Why it's doubtful we need another interest rate rise

There’s nothing the media likes more than an interest rate rise on Melbourne Cup day. It’s surprising how often it’s happened, and many in the financial markets have convinced themselves that’s what we’ll get next Tuesday. And the good news is that, despite the radical reform of moving to a mere eight board meetings a year, the Reserve Bank has ensured that meetings on cup day will continue.

What I’m not sure of is whether, if we do get a rate rise next week, it will be happening by accident or design. In central banking, getting your timing right is just as important as it is in a comedy routine.

It was no surprise last week when new Reserve Bank governor Michele Bullock used her first big speech to make sure everyone noticed her bulging anti-inflation muscles. “There are risks that could see inflation return to target more slowly than currently forecast,” she warned.

“The board will not hesitate to raise the cash rate further if there is a material upward revision to the outlook for inflation,” she said. She added some qualifications but, predictably, neither the markets nor the media took much notice of them.

Any new governor would have said the same in their first speech. Trouble is, her tough statement about not being willing to return to the 2 to 3 per cent inflation target “more slowly than currently forecast” came just the day before publication of the consumer price index for the September quarter.

And while it showed the annual rate of inflation continuing to fall from its peak of 7.8 per cent at the end of last year to 5.4 per cent nine months later, it also showed the quarterly inflation figure rising from 0.8 per cent to 1.2 per cent.

This was 0.2 percentage points or so higher than the markets – and, they calculate, the Reserve – were expecting. Bingo! Rate rise a dead cert. All the big four banks are laying their bets accordingly.

But the main reason for the slightly higher number was a rise in petrol prices, which contributed 0.25 percentage points of the 1.2 per cent. This rise comes from insufficient supply: the higher world price of oil, forced up the OPEC oil cartel and others trying to increase the price by restricting their supply.

It does not come from excessive Australian demand – which is the one factor the Reserve can moderate by increasing interest rates. Similarly, the next-biggest price increases, for newly-built homes (imported building materials), rents (surge in immigration) and electricity (Ukraine war) aren’t caused by anything a rate rise can fix.

So I think the case for yet another rate rise is weak. As Bullock clearly demonstrated elsewhere in her speech, the Reserve’s single, crude instrument, raising interest rates, delivers most of its punishment to the quarter or so of households with big mortgages.

Too many of these people are really hurting, and the full hurt from rate rises already made has yet to be felt. The economy is slowing, consumer spending is hardly growing, real income per person is falling.

And, as Treasury secretary Dr Steven Kennedy noted in a speech last week, last financial year’s budget surplus of $22 billion shows the budget’s “automatic stabilisers” are working hard to help the Reserve restrain demand – a truth that’s been completely missing from the Reserve’s commentary. That’s gratitude for you.

But if, having thought hard about such a small change to the “outlook for inflation”, Bullock decides a further rate rise isn’t warranted, what are the money market punters (and I do mean people making bets) going to think, considering all her chest-beating? That she speaks big but carries a soft stick?

There are a few things she – and her urgers in the financial markets (most of whom have never in their lives had reason to worry about the cost of living) – need to remember.

First, at this late stage in the game, we really are into fine-tuning. And acting because a revised forecast means we’ll return to target later than we had expected suggests you’ve forgotten what every governor needs always to remember: as with all economists, the Reserve’s forecasts are more likely to be wrong than right.

They can be wrong by a lot or wrong by a little. Worst, they can prove too optimistic or too pessimistic. If your previous forecast was wrong, what makes you so sure your next one will be right? When it comes to forecasts, the person making the actual decisions needs to be the biggest sceptic.

Second, the Reserve’s previous forecast was for inflation to be back to the top of the target range by the first half of 2025. If its latest forecast pushes that out to the second half, what’s so terrible about that? How much extra pain for young people with huge mortgages does that justify?

Ah, says the Reserve, the reason we can’t wait too long to get inflation back to target is that, the longer we leave it, the greater the risk that business’ and workers’ expected rate of inflation rises above the target range.

If that happened, we’d need much higher interest rates and much more pain to get expectations back down to the only range we’ve decided is acceptable.

This is true in principle but, in practice, it’s mere speculation. The fact is, the world’s central bankers have no hard evidence on how long it takes for inflation expectations to adjust – a few years or a few decades.

I’m old enough to remember that when inflation returned, in the late-1960s and early-’70s, it took a decade or two for expectations to adjust. The smarties used to advise youngsters to borrow as much as anyone would lend them. Why? Because real interest rates were negative.

But when a decade or two of tough inflation fighting eventually got expectations down to what became the target range, after the recession of the early ’90s, they’ve shown zero sign of moving for 30 years. Not even during the present inflation surge.

So when nervous-nelly governors decide to err on the safe side, they’re deciding to beat young home buyers even further into the ground. Either sell your house or starve your kids.

Finally, in her answers to questions last week, Bullock implied that the risk of rising inflation expectations was now so great that the Reserve could no longer afford the nicety of distinguishing between supply-side shocks and price rises driven by excessive demand.

Whatever the cause, continuing delay in getting inflation back to target presented such a threat to expectations that rates would have to keep rising regardless.

This means that if our return to target is delayed by supply-side problems – mismatches in the transition to renewable energy, leaps in meat and veg prices caused by extreme weather, or higher oil prices caused by worsening conflict in the Middle East – the home buyers cop it.

In this era of continuing supply shocks, failure to distinguish between the causes of price rises would be a recipe for deep recession. The Reserve’s professed “dual mandate” – full employment – would be out the window.

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Jury still out on how much hip pocket pain still coming our way

It’s not yet clear whether the Reserve Bank’s efforts to limit inflation will end up pushing the economy into recession. But it is clear that workers and their households will continue having to pay the price for problems they didn’t cause.

Prime Minister Anthony Albanese didn’t cause them either. But he and his government are likely to cop much voter anger should the squeeze on households’ incomes reach the point where many workers lose their jobs.

And he’ll have contributed to his fate should he continue with his apparent intention to leave the stage-three income tax cuts in their present, grossly unfair form.

The good news is that we’re due to get huge hip pocket relief via the tax cuts due next July. The bad news is that the savings will be small for most workers, but huge – $170 a week – for high-income earners who’ve suffered little from the squeeze on living costs.

Should Albanese fail to rejig the tax cuts to make them fairer, you can bet Peter Dutton will be the first to point this out. But he’ll need to be quick to beat the Greens to saying it.

Those possibilities are for next year, however. What we learnt this week is how the economy fared over the three months to the end of June. The Australian Bureau of Statistics’ “national accounts” show it continuing just to limp along.

Real gross domestic product – the value of the nation’s production of goods and services – grew by only 0.4 per cent – the same as it grew in the previous, March quarter. Looking back, this means annual growth slowed from 2.4 per cent to 2.1 per cent.

If you know that annual growth usually averages about 2.5 per cent, that doesn’t sound too bad. But if you take a more up-to-date view, the economy’s been growing at an annualised (made annual) rate of about 1.6 per cent for the past six months. That’s just limping along.

And it’s not as good as it looks. More than all the 0.4 per cent growth in GDP during the June quarter was explained by the 0.7 per cent growth in the population as immigration recovers.

So when you allow for population growth, you find that GDP per person actually fell by 0.3 per cent. The same was true in the previous quarter – hence all the people saying we’re suffering a “per capita recession”.

As my colleague Shane Wright so aptly puts it, the economic pie is still growing but, with more people to share it, the slices are thinner.

It’s possible that continuing population growth will stop GDP from actually contracting, helping conceal from the headline writers how tough so many households are faring.

But the media’s notion that we’re not in recession unless GDP falls for two quarters in a row has always been silly. What makes recessions such terrible things is not what happens to GDP, but what happens to workers’ jobs.

It’s when unemployment starts shooting up – because workers are being laid off and because young people finishing their education can’t find their first proper job – that you know you’re in recession.

In the month of July, the rate of unemployment ticked up from 3.5 per cent to 3.7 per cent, leaving an extra 35,000 people out of a job. If we see a lot more of that, there will be no doubt we’re in recession.

But why has the economy’s growth become so weak? Because households account for about half the total spending in the economy, and they’ve slashed how much they spend.

Although consumer spending grew by 0.8 per cent in the September quarter of last year, in each of the following two quarters it grew by just 0.3 per cent, and in the June quarter it slowed to a mere 0.1 per cent.

Households’ disposable (after-tax) income rose by 1.1 per during the latest quarter but, after allowing for inflation, it actually fell by 0.2 per cent – by no means the first quarter it’s done so.

What’s more, it fell even though more people were working more hours than ever before. People worked 6.8 per cent more hours than a year earlier.

So why did real disposable income fall? Because consumer prices rose faster than wage rates did. Over the year to June, prices rose by 6 per cent, whereas wage rates rose by 3.6 per cent.

Understandably, people make a big fuss over the way households with big mortgages have been squeezed by the huge rise in interest rates. But they say a lot less about the way those same households plus the far greater number of working households without mortgages have been squeezed a second way: by their wage rates failing to rise in line with prices.​

This is why I say the nation’s households are paying the price for fixing an inflation problem they didn’t cause. It’s the nation’s businesses that put up their prices by a lot more than they’ve been prepared to raise their wage rates.

Businesses have acted to protect their profits and – in more than a few cases – actually increase their rate of profitability. In the process, they risk maiming the golden geese (aka customers) that lay the golden eggs they so greatly covet.

If you think that’s unfair, you’re right – it is. But that’s the way governments and central banks have long gone about controlling inflation once it’s got away. It was easier for them to justify in the olden days – late last century – when it was often the unions that caused the problem by extracting excessive wage rises.

But those days are long gone. These days, evidence is accumulating that the underlying problem is the increased pricing power so many of our big businesses have acquired as they’ve been allowed to take over their competitors and prevent new businesses from entering their industry.

The name Qantas springs to mind for some reason, but I’m sure I could think of others.

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Hate rising prices? Please blame supply and demand, not me

Have you noticed how, to many economists, everything gets back to the interaction of supply and demand? Understand this simple truth and you know all you need to know. Except that you don’t. It leaves much to be explained.

Why has the cost of living suddenly got much worse? Because the demand for goods and services has been growing faster than the economy’s ability to supply those goods and services, causing businesses to put their prices up.

Since there is little governments can do to increase supply in the short term, the answer is to use higher interest rates to discourage spending. Weaker demand will make businesses much less keen to keep raising their prices. If you hit demand really hard, you may even oblige businesses to lower their prices a little.

But, as someone observed to me recently, saying that everything in the economy is explained by supply and demand is a bit like saying every plane crash is explained by gravity. It’s perfectly true, but it doesn’t actually tell you much.

Consider this. After rising only modestly for about a decade, rents are now shooting up. Why? Well, some people will tell you it’s because almost half of all rental accommodation has been bought by mum and dad investors using borrowed money (“negative gearing” and all that).

The sharp rise in interest rates over the past year or so has left many property investors badly out of pocket, so they’ve whacked up the rent they’re charging.

Ah no, say many economists (including a departing central bank governor), that’s not the reason. With vacancy rates unusually low, it means that the demand for places to rent is very close to the supply available, and landlords are taking advantage of this to put up their prices.

So, what’s it to be? I think it’s some combination of the two. Had the vacancy rate been high, mortgaged landlords would have felt the pain of higher interest rates but been much less game to whack up the rent for fear of losing their tenants.

But, by the same token, it’s likely that the coincidence of a tight housing market with a rise in interest rates has made the rise in rents faster and bigger than it would have been. It would be interesting to know whether landlords with no debt have increased their prices as fast and as far as indebted landlords have.

The point is that knowing how the demand and supply mechanism works doesn’t tell you much. It doesn’t allow you to predict what will happen to either supply or demand, nor tell you why they’ve moved as they have.

It’s mainly useful for what economists call “ex-post rationalisation” – aka the wisdom of hindsight.

Economic theory assumes that all businesses – including landlords – are “profit-maximising”. But in their landmark book, Radical Uncertainty, leading British economists John Kay and Mervyn King make the heretical point that, in practice rather than in textbooks, firms don’t maximise their profits.

Why not? Well, not because they wouldn’t like to, but because they don’t know how to. There is a “price point” that would maximise their profits, but they don’t know what it is.

To economists, when you’re just selling widgets, it’s a matter of finding the right combination of “p” (the price charged) and “q” (the quantity demanded). Raising p should increase your profit – but only if what you gain from the higher p is greater than what you lose from the reduction in q as some customers refuse to pay the higher price.

What you need to know to get the best combination of p and q is “the price elasticity of demand” – the customers’ sensitivity to changes in price. In textbooks or mathematical models, the elasticity is either assumed or estimated via some empirical study conducted in America 30 years ago.

In real life, you just don’t know, so you feel your way gently, always standing ready to start discounting the price if you realise you’ve gone too far. And the judgments you make end up being influenced by the way you feel, the way your fellow traders feel, what you think the customers are feeling and how they’d react to a price rise.

How flesh-and-blood people behave in real markets is affected by mood, emotion, sentiment, norms of socially acceptable behaviour and other herding behaviour – all the factors that economists knowingly exclude from their models and know little about.

Keynes called all this “animal spirits”. Youngsters would call it “the vibe of the thing”. It’s psychology, not economics. And it’s because conventional economics attempts to predict what will happen in the economy without taking account of airy-fairy psychology that economists’ forecasts are so often wrong.

They may know more about how the economy works than the rest of us, but there’s still a lot they don’t know. Worse, many of them don’t think they need to know it.

It’s clear to me that psychology has played a big part in the great post-pandemic price surge. It didn’t cause it, but it certainly caused it to be bigger than it might have been.

The pandemic’s temporary disruptions to supply and the Ukraine war’s disruption to fossil fuels and food supply provided a cast-iron justification for big price rises, and it was a simple matter for businesses to add a bit extra for the shareholders.

It was clear to the media that big price rises were on the way, so they went overboard holding a microphone in front of every industry lobbyist willing to make blood-curdling predictions about price rises on the way. (I’m still waiting to see the ABC’s prediction of the price of coffee rising to $8 a cup.)

Thus did recognition that the time for margin-fattening had arrived spread from the big oligopolists to every corner store. One factor that constrains the prices of small retailers is push-back from customers – both verbal and by foot.

All the media’s fuss about imminent price rises softened up customers and told the nation’s shopkeepers there would be little push-back to worry about.

In the home rental market, dominated as it is by amateur small investors, who rightly worry about losing a tenant and having their property unoccupied for more than a week or two, it’s the commission-motivated estate agents who know when’s the right time to urge landlords to raise the rent, and how big an increase they can be confident of getting away with. 

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Why you should and shouldn't believe what you're told about inflation

If you don’t believe prices have risen as little as the official figures say, I have good news and bad. The good news is that most Australians agree with you. The bad news is that, with two important qualifications, you’re wrong.

Last week the officials – the Australian Bureau of Statistics – reminded us of a truth that economists and the media usually gloss over: the rate of inflation, as measured by the consumer price index, can be an unreliable guide to the cost of living. Especially now.

But first, many people who go to the supermarket every week are convinced they know from personal experience that prices are rising faster than the CPI claims. Wrong. Your recollection of the price rises you’ve noticed at the supermarket recently is an utterly unreliable guide to what’s been happening to consumer prices generally.

For a start, only some fraction of the things households buy are sold in supermarkets. The CPI is a basket of the manifold goods and services we buy – some weekly, some rarely.

Apart from groceries, the basket includes the prices of clothing and footwear, furnishings, household equipment and services, healthcare, housing, electricity and gas, cars, petrol and public transport, internet fees and subscriptions, recreational equipment and admission fees, local and overseas holidays, school fees, insurance premiums and much more.

But the main reason no one’s capable of forming an accurate impression of how much prices have risen is our selective memories. Have you noticed that no one ever thinks prices have risen by less than the CPI says?

That’s because we remember the big price rises we’ve seen – they’re “salient”, as psychologists say; they stick out – but quickly forget the prices that have fallen a bit. Nor do we take much notice of prices that don’t change. We don’t, but the statisticians do – as they should to get an accurate measure of the rise in the total cost of all the stuff in the basket.

Sometimes the price of the latest model of a car or appliance has risen partly because it now does more tricks. Because they’re trying to measure “pure” price increases, the statisticians will exclude the cost of this “quality increase”.

My son, who watches his pennies, was sure the eggheads in Canberra wouldn’t have noticed “shrinkflation” – reducing the contents of packets without changing the price. No. This trick’s intended to fool the unwary punter; it doesn’t fool the statisticians. It counts as a price rise.

But now for the two reasons the CPI can indeed be misleading. The first is that averages can conceal as much as they reveal. Remember the joke about the statistician who, with his head in the oven and his feet in the fridge, said he was feeling quite comfortable on average.

The most recent news that, according to the CPI, prices rose by 0.8 per cent in the three months to the end of June, and 6 per cent over the year to June, was an average of all the households – young, middle-aged and old; smokers and non-smokers, drinkers and teetotallers, no kids and lots, renters, home buyers and outright owners – living in the eight capital cities.

Now note this. Economists, politicians and the media tend to treat the CPI and the “cost of living” as synonymous. But if you read the fine print, the bureau says that, while the CPI is a reasonably accurate measure of the prices of the goods and services in its metaphorical basket, it’s not, repeat not, a measure of anyone’s cost of living.

Why not? Partly because it does too much averaging of households in very different circumstances, but mainly because of the strange – and, frankly, misleading – way it measures the housing costs of people with mortgages.

The cost of being a home buyer is the interest component of your monthly payments on your mortgage.

But that’s not the way the CPI measures the cost of home buying. Rather, it’s measured as the price of a newly built house or unit. Which makes little sense. Many people with mortgages haven’t bought a new home.

And even those people who did buy a newly built home, did so some years ago when house prices were lower than they are now.

The bureau changed to this strange arrangement a couple of decades ago. Why? Because the Reserve Bank pressured it to. Why? Well, as you well know, the Reserve uses its manipulation of interest rates to try to keep the annual rate at which prices are rising, as measured by the CPI, between 2 and 3 per cent on average.

But, after it had adopted that target in the mid-1990s, it decided that it didn’t want the “instrument” it was using to influence prices – interest rates – to be included in the measure of prices it was targeting, the CPI.

So, the bureau – unlike other national statistical agencies – switched to measuring home buyers’ housing costs in that strange way. And the bureau began publishing, in addition to the CPI, various “living cost indexes” for “selected household types”.

The main difference between these indexes and the CPI is that home buyers’ housing cost is measured as the interest they’re paying on their loans, not the cost of a newly built house. But, of course, different types of households will have differing collections of goods and services in the basket of things they typically buy.

So, whereas the CPI tells us that prices rose by 6 per cent over the year to the end of June, the living cost indexes show rises varying between 6.3 per cent and 9.6 per cent.

Among the four selected household types (which between them cover about 90 per cent of all households), the type with the highest price rises was the employees, whose costs rose by 9.6 per cent overall.

That’s mainly because most of the people with mortgages would be is this category. Mortgage interest charges rose by 9.8 per cent in the quarter and (hang onto your hat) by 91.6 per cent over the year.

At the other end of the spectrum, supposedly “self-funded retirees” had the lowest living-cost increase of 6.3 per cent – mainly because almost all of them would own their homes outright.

Then come age pensioners, with cost rises of 6.7 per cent – few with mortgages, but some poor sods renting privately.

And finally, “other government transfer recipients” - those of working age, including people on unemployment benefits, on the disability pension and some students. They’re costs are up 7.3 per cent. Some of these would have mortgages, most would have seen big rent rises.

What this proves is that using interest rates to control prices makes the cost of living worse before making it better.

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Don't miss the good news among the bad: we've hit jobs, jobs, jobs

Here is the news: not everything in the economy is going to hell. Right now, jobs, jobs, jobs are going great, great, great.

The news media (and yours truly) focus on whatever’s going wrong – the cost of living, interest rates, to take two minor examples – because they know that’s what interests their paying customers most.

This bias in our thinking exists because humans have evolved to be continually on the lookout for threats. Those threats used to be wild animals, poisonous berries and the rival tribe over the river, but these days they come more in the form of politicians who aren’t doing their job and business people on the make.

If you’re not careful, however, the preoccupation with bad news can leave you with a jaundiced view of the total picture. Everything’s bad and nothing’s good.

But it’s rare for anything to be all bad or all good. And, particularly where the economy’s concerned, it’s common for good things and bad things to go together.

For instance, when unemployment is high, inflation is usually low. And when inflation is high, unemployment’s usually low. (It’s in the rare event where they’re both high at the same time – “stagflation” – that you know we’re really in trouble.)

So, when our present Public Enemy No. 1 – Reserve Bank governor Dr Philip Lowe – began a speech last week by making this point, I realised I should make sure that you, gentle reader, hadn’t missed the rose among all the thorns.

Lowe said the high inflation we’re experiencing was “one of the legacies of the pandemic and of Russia’s invasion of Ukraine”. But “another remarkable, but less remarked upon, legacy of the pandemic is the significant improvement in Australia’s labour market”.

“Significant improvement” is putting it mildly. Have you heard of “full employment”, where everyone who wants a job has one? It’s the way our economy used to be for about three decades following World War II.

But you have to be as ancient as me to remember what it was like. One reason I quit my job and embarked on a course that eventually led me to this august organ was the knowledge that, should I need to get a job, all I had to do was wait until next Saturday’s classified job ads, and pick the one I wanted.

That’s full employment. And the world hasn’t been like that since Gough Whitlam was prime minister. Until now. We have more people with jobs than ever in our history.

At about 3.5 per cent, the rate of unemployment is lower than at any time since 1974. And before any of the imagined experts let fly on Twitter, this is not because any government, Labor or Liberal, has fiddled the figures.

What’s true is that, in recent decades, more people have been under-employed – they haven’t been able to get as many hours of work as they’ve needed.

But as Lowe says, in recent times, people have found it easier to obtain more hours of work. So the rate of underemployment is at multi-decade lows, and the proportion of jobs that are full-time is higher than it’s been in ages.

We now have 64 per cent of people of working-age actually in a job, the highest ever. The proportion of people either already in a job or actively seeking one – the “participation rate” - is also at its highest.

A lot of this is explained by the record high in women’s participation in the labour force.

Lowe says the rate of participation by young people is “the highest it has been in a long time” and the youth unemployment rate is “the lowest that it has been in many decades”.

If all that’s not worth celebrating, I don’t know what is.

But for all those desperate to find a negative – often for reasons of partisanship – it’s not that you can’t believe the figures. It’s this: can you believe they’ll continue?

With the Reserve raising interest rates so fast and far to slow the economy’s growth and reduce inflation pressure, it’s clear that this is as good as it gets in the present episode.

For the past couple of months, we’ve seen the figures edging back a fraction from their best, and on Thursday we’ll see if that’s yet become a trend.

At present, Lowe is at the controls bringing the economic plane in to land. He’s aiming for a soft landing, but may miscalculate and give us a bumpy landing which, to mangle the metaphor, will send unemployment shooting up.

If so, we may have had just a fleeting glimpse of full-employment nirvana before it disappeared into the mist.

But for the more optimistically inclined, even if the landing is harder than planned, we’ll have started from a much lower unemployment rate than in past recessions, meaning it won’t go as high as it has before, and it should be easier to get back to the low levels we’d now like to become accustomed to.

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How about sharing the economic pain arround?

If you don’t like what’s happening to interest rates, remember that although the managers of the economy have to do something to reduce inflation, it’s not a case of what former British prime minister Maggie Thatcher called TINA – there is no alternative.

As Reserve Bank governor Dr Philip Lowe acknowledged during his appearance before the House of Representatives Standing Committee on Economics last week, there are other ways of stabilising the strength of demand (spending) and avoiding either high inflation or high unemployment, which are worth considering for next time.

So, relying primarily on “monetary policy” – manipulating interest rates – is just a policy choice we and the other advanced economies made in the late 1970s and early 1980s, after the arrival of “stagflation” – high unemployment and high inflation at the same time – caused economists to lose faith in the old way of smoothing demand, which was to rely primarily on “fiscal policy” – manipulation of taxation and government spending in the budget.

The economic managers have a choice between those two “instruments” or tools with which smooth demand. The different policy tools have differing sets of strengths and weaknesses.

Whereas back then we were very aware of the weaknesses of fiscal policy, today we’re aware of the weaknesses of monetary policy, particularly the way it puts a lot more pain on people with home loans than on the rest of us. How’s that fair?

Lowe says the conventional wisdom is to use monetary policy for “cyclical” (short-term) problems and fiscal policy for “structural” (lasting) problems, such as limiting government debt.

But it’s time to review what economists call “the assignment of instruments” – which tool is better for which job. The more so because the government has commissioned a review of the Reserve Bank’s performance for the first time since we moved to monetary policy dominance.

It’s worth remembering that the change of regime was made at a time when Thatcher and other rich-country leaders were under the influence of the US economist Milton Friedman and his “monetarism”, which held that inflation was “always and everywhere a monetary phenomenon” and could be controlled by limiting the growth in the supply of money.

It took some years of failure before governments and central banks realised both ideas were wrong. They switched back to the older and less exciting notion that increasing interest rates, by reducing demand, would eventually reduce inflation. There was no magic, painless way to do it.

Macroeconomists long ago recognised that using policy tools to manage demand was subject to three significant delays (“lags”). First there’s the “recognition lag” – the time it takes the econocrats and their bosses to realise there’s a problem and decide to act.

Then there’s the “implementation lag” – the delay while the policy change is put into effect. Lowe described the cumbersome process of cabinet deciding what changes to make to what taxes or spending programs. Then getting them passed by both houses, then waiting a few weeks or months for the bureaucrats to get organised before start day.

He compared this unfavourably with monetary policy’s super-short implementation delay: the Reserve Bank board meets every month and decides what change to make to the official interest rate, which takes immediate effect.

He’s right. While the two policy tools would have the same recognition lag, monetary policy wins hands down on implementation lag.

But on the third delay, the “response lag” – the time it takes for the measure, once begun, to work its way through the economy and have the desired effect on demand – monetary policy is subject to “long and variable lags”.

Lowe said it took interest rate changes 18 months to two years to have their full effect. But I say most budgetary changes – particularly tax changes – wouldn’t take nearly that long. So, that’s a win for fiscal.

The sad truth is that measures to strengthen demand by cutting interest rates, or cutting taxes and increasing government spending, are always popular with voters, whereas measures to weaken demand by raising interest rates, or raising taxes and cutting government spending, are always unpopular.

This meant politicians were always reluctant to increase interest rates when they needed to, Lowe said. This is a good argument for giving the job to the econocrats at the central bank and making them independent of the elected government.

This became standard practice in the rich economies, although we didn’t formalise it until the arrival of the Howard government in 1996. Lowe advanced this as a good reason to stick with monetary policy as the dominant tool for short-term stabilisation of demand.

Against that, using monetary policy to get to the rest of us indirectly via enormous pressure on the third of households with mortgages shares the burden in a way that’s arbitrary and unfair.

What’s more, it’s not very effective. Because such a small proportion of the population is directly affected, the increase in interest rates has to be that much bigger to achieve the desired restraint in overall consumer spending.

But if the economic managers used a temporary percentage increase in income tax, or the GST, to discourage spending, this would directly affect almost all households. It would be fairer and more effective because the increase could be much smaller.

Various more thoughtful economists – including Dr Nicholas Gruen and Professor Ross Garnaut – have proposed such a tool, which could be established by legislation and thus be quickly activated whenever needed.

A special body could be set up to make these decisions independent of the elected government. Ideally, it would also have control over interest rates, so one institution was making sure the two instruments were working together, not at cross purposes.

Another possibility is Keynes’ idea of using a temporary rate of compulsory saving – collected by the tax office – to reduce spending when required, without imposing any lasting cost on households.

They say if it ain’t broke, don’t fix it. It’s obvious now that macroeconomic management needs a lot of fixing.

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