Reserve Bank governor Philip Lowe has substantially upped pressure on governments to increase pay packets for public servants, blaming caps on public sector wage growth for suppressing wages across the board.
Dr Lowe said he understood why governments were constraining pay, given wages accounted for about 70 per cent of state government budgets, and one-third of the country's workforce was employed directly or indirectly in the public sector.
But he said the wage caps in the public sector were "cementing low wage norms across the country because the norm is now 1 to 1.5 per cent and partly that's coming from the decisions that are being taken by the state governments".
Dr Lowe's comments, which he acknowledged as controversial, will give heft to union claims for higher wages in the public service.
No sooner than he had spoken at a parliamentary hearing in Canberra on Friday than Greens public sector spokesman Adam Bandt called for a pay rise for public servants of more than 3 per cent - and 4 per cent for non-executive public servants for four years.
"The Liberals' 2 per cent pay cap isn't just hurting public servants, it's a threat to the economy," he said.
A 4 per cent wage rise would cost $12 billion over four years, Mr Bandt said.
Dr Lowe said he would like to see wages increase by "three point something" in the medium term.
He was more cautious when asked whether he supported an increase in the unemployment benefit, Newstart.
The question is politically charged, given Prime Minister Scott Morrison's refusal to budge in the face of calls on all sides of politics for an increase.
Dr Lowe said Newstart payments were low and had not been increased for in real terms for a number of years. If people on Newstart were given more money they would spend it and help lift aggregate demand. But he said it was a balancing act, given the cost to the budget.
In the short run it was clear that giving money to people with a high propensity to spending it - those on low incomes - would stimulate spending. In the longer run, it may be that lower taxes for people on higher incomes would stimulate more growth in economy, he said.
Minister for Finance Mathias Cormann said public sector and private sector wages were together growing at about 2.4 per cent, well above inflation, at 1.3 per cent.
Average earnings in the public sector were about $95,000, compered with $85,000 in the private sector.
"Lowering income tax, as we have done, puts more money into wage earners pockets, on top of above inflation wages growth," he said, insisting the government must live within its means.
Community and Public Sector Union secretary Nadine Flood said the government had "a shocking record" of capping wage rises for the public service and Australian Defence Force.
"Most public servants got just 1 per cent a year under this Government, while some officers in the Department of Home Affairs had their take-home pay cut to pre-2013 levels," she said.
"The government has within its reach the policy levers to fix our economy. Their decision to implement a low wages cap is one that can be changed, and one that should be changed."
Only the ACT and South Australia don't have a cap, according to the union.
The ACT's most recent agreement in March 2019 has a 2.7 per cent wage rise, the highest of any jurisdiction.
The Commonwealth has had a 2 per cent wages cap since 2014. NSW has had a legislated maximum of 2.5 per cent since 2011. Queensland has a 2.5 per cent cap on public sector wages, and 2 per cent apply in Victoria, Tasmania and Northern territory.
Western Australia has the toughest clampdown on public service pay, limiting increases to $1000 a year.
Dr Lowe said it had been more difficult than expected to generate upward pressure on wages and that was likely to remain the case for the next couple of years.
The 5.2 per cent unemployment rate was higher than expected at the beginning of the year because of more supply - more women and older people in the labour market than ever before. That meant it was "harder to generate a tight labour market and so, in turn, it is harder to generate a material lift in aggregate wages growth".
Dr Lowe predicted the economy had reached "a gentle turning point", but he said rises in interest rates were some years off, and he detailed the Reserve Bank's options for extreme measures in the opposite direction should they become necessary.
The Reserve Bank would not consider raising rates until it was comfortable that inflation was in the target range of 2 to 3 per cent and unemployment had dropped to about 4.5 per cent, he said.
Dr Lowe continued to push for governments to do more, not only on wages but also on infrastructure. While opportunities for "megaprojects" in Sydney and Melbourne might be limited, there was capacity for a series of smaller regional projects.
If governments didn't come to the party the economy was still likely to be "ok".
"But I hope that we can lift our sights higher than things being okay, and I think, as a country, we can do that," he said.
"... That does require the political classes to come together to agree on and support some structural changes. That's completely out of the area of the central bank. It's really in your area.
"Are we happy for things to be okay or do we aspire for something better? I hope, as an Australian, we can do the latter."
But he called for an improvement in the way governments chose and managed projects.
"If the public see money not being spent wisely, they lose support for governments building assets, which, in the end, will harm us all," he said.
He faced critical questioning at Friday's parliamentary inquiry from Labor committee member and Canberran Andrew Leigh, who pushed Dr Lowe to acknowledge he had been mistaken not to have cut rates earlier. The bank had failed to reach the inflation target of 2 to 3 per cent throughout Dr Lowe's tenure, despite being "slap bang" in the middle of the range under his predecessor.
Dr Leigh said pointed to work by two economists in the Reserve Bank itself who had found that not cutting interest rates by 1 percentage point had cost about 20,000 jobs.
"If it was a mistake, only time well tell," Dr Lowe said, stressing that "things looked pretty good and they were clearly moving in the right direction" in the first half of last year.
Lifting interest rates would have encouraged more borrowing and higher housing prices when there was already "exuberance" in the housing market through 2017 and early 2018.
He acknowledged different views among bank economists.