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Lower interest rates underpinned by market reform

By Corin McCarthy - posted Thursday, 3 December 2009

There is a significant opportunity for Prime Minister Kevin Rudd to start reforming water and infrastructure policy and announce a staged stimulus withdrawal at the Council of Australian Governments on December 7.

With strong signs of growth from the private sector, Prime Minister Rudd can shift away from the “magic pudding economy”, where stimulus growth is “created” through government spending, to an agenda of long-term productive prosperity.

Only the best allocation of resources in an economy can deliver low inflation and strong growth in reasonably buoyant labour markets without elevated interest rates. With more buoyant labour markets than commentators expected, Rudd may put elevated interest rates on the dinner table if he doesn’t act soon.


We need COAG to place markets at the heart of the future economic model. It needs to focus on removing impediments to market led growth and structural adjustment for better-allocated water and a lower carbon economy with a higher population.

This will allow the economy to best allocate resources to the most productive tasks. Without this, Rudd’s “productivity agenda” is at best treading water.

The Productivity Commission has already warned the government that the current policy settings on industrial relations, industry assistance and infrastructure across both tiers of government could potentially make inflationary pressures worse if government decisions further misallocate resources in the economy.

Therefore COAG should be discussing scaling back the stimulus package agreed in February. When COAG agreed to a $42 billion stimulus package, at that time, no one expected that global growth would perform as well as it has in 2009.

Good policy would now respond to this change in expectations and move forward only with those parts of the building program that pass cost-benefit tests and are likely to relieve inflation pressures. This could involve halting a substantial proportion of the school hall stimulus program.

Gary Banks, Chair of the Productivity Commission put it simply in a recent speech, that poorly conceived or executed infrastructure projects imposed a double burden on the economy, with future generations having to service higher debts from incomes that are lower than they would otherwise be.


If some stimulus is still required, the obvious candidate is for the states to slash payroll tax. The commonwealth could pay the states and territories for revenue forgone from reducing payroll tax. The scale and length of the package could depend on the amount that Treasury advises is needed to underpin the recovery among businesses and the willingness of states to contribute. The expansionary effects of such a tax cut should be paid for by reducing the generosity of family payments to high income households.

The government must now ensure the economy allows for the allocation of resources to their most productive use.

Reserve Bank Governor Glenn Stevens says: “Some spare capacity [in the economy] does exist and will do so for a little while, which is why we think underlying inflation will probably come down a little more in the period ahead. But it does underline the importance of adding to supply, not just to demand, during the medium term, and of maximising the productivity of the factors of production that already exist, if we are to have the sort of growth that brings prosperity.”

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About the Author

Corin McCarthy was an adviser in opposition and government to Craig Emerson MP. He also advised Labor’s 2007 election campaign on small business issues. He has written widely on these issues in The Australian and On Line Opinion. He currently works as a lawyer in London advising on major infrastructure projects. These views are his own.

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All articles by Corin McCarthy

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