.

  • 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

VIDEO: Michelle Grattan on the family law inquiry - and the UN climate change summit

University of Canberra Deputy Vice-Chancellor Leigh Sullivan discusses Scott Morrison’s new family law inquiry with Michelle Grattan. They also speak of the developments in the Tamil family from...

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

Climate explained: why don't we have electric aircraft?

CC BY-ND Climate Explained is a collaboration between The Conversation, Stuff and the New Zealand Science Media Centre to answer your questions about climate change. If yo...

Dries Verstraete, Senior Lecturer in Aerospace Design and Propulsion, University of Sydney - avatar Dries Verstraete, Senior Lecturer in Aerospace Design and Propulsion, University of Sydney

Be excellent: how ancient virtues can guide our responses to the climate crisis

What would Socrates say about coal mining? Or recycling? www.shutterstock.comAs world chiefs and youth leaders gather in New York at the United Nations Climate Action Summit, many of us as individua...

Roger Crisp, Professorial Fellow, Dianoia Institute of Philosophy, Australian Catholic University - avatar Roger Crisp, Professorial Fellow, Dianoia Institute of Philosophy, Australian Catholic University

A shot of hope in the face of climate despair

We have a path forward through climate change. Ellie Barr/Unsplash, CC BY-SAHope, like a slinky, springs eternal. While rage, fear and disgust are all appropriate responses to the realities of climate...

Madeleine De Gabriele, Deputy Editor: Energy + Environment - avatar Madeleine De Gabriele, Deputy Editor: Energy + Environment

It's safest to avoid e-cigarettes altogether – unless vaping is helping you quit smoking

The recent vaping-related deaths in the US have brought the issue into the spotlight around the world. From shutterstock.comHealth authorities in the United States are investigating 530 cases of lung ...

Coral Gartner, Associate Professor, School of Public Health, The University of Queensland - avatar Coral Gartner, Associate Professor, School of Public Health, The University of Queensland

What is the charge of concealment of birth and why is it still happening in Australia?

There has been a long history of women being charged with, and prosecuted for, concealment of birth both within WA and the rest of Australia. ShutterstockIn August, a 24-year-old woman appeared before...

Amanda Gardiner, Lecturer, Edith Cowan University - avatar Amanda Gardiner, Lecturer, Edith Cowan University

We want to learn about climate change from weather presenters, not politicians

Melbourne's ABC weather presenter Paul Higgins discussing a trend towards warmer April days. ABC/MCCCRHOne of the great paradoxes of climate change communication in Australia is that politicians comma...

David Holmes, Director, Climate Change Communication Research Hub, Monash University - avatar David Holmes, Director, Climate Change Communication Research Hub, Monash University

Another stolen generation looms unless Indigenous women fleeing violence can find safe housing

In Western Australia more than half the children placed in state care are Aboriginal. The state government committed this month to reducing this over-representation, in a move that parallels the Closi...

Kyllie Cripps, Scientia Felllow and Senior Lecturer, Faculty of Law UNSW Sydney, UNSW - avatar Kyllie Cripps, Scientia Felllow and Senior Lecturer, Faculty of Law UNSW Sydney, UNSW

Ignoring young people's climate change fears is a recipe for anxiety

This story is part of Covering Climate Now, a global collaboration of more than 250 news outlets to strengthen coverage of the climate story. Thousands of school students across Australia are expecte...

Rachael Sharman, Senior Lecturer in Psychology, University of the Sunshine Coast - avatar Rachael Sharman, Senior Lecturer in Psychology, University of the Sunshine Coast

Friday essay: on the ending of a friendship

Shutterstock Friendship is an incomparable, immeasurable boon to me, and a source of life — not metaphorically but literally. -Simone Weil About eight years ago, I went to dinner with a de...

Kevin John Brophy, Emeritus Professor of Creative writing, University of Melbourne - avatar Kevin John Brophy, Emeritus Professor of Creative writing, University of Melbourne

We don't need another inquiry into family law – we need action

Over the next 12 months, a joint parliamentary committee will examine Australia’s family law system. It will be led by conservative Liberal MP Kevin Andrews and One Nation leader Pauline Hanson...

Miranda Kaye, Senior Lecturer, Faculty of Law, University of Technology Sydney - avatar Miranda Kaye, Senior Lecturer, Faculty of Law, University of Technology Sydney

Procurement’s role in climate change: putting government money where policy needs to go

Governments can choose to spend money in ways that support climate change policy, including a shift to electric vehicle fleets. from www.shutterstock.com, CC BY-NDThis story is part of Covering Climat...

Barbara Allen, Senior Lecturer in Public Management, Victoria University of Wellington - avatar Barbara Allen, Senior Lecturer in Public Management, Victoria University of Wellington

Why do men have nipples?

Men have nipples because of a quirk in how embryos develop. But that's only part of the story of this seemingly redundant body part. from www.shutterstock.comWomen’s nipples have long been a sou...

Michelle Moscova, Senior Lecturer in Anatomy, UNSW - avatar Michelle Moscova, Senior Lecturer in Anatomy, UNSW

Your brain has 'landmarks' that drive neural traffic and help you make hard decisions

The human brain has an estimated 100 billion neurons and 100 trillion neural connections. shutterstockBrain regions exchange information by sending and receiving signals through a network of nerve co...

Caio Seguin, PhD candidate, University of Melbourne - avatar Caio Seguin, PhD candidate, University of Melbourne

It's Newstart pay rise day. You're in line for 24 cents, which is peanuts

The extra 24 cents per day can buy an extra 36 peanuts per day, more if you buy in bulk. ShutterstockNewstart recipients and other Australians on benefits get their half-yearly pay rise today (and als...

Peter Martin., Visiting Fellow, Crawford School of Public Policy, Australian National University - avatar Peter Martin., Visiting Fellow, Crawford School of Public Policy, Australian National University

The big budget question is why the surplus wasn't big

Treasurer Josh Frydenberg and Finance Minister Mathias Cormann unveil a budget outcome as good as balanced on Thursday. Lukas Coch/AAPThe budget was for practical purposes in neither deficit nor in su...

Warren Hogan, Industry Professor, University of Technology Sydney - avatar Warren Hogan, Industry Professor, University of Technology Sydney

Vital Signs: NBN's new price plans are too little, too late

Lack of speed kills: finally NBN Co is thinking about a genuinely 21st century offering for customers. www.shutterstock.comThis week NBN Co announced pricing changes for the National Broadband Network...

Richard Holden, Professor of Economics, UNSW - avatar Richard Holden, Professor of Economics, UNSW

Grattan on Friday: Morrison government solid on industrial relations reform but bootlicks One Nation on family law

John Howard is remembered by his Liberal tribe as a reformer, but his legacy is mixed. The GST has endured but he essentially doomed his government when he let his ideological obsession with industria...

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

How rising temperatures affect our health

The first half of 2019 is the equal hottest on record and summer is set to be a scorcher. Chayathorn Lertpanyaroj/ShutterstockThis story is part of Covering Climate Now, a global collaboration of more...

Liz Hanna, Honorary Senior Fellow, Australian National University - avatar Liz Hanna, Honorary Senior Fellow, Australian National University

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

Yvonne Allen: Eight ways to super impress someone on a first date

According to Yvonne Allen well known relationship mentor, psychologist and matchmaker, a first dat...

Picking The Right Crystal Yoni Egg: Tips And Instructions

When you are ready to pick your own crystal yoni egg, you need to decide what you will use it for...

Top 5 Tips for Paddleboarding In Whitewater

Paddleboarding can be relaxing as well as intense. If you occasionally want to do something differen...

3 Most Promising Career Occupations for Graduates in 2019

Studying in college is a great adventure which opens up lots of career opportunities. Yet, at times...