One of my grand kids is studying economics at the University and, to help him with an essay on current macroeconomic policy in Australia, he asked me three rather pertinent questions..

1. If there is an inflation problem which is overwhelmingly supply-side driven, as we now seem to have in Australia, and if everyone expects a significant slow-down in domestic demand in the year or two ahead, why are the Reserve Bank and the Government responding (or planning to respond) with demand-deflation policies? That is not what my textbooks tell me is the right response.

2. I notice that rents are soaring and that is one of the reasons why the RBA felt it needed to act to curb the housing boom - but it seems to be having perverse results. The sharp rise in mortgage lending rates is causing a slump in new dwelling approvals and commencements – that is, the supply side problem (inadequate accommodation to house our rapidly rising population) will be worsened in the year ahead. Won’t this simply accentuate the rent inflation problem and what will the Bank do next?

3. Federal and State governments are expressing concern about the prospective erosion of revenue from the asset market decline, the slow down in retail and housing and a possible rise in unemployment. Their official response has been to try to “make up” for the expected revenue loss in the year ahead by blocking or deferring many “worthwhile” spending proposals (as a spokesperson from the Brumby Government put it). In aggregste, won’t this just accentuate the risk of an economic slow down and won’t this have adverse secondary effects on government revenue? What will they do next? My textbook tells me this is exactly why the Great Depression occurred in 1929.

I gave him the usual economic bullshit – distinguishing between short term and long term, between “micro” and “macro” effects and why it might be better to tolerate a little unemployment in order to avoid blowing out inflation expectations and starting a wage-price cycle. I added that macro policy is an imperfect science and that sometimes policy advisers get things wrong.

But I was far from convinced I gave him a good anwer. Perhaps smarter economists can help me out.