From March 2000 the gap between the 90-day bank bill and 10-year government bonds began to narrow, with the bill rate exceeding the bond rate the following May, after which the yield curve remained inverted until March 2001. Now in early 1999 business investment rapidly declined despite the fact that the yield curve was quickly turning positive. In June 1999 the PMI (performance manufacturing index) reached 55 it then declined, reaching 45 in December 2000.

Of particular interest for the Australian economy is that business investment took a rapid turn for the worst in early 1999. In June the PMI peaked, declining from just over 55 to under 45 in December 2000. Now the second chart shows that from March 2001 to December 2001 the yield curve rapidly turned positive. This period also experienced a 22 per cent expansion in M1 which in turn saw a rapid recovery in manufacturing. The yield curve once again narrowed, turning negative in October 2004 and remained so until going positive in January 2009.

Source: RBA

The period October 2004 to January 2009 had commentators arguing that Australia was evidence that an inverse yield curve no long signalled recession. As usual, they were wrong. In December 2007 the 90-day bill rate exceeded the 10-year bond rate by 0.97 base points. It was in this month that the PMI and the production index peaked at 58.4 after which they both dropped, bottoming out last April at 30.1 and 28.8 respectively. In other words, Australia had started to slide into recession, even though it was not until May 2008 manufacturing started a significant shedding of labour and it was the following August before aggregate unemployment began to rise.

This sequence of events was self-evident to any Austrian. So how did our economic punditry do? Displaying their usual grasp of economic history and the history of economic thought they completely misread the signals. Even worse, some of them made asinine statements about the emergence of a "two-speed economy" or a "dual economy" as if the economy is actually divided into two distinct parts.

I think three things are pretty clear so far: Firstly, short term rates rise near the end of a boom. This should be taken as a signal that a bust is approaching. Secondly, the inverted yield curve as an indicator of an oncoming recession is not dead. Thirdly, that manufacturing is a leading indicator. Some might wonder about the cash rate and the money supply having a greater impact on short term rates rather than a rise in demand from business for loans. Let us take the money side first, starting with 90-day bills.

Source: RBA

We can see that from December 1997 to December 2000 the bill rate and the money supply basically rose together. There is no indication in the chart that monetary slowdowns are always responsible for high bill rates. And nor should there be. According to Austrian thinking short term rates could continue to rise even as the money supply accelerated. We largely find the same tendency for the period January 2005 to July 2009, with the apparent exception of the period November 2007 to April 2008. Even here it should be noted that the yield was already rising before the mild monetary contraction set in. From June 2008 to April 2009 M1 was basically flat while the 90-day yield fell from 7.81 per cent to 3.1 per cent, a drop of 60.3 per cent.

It is my opinion the principal force behind this drop came from the business demand side. It could be argued that an upward movement in the cash rate drove up short term rate. Yet the figures reveal that while the cash rate started to rise in November 1999 the yield on 90-day bills started climbing in in May 1999. Moreover, the chart below suggests that using the interest rate to regulate the money supply is not very effective. It has been said that if you target the interest rate you lose control of the money supply while if you target the money supply you cannot control the interest rate. As the interest — the price of time — is a market phenomenon, trying to control it makes as much sense as trying to control the price of potatoes, and a lot more damaging considering that interest is the most important and pervasive price in the economy.

Source: RBA

I am not going to argue that the above is conclusive, merely that our free marketers should seriously consider what the Austrian school has to say on the boom-bust-cycle. This they adamantly refuse to do. When one points out their errors and omissions one is usually met with silence or is charged with "backstabbing" or attacking one's "friends and allies". Now if I make a mistake I want to be corrected. Correcting mistakes is part of the learning process. Why our free marketers should find this offensive baffles me.

Finally, if any person who writes on economics is not prepared to correct their errors, reconsider their omissions or even defend what they have written then they really have no business writing on the subject. And they certainly have no business whining about anyone exposing their faulty economic reasoning and errors of history. In addition, anyone I criticise has full and unconditional right of reply. It is no fault of mine if they refuse to avail themselves of this offer.

Gerard Jackson is Brookesnews' economics editor