Tuesday’s decision tells a tale of misdiagnosis of the causes of the bout of inflation that started in late-2022.

All developed countries experienced a cost-of-living surge in the early 2020s, peaking in Australia at 7.8 per cent in the final months of 2022.

Its main cause was shortages of goods and services created by Covid-19 lockdowns and disruptions to global supply chains.

Monetary authorities around the world sought to suppress inflation by raising official interest rates, reducing demand for these restricted supplies of goods and services.

It was reminiscent of the double-digit inflation and unemployment in the early 1980s following the second oil-price shock of the late-1970s.

Back then it was reasonable to ask – how would jacking up interest rates in Australia reduce the international price of fuel?

The worry at that time was that trade unions would demand wage rises to compensate for higher prices. And they did, successfully, in our centralised wage-fixing system when union membership was high, at 50 per cent of the workforce.

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The Prices and Incomes Accord between the union movement and the Hawke government arrested that wage-price spiral when wage restraint was agreed in exchange for increases in the social wage in the form of Medicare and family payments.

But fast forward to the mid-2020s and our wage-fixing system is largely decentralised with union membership down to about 13 per cent.

Yet the Reserve Bank has repeatedly warned of the prospect of a wage-price spiral reminiscent of the early 1980s, which it has renamed a price-wage spiral.

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The Reserve Bank’s feared post-pandemic price-wage spiral is the economists’ version of the Abominable Snowman – much feared but as yet unsighted.

Having adopted another economists’ notion: The non-accelerating inflation rate of unemployment – or the NAIRU – the Reserve Bank estimated what it has been in Australia.

As its name suggests, the NAIRU is the rate of unemployment consistent with inflation not accelerating.

A few years ago the central bank, using economic modelling, estimated the NAIRU at 5 per cent. Subsequently, it lowered its estimate to 4.5 per cent.

More recently, the Reserve has hinted that it has again re-estimated the NAIRU at 4.25 per cent.

But for more than a year the actual unemployment rate has been about 4 per cent – considerably below the Reserve Bank’s estimated NAIRU.

This should mean that inflation has been accelerating. But it hasn’t.

Instead, the inflation rate has fallen from 7.8 per cent to just 2.4 per cent, in the middle of the Reserve Bank’s target range of 2-3 per cent.

So why did the Reserve Bank board – by a majority of six to three – decide to keep the cash rate on hold?

Is it determined to push unemployment up from 4 per cent to its estimated NAIRU of 4.25 per cent or even higher?

For a clue, we should look at a different concept – the neutral interest rate. This is the Reserve’s cash rate that neither stimulates nor restrains economic growth.

That’s where the Reserve Bank should want the cash rate to be. Any higher and the RBA would be deliberately slowing the economy when there’s no need to do so.

Last November, the Reserve revised down its estimate of the neutral interest rate from 3.6 per cent to 2.9 per cent. Then in May it dropped it again, to 2.7 per cent.

Yet the cash rate following Tuesday’s central bank board decision remains at 3.85 per cent – much higher than its estimate of the neutral rate of 2.7 per cent.

In other words, the Reserve Bank board has adopted a deliberately restrictive monetary policy at a time when inflation has been falling, not rising.  

What is it waiting for? The Trump tariffs to force up consumer prices in America, which they will?

But the main effect of those tariffs will be to slow economic growth around the world. That is, the Trump tariffs will be contractionary, and the RBA’s decision will make matters worse by maintaining a contractionary cash rate here in Australia.

It’s time for the Reserve to put away its economic models and cut interest rates.

Instead, the Reserve Bank wants to slow the Australian economy in anticipation of a wage-price spiral that its models continue to predict but which, like the Abominable Snowman, hasn’t shown up.  

Craig Emerson is executive director of the APEC Study Centre at RMIT University, CEO of Emerson Economics Pty Ltd, an adjunct professor at Victoria University’s Centre of Policy Studies, a former trade minister, and a former economic adviser to prime minister Bob Hawke