Australia is a current-account deficit country again. Thirty years ago that sentence would have led the evening news. Today it barely rates a mention.
The silence has a history. In the 1990s an ANU economist, John Pitchford, won an argument that the current-account deficit was not a policy problem. His view became the official view. This post recaps that argument, and then asks whether it still offers comfort. I think it does not, and on Pitchford’s own terms.
Each month I have been reflecting on the war in Iran. In August I described the Iran war as a morass. It still is. But something important has changed.
America appears to have found a way to live in it.
Australia's neutral rate is going up, and I think it stays up. Two charts.
Chart one: two proxies for nominal r*. The orange line is trend real GDP per capita growth plus my model of inflation expectations, the Wicksellian anchor, now 3.23 and still drifting down. The blue line is the AOFM 5y5y risk-neutral forward, the bond market's guess at where the cash rate settles, now 3.87 and climbing since 2020. They disagree by over half a point and the gap is widening.
The Reserve Bank of Australia (RBA, the Bank) has had an inflation target roughly since 1993. Thirty years is long enough to judge it. This post does that with six charts, five of them built from my own models, and it reaches a verdict that is kinder to the bank before the GFC than after it. The bank has had two failures since then. They were different in kind, and only one of them was a choice.
How do you estimate something you cannot observe?
That is the basic problem with r-star, the neutral real interest rate. In the standard monetary-policy framework, it is the real interest rate consistent with the economy operating at potential and inflation stable. Put the real policy rate below r-star and monetary policy should stimulate demand. Put it above r-star and policy should restrain it.
But r-star is not a market price we can look up. It has to be inferred from other things we can observe, using some model of how those things relate to it.
I started trying to estimate an Australian r-star using the standard Holston-Laubach-Williams (HLW) model. That attempt failed. The Australian data did not contain enough information for the model to identify the relationship it needed to recover r-star.
That failure led to a different question. If I cannot see Australian r-star through the HLW model, can I see it through other windows?
I have now tried three. One looks at international and Australian bond markets. One looks at the RBA's own interest-rate decisions. The third imposes the IS relationship that HLW failed to estimate and works backwards to the r-star required to make it hold.
These are not minor variations on the same model. They obtain their information about r-star from quite different places. All three estimate cleanly. More importantly, all three recover a recognisably similar low-frequency history: Australian r-star was much higher, fell substantially over the decades before COVID, and has risen again since the pandemic.
But they disagree materially about exactly where r-star sits.
That combination is the interesting result. I have a much better window on the direction of Australian r-star than I do on its level.
I have written about r-star twice this year. The first post tried to pin down Australia's natural rate the standard way, a Holston-Laubach-Williams state-space model, trend growth and the IS curve doing the identifying work. It couldn't be done. The IS curve coefficient on the real rate gap came out at around minus 0.05, against quarter-to-quarter noise of about 0.7. A signal one-fourteenth the size of the noise floor cannot identify anything. Every variant I tried failed the same way, the latent r-star collapsing onto whichever prior I fed it.
The second post started with the premise that liquidity is global, and in every country investment seeks out the best returns in the world. The standard approach to r-star instead asks Australian output and inflation to reveal the real interest rate that balances desired saving and investment, as though that equilibrium were fundamentally domestic. But saving and investment now meet in a global capital market. A single global market still leaves room for a country-specific wedge, the way a single global oil market leaves room for regional basis differentials between Brent, WTI and everything else. The wedge is the local story. The level it sits on top of is not.
This post takes that global understanding and uses it to model Australia's neutral real rate of interest, r-star. World r-star plus the Australian wedge gives Australian r-star, rather than Australian output, inflation and trend growth being asked to produce one on their own. Australia's own market tells you the wedge on top, not the underlying price.
Four numbers rarely line up the way they have this year. Growth sits above potential. Unemployment sits below the non-accelerating inflation rate of unemployment (NAIRU). Inflation sits above the target band. And the cash rate sits above the neutral rate, r*, but still short of what a standard Taylor rule would prescribe. Put together, these estimates describe an economy running hot while policy leans against it, but not hard enough.
Headline GDP growth through the year is running at 2.14%, although most of that growth happened in the tail end of 2025. Growth in the first half of 2026 was much more modest.
When a central bank moves the cash rate, it’s acting on a specific model of how the economy works. That model is the New Keynesian synthesis, and it’s the closest thing modern economics has to an operating manual for monetary policy. Every inflation target, every rate decision, every line in a central bank statement about “returning inflation to target” comes out of this framework. Understanding it is the difference between watching the news cycle of rate rises and cuts and actually seeing the logic behind it.
This isn’t a history of how these ideas came together, nor an account of what exactly got synthesised between classical and Keynesian economics. It’s a walk through the intuition: how the pieces of the model fit together, and where they hold up worse than the theory suggests.
Every economy has a speed limit. Economists call it potential output, or Y*. It represents how much an economy can produce when its workers, factories, and capital are all fully but sustainably employed. Actual output (also known as GDP or Y) moves around this limit. The difference between the two, Y minus Y*, is called the output gap. Sometimes it’s negative and Y sits below Y*, and resources go idle. Sometimes it’s positive and Y pushes above Y*, and something has to give.
People throw around the word "crisis" every time yields move. It's worth being precise about what that word actually covers, because the different versions call for completely different responses.
Markets reprice all the time as new information arrives. That's their job. A repricing on its own is not news. What matters is the size of the move, the speed of the move, and whether anything underneath the market itself is breaking. Those questions are what separate the ordinary from an actual crisis.
Every few weeks someone describes potential growth as the economy’s speed limit. The metaphor is useful, but it is attached to the wrong thing. The real speed limit is potential output, the level: the amount the economy can produce sustainably with inflation at target. Potential growth is only the rate at which that limit itself moves. The two answer different questions, and mixing them up produces bad readings of the cycle.
This post uses a small model of Australian potential output to make one point. Conventionally, the output gap is the difference between actual and potential output, a difference between two levels. This model goes one step further and splits that observed difference into an inflation-related component and a residual. Potential growth tells you how fast the potential level is moving. It does not tell you the sign of the gap, and neither potential growth nor observed GDP growth on its own tells you where inflationary pressure sits.
The latest in a series of monthly reflections on the war in Iran.
Six months ago the United States began the largest military campaign it has fought since 2003. It killed a head of state on the first morning. It has struck more than eleven thousand targets. Eighteen American service members are dead and 756 wounded. The Strait of Hormuz has been closed (again) since 11 July.
You would barely know it.
That is not an accident, and I do not think it is simple neglect. The silence is the most informative thing that happened in August.
Australian inflation took off in 1973 and did not get back below five per cent, and stay there, until 1991. Eighteen years. Germany peaked at 7.9 per cent and was under 5 within three. The United States peaked at 14.8 and took nine. We peaked at 17.5, and the Reserve Bank's own 1992 conference on disinflation ranked Australia poorly on the unemployment cost of getting there, putting it down to high real rigidities.
Money for long-term borrowing moves freely across borders, so liquidity is a global phenomenon. QE bought bonds from asset holders and paid in cash. With this cash they bought other assets, everywhere and in every class. Asset prices rose worldwide, including in countries that never ran a QE programme of their own.
That was inflation, in a market the consumer price index does not cover. And bidding an asset's price up is bidding its yield down, so the same event was a global fall in borrowing costs.
None of this began in 2009. Bernanke saw low rates in 2005 and diagnosed a global savings glut as the cause, favouring a structural explanation over a liquidity one.
Most econometric models that estimate the neutral rate are fitted to consumer prices, output and interest rates. Asset prices are not among the inputs. So the figure they report is the rate that is neutral for groceries, and it has nothing to say about whether borrowing was running ahead of the capacity to service it.
There is a second problem underneath. The models infer the rate from two relationships that a decade of successful stabilisation had flattened, leaving the history of the policy rate itself as the main thing to lean on. Policy rules then took that estimate as an input, and naturally recommended something close to the policy already in place.
Estimation needs variation, and stabilisation exists to remove variation. A central bank that succeeds gradually erases the evidence it needs to keep doing its job.
The liquidity story does the work of several. It explains why asset prices boomed where no programme ran, why consumer prices stayed quiet and then surged in 2021 when the same mechanics reached households instead, and why every country's estimate fell together despite different demographics, deficits and growth.
For a decade, the rate that would have kept borrowing serviceable sat far above the one the models report. That is not a measurement problem. It is a specification problem, and a specification problem returns a confident number to the wrong question.
Everyone is panicking about the US bond market. Here is thirty years of data on the thing they are panicking about.
I use AI to write. I use it to research, to draft, to code, and to argue with. This essay included.
I expect that within a few years the disclosure will read oddly, the way it would read oddly if I told you I had used a pen. Or a spreadsheet. Or a search engine. Tools stop being remarkable once everyone has them, and the announcement stops being a confession and becomes a tic. We are not there yet, so here is the confession.
Privatisation, at its broadest, is the transfer of ownership, financing or delivery of a government function into private hands. Four distinct transactions travel under that one word.
