Government has lowered expectations on labour market success

The cash rate is 3.5% right now.  The market is expecting it to rise to 5% by next November.  That is six 25 basis point increases over the next year.  Each time rates rise, the media will wheel out those individuals who are doing it tough as a result of the rates rise.  This is political Chinese torture for any government.

It is not clear what other choices the RBA governor Glenn Stevens can make.  The preferred RBA inflation measure has risen above the target band of between 2%-3% and has remained above that band since September 2007.  Despite the high levels of underlying inflation, given the state of the global economy many (including myself) have argued that domestic interest rates were too high in 2008.  Once the extent of the economic crisis became evident, the RBA moved quickly to reduce rates.

It is now clear that the global financial crisis has had a mild effect on the Australian economy and the "Go early, go hard, go household" advice to government was inappropriate.  The economy did not collapse as forecast;  unemployment did not rise to 8.5%, or even 6.75%.  The Mid-Year Economic and Fiscal Outlook (MYEFO) invites us to believe that unemployment will still rise another 1%.

In its panic the government has over-stimulated the economy and that fiscal mistake is going to have adverse consequences.  It seems that some minor aspects of the stimulus packages are being recalibrated and delayed and so on.  But that just highlights that the packages were not timely, targeted and temporary.  Some of the temporary spending is now delayed for two years.

The bottom line is that interest rates will have to rise quickly to constrain inflation.  At the same time the government is finding that borrowing costs are somewhat higher than they had expected.  This is adding to the government interest bill even as the government is telling us that debt won't be as high as we had thought.  That translates into us paying more for less money.  We shouldn't be surprised;  government spending routinely delivers less bang for buck than was promised.

The real problem is that the government won't come clean.  Rather than cut the spending the now, it still maintains the myth of "jobs being saved or supported".  Just because the government can imagine a world where unemployment rose dramatically, that doesn't mean that its actions did or could have saved any jobs.  It is obviously hoping that nobody will question its counter-factual.  What is damning, however, is that it has very quietly lowered expectations as to labour market success.  The MYEFO indicates that Australia has a natural rate of unemployment of 5% (that is the non-accelerating inflation rate of unemployment for the cognoscenti).  With unemployment now only at 5.7%, it shouldn't take long before the government can claim to have solved the problem.

The government is also fudging the crowding-out aspects of its policies.  With interest rates rising and the exchange rate appreciating some, perhaps much, displacement is likely to occur.  Yet the government is quoting Glenn Stevens as having suggested that this is not due to fiscal policy.  Stevens, of course, is not in a position to openly criticise fiscal policy;  his actions will be speaking louder than his words over the next year.

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