On 12 February the Assistant Governor of the Reserve Bank of Australia, Sarah Hunter, gave an important speech on the relationship between the labour market and inflation. This speech suggests the RBA has re-thought its position and has partially gone back to an earlier orthodoxy, but in so doing it now holds untenable positions on such issues as the natural rate of unemployment. We first need a quick potted history of post-war macroeconomic thinking in Australia.
In the early post war period, a version of Keynesian economics reigned supreme. This model recognized that capitalist economies are inherently unstable and policy involved the management of aggregate demand so as to maintain full employment with low inflation. For many years unemployment was under 2% in Australia and when it went over that in 1961 the long-lived Menzies Coalition Government was reduced to a majority of one seat at the subsequent federal election.
The Phillips Curve, named after its inventor, AW Phillips of the London School of Economics at the time, was influential in positing a stable tradeoff between inflation and unemployment. This provided policy makers with an apparent choice between lower inflation or lower unemployment. For example, suppose say 3% unemployment was associated with 5% inflation, policy makers would read that from the Phillips Curve and then use aggregate demand to achieve that outcome.



