It will take time to get used to living with the new virus

The coronavirus is deadly – it will end up killing quite a few oldies – but we (and the rest of the world) are making so much fuss about it mainly because it’s new. Thanks to that fuss, it’s likely to do more damage to the economy than it does to life and limb.

How much damage we do to the economy – and whether it lasts a few months or a few years – will be determined largely by the way Scott Morrison and his ministers manage all the fuss: on the medical side and the economic side.

There’s one sound medical reason for being concerned about the newness of this particular virus: as yet, we have no natural immunity to it. But don’t worry, we’ll get it in due course – although we’ll have calmed down long before that. The “novel coronavirus”, as the medicos call it, will have lost its novelty in a different sense.

The news media are making a great fuss for no reason other than the virus’ newness. New is what news is about. What’s new is unknown and what’s unknown is frightening.

You may think we’re making all this fuss not because the virus is new, but because it’s deadly. But we have daily contact with a lot of deadly things we don’t make a fuss about because we’re used to them.

It could be that road accidents cause more deaths – and certainly more injury – than the virus does this year. And seasonal flu carries off a lot of oldies every year without much fuss. In the end, Sydneysiders decided that the death and injury caused by late-night drinking wasn’t a good enough reason to limit the fun.

One key group who are understandably worried about the virus because of its newness are doctors and other health and aged-care workers. It does matter more if someone in such intense contact with the elderly and the ill gets the virus than if I get it.

But what’s worrying the doctors is how little we yet know about the characteristics of the virus and, more particularly, how little they’ve been told about what to do. Where are the protocols on how to handle patients who present with symptoms? What about face masks and testing kits?

Our surgery or hospital or old people’s home is already stretched, how will we cope with the influx? What will we do if we have to send key workers home for a fortnight because they’ve caught it or may have caught it?

I’m sorry to disillusion you if you haven’t worked it out yet, but the health authorities aren’t trying to stop the spread of the virus. They’re not trying to nip it in bud or stop it in its tracks. The cat’s out of the bag and it’s too late for that.

So what are they trying to do? Just slow down its spread. Why? To give the medical and aged care system time to prepare for the onslaught – including the time to set up separate “fever assessment clinics” where the “worried well” are kept away from those likely to have caught the virus, and away from those known to have.

As the disease spreads to many more people, it won’t be possible to put lots of medical time into tracing the contacts of every particular carrier – nor close a school for a few days while you do it. That is, in the best sense, a delaying tactic.

As Dr Katherine Gibney, of Melbourne’s Peter Doherty Institute for Infection and Immunity, and others, explain on the universities’ The Conversation website, as case numbers rise, case management will need to be streamlined. “While many mild cases have been admitted to hospital during the containment phase, community-based care [that is, staying at home] will be the reality for most people,” they say.

Australia’s Chief Medical Officer, Professor Brendan Murphy, says travel bans are only a way to slow down the spread of the virus. “It is no longer possible” to prevent new cases entering Australia, he says. This suggests that, before long, the border measures will be relaxed.

Last week the NSW Chief Health Officer, Dr Kerry Chant, was blunt: “We are not going to be able to contain this virus.”

Gibney and colleagues say “it’s likely, but not certain, that COVID-19 will remain in circulation beyond 2020 and become ‘endemic’ in Australia – that is, here for good” – like many viruses before it, including seasonal flu. Last season almost 300,000 cases of flu were reported, with 810 deaths – a fatality rate of about 0.27 per cent.

As yet, figures for the coronavirus are preliminary but it’s thought to be much more deadly than the flu, with a fatality rate of 1 or 2 per cent. It’s also more contagious than the flu, though much less so than measles. Its incubation period of two to 14 days is three times longer.

Even so, about 80 per cent of those who get it have a mild to moderate illness and only 20 per cent have a severe to critical illness. Most people who aren’t elderly and don’t have underlying health conditions won’t become critically ill.

Disruption to the economy is unavoidable, but the danger is that hour-by-hour reporting of efforts to slow the spread is frightening a lot of people and will lead them to overreact to the risk of infection, closing businesses and purses and making everything worse than it needs to be.

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Back in Black one minute, loose talk of recession the next

For most of last year, people kept asking me if our slowing economy was headed for recession. I always replied that we weren’t, but that our chronic weakness left us exposed to any adverse shock.

Turns out we’ve been hit by two. According to Treasury’s estimates, the bushfires will subtract 0.2 percentage points from whatever growth we get from other sources in the present March quarter, and the response to the coronavirus outbreak will subtract a further “at least 0.5 percentage points”.

With just three weeks of March quarter left to run, it’s clear the coronavirus response will also subtract from growth in the June quarter. By how much? Showing better judgment and greater experience than his political masters, Treasury secretary Dr Steven Kennedy told Senate Estimates on Thursday that it would be “unhelpful” to speculate. True.

Had he been paying attention – or just been willing to meet the former fire chiefs – Scott Morrison had plenty of reason to expect a bad, economy-damaging bushfire season, but he asks us to put up our hand if we expected the coronavirus. A neat rhetorical trick but, from the leader of a party claiming to be good at managing the economy, not good enough.

The risk of the economy being hit by shocks (good or bad) is always present. We could have had a terrible cyclone up north – or more than one. The US-China trade war could have escalated. And this isn’t the first virus to spread around the world.

Consider this. If you were to contract the coronavirus, in what physical state would you prefer to be at the time – in good health or poor health? It’s the same with economies. The stronger the economy is when the adverse shock hits, the easier it is to contain the disruption and get back on track.

Point is, good economic managers don’t allow the economy to get so weak that, should it be hit by a serious shock, recovery from that shock would be much harder and the risk of it turning into an actual recession much greater.

This helps explain why Reserve Bank governor Dr Philip Lowe has been urging Morrison to use the budget to strengthen the economy for several years, backed up by the International Monetary Fund, the Organisation for Economic Co-operation and Development and many of the nation’s macro-economists.

But no, our headstrong Prime Minister knew better. If he wasn’t prepared to take advice from fire chiefs and climate scientists, why would he listen to economists on a subject which, being a Liberal, he already knew all he needed to know: despite its weakness, the economy can take its chances while we get the budget Back in Black. That will leave us better-placed to respond to a recession once it’s upon us.

Turns out it took the medicos to bring him to his senses. Impose travel bans that decimate most of our services export industries? Yes, doctor, certainly, doctor. So now we’re doing what we said only spendthrift, Keynes-crazed Labor governments do: spending money and, more particularly, cutting tax receipts, to offset the damage the travel bans are doing.

Since the return to surplus is no more, we could use the opportunity to give the economy a much wider stimulus – put money directly into the hands of consumers, for instance – but no. It seems Morrison is still hoping a quick recovery from the virus shock will have the budget back to surplus in time for the next election.

Really? This is where his amateurism is still showing. In principle, the virus is, as Kennedy says, no more than a “short-term shock” from which the economy soon bounces backs. And that’s the right objective for fiscal (budget) policy.

But if that’s your objective, you don’t brief political journalists in ways that encourage them to inform their audience that two successive quarters of contraction in real GDP are likely, which – as God ordained, and every fool knows – equals a recession. Even the usual weasel-word “technical” is missing from these confident assertions.

What’s missing from the government’s – but, if you read them carefully, not its econocrats’ – thinking is an understanding that managing the confidence and expectations of consumers and businesses is half the battle. Animal spirits, as some unmentionable economist once put it.

If you’re trying to ensure that a short-term shock doesn’t become a lasting recession, you don’t encourage the media to make free with the R-word, even though it does help you cover your embarrassment at having claimed we were Back in Black when we weren’t, and now aren’t likely to be for ages.

When is a temporary economic shock a recession? When you listen to your political spin doctors, but not your econocrats.

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Lucky Country has lost its dynamism and can't find where it is

Do you know what economists mean when they talk about the nation’s “economic fundamentals”? I thought I did until I heard what Reserve Bank governor Dr Philip Lowe said they were.

When Lowe had a meeting with Treasurer Josh Frydenberg after last year’s election, I was puzzled by him saying that the economy’s fundamentals were “sound”. How could he say that when the economy had grown by an exceptionally weak 1.8 per cent over the year to March?

But at his appearance before the House of Reps economics committee last week, he had to respond to a challenging description of the state of the economy by Labor’s Dr Andrew Leigh, a former economics professor.

“We have seen declines in labour productivity for the first time on record, the slowest wage growth on record, declining household spending per capita, record household debt, record government debt, below average consumer confidence, retail suffering its worst downturn since 1990 and construction shrinking at its fastest rate since 1999,” Leigh said.

“The economy is in a pretty bad way at the moment, isn’t it?” he asked.

“That wouldn’t be my characterisation,” Lowe responded. “One thing you left out of that list is that a higher share of Australians has jobs than ever before in our history ... ultimately what matters is that people have jobs and employment and security.”

What’s more, “our fundamentals are fantastic”, Lowe went on – but this time he spelt out what he meant.

“We enjoy a standard of living in this country that very few countries in the world enjoy. More of us have jobs than ever before. We live in a fantastic, prosperous wealthy country, and I think we should remember that.”

Well, if that’s what he thinks our fundamentals mean, who could argue? Even if Leigh thought the weaknesses he was outlining were a description of our fundamentals. Maybe Lowe’s fundamentals are more fundamental fundamentals than other people’s are.

Under further questioning from Leigh, however, Lowe said he didn’t want to deny that “we have very significant issues, and the one that worries me most is weak productivity growth ... We’ve had four or five years now where productivity growth has been very weak ... in my own view it’s linked to very low levels of investment relative to gross domestic product.”

This is an important point. As former top econocrat Dr Mike Keating has been saying for some years, you can take a neo-classical, supply-side view that weak productivity improvement explains why the economy’s growth has been so weak (a view that assumes productivity improvement is “exogenous” – it drops on the economy from outside), or you can take a more Keynesian, demand-side view that weak economic growth explains why productivity improvement has been so weak (that is, productivity is “endogenous” – it’s produced inside the economy).

Keating keeps saying that it’s when businesses upgrade their equipment and processes by replacing the old models with the latest, whiz-bang models that improving innovations are diffused throughout the economy, making our industries more productive.

Why is it that our businesses (particularly those other than mining) haven’t been investing much in expanding and improving their businesses? The simple, demand-side answer is that they haven’t been seeing much growth in the demand for their products.

But Lowe sees something deeper. “I fear that our economy is becoming less dynamic [continuously changing and developing],” he told the economics committee. “We’re seeing lower rates of investment, lower rates of business formation, lower rates of people switching jobs, and in some areas lower rates of research-and-development expenditure.

“So right across those metrics it feels like we’re becoming a bit less dynamic. I worry about that for the longer term.

“Public investment is not particularly low at the moment. What is low is private investment. Firms don’t seem to be investing at the same rate that they used to, and I think this is adding to the sense I have that the economy is just less dynamic ...

“There’s something deeper going on, and it’s not just in Australia: it’s everywhere. At the meetings I go to with other central bank governors, this is the kind of thing we talk about. Something’s going on in our economies that means the same dynamism that used to be there isn’t there.”

Asked later by another MP what was causing this loss of dynamism, Low replied, “I wish I knew the answer to that ... My sense is, as an Australian and looking at what’s going on in our economy, that we’re becoming very risk-averse.” (A sentiment I know other top econocrats share.)

“It’s a global thing that happens – I think it probably happens partly when you’re a wealthy country. The standard of living here is fantastic. It’s hardly matched anywhere in the world, so we’ve got something important to protect,” he said.

“But I think in that environment you become more risk-averse. Probably with the ageing of the population, we become more risk-averse. When people have a lot of debt, they’re probably more risk-averse.

Risk-aversion seems to help explain the slow wage growth we’ve had “for six or seven years” now. “It’s the sense of uncertainty and competition that people have, and this is kind of global. Most businesses are worried about competition from globalisation and from technology, and many workers feel that same pressure.

“There are many white-collar jobs in Sydney and Melbourne and Canberra that can be done somewhere else in the world at a lower rate of pay, and many people understand that ...,"Lowe said.

“So the bargaining dynamics ... for workers is less than it used to be. And firms are less inclined to bid up wages to attract workers because they’re worried about their cost base and competition,” he said.

Doesn’t sound too wonderful to me. But not to worry. Just remember, our fundamentals are fabulous.

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RBA should stop pretending there's any more it can usefully do

Every institution – even, as we’ve learnt to our sorrow, the Christian church – is tempted to put its own interests ahead of its duty to the greater good. Now it’s time for the Reserve Bank to examine its own conscience. If it cuts interest rates again in a fortnight’s time, in whose interests will it be acting?

Many of the Reserve’s immediate customers in the financial markets expect it to cut the official interest rate at its meeting early next month and then again a few months later, at which point the rate will be down to its "effective lower bound" – 0.25 per cent – and it will be time for it to move to using purchases of government bonds to lower the risk-free rate of interest more widely in a program of "quantitative easing".

That’s what its market customers expect of it and it will be tempted to comply, showing it’s still at the wheel, in charge of steering the economy, doing all it can to get things moving and keeping itself at the centre of the macro-economic action.

What could be wrong with that? Just that it’s unlikely to do any good, and could do more harm than good. It’s hard to see that yet another tiny interest-rate cut will do anything of consequence to stimulate spending.

Rates are already so exceptionally low it’s clear that it’s not the cost of capital that’s making businesses reluctant to invest in expanding their production capacity. Whatever their reasons for hesitating, cutting rates further won’t change anything.

Moving to households, the record level of household debt does much to discourage them from borrowing to buy goods and services and so boost economic activity. Interest-rate movements mainly affect discretionary spending on household durables (cars, white goods, lounge suites etc), but sales of these are in the doldrums despite already super-low rates. So, again, another cut is unlikely to change that.

In justifying recent rate cuts, the Reserve has relied heavily on the expected consequent fall in our exchange rate, which should stimulate the economy by making our export and import-competing industries more price competitive internationally.

And the reverse is also true: if we leave our rates well above the low levels of the big advanced economies, the dollar will appreciate and make our industries less price competitive. However, that argument’s of little relevance by now, and we shouldn’t be encouraging a beggar-thy-neighbour game of competitive devaluations.

But even if further rate cuts, and quantitative easing after that, will do little to boost demand, surely they couldn’t do any harm? Don’t be too sure of that. They’d hurt those who rely on interest income from financial investments – though bank interest rates could hardly fall any further.

Speaking of banks, the closer interest rates get to the floorboards, the more their profits are squeezed. If you don’t see that as a worry, you should: when lending becomes unprofitable banks become reluctant to lend. Sound good to you?

There may also be some truth in the argument that whereas in normal times news of an interest-rate cut boosts the confidence of consumers and businesses, at times like this they’re a sign the economy isn’t travelling well and new commitments should be delayed.

But here’s the biggest reason further rate cuts would do more harm than good: the clear evidence that, since the cuts began and prudential supervision was relaxed, house prices in Melbourne and Sydney have resumed their upward climb.

This is an appalling development. Getting our households even more heavily indebted is a cheap price to pay for scraping the last bit of monetary stimulus off the bottom of the barrel? Making first-home ownership even more unaffordable for our young people is just something we have to live with?

The one thing we know is that while "monetary policy" has lost its ability to stimulate demand for goods and services, its ability to stimulate demand for assets - such as houses, commercial property and shares - most of it fuelled by rising debt, continues unabated.

When in the 1970s we switched from using the budget to using interest rates to manage demand, we little realised that the serious side-effect of monetary stimulus was rising asset prices and rising debt.

Essentially, Australians buy and sell our houses among ourselves, bidding up the price of that little-changing stock of houses. Then we tell ourselves we’re all getting richer. Why is this anything other than damaging self-delusion? Why should the Reserve Bank be one of its chief promoters?

It’s time for Reserve governor Dr Philip Lowe to stop doing more harm than good and turn the management of demand back to the people we elected to run the economy.

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Living in the post-inflation era turns out to be no fun

It’s Christmas shopping time, when the bills mount up and your money never goes far enough. So how come people are saying the inflation rate should be higher? I thought inflation was meant to be a bad thing?

It’s a good question when one of those people is Reserve Bank governor Dr Philip Lowe. He keeps saying we need to get unemployment lower and inflation back up into the 2 to 3 per cent target range. (At last count the annual rate of increase in consumer prices was "only" 1.7 per cent. I can remember when, for a brief period in the 1970s, it was 17 per cent.)

The short answer is that Lowe doesn’t see higher prices as a good thing in themselves. Rather, he sees them as a means to an end. Or better, as a symptom or by-product of something that is a good thing.

Why do prices rise? Because the demand for goods and services – the desire to purchase them – is growing faster than the supply of them – our businesses’ ability to produce them. So the rate of price inflation is a symptom or sign of strong demand.

And strong demand for goods and services is a good thing because it means the economy is growing and so is employers’ need for workers to help produce more goods and services. Employment increases and unemployment falls.

So Lowe wants to see higher prices simply because they’re a means to the end of lower unemployment. What’s more, increased employer demand for labour relative to its supply makes labour – particularly skilled labour – scarcer and so puts upward pressure on its price, otherwise known as wages.

And, as he’s often said, Lowe would like to see employers paying higher wages than they are, because consumer spending – consumer demand – is so weak at present mainly because wages are hardly growing faster than consumer prices, and real wages are the main thing that drives consumer spending.

All that make sense? Good – because now I’ll give you the more complicated answer. Surely, although strong demand is good for the economy, it would be better if supply was just as strong, meaning we could have growth in jobs and living standards without any inflation?

That makes sense in principle, but not in practice. The managers of the macro economy believe we need some inflation, though not too much. For two reasons. First, though you’ll find this hard to credit, economists are sure our consumer price index (like other countries’ CPIs) overstates inflation.

That’s because the official statisticians are unable to pick up all the cases where prices rise not simply because the firm’s costs have risen, but because the quality of the product has been improved. If so, aiming for a measured inflation rate of zero would require you to crunch the economy hard enough to make actual inflation less than zero – that is, prices would be falling.

The second reason is that sometimes, when the economy is growing too strongly, wages rise too much, prompting firms to lay off workers. Trouble is, workers hate having their wages cut. But if you’ve got a bit of inflation in the system, you can cut wages in real terms simply by skipping an annual pay rise, which workers find less unpalatable.

When the Reserve Bank set its target for inflation in the early 1990s, it settled on 2 to 3 per cent a year ("on average over the medium term"). It thought such a range would overcome both problems and insisted such a target range constituted "practical price stability".

But things in our economy and all the advanced economies have changed a lot since the 1990s. Demand has been chronically weak relative to supply since the global financial crisis and, in consequence, inflation rates have been below-target everywhere.

Some people have suggested we move to a lower, more realistic target range, but Lowe has resisted, arguing that to do so would lower firms’ and workers’ expectations about inflation, making our weak-demand problem even worse. He may be right.

But now try this thought. Inflation is 1.7 per a year, while wages are growing by 2.2 per cent and workers aren’t at all happy. I’ve had several top economists agree with my contention that, if we could wave a magic wand and raise both inflation and wages by, say, 2 percentage points, so that wages were growing by 4.2 per cent, workers would be a lot less discontented.

Why? Because of a phenomenon that economists used to talk about a lot in in the 1960s, but rarely mention today, called "money illusion". People who aren’t economists keep forgetting to allow for inflation. If so, the era of very low inflation isn’t proving to be much fun.

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Weak wages the symptom of our stagnant economy, but why?

If you don’t like the term "secular stagnation" you can follow former Bank of England governor Mervyn King and say that, since the Great Recession of 2008-09, we’ve entered the Great Stagnation and are "stuck in a low-growth trap".

On Friday we saw the latest instalment of our politicians’ and econocrats’ reluctant admission that we’re in the same boat as the other becalmed advanced economies, with publication of the Reserve Bank’s latest downward revisions of its forecasts for economic growth.

This time last year, the Reserve was expecting real growth in gross domestic product of a ripping 3.25 per cent over the present financial year. Now it’s expecting 2.25 per cent. Even that may prove on the high side.

What their eternal optimism implies is our authorities’ belief that the economy’s weakness is largely "cyclical" – temporary. What the past eight years of downward revisions imply, however, is that the problem is mainly "structural" or, as they used to say a century ago, "secular" – long-lasting.

If the weakness is structural, waiting a bit longer won’t see the problem go away. The world’s economists will need to do a lot more researching and thinking to determine the main causes of the change in the structure of the economy and the way it works, and what we should be doing about it.

Apart from dividing problems between cyclical and structural, economists analyse them by viewing them from the perspective of demand and then the perspective of supply.

Obviously, what you’d like is demand and supply pretty much in balance, meaning low inflation and unemployment, with economies growing at a good pace and lifting our material standard of living. In practice, however, it’s not that simple and demand and supply don’t always align the way we’d like.

For about the first 30 years after World War II, the dominant view among economists was that the big problem was keeping demand strong enough to take up the economy’s ever-growing potential supply – its capacity to produce goods and services – and keep workers and factories in "full employment". Keynesian economics was developed to use the budget ("fiscal policy") to ensure demand was always up to the mark.

From about the mid-1970s, however, the advanced economies developed a big problem with inflation. After years of uncertainty and debate, the dominant view emerged that the main problem wasn’t "deficient" demand, it was excessive demand, always threatening to run ahead of the economy’s capacity to produce and thus cause inflation.

The answer was to get supply – potential production – growing faster. Most economists abandoned Keynesian economics and reverted to the former, "neo-classical" macro-economics, in which the central contention was that, over the medium-term, the rate at which an economy grew was determined on the supply side, by the three key determinants of production capacity, "the three Ps" – population, participation (by people in the labour force), and productivity – the rate at which investment in more and better machines and structures allowed workers to produce more per hour than they did before.

If so, the managers of the macro economy could do nothing to change the rate at which the economy grew over the medium term. Their role was simply to ensure that, in the short term, demand neither grew faster than the growth in the economy’s production potential (thus casing inflation) nor slower than potential (thus causing unemployment).

And the best instrument to use to achieve this balancing act was, as Treasury secretary Dr Steven Kennedy explained recently, monetary policy (moving interest rates up and down).

Everyone agrees that the problem with the advanced economies at present – including ours – is weak demand. The question is whether that weakness is mainly cyclical or mainly structural. If it's cyclical, all we have to do is be patient, and the old conventional wisdom - that, fundamentally, growth is supply-determined - doesn’t need changing.

But the conclusion that fits our circumstances better is that the demand problem has structural causes. Consider this: we’ve had plenty of episodes of weak demand in the past, but never has demand been so weak that inflation is negligible. Nominal interest rates are way down in consequence, but even real global interest rates have been falling since even before the financial crisis.

That’s why monetary policy has almost done its dash. It doesn’t do well at a time of negligible inflation, and fiscal policy is back to being the more effective instrument. But if the demand problem is mainly structural, then a burst of stimulus from the budget may help a bit, but won’t get to the heart of the problem.

As former top econocrat Dr Mike Keating has argued consistently, weak growth in real wages seems the main cause of weak growth in consumer spending and, hence, business investment, productivity improvement and overall growth – both in Australia and the other advanced economies.

Reserve Bank governor Dr Philip Lowe would agree. But he tends to see the wage problem as mainly cyclical: wait until we get more growth in employment, then the labour market will tighten, skill shortages will emerge and real wages will be pushed up.

Other economists stick to the supply-side, neo-classical approach: if real wages aren’t growing fast enough it can only be because the productivity of labour isn’t improving fast enough, so the answer is more micro-economic reform. Not a big help, guys.

The unions say the root cause is that deregulation has robbed organised labour of its bargaining power – and there may be something in that. But Keating’s argument has been that skill-biased technological change has hollowed out the semi-skilled middle of the workforce, with wage increases going disproportionately to the high-skilled, who save more of their income than lower-paid workers.

So Keating wants any budget stimulus to be directed towards the lower-paid, and a lot more spending on all levels of education and training, to help workers adopt and adapt to the digital workplace.

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It may upset you to think about climate change and the economy

It’s coming to something when we get so little leadership from the bloke we pay to lead us that the unelected have to fill the vacuum. Now 10 business organisations have united to urge Scott Morrison either to set out the climate policy rules to drive action by the private sector, or end up spending a shedload of taxpayers’ money fixing the problem himself.

It’s not just business that’s dissatisfied. The Morrison government may be dominated by climate-change deniers, but almost all economists accept the science of global warming and believe we should be doing our bit to help limit it.

And though our elected government may be in denial, the Reserve Bank – like other central banks – isn’t. Nor are the Australian Prudential Regulation Authority and the Australian Securities and Investments Commission.

The Queensland Treasurer, Jackie Trad, asked federal Treasurer Josh Frydenberg if the Reserve’s deputy governor, Dr Guy Debelle, could be invited to talk about climate change and the economy at the recent meeting of treasurers, but Frydenberg declined.

So what was it Frydenberg didn’t want his fellow treasurers thinking about? Well, we can get a fair idea of what Debelle would have said from a speech he gave earlier this year.

But first, why do so many economists accept the science? Because they know very little about the science and so accept the advice of the experts, especially since there’s so much agreement between them.

And there’s another reason. Economists believe they can use their expertise to help the community make the changes we need to make with the least amount of cost and disruption to the economy.

As Debelle reminds us, “the economics profession has examined the effects of climate change at least since Nobel Prize winner William Nordhaus in 1977. Since then it has become an area of considerably more active research in the profession. There has been a large body of work around the appropriate design of policies to address climate change (such as the design of carbon pricing mechanisms), but not that much in terms of what it might imply for macro-economic policies” – that is, for efforts to stabilise the macro economy as it moves through the ups and downs of the business cycle.

Debelle says the economy is changing all the time in response to a large number of forces, but few of them have the scale, persistence and risk to the system that climate change has.

Macro economists like to classify the various “shocks” that hit the economy as either positive or negative and as hitting the demand side of the economy or the supply side. For instance, they know a positive demand shock increases production (gross domestic product) and prices. The monetary policy response to such a shock is obvious: you raise interest rates to ensure inflation doesn’t get out of hand.

Shocks involving the climate affect the supply (output) side and are common. An unusually good growing season would be a positive supply shock, whereas a drought or cyclone or flood would be a negative supply shock, reducing output but increasing prices.

This is a trickier shock for monetary policy to respond to because it’s both contractionary (suggesting a cut in interest rates) and inflationary (suggesting higher rates). The Reserve’s usual response is to “look through” (ignore) the price increase, assuming its effect on inflation will be temporary.

Historically, the Reserve has assumed all climate events are temporary, with things soon returning to where they were. That is, they’re cyclical. It’s clear from the reports of the Intergovernmental Panel on Climate Change, however, that climate change is a trend - a lasting change in the structure of the economy, which will build up over many years.

Of course, though climate change’s impact on agriculture continues to be great, it presents significant risks and opportunities for a much broader part of the economy than agriculture.

Debelle says we need to reassess the frequency of climate events and our assumptions about the severity of those events. For example, the insurance industry has recognised that the frequency and severity of tropical cyclones has changed. It has “repriced” how it insures against such events.

Most of us are focused on “mitigating” – reducing – future climate change. But Debelle says we also need to think about how the economy is adapting to the climate change that’s already happened and how we’ll adapt to the further warming that’s coming, even if we do manage to get to zero net emissions before too long.

“The transition path to a less carbon-intensive world is clearly quite different depending on whether it is managed as a gradual process or is abrupt,” he says euphemistically. “The trend changes aren’t likely to be smooth. There is likely to be volatility around the trend, with the potential for damaging outcomes from spikes above the trend.”

Both the physical impact of climate change and the adjustment to a warmer world are likely to have significant economic effects, he says.

Economists know from their experience with reducing import protection that the change from the old arrangements to the new involves adjustment costs to some people (workers who have to find jobs in other industries, for instance) even if most people (consumers of the now-cheaper imports, for instance) are left better off.

Economists press on with advocating such painful changes provided they believe the gains to the winners are sufficient to allow them to compensate the losers and still be ahead. But Debelle admits that, in practice, the compensation to the losers doesn’t always happen, leaving those losers very dissatisfied.

That’s bad enough. But Debelle fears that, with climate change and the move to renewables, the distribution of benefits and costs may be such that the gains to the winners in new renewables industries aren’t great enough to cover the losses to the losers even in principle, let alone in practice.

Nah, all too hard. Let’s just ignore it and hope it goes away.

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Morrison hasn't noticed that economic times have changed

Apparently, if you think Scott Morrison's refusal to use the budget to boost the economy is motivated by an obsession with showing up Labor by delivering a huge budget surplus, you’re quite wrong.

No, he’s sticking to the highest principles of macro-economic management (which principles Reserve Bank governor Dr Philip Lowe doesn’t seem to understand).

We now know this thanks to the first speech of the new secretary to the Treasury, Dr Steven Kennedy, made last week. He explained to Senate Estimates the long-established orthodoxy among macro-economists in the advanced economies that "short-term economic weakness or unsustainably strong growth is best responded to by monetary policy" (interest rates) not fiscal policy (government spending and taxation).

Although the budget’s "automatic stabilisers" shouldn’t be prevented from assisting monetary policy in keeping growth stable, fiscal policy’s medium-term objective was to "deliver sustainable patterns of taxation and government spending".

Temporary fiscal actions should be taken only in "periods of crisis", which would be uncommon.

Now, I have to tell you Kennedy isn’t making these rules up. They did become orthodoxy in advanced-economy treasuries in the 1980s. They’re the reason John Kerin’s budget of 1991, delivered in the depths of "the recession we [didn’t] have to have" contained zero stimulus, meaning the stimulus, when it came in February 1992, came too late.

And it was the lesson he learnt from this stuff-up that prompted former Treasury secretary Dr Ken Henry to urge Kevin Rudd to "go early" after the global financial crisis in 2008.

These rules will have a familiar ring to those of us who each year study the fine print in budget statement 3 on the fiscal strategy. Particularly in the reference to the role of the budget’s automatic stabilisers, you see the fingerprints of Treasury’s leading macro-economist in recent decades, Dr Martin Parkinson.

Which is all very lovely. Just one small problem: the circumstances of the advanced economies – including ours – have changed radically since those rules were establish in the 1980s. They made sense then; they make no sense now.

For a start, how can you say, leave it all to monetary policy, when the official interest rate is almost as low as it can go? Has no one in the Canberra bubble noticed? Or do they imagine a switch from conventional to unconventional monetary policy tools would be seamless and involve no loss of efficacy or adverse consequences?

And since when did the orthodox assignment of roles between fiscal and monetary policies involve monetary policy resorting to unconventional measures?

The diminished effectiveness of monetary policy is a big part of the reason the world’s leading macro-economists have for some time been moving away from the old view that monetary policy was superior to fiscal policy as the main instrument for stabilising demand.

All those reasons are spelt out by Harvard’s Professor Jason Furman – a former chairman of President Obama’s Council of Economic Advisers – in a much-noted paper (summarised by me here). It was written as long ago as 2016, but doesn’t seem yet to have reached the banks of the Molonglo.

If there’s one thing macro economists know it’s that, these days, the economies of the developed world – including ours – don’t work the way they used to in the 1980s, or even before the financial crisis.

Interest rates are at record lows around the developed world not only because inflation is negligible but also because the world neutral real interest rate has been falling for decades and is now lower than it’s ever been.

This is linked to the fact – often referred to by Lowe, but not mentioned by Kennedy - that the supply of loanable funds provided by the world’s savers greatly exceeds the demand to borrow those funds for real investment.

Around the developed world – and in Australia – consumption is weak, business investment is weak, productivity improvement is low and real wage growth is low, while employment growth is stronger than you’d expect in the circumstances. Countries keep revising down their estimates of the "non-accelerating-inflation rate of unemployment" (that is, full employment), but no one really knows just how low it now is.

To give him his due, Kennedy’s speech reveals him to be just as puzzled as the rest of us about why the economy is behaving so differently.

But one thing seems clear: the private sector isn’t generating sufficient demand to get us out of "secular stagnation," so it’s up to the public sector to fill the void. And, sorry, but with monetary policy down for the count, that means using fiscal policy. They're the new, 21st century rules.

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Treasury explains why we shouldn't worry about the economy

There’s a lesson for Scott Morrison in new Treasury secretary Dr Steven Kennedy’s first public speech this week: put the right person at the top of Treasury and they’ll defend the government’s position far more eloquently and persuasively than any politician could. The econocrat’s greater credibility demands they be taken seriously.

I fear that time will show it's been a costly mistake by the government not to respond to Reserve Bank governor Dr Philip Lowe’s unceasing requests for budgetary stimulus to supplement the diminishing effectiveness of interest rate cuts. Costly in terms of lost jobs – perhaps even including the Prime Minister’s.

But that Kennedy’s opening statement at Treasury’s appearance before Senate Estimates is a robust defence of official policy should surprise no one (except politicians, who are prone to paranoia). In my experience, senior Treasury officers never gainsay the government of the day, in public or private. If it’s an independent view you’re after, try the Reserve.

However, since this is the most ably argued exposition of the government’s case for sitting tight, it deserves to be reported in detail.

Kennedy is clearly worried about the threat to us from events in the rest of the world, but is
"cautiously optimistic" that the domestic economy will pick up. According to the government’s long-established "frameworks" for the respective roles of the two policy arms used to manage the macro economy – monetary policy (interest rates) and fiscal policy (the budget) – the heavy lifting is done by monetary policy, with fiscal policy being used only during a crisis. As yet, there’s no crisis.

Over the past year, Kennedy says, global growth has slowed. As a result, the International Monetary Fund and the Organisation for Economic Co-operation and Development now expect world growth this calendar year to be the slowest since the global financial crisis in 2008. Even so, they expect growth next year to improve to about 3 to 3.4 per cent – "which is still reasonable".

Chief among the factors involved are the ongoing and still evolving "trade tensions" between the United States and China. "There is no doubt that trade tensions are having real effects on the global economy, which you see in trade data from the US and China," he says.

Combined with other problems – Brexit, Hong Kong, and concerns about the financial stability of some countries – trade tensions are leading to an increased level of uncertainty around the outlook for the world economy.

Many central banks have responded to slowing global growth by supporting their economies. And South Korea and Thailand have also provided more supportive fiscal policy.

Turning to the domestic economy, it slowed in the second half of last year, then grew more strongly in the first half of this year. This amounted to growth of just 1.4 per cent over the year to June.

Household consumption, the largest part of the economy, grew by 1.4 per cent, held down mainly by weak growth in wages. Linked to this is a fall in home building over the past three quarters, which is likely to continue in the present financial year.

Moving to business investment spending, mining investment fell by almost 12 per cent over the year to June, and non-mining investment was weaker than expected.

But, Kennedy argues, these problems are temporary and "there are reasons to be optimistic about the outlook". Recent figures have shown early signs of recovery in the market for established housing. Overall, capital city house prices have risen for the past three months. Auction clearance rates have picked up and more homes are changing hands.

Consumer spending will be supported by the government’s tax cuts and the Reserve’s three cuts in interest rates.

The substantial investment in mining capacity of past years is boosting exports, and mining investment spending is expected to grow this year rather than contract, as it had been since 2012.

Despite modest growth in the economy, employment has continued to be strong, increasing by more than 300,000 over the past year. The rate of unemployment has been "broadly flat" rather than falling because near-record rates of new people are joining the labour force and getting jobs.

The rate of improvement in the productivity of labour – output per hour worked – has averaged 1.5 per cent a year over the past 30 years, but slowed to just 0.7 per cent a year over the past five. This isn’t as bad as it looks because it’s exactly what arithmetic would lead you to expect when employment is growing faster than output. And even 0.7 per cent is higher than the G7 economies can manage.

Now to the question of whether the government should be applying fiscal stimulus to guard against a recession.

Kennedy says that, in an open economy such as ours, having a medium-term "framework" (set of rules) for the way fiscal policy should be conducted, in concert with a medium-term framework for the way monetary policy should be conducted, "has long been held to be the most effective way to manage the economy through cycles".

Under this view, fiscal policy’s medium-term objective is to deliver sustainable patterns of taxation and government spending [and thus a sustainable level of public debt].  A further objective is usually to minimise the need for taxation, as is the case in Australia.

This approach reflects an assessment that apparent short-term economic weakness or, alternatively, unsustainably strong growth, is best responded to by monetary policy, not fiscal policy.

Within this framework, however, the budget’s in-built "automatic stabilisers" will assist monetary policy in stabilising the economy. For instance, revenue will weaken, and payments will strengthen, when an economy experiences weakness.

The other exception to the rule that fiscal policy should be focused exclusively on achieving sustainable public debt is that there’s a case for "temporary [note that word] fiscal actions" in periods of crisis.

But "the circumstances or crisis that would warrant temporary fiscal responses are uncommon".

So, sorry, Phil. Application denied.

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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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