A troubling economic scenario

This post builds on a discussion from earlier this month on what ails the Australian economy and what our governments can do about it. But before getting into that, I want to point out that the economic situation is not quite as bad as people are making it out to be: the unemployment rate is 4.0%; inflation has cooled (but is still far too high); mortgage stress is falling; real household incomes are where they were pre-pandemic; and a large part of the ongoing GDP per capita recession is due to temporary statistical quirks, making it a misleading indicator for what the average Australian is feeling right now.

But that doesn't mean it couldn't be better. Real growth truly has plateaued, largely due to a long-term lack of reform at all levels of government, the unwinding of the most recent mining boom, and the growing share of non-market activity in the economy. It all adds up to stagnant productivity growth (zero since 2016), which is the key ingredient for improving long-run living standards. Basically, we are where we are today because of decisions made (or not made) by this and previous governments going back to at least John Howard.

The great Adam Smith once observed that there's a lot of ruin in a nation, meaning that countries can endure significant economic mismanagement before reaching a crisis point. In Australia, the amount of ruin really took off when then pandemic hit and former PM Scott Morrison, with the support of the Reserve Bank of Australia (RBA), decided to run the economy hot. Rather than wind back the pandemic-period's extensive government spending, the Albanese government has instead embarked on its own big government adventure.

While it has done some good – e.g. its pharmacy reforms and ongoing attempt to restore the National Competition Policy – it has blown most of its political capital on gimmicks like several billion dollars worth of debt-financed "cost of living" handouts, imposing social media age limits, Build to Rent/Help to Buy, student debt relief and childcare subsidies for the relatively well-off, and its refusal to legalise the safest, most reliable form of clean energy that we know of: nuclear.

Then who could forget its revival of the policy failures of the 50s, 60s, and 70s in the form of a Future Made in Australia, along with an increase in its spending share of the economy to an all-time high 26.5%, with a projected 5.7% increase in real spending this financial year alone.

But it's not all the Albanese government's fault.

Running it hot

While Scott Morrison and his then-Treasurer Josh Frydenberg deserve their fair share of the blame for where Australia's macro economy is at today, they certainly weren't alone in their decision to run the economy too hot. In fact, most advanced economies around the world did pretty much the same thing, which US commentators dubbed "run it hot economics" at the time. Inspired by the fringe Modern Monetary Theory or MMT movement, it ended how orthodox economics predicted it would:

"On the fiscal side, extravagant spending greatly increased government indebtedness. On the monetary side, running the printing press to keep interest rates low flooded financial markets with liquidity. The predictable result was too much money chasing too few goods — the classic recipe for dollar depreciation, better known as inflation."

In Australia, the demand surge caused by fiscal and monetary stimulus is clearly visible in the national accounts:

I asked Claude what might be going on in a country where the Gross National Expenditure Implicit Price Deflator (GNEIP) – a crude measure of inflation that captures the average price changes across all goods and services, so cannot be as easily manipulated by government policy like the Consumer Price Index (CPI) – is growing at 3.6%, while real GDP is 0.8% and real GDP per capita is -1.5%.

It said that taken together, such data "paints a troubling economic scenario":

"This combination of low real growth and high price increases is particularly challenging because it suggests the economy is not generating additional value, but prices are rising significantly. This can lead to reduced living standards, decreased business investment, and overall economic stress.

It's a red flag for economic policymakers, indicating a need for careful economic management to address both the low growth and high inflation simultaneously."

I think that gets to the problem of the Albanese government. Did it cause the mess? Not entirely; plenty of damage was done by the (now) opposition. But it has done very little to fix it, and plenty to worsen it. It's essentially making the same mistakes Joe Biden's government made with its "continued fiscal follies":