Former TD Securities economist and advisor to Julia Gillard, Stephen Koukoulas, has emerged as an interesting new voice in the blogosphere in the past few months. Today he appears in the AFR to put his stamp of approval on the Swan plan to drive a surplus as soon as possible:
There is an almost unlimited demand on government finances. Be it a dental scheme, disability insurance, aged care, a literary award or infrastructure, a case can be made for government funding and intervention. Many demands for government funds are driven by micro-economic imperatives aimed at lifting productivity; others go to common decency and fairness for a very rich country like Australia. Others are political largesse and these are the kind that need to be not only rejected, but abolished.
The harsh reality of governing is that there is a limited supply of funds. This point is all the more problematic when constituents shy away from having to pay tax, or indeed the government tax take is running near historical lows due to prior discretionary tax cuts and a cyclical downswing in revenue as the result of a sustained period of below trend economic growth.
Treasurer Wayne Swan’s 2012-13 budget next month will see the government lock in fiscal surpluses based largely on cuts in spending, aided by a turn in the cycle of tax receipts that will deliver a little more revenue. It will certainly not be a surplus brought about by strong economic activity.
One problem for the government is that it inherited a financial time bomb set by the Howard government where the electorate was given and now expects to receive money or assistance from the government for a range of issues where there was no market failure nor where there is a social or equity basis.
Policies such as the first-home owners’ grant, the abolition of the indexation of petrol excise, the baby bonus and the tax-free status of income for retirees are a few examples of massively expensive and unnecessary policies that are now politically difficult to revisit.
These unfair and misguided examples of government intervention have damaged the structural underpinnings of the budget – and incidentally left Australia with an interest rate structure that is higher than it need be.
This all makes makes sense enough and is true, though I’m sure Liberal Party supporters would counter with their own list of profligate spending, which could include Labor’s increasing the First Home Owner’s Grant to existing properties. No doubt the Kouk would respond by reiterating a distinction between counter-cyclical spending and structural spending, which would again be fair enough. But then we run into a problem:
This fiscal strategy will create a window for the Reserve Bank of Australia to further loosen monetary policy, which in turn will address some of the patchwork issue. Lower interest rates will bias the dollar lower, and assist tourism, manufacturing and other trade exposed sectors. Lower interest rates will encourage a desperately needed pick-up in housing construction and consumer spending and support investment in sectors outside mining.
The macro-economic reasoning here is sound. Ironically, however, in targeting the structural deficit, the Kouk misses or fails to reference a larger structural deficit still: household debt. While it is true that a lower dollar will assist trade exposed sectors, and I’m all for that, it matters a great deal how you achieve it. If it comes at the price of boosting mortgage credit, which the Kouk is implicitly arguing for, then it is no solution at all.
Consider, housing construction is being weighed down largely because it is the canary in the coal mine vis-a-vis the falling house prices that have resulted from the slowdown in mortgage credit. Banks have implicitly tightened lending criteria for new houses as valuations have fallen. That is, to get a loan, a whole segment of first home buyers now need a much larger deposit because the price of the home is higher than the valuation upon which the loan is based. The only way the Kouk’s strategy will solve this problem is if broader house (land) prices begin to inflate again, which will require increased rates of credit issuance.
Moreover, the fall in the rate of growth of credit issuance is a structural correction that, in my view, is inevitable and healthy in the post GFC world. As Glenn Stevens put it last year when discussing the cautious consumer:
But those pressures for structural change are also coinciding with changes in household behaviour that are associated with the longer-run financial cycles I have just talked about. Just as some sectors are having to cope with the effects of changes in relative prices – manifest to most of us in the form of a large rise in the exchange rate – some sectors are also seeing the impacts of a shift in household behaviour towards more conservatism after a long period of very confident behaviour.
It would be perfectly reasonable to argue that it is very difficult for everyone to cope with both these sets of changes together – not to mention other challenges that are in focus at the same time. However, if we were to think about how things might have otherwise unfolded – if households had been undergoing these shifts in saving and spending decisions without the big rise in income that is occurring, to which the terms of trade have contributed – it is very likely that we would have had a considerably more difficult period of adjustment.
I’m all for lowering interest rates to give folks more discretionary spending power and to relieve pressure on the tradable sectors but the Kouk is implicitly arguing for more household debt, which strikes me, and the RBA too I’d guess, as a poor idea. The AFR and the Kouk’s discussion about the surplus continues to ignore the broader context of the new normal for global capital markets.
The Kouk finishes with a flourish:
A firm budget that dampens public demand is the right policy for the right time, especially when the RBA moves monetary policy settings to an accommodative position. It is a policy trade-off that will support economic growth and lock in Australia’s status as one of the best run economies in the world.
Wrong. Boosting household debt will reduce the flow of savings into banks, increase their offshore borrowings and upset both the ratings agencies and our foreign creditors.