The Kouk wants you to borrow

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.

David Llewellyn-Smith
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  1. “Stephen Koukoulas, has emerged as an interesting new voice in the blogosphere”. Really???
    He reads like ALP propaganda to me.

  2. This poor Government is going to be bled dry – it is getting to be like a bay who should have been weaned at 1 year; but is still attached to the breast at 21!

  3. Yes, he has been furiously been campainging for a RBA cut of 0.5% in May. If that were to happen, I wonder how much megabank would pass on?

  4. “Lower interest rates will bias the dollar lower, and assist tourism, manufacturing and other trade exposed sectors”

    As if 50bps will do anything to dent the aussie, when everybody else is already at zero. Bernanke only needs one word to send the AUD back to 1.10. The EUR has big problems on its own. The relatively high dollar is here to stay. We are lucky if we can get it down to around parity.

    • I think that is probably true, though a 50 point cut would shock the dollar lower I think. 2.5 GDP in public spending is a lot, though and will lower rates more than that I reckon.

      • The shock will not last long IMO and actually some cuts are already priced in. I do not see many more rate cuts if unemployment stays at 5.2% and commodity prices remain high.

    • Agreed. And it’s not just the dollar that needs devaluing anyway (even if that were easily achievable). It’s land and wages and other costs such as utilities too. Australia needs to devalue these things if we’re to become a competitive place to do business again. But that’s a truth too painful to face. Far easier to cut rates and start up the housing music again.

    • “We are lucky if we can get it down to around parity”

      as the lucky country our “luck” has run out. it was due to our luck that the AUD hit 1.10. now the luck has run out the AUD will fall back to where it belongs…well below parity.

      • GB, if the AUD falls back to well below parity this year, you want to be selling your shares now.

        • youve got it round the wrong way (again.) falling AUD cuased by falling interest rates are positive for equity market valuations so you really want to be buying.

          • GB
            surely falling AUD means increased import costs especially oil, so increased inflation and with the consumers low spending levels this means less consumption so less profits. Also with our mineral majors facing reduced volumes/prices surely their stock prices will decrease. In addition we have possibility of increased unemployment so lower spending and of course the MB view of a crashing house market and resultant affect on banks.
            Then of course we can look overseas, EU and USA, for other reasons to be negative about markets.

          • You are fast in calling people wrong mate (again)… a gently falling AUD is good for shares as discussed, but a AUD that crashes down means the world market are crashing, so you sell now and buy after they have crashed. Simple.

  5. We are all being softened up for a very severe extension of fiscal tightening. This will be highly likely to cause a recession, and will therefore probably not result in the hoped-for budget surplus. Instead, the budget will remain in deficit, but will be associated with lower levels of demand and output.

    Businesses will do what they have to do in a recession: retrench workers and postpone investment. Households will do what they usually do when the labour market goes bad and the economy contracts: reduce their spending and increase their savings.

    So interest rates may very well fall, but there will almost certainly be no immediate stimulus to housing. More likely, as unemployment starts to rise, both the demand for and supply of credit for housing will decline, leading to a deeply deflationary correction in the property market. Such a correction could last for many years, considering how over-bid the market has become.

    The political drive to achieve a surplus will most likely have the opposite effects: a recession, revenue collapse, rising unemployment and a property rout.

    We have avoided this so far because of the twin countervailing forces of rising export income and foreign investment in the resources sector. If these taper away – or start to subside – then the intended fiscal tightening will induce a GDP shock of European proportions.

    What is most surprising about all this is that while it is completely obvious to anyone who thinks about it at all, there is almost no challenge to policy settings.

    Fiscal policy is too tight and getting tighter. Monetary policy is too tight and staying that way.

    It should be no surprise when recession hits in 2013. We will then get to see what happens to employment and prices in a shrinking economy with a chronic current account deficit, a persistent public-sector deficit and huge private sector indebtedness.

      • GB, we are now about one-third through 2012 and private sector incomes are still expanding, so recession is not imminent. However, the effects of fiscal retrenchment will kick in from July and begin to detract from the private economy on a cumulative basis. By around the end of the year, you would expect the tightening to start to affect household incomes and precipitate changes in private sector behaviour. In particular, we will then see both the public and the household sectors trying to protect or increase their savings rates at the same time, and a policy-induced recession will become unavoidable.

        Fiscal tightening at the present juncture is one of the most recklessly adventurous developments in economic policy this country has seen, and yet it is almost universally acclaimed. This just shows that political rhetoric has defeated calm reason, once again.

        • If balancing your budget now is an adventurous development, when will it ever be the right time? I know the answer: never. 🙂

          Our total private debt is a large multiple of our public debt, and we simply can’t have both.

          • The attempt to balance the budget through cutting spending by 2.5% of GDP almost certainly will only cause a recession. Tax receipts will fall, outlays will rise and the budget will remain where it started: in the red.

            Achieving a balanced budget in 2012/13 is a political imperative, not an economic one. The economic priorities should be to sustain full employment, delivering both economic growth and fiscal stability while enabling gradual household delevering to continue.

            If the economy grows, the budget will return to surplus over time. But if the economy is destabilized by pronounced fiscal contraction, then we can kiss goodbye to full employment as well as fiscal balance.

            The Government have made the mistake of being sucked in by the rhetoric of the Opposition. The result will be a completely unnecessary and damaging economic slump of unpredictable intensity and duration.

          • I understand your point of view, but there will always be a reason not to balance the budget.

  6. HnH, you do realise that household debt is still an unorthodox economic issue?

    To a massive insider like The Kouk who understands and endorses the politico complex around ‘economic management’, that falls on deaf ears.

  7. MsSolarFelineAU

    This Kouk-person is in a tall building, and not out in the real world. He doesn’t run a business providing a service, he’s paid to parrot a paradigm.

    I don’t expect money or assistance for anything. Our ENTIRE taxation-system is incorrect and unbalanced.

    Why does this feel like 1991 – although an infinitesimal-times worse??

    We are on our own, and we must concern ourselves with ourselves and not expect that a Government will be able to provide for us.

    • Why does this feel like 1991 – although an infinitesimal-times worse??

      Hawke and Keating spent their time post-Volcker up to 1991 trying to eliminate the unviable economic crud. There was plenty of inertia but the 1991 recession flushed it all out.

      Howard rewarded unviable economic crud at the expense of ‘Smart Australia’ industries, and these smart industries folded, leaving only unviable economic crud.

      That’s why it feels bad. We have to eliminate all our economic crud and we need a recession to do it… but then you realise.. we have nothing else.

  8. “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.”

    Strange comment, imo the Libs love anything that sends asset prices north, I would bet that we will see the upping of the FHB grant on election of a Liberal govt.

  9. Houses

    If you recall the Howard era “interest rates will be lower under us” mantra, the basic idea was lower deficits hence lower interest rates. Amazing that 5 years after that finished that Labor is politically cornered to follow it still. A fair bit of the 2009 spending leaked o/s through the higher currency – so you would expect austerity would fund a lower currency and hence the impact on activity would be less severe than first thought provided the transmission lags line up. But Swan’s approach does nothing for investing certainty – either all brake or all gas, like a bad cab driver. Who would abandon the “brace” position when shocks are coming at you internally and externally? Don’t think you have to worry about rampant credit growth for quite some time yet.

  10. “First-home owners’ grant, the abolition of the indexation of petrol excise, the baby bonus and the tax-free status of income for retirees left Australia with an interest rate structure that is higher than it need be???” What is the link there?

      • Yep, crowding out occurs in a debt-deflationary environment.No question about it.
        Never mind America’s recent experience or Japan over the last 20 years.

        Seriously, am I only the one having brain spasms over this? Or having I have been reading too much Bill Mitchell and Modern Monetary Theory?

        • Alex78,

          ..reading too much Bill Mitchell and Modern Monetary Theory

          Reading any more MMT beyond the part where they talk about the success of their proposals relying on good governance is probably “too much”.

      • “larger government deficits lead to higher interest rates” … if they are profitable deficits! But if they are full of wasteful spending…

        • Perhaps “wasteful spending” like a brand new public high school assembly hall that was built to replace an existing assembly hall which was no longer large enough for the student population.

          A new hall that cost twice as much per sqm as buildings constructed by private schools under the same Fed program. A new hall that was no larger than the old hall. With no north-facing windows so it requires more artificial lighting and heating than the existing building.

          No alterations to the plans were permitted and, of course, no input was sought from the principal, teachers or staff on their requirements. It was the official, approved design by the Feds. Central planning at its finest.

          /rant over

          • drsmithyMEMBER

            Well, don’t keep us in suspense. Where was this hall built and who were the builders who defrauded us all ?

          • How was Abbott coming out saying he would up the baby bonus to $10 k if he gets in? Funny how l live in a nice suburb and can’t afford more Than three kids yet out west they can afford 7, I wonder why? And tony pull your head in

  11. I love swans talk about a surplus putting downward pressure on interest rates? Yep it will for those still left?
    Imagine if Julia gillard ends up owning a fish and chip shop after she leaves politics,……and struggles.

    • The tuck shop girl was definitely no genius but you’ve got to love the irony. We all laughed and sneered at her suggestion that we print money when we fall on hard economic times. Fifteen years later……….

      Too much like hard work for Jools. Easier to mooch off the public purse or some unfortunate union membership.

  12. “if broader house (land) prices begin to inflate again.”

    Thank you, HnH for explicitly recognising it is LAND prices not structure prices that cripple people. If only the bogans saw the distinction.