The big inflation gamble that has failed middle Australia
Like Joe Biden, Jim Chalmers and Steven Kennedy have bet the house on an economic policy dud.
As if we needed it given our own political history, the US election was a stark reminder of the political poison of high inflation. Under Joe Biden’s watch, local prices rose by a cumulative 20 per cent: a punishing regressive tax on middle America’s money wages.
This was never forgotten by American voters.
In the days after Donald Trump’s victory, Betsey Stevenson, a well-connected Democrat economist, said: “The public would have preferred a slower recovery with much higher unemployment, as long as prices had been stable.”
Biden had bet the house on full employment and climate change activism, relegating inflation reduction to an after-thought. It did not pay off.
In Australia, Jim Chalmers and Steven Kennedy – Chalmers’ Treasury secretary, close confidant and a member of the Reserve Bank of Australia board – took exactly the same political gamble in 2022, enlisting newly appointed RBA governor Michele Bullock to their cause in September 2023.
In the face of an inflationary crisis we had not witnessed since the late 1980s, they set out to keep unemployment as low as possible, even if inflation remained higher for longer and did not return to the top of the RBA’s 2-3 per cent target until 2024 or even after the 2025 election.
This gamble has not paid off.
While this story is now familiar, what has yet to be properly understood is why this call was made in the first place.
To answer this question, we need to look at the motivations, assumptions and blind spots of the two principal actors in this tale, Chalmers and Kennedy.
And we need to acknowledge the brutal campaign they waged in 2023 to bring the Reserve Bank, our traditional bulwark against high inflation, to heel.
From the moment he was sworn in as Treasurer, Chalmers made it clear his focus was on maximising employment rather than fighting inflation. (Of course, these two goals are not in conflict across the medium term, but when inflation is too high a short-term choice must be made.)
His objective was not a permanent reduction in unemployment, which requires a more productive, flexible and efficient economy, but to maintain for as long as possible our over-stretched, post-pandemic labour market in which employers were desperately competing for available workers.
He had two aims in mind: to “get wages moving again” and boost the bargaining power of Labor’s paymasters in the trade union movement.
The latter would clear the way for the radical, and inflationary, reregulation of our industrial relations system on which Chalmers and Anthony Albanese were bent.
This was the agenda behind the farcical Jobs and Skills Summit in September 2022, when unemployment was only 3.7 per cent. Voters may well ask: Why wasn’t an inflation summit called?
Chalmers’ political strategy faced no pushback from Treasury, which in the early 1970s did all it could to dissuade Gough Whitlam from fuelling inflation by excessive public spending. Indeed, it was wholeheartedly supported by Kennedy.
Kennedy, in common with a clique of Labor-aligned economists in Canberra – including figures such as Ross Garnaut and Craig Emerson – had adopted a radical Keynesian interpretation of the slow growth rates we saw in developed economies following the global financial crisis. They viewed this as evidence of “secular stagnation”.
Their fear was not inflation, which they confidently assumed had been tamed for all time, but persistent deflation.
Kennedy’s group felt the RBA board kept the cash rate too high in the years before the pandemic, leaving us with – in their view – a needlessly elevated 5 per cent-plus unemployment rate.
They strongly backed pandemic-era stimulus measures – which flooded the economy with cash as fiscal deficits were funded by the RBA (an irresponsible experiment in modern monetary theory) – but failed completely to anticipate the inflationary tsunami they unleashed.
In late 2022, Chalmers and Kennedy were on the same page. Kennedy was entirely comfortable with Chalmers’ desire to test the limits of full employment, even if prolonged inflation was the result.
The biggest potential obstacle they faced was the RBA.
RBA governor Phil Lowe’s seven-year term was due to expire in September 2023. If he had been appointed to a second term – as had been the usual practice in recent decades – I believe he would have fought tooth and nail to get inflation back under control.
After all, he had a badly damaged reputation to repair after having let the inflation genie out of the bottle.
But Chalmers, probably on Kennedy’s advice, decided not to reappoint Lowe. And not happy with that, they determined – at the worst possible time – to turn our entire monetary policy architecture upside down, commissioning a wide-ranging and in my view hostile review of the RBA.
This review delivered them exactly what they wanted. In particular, it recommended that monetary policy give equal weighting to full employment and achieving low and stable inflation – a marked departure from the RBA’s long-time policy of giving primacy to the latter (as the best way to secure sustained full employment).
Under Chalmers’ and Kennedy’s direction, we have seen a complete overhaul of our central bank since late 2023. In rapid succession, Chalmers appointed a new governor and deputy governor; he put in place a new Statement on the Conduct of Monetary Policy, giving far greater emphasis to full employment; and he appointed two former trade unionists to the RBA board, including the former head of the Fair Work Commission. A new RBA chief economist was parachuted in from Kennedy’s department.
Chalmers and Kennedy quickly won the support of Bullock for their full employment gamble.
In June 2023, before her elevation to the governor’s role, Bullock had upset union leaders by saying unemployment would have to rise to help get inflation back to target.
Chalmers’ own union, the Australian Workers Union, was one of Bullock’s most vocal critics.
Once she was in the governor’s seat a few months later, Bullock changed her tune. She now spoke about the “narrow path” she wanted to tread, her goal being to get inflation down in a way that preserved, as much as possible, our pandemic-era employment gains.
In doing so, she had signed up to the Chalmers-Kennedy strategy and parted company with her central bank peers in the developed world, who remained firmly focused on inflation reduction.
If there were any doubt about the RBA doing Chalmers’ bidding, Andrew Hauser (Bullock’s British deputy) put it to rest when he foolishly said in a June 2024 interview: “If there is an opportunity to capture those gains on the employment side, I think we have an obligation to do it and that’s what the Treasurer and that’s what the parliament and that’s what the public of Australia have asked us to do.”
On November 7, 2023, the RBA board raised the cash rate for the 13th time, taking it to its current 4.35 per cent.
When this step was taken, Chalmers, Kennedy and Bullock were no doubt hoping this would be enough to break the back of our inflation – allowing the cash rate to be reduced sometime this year.
But as we know, things did not pan out that way. Since late 2023, our inflation rate has proved to be remarkably, and for all three embarrassingly, stubborn.
By the middle of 2024, it must have been clear to Bullock and her staff that the November 2023 rate increase had failed to deliver the goods.
To add insult to injury, our peer economies – including the US, Britain, Canada and New Zealand – were now starting to cut their official rates. They had adhered to traditional central bank orthodoxy and raised their rates into the fives.
Not surprisingly, public tensions came to the surface between Bullock and Chalmers at this time.
In early September, Chalmers, perhaps concerned that Bullock was leaning towards a possible rate increase, started to tell anyone who was willing to listen that the current cash rate was “smashing” the economy. His mentor Wayne Swan even accused the RBA of “punching itself in the face”.
This pressure has only intensified since. In the lead-up to the RBA’s December board meeting, a public campaign was waged by the union movement, Garnaut and other Labor-aligned economists to browbeat the board into cutting the cash rate. This was orchestrated in my view.
Kennedy’s presence on the RBA board – a glaring governance flaw in our monetary policy arrangements – does not make Bullock’s job any easier. Kennedy and Garnaut are close.
Let’s be absolutely clear: getting inflation under control in 2023 and 2024 did not require a massive increase in unemployment, just a central bank that stuck to its knitting – as every other developed economy central bank did. Neither did it require economic foresight but the simple recognition that it would have been better – as I wrote in these pages in June – to err on the side of the cash rate being a little too high rather than, as we have seen, a little too low.
In any case, if Chalmers and Kennedy wanted to take pressure off the RBA, they could have slowed government spending and reversed damaging energy and industrial relations policies, but they did no such thing. Indeed, the mid-year economic and fiscal outlook confirmed that federal spending will grow by a breakneck 5.7 per cent in real terms this year.
Chalmers, with Kennedy’s public support, has even declared victory over inflation by pointing to the manipulated headline inflation number. Now we are in the endgame. With the labour market still very tight (indeed, the unemployment rate fell to 3.9 per cent in November), the economic case for a pre-election rate cut remains weak in my view. That the board is now signalling a preparedness to take this step is worrying.
Regardless of what it does, when voters cast their ballots next year many millions of them will have the cost of living on their minds. No amount of spin or bribery of the public can erase the fact that prices have risen by 16 per cent across the past three years.
This is the main reason Australian living standards have fallen by 8.7 per cent since the March quarter of 2022 – far outstripping the falls we saw in the 1980s and ’90s and worse than any other OECD economy across this time.
The tragedy is that this was an avoidable economic disaster, a failure of economic leadership and policy advice that may leave us with a lost economic decade.
David Pearl is a former Treasury assistant secretary.
For ABC viewers, reality must come as quite a shock
The Auschwitz fail may be the last straw for our toxic, taxpayer-funded broadcaster and its warped anti-journalism.
Hamas’s kinocide is a unique crime born of unique evil
The images of Naama Levy being dragged into Gaza on October 7 have haunted me. But there is another photo that points to an atrocity we must call for what it is.