ICYMI RN Breakfast had a fantastic Q&A session yesterday, where economists Sally Auld and Saul Eslake answered listener questions.

You can listen to the whole thing via the link below, but I’ve picked out my favourite question and a brilliant answer to it from Saul Eslake.

Q: Why do interest rates need to go up? (Why can’t we tax corporations and the ultra wealthy instead?)

A: You could. And, in fact, prior to the late 1970s, the standard response to increased inflation was to increase taxes. And when unemployment was looking like being unacceptably high, it was to reduce taxes.

And, most notoriously, in the shadow of the highest inflation Australia’s ever had of over 20% in the aftermath of the Korean War wool boom, the Menzies government imposed 10% charges on both company and personal income tax, and raised the wholesale sales tax rate from 8.5% to 12.5%. And the then-treasurer said afterwards he could have fitted all of his friends into a phone box, and it worked.

But, as times changed, monetary policy became intellectually fashionable among economists and others, led by the theorising of Milton Friedman. Interest rates could be adjusted more quickly than taxes, which required legislation to get through the parliament, and after governments ceased to have control of the Senate in the 1970s, that was more difficult to do.

But I guess what we’ve also seen, particularly more recently, is that it’s very easy for treasurers and governments to say, when interest rates go up, “I feel your pain, but it’s not my fault, blame the independent central bank.”

So politicians aren’t as willing as they used to be to take decisions that made people temporarily worse off. They try to avoid doing those sorts of things, even if they know it’s in the national interest. And the Reserve Bank provides a convenient foil for politicians in that context.

A fantastic economic history lesson there from Saul.

The big trade-off for using monetary policy instead of fiscal policy to shape the economy is distributional. If you use monetary policy, then each action has inevitable distributional effects within the economy, shifting benefits and costs between savers and borrowers. If you use fiscal policy, the government retains control of the distributional effects. For example, you could skew the tax increases towards higher-income earners or wealthier individuals and insulate less well-off households, as the listener proposed in the question.