Australia has a productivity problem. You've heard this before. But the usual story - a gradual slowdown, structural shifts toward services, Baumol's disease - misses what's actually happened.
The real story is starker: Australia had exactly one period of meaningful productivity growth in the last 45 years. It lasted about twelve years. Before and after: stagnation. And since 2015, even the strategies that previously masked this problem have stopped working.
The original Phillips Curve is a beautiful empirical regularity: lower unemployment meant higher inflation. Policymakers in the 1960s thought they faced a stable menu of choices - trade off a bit more inflation for a bit less unemployment, or vice versa. The current Phillips curve in respect of Australia looks like this.
I have been trying to get an understanding of why the US invaded Venezuela. So far I have a bunch of theories, none of which I find compelling.
Australia's potential GDP growth is closer to 2% than the 2.5% Treasury assumes. The difference matters for inflation, interest rates, and fiscal policy.
Before I tell you about my failure, let me explain what I was trying to build. A DSGE model - Dynamic Stochastic General Equilibrium model - is the workhorse of modern macroeconomics. It's a mathematical representation of an economy where households decide how much to spend and save, firms decide how much to produce and hire, and a central bank sets interest rates. Everything ties together through prices and interest rates until supply equals demand. "Equilibrium" means all the pieces fit; "dynamic" means it evolves over time; "stochastic" means random shocks hit the economy and we watch how it responds.
Central banks around the world use these models to forecast inflation and guide interest rate decisions. More sophisticated versions of this approach won Nobel Prizes. I figured if I built one for Australia, I'd learn something about how the macroeconomy actually works.
I expected the model to explain Australian inflation, natural rate of unemployment and potential output. Instead, it explained why the model no longer worked.
Australia enters 2026 with an economy running close to its speed limit - and that speed limit has fallen. The collapse in multifactor productivity (MFP) growth, structural shifts in the composition of the economy, and a more fraught global backdrop all point to an extended period of modest growth, sticky inflation, and a Reserve Bank less willing to provide accommodation than at any time since the global financial crisis.
One of the enduring puzzles in macroeconomics is the flattening of the Phillips curve - the relationship between unemployment and inflation that once seemed so reliable has become frustratingly weak in recent decades. Today's work on our Bayesian state-space model for the Australian economy tackled this head-on, with some satisfying results.
