Facts are smashing the government, not the RBA

The government’s low-key campaign to influence RBA decisions on interest rates flared into open conflict this week. The Treasurer vented his clearly-rising frustration that the RBA won’t just agree the government’s economic management has been sound and do what he wants: cut interest rates.

This challenge to RBA independence should be resisted. Not because the RBA is perfect — it clearly isn’t — but because the critics are factually wrong and the alternative policy prescriptions will likely make things worse.

At issue is whether or not the government should curtail its spending plans to assist in the fight against inflation. The government has tried to have its cake and eat it too, insisting that its agenda was boosting growth and raising wages all while bringing inflation down.

While circumstantial evidence seems to be building up in contradiction these claims, it goes beyond the circumstantial. The government’s explanation for the causes and effects of inflation is fundamentally wrong.

In a recent paper, Government Spending and Inflation, economist Robert Carling pointed to the national accounts released by the Australian Bureau of Statistics on Wednesday, noting they confirm the contribution government spending is making to inflation.

The government continues to insist its accounting tricks with power bills and elsewhere mean that it is reducing inflation. However, all this is doing is fudging the measurement of inflation.

This should be self-evident. If giving everyone $1,000 to spend would be inflationary — and there are few who would contend otherwise — why would government paying $1,000 off everyone’s bills suddenly reduce inflation?

Nor should we forget the impact of COVID stimulus.

Massive government transfer payments to the private sector during the pandemic — although temporary — over-compensated for lost income. These payments did not directly increase final demand at the time; but the money did not disappear.

Once the pandemic restrictions were removed, and consumers spent more freely in 2022 and 2023, their effect on inflation became much more apparent.

This does not mean the current inflationary episode is being driven by the private sector. Indeed, the national accounts show again that the strength of aggregate demand is coming from the public sector, not the private sector.

The recent accounts data therefore reinforce the correctness of the Reserve Bank’s interpretation: the high level of aggregate demand relative to the economy’s potential output is the fundamental cause of persistent inflation.

And that means government is contributing to the problem, not the solution.

This is deeply unwelcome news to many who see this stoush with the RBA as an important battle towards shifting economic thinking as a whole.

Many on the progressive side of politics and economics openly celebrated the achievement of 3% unemployment as evidence of what the government could do in the economy with its spending, notwithstanding the explosion of inflation this created.

Moreover, there has been plenty of support for the government’s preferred approach of rate cuts; despite high inflation from prominent left leaning economists, including former Labor Minister Craig Emerson and Professor John Quiggin from University of Queensland.

At the risk of overgeneralising the position, it seems to be driven by a greater focus on the employment and wage effects of aggregate demand management, with a corresponding dismissal or relegation of inflation to almost a secondary consideration.

Regardless of the arguments for or against the RBA focus on returning inflation to target, if the government wants to change the focus it should do it through the policy process if it wants to. After all it has the power to change the RBA mandate if it wishes.

It should not get a free pass to castigate the RBA publicly for refusing to disregard its mandate, simply because it would be politically convenient for the government if the RBA did so.

Further, any open discussion of these issues would lay bare the downsides and trade-offs of any change. You know… the ones the government furiously asserts are not currently happening in the face of the evidence to the contrary: like sustained inflation and low growth.

If active government intervention in the economy is your political goal, it becomes very important to minimise or challenge institutions and individuals pointing out the downside of this intervention.

Whatever preference the Treasurer has on inflation targeting, it is clear he believes there should be a fundamental shift of the government to the centre of the economy.

We should be careful to avoid pejoratives like ‘socialism’ to describe this thinking: Chalmers’ philosophy has little in common with traditional socialism. The government doesn’t want to own everything, it just wants to be acknowledged and deferred to, because it earnestly believes it is ‘the smartest people in the room’.

The progressive vision for the economy is much like a children’s sport team where the government is both the umpire and the coach. They clearly ‘know’ much more than the players and are expected to take a more active role not just in enforcing the rules but in directing the play.

In this analogy, the players will always have less agency. The government has the broader vision and ‘knows best’. Any push back from the players is met with instant hostility.

In an economy oriented around free markets, the role of government is much more akin to the umpire in professional football. This means enforcing the rules among players who treat the umpire with respect (ideally) but likely have any equally clear understanding of the rules.

The players are adults with full agency.

Ultimately, that is the choice to be made in so many areas of politics and economics. Do we embrace agency, even where the choices may not be ‘optimal’? Or do we trust the government to decide not only what to do but also to validate the evidence of its success or failure?

Simon Cowan is Research Director and Robert Carling is Senior Fellow at the Centre for Independent Studies.

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