(Image: Tom Red/Private Media)

In the space of less than 24 hours, the two key narratives around the economy have shifted dramatically.

At 11.29am yesterday, expectations around monetary policy reflected that a burst of inflation was coming and either the Reserve Bank would look through it and stick to its plan to keep interests at near-zero until 2024, or that this burst of inflation was a harbinger of a resurgence of inflation around the world stoked by irresponsible central banks and profligate governments providing too much stimulus, and the only responsible course for the Reserve Bank was to expedite its tightening of monetary policy before too much damage was done.

Expectations around fiscal policy were a kind of photographic negative: the government was planning to significantly tighten fiscal policy, a course of action most economists worried would pull the rug out from under the strong recovery we’ve enjoyed so far. A few, ultra-hawkish types think governments have spent too much already and further fiscal stimulus is damaging (they point to the Biden administration as the worst example).

At 11.30am the monetary policy narrative was wiped out, and a few hours later Josh Frydenberg was dropping to friendly journalists his plan to abandon plans for a dramatic tightening of fiscal policy in favour of supporting the recovery.

The Australian Bureau of Statistics’ CPI number came in below expectations — sufficiently that the RBA might even be disappointed that, despite the recovery going strongly and employment falling much more quickly than expected, inflationary pressures remain subdued.

CPI rose just 0.6% in the March quarter after a 0.9% rise in the December quarter. The market had been expecting a repeat of 0.9%, reflecting both a strong recovery and rising input costs. The annual rate for the year to March was 1.1%, up from 0.9% in the December quarter.

The key underlying inflation measures favoured by the Reserve Bank tell that story with the lowest annual growth rate on record for the trimmed mean — just 1.1%. The weighted median, the other core measure, was up 1.3% over the year. They suggest there is little businesses can do to recover rises in input costs.

Waiting, waiting…

According to some commentators, the numbers put paid to the RBA bringing forward any rate cuts. But as the RBA has said to the point of tedium, it was never going to do anything other than wait until wages growth was sufficiently strong that CPI was sustainably up into its target band.

“This would require significant gains in employment and a return to a tight labour market,” the RBA said in its most recent board minutes. “The board does not expect these conditions to be met until 2024 at the earliest.”

Part of the RBA’s thinking was what kind of fiscal policy it would have to work with: was the government going to stick to its plan to begin fiscal consolidation and the long path back to surplus now, given unemployment was well below its target level of 6%?

The economic consensus outside a few superhawks is that fiscal consolidation now would mean that the recovery would sputter out later in the year as all those savings accumulated during lockdown were expended and we returned to pre-pandemic economic normality — which for Australia is growth of barely over 2%. Many of us have been urging the government to avoid the error the Europeans and the Americans made after the financial crisis — starting fiscal consolidation too soon — which cost millions of jobs.

Now the treasurer has said this morning what he told a number of outlets he would say, overnight — that the government won’t be trying to slash the deficit, but instead aim to get unemployment down closer to the kind of level the RBA wants — below 5%, and hopefully below 4.5%, with a slower deficit reduction process.

Three cheers to the government on that — it made the right call last year to support the economy with historic fiscal stimulus and if this is reflected in the budget in May, that will be the right call too.

Conveniently, that also coincides with the government’s political interests — something strangely absent from the commentary on Frydenberg’s drop overnight — given the government is currently trailing in the polls when every other government in the country is streets ahead on the back of our successful handling of the pandemic.

It might get even better if the government aims spending at some significant productivity, human capital and participation measures — such as reducing childcare-related disincentives for women to work, or addressing our aged care workforce challenges. That would hit the trifecta of good macroeconomic policy, good microeconomic policy and good politics.

On the other hand, the government still believes it’s good policy and good politics to keep suppressing wages through industrial relations policies, opposition to minimum-wage rises and punishing public servants. Wouldn’t it be strange if its war on wages ended up undermining its fiscal policy aim of supporting the recovery. Does Josh Frydenberg’s economic flexibility extend to understanding that?