life. Forget about what’s happened to the natural environment, what we’ve done to limit climate change, and what we’ve done about intergenerational equity – the way we rigged the system to favour the elderly at the expense of the young.

Next, Dutton’s question is quite subjective. He’s not asking us to do some calculations about our household budget or to look up some statistics, just to say whether we feel better or worse off.

Guess what? This subjectivity makes us more likely to answer no. As we’ve learnt from the psychologists, humans have evolved to remember bad events more strongly than good events.

This is why most people believe that inflation is much higher than the consumer price index tells us. As they do their weekly grocery shopping, they remember the price rises much more clearly than any price falls. And in the personal CPI they carry in their heads, they take no account of the many prices that didn’t change – which they should, and the real CPI does.

Humans find the bad more interesting and memorable than the good because the bad is more threatening, and we have evolved to search our environment for threats.

In this case, however, objective measurement confirms that most people are right in thinking their household budgets are harder to balance than they were three years ago. There are various ways to measure living standards, but probably the best single measure is something called “real net national household disposable income per person”.

Between June 2022 and March 2024 (the latest quarter available), it fell by 3.6 per cent. It may have recovered a bit in the 12 months since then, but not by enough to stop it having fallen overall.

But that’s just an economy-wide average. We can break it down into more specific household categories. Those dependent on income from wages are worse off because consumer prices rose a little faster than wages – though wage rises fell well short of price rises in the couple of years before Labor came to power. This is a shortfall wage-earning households would still be feeling in their efforts to balance their budgets.

The rise in interest rates since the last election means the households feeling by far the most pain over the past three years are those with mortgages.

This also means those who own their homes outright have felt the least pain. Most people on the age pension have done OK because most of them own their homes and the age pension is fully indexed to the rise in consumer prices.

As for the so-called self-funded retirees, they’ve been laughing. Not only do they own their homes, their super and other investments earn more when interest rates are high.

True, it’s common for elections to be used to sack governments who’ve presided over tough economic times. Be in power during a recession and you’re dead meat. So elections are often used to punish governments, on the rationale that the other lot couldn’t possibly be worse.

But the side that benefits from such circumstances, taking over when everything’s a mess, won’t have it easy getting everyone back to work and having no trouble with the mortgage in just three years.

I can remember when the Morrison government was tossed out in 2022, smarties among the Liberals telling themselves this probably wasn’t a bad election to lose. Why? Because they could see consumer prices had taken off and had further to go. Using higher interest rates to get the inflation rate back down would be painful and protracted, possibly inducing a recession.

This is why Dutton’s question is so seductive to people who don’t follow politics and the economy, and don’t want to use their grey matter. “If I felt the pain on your watch, it’s obvious you’re to blame and you get the sack. Don’t bother me with the details.”

Remember, however, that all the rich economies suffered the same inflation surge we did, all of them responded with higher interest rates, and most suffered rising unemployment and even, like the Kiwis, a recession. But not us.

So let me ask you a different question: over the past three years have you ever had cause to worry about losing your job? Have you spent a lot of time unemployed while you find one? Have more people in your house been able to find work?

Our employment rate is higher than it’s ever been. Our rate of unemployment is still almost the lowest it’s been in 50 years. This has happened because the Albanese government and the Reserve Bank agreed to get inflation down without a recession.

But the price of avoiding recession is interest rates staying higher for longer. If you think Labor jumped the wrong way, kick the bastards out.

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The government is timid and uninspired. This budget is a perfect fit

If you’re having trouble working up much interest in the budget, don’t feel bad. It’s not you, it’s the government. So much fuss is made about the annual federal budget that we expect it to be full of major announcements. Well, not this one, and not from a government that never wants to rock the boat.

It is, however, a budget we’ve wished on ourselves. We’ve made it clear that, while ever we’re feeling pain from the cost of living, we’re not much interested in anything else, and an unambitious government has been relieved to take us at our word.

Most of the measures in the budget are small cuts to various charges that affect households’ budgets. The government will be spending more to encourage GPs to bulk-bill their patients and to cut the maximum cost of a pharmaceutical prescription to $25 a pop.

It will extend the electricity bill rebate for the last half of this year, yielding households a saving of $150.

And not forgetting the big one that will make all the difference to the cost of living: indexation of the excise on draught beer will be paused for two years. Anyone who can see the saving per glass gets a prize for exceptional eyesight.

All this is to be done just as soon as we vote to re-elect the Albanese government – except that Peter Dutton has promised a Coalition government would do the same.

Of course, all these measures to ease the cost of living have already been announced, with one exception: a two-stage cut in income tax. Who knew? Surely, that’s something to get excited about?

Well, yes, until you examine the details. When Treasurer Jim Chalmers says the tax cuts are modest, he’s not exaggerating.

It boils down to this: in 15 months’ time, July next year, everyone earning more than $45,000 a year ($860 a week) will get a tax cut of a bit over $5 a week. A year later, they’ll get a further cut of $5, taking it up to $10.30 a week. Part-timers earning between $350 and $860 a week will get an initial saving of up to $5 a week.

Even with this last-minute addition, it’s not hard to believe that, until Cyclone Alfred intervened, Labor was hoping to hold the election in April and leave the budget until later. Why did the delayed election date prompt it to go ahead with a budget when it had nothing much to announce? Law and practice. It had to.

Still, budgets also tell us the government’s latest forecasts for the economy and for the budget bottom line: is the government expecting to spend more than it raises in taxes, or less? More. Every financial year for the next 10.

So the government foresees a decade of budget deficits and further borrowing to cover those deficits. Does it have any plan to correct this? Not that it’s telling us about. My guess is that its policy is to worry about that only after it has been re-elected. If it isn’t, good luck, Mr Dutton.

But since we can’t see further than the cost of living, how are we doing? On the face of it, we’re well over the worst. Over the year to December, consumer prices rose by a modest 2.4 per cent.

The rate of inflation is forecast to stay low, meaning the Reserve Bank is likely to keep cutting interest rates in coming months by a total of 1 percentage point or so, which will take a lot of pressure off people with big mortgages.

The government expects wages to rise a bit faster than consumer prices which, if it comes to pass, will ease the cost of living to a small extent. But if many people still feel it’s a struggle to pay their bills, I won’t be surprised.

Why not? Because, over the five years to last December, consumer prices rose by about 4.5 per cent more than wages did. Until that “wage deficit” is closed, many people will still be feeling the pinch.

This makes it all the more important to understand why the government’s move to continue its energy rebate for another six months isn’t as good as it sounds.

The rebate – which is temporary and paid directly to your electricity retailer – began from July 1 last year. It thus caused quarterly electricity bills to be $75 less than they otherwise would have been.

Its extension for the last two quarters of this year won’t stop your bills being higher than they were because your retailer has increased its prices. But it will stop your bill also being $75 a quarter higher than otherwise. Thanks to generous Anthony and Jim, that unpleasant surprise won’t come until you get your first quarterly bill in 2026. (Come to think of it, maybe the new tax cut is timed to ease the pain of higher power bills.)

As for Trump and his planned trade war, the T-word doesn’t get a mention. Rather, Chalmers worries about “heightened global uncertainty” and “escalating trade tensions”. Why the obfuscation? Maybe Chalmers wants us to see what a great job the government’s done fixing the cost of living and doesn’t want that terrible man raining on his parade.

Actually, it’s too early for concrete actions. We don’t yet know how stupid Trump intends to be, let alone whether the other big economies intend to worsen it by giving as good as they get (otherwise known as cutting off your nose to spite your face).

So right now is the time to think hard about our options, not announce a response. We do know our government won’t be tempted to retaliate, and Chalmers is right to say we must make our economy more resilient to shocks from overseas.

But spending on a new “buy Australian” campaign? It may make uninformed voters feel better, but I doubt it will fix the problem.

This government is timid, uninspired and uninspiring. This budget fits it perfectly.

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It's official: supermarkets are overcharging. So change the subject

Why does a government release a highly critical report on the conduct of Woolworths and Coles on the Friday before a budget that will lead straight into an election campaign? Short answer: not for any worthy reason.

One worthy reason could have been to show Anthony Albanese and Treasurer Jim Chalmers really wanted to do something about fixing the cost of living, by making the question of what we should do about our overcharging grocery oligopoly a major issue for discussion in the campaign.

Since the remedies proposed by the Australian Competition and Consumer Commission in its report seem so inadequate, should the two grocery giants be broken up? As, indeed, Opposition Leader Peter Dutton says he would do if elected.

As the business press so indelicately put it, the competition watchdog’s mild-mannered recommendations despite all its evidence of what the punters see as “price gouging” meant the supermarket giants had “dodged a bullet”. But should they have? Let’s discuss it.

Sorry, I’ve been observing the behaviour of politicians for too long to believe Labor’s motives for releasing the report at such a time could possibly be so pure. It’s more likely the reverse: Labor wants to close the issue down.

What Labor did last week looks suspiciously like what’s known in the trade as “taking out the trash”. When you’ve got an embarrassing report you hope won’t get much notice from the media, you release it on a Friday, when the media’s busy packing up for the weekend. The reporters ought to return to the topic on Monday, but they don’t because of their obsession with newness. Spin doctors 1; press gallery 0.

Or governments can achieve the same result by releasing an embarrassing report at a time when everyone’s attention is turned to a much bigger issue – say, a budget, or an election campaign.

But why didn’t Labor just keep the report to itself until after the election? Because, I suspect, it wanted to show it had been on the job, investigating complaints about supermarket overcharging.

And it probably wanted to arm itself to reply to Dutton’s promise to break up the two giants. “We had the competition watchdog investigate the matter, and it explicitly declined to recommend divestment. But it did make 20 recommendations, and we’ve accepted them all.”

(The last time I heard that one was before the 2019 federal election, when the Morrison government released the report of the royal commission into misconduct in banking and said it had accepted all its recommendations. After the election it dropped many of them.)

But if even Labor isn’t game to touch the thought of breaking up Coles and Woolies, why are the Liberals promising to do it? Because they wouldn’t really.

Why does the notion of divestment frighten Labor? Because it doesn’t want to get offside with business. However, in the case of the two supermarket giants, their interests are defended inside Labor’s corridors of power by their union, “the shoppies”, aka the Shop, Distributive and Allied Employees Association.

Trouble is, the report’s findings show there’s a lot to try sweeping under the carpet. The two chains account for two-thirds of all supermarket sales, and their market share has increased since 2008 despite the advent of Aldi. Their profitability is among the highest in the world and their profit margins have increased over the past five financial years.

“Grocery prices in Australia have been increasing rapidly over the last five financial years,” the report says. “Most of the increases are attributable to increases in the cost of doing business across the economy, including particularly production costs for suppliers, which has increased supermarkets’ input costs.

“However, Aldi, Coles and Woolworths have increased their product [margins] and earnings-before-interest-and-tax margins during this time, meaning that at least some of the grocery price increases have resulted in additional profits.”

So if the Libs don’t seize on the report’s findings to step up their claim to want to do something real and lasting about the cost of living, it will be a sign they’re not genuine in their professed desire to break up the grocery oligopoly. A sign both sides of politics want the report and its disturbing findings buried ASAP.

But it’s not just the political duopoly that doesn’t want to know about the pricing power of the grocery market’s big two. Most of the nation’s economics profession don’t want to think about it either. Why not? Because it’s empirical evidence that laughs at their conventional model – whether mental or mathematical – of how the economy works.

There’s a host of contradictions in their model, and the profession long ago decided that the easiest way to leave its beliefs unchallenged and unchanged was to avoid thinking about them. (And for all those economists snorting with derision as they read yet more of Gittins’ nonsense, I have five words: “theory of the second best”. Those words strike terror into the heart of every conventional economist.)

Economists divide their discipline into micro (the study of how individual markets work) and macro (study of how the whole market economy works), but they’ve given up trying to make the two approaches fit together. This groceries report is a classic example of how the two lines of thinking don’t fit.

Every microeconomist studying “imperfect competition” (aka “industrial organisation”) knows oligopoly brings market power and allows firms to avoid competition on price. But every macroeconomist assumes – explicitly or implicitly – that market power isn’t a relevant problem.

As we saw with the conventional wisdom on the domestic causes of the recent inflation surge, the Reserve Bank assumed it was caused by excessive monetary and budgetary stimulus. That is, it was caused by “demand-pull” not “cost-push” inflation pressure.

The fact that, through our own neglect, we have one of the most oligopolised economies in the developed world, is assumed away. We’ve allowed our economy to become inflation-prone, while economists in general, and the supposedly inflation-obsessed Reserve Bank, have said not a word.

But not to worry. We’ll compensate for our negligence by punishing people with home loans all the harder.

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Maybe the inflation surge didn't happen the way we've been told

According to Reserve Bank deputy governor Andrew Hauser last week, we’ve entered a world characterised not just by volatility, complexity and uncertainty, but also by “ambiguity” – a world where “you don’t know the model”, meaning that “judgment and instinct are as important as formal analysis”.

At last, someone is talking sense.

Academic economists may be locked into their maths and econometric models, but practising economists know it ain’t that simple. Economics is as much an art as a science.

Economics would be much easier if only human consumers and businesspeople behaved like rational automatons, reacting automatically and mechanically to known incentives, as you implicitly assume they do when you use a set of equations to guide you through the inevitable uncertainty caused by the lamentable truth than the humans who constitute the economy are . . . human.

Keynes reminded his fellow academics of the need to take account of people’s “animal spirits”. Anyone familiar with markets knows they tend to alternate between periods of optimism and pessimism. I prefer to say that maths without psychology will usually get it wrong.

Contrary to the assumption of the simple model that dominates the thinking of almost all economists, humans are not rugged individualists who decide for themselves the best thing to do, then do it without regard to what anyone else is doing.

In reality, consumers and businesspeople are heavily influenced by what other people are doing. We’re susceptible to herd behaviour, fads and fashions. And we live in a permanent state of uncertainty.

In their landmark book, Radical Uncertainty: Decision-making Beyond the Numbers, John Kay and Mervyn King say it’s not true, as economists assume, that businesses are “profit maximising”. That’s not because they wouldn’t like maximum profits, but because they don’t know the magic price to charge that would do the trick.

As the punters often forget, when a firm raises its price, it’s taking a risk. It’s taking a bet that what it gains in higher revenue won’t be cancelled out by the sales it loses from customers unwilling to pay the higher price.

In the real world, firms feel their way with price increases, hoping to avoid going over the top and ending up worse off. But get this: they feel a lot more comfortable putting up their prices when everyone else is putting up theirs. You know, like our firms were doing a year or two ago.

Hauser says that, at present, “we don’t know the model” but, in fact, the Reserve and everyone else are using the same orthodox, mainstream model to explain why, after staying low for almost 30 years, the annual rate of inflation took off in late 2021 and reached a peak of 7.8 per cent by the end of 2022.

As I’ve written incessantly, this first inflation surge in three decades was caused by the COVID-19 pandemic (with a little help from Russia’s attack on Ukraine). The pandemic caused worldwide disruptions to supply, in turn causing the prices of many goods to leap. The second factor was the massive monetary and budgetary stimulus the authorities let loose to keep the economy alive during the lockdowns.

This conventional wisdom is easily accepted because it blames most of the problem on the government. Inflation surged because the authorities cut interest rates and increased government spending by far more than proved necessary. All of us borrowed more and spent more, causing demand to run ahead of supply and prices to rise.

But I’ve long suspected this isn’t the whole story, or even the main story. So, since even the Reserve Bank isn’t sure we’ve got the right model to explain what’s happening in the economy, let me show you my model, which puts most emphasis on psychological factors.

When people in many countries were confined to their homes, they could still use the internet to buy goods, but they couldn’t spend on personally delivered services. So spending on goods surged to levels far greater than businesses were used to supplying. And, since most manufactured goods are imported, we got shortages of ships and shipping containers to go with shortages of cars, silicon chips, building materials and much else.

When Russia’s invasion of Ukraine caused oil and gas prices to soar as well, the media went for weeks with stories of how much prices would be rising. Reporters would go to industry lobby groups, whose shills would regretfully affirm that, yes, prices would be rising hugely. The ABC gave much publicity to some wiseguy claiming the price of a cup of coffee would jump to $8. Great story; pity it was BS.

I could see what was happening at the time. Businesses were using the media to soften up their customers for big price rises. They were setting up a self-fulfilling prophecy.

Only in recent times have academic economists begun to understand the important role played in the economy by “signalling” – a role not captured by their equations. Not only were firms signalling to customers that, due to causes entirely beyond their control, big price rises were unavoidable, they were signalling to all their mates that now would be a great time to whack up their own prices.

But my alternative explanation doesn’t start there. Remember that, for seven whole years before this latest price surge, the inflation rate was stuck below the bottom of the 2 to 3 per cent target range, despite the Reserve’s efforts to get it up.

Why was inflation unacceptably low? My theory is it was another self-fulfilling prophecy. Businesses weren’t game to raise their prices because no other businesses were raising theirs. Everyone was waiting for some inflationary event to give them some cover, but nothing turned up.

Until the pandemic’s supply disruptions and the Russia-induced jump in oil and gas prices turned up. As soon as it did, everyone breathed a sigh of relief and began wondering how big an increase they could get away with.

The irony is that the pandemic-induced supply disruptions – and even, to an extent, the oil and gas price rises – proved temporary and were reversed. Leaving all the unrelated price rises to stand.

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The nation is finally coming to grips with home affordability

Right now, the prospect of much improvement in being able to afford a home of your own isn’t bright. We don’t look like solving the problem any time soon. But I’ve been watching and writing about the steady worsening in housing affordability for the best part of 50 years, and I’m more optimistic today than I’ve ever been.

Why? Not because we’ve got the problem licked – and certainly not because mortgage interest rates will soon be coming down – but because it’s become so bad no one can go on ignoring it. At every level, from governments at the top to mums and dads and angry young people at the bottom, we’re realising that house prices just can’t be allowed to keep going up and up forever.

For the first time in my experience – and probably the first time since the housing crisis immediately after World War II – all of us are realising something must be done to turn things around. Politicians, treasuries, economists and parents are coming to grips with the problem. We’ve begun thinking hard about all the factors contributing to the problem and the many things that will need to change.

Until now, people have focused on fixing this favourite factor or that one. Now we’ve finally realised the problem is multi-faceted and needs to be attacked at every level from every angle. There’s no magic bullet.

Although affordability has been worsening for decades, the disruptions of the pandemic and its lockdowns – closing our border then reopening and having people flock in – have made the problem acute as well as chronic. It’s the same in other rich countries, but I bet ours is worse.

For many years, politicians on both sides and at both levels of government expressed sympathy for “first home buyers” but didn’t really care. That’s because voters who own their home far outnumber those who don’t, and home owners love seeing the value of their home going higher and higher.

But now home owners are joining the dots and realising their growing wealth comes with a major drawback. Their kids can’t afford a home without big withdrawals from the bank of mum and dad. Why is this a smart way to run the country?

People complaining about housing affordability tend to blame the federal government. In fact, it’s the state governments that have most influence over how many new homes are built, where they’re located and whether there’s enough higher-density housing in the parts of cities where people most want to live.

That’s why the Albanese government’s National Housing Accord with the states is a big advance. That’s true even though their agreement to deliver 1.2 million new dwellings over the five years to mid-2029 is running well behind schedule and may not be achieved.

The accord is important because it represents both levels of government accepting responsibility for housing affordability and being willing to co-operate in making progress. The time-honoured way to get the states pulling their weight is for the feds to pull out their chequebook. Which they have.

You don’t need an economics degree to see that if house prices keep rising it must be because the demand for homes is growing faster than their supply. That’s true, but it’s not that simple. For one thing, if all the extra houses are on the city’s fringe, people who want to live closer in will still be bidding up the prices of the better-located houses and units.

That’s why a big part of the deal with the states is for them to permit more better-located higher-density apartments. This switch of emphasis from doing things to reduce the demand for housing (by ending the tax breaks that help investors outbid first home buyers) to increasing the supply of well-located homes is a big step forward in the thinking of politicians, econocrats and economists.

But we’ll probably need to reduce demand as well as increase supply – so don’t think you’ve heard the last on “negative gearing”.

And don’t assume that if the NIMBYs have been beaten back and permission given for more middle-ring high-rise, they’ll start springing up in a few months’ time. Now the experts have their minds focused on housing, we’ve realised our home-building industry isn’t in tip-top shape. When demand surges, the businesses are much better at whacking up their prices than at building a lot more homes.

Right now, the industry’s discovered it can’t get the tradespeople it needs to expand its production. That’s why, at present, it’s building fewer homes than usual when it should be going flat-chat. We’re told it has lost a lot of its tradespeople to the construction of transport and other infrastructure for … the state governments.

Well, maybe. But my guess is the industry long ago gave up ensuring it was training lots of apprentices because they’d be needed in the next building boom. Similarly, the bureaucrats issuing visas to skilled immigrants don’t seem to have worried much about how their decisions would affect the building industry.

In the post-war years, state governments built and owned thousands of homes rented to people in need. But that went out of fashion decades ago, and now they own little social housing. Changing that will be another part of what’s needed to get housing affordability under control.

Finally, the Reserve Bank. The modest falls in mortgage interest rates we’ll see this year and next are unlikely to do anything lasting to improve housing affordability. When you’ve got a shortage of homes, making it a bit cheaper to borrow just allows someone to win the auction by paying more than the other bidders.

The Reserve has always denied that its use of the interest rate lever to keep inflation low has any lasting effect on housing affordability. But this assumes its ups and downs never cause borrowers to do crazy things for fear of missing out. Maybe the Reserve will need to change too.

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In 50 years, Trump will be remembered as just a puzzling footnote

I know I’m a bit late, but welcome to 2025. Before we get on with a year of absolutely gratuitous economic angst courtesy of a great American conman’s second coming, let’s take a breath and realise we’re already a quarter of the way through what many still think of as the “new” century.

How time flies while you’re preoccupied with one crisis – one damn thing – after another. I hate to undercut the media’s business model, but old age has taught me that most of the things we find so momentous at the time don’t leave much of a mark on the course of history.

In the heat of battle, we imagine the distant future having been irreversibly shaped by the latest unexpected excitement. A global trade war, for instance. Sorry, a beginner’s error.

Late last year I learnt that, in 1975, “15 leading Australians” had produced a book titled Australia 2025, which examined “the changing face of their country 50 years from now”. It was published by Electrolux, maker of vacuum cleaners.

What a great way to kick off another year of columns, I thought as I asked our library to disinter this gem from the archives. To be honest, I expected it would be great fun. All those fearless predictions about how, by 2025, we’d be flying to work in our spaceships. Or maybe by then computers would mean everyone was working from home.

Wrong. The chapter on the economy was written by someone I dimly remember, BHP’s chief economist at the time, John Brunner. He was far too smart to get caught making fanciful predictions about spaceships or anything else much. He devoted most of his 10 pages to explaining why anything he predicted was likely to be wrong.

He listed all the country’s recent problems, which many more impetuous observers could be tempted to foresee changing our future, while then expressing his doubts. For example, at that time, and still under the Whitlam government, we had a big problem with double-digit inflation. Would this problem be with us for another 50 years?

Brunner recorded all the reasons for thinking it might: “the increasing power of the unions, more generous unemployment benefits, vulnerability of capital-intensive industry to strikes” and “perhaps most potent of all, the commitment of governments to full employment”.

Even so, Brunner doubted it. And he was right. “What?” you say. “We’ve had a problem with high inflation in just the past few years.”

True. But much of the reason we’ve found it so disconcerting is that we’ve become so unused to high inflation. This latest, pandemic-caused surge in prices ended a period of about 30 years in which inflation stayed low, in Australia and all other rich countries.

Why is it so rare for the problem of the moment to be the thing that shapes the next 50 years? Because, as Brunner well understood, when big problems emerge, ordinary businesses and consumers look for ways around them, while governments look for ways to fix them. Action leads inevitably to reaction. And market economies like ours are adept at finding solutions to problems.

Consider Brunner’s list of reasons for predicting eternal high inflation. Powerful unions? Globalisation stopped that. So did the deregulation of wage-fixing. Generous unemployment benefits? Tell that to the Australian Council of Social Service. These days, every sensible person thinks the dole is too low.

As for “the commitment of governments to full employment”, it became a commitment in name only just a few years after Brunner was writing. Overseas economists invented an escape clause they called the “non-accelerating inflation” rate of unemployment, or NAIRU, and naturally, our government and its econocrats jumped at it.

For about the first 30 years after World War II, our rate of unemployment rarely got above 2 per cent. Allow for the workers who happened to be between jobs at any given time and that really was full employment.

But by 1975, inflation was in double digits and the unemployment rate had jumped to 4.6 per cent. The governments of the rich economies dumped the full-employment objective and turned every effort towards getting inflation down.

Thanks mainly to all the extra money the Morrison government spent during the pandemic, our unemployment rate fell to 3.5 per cent early in the Albanese government’s term. As I hope you remember hearing, this was the lowest unemployment had fallen to “in about 50 years”.

Quite accidentally, we’d got back to something like full employment. But get this. If you wonder why the Reserve Bank is so reluctant to cut interest rates, it’s because its battered old NAIRU machine keeps telling it unemployment is still too low.

This brings me to a bit of Brunner wisdom worth repeating 50 years later. “One of the superstitions to which modern man is particularly susceptible is the idea that what comes out of the computer must represent the law and the prophets [the Old Testament].”

“But of course what comes out of a computer depends on what goes into it and if you feed in neo-Malthusian assumptions you will get gloomy answers.” (Thomas Malthus was a notoriously pessimistic English economist from the 18th century.)

Finally, this: “Probably no profession spends more time contemplating the future than the economics profession and yet few are worse equipped for the task. For whatever facility they may have for manipulating economic variables, economists really know very little indeed about what determines economic magnitudes, particularly in the long run.

“The long-term rate of economic growth, for instance, will be determined by a host of political, technological and cultural factors which no economist has any special claims to be able to predict.”

Ah. They don’t make business economists like him any more.

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Think the measurement of inflation's a bit off? You're probably right

By MILLIE MUROI, Economics Writer

If you’ve ever looked at the latest inflation figures and thought to yourself it doesn’t really reflect the ballooning or shrinking prices you’ve been paying, you’re probably right.

Like most measures of our economy’s health, the consumer price index (CPI) – our main inflation gauge – is only a rough estimate of what’s happening to prices. It tracks changes in the costs of a vast range of things but also skips over some key items we spend on.

This week, we learned prices at the end of last year were climbing at the slowest annual rate since March 2021 at 2.4 per cent (a much more reassuring figure than the 7.8 per cent we were seeing two years ago). But if you feel like the prices you’re paying are moving to a different tune, they probably are.

The index, measured by the Australian Bureau of Statistics, basically tracks the change in the price of a typical “basket” of goods and services that we, as households, consume. Think: a big shopping trolley that carries a lot more than what you’d find in a supermarket. Sure, it includes eggs and fruit, but it also includes things like school fees, specialist visits and subscriptions to your favourite streaming platform.

Of course, you probably don’t spend on the exact same things, or buy the exact same amount, as people on the other side of the country – or even your neighbours – which is why the inflation measure isn’t a perfect fit for specific households.

The CPI is based on the average spending habits of everyone (well, at least those living in the capital cities). Then, based on this data, the bureau gives different “weightings” – a measure of an item’s relative importance in the total basket – to different items and categories. Things we spend a lot of our money on – like housing costs and food – get a bigger weighting in the index, meaning any changes in prices in those categories will shift the dial more when it comes to the final inflation figure.

Since the things we tend to spend on change over time, the bureau frequently updates these weightings.

The first ever “basket” in 1948, for example, put the proportion of our spending on food and non-alcoholic beverages at nearly one third, with dairy products alone taking up nearly a quarter of our food budget. Women’s clothing, meanwhile, accounted for about 10 per cent of our total spending. Combined with spending on men’s attire at nearly 5 per cent, our total spending on clothing back then took a bigger bite out of our budget than the 12 per cent we used to spend on housing!

Today, food and non-alcoholic drinks account for 17 per cent of the typical household’s spending, and both dairy products and women’s clothing just 1 per cent each – the latter being largely thanks to the rise of mass-produced and cheap imported garments. It’s perhaps little surprise that the biggest share of our spending is now on housing at more than 20 per cent, while transport, including our spending on cars, burns about 11 per cent (transport spending was measured through fares – such as the price of train tickets – which took up about 6 per cent of the typical household budget in 1948 before cars became widespread).

So, how does the bureau know what we’re spending on?

One way is through the household expenditure survey, which is conducted roughly every five years and gives the bureau an indication of how much we’re spending on different goods and services. It’s the reason why, for many years, the CPI weightings – only changed about every five years. Now, as collecting information has become easier and more digital, the weightings are updated every year and rely on various sources including retail trade and transaction data.

The bureau gets its pricing data by monitoring the prices of thousands of products. It looks for this information through everything from websites, to supermarket and department store data, as well as pricing data it receives from government authorities, energy providers and real estate agents.

Combining the pricing and weighting data gives us the consumer price index which is released in its complete form every three months. Since September 2022, the bureau has also published a monthly CPI reading, although the goods and services measured each month tend to alternate, giving us an incomplete picture of what’s going on.

As we’ve talked about, the CPI isn’t an accurate measure of our cost of living, although we all assume it is.

A better measure is the bureau’s “selected living-cost indexes” which break down changes in the cost of living for different types of households. Working households, for example, saw their annual living costs rise by 4.7 per cent last September quarter, while self-funded retirees only experienced a 2.8 per cent increase.

That’s mostly because different household types tend to splash cash on different things. Self-funded retirees and age pensioners might, for instance, spend slightly more on health, meaning any price changes there may bump their cost of living more than it would for working households.

But by far the biggest reason for the difference between working households and older cohorts is that working households are more likely to have a mortgage they are paying off. This means changes in interest rates – which are included in the selected living cost indexes but not the CPI – have a bigger impact on their overall cost of living.

It’s also one of the biggest shortcomings of the CPI. In the early 1990s, the Reserve Bank started using interest rates to target inflation: a practice that’s now become very familiar to us all. But later that decade, the bank asked the bureau to remove interest rates from the consumer price index. Why? Because the bank didn’t want the instrument it was using to control the rise in prices — interest rates — to be included among the price rises being measured. Your instrument should be separate from your target.

Instead, since 1998, the CPI has measured housing prices through changes in components such as rents, the cost of building new homes, and the cost of maintenance and repairs. But that means for the roughly one third of Australian households with a mortgage, the CPI is not a very good measure of the price pressures they are facing.

While the CPI is a rough estimate of the cost of living pressures we’re facing, if you feel like the pinch you’re feeling is harder or softer than the latest figures suggest, you’re probably right.

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Why we'd be mugs to focus on the cost of living at the election

It’s a good thing I’m not a pessimist because I have forebodings about this year’s federal election. I fear we’ll waste it on expressing our dissatisfaction and resentment rather than carefully choosing the major party likely to do the least-worst job of fixing our many problems.

Rather than doing some hard thinking, we’ll just release some negative emotion. We’ll kick against the pricks – in both senses of the word.

We face a choice between a weak leader in Anthony Albanese (someone who knows what needs to be done, but lacks the courage to do much of it) and Peter Dutton (someone who doesn’t care what needs to be done, but thinks he can use division to snaffle the top job).

By far the most important problem we face – the one that does most to threaten our future – is climate change. We’re reminded frequently of that truth – the terrible Los Angeles fires; last year being the world’s hottest on record – but the problem’s been with us for so long and is so hard to fix that we’re always tempted to put it aside while we focus on some lesser but newer irritant.

Such as? The cost of living. All the polling shows it’s the biggest thing on voters’ minds, with climate change – and our children’s future – running well behind.

Trouble is, kicking Albanese for being the man in charge during this worldwide development may give us some momentary satisfaction, but it will do nothing to ease the pain. Is Dutton proposing some measure that would provide immediate relief? Nope.

Why not? Because no such measure exists. There are flashy things you could do – another big tax cut, for instance – but they’d soon backfire, prompting the Reserve Bank to delay its plans to cut interest rates, or even push them a bit higher.

We risk acting like an upset kid, kicking out to show our frustration without thinking about whether that will help or hinder their cause.

Rather than finding someone to kick, voters need to understand what caused consumer prices to surge, and what “the authorities” – in this case, Reserve Bank governor Michele Bullock and the board, not Albanese – are doing to stop prices rising so rapidly.

The surge was caused by temporary global effects of the pandemic – which have since largely gone away – plus what proved to be the authorities’ excessive response to the pandemic, which is taking longer to fix.

It’s primarily the Reserve Bank that’s fixing the cost of living, and doing it the only way it knows: using higher mortgage interest rates to squeeze inflation out of the system. But doesn’t that hurt people with mortgages? You bet it does.

What many voters don’t seem to realise is that, by now, the pain they’re continuing to feel is coming not from the disease but the cure. Not from further big price rises but from their much higher mortgage payments.

So it’s the unelected central bank that will decide when the present cost-of-living pain is eased by lowering interest rates, not Albanese or Dutton. A protest vote on the cost of living will achieve little. Of course, if you think it would put the frighteners on governor Bullock, go right ahead. She doesn’t look easily frightened to me.

But there’s another point that voters should get. When people complain about the cost of living, they’re focusing on rising prices (including the price of a home loan). What matters, however, is not just what’s happening to the prices they pay, but what’s happening to the wages they use to do the paying.

When wages are rising as fast as prices – or usually, a little faster – most people have little trouble coping with the cost of living. But until last year, wages rose for several years at rates well below the rise in prices. Get it? What’s really causing people to feel cost-of-living pain is not so much continuing big price rises or even high mortgage payments, but several years of weak wage growth.

Why does this different way of joining the dots matter? Because, when it comes to wages, there is a big difference between Albanese and Dutton.

Since returning to government in 2022, Labor has consistently urged the Fair Work Commission to grant generous annual increases in the minimum award pay rates applying to the bottom fifth of wage earners.

This will have helped higher-paid workers negotiate bigger rises – as would Labor’s various changes to industrial relations law. Indeed, this is why wages last year returned to growing a fraction faster than prices.

These efforts to increase wage rates are in marked distinction to the actions of the former Coalition government. So kicking Albanese for presiding over a cost-of-living crisis risks returning to power the party of lower wages.

But here’s the trick: it also risks us taking a backward step on climate change. The party that isn’t trying hard enough could be replaced by a Coalition that wants to stop trying for another decade, while it thinks about switching from renewables to nuclear energy.

From the perspective of our children and grandchildren, the best election outcome would be a minority government dependent on the support of the pollies who do get the urgency of climate action: the Greens and teal independents.

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What's happened to the cost of living is trickier than you think

It’s been a year of wearying in the fight against inflation. But if you think you know what it all proves, you’re probably kidding yourself. The first mistake is to subject it to too much rational analysis.

While voters in Oz complain incessantly about “the cost of living”, the mug punters who put Donald Trump back in the White House were said to be on about “inflation”. Aren’t they the same thing? Well, maybe, maybe not.

A penny dropped for me when I heard some woman in America justify voting for Trump by saying that the prices went up and they never came back down. What? Since when does inflation go away because retail prices have come back down?

Well, only in economics textbooks. In the real world, inflation is the rate of increase in prices, and you fix it not by reducing the level of prices, but by reducing the rate at which they continue rising.

So what was that woman on about? Don’t ask an economist. Ask a psychologist, however, and they’ll tell you that the reason people give you for doing something – buying this house rather than that one; voting for Trump rather than Joe Biden – isn’t necessarily the real reason. Indeed, the person may not actually know why they jumped the way they did.

Their subconscious mind made a snap decision to favour A rather than B and then, when asked why, their conscious mind came up with a reason they thought would sound plausible. The woman’s subconscious may simply have liked the look of Trump rather than Biden. Or maybe a lot of the people she knew were voting for Trump, so she did too.

Biden and his supporters – plus many rational economists – couldn’t see why everyone was so upset about inflation. The rate of inflation had come back a long way, wages were growing solidly and all without unemployment worsening much. Pretty good job, I’d say. What’s the problem?

Ah, said the smarties, you don’t understand that people care far more about inflation than about unemployment. Inflation hits everyone, whereas unemployment affects only a few.

Is that what you think? If so, you’re probably too young to know what happens in a real recession. When unemployment is soaring and the evening news shows pictures of more workers getting the sack every night, believe me, the punters get terribly frightened they may lose their own job.

It’s a Top 40 effect. No matter how few tunes are selling, there’s always one that’s selling a fraction more copies than the others. That’s what’s topping the pops this week. If people aren’t worried about their jobs, they can afford to be worried about high prices. When they are worried about their jobs, they stop banging on about prices.

This means the managers of the economy – and the government of the day – are often in the gun. Whatever dimension of the economy, and people’s lives, isn’t travelling well at the time is what the punters will be complaining about.

But also, it’s worth remembering that whenever pollsters ask Aussies what’s worrying them, “the cost living” always rates highly – even at times when economists can’t see there’s a problem. Why? Ask a psychologist. It’s because retail prices have “salience” – they stick out in the minds of people who shop at the supermarket every week.

The one thing voters know is that prices keep rising. And they’ve never liked it. They don’t like it whether prices are rising by 2 per cent or 10 per cent – and the highly selective consumer price index they carry in their heads always tells them it’s nearer 10 per cent than 2.

Why? Salience. They remember every big price rise indelibly, but soon forget any falls in prices. And get this: in their mental CPI, all the prices that don’t change get a weighting of zero.

When Australian voters complain about the “cost of living” and American voters complain about “inflation”, are they talking about the same thing? Logically, they shouldn’t be, but actually, they are.

To a rational economist, determining what’s happening to the cost of living involves comparing what’s happening to prices on the one hand with what’s happening to wages and other income on the other. Strictly, the comparison should be with after-tax income.

But that’s not how voters in either country see it. They keep prices in one mental box, but wages in another. The pay rises they get are taken for granted as something they’ve earned by their own hard effort. But then, when I got to the supermarket, I discovered the cheating bastards had whacked up all their prices. I’ve been robbed!

Does this mean workers don’t mind if their take-home pay isn’t keeping with prices? Of course not. They feel the loss; they’re just confused about what’s causing it. I think that, for many people, what matters, and sticks in their mind, is how often they run out of money before their next payday.

My theory is that, because wages rose a bit faster than prices for so many years, many people have developed the unconscious habit of spending a little more each year. But when wages stop rising a little faster than prices – as they have done since March 2021 – people do feel it. They look around for someone to blame and the first thing they see is Woolies and Coles.

But there’s one factor causing pain that’s so well concealed that few people – even few economists – have noticed. One reason take-home pay has fallen well behind prices – a reason the unions and Labor thought was a great thing, and the Morrison government was too weak-kneed to stop – was the mandatory rises in employers’ contributions to their workers’ superannuation savings, which have lifted it from 9.5 per cent of your wage in 2021 to 11.5 per cent in July this year, and will take it to 12 per cent in July next year.

To the naked eye, it’s the employers who’re paying for this. But there’s strong evidence that the bosses reduce their ordinary pay rises to fit. If so, this will be a pain wage earners are feeling without knowing who to blame.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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How supermarkets get away with raising their prices

 By Millie Muroi, Economics Writer, October 4,2024 

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

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

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

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

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

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

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

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

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

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

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

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

Time-poor and lazy

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

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

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

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

Fluffy handcuffs

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

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

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

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

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What goes on in the Reserve Bank's mind

By MILLIE MUROI, Economics Writer

So far, the Reserve Bank is winning. Every time we’ve had a new inflation read or jobs data, the country has held its breath … and exhaled a sigh of relief. Things are a little tougher for a lot of people, and a lot harder for some. But inflation, our public enemy number one, is gradually slinking away, and a historically high bunch of us have jobs.

The Reserve Bank might not be high-fiving itself yet, but it’ll be cautiously relieved that things are going (mostly) the way it planned. As the bank gets closer to the finish line, though, the balancing act will get harder. The reserve has been laser-focused on shrinking inflation, which it has. But the labour market is weakening, and there’s a risk we won’t feel or see the full impact on jobs of keeping interest rates on hold until after we’ve gone too far.

What is “too far”? Well, it’s tricky to say, because there’s no exact number to guide us on how many job losses we’d be OK with. And because – until we’ve locked inflation well within the 2 to 3 per cent target range – a strong jobs market is also a sign the economy might be pushing too hard to keep up with demand, and therefore that inflation might be here for a bit longer.

As one of the country’s leading labour economists, Jeff Borland, has pointed out, while recent data points to the Reserve Bank’s success so far, there probably needs to be a turning point in the bank’s thinking soon if we’re to avoid a big round of lay-offs.

Underlying inflation, the measure the bank cares about – and which doesn’t count items with especially large price changes – fell to 3.4 per cent over the year to August. Gross domestic product (a measure of how many goods and services the economy is producing), while crawling along, is still growing. And at 4.1 per cent in August, the unemployment rate shows we’ve managed to hold on to a lot of the gains in our labour market.

Compared with the US, UK and Canada, Australia seems to be the Goldilocks country. Partly because of Australia’s responsiveness to interest rate changes (we have one of the highest shares of mortgage-holders on variable rate loans, which means interest rate changes are felt pretty much immediately), the central bank has been less aggressive in ramping up interest rates to curb inflation.

While the US Federal Reserve jacked up rates by 5.3 percentage points from 2022 to its peak, Australian interest rates rose only 4.3 per cent (that’s also lower than in Canada and the UK). Despite this, the increase in Australia’s inflation rate since the first interest rate rise hasn’t strayed far from its peers. In fact, the 2.7 percentage point increase in inflation since the first rate rise is a lot lower than in the UK, where inflation surged 4.8 percentage points from its first rise.

The downward journey in inflation has also been fairly even across the countries. From its peak, Australia’s inflation rate has fallen about 0.7 percentage points every quarter, the same as in Canada and only a touch slower than the 0.8 percentage points in the US. The UK, with a high inflation peak, has had the fastest decline at 1 percentage point every quarter.

Australia’s approach has also limited damage to the jobs market. While unemployment increased 1.6 percentage points in Canada since the first rate rise and 0.8 percentage points in the US, the UK and Australia have managed to keep the lift in unemployment to just 0.6 percentage points.

At the same time, Australia’s participation rate has climbed 0.7 percentage points – the highest of its peers – since unemployment started rising. The participation rate is the proportion of working-age people (those aged over 16) who either have a job – full-time or part-time – or are actively seeking one (we call all these people “the labour force”) in the wider working-age population.

All this, together with high inflation, signals to the Reserve Bank that the Australian economy is still “running hot” as the Reserve’s chief economist Sarah Hunter has put it.

We tend to focus on the rate at which the economy is growing rather than the level it is sitting at. That’s why, when we see weak figures such as 0.2 per cent GDP growth for the most recent quarter (and for the quarter before that, and the one before that), we hear warning bells ringing about recession: commonly defined as two back-to-back quarters of falling growth.

So, why isn’t the bank in a rush to ease up on interest rates?

For as long as employment is growing and unemployment has risen only a bit, the bank won’t be living in fear, as many of its critics are, that the economy could drop into recession at any moment.

While the movement in GDP and household consumption has been very weak, the levels they’re at are still high – especially when compared with how much production capacity we have in the economy.

A strong labour market (one where most people who want a job can find one), means there’s still a lot of demand from businesses for workers. Why? Because there’s strong demand for their goods or services, and they need people to help produce or provide them. In August, for example, the Australian economy added more than 47,000 jobs.

But there are some signs the labour market is weaker than the headlines might tell us.

Some of the additional jobs and additional hours worked are a result of a big boost in immigration and therefore our population. In August, our population grew by 50,000 – but this growth won’t last forever, especially with the government’s cap on international students.

A lot of the growth in hours has also been in industries such as education, healthcare and social assistance. As Borland points out, about 40 per cent of the extra hours worked in recent months were in these largely government-funded industries – which, once again, cannot last forever.

We also know businesses are likely to be hoarding workers (firms tend to cling onto their workers when the economy starts to slow, until the very last minute, because it can be a pain to rehire them), and that interest rates take up to 12 to 18 months to impact the economy, meaning we may be yet to see the full impact of our rate rises.

Until underlying inflation sits comfortably within the target zone, GDP turns negative, or the jobs market deteriorates more noticeably, the Reserve Bank won’t be in a rush to dust off its bias towards reining in inflation.

But we know job loss has life-altering and long-lasting consequences for those affected. For the bank to keep Australia on the “narrow path” and continue to kill it (its job, that is, not the economy), it might need to start shifting its focus towards keeping us all in our jobs.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Our economy has turned into a tortoise. The RBA will be pleased

By Millie Muroi, Economics Writer

Most of us know the age-old saying: slow and steady wins the race. Numbers released into the wild on Wednesday show the Australian economy is definitely a tortoise – but it should make the Reserve Bank pretty happy.

The national accounts – data gathered and shared every three months by the Australian Bureau of Statistics – gives us one of the most detailed pictures of how our economy has been tracking. The numbers always run slightly behind where we are because all the information has to be collected, crunched and spat out into a digestible clump. This week’s data drop was for the three months to June.

So, how did we go? There’s not much that should come as a surprise. Economists have long known the economy has been slowing. And most of the household data points to trends you’ve probably seen and lived yourself less spending, less disposable income and less of our income being put away for a rainy day.

Economic growth – or gross domestic product (GDP) – was weak, expanding 0.2 per cent in the June quarter for the third quarter in a row. But economic growth per person, which matters more when assessing our living standards, has tumbled … again. It fell 0.4 per cent – the sixth back-to-back quarter of shrinkage.

Will this worry our decision makers? Probably not. The focus is almost always on the total, not what’s happening on an individual level. It’s also much simpler to talk about GDP than GDP per capita – and much easier to fit in a headline!

The Reserve Bank, for one, won’t be worried by Wednesday’s figures. In fact, it’s probably quite happy. Why? Because its decisions are made at an aggregate level: it looks at the big picture, not the finer details.

There’s always a risk the bank will push the economy too far down the drain.

The bank’s forecasts for certain sections of the national accounts might have fallen on the wrong side of the fence: disposable income (how much people have to spend or save after taxes) for example, came in 0.3 per cent lower over the year, compared with the bank’s expectations for a 1.1 per cent increase.

But the Reserve Bank has one thing at the front of its mind: pushing inflation back into the 2 per cent to 3 per cent target range. In June, annual inflation was still sailing in at 3.8 per cent.

Sure, the bank also wants to keep Australians employed. But with the number of jobs still growing, and the unemployment rate (at least the headline measure) staying low by historical standards, it’s inflation that the bank is worried about.

As you know, inflation is determined by the balance – or imbalance – between demand and supply. There’s not much the Reserve Bank can do about supply (except shout from the sidelines about the importance of boosting productivity), so its focus is on demand.

From the bank’s perspective, it doesn’t matter where that demand comes from, or who exactly is doing the demanding. Its mission is to dampen demand when inflation is high, and give it a boost when inflation is low and the economy is slow.

There’s always a risk the bank will push the economy too far down the drain. We know GDP is only just managing to keep pace and the Reserve Bank has one tool – interest rates – which it’s not afraid of holding high until there’s a clearer sign it has inflation under its thumb.

After all, it doesn’t want inflation running high and finishing first, unless finishing means an end to high inflation.

For this to happen, the bank needs demand to slow down. That means less spending – at least until we figure out a way to pump out more goods and services with the limited people, machinery and materials we have.

It’s clear households are feeling more pressure. The proportion of households’ income that they were able to save dropped to 0.6 per cent in the June quarter, compared with 1.7 per cent at the same time last year. That’s despite households also cutting their spending.

Household consumption, at more than half of GDP, is the single biggest driver of economic growth. But with household spending down, it was government spending (which contributed 0.3 percentage points to growth) that helped keep the economy expanding. Investment spending on new homes, business equipment and building had no impact this time around, while net trade (the difference between exports and imports) contributed 0.2 percentage points, largely thanks to international students and all the spending they did in our economy.

Overall, there’s little in the national accounts to spook the Reserve Bank. Treasurer Jim Chalmers copped some heat this week for a tweak in his language when he said interest rates were “smashing” the economy. But Chalmers and the bank know that without a miracle or a slowing economy, it’s hard to see inflation being reined in anytime soon.

If anything, the national accounts show the economy is moving the way the bank wants. That means both an interest rate cut and rise are unlikely for the time being. The Reserve Bank doesn’t want the economy to stall, but it needs any increase in demand to run behind growth in supply, for inflation to come down.

Right now, our country is still running too hard down the shopping aisle for suppliers to keep up, meaning we’re putting upwards pressure on prices. That’s where the government needs to strike a fine balance. Spend too little and, as our figures showed, we could slip into recession. But spend too much and inflation could stick around for longer.

Anyone who runs knows it’s impossible to sprint all the time. Going slow is not always fun, but until we build up the stamina, muscle and skill, we have to make sure not to push ourselves too hard for too long in case we sustain an injury.

It’s a similar story for the economy. The demands we put on it have to grow alongside our ability to cater for them. The Reserve Bank is like a coach making tough calls because it thinks we’re pushing too hard.

Our economy is slowing, and it’s a fine balance to strike when jobs are on the line. But as long as we’re not running backwards, and with the jobs market so strong, the bank will be happy to stay the course with our tortoise economy.

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