Why ScoMo should borrow big for stimulus

Last week, the Australian Office of Financial Management (AOFM) issued a $1.2 billion 10-Year Treasury Bond at a yield of only 0.82%:

Thus, with Australia’s inflation rate running at 1.8% currently, the federal government effectively borrowed at a negative real interest rate of nearly 1%.

Put another way, even if the federal government only returns inflation on whatever it uses these borrowings for (e.g. infrastructure investment), then the Australian taxpayer will still come out ahead.

Therefore, the obvious question arises: why is the Morrison Government so wedded to maintaining a budget surplus when the economy is experiencing a worsening demand deficit, and financial markets are effectively begging it to borrow and willing to lend money at negative real interest rates?

That’s the question asked by The Australia Institute (TAI), which has released a new paper claiming the Morrison Government’s “Budget Surplus Objective” is “an example of how economics is broken”. Below is an edited extract:

The main aim of the Government’s economic strategy seems to be achieving a budget surplus and so reducing government debt. Generally, a budget surplus produces an equal reduction in net government debt. The purpose of this paper is to question the arguments put in favour of the strategy and point to some of the consequences of the surplus strategy.

Part of the appeal of surpluses is the picture of horror associated with their opposites—government deficits and the consequent debt. With regard to debt, and the fear it arouses, we point to the two points below.

1) Australia’s history when debt was much higher without apparent damage:

As can be appreciated from Figure 1, Australia’s gross debt to GDP ratio is just above its post-war low. Net debt8 figures are not available for the whole post-war period and the gross figures will overstate the net position somewhat.9 Nevertheless, the gross figures are interesting as they reveal that Australia’s debt has fallen substantially over the course of the post-war period. In net terms, Commonwealth debt actually disappeared in 2005–06 and then reappeared in 2009–10 with the global financial crisis. By any criterion, Australia’s debt is now at an historic low.

2) Australia’s’ debt is low compared to other countries:

The Australian Government’s debt is also very low compared with other developed economies. Figure 2 shows Australia’s recent net government debt and compares it with the debt in other major countries, expressed as a ratio of debt to GDP using IMF data expressed in calendar years. Australia’s ratio is shown in red.

Figure 2 makes it immediately apparent that Australian debt is well below the levels currently experienced in other economies where debt ratios tend to be 50 per cent or more, well above the Australian rate. Indeed, Australia’s debt at 20 per cent is much lower than most economies included in Figure 2…

Government surpluses tax people more than necessary to finance the government’s activities. Associated with that is a liquidity drain as cash in the banking system dries up. To compensate the government must purchase assets from the private sector in a way that does not compromise the surplus. Under the Howard/Costello Government it did that by buying back government bonds. But the present Government intends to inject liquidity into the system by not buying back government debt but buying other financial assets to reduce net debt. As we explore this issue more closely there are some interesting implications of the surplus. Effectively parts of the government sector are looking more and more like an investment bank with both large liabilities and large assets. Government bonds on issue will be 27.7 per cent of GDP in mid-2020 compared with net debt of 19.5 per cent of GDP. The difference is the value of financial assets financed by excess government borrowing.

The Treasurer sometimes cites the interest the government has to pay on government debt as a reason for running surpluses and reducing the debt. However, the Treasurer modestly ignores the income the government receives through interest and dividends on its earning assets. As it happens, over the forward estimates interest and dividend earnings will be just short of interest payments…

The view of this paper is that governments can and should use fiscal policy to help deliver a desirable set of macroeconomic and social outcomes achieved by setting the spending and taxing tasks to fit the needs of the economy. This is exactly what Australian governments did in response to the 2000–01 downturn and the global financial crisis beginning in 2008.

These events suggest that the appropriate thrust of fiscal policy should be consistent with Australia’s macroeconomic targets. The outcome in terms of the budget balance — be it surplus or deficit — should be whatever is required to fit in with spending and taxing tasks…

Briefly, the active fiscal policy hypothesis calls for a budget balance that is whatever is needed to achieve full employment without inflation. If the economy enters a downturn, the active fiscal policy view holds that there is a need for government stimulus, which normally results in a budget deficit. On the other hand, if the economy is heading for a boom, contractionary, anti-inflationary measures are called for whereby spending is reined in and/or taxes increased, which may result in a surplus…

At any time, the fiscal balance should be decided by a pragmatic concern for government priorities and reaction to the needs of the economy and society. Those priorities should not be held hostage to arbitrary targets for the fiscal balance.

Too right. With the Australian economy entering a protracted downturn from the coronavirus, now is the time for the Morrison Government to abandon its surplus fetish and borrow large to pump-prime the economy.

Leith van Onselen
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