Damn, who wouldn’t run a newspaper? Aside from the small problem that you lose money hand over fist, it entitles you pontificate every which way with no consequences.
Yesterday I noted that the AFR had backflipped its editorial direction on the need for a Budget surplus. Today it’s official:
Standard & Poor’s and Fitch Ratings delivered a timely wake-up call with their warning in this newspaper yesterday that federal Treasurer Wayne Swan needs to deliver a tough budget next month in order to protect Australia’s coveted AAA credit rating. Mr Swan, to his credit, seems to understand the economic imperative of returning the budget to surplus in 2012-13 in order to send a strong signal about the importance of responsible fiscal management.
But it is worrying that business groups such as the Australian Institute of Company Directors, as well as most economists working in the financial markets, seem to think achieving a surplus next year is neither here nor there.
The Australian Financial Review will be the first to applaud Mr Swan if his budget on May 8 vigorously cuts wasteful government spending, delivers more than a paper-thin surplus and provides a credible path for eliminating the budget’s substantial structural or underlying deficit.
Actually no, not the first. The AFR has indulged a round of surplus bashing and it took MB to set it straight. Another point for the blogosphere. Anyways, now it’s on board with reality, the paper is equally failing to analyse the implications of its own belated recommendation. Apparently:
Those cautioning against the need to bring the budget back to surplus continue to see fiscal policy as a short-term tool for managing the business cycle, arguing that cutting government spending will hit the economy too hard. Fiscal policy was certainly called upon, and then overused, during the global financial crisis. But the bigger lesson of Europe and the United States is that fiscal policy needs to be set on a medium-term basis.
Using fiscal policy to try to manage the ups and downs of the business cycle invites trouble as it is too politicised, making it too clumsy for the purpose and resulting in a bias towards increased government spending. Politicians will use every chance they get to throw money around to cushion downturns, but are all too reluctant to take it back during booms. Tighter budget policy will also allow the weight of economic management to fall on interest rates and the dollar, giving the Reserve Bank of Australia more room to ease monetary policy if the economy does weaken. What is needed is a broader medium-term framework to guide budget planning over a longer period rather than the approach now employed, which projects revenue and expenditure only over the next four years.
The RBA successfully uses a medium-term approach to monetary policy, anchoring price expectations around a low-inflation target that makes its job much easier. Ratings agencies also take a longer view when assessing Australia’s creditworthiness, with S&P pointing out the government must show it is committed to stabilising debt over the medium term. Australia’s myopic fiscal policy has led us to the invidious position of having a budget that is still in the red despite terms of trade at unprecedented highs and unemployment that has declined to about its natural rate. The argument that a small deficit wouldn’t matter ignores the bad signal this would send to foreign creditors.
Whoa, where do I begin! First, the RBA is s false analogy. It does not have a medium term horizon going beyond 4 years. That’s absurd. Next and oddly enough, we don’t have a political culture obsessed with throwing money around. We have the opposite, one obsessed with public surpluses, irrespective of what ratings agencies think.
Moreover, the only part of the 2008 stimulus that was profligate were the measures aimed at supporting house prices. These cost very little but combined with monetary easing to cause a blowoff in household mortgage debt. Beyond that, the stimulus was copy book. Well designed and well executed. With timely roll out, as well as fantastic results for growth and the job market. It’s logically absurd to criticise government for wasted stimulus which is by definition quick and widespread not precise and parsimonious. The AFR’s ideological clap trap then leads it to rewrite history:
Australia squandered too much of the first stage of the mining boom, reinforcing unrealistic political expectations that we have plenty of room for big-spending programs such as disability insurance schemes, universal dental care, paid parental leave and childcare rebates for nannies.
Australia needs to make the most of its prosperity by getting its economic house in order, reducing our vulnerability to future external shocks. Mr Swan must use his fifth budget next month to lay down a marker, ignore the pleas of naysayers, and deliver the 2012-13 surplus that he has repeatedly promised.
Where was the AFR during the mining boom? Did it call for mass cuts, an SWF etc. No. Did it take the banks to task as they built the housing bubble and became too-big-fail? No. Has it led an intellectual debate about how to return the risk currently borne by the tax payer to the banks? No.
That’s enough AFR bashing for today. But now we need to ask what exactly are the consequences of a surplus drive that will pull growth down by 2.5% over the next 12 months. Since Q1 2008, GDP growth has averaged 2.3%. Ipso facto the AFR wants a recession.
That may be. Then again, it may not. The outcome will depend upon how the private sector responds. Such a hit to growth will, of course, drive down interest rates. And the question is, what will that do?
There are several possible outcomes. The dollar will fall and, assuming world growth remained on track, imported inflation pressures would rise. That’s not necessarily a problem, though. There may be enough deflationary pressure emanating from the Budget cuts, which could force further household retrenchment.
The upside from the dollar falling is that exporters will no longer have to take the brunt of the adjustment to mining led growth.
So one possible outcome is that we shift the burden of adjustment further onto the household sector.
But that may not happen. Despite the budget cuts, lower rates may, rather, trigger a renewed desire to borrow, especially to speculate on houses. If that happens, then we’d enter a nice little mini boom, that would last a few months before either the RBA or ratings agencies snuffed it out. Why? Because inflation risks would quickly rise and/or it would cause the rush of deposits into the banks to dwindle and offshore borrowing to resume. I can’t see foreign creditors celebrating that.
We’d reach a nice little surplus, though, just before we crashed.
This is the trap in which we are caught. It is not going to be resolved by pontificating this way, that way, or both ways. Hard questions need to be asked about how to elude it. These include:
- do we need a macro-prudential policy to prevent the banks from firing up another round of mortgage mayhem on lower rates?
- what is the precise time frame for a return to surplus that balances growth and banking liabilities?
- what new economic narrative is needed from the government to help Australians navigate this trap?
- does the current policy of export replacement to contain the mining boom making any sense at all in this environment?
- how can the bank’s offshore liability risk be decoupled from the national budget?
- do we need a Son of Wallis inquiry?
- what roll should the tax reform play? What of mining taxes and investment property concessions like capital gains, as well as negative gearing?
- how can interests be prevented from doing what needs to be done in the national interest?
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