We’re relying on a government that spurns economic advice

I’m starting to wonder if the trouble with our politicians is that they’ve evolved to do politics but not economics, making them unfit to cope with the economic threats we now face.

On the one hand, they’ve been able to leave the management of the economy to the independent Reserve Bank, whose tinkering with interest rates – up a bit, down a bit – has successfully kept the economy growing for 28 years.

On the other hand, the pollies have been locked in a decade of unprecedented political instability where, since the demise of the Howard government in 2007, no prime minister has been safe from attack – from their own side.

In such an environment, with monetary policy (interest rates) so successfully managing the economy, the budget ceases to be “fiscal policy” and becomes just an instrument of politics.

Because you’re eternally looking over your shoulder trying to spot the next colleague holding a dagger behind his back, you use the budget primarily to shore up your support within the party, rewarding the base and punishing its designated enemies.

Be slavish in feeding the 24-hour news cycle. Keep up the pressure for ministers and their departments to provide a continuous flow of minor “announceables”. Remember, any vacuum you leave will be filled by your enemies (external or internal). If you run out announceables, just slag off your (official) opponents.

Of course, if the punters understood what you were up to, they wouldn’t be impressed. So when you’re trying to shore up the support of big business by cutting the rate of company tax, you keep claiming it’s a “plan for jobs and growth”.

When you’re using an income tax tax cut to buy some popularity at the election, you pretend that economic growth is driven by lower taxes.

The worst of it is, since the things your side really cares about – cutting taxes, preserving tax breaks favouring high income-earners, cracking down on the leaners and loafers on social welfare – are economic measures, you convince yourself you’re really into economics.

And running a budget surplus – that’s economic isn’t it? (No, not when your forecasts of a strong economy have proved way too optimistic and you’re counting on a freak improvement in iron ore prices to get you over the line. Then, it becomes an indulgent stretch for political kudos.)

You don’t actually know enough economics to realise economics is about rolling back rent-seeking and increasing the efficiency with which resources are allocated, at the micro level, and managing the economy through the ups and downs of the business cycle, at the macro level. All the rest is politics.

We’ve come to expect that if the person taking the treasurer’s job doesn’t know much about economics, Treasury will give them a crash course and get ’em up to speed. But former senior Treasury officer Paul Tilley’s new book, Changing Fortunes, leads me to think this no longer happens.

These days, treasurers are so preoccupied by the daily battle for political survival they have little time or interest in economics tutorials. Treasury has got out of the habit of giving the treasurer any advice his staff doubts he’d want to hear. Treasury’s job is largely to supply facts and figures when demanded by the treasurer’s staff.

In which case, you have to worry about how much professional rigour goes into producing the budget forecasts. How much they’re designed to avoid giving the treasurer news he doesn’t want to hear.

The Reserve Bank’s latest forecasts for wage growth are laughing at the optimistic forecasts of the budget in April. Where the budget has wages growing by 3.25 per cent a year by June 2021, the Reserve has the growth rate rising only a fraction to 2.4 per cent.

But here’s the surprising thing. Despite the central importance of wages in driving consumer spending and overall economic growth, the Reserve’s year-average forecasts for real GDP differ little from those in the budget.

I find this suspicious. And worrying. If the central bank feels constrained by the forecasts of a Treasury anxious to avoid displeasing its political masters, we’ve got a problem.

Last week, while worries about how much damage Trump’s trade war might do to the world economy were causing share markets to plunge, Treasurer Josh Frydenberg – who was 20 at the time of our last big recession – emerged from his bunker to assure us the government would “take the necessary actions to ensure our economy continues to grow”.

Great. But who’ll be advising him on which actions are necessary? The young punks in his office?

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Despite the photo-op, RBA knows we need fiscal stimulus

Never fear, Reserve Bank governor Dr Philip Lowe may have stumbled on the optics of agreeing to a photo-op with Treasurer Josh Frydenberg the other week, but the Reserve’s independence remains intact and our weak economy remains in need of budgetary stimulus.

Politicians have damaged our trust so badly that they like having respected econocrats appearing beside them to bolster their credibility. But central bank governors who wish to preserve the authority of their office don’t oblige, just as Lowe’s predecessor, Glenn Stevens, declined to be used as a prop by Kevin Rudd.

That’s the trouble, of course. There’s nothing wrong with treasurers and governors having private meetings – the more the better – but once the media are invited in the pollies will always be playing their own game, and it’s always one that puts their political standing ahead of the economy’s interests.

I suspect the message Frydenberg wanted to convey to viewers was that the economy was going fine and he had no intention of allowing fiscal stimulus to jeopardise the budget’s predicted and glorious return to surplus, which would make his name as a treasurer.

He and his Treasury officers had spent two hours explaining this to Lowe, and Lowe had accepted their arguments.

I very much doubt that’s what really happened. Nor do I except the media interpretation that, pressured by Frydenberg, Lowe went on to repudiate all he’d been saying about the economy’s weakness and why he’d needed to cut the official interest rate two months in a row.

Why then did Lowe say “I agree 100 per cent with you [Frydenberg] that the Australian economy is growing and the fundamentals are strong”?

Well, for a start, no one denies that the economy is still growing. And “the fundamentals” is such a vague concept it could be taken to mean lots of things. Presumably, Lowe doesn’t include wages among the fundamentals, because annual growth of 2.3 per cent is not what I’d call strong.

I think all he was trying to say was that he was confident we aren’t heading into recession.

But there’s a deeper point to understand: central bankers see it as an important part of their job to exude calm and confidence. No matter how worried they are, they take pride in never showing it.

They’re like a duck: moving serenely above the water, paddling furiously underneath. Lowe has spoken several times recently about the need to preserve stability and confidence.

So never hold your breath waiting for a Reserve governor, Treasury secretary or, let’s hope, treasurer  to be the first to warn that recession is possible. They’ll be the last to admit it.

Like Paul Keating on the day he tried to conceal his failure by bulldusting about “the recession we had to have”, they don’t use the R word until the figures make it impossible to deny.

And that is just as it should be. Why? Because – particularly when it’s negative, and when sentiment is wavering – what they say has too much influence over what the rest of us think and do. Too much risk of their prophesies becoming self-fulfilling.

That’s why, as a mere media commentator, it’s my job to be brutally frank, and theirs to be circumspect.

And that’s why it’s wrong to claim Lowe has suddenly changed his tune about the economy’s prospects. Those who think otherwise are like the people in the famous psych experiment who were so busy counting points in a basketball match they didn’t notice a gorilla run across the court.

In his announcement of the second rate cut – as in almost all his recent public utterances – Lowe insisted that “the central scenario for the Australian economy remains reasonable, with growth around trend expected”.

The significant change has been the Reserve’s revised judgement that the “non-accelerating-inflation rate of unemployment” has fallen from about 5 per cent to 4.5 per cent or lower. Lowe has used this as his justification for cutting interest rates.

“Today’s decision to lower the cash rate will help make further inroads into the spare capacity in the economy” and “will assist with faster progress in reducing unemployment . . .”, he said in the announcement.

It’s a lovely thought, but I fear the immediate challenge is not to get unemployment lower, but to stop it continuing to rise. And the latter risk fits better with Lowe’s repeated calls for more help from the budget – for it to be pointing in the same direction as monetary policy (interest rates), not the opposite direction, as at present.

Frydenberg’s photo-op made it clear his answer is no. Perhaps at their next two-hour meeting Lowe should explain to him how the budget’s “automatic stabilisers” work, and may well wash away his promised budget surplus.

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Poor Josh Frydenberg: on the wrong tram, heading for trouble

It’s not my policy to feel sorry for any politician – they’re all hugely ambitious volunteers – but I do feel sympathy for Treasurer Josh Frydenberg. He’s not the first treasurer to be strong on party dogma but light on economic understanding, but he’s among the first to be heading into stormy weather light on expert advice from a confident and competent Treasury.

There he was, thinking his first budget would be his last, primping up a pre-election budget that claimed to have fixed the economy and delivered on deficit and debt when that was all in the future and built on nothing more than years of wildly optimistic forecasts, combined with a massive tax bribe whose cost will keep multiplying for seven years.

Do you think that while cooking up the happy forecasts needed to justify his claims of Mission Accomplished and make his tax cuts seem affordable, Treasury warned him of the risks he was running, making himself and his government hostages to fortune?

I doubt it. They wouldn’t have been game to. The Coalition’s politicisation of Treasury, intended to kill its corporate sense of mission and replace it with people who’d proved their right-thinking and party loyalty as ministerial staffers, sent the message that the government wanted people who spoke only when spoken to and kept any contrary opinions to themselves.

In the process, however, most of the people with a deep understanding of macro-economic management have drifted away. People who understood the mysteries of the business cycle, with experience of recessions - and how excruciatingly painful they are for the government of the day.

These are people who know how much worse you make it for yourself – and for the economy voters depend on – by refusing to face the mess you’ve got yourself into, and who know how to help you change trams with as little loss of face as possible.

People game to tell you to stop digging. People who know that the longer you take to accept that the game has changed, the harder it will be to get the economy back on track – and, incidentally, to avoid getting the blame for completely stuffing it up.

People who’ll tell you to blame your about-face on changes coming from the rest of the world, but not to believe your own bulldust. People who’ll tell you to forget about party political doctrine – and the crowing of your opponents - and be completely pragmatic in doing whatever needs to be done to get you and the economy out of the poo.

Here’s what Frydenberg’s experts should be telling him, but probably aren’t – unless he speaks to Reserve Bank governor Dr Philip Lowe a lot more regularly than I imagine he does.

First, worrying about deficit and debt is something national governments can afford to do only when they’ve got an economy that’s growing strongly. The three successive quarters of pathetically weak growth we’ve experienced – complete with rising unemployment and underemployment - may prove to be just a blip, as the budget’s forecasts assume they will, but it’s much easier to believe they show the economy is fast running out of puff.

Recession is neither imminent nor inevitable in the next year or three, but with the economy in such a weakened state it is vulnerable to any adverse shock that happens along – whether of domestic or international in origin.

In such circumstances, it would be economically damaging and fiscally counterproductive (not to mention politically disastrous) to press on with fiscal consolidation rather give top priority to boosting economic activity and getting the economy back into strong-growth mode.

The problem is, the economy seems to be running out of puff because it’s caught in a vicious circle: private consumption and business investment can’t grow strongly because there’s no growth in real wages, but real wages will stay weak until stronger growth in consumption and investment gets them moving.

Policy has to break this cycle. But, as Lowe now warns in every speech he gives, monetary policy (lower interest rates) isn’t still powerful enough to break it unaided. Rates are too close to zero, households are too heavily indebted, and it’s already clear that the cost of borrowing can't be the reason business investment is a lot weaker than it should be.

That leaves the budget as the only other instrument available. The first stage of the tax cuts will help, but won’t be nearly enough. “Structural reform” is always a nice idea, but fixing a problem of deficient demand from the supply side would take far too long to be of practical help.

Over to you, Josh. If you’ve got the greatness in you, this could be your finest hour.

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How to multiply the bang from your budget buck

Years ago, I came to a strong conclusion: the politician who could resist the temptation to use the budget to prop up the economy when it’s falling in a heap and making voters hugely dissatisfied has yet to be born.

So let me make a fearless prediction: whatever they’re saying now, sooner or later Treasurer Josh Frydenberg and his boss Scott Morrison will use “fiscal policy” (aka the budget) to help counter the sharp slowdown in the economy that, if we’re not careful or our luck doesn’t hold, could lead to something much worse.

How can I be so sure? Because I’ve seen it happen so many times before. As I wrote in this column last week, since the late 1970s it’s been the international conventional wisdom among governments and their advisers that “monetary policy” (interest rates) should be the chief instrument used to stabilise the economy as it moves through the ups and downs of the business cycle, with fiscal policy focused instead on achieving “fiscal sustainability” – making sure the public debt doesn’t get too high.

Take Malcolm Fraser, for instance. He spent almost all his time as prime minister trying to eliminate the big budget deficit he inherited from the Whitlam government.

Until, that is, his advisers noticed indications of what became the recession of the early 1980s. In his last budget, he cut taxes and boosted government spending.

The Hawke government was totally committed to leaving it all to monetary policy, and stuck to that even when Treasurer John Kerin brought down the 1991 budget during the depths of the recession we didn’t have to have in the early 1990s.

Except that, by this time, Paul Keating was on the backbench, telling everyone who’d listen that you’d have to be crazy not to be using the budget to stimulate the economy.

In February 1992, soon after he’d deposed Bob Hawke, Keating unveiled his own big One Nation stimulus package – which by then was far too late.

It was Dr Ken Henry’s realisation at the time that politicians will always do something, even if they should have done it much sooner that, after the global financial crisis in 2008, saw him urging Kevin Rudd to “go early, go hard, go households”.

Combined with a cut in interest rates far bigger than would be possible today, that fiscal stimulus was so effective in keeping us out of the Great Recession that, today, the punters have forgotten there was ever any threat and the Coalition has convinced itself it was never needed in the first place.

Now, as we also saw last week, with interest rates so close to zero, fiscal policy is back in fashion internationally – though I’m not sure the carrier pigeon has yet made it as far as Canberra. So we’ve got time for a quick refresher on how fiscal stimulus works while we wait for the penny to drop in the Bush Capital.

There is a “circular flow of income” around the economy, caused by the simple truth that one person’s spending is another person’s income. This means that $1 spent by the government (or anyone else, for that matter) can flow around the economy several times.

This is what economists call the “multiplier” effect. Just how big the multiplier is for any spending will depend on the “leakages” from the flow that happen when someone decides to save some of their income rather than spend it all, or when they spend some of their income on imported goods or services (including overseas holidays).

(There are also “injections” to the flow from investment – someone uses or borrows savings to spend on a new house or office or equipment – and from exports of goods or services to foreigners.)

This means that the degree of stimulus the economy receives will differ according to the choices the government makes about the form its stimulus will take.

In a briefing note prepared by Dr Peter Davidson for the Australian Council of Social Service, he quotes research on the size of multipliers calculated by the Congressional Budget Office for the various measures contained in President Obama’s stimulus package in 2009, after the financial crisis.

Where the government spent directly on the purchase of goods and services, $1 of spending increased US gross domestic product by between 50¢ and $2.50. Where the spending was money given to state governments for the construction of infrastructure, the multiplier ranged between 0.45 and 2.2.

For spending on social security payments, the multiplier ranged between 0.45 and 2.1. For one-off payments to retirees, it was between 0.2 and 1. For grants to first-home buyers, between 0.2 and 0.7.

Turning from government spending to tax cuts, the budget office found than tax cuts for low to middle income-earners yielded a multiplier of between 0.3 and 1.5. For tax cuts for high income-earners, it was between 0.05 and 0.6. For additional company tax deductions, it was 0.4.

These big differences aren’t hard to explain. Multipliers are highest for direct government purchases or construction because there’d be no initial leakage into saving and little into imports.

The multipliers for tax cuts are lower because of initial leakage into saving and imports – not so much for low and middle income-earners, but hugely so for high income-earners.

Davidson’s conclusion is that a fiscal stimulus package would give the biggest bang per buck if it focused on direct government spending (particularly on timely infrastructure projects) and transfer payments to social security recipients.

Unsurprisingly, he slips in a plug for a $75 a week increase in dole payments to single people and single parents which, because it went to the poorest households in the country, would be spent down to the last penny and on essentials such as food and rent, not imports. It would also go to the poorest regions in the country.

Sounds good to me – and also to Reserve Bank governor Dr Philip Lowe.

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It's the budget, not interest rates, that must save the economy

According to a leading American economist, there are two views of the way governments should use their budgets ("fiscal policy") in their efforts to manage the macro economy as it moves through the business cycle: the old view – which is now wrong, wrong, wrong – and the new view, which is now right.

In late 2016, not long before he stepped down as chairman of President Obama’s Council of Economic Advisers and returned to his job as an economics professor at Harvard, Jason Furman gave a speech in which he drew just such a comparison.

I tell you about it now because, with our economy slowing sharply, but the Reserve Bank fast running out of room to cut its official interest rate so as to stimulate demand, it’s suddenly become highly relevant.

Furman says the old view has four key principles. First, "discretionary" fiscal policy (that is, explicit government decisions to change taxes or government spending, as opposed to changes that happen automatically as the economy moves through the ups and downs of the cycle) is inferior to "monetary policy" (changes in interest rates) as a tool for trying to stabilise the economy.

This is because, compared with monetary policy, fiscal policy has longer "lags" (delays) in being put into effect, in having its intended effect on the economy and in being reversed once the need for stimulus has passed. Scott Morrison’s inability to get his tax cut through Parliament by July 1, as he promised he could, is a case in point.

Second, even if governments could get their timing right, stimulating the economy just when it’s needed, not after the need has passed, discretionary fiscal stimulus wouldn’t work.

It could be completely ineffective because, according to a wildly theoretical notion called “Ricardian equivalence”, people understand that a tax cut will eventually have to be paid for with higher taxes, so they save their tax cut rather than spending it, in readiness for that day. Yeah, sure.

Or it could be partially ineffective because the increased government borrowing need to cover the budget deficit would force up interest rates and thus "crowd out" some amount of private sector investment spending.

Third, use of the budget to try to boost demand (spending) in the economy, should be done sparingly, if at all, because the main policy priority should be long-run fiscal balance or, as we call it in Oz, "fiscal sustainability" – making sure we don’t end up with too much public debt.

Now, I should explain that this view is the international conventional wisdom that eventually emerged following the advent of "stagflation" in the early 1970s, and the great battle between Keynesians and "monetarists" that ensued.

But Furman adds a fourth principle to the old view of fiscal policy: policymakers foolish enough to ignore the first three principles should at least make sure that any fiscal stimulus is very short run, so as to support the economy before monetary stimulus fully kicks in, thereby minimising the harm done.

Remind you of anything? The package of budgetary measures – the cash splashes and shovel-ready capital works – designed mainly by Treasury’s Dr Ken Henry after the global financial crisis in 2008 which, in combination with a huge cut in interest rates, succeeded in preventing us being caught up in the Great Recession, was carefully calculated to be "timely, targeted and temporary".

Furman says that, today, the tide of expert opinion is shifting to almost the opposite view on all four points.

That’s because of the prolonged aftermath of the financial crisis, the realisation that the neutral level of interest rates has been declining for decades, the better understanding of economic policy from the past eight years, the new empirical research on the impact of fiscal policy, and the financial markets’ relaxed response to large increases in countries’ public debt relative to gross domestic product.

Furman admits that this "new view" of the role of fiscal policy is essentially the "old old view" dating back to the Keynesian orthodoxy that prevailed between the end of World War II and the mid-1970s.

Furman outlines five principles of the new view of fiscal policy. First, it’s often beneficial for fiscal policy to complement monetary policy.

This is because the use of monetary policy is constrained by interest rates being so close to zero.

This isn’t new: the real interest rate has been trending down in many countries since the 1980s and was already quite low before the financial crisis.

Second, in practice, discretionary fiscal policy can be very effective. Experience since the crisis shows that Keynesian “multipliers” (where stimulus of $1 adds more than that to GDP) are a lot bigger than formerly thought.

And when you apply fiscal stimulus at a time when private demand is weak, there's little risk of inflation, so central banks won’t be tempted to respond by tightening monetary policy and lifting interest rates, thus countering the fiscal stimulus.

Third, governments have more “fiscal space” to run deficits and increase debt than formerly believed. The economic growth that fiscal stimulus causes means nominal GDP may grow as fast or faster than the increase in government debt.

Partly because of reform, the ageing of the population won’t be as big a burden on future budgets as formerly thought.

Fourth, if government spending involves investment in needed infrastructure, skills and research and development, it not only adds to demand in the short term, it adds to the economy’s productivity capacity (supply) in the medium term.

And finally, when countries co-ordinate their fiscal stimulus – as they did in their initial response to the financial crisis - the benefit to the world economy becomes much greater. This is because one country’s “leakage” through greater imports is another country’s “injection” through greater exports, and vice versa.

It seems clear Reserve Bank governor Dr Philip Lowe understands all this.

But whether the present leaders of Treasury, and Treasurer Josh Frydenberg’s private advisers, have kept up with the research I wouldn’t be at all sure.

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Interest rate cuts may not do much to counter slowdown

This won’t be the only cut in interest rates we see in coming months – which may be good news for people with mortgages, but it’s a bad sign for the economy in which we live and work.

The Reserve Bank is cutting rates because the economy’s growth has slowed sharply, with weak consumer spending and early signs that unemployment is rising.

In such circumstances, cutting interest rates to encourage greater borrowing and spending is the only thing it can do to try to push things along.

Whether we see just one more 0.25 percentage-point cut in a month or two’s time, or whether there will be more after that depends on just how slowly the economy is growing. The Reserve – and the rest of us - will get a much better idea of that on Wednesday morning, when the Australian Bureau of Statistics publishes the quarterly “national accounts”, showing by how much real gross domestic product grew during the first three months of this year.

If you’re thinking that cutting interest rates by a mere 0.25 per cent isn’t likely to make much difference, you’re right. That’s why we can be sure there’ll be at least one more cut.

While it’s true that, with the official interest rate now at a new record low of 1.25 per cent, the Reserve has limited scope for further cuts, don’t expect it to follow the advice from some chief executives that it should refrain from responding to further evidence of weakness in the economy with further cuts so that, once the economy’s reached the point of being really, really weak, the Reserve will still have something left to use to give it life support.

Let’s hope these executives are better at running their own businesses than they are at offering the econocrats helpful hints on how they should be doing their job.

No, we can be confident that, until it believes the economy is picking up, the Reserve will keep doing the only thing it can to help – cutting rates further.

Should this mean the official rate gets to zero, Scott Morrison and his government will then have no choice but finally to respond to governor Dr Philip Lowe’s repeated requests – repeated again only two weeks ago – that they put less emphasis on returning the budget to surplus and more on helping to keep the economy growing, by spending more on needed (note that word) infrastructure and doing it soon, not sometime in the next decade.

Morrison got himself re-elected by claiming to be much better at running the economy than his political opponents. In the next three years we’ll all see just how good he is. Boasting about budget surpluses while unemployment rises is unlikely to impress.

But back to the efficacy of interest rate cuts. Even if we get several more of them, the economy’s circumstances are such that this wouldn’t offer it a huge stimulus.

One part of this is that while interest rates are an expense to borrowers, they are income to lenders, so that a rate cut reduces the spending power of the retired and others. This is always true, but it’s equally true that borrowers outnumber lenders, so the net effect of a rate cut is to increase spending.

In principle, the mortgage payments of households with home loans will now be a little lower, leaving them with more to spend on other things. In practice, many people leave their payments unchanged so they’re repaying the mortgage a little faster.

In principle, lower mortgage rates allow people to borrow more. And moving houses almost always involves increased spending on consumer durables - new lounge suites and the like. In practice, Australian households are already so heavily indebted that few are likely to be tempted to borrow more.

In principle, lower interest rates should also encourage businesses to borrow more to expand their businesses. In practice, what’s constraining businesses from borrowing more is poor trading prospects, not the (already-low) cost of borrowing.

In principle, lower rates are good news for the property market. But the Reserve wouldn’t be cutting rates if it thought the property boom might take off again. Combined with the removal of Labor’s threat to negative gearing, the likely result is a slower rate of fall in house prices, or maybe a floor for them to bump along for a few years. The home building industry won’t return to growth for some years yet.

The rate cuts should, however, cause our dollar to be lower, which may not please people planning overseas holidays, but will give a boost to our export and import-competing industries.

Putting it all together, even if we get a few more rate cuts that isn’t likely to give the economy a huge boost. Which means it’s unlikely to do much to fix the underlying source of the economy’s weakness: very small increases in wages.

The Fair Work Commission’s decision to raise all award minimum wage rates by 3 per cent will help about 2.2 million workers, but few of the remaining 10.6 million are likely to do as well.

Morrison’s promised $1080 boost to tax refund cheques, coming sometime after taxpayers have submitted their annual returns from the end of this month, will provide a temporary fillip, but it's a poor substitute for stronger growth and the improved productivity it helps to bring.

I have a feeling Morrison and his merry ministers will really be earning their money over the next three years.

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Now the pilot's back, economy flying on a wing and a prayer

It’s always nice for the country to be led by someone who’s obviously got God on his side. When he prays for a miracle, he gets it. And the challenges facing the economy are such that Scott Morrison may need all the divine assistance he can summon.

The Coalition – and their dispirited opponents - should remember the fate of the last chap who won an unwinnable federal election: Paul Keating in 1993. By the time the next election arrived, voters were, in Queensland Labor premier Wayne Goss’s words, “sitting on their verandas with baseball bats”.

The Liberals shouldn’t forget the miraculous nature of their win. After their years of infighting and indiscipline they richly deserved to be thrown out, but were saved by Morrison’s superior campaigning skills and his success in convincing people with nothing to fear from restrictions on franking credits and negative gearing that they should be fearful (not sure what God thought about that).

This was not a historic vindication, just a reprieve. Carry on the way you have been, and your fate will only have been delayed.

And remember: Keating’s reprieve came as part of the 25 years Australians spent trembling at the thought of a tax on services as well as goods. “If you don’t understand it,” Keating told the punters, “don’t vote for it.”

We’ve now had such a tax for almost 20 years. And would you believe? Turned out the GST was no biggie. What brave souls we are.

Come July, we’ll have gone an amazing 28 years without a severe recession. Starting to sound ominous.

Look around the world – trade war between America and China, China’s faltering economic miracle, America’s boom that must bust, Japan and Europe with chronically weak economies and Brexit Britain about to shoot its economy in both feet – and it’s not hard to think you see our next recession in the offing.

Certainly, it has to come some time. But I don’t see one as imminent. What many don’t realise is we have enough troubles of our own, without help from abroad.

Ever since the global financial crisis in 2008-09, and more so since the busting of our mining construction boom in 2013, our economy has been acting strangely, behaving in ways it used not to.

If Morrison and his Treasurer, Josh Frydenberg, understand the way it hasn’t been back to business as usual, they’ve shown little sign of it.

If they haven’t yet got the message – perhaps because a politicised Treasury hasn’t been game to give them news they won’t like – enlightenment, in the form of being hit on the head by the bureau of statistics, may not be far off.

Ever since Treasury’s optimistic forecasts encouraged Labor’s Wayne Swan to claim to be delivering four budget surpluses in a row – a claim Frydenberg repeated in the April budget – the econocrats have just shifted forward another year their unwavering conviction that everything will soon be back to the old normal.

It hasn’t happened throughout the Coalition’s two terms. The economy’s just kept grinding along in second gear, failing to reach the cruising speed the econocrats profess to see coming.

It hasn’t happened because the economy’s productivity – output per unit of input - hasn’t improved as fast as it used to, and what little improvement we’ve had hasn’t flowed on to wages. It’s because wages haven’t grown faster than prices, as we’ve come to expect, that so many people are complaining about the cost of living.

What has concealed the truth from us is our rapid, immigration-fuelled population growth. The other rich countries’ populations haven’t been growing nearly as fast. This has given us a bigger economy, but not a richer one.

Of late we have had a partial – and probably temporary – rebound in the prices we get for our mineral exports. Combined with years of bracket creep, the boost to mining company profits (and their tax payments) has finally made Frydenberg’s budget look a lot healthier than the economy does.

Weak growth in real wages (plus continuing bracket creep) mean weak growth in the disposable income of Australia’s households. Which, in turn, means weak growth in the economy’s mainstay, consumer spending.

All this became unmissable when the economy slowed to a crawl in the second half of last year. Predictably, the April budget took this to be little more than a blip on the onward and upward trajectory.

But all the economic indicators we’ve seen since the budget – weak inflation, no improvement in wage growth – suggest the weakness is continuing.

Another respect in which the economy has been behaving strangely is that employment – particularly full-time jobs - has been growing much more strongly than the modest growth in the economy would lead us to expect.

It’s this that Morrison and Frydenberg trumpeted during the election campaign as proof positive of their superior management of the economy. Fine. But the rate of growth in employment is slowing and the rate of unemployment, having fallen slowly to 5 per cent, seems now to be going up, not down.

With the election out of the way, the Reserve Bank won’t wait long before it cuts interest rates to try to give the economy a boost. The $1080-a-pop tax refund cheques after June 30 will also help, provided Morrison can get them through Parliament in time. More earnest prayer required, I think.

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Let's stop pretending the old normal is just around the corner

Just as a new chief executive makes sure their first act is to clear out all the stuff-ups left by their predecessor, so a new federal government needs to release its econocrats from the ever-more dubious proposition that nothing in the economy has changed and we’ll soon be back to the old normal.

That’s the old normal of productivity improving by 1.5 per cent a year, the economy growing by 2.75 per cent and wages growing more than 1 per cent faster than the 2.5 per cent inflation rate, with unemployment of 5 per cent and a fat budget surplus rapidly returning the government’s net debt to zero.

That’s the happy fantasy the econocrats have been predicting every year since 2012, the year they helped former treasurer Wayne Swan delude himself he was “delivering” four budget surpluses in a row.

It’s the same fantasy guiding the forecasts in this year’s budget and allowing Treasurer Josh Frydenberg to repeat Swan’s prediction.

A new government would do well to start by freeing itself from the purgatory of endlessly under-achieved forecasts. A re-elected government, of course, would find it much harder to free itself from addiction to the happy pills.

A now highly politicised Treasury seems to have had little trouble keeping this dubious faith that nothing fundamental in the economy has changed and that, every year the return to the old normal fails to happen – we’re up to seven and counting – makes this year’s forecast all the more likely to be the lucky winner.

No, it’s the Reserve Bank and its governor, Dr Philip Lowe, that’s had trouble reconciling the she’ll-be-right forecasting methodology with the daily reality of economic indicators that didn’t get the memo. Unlike Treasury, Lowe has to do it in public – and update his forecasts every quarter, not just twice a year.

The Reserve may be independent when it comes to making decisions about interest rates – though, as we saw last week, not still so independent it’s game to risk pricking the political happy bubble by cutting rates during an election campaign – but it has never allowed itself to be independent of Treasury’s forecasts.

Being bureaucrats, the Reserve’s bosses live in fear of ignorant journalists writing stories about Treasury and the Reserve being at loggerheads. So they never allow their forecasts to be more than a quarter of a percentage point at variance with Treasury’s.

Their bureaucratic minds also mean they prefer to initiate rate changes in February, May, August or on Melbourne Cup day, so their move can be justified in the quarterly statement on monetary policy published the following Friday.

All this does much to explain the contortions Lowe put himself through last week. Everything the Reserve said about the immediate outlook for the economy implied it should have begun cutting last week.

It slashed its forecasts for consumer spending, inflation and GDP for the rest of this calendar year, which of itself was enough to justify an immediate cut. Last Tuesday it told us enigmatically it “will be paying close attention to developments in the labour market”, but three days later forecast that unemployment would be unchanged at 5 per cent for the next two years.

What Lowe hasn’t explained is that the only thing in the labour market that would stop him cutting rates in the next few months is if unemployment were to fall. That’s because the one respect in which he’s broken free of the Treasury orthodoxy is his acknowledgement, before a parliamentary committee, that the best estimate of full employment (the “non-accelerating-inflation rate of unemployment”) has dropped from about 5 per cent to about 4.5 per cent. If you’re not heading down to 4.5 per cent, why aren’t you cutting?

Trouble is, if full employment is 4.5 not Treasury’s 5, that means our “potential” growth rate is likely to be below Treasury’s 2.75 per cent (including its assumption of 1.5 per cent annual improvement in productivity). And, if that’s so, then our “output gap” will be less than the 1.25 percentage points that Treasury uses to justify its projection that the economy will grow for five years in a row at 3 per cent, before dropping back to 2.75 per cent a year.

The trick to Treasury’s forecasting is that, though it always cuts its immediate forecasts to accommodate the latest disappointment in the actual data, its mechanical projections assume “reversion to the mean”, so its later forecasts have to rise to meet the start of the we’re-back-to-normal projections. But it’s always the old mean we'll be reverting to, not any new one.

Now get this: measured on a consistent “year-average” basis, the Reserve’s latest “slashed” forecasts differ in no significant way from those Treasury put in this year's budget. When it comes to forecasting, the Reserve is slave to a politicised Treasury.

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Interest rate cuts are coming, which isn't good news

The Reserve Bank may have decided not to cut interest rates right now, but it’s likely to be only a few months before it does start cutting, and it’s unlikely to stop at one. So, is it just waiting until after the election? I doubt that’s the reason.

The Reserve has moved interest rates twice during election campaigns – raising them in 2007 (much to the surprise of Peter Costello, whose mind was on politics at the time) and cutting them in 2013 – so, had Reserve governor Dr Philip Lowe considered an immediate cut was needed, I doubt he would have hesitated to make it.

The Reserve acts independently of the elected government, so it is – and must be seen to be - apolitical. Lowe’s predecessor, Glenn Stevens – who instigated both those previous moves – decided that the only way to be genuinely apolitical was for him to act as soon as he believed the best interests of the economy required him to, regardless of what the politicians were up to at the time.

I doubt his former deputy and understudy, Lowe, would see it any differently.

So, is Lowe’s judgement that a rate cut isn’t needed urgently bad news or good for Scott Morrison – or, conversely, for Bill Shorten?

First point: stupid question. What matters most is whether it’s good or bad news for you and me, and the economy we live in, not the fortunes of the people we hire to run the country for us. The rest is mere political speculation.

The media invariably judge a fall in interest rates to be good news and a rise bad news. But this is far too narrow a perspective. For a start, it assumes all their customers have mortgages and none are saving for a home deposit or for retirement. The retired are absolutely hating the present protracted period of record low interest rates.

For another thing, it assumes that our loans or our deposits are the only things that matter to our economic wellbeing. That the central bank’s movement of interest rates has no implications for, say, our prospects of getting a decent pay rise, or of hanging onto our job.

The fact is that central banks use the manipulation of interest rates to influence the rate at which the economy’s growing. They raise rates when everything’s going swimmingly and, in fact, needs slowing down a bit to keep inflation in check.

They cut interest rates when things aren’t going all that well – when, for instance, low wage increases are causing anaemic growth in consumer spending and this is giving businesses little incentive to expand their operations, or when a rise in unemployment is threatening.

Penny dropped? A cut in interest rates is a portent of tougher times ahead, whereas a rise in rates says the good times are rolling and will keep doing so for a while yet.

So it’s not at all clear that, had he cut rates, Lowe would have been doing Morrison a favour politically and doing Shorten a disservice.

In Treasurer Josh Frydenberg’s budget speech a month ago – it seems an eternity – he used the phrase “strong growth” 14 times. Turned out Morrison was basing his case for re-election on the claim that the Coalition had returned the economy to strong growth – after the mess those terrible unwashed union people had made, as they always do.

That claim is now not looking so believable. It was in trouble even before the budget, when we learnt in March that the economy had suffered a second successive quarter of weak growth, slashing the rise in real gross domestic product during 2018 to just 2.3 per cent – rather than the 3 per cent the Reserve had been talking about.

This was the first sign that, having left its official interest rate steady at 1.5 per cent for more than two and a half years, the Reserve needed to think about using a cut in rates to help push the economy along.

The next sign came just a fortnight ago, when the release of the consumer price index showed that, while some prices fell and others rose during the March quarter, on balance there was no change in the cost of the typical basket of goods and services bought by households.

This caused the annual rate of price increase to fall from 1.8 per cent to 1.3 per cent – at a time when the Reserve had gone for more than three years assuring us it would soon be back in the Reserve’s target range of between 2 and 3 per cent.

So, quite a blow to the Reserve’s assurances that the economy was getting stronger, and a sign it should be thinking seriously about cutting rates to kick things along. (Prices tend to rise faster the faster the economy is growing so, paradoxically, very low inflation is a worrying sign.)

In which case, why has Lowe hesitated? Because, I suspect, he’s waiting for the third shoe to fall. Employment has been growing faster than you’d expect in a weak economy, so he may be waiting for signs it’s slowing, too.

And he’d want to be confident a cut in interest rates didn’t restart the housing boom in Sydney and Melbourne, which has left too many people with far too much debt.

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Budget makes Frydenberg an unwitting Keynesian stimulator

Treasurer Josh Frydenberg doesn’t want anyone saying the budget he unveiled this week involves applying some “fiscal stimulus” to get the economy moving faster. He’d prefer to say his budget is “pro-growth”.

But what is fiscal stimulus? And does that label apply to this year’s budget? Only if you’re prepared to be called a “Keynesian” economist. Which Frydenberg isn’t.

Why not? Because in the hard right circles in which many Liberals move, the name of John Maynard Keynes (rhymes with Brains) has become a swearword. (That’s because their penchant for dividing people into political friends and foes exceeds their understanding of economics.)

The K-word isn’t one used a lot by the Reserve Bank. My guess is it would be quite pleased with what Frydenberg has done in coming up with his own version of what, when Kevin Rudd did it after the global financial crisis in 2008, was dubbed a “cash splash”.

But the Reserve would limit itself to saying Frydenberg has made the budget “less contractionary” than it would have been.

The “fiscal” in fiscal stimulus is just a flash word for anything to do with the budget. The managers of the macro economy often do things intended to stimulate it to grow faster, create more jobs and make us more prosperous.

In last year’s budget, Scott Morrison introduced a new “low and middle income tax offset” (known to aficionados as the lamington) worth $530 a year, to be received by workers earning between $48,000 and $90,000 a year, with those on lower or higher incomes getting lesser amounts, starting from last July.

The offset was equivalent to about $10 a week but, because it’s a “tax offset”, they don’t get it until they’ve submitted their annual tax return at the end of the financial year and received their tax refund cheque. That cheque (these days actually a transfer to their bank account) will include the offset.

So workers should receive their first offset payment as a lump sum sometime in the September quarter of this year.

But this week the government decided to increase the amount of the offset by $550 and to backdate it to last July. So about 4.5 million taxpayers will be given a cash grant of $1080 in a few months’ time. When they spend that money, it should give the economy a kick along.

First point to understand, however, is that though the motive for the policy changes politicians announce in budgets is usually political – they just want to buy our votes, for instance - that doesn’t stop those measures having an effect on the economy.

Economists ignore the political motivations and focus on the likely economic effects.

Second point, while it’s easy to see that something as sexy as a tax cut could, when it’s spent, add to economic activity, that’s just as true of the government's spending to build new infrastructure, or add new medicines to the pharmaceutical benefits scheme, or spend more on education.

So what will stimulate the economy is all the new programs the government decides to spend on, less any cuts in government spending or new tax increases it makes.

The budget papers show that, since the midyear budget update in December, the government’s decisions to change tax and spending programs total $5.7 billion, spread over the present financial year and the coming year.

That total stimulus is equivalent to about 0.3 per cent of gross domestic product – meaning that, despite all the excitement, it’s not exactly huge.

Third point, while most people see immediately that the things governments do with their budgets affect the economy, it takes them longer to realise that, particularly because the economy (GDP) is about four times bigger than the budget, the things the economy does also affect the budget.

That is, there’s a two-way relationship between the budget and the economy.

As the economy grows during the upswing of the business cycle, this should improve the budget balance, as the progressivity of the income tax scale (aka bracket creep) causes income tax collections to grow faster than income itself, and government spending on dole payments falls as more people find jobs.

Alternatively, as the economy slows during the downswing of the business cycle, tax collections also slow down and dole payments grow as people lose their jobs.

Keynesian economists refer to this source of improvement or deterioration in the budget balance as the “cyclical” component.

In contrast, they refer to the improvement or deterioration in the budget balance caused by the explicit decisions of the government to change taxes and government spending as the “structural” component.

Keynesians judge the “stance of policy” adopted in the budget by the change in this structural component. And, as we’ve seen, they’d judge the stance this year to be mildly stimulatory.

The Reserve – which needs to know what effect changes in the budget are having on the strength of demand in the economy so it can decide what it needs to do about interest rates – makes no distinction between the cyclical and structural components of the budget balance.

It simply looks at the direction and size of the expected change in the overall budget balance, which it calls the “fiscal impact”.

As well as seeing that the balance was expected to swing from deficit to surplus, it would note from the budget papers that, since the midyear budget update in December, tax collections and spending underruns were expected to improve the budget balance by $9.7 billion over the present and coming financial years.

In other words, the budget was now expected to take a further $9.7 billion more out of the economy than it put back in. Such a fiscal impact would be contractionary, not stimulatory.

But Frydenberg’s new spending and tax cut, costing $5.7 billion, will make the budget a bit less contractionary than it could have been. Good.

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Beware of groupthink on why the economy’s growth is so weak

According to our top econocrats, the underlying cause of the economy’s greatest vulnerability – weak real wage growth – is obvious: weak improvement in productivity. But I fear they’ve got that the wrong way round.

We all agree that, in a well-functioning economy, the growth in wage rates exceeds the rise in prices by a percentage point or two each year. On average over a few years, this “real” growth in wages is not inflationary, but is justified by the improvement in the productivity of the workers’ labour.

If this real growth in wages doesn’t happen, then real growth in gross domestic product will be chronically weak. That’s because consumer spending accounts for about 60 per cent of GDP.

Consumer spending is driven by household disposable income which, in turn, is driven mainly by wage growth.

We would get some growth in GDP, however, because our rate of population growth is so high. But look at growth per person, and you find it’s growing by only about 1 per cent a year.

It’s long been believed that real wages and productivity are kept in line by some underlying (but unexplained) equilibrating force built into the market economy.

Since the two have kept pretty much in line over the decades, few economists have doubted the existence of this magical force, nor wondered how it worked.

In America, however, real wages haven’t kept up with productivity improvement for the past 30 years or more.

And, as Reserve Bank governor Dr Philip Lowe acknowledged while appearing before a parliamentary committee recently, for the past five years nor have they in Australia.

Unlike the unions, which see the weakness in wage growth as the result of past industrial relations “reform” shifting the balance of wage-bargaining power too far in favour of employers, Lowe remains confident the problem is temporary rather than structural.

“Workers and firms right around the world feel like there’s more competition, and they feel more uncertain about the future because of technology and competition,” he said.

So, be patient. As the economy continues to grow and unemployment falls further, workers and their bosses will become more confident, wages will start growing faster than inflation and everything will be back to normal.

To be fair, Lowe is saying we have had “reasonable” productivity improvement over the past five years, which hasn’t been passed on to wages.

It would be better if productivity was stronger, of course, and “there’s been no shortage of reports giving . . . ideas of what could be done” to strengthen it.

But last week the newish chairman of the Productivity Commission, Michael Brennan, broke his public silence to give an exclusive statement to the Australian Financial Review.

“Productivity growth has been disappointing over the last few years in Australia, as it has been in many countries. There are no magic wands . . . but there are some clear remedies for Australia that should start with a focus on governments’ capacity to influence economic dynamism and productivity,” he said.

Oh, no, not that tired old line again. If wages aren’t growing satisfactorily, that’s because productivity isn’t improving satisfactorily, and the only way to improve productivity is for governments to instigate “more micro-economic reform”.

So, weak wage growth turns out to be the workers’ own fault. Their electoral opposition to “more micro reform” is making governments too afraid to do the thing that would raise their real wages.

We’ve become so used our econocrats’ neo-classical way of thinking that we don’t see its weaknesses.

It’s saying that, if the problem is weak demand, the cause must be weak supply, and the solution must be faster productivity improvement, which can be brought about only by “more micro reform”.

This ignores the alternative, more Keynesian way of analysing the problem: if the problem is weak demand, the obvious solution is to fix demand, not improve supply.

Since the global financial crisis, the developed countries, including us, have suffered a decade of exceptionally weak growth.

We’ve had weak consumer spending because of weak wage growth, the product of globalisation and skill-biased technological change, which has diverted much income to those with a lower propensity to consume.

With weak growth in consumer spending, there’s been little incentive to increase business investment rather than return capital to shareholders.

It’s this weakness in business investment spending that’s the most obvious explanation for weak productivity improvement.

That’s because it’s when businesses replace their equipment with the latest model that advances in technology are disseminated through the economy.

Our econocrats are like the drunk searching for his keys under the lamppost because that’s where the supply-side light shines brightest.

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Top economy manager wants you to get bigger pay rises

This year more than usually, if you want straight talking about the state of the economy and its prospects, listen to the econocrats not the election-crazed politicians.

Late last week, Reserve Bank governor Dr Philip Lowe had more sensible things to say in three hours than we usually get in a month.

He was giving evidence to the House of Representatives standing committee on economics. For a start, he left little doubt about his disapproval of the way the two sides are turning the election campaign into a bidding war.

It’s clear the reason the election is being delayed until May is so Scott Morrison can use the April 2 budget to announce tax cuts in addition to the three-stage, $144 billion-over-10-years cuts he announced in last year’s budget.

He’s upping the ante not just because he’s behind in the polls, but also because Bill Shorten is promising to make the first-stage cuts about twice the size of Morrison’s. And big increases in spending on health and education.

Plus Shorten is claiming he’d have bigger budget surpluses. How? By reducing tax breaks used mainly by higher income-earners. The risk, however, is that Labor could get locked into cutting taxes and increasing spending, but not be able to get its revenue-raising measures through the Senate.

What would be worrying Lowe is that, just as we’ve come within sight of returning the budget to (tiny) surplus – but before we’ve made any progress in repaying the huge debt successive governments have racked up over the past decade – both sides have declared Mission Accomplished and started promising tax cuts galore.

Lowe said we should be running big budget surpluses and cutting back the debt as a sort of insurance policy against the next downturn in the economy – which he doesn’t see happening in the next year or two, but will happen one day.

Consider this. When the global financial crisis hit in October 2008, Lowe’s predecessor acted to protect us from the tsunami by cutting the official interest rate by 4 percentage points in about as many months.

Trouble is, we’ve since entered a low growth, low inflation world, and interest rates have remained low. The official interest rate is just 1.5 per cent. So the central bank has little scope to stimulate the economy the way it did last time.

In that case, the government should use its budget to stimulate the economy by splashing cash, spending on school playgrounds and the like.

See the problem? We won’t have much scope to do that, either, if we’ve been so busy awarding ourselves tax cuts that we’ve made little progress in reducing all the debt we’ll be starting with.

Moving on, Lowe said the economy’s two main worries were the weak growth in wages and falling house prices. But he stressed that wages and household income were far more significant than house prices.

If you were thinking it was the other way round, that may be because the media have misled you. “It’s largely the income story which doesn’t get talked about enough, because the media love talking about property prices,” he said.

Whereas household income, coming mainly from wages, used to grow by about 6 per cent a year (before allowing for inflation), in recent years it’s grown by less than 3 per cent.

Lowe didn’t say it, but what economists see as weak growth in wages, most ordinary mortals perceive as the worsening “cost of living” – which polling shows is now voters’ greatest concern.

People are having trouble balancing their own budgets, not because prices generally are soaring, but because their wages aren’t growing a per cent or two faster than prices, the way they used to.

Lowe is confident wages will gradually improve, but “if we have another five years where workers don’t get their normal share of productivity growth [that is, if wages don’t return to growing a per cent or so faster than prices each year], we’ll have all sorts of economic, social and political problems”.

Gosh. He did have some good news, however. He’s confident employment will continue growing strongly because the rate of job vacancies is higher than it’s ever been.

And whereas economists have long believed the rate of unemployment couldn’t fall below “about 5 per cent” before we started getting excessive wage settlements and rising inflation, Lowe now believes unemployment can fall further to “about 4.5 per cent” before there’s a problem. (May not sound much to you, but it gives us scope for 67,000 more jobs.)

Lowe says there’s more competition between the big banks than we’re told about. Remember a few months ago when they raised their mortgage interest rates by between 0.1 and 0.15 percentage points?

That’s what they told the media and what they wrote on their price lists. In truth, however, rates rose by only 0.03 or 0.04 points. Why? Because too many of their customers threatened to take their business elsewhere.

Finally, some free advice from the nation’s most powerful economist: “I encourage everyone who has a mortgage, if they haven’t done so recently, to go and ask their bank for a better deal. And if the bank says no, go look for another bank.”

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Back to the future: Keynes can lift us out of stagnation

Every so often the economies of the developed world malfunction, behaving in ways the economists’ theory says they shouldn’t. Economists fall to arguing among themselves about the causes of the breakdown and what should be done. We’re in such a period now.

It’s called “secular stagnation” and it’s characterised by weak growth – in the economy, in consumer spending, in business investment and in productivity improvement. This is accompanied by low price inflation and wage growth, and low real interest rates.

Let me warn you: the last time the advanced economies went haywire, it took the world’s economists about a decade to decide why their policies of managing the macro economy were no longer working and to reach consensus around a new policy approach.

That was in the mid-1970s, when the first OPEC oil-price shock brought to a head the problem of “stagflation” – high unemployment combined with high inflation – a problem the prevailing Keynesian orthodoxy said you couldn’t have.

The Keynesians’ “Phillips curve” said unemployment and inflation were logical opposites. If you had a lot of one, you wouldn’t have much of the other.

The developed world’s econocrats lost faith in Keynesianism and flirted with Milton Friedman’s “monetarism” – which was just a tarted-up version of the “neo-classical” orthodoxy that had prevailed until the Great Depression of the 1930s.

That was the previous time the economics profession fell to arguing among itself. Why? Because neo-classical economics said the Depression couldn’t happen, and had no solution to the slump bar the (counter-productive) notion that governments should balance their budgets.

It was John Maynard Keynes who, in his book The General Theory, published in 1936, explained what was wrong with neo-classical macro-economics, explained how the Depression had happened and advocated a solution: if the private sector wasn’t generating sufficient demand, the government should take its place by borrowing and spending.

In the period after World War II, almost all economists – and econocrats – became Keynesians. Until the advent of stagflation.

Notice a pattern? We start out with neo-classical thinking, then dump it for Keynesianism when it can’t explain the Depression. Then, when Keynesianism can’t explain stagflation, we dump it and revert to neo-classicism.

Enter Dr Mike Keating, a former top econocrat, who thinks the present crisis of stagnation means it’s time to dump neo-classicism and revert to Keynesianism.

Why do economists have rival theories and keep flipping between them? Because neither theory can explain every development in the economy, but both contain large elements of truth.

So it’s not so much a question of which theory is right, more a question of which is best at explaining and solving our present problem, as opposed to our last big problem.

I think there’s much to be said for this more eclectic, horses-for-courses approach. There’s no one right model. Rather, economists have a host of different models in their toolbox, and should pull out of the box the model that best fits the particular problem they’re dealing with.

And much is to be said for Keating’s argument that we need a different economic strategy to help us into the 21st century. Got a problem with stagnation? The tradesman you need to call is Keynes.

Although the rich economies are in a lot better shape than they were during the Depression – mainly because, in the global financial crisis of 2008, governments knew to apply Keynesian stimulus - Keating sees similarities between the two periods of economic and economists’ dysfunction.

In this context, the key difference between the rival theories is their differing approaches to supply and demand.

Neo-classical economics assumes the action is always on the supply side. Something called Say’s Law tells us supply creates its own demand, so get supply right and demand will look after itself.

The modern incarnation of this is “the three Ps”. In the end, economic growth is determined by the economy’s potential capacity to produce goods and services, and our “potential” growth rate is determined by the growth in population, participation and productivity improvement (with the last being the most important).

By contrast, Keynesianism is about fixing the problem Say’s Law says we can never have: deficient demand. Insufficient demand was what kept us trapped in the Depression. Keating argues the fundamental cause of our present stagnation is deficient demand, and the solution is to get demand moving again.

Back in the stagflation of the 1970s, however, the problem wasn’t deficient demand. It was the supply side of the economy’s inability to produce all the goods and services people were demanding, thus generating much inflation pressure.

After realising that Friedman’s targeting of the money supply didn’t work, the rich world’s eventual solution to the problem was what we in Australia called “micro-economic reform” – reduced protection and government regulation of industries, so as to increase competition within industries and spur greater productive efficiency and productivity improvement, thus increasing our rate of “potential” growth.

Keating – who, with another bloke of the same name, played a big part in making those early reforms – insists they worked well and left us with a more flexible, less inflation-prone economy. True.

By now, however, assuming you can fix a problem of deficient demand by chasing greater competition and improved productivity just shows you haven’t understood the deeper causes of the problem.

But when Keating advocates a new economic strategy of demand management, he doesn’t just mean governments borrowing and spending a lot of money now to give demand a short-term boost.

He mainly means a new kind of micro reform that, by increasing the income going to those likely to spend a higher proportion of it, and by lifting our education and training performance to help workers cope with new technology, ensures demand strengthens and stays strong in the years to come.

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“Lags”: one reason economists keep getting it wrong

I’m compiling a short-list of the main things economics teaches us. One is: economic developments take longer to affect the economy than you’d expect. Economists call these delays “lags”. That there are so many of them – and their lengths keep changing – does a lot to explain why economists’ forecasts are so often wrong.

Last week Dr Luci Ellis, an assistant governor of the Reserve Bank, gave a prestigious lecture at the Australian National University devoted solely to the problem of lags.

Ellis says a lag occurs in any instance where time passes between when an activity is initiated and when it has its impact. “Almost all economic phenomena involve lags,” she says. And she’s divided them into three types.

The first is “process lags” – the time it takes for any production process to be finished. The time it takes to build a house, for instance.

This includes the time it takes to make a decision (say, about whether to build the house). Particularly where decisions are made by governments or big businesses, this can take some time. You may have to gather information, do analysis, prepare documents, convene meetings and complete review processes before you’ve decided.

Economists often compare the strengths and weaknesses of the two main instruments they use to manage the macro economy: monetary policy (the manipulation of interest rates) and fiscal policy (the manipulation of government spending and taxation in the budget).

An important difference between the two is that decisions to change interest rates can be made quickly and easily. The Reserve Bank board meets monthly, decides, has lunch and then announces its decision.

By contrast, decisions to change taxes or government spending require a lot more preparation and debate by the cabinet. Then there can be a delay of weeks or months before legislation is passed by parliament and put into effect. Sometimes the firms affected have to be given notice to prepare for the change.

The trick is, once decisions have taken effect, changes to taxes and government spending usually affect the economy more quickly than do changes in interest rates, for which the lags are “long and variable”. The full effect of a rate change could take up to three years.

Another example of decision lags is the local government approval process for building projects, which can take months.

An important case of process lag is known as the “hog cycle”. A farmer takes his pigs to market, discovers prices are high, so decides to grow more pigs.

Trouble is, this takes a few years. And pork prices have fallen back long before the pigs are ready. But when they are, the farmer still has to sell them – which depresses prices even further.

Hog cycles occur in many industries where the long delay between deciding to produce something and getting it finished means demand and supply for the product are never in sync. This causes prices to boom when demand exceeds supply, then bust when supply exceeds demand.

It’s happening now with new apartments. Demand has fallen off, but buildings begun a year or two ago are still adding to supply, putting downward pressure on prices.

The hog cycle – the long lag between rising mineral commodity prices on world markets and our new mines and gas plants finally coming on line – does much to explain the wringer the resources boom and bust has put our economy through over the past decade and a half.

Ellis’s second category is “stock-flow lags”. A stock is the amount of something at a particular point in time – say, the money in a bank account at June 30. A flow is the amounts flowing in and out of the account during a period of time. The difference between the stock at the start of a year and the stock at the end of the year will be the flows in and out.

This is important in housing, where the number of newly built homes in a year is a small fraction of the stock of all existing homes (especially after you allow for the homes that were knocked down during the year).

So if the stock of homes has fallen far short of the number of homes needed, it can take longer than you’d expect to make up the gap.

Historically, macro-economics has tended to focus on flows and ignore stock levels. But Ellis says “if you aren’t taking stocks and flows seriously you probably don’t have a realistic model of the economy”.

Her third category is “learning lags”. This is the time it takes individuals – or the whole economy – to realise economic relationships have changed and to change their behaviour accordingly.

These lags can vary because some people are quicker on the uptake than others. But also because how long it takes before you can conclude a change has occurred depends on many factors: the “noisiness of the data” (the way monthly or quarterly statistics jump around for no apparent reason) and how open you are to changing your views about how things work.

This takes us to the common case of economists having to decide whether some problem is “cyclical” (temporary) or “structural” (lasting).

Ellis says our knowledge that lags often vary in length should make us slow to conclude that the economy’s structure has changed, but human nature seems to push us the other way. It’s too easy to convince ourselves “this time is different” when usually it isn’t.

The big debate between economists at present fits this pattern: is the weakness in wage growth just the product of longer lags than we’re used to in the recovery phase, or has there been some change in workers’ bargaining power that needs correcting?

Whatever the answer, you see how ubiquitous lags are in the economy, how their length can change, how they contribute to the ups and downs of the business cycle, and how hard they make it to be sure where we are now, let alone where we’re headed.

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Current account deficit improves without us noticing

They say a watched pot never boils, so maybe it's a good thing we now spend so little time worrying about the current account deficit. While our attention's been elsewhere, it's got a lot smaller.

This news comes courtesy of the International Monetary Fund's latest country report on Australia, issued this week.

Settle back. The nation's "balance of payments" is a statement summarising all the transactions between Australians (whether businesses, governments, or individuals) and the rest of the world.

It's divided into two main accounts. First is the "current account", which summarises exports and imports of goods and services, plus inflows and outflows of income, particularly payments of dividends and interest on loans.

Then there's the "capital and financial account" which, as its name implies, summarises the inflows and outflows arising from the financial-capital dimension of the transactions included in the current account.

Because the balance of payments is calculated using the accountants' double-entry bookkeeping system of debits and credits, the balance of payments is always in balance. So if the current account sums to a deficit, the capital account must sum to a surplus of the same size.

The fund's report acknowledges that Australia almost always runs a deficit on the current account, with an offsetting surplus (net capital inflow) on the capital account.

This is because we've always invested a lot more each year (in new business equipment and structures, homes and public infrastructure) than we (businesses, households and governments) have saved each year, so we've always needed to call on the savings of foreigners to make up the gap.

Foreigners' savings come as either loans (known as "debt capital") or the purchase of shares in our businesses or real estate ("equity capital").

Worries about the size of the deficit on the current account go back to the days before 1983, when the Australian dollar's rate of exchange with other currencies was fixed at a certain level by the government.

It was the government's job to defend that fixed rate by making sure the current account deficit and the capital account surplus were never too far apart.

This "balance of payments constraint" meant that if the current deficit got too big relative to the capital surplus, the government would have to crunch the economy so as to get imports down and thus help it keep the dollar's value unchanged.

If this didn't happen, the government would suffer the ignominy of devaluing our dollar and hoping this would get the current deficit and capital surplus back together.

When, in 1983, we decided to allow the value of the dollar to "float", however, this allowed it to move up or down automatically and continuously by however much was needed to keep the current deficit and the capital surplus exactly equal at all times.

It took until some years after the float for economists to realise that, in the new, more globalised world of floating currencies and unrestricted flows of financial capital between countries, there was much less reason to worry about the excessive size of the current deficit.

The necessary "devaluation" of the exchange rate would be brought about by the foreign exchange market, not the government.

The fund's report notes that, in the 1960s and '70s, the current account deficit fluctuated around 1 and 2 per cent of gross domestic product.

During the 35 years since the float, however, the current deficit blew out, averaging about 4 per cent of GDP. In consequence, there was a huge increase in our foreign liabilities, particularly our net foreign debt – to a mere $990 billion at last count.

This is what worried many people – until the economists and politicians decided to stop talking about it and focus on something different, the federal government's budget deficit and net government debt.

But here, at last, is the news: the fund reports that, since the global financial crisis in late 2008, the current account deficit has been a lot smaller. It's expected to have been only 2 per cent in 2017.

Why the improvement? Since the current deficit and the capital surplus are two sides of the same coin, you can explain changes by looking at either side – or both. The report offers two reasons for the smaller current deficit and three for the smaller capital surplus.

On the current account, it says we suffered a larger slowdown in growth in domestic demand (spending on consumption and investment goods) following the crisis than did our major trading partners (which, remember, are mainly fast-growing Asian economies).

So our imports from them weakened by more than our exports to them.

As well, the current deficit has been reduced by a lower "net income deficit" – gone from 3 per cent of GDP before the crisis to 1.5 per cent since – because world interest rates are so much lower, and our interest payments to foreigners far exceed their interest payments to us.

On the capital account surplus – representing the amount by which national investment exceeds national saving - the report notes that households have been saving a higher proportion of their incomes since the crisis than before it (even though they're saving less now than they were a few years back).

Second, since the crisis, our companies have saved more by retaining more of their profits rather than paying them out in dividends and, despite the surge in investment spending by mining companies that's only now ending, other companies haven't been investing much until recently.

Finally, the tightening up of international capital adequacy requirements in reaction to the crisis has obliged our banks to increase their saving by retaining more of their profits.

The report foresees the current account deficit stabilising at about 2.5 per cent of GDP in the next few years – which would be almost back to its modest levels when our exchange rate was still fixed.

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How we've grown for so long: safety valves and buffers

How has poor little Oz managed to keep our economy growing continuously for 25 years while, in the same period, other economies have suffered a recession or even two? We've had good insurance policies.

That's the answer the new Reserve Bank governor, Dr Philip Lowe, gave in a speech this week. As he explains it, however, it's a detailed story.

Actually, there are two parts to his explanation for our economic success: the first is our good "fundamentals" and the second is our ability to ride out the various "economic shocks" that hit every economy from time to time.

Lowe lists our good fundamentals as including our abundance of natural resources, our well-educated workforce, our "generally favourable demographics" (I think he means our growing population and that our ageing population isn't too aged), our openness to international trade and investment, our links with the fast-growing Asian region, and our demonstrated ability to reform the structure of our economy to boost its productivity.

Lowe adds that the reforms of the 1980s and '90s have given us a more flexible economy, one better able to roll with the punches than it used to be. He nominates three key areas of greater flexibility: our exchange rate, our conduct of monetary policy and our labour market.

Since we allowed our dollar to float in 1983, it has generally moved up or down in response to developments in ways that tend to limit inflation pressure and to stabilise growth.

Since we decided in the mid-1990s to let the central bank - rather than the politicians - make decisions about when to increase or decrease interest rates, as guided by the target of keeping inflation between 2 and 3 per cent on average over the medium term, we've kept the inflation rate reasonably stable and minimised swings in unemployment.

Since we ended the centralised wage-fixing system and moved to collective bargaining at the enterprise level in the first half of the 1990s, we've avoided wage inflation, kept real wages rising in line with improvements in productivity (until recently, anyway) and made employers less inclined to respond to downturns with mass layoffs.

These great areas of flexibility - the floating exchange rate, the independent, target-based approach to monetary policy (interest rates), and enterprise-based wage-fixing - have helped us avoid being derailed by economic shocks.

And it's not as if there's been a shortage of such shocks that could have derailed us, Lowe says.

First, there was the Asian financial crisis of 1997-98, which did derail some of our Asian trading partners. Then there was the bust of the US tech boom - the Tech Wreck of 2001 - then the global financial crisis of 2008-09.

 As well, there's the resources boom. With its once-in-a-century surge and then collapse in coal and iron ore prices and consequent surge and falloff in mining construction, the resources boom was a massive, decade-long shock to our economy.

Australia's economic history is littered with commodity booms soon leading to recessions, but not this one (except in Western Australia, thanks to mismanagement by its state government).

But all that's just by way of background. Lowe's main point is to draw attention to the way our possession of certain "buffers" absorbs some of the blow when shocks hit.

We build up and hold these buffers as a kind of insurance policy against the day when trouble arises. Like all insurance policies, they come at a cost. There's a premium to be paid.

So where do you find these buffers? On the balance sheets of banks, governments and households. They're about ensuring your assets exceed your liabilities by a decent safety margin, in case some unexpected problem arises.

In the years leading up to the global financial crisis, our banks maintained higher ratios - of their shareholders' capital to their lending to borrowers - than did banks in America and Europe.

That's why our banks were able to keep lending after the crisis, whereas the others weren't. Their inability to keep lending amplified the original shock.

In the years since then, international authorities have imposed higher levels of capital adequacy and liquidity on the world's banks, including ours.

These greater restrictions make banks safer, but also reduce their profitability. We're still waiting to see how the cost of this insurance premium will be shared between our banks' customers and their shareholders.

At the time of the financial crisis, our government had "positive net debt" - it had more money in the bank than it owed to people holding its bonds.

This made it a lot easier for our government to support the economy by borrowing and spending. Now, Lowe argues, we need to gradually move the budget from deficit back to surplus, rebuilding our fiscal buffer for the next time it's needed.

The total debts of our households have risen to 185 per cent of their annual disposable income. This is a lot higher than for other rich countries, but that's partly because unusual distortions in our tax system encourage borrowing for rental properties to be done by individuals rather than big companies.

More to the point, households have been building up buffers by using mortgage offset and redraw facilities to reduce their net debt by 17 per cent of the gross debt, in the process getting a collective 2½ years ahead of their scheduled repayments.

More than half of all households with mortgage debt, at each level of income, are ahead on their repayments.

If you subtract from our households' debt all the money they hold in currency and bank deposits, the nation's households' net debt falls to about 100 per cent of their annual disposable income.

Our household debt is high, but we've got a fair bit of buffer.

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Go to ex-bureaucrats' blogs for the good oil on policy

Dr Ken Henry, a former Treasury secretary, says he can't recall a time when the debate about public policies has been poorer. I can't either, and I guess the dreaded MSM - mainstream media - is part of the problem.

But if the challenge of digital disruption has tempted the mainstream to devote more time to political colour and movement and less to debating government policies, there's one respect in which the internet has made things better.

The advent of blogging has given anyone who wants to the ability to air their thoughts to the world. A lot of blogs come under the heading of you're-entitled-to-your-opinion, but sometimes they're written by people who know a lot more about the topic than most of us and have a valuable contribution to make.

That's particularly true when academics take to blogging. One of the earliest bloggers about economic policy  was Professor John Quiggin, of Queensland University. Other high quality Australian blogsites are Club Troppo, Core Economics and, for the more libertarian, Catallaxy Files. (There was a blog called Ross Gittins, Corrected but they seem to have given up.)

The best academic blogsite is undoubtedly the uni-sponsored The Conversation. To have all those academics writing short, timely, readable pieces in their area of specialty is an invaluable contribution to the policy debate.

And then there's the blog of the former bureaucrat John Menadue, called Pearls and Irritations. Menadue brings in other contributors, and his blog is the place to go to see ex-bureaucrats casting a critical eye over present government policy.

These guys know where the bodies are buried, and no one sees through the political smoke and mirrors  more easily than they do.

Earlier this year Menadue teamed up with the former econocrat Dr Mike Keating to instigate a special series on the many challenges facing the government today, called Fairness, Opportunity and Security, with a wide range of contributions from ex-bureaucrats (including Stephen Fitzgerald, David Charles, Andrew Podger and Jon Stanford), academics (including Michael Wesley, Ian Marsh, Ian McAuley and Julianne Schultz) and academics who've spent time in government (including Ross Garnaut, Glenn Withers and Stuart Harris).

Now Menadue and Keating have turned the series into a book of the same name, published by AFT Press, which they asked me to launch last week. It covers 13 topics ranging from the role of government to the economy, foreign policy, health, the environment and Indigenous affairs.

In his discussion of the way vested interests seem to have excessive influence over policymaking, Menadue notes the remarkable rise of the lobbying industry, estimating there are now more than 1000 lobbyists operating in Canberra.

"The health 'debate' is really between the minister and the Australian Medical Association, the Australian Pharmacy Guild, Medicines Australia and the private health insurance companies," he writes.

"The debate is not with the public about health policy and strategy; it is about how the minister and the department manage the vested interests."

Menadue says much of the policy skills in Canberra departments have been downgraded and policy work is contracted out to accounting and consultancy firms. Policy work within the government is now undertaken more in specialist organisation such as the Productivity Commission.

"Departmental policy capability has been seriously eroded. That is the real story behind the problems of the pink batts scheme."

As for the "inexperienced and young ministerial staffers", they're "much more likely to listen to vested interests".

On foreign affairs and internal security, the blog collection says we've become overdependent on the United States at the expense of our relations in our region. As Paul Keating once said, we should be "finding our security in, not from, Asia".

In dealing with the threat from terrorism, "a balance needs to be struck between national security and the freedoms essential for a civil society, including the humane treatment of refugees. The politicisation of security has arguably made us less safe."

On Medicare we're told it "has stood the test of time but it now represents the single biggest budgetary challenge and it is over 30 years since it has been seriously reviewed and reformed".

On superannuation, Andrew Podger, former head of various government departments and now a professor at the Australian National University's Crawford School of Public Policy, makes a plea for considered and balanced reform rather than piecemeal tinkering.

You'll go a long way before you find someone providing a more authoritative, independent and sensible commentary on budget repair and other fiscal matters than Mike Keating, former head of the Finance department and Prime Minister's and Cabinet.

In this book he has hardheaded things to say about the dream of lower taxation, which "has been embraced by all political parties without any evidence that, given our already low starting point, less taxation will in fact lead to higher economic growth, let alone pay for itself".

He quotes John Howard saying that tax cuts should be considered only "after you have met all the necessary and socially desirable expenditures".

All the evidence is that these spending demands, even if efficiently funded, are most unlikely to be fiscally sustainable without a modest increase in taxation relative to gross domestic product.

"Indeed, Australia already has lower taxation than almost any other advanced nation, but we aim to provide the same level of public services and welfare as the others," he writes.

"Thus the biggest challenge facing modern governments is the gap between expectations on them and their capacity to deliver.

"In these circumstances, encouraging unrealistic expectations of tax cuts is only making government more difficult."

Reading this collection of blogs leaves you with the impression the good bureaucratic advice our successive governments have needed to do a better job of running the country now resides outside the public service, in the minds of the retired bureaucrats who're from the days when they were expected to know about policy.

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GITTINS the book: sneak preview II

Why did an accountant who'd forgotten most of the economics he was supposed to have learnt at uni and never really learnt to be a reporter, go from cadet journalist to economics editor in four years?

Because he had the immense good fortune to be in the right place at the right time.

I joined the Herald just as the startling policies of the Whitlam government and the global economic disruption of the first OPEC oil price shock were convincing the nation's editors that the biggest part of politics was economics, and that they needed to run a lot more stories about the economy and needed more journalists proficient in economics to do it.

The oil price shock of December 1973 happened to make my first year at the Herald, 1974, a watershed in the global economic history of the 20th century.

It proved to be the last year of the almost 30-year postwar Golden Age of strong and steady growth in all the developed countries, with low inflation, full employment and ever-rising living standards and a narrowing gap between rich and poor.

The oil shock wrong-footed Western governments and brought to light the hitherto unknown problem of "stagflation" – simultaneously high unemployment and inflation.

The advent of stagflation caused a loss of confidence in traditional Keynesian macro-economic management, which could deal with either high inflation or high unemployment, but not both at the same time. In the search for an alternative, many turned to "monetarism" - controlling the growth in the supply of money.

I became an economic journalist when the battle between Keynesians and monetarists was at its height. It turned out that through much of the monetarist criticism of Keynesianism had merit – money did matter, as the monetarists had argued – the rest was mumbo jumbo.

Money-supply targeting wasn't the magic answer promised. It didn't even work. Even so, the main instrument for managing the ups and downs of the economy was switched from fiscal policy (the budget) to monetary policy (interest rates).

Another solution to stagflation was "incomes policy" – direct control over wages, other incomes and prices. Its Australian version came late in the form of the Hawke-Keating government's "accord" with the union movement.

It took until the mid-1990s to get inflation down to the 2 or 3 per cent that had pertained during the Golden Age.

Dr Don Stammer, a veteran business economist, says you need to have seen four recessions before you're fully qualified. I thought the global financial crisis of 2008-09 would bring my fourth, but if you don't count that – I count it as a potentially severe recession turned into a mild one by remarkably skilful management – I've seen three big ones.

The recession of 1974-5 would by the itself have caused the Whitlam government's defeat had there not been more than enough other reasons.

The severe recession of the early 1980s brought the Fraser government's reign to an end after just seven years and the severe recession we didn't have to have in the early 1990s – in the sense that all recessions happen by accident rather than design – finally did for the perpetrator of that bravado in 1996, although Paul Keating's execution was delayed three years by the inexperience of a former economics professor, Dr John Hewson.

Feel free to write this on my tombstone: "he never fell for the line that economists had finally conquered the business cycle". You only had to live through the Keynesians' humiliation in the world recession of 1974-75 to be permanently cured of such hubris. I soon formed the view that recessions occurred roughly every seven years.

I know from the three recessions that have occurred so far "on my watch" – each of them accurately branded "the worst since the Great Depression" - how terrible recessions are: the fear and pain they cause to small business people, workers who lose their jobs and young people who have the misfortune to be leaving school or university at the time.

In 40 years I've been around for 13 federal treasurers. The Whitlam government's Frank Crean was my first. I was too junior to get to know him, which was a pity. I liked him because he reminded me of my father. I had little to do with Dr Jim Cairns and didn't get to know Bill Hayden until he was in opposition.

After the Fraser government arrived I didn't get to know rubbery Phil Lynch, but John Howard was a different matter.

Keating was an assiduous worker of gallery journalists, who learnt much of his economics from [former Australian Financial Review editor] Max Walsh until Treasury took over. I was seen as to partial to him and his policies, but that was because I invariably agreed with them – rationalism with a human face. Our greatest treasurer, with daylight second.

His successor, John Kerin, did a more-Keating-than-Keating impression. With a degree in agricultural economics, Kerin was far better qualified than most treasurers, so I thought it terribly unjust when the TV news bulletins hounded him from office by repeatedly playing a clip of him forgetting that GOS stood for gross operating surplus. None of his righteous accusers would have known that.

John Dawkins was competent but tetchy. Ralph Willis was well qualified academically, but terribly reserved.

Peter Costello had two counts against me: I was from Sydney and, like virtually all journos, I was biased against him politically. It's true I criticised him on more issues than I supported him.

But though I backed him vigorously on some unpopular measures, it would never have crossed his mind that my criticism arose from our differing values, not from partisanship.

Once, his press secretary decided to give me the treatment regularly dished out to gallery reporters who'd incurred his displeasure by inviting all economic journalists to some function except me.

I couldn't believe he could be so incompetent. Gallery reporters had no choice but to cop such treatment in silence, but as a columnist in Sydney, I had nothing to lose and everything to gain by making it public. Normally I resist the temptation to go for cheap cheers, but this time I opted for a little self-publicity.

I kept it up for two weeks until the call came through from Costello. "I'm sorry to shock you, Ross, but I didn't actually read the column you say I took offence at." Etcetera. It was as close to a conciliatory call as Costello could get, so I too was conciliatory.

People kept telling me Costello was bright but lazy, but a treasurer who didn't read my columns? I believed him.

Costello's greatest achievements were his carriage of the goods and services tax and his reform of the prudential supervision of the financial system, which kept our banks out of trouble in the GFC. The notion that he's up there with Keating as a reformer is partisan propaganda.

Wayne Swan fell short of either of them. The truth is I feel a bit guilty about Swan. I let my liking for the man stop me from writing what I thought: that he was too weak to be treasurer. He wasn't brave enough on the reform front nor tough enough in controlling government spending and he couldn't sell ice-creams on a hot day at the beach.

When he was succeeded by Chris Bowen my first thought was regret that I'd neglected to take up opportunities to get to know Bowen better. But thinking about my problem with Swan I decided I was better off not getting to like these guys and so being freer to judge them on their merits.

I know Joe Hockey well enough to know he's a likable guy – and to expect him to see more easily than Costello that, with me, he'll win some and lose some – so that's close enough.

My experience watching the bad, indifferent and good management of our economy over the past 40 years has left me sure of one thing: Malcolm Fraser may have lacked the resolve to live up to it, but his slogan "Fight Inflation First" is dead right.

Part of the policy debate between Keynesians and their opponents rested on the belief that Keynesians cared most about unemployment because they worried about people at the bottom, whereas conservatives carried most about inflation because it diminished the wealth of the rich.

In one of his first speeches as [Reserve Bank] governor Bernie Fraser demolished that neat dichotomy by pointing out inflation actually hurt the poor more than the rich because the poor were unable to afford the expert advice needed to protect themselves from – even benefit from – the effects of inflation. Negatively geared investment in property or shares is a classic instance of benefiting from inflation.

If you force me to choose which is the greater evil, inflation or unemployment, there's no shadow of doubt in my mind: unemployment wins. But the choice we have to make – and the relationship between those two evils – is more subtle than that.

To me, if you care about achieving low unemployment in anything but the short term, you start by fixing inflation and keep it fixed, so you can then grow the economy at a steady but healthy rate and thus grind down unemployment and keep it low for as long as possible.

That describes how we've managed our economy over the past 20 years. In the preceding 20 years governments pursuing the alternative strategy of fighting unemployment first would rev up the economy after ever recession, soon bringing inflation back up and thus sowing the seeds of the next bust.

Edited extract from Gittins, by Ross Gittins (Allen & Unwin), out this week.

Ten reforms that transformed Australia

1. Floating the dollar

2. Deregulating the banks

3. New taxes on capital gains and fringe benefits

4. Removing import protection

5. Privatising government businesses

6. Enterprise bargaining

7. National competition policy

8. Central bank independence

9. Goods and services tax

10. Taxes on mining and carbon


My five worst predictions

1. Expecting the severe recession of the early 1990s to be a "soft landing".

2. Doubting the move from centralised wage-fixing to enterprise bargaining would be an improvement

3. Saying the US authorities were right to allow Lehman Brothers to fail in September 2008

4. Expecting Australia to be caught up in the subsequent Great Recession

5. Failing to foresee the adverse social effects of micro-economic reform


The best of 13 treasurers

1. Paul Keating. By a country mile. He instigated the sweeping reforms that transformed the economy and laid the groundwork for better day-to-day management of it. He made the economy less inflation-prone and more flexible, thus able to reduce unemployment faster.

2. Peter Costello. Greatest achievement was to free the Reserve Bank to change interest rates as it saw necessary, meaning the economy is now  managed more by econocrats than politicians. He also ensured our banks were tightly supervised while the Americans were letting theirs create so much havoc.

3. Wayne Swan. Despite his failings he deserves a spot on the treasurers' honour board purely for his surprisingly deft handling of stimulus spending and human confidence in the wake of the global financial crisis, ensuring we suffered only the mildest of recessions.

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