.

  • Written by Gabriele Gratton, Associate Professor of Economics and Scientia Fellow, UNSW
Our standard economic model says when labour is scarce, the cost of labour should increase. But something is broken. This is not happening. www.shutterstock.com

Exactly two weeks before the Reserve Bank of Australia cut interest rates to a record low, the bank’s head, Philip Lowe, outlined a predicament to the Economic Society of Australia.

It is a global problem, in fact – and one no one really understands or knows how to fix. It is almost the exact opposite of the crisis that faced industrialised economies in the 1970s.

Four decades ago economies were hit by two malaises: on the one hand, stagnation, with unemployment rates high and rising; and on the other rampant inflation, with prices and wages growing ever faster.

Stagnation and inflation were not meant to occur at the same time. That they did so challenged to the core the post-Keynesian economic orthodoxy of the times. It was so baffling economists gave it a new term: stagflation.

“Today,” said Lowe, “the picture is very different: we have low unemployment and low inflation.”

No one has given it a name, and Lowe says it is better than stagflation, but it’s still a worry. For one thing, if wages fail to rise as the cost of assets such as housing keeps growing, we end up with greater inequality.

“Understanding why this has happened is a priority for us,” Lowe said.

Quite so. Experience shows the perils of seeking to fix something without knowing why it is broken. It can lead to a Kafkaesque outcome.

Against the law (of supply and demand)

Standard supply and demand curves. Paweł Zdziarski /Wikimedia, CC BY-NC

The driving force behind any macroeconomic reasoning is the law of supply and demand. In short, if the supply of something increases, but demand does not, those trying to sell it will make discounts, and its price will go down. Conversely, if demand for something increases but supply does not, wannabe buyers will outbid each other to secure the good, and its price will go up (as illustrated right).

Given this basic law of economics, the combination of low unemployment and no wage growth baffles economists.

Low unemployment means labour is in high demand and excess labour (people looking for jobs) scarce. That should mean that employers need to offer more money to attract employees. So we would expect low unemployment to always be accompanied by an increase in the price of labour (the wage).

This relationship was first outlined by the New Zealand economist A.W. (Bill) Phillips in a paper published in 1958. Below is his original scatter diagram showing the relationship between unemployment and the rate of change of wage rates in Britain from 1861 to 1913.


Bill Phillips’ original scatter diagram of the rate of change of wage rates and the unemployment rate in Britain for the years 1861 to 1913. A.W. Phillips, The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957

This relationship, now known as the Phillips curve, forms the basis for monetary policy – the use of interest rates to control money supply.

When unemployment is high, central banks like the Reserve Bank of Australia lower interest rates to make borrowing easier. This results in greater spending in things like building a home or starting a business. Such investment increases the demand for labour.

Conversely, when unemployment is very low and wages start to grow out of control, the Reserve Bank will lift interest rates to make borrowing harder. This dampens economic activity and the demand for labour.

Bent, possibly broken

But somehow in recent times the Philips curve appears broken, and nobody knows why.

Australia’s reserve bank has been sitting on record low interest rates for three years, and yet nothing at all has happened to wages and inflation.

There are competing theories. One is that automation is to blame, by reducing the value of human labour. Others involve political changes, market concentration and the gig economy undercutting workers’ bargaining power.

Nobody knows which theory, if any, is right.

This should not come as a surprise. After all, it took economists and policy makers almost a decade to make sense of the 1970s stagnation.

But if circumstances take a dive, and people start demanding that something be done, we have a problem.

We don’t yet know what should be done. As Lowe told the Economic Society of Australia:

“We are still searching for the full answers… We can’t be sure how long these effects will last and whether the coexistence of low inflation and low unemployment is temporary, or whether it is a new normal.”

Translation: he is not really sure what we should do, but the situation is bad enough to try to do something.

If the Reserve Bank can’t fix the problem, economic commentators and the public will look to the government, perhaps through spending more, or reducing taxes.

Under pressure from a public demand for action, the danger is that politicians may take shots in the dark and deliver the wrong type of change.

Learning from Italy

The Italian experience in this regard is particularly instructive. It’s something that I and three Italian colleagues (Luigi Guiso, Claudio Michelacci and Massimo Morelli) have documented.

Political instability, strong pressure for reforms and short-lived governments have shifted Italy towards a Kafkaesque state where the bureaucracy wastes its time on frequently useless reforms.

Though Italy has a reputation as a land of eternal disorganisation, in the early 1990s its productivity was greater than Germany’s. On the downside, youth unemployment was high, and political corruption widespread. Voters demanded change.

Politicians responded with zeal. After 1992, the Italian parliament doubled the number of bills it passed each year, with new laws three times as long as old laws.

Within just a few election cycles new reforms began contradicting reforms passed a year or two earlier. Governments routinely attributed failures to previous governments and reforms. Voters lost track of who did what.

Nobody knew exactly what to do to solve the economic problems, and nobody knew how to evaluate the effect of individual reforms, because it was impossible to distinguish the effects of one reform from another.

In this new chaotic environment, incompetent politicians thrived, proposing ever more ambitious reforms – all useless.

Public infrastructure projects were started but never completed (647 of them, last time anybody counted). New education programs have been introduced, only to be replaced by a newer programs; the high-school examination system is this year going through its third major overhaul in just 21 years. The failure to deliver essential services have buried city streets in piles of garbage.

The Italian experience is a warning tale for us all: when organisations change too much and too often, we lose the ability to track down results and ultimately generate chaos. This is even more true for the largest and most complex organisation of all – the state.

Gabriele Gratton has received funding from the Australian Research Council.

Authors: Gabriele Gratton, Associate Professor of Economics and Scientia Fellow, UNSW

Read more http://theconversation.com/our-economic-model-looks-broken-but-trying-to-fix-it-could-be-a-disaster-118397

An 8-year-old made US$22 million on YouTube, but most social media influencers are like unpaid interns

A whopping 12% of the population aged 13 to 38 consider themselves social influencers, according to marketing company Morning Consult. www.shutterstock.comLike any eight-year-old, Ryan Kaji loves to p...

Dr Natalya Saldanha, Academic, RMIT University - avatar Dr Natalya Saldanha, Academic, RMIT University

Domestic violence will spike in the bushfire aftermath, and governments can no longer ignore it

Over the past two weeks, bushfires have raged across New South Wales and Queensland. While the narrative appears focused on potential causes and political point-scoring, what’s lost in this disc...

Rowena Maguire, Senior Lecturer, Faculty of Law, Institute for Future Environments, Queensland University of Technology - avatar Rowena Maguire, Senior Lecturer, Faculty of Law, Institute for Future Environments, Queensland University of Technology

The main problem with virtual reality? It's almost as humdrum as real life

Virtual horse racing, at a real racecourse? Zero points for imagination. Rachel Grey/AAP ImageJust a few years ago, virtual reality (VR) was being showered with very real money. The industry raised an...

Tomas Trescak, Senior Lecturer in Intelligent Systems, Western Sydney University - avatar Tomas Trescak, Senior Lecturer in Intelligent Systems, Western Sydney University

Children learn through play – it shouldn’t stop at preschool

Over the next few weeks, many preschoolers will meet their foundation teachers, spend some time in a classroom and hopefully make some new friends. from shutterstock.comThe transition from preschool t...

Kate Noble, Education Policy Fellow, Mitchell Institute, Victoria University - avatar Kate Noble, Education Policy Fellow, Mitchell Institute, Victoria University

GOD save us: greenspace-oriented development could make higher density attractive

The lure of suburbia clearly remains strong. To deal with sprawl, planners need to increase urban density in a way that resonates with the leafy green qualities of suburbia that residents value. Juli...

Julian Bolleter, Deputy Director, Australian Urban Design Research Centre, University of Western Australia - avatar Julian Bolleter, Deputy Director, Australian Urban Design Research Centre, University of Western Australia

Re-imagining a museum of our First Nations

The Quandamooka Art, Museum and Performance Institute offers a new way of considering the shape of First Nations museums in Australia. Cox Architecture/QYACIndigenous voices are finally being ackno...

Kieran Wong, Adjunct Senior Research Fellow, Monash University - avatar Kieran Wong, Adjunct Senior Research Fellow, Monash University

Making sense of menopausal hormone therapy means understanding the benefits as well as the risks

Grappling with the pros and cons of menopausal hormone therapy can be confusing. From shutterstock.comAt menopause, a woman’s ovaries lose their reproductive function. Eggs are no longer release...

Susan Davis, Chair of Women's Health, Monash University - avatar Susan Davis, Chair of Women's Health, Monash University

What are the best bed sheets

Looking for new bedsheets? With so much choice on the market, finding the best bed sheets can be a challenge – but when you’re between the sheets for so many hours, it’s important to get it ri...

Digital 360 - avatar Digital 360

6 Groovy ‘70s Costume Ideas to Help You Stand Out at Your Next Retro Party

In the early 1970’s Vogue magazine famously proclaimed, “There are no rules in the fashion game now.” Indeed, by following in the footsteps of the ‘60s – defying old traditions and exp...

Digital 360 - avatar Digital 360

Chinese embassy says Liberal critics Hastie and Paterson should “repent”

The Chinese embassy has lashed out at two Liberal members of parliament, Andrew Hastie and James Paterson, saying they would need to “repent and redress their mistakes” before they would b...

Michelle Grattan, Professorial Fellow, University of Canberra - avatar Michelle Grattan, Professorial Fellow, University of Canberra

VIDEO: Michelle Grattan on the government's response to the bushfires

University of Canberra Deputy Vice-Chancellor Professor Geoff Crisp discusses the the week in politics the government’s response to the bush fires as well as the Emergency Leaders for Climate Ac...

Michelle Grattan, Professorial Fellow, University of Canberra - avatar Michelle Grattan, Professorial Fellow, University of Canberra

Conditions built into Frydenberg's okay for Chinese baby formula takeover

Bellamy’s will have to have to manufacture in Victoria and keep its Australian headquarters for ten years. Bellamy’s AustraliaThe proposed acquisition of infant formula producer Bellamy&rs...

Michelle Grattan, Professorial Fellow, University of Canberra - avatar Michelle Grattan, Professorial Fellow, University of Canberra

Outdoor Lighting Solutions – How to Make the Right Choice?

Whether it’s your patio, your deck, your porch, or your backyard – your outdoor space needs to be illuminated properly if you want your entire property to look good. This is also a way to boos...

Diana Smith - avatar Diana Smith

Climate change: why Sweden's central bank dumped Australian bonds

Sweden's central bank ways it will no longer invest in assets from governments with large climate footprints, even if the yields were high. ShutterstockWhat’s happening? Suddenly, at the level...

John Hawkins, Assistant professor, University of Canberra - avatar John Hawkins, Assistant professor, University of Canberra

The Conversation Yearbook 2019: celebrate with us and grab your discounted copy

The Conversation's Deputy Health Editor, Phoebe Roth, and Assistant Editor: Technology, Noor Gillani, agree this is the must-have read of 2019. Wes Mountain/The ConversationA little bit of authority ...

Molly Glassey, Digital Editor, The Conversation - avatar Molly Glassey, Digital Editor, The Conversation

Place your bets: will banning illegal offshore sites really help kick our gambling habit?

While total gambling spending in Australia decreased during 2016-17, sports betting increased by 15.3%, from A$921 million to A$1.062 billion. SHUTTERSTOCKThe Australian Communications and Media Auth...

Charles Livingstone, Associate Professor, School of Public Health and Preventive Medicine, Monash University - avatar Charles Livingstone, Associate Professor, School of Public Health and Preventive Medicine, Monash University

Stop the world, I want to get off! In Exit Strategies, one woman leaves and leaves again

The script for Exit Strategies was developed by performer Mish Grigor during an artist’s residency in the UK, against the backdrop of Brexit. Bryony JacksonTo perform an exit is not as simple as...

Sandra D'urso, Researcher, The Australian Centre, University of Melbourne - avatar Sandra D'urso, Researcher, The Australian Centre, University of Melbourne

Sri Lanka election: will the country see a return to strongman politics?

Gotabaya Rajapaksa, the frontrunner in Sri Lanka's presidential election, faces a lawsuit in the US for alleged extrajudicial killing and torture. M.A. Pushpa Kumara/EPASri Lanka’s presidential ...

Niro Kandasamy, Tutor, University of Melbourne - avatar Niro Kandasamy, Tutor, University of Melbourne

Is social media damaging to children and teens? We asked five experts

They need to have it to fit in, but social media is probably doing teens more harm than good. from www.shutterstock.comIf you have kids, chances are you’ve worried about their presence on socia...

Alexandra Hansen, Chief of Staff, The Conversation - avatar Alexandra Hansen, Chief of Staff, The Conversation

Sick and Tired of Your Dead End Job? Try Teaching!

Tired of the same old grind at the office? Want an opportunity to impact lives both in your community and around the world? Do you love to travel and have new experiences? Teaching English is the perfect job for you! All you need is a willingness to ...

News Company - avatar News Company

The Impact of an Aging Population in Australia

There’s an issue on the horizon that Australia needs to prepare for. The portion of elderly citizens that make up the country’s overall population is increasing, and we might not have the infrastructure in place to support this. Australians h...

News Company - avatar News Company

LifeStyle

How to Make Your Girlfriend’s Birthday Extra Special

Your girlfriend’s birthday is your opportunity to show her how much you care. But how exactly do...

A Guide to Building Your Kid’s Confidence

As your child grows, confidence is key. Having low self-esteem as a child can have a detrimental e...

3 Hacks that Will Extend the Life of Your Hair Extensions

Everybody has the right to enjoy beautiful, long hair, including you! If you’ve always heard a...

Lessons in Empathy for Children

The ability to be able to understand and share the feelings of a fellow human being – empathy ...