The AFR has some more today on the RBA board and fiscal policy:
Former RBA board member Warwick McKibbin said it was unlikely the duo was formally speaking on behalf of the RBA.
“But no doubt [they] are frustrated by the government putting everything on the RBA to deal with the current economic situation.”
McKibbin would know. He was a very outspoken board member. And it’s true that the government has washed its hands. The singular surplus strategy with no attempt at fiscal remedies for the dollar nor fiscal adjustments or bank reform to prevent rate cuts being siphoned into house prices has done nothing to assist the RBA in its project to correct the economy’s various structural imbalances which do impact its mandate.
It also appears that the AFR held back some of its interview with Bob Gregory yesterday, no doubt to sex-up the mild rebuke he delivered board members. Gregory confirmed the forthcoming downturn I’ve been discussing with readers:
“There’s going to be a hole,” he told The Australian Financial Review.
“With the high exchange rate and the state of the world it’s not going to be easy to fill that hole, which is why I’m prone to [support] infrastructure spending….We don’t say the mining industry shouldn’t be investing in mines, and businesses that are doing well shouldn’t build buildings,” he said. “It should be thought of as investment that pays off for Australia,” he said.
Indeed. Cutting public spending into that hole will dig it deeper. The RBA is obviously onto the bull trap, even if much of the nation is not, but equally clearly, it does not want to cut rates further. I remain unconvinced that this was not an unofficial, official message.
More importantly, for those that are unhappy about the prospect of counter-cyclical fiscal spending to offset the forthcoming growth hole, let me remind you that it is rare in business cycles that mainstream economists get the chance to prepare for a downturn. It is usually a surprise (for some reason) and hence the stimulus that results can be criticised as a “sugar hit”, rushed to market in the form of cash quickly spent or misappropriated in the name of speed. Here the RBA is delivering the opportunity to prepare sensible spending on infrastructure with long-term economic benefits that is “shovel ready” with a lead time sufficient for good planning.
The expectations for the quality of the spending should be all the higher. It’s a unique opportunity.
Another question yet to be asked is how much can be spent? There are very real limits to how much more the Federal government can safely borrow. The pressure on the budget to keep itself in shape in terms of its debt stock is less than it in terms of the flow. Ratings agencies have made it plain that a budget that fails to aim for surplus “across the cycle” will result in downgrades. Regular readers will know that those downgrades will flow on to the banks. That is perhaps no longer disastrous but should certainly be avoided.
In stock terms, debt to GDP could probably rise another 20% without ratings action. But that sort of money would take many years to spend and is not viable in terms of flow. At a guess, the government has a year or more before it would have to start displaying discipline again, especially if the global economy is travelling all right.
Perhaps we could use infrastructure bonds vis an independent entity like Infrastructure Australia (which is where I would look for guidance on what to build) but I’m not sure if that will work. The bonds will still need to carry the sovereign stamp, even if off balance sheet. It might still be a useful tool to focus future stimulus efforts and would make perfect sense if yoked to a resource rent tax and fiscal stabilisation mechanism like a sovereign wealth fund but these are policy endeavours beyond our current political economy it seems.
So, deficit spending is a bridge to somewhere new, not a cure to our fundamental ills. 2014-15 is when the current LNG investments begin to deliver a serious volume expansion that will aid growth. So that’s something to aim for. But if, like me, you believe China is embracing change over time and the demand for bulk commodities is going to fall permanently, it still won’t be enough. The only long-term solution is to lower the dollar.
Deficit spending buys time to do it but it still needs to done.
