Why the RBA needs functional finance

As cost-of-living pressures mount, critics argue Australia’s inflation response is worsening the pain rather than solving the problem, writes David Higginbottom.

When the COST OF LIVING increases, the Reserve Bank of Australia (RBA)’s answer is to increase the cost of living even further.

RBA governor in May 2026 Michele Bullockboard votes to raise cash interest rate to 8-1 4.35 percent – the third rise of the year – in response to a surge in inflation driven by global fuel prices and supply chain disruptions that no Australian interest rate decision is likely to fix.

The logic is circular, the tool is unclear and the ones paying the price are a third of Australian households with a mortgage. But the governor is not the problem. The problem is in the machine.

Bullock operates within a macroeconomic framework that is taught as a hard science in universities, treated as an objective fact by governments, and accepted as a law of nature by the media. It’s none of these. This is a set of theories built on clearly false assumptions.

There is a well-known result in data science: Garbage in, garbage out. When the model is corrupted, the quality of the data fed into it becomes irrelevant; The machine turns facts into garbage.

illusion of science

Economics faces a deep problem of physics envy. It attempts to apply the hard mathematics of the natural sciences to the complex reality of human behavior, assuming perfect knowledge, perfect foresight, and rational actors that ensure markets automatically return to equilibrium. None of these are true. But models treat these assumptions not as simplifying abstractions but as the real mechanics of reality.

If the models are so obviously flawed, why does the system always assume it will correct itself? The answer lies in an invisible political assumption: the “democratic solution”. Neoclassical economics separates “the economy” from “politics” with an artificial wall, assuming that a completely neutral, uncorrupted democratic regulator will step in when markets crash.

But the turning point 2014 Gilens and Page US study This indicates that the editor may not exist. Economic elites have significant, independent influence on government policy, while average citizens have statistically close to zero influence.

The doctrine of RBA independence is based on the same fiction: monetary policy is a neutral lever with no lasting effects in the real world. Anyone who has followed the Australian housing market over the last two decades knows otherwise.

Policy test: 2008 and COVID-19

When forced to confront reality, models fail catastrophically. 2008 Global Financial Crisis and the COVID-19 pandemic has provided rare natural experiments.

In standard macroeconomic models, government intervention is a general input; the “G” in the equation. The model cannot distinguish between a central bank buying bonds from a hedge fund, a government sending an untargeted stimulus check, or a targeted wage subsidy that keeps a worker tied to a firm. These are considered the same.

Following both the GFC and COVID-19, central banks stepped in quantitative easing – buying bonds from the private financial sector. The model assumed that this liquidity would flow into productive investments. Instead it flowed into stocks and real estate.

Research shows that only 3 to 5 cents of every dollar The appreciation of assets is reflected in personal consumption. The machine transformed the crisis response into the largest upward transfer of wealth in modern history.

Compare this to Australia’s direct fiscal interventions. Rudd Government’s targeted stimulus during the 2008 GFC Kept Australia out of recession while the rest of the developed world collapses. During COVID-19, Job Watchman It protected the employer-employee relationship and delayed the onset of inflation. Lacking the necessary infrastructure for such targeting, the United States relied on large stimulus checks and untargeted bank loans to create an estimated figure. 2.5 additional percentage points inflation.

The model treats both as equivalent forms of “expansionist policy.” Because the assumption is wrong, the policy prescription is also wrong.

Solution: Functional finance

RBA’s own expression It recognizes that the current increase in inflation is due to: ‘capacity pressures’ And ‘Serious increase in fuel and related commodity prices’ from conflicts in the Middle East. These are supply side shocks. Raising domestic interest rates will not produce more oil or eliminate global shipping bottlenecks.

As Dr Bronwyn Kelly repeatedly argues in these pages, raising interest rates only pushes prices higher; it doesn’t drop them. The deliberate mechanism of the RBA’s approach is to increase unemployment so that people lose their ability to pay their bills at the same time that bills rise. This isn’t just ridiculous; This is so cruel.

There is an alternative. Kelly’s recent work on functional finance provides the roadmap. Developed by Abba Lerner In the 1940s, functional finance recognized that fiscal policy (government spending and taxation) was a much more powerful and precise tool for managing inflation than monetary policy.

As Kelly summarized in his recent Independent article A.In Australia, it works according to three basic rules: using government spending and taxation to keep total spending at the level needed to buy all the goods the economy can produce; using government borrowing or debt repayment to obtain the interest rate that results in the most desirable level of investment; and manage the money supply as necessary to fulfill the first two rules.

In this context, it becomes clear that the balance between price stability and full employment is a myth. The solution to inflation is not to suppress demand and create unemployment, but to increase supply, increase public expenditures and encourage investments to ensure that employment and production grow together. This is the basis of what Kelly calls “Public Interest Economics.”

Alternative tradition: MMT and Piketty

Functional finance is not an isolated idea. Modern Monetary Theory (MMT), which Lerner provides macroeconomic philosophy, is its direct institutional continuation, as economists Wray, Kelton And Mitchell He provided the modern operating guide to show that the only real constraint on government spending is real resources, not money.

Thomas Piketty It provides empirical evidence of what happens when you run the neoclassical method. Inside Capital in the Twenty-First Centuryproved that the rate of return on capital has historically exceeded economic growth. When central banks pump money into the financial system through QE, that money flows into assets. The wealthy class is making gains; wage earners are left behind. Neoclassical monetary policy not only fails to reduce inequality; It is structurally designed to increase this.

If inflation is demand-driven, taxing excessive spending will be a much more effective and fair solution than raising interest rates. Instead of indiscriminately punishing mortgage holders, it directly targets extremism.

We should not take the governor to task for pulling the only lever he is allowed to touch. We must reckon with the fact that it sits within a machine that was never science, was never fit for the real world, and is now clearly failing the people it is supposed to serve.

It is time for the government and the RBA to abandon the broken neoclassical model. As Kelly has powerfully shown in his recent articles, functional finance offers a way out of the heresy of using unemployment to control prices. It offers a solution to inflation without unemployment. Now is the time for us to listen to it and use it.

David Higginbottom is a member of the coordinating committee. Independent and Peaceful Australia Network (IPAN) and coordinator of the Make Peace Our Priority campaign (mpap.au).

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