Australia’s economy is too hot like it was in the 1970s

The decade and more of cheap money, big fiscal stimulus, dysfunctional climate and energy policies, and lack of investment in productivity has finally caught up.

Energy prices are soaring. Amazingly, a nation richly endowed with coal, gas, uranium used for nuclear power and renewables such as wind and solar is struggling to keep the lights on and has suspended the national electricity market.

It’s an unlucky combination of cold weather, coal-fired power disruptions and sanctions on gas-rich Russia, capped by a failure of carbon pricing to provide certainty for investments in electricity generation and transmission. ‘energy.

too much stimulation

Inflation is out of control and the Governor of the Reserve Bank of Australia, Philip Lowe, estimates that it will reach 7%.

The war involving energy-rich Russia and China’s pandemic lockdowns are the main causes of the price pressures.

But too much stimulus from central banks and governments has gone on too long.

Lowe admits consumer spending is too strong and needs to be curbed by higher borrowing costs.

Central banks are belatedly realizing that they need to take the punch bowl out of the party, as evidenced by the US Federal Reserve raising the interest rate by 0.75 percentage points.

The RBA will likely follow with another 0.5 percentage point hike in July and will need to continue higher thereafter.

The cost of capital will continue to rise for governments, businesses and households – moving through stock markets, pension yields and house prices.

The new Albanian government must join the fight against inflation, to avoid the crisis of stagflation of the 1970s which required years of painful tightening of interest rates.

Overspending

The answer now surely lies in reining in the overspending built into the budget, combined with the repetition of a program of economic reforms à la Bob Hawke and Paul Keating of the 1980s to boost productivity and real wages.

With $18 billion in campaign spending commitments in areas such as childcare, health, education and green energy, the new Labor government will have to cut other spending.

The government may also need to consider removing tax breaks, without hampering incentives for workers to work and businesses to invest, as Treasury Secretary Steven Kennedy has suggested.

The Treasury and the RBA are on a mission to test the achievement of the lofty economic and social goal of full employment.

But they are testing the limits of the inflection point of the Phillips curve, which suggests that at a certain level of unemployment, wages will soar sharply.

Surprisingly, 60,600 additional jobs were created in May. More people were drawn into the job market, as the participation rate reached a record 66.7%.

The combined rate of unemployment and underemployment is the lowest since 1982.

We are flirting with full employment, but that will only be seen in the rear view mirror, when wages rise significantly.

Built-in expectations

The steep 5.2% increase in the Fair Work Commission’s minimum wage and at least 4.6% increase for 2.7 million industry-rewarded workers brings the inflection point closer.

The risk now is that higher wages and inflation expectations become entrenched in the psychology of Australians.

The indexation of wages for civil servants and union members in the 1970s under the Whitlam Labor government reversed the oil price shock, ensuring dire stagflation.

Inflation soared, recession ensued, and rising unemployment lasted for decades.

It took us 48 years to bring unemployment below 4%.

Today, a more flexible labor market and economy, a floating Australian dollar and earlier central bank rate hikes will help avoid the worst of the 1970s.

But the Albanian government and trade unions must also drop their false pretense that workers’ real wages cannot fall.

If inflation reaches 7%, the economy will not be able to cope with a wage increase of more than 7% for minimum wage and paid workers.

It would be economic suicide.

Otherwise, Lowe will have to repeat the harsh medicine of former US Fed Chairman Paul Volcker in the 1980s to crush inflation and remove heat from the economy via crushing rate hikes.

Hopefully we can avoid the feeling of deja vu.

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