Led on by crusading Reserve Bank governors, the nations economists are determined to protect us from the scourge of inflation, no matter the cost in jobs lost.

But theres a black hole in their thinking about the causes of inflation, only some of which must be stamped on. Others can be ignored. Meanwhile, heres another sermon demanding the government act to raise productivity.

In your naivety, you may think that inflation is caused by businesses putting up their prices. But economists know thats not the problem. Businesses raise their prices only in response to market forces. When demand for their products exceeds the supply, businesses seize the chance to raise their prices. In your ignorance, you may think they do this out of greed, a desire to increase shareholder value at the expense of their customers. But thats the wrong way to look at it.

In raising their prices, businesses arent being opportunistic, theyre doing what comes naturally, playing their allotted role in allowing the price mechanism to bring demand and supply back into balance. As balance is restored, the price will fall back, pretty much to where it was before. What? You hadnt noticed? Funny that, neither had I.

No, what causes prices to keep rising at a rapid rate is when the greedy workers and their unions force businesses to increase their wages in line with the rise in the cost of living. Cant the fools see that this merely perpetuates the rapid rise in prices?

So, what we need to get inflation down quickly is for workers to take it on the chin. They can have a bit of a pay rise say, 2.5 per cent but nothing more, especially when theres been no increase in the productivity of their labour.

This will cut the workers real incomes and lower their standard of living, of course, but that cant be helped. Its the only way we can make them stop spending as much, so businesses wont be able to get away with continuing to raise their prices by more than 2.5 per cent.

But cutting real wages probably wont be enough to stop businesses raising their prices so high, so well need to raise interest rates andreallyput the squeeze on workers with big mortgages. Sorry, nothing else we could do.

Another worry is our return to full employment. If the demand for labour exceeds its supply, that would allow the suppliers of labour (workers) to raisetheirprices (wages) and that would never do. Indeed, our history-based calculations say the unemployment rate has already fallen below the level that causes wage and price inflation to take off. It hasnt yet, but it will.

But not to worry. As incoming Reserve Bank governor Michele Bullock explained in a speech extolling full employment, the Reserve estimates it should be necessary to raise the rate of unemployment by only 1 percentage point to 4.5 per cent to get inflation back down to where we want it.

What! Cried the punters in stunned amazement. To get inflation down, you will put about 140,000 workers out of work? How could you be so inhuman?

What stunned and amazed the nations economists is that anyone should be surprised or offended by this. Dont they know thats the way we always do it? And 140,000 would be getting off lightly.

Just so. When, as now, the Reserve Bank and the government accidentally overstimulate the economy, allowing businesses to increase their prices by more than they need to, what we always do to stop businesses raising their prices is bash up their customers until the fall-off in households spending caused partly by people losing their jobs makes it impossible for businesses to keep increasing their prices.

Problem solved. Standard practice is to stop businesses opportunism (rent-seeking as economists say) by bashing up their workers and customers until the businesses desist.

But what never happens is that thelevelof prices falls back to about where it was before the econocrats stuffed up as the economists price mechanism theory promises it will.

Why doesnt the theory work? Because whats required to make it work is intense competition between many small firms. When one firm decides to raise its prices and fatten its profit margin, the others undercut it and it either pulls its head in or it goes out backwards.

In the real world, industries are increasingly dominated by just a few huge firms firms that have become so mainly by taking over their smaller competitors. This is true in all the rich economies, but none more so than ours. Economists know oligopolies form because its easier for a few big firms to gain a degree of control over the prices they charge (whereas the price mechanism theory assumes theyre too small to have any control).

The few big players compete on marketing and advertising, and using minor product differentiation, but never on price. When prices rise, they rise together and they rarely come back down.

Economists know all this its knowledge gained and taught by economists but its classed as microeconomics, whereas the econocrats seeking to manage the economy and keep inflation low specialise in macroeconomics. And they never join the dots though thats changing in other countries. This year the European Central Bank, the IMF and the OECD have delved into the national accounts and determined that rising profit margins explain a high proportion of the recent inflation surge.

But when the Australia Institute replicated this analysis for Australia, both Treasury and the Reserve Bank used dodgy graphs and dubious arguments to dismiss its work as flawed.

Entrenched inflation emerged as a problem in the 1970s. After much debate, the worlds economists decided the problem was caused by powerful unions, whose expectations of continuing high inflation caused a wage-price spiral, which could be broken only by using high interest rates to put the economy into recession.

This is the thinking weve had full strength from the Reserve for the past year or more. Since the 1970s, however, multiple developments have weakened union bargaining power, while decades of takeovers have increased our big businesses pricing power without the econocrats noticing.

And despite their sermons about the need for governments to increase national productivity, its never occurred to them that the primary driver of productivity improvement is intense competition between businesses.

The calls by successive heads of the ACCC for stronger powers to block mergers that would substantially lessen competition have gained no support from the Reserve, Treasury or economists generally. But we wont fix inflation until we have stronger laws defending competition.

First published in The Sydney Morning Herald August 21, 2023