The politics of the RBA's independence means a struggle over Australia's economic outlook is being fought in the shadows

When the prime minister fronted the media just after 8am on Friday, the sense of elation was palpable.

The extraordinary flurry of law-making in the Senate on Thursday stood in stark contrast to the PM's earlier problems, when he was forced to shelve misinformation legislation, as well as unloved reforms on the environment, gambling ads and electoral donations.

A week ago, the government was confronting a gloomy and frustrated end to the year: blocked on delivering signature housing policies; not expecting its Future Made in Australia manufacturing policy to go through; and blocked in its attempts to cap international student numbers.

The steering of 31 bills through the Senate on Thursday made all that a distant memory. The spinners were out early to say this was all part of a cunning plan weeks in the making.

But frankly, the government couldn't quite believe its luck on some of the legislation that had long ago seemed to hit the fence but has now been passed by the parliament.

This included changes to the Reserve Bank Act which, amongst other things, will now have a second board solely responsible for setting interest rates.

We now live in a world where the sainted independence of the RBA is such that the treasurer can't even be seen to be giving it a few "helpful suggestions" about interest rates.

But whoever sits on the new board — which will be announced soon, but it won't start operating until at least March 1, after the (politically) crucial February board meeting — the difficult politics of sainted independence means a current complex struggle over the economic outlook between the government and the central bank is being fought in the shadows.

Even if it is a much more nuanced and important dance than any multi-party negotiations conducted with the various parties in the Senate.

Should interest rates be heading lower?

It's not just a matter of the government desperately hoping that the RBA will cut rates before the election.

Some of the country's biggest financial institutions and senior economists have publicly questioned central planks of the RBA's economic assessment.

Even Treasury has taken a different path to the bank, in a quiet Treasury sort of way.

The issue is the state of the labour market.

Before we get to the labour market though, let's consider some various factors which might lead the casual observer to think that interest rates just maybe should be heading lower.

First of all, growth. The economy has been growing below "trend" for 18 months, and we have been in a "household recession" for the longest period in decades.

Headline annual inflation was down to just 2.1 per cent (and steady) in October, according to this week's monthly numbers, while the trimmed mean, or underlying inflation rate, was up from 3.2 per cent to 3.5 per cent.

(Keep in mind that the RBA is trying to get inflation back to between 2-3 per cent.)

The Reserve Bank, pragmatically, has only two things going for it as a policy operator: one is the actual official interest rate it sets; and two is its credibility.

Changes in interest rates take a long time to hit the economy — between one and two years.

That's why official rates have previously been cut when the headline inflation rate was above 3 per cent in four out of the five previous easings.

So why does the bank continue to send out bearish messages that it won't be cutting rates for some months?

The state of the labour market

That brings us back to the labour market and the NAIRU (the Non-Accelerating Inflation Rate of Unemployment, a theoretical unemployment rate at which inflation and wage growth are stable).

A high NAIRU number suggests conditions in the labour market will continue to generate inflationary numbers even when unemployment is high or rising.

The difference of opinion about the shape of the economy revolves around the NAIRU. For those of us who aren't economists, it revolves around assessments about the strength of the labour market.

Some significant figures in the economic debate, including the Commonwealth Bank, the ANZ and labour market economist Jeff Borland think the RBA has got it wrong on the NAIRU.

The RBA's estimate of the NAIRU is that it sits at 4.5 per cent or higher. Treasury's estimate is 4.25 per cent, while Borland puts it at 4 per cent and the ANZ at 3.75 per cent.

The CBA's head of Australian economics, Gareth Aird, wrote last week that "the most recent wages data suggests [the RBA's NAIRU] estimate is too high".

He says for the RBA's wage forecast to be achieved, "the quarterly pace of wages growth would need to accelerate to 1 per cent [per quarter in the final quarter of 2024]".

"Such a result looks improbable, which means the RBA has likely overestimated the strength of wages growth in the economy."

Overall, the data suggests "that the economy can run a lower level of unemployment that is consistent with inflation sustainably within the RBA's 2-3 per cent target band".

By comparison, when RBA Governor Michele Bullock addressed a conference in Sydney on Thursday night she said that "at present, we judge that conditions in the labour market remain tighter than what would be consistent with low and stable inflation".

The CBA says that "overall we see continued evidence that the disinflation process remains on track, economic growth remains below trend and wages pressures are dissipating".

The difference in assessments is crucial

The Commonwealth Bank notes that the November RBA board minutes say that "it is important to remain forward looking, avoiding an excessive reliance on backward-looking information that might lead the board to react too late to a change in economic conditions".

"But we struggle to reconcile that statement with the line from the minutes that, in response to a scenario where inflation fell more quickly, 'this could warrant an easing in the cash rate target, but that they (i.e. members) would need to observe more than one good quarterly inflation outcome to be confident that such a decline in inflation was sustainable'."

The CBA pointedly says that "the policy setting process cannot be forward looking if the board is on a predetermined path to wait for more than one 'good' quarterly CPI before being willing to commence the process of normalising the cash rate. Inflation is a lagging indicator, notwithstanding too the publication lag given the quarterly frequency".

In the latest ANZ assessment on Friday, head of Australian economics Adam Boynton says that "at turning points, we should focus more on what the RBA should do rather than its rhetoric".

The ANZ's underlying assessment is that given the "NAIRU is likely around 3.75 per cent, wages growth should undershoot the RBA's expectations".

"The weakness in private demand and the cooling in the housing market also suggest that rates are indeed on the restrictive side".

The difference in assessments is pretty crucial to how the RBA sees the world, and what it may do at its December and February meetings.

The added layer of complication is that, just as Jim Chalmers can't be seen to be interfering in the deliberations of the bank, the bank has always been reluctant to make interest rate decisions close to an election.

What it should do is make those decisions free of either political interference or concern about perceptions about political judgements, or how it may be judged by critics.

The decisions it makes affect the rest of us. And therefore should continue not to be taken lightly, whichever board might make them.

Laura Tingle is 7.30's chief political correspondent.