Rising unemployment endangers the recovery

In China, banks were exhorted to lend like drunken tavern keepers in the first half of 2009 and now are being told to sober up quickly. This injects a natural instability into the major developing economy in the world, whose health is vital to Australia.

Australia has injected substantial fiscal stimulus, mostly in the form of handouts to middle and lower-income taxpayers and spending on schools and houses that will have little, if any, positive effect in promoting productivity.

The Prime Minister's latest economic advice to the nation stresses the importance of promoting productivity, so perhaps there is some implicit recognition of mistakes made in panic when it seemed a nasty downturn was becoming a Great Recession.

Australia's monetary expansion was in nominal terms not so dramatic as that in other nations, where nominal cash rates have been close to or actually zero.

With continuing inflation of consumer prices in most nations, one can argue "real" rates of interest are effectively negative.

The latest measure of underlying consumer inflation of 3.9 per cent suggests for Australia not a very different picture of monetary policy of extreme ease.

Rarely has monetary and fiscal policies been eased so quickly by so much, never before except in major wars. Wars have almost always been accompanied or followed by major inflationary outbursts, which suggests a clear and present danger.

Put "inflation" with bank failure on the list of serious risks to recovery.

The graph shows a 50-year history of consumer inflation and household inflationary expectations. The great inflation of the 1970s is clearly evident, sparked by the actual war in Indochina and the unwinnable war on poverty of US "Great Society" spending. The long struggle to eliminate inflation during the 1980s and in the first half of the 1990s involved costly recessions and high rates of unemployment.

The inflation of the late 1990s and the early noughties was, however, most evident in asset prices. As we argued at the time, central banks were confused by their operational focus on consumer price inflation when that indicator was held down by China's emergence as a major producer of cheap manufactured goods.

Excessively easy monetary policy spilled instead into asset prices, which became in many markets asset bubbles.