Fiscal policy austerity for the sake of reducing budget deficits and cutting government debt during times of economic weakness has been exposed for the economic vandalism it always has been.
A key point to come from the G20 meetings in Washington is that the recent bouts of fiscal austerity have been counter-productive in that they have hurt economic growth, underpinned higher unemployment and done precious little to reduce government debt levels. The G20 concluded that rather than ramping up the speed at which debt reduction policies should be implemented, it concluded that “further actions are required” to help deliver an economic recovery.
The communiqué praised Japan and South Korea for recent policy stimulus measures, but “much more is needed to fulfill our commitment to address the ongoing weakness in the global economy”.
The G20 assessment of the follies of fiscal austerity comes after a hugely influential study by Carmen Reinhard of Harvard Kennedy School and Kenneth Rogoff, an economist at Harvard, published in 2010, was exposed as a fraud that was riddled with errors. Those errors appear to have been deliberate to make sure the results fit with the authors’ political and economic disposition.
Our own Jessica Irvine wrote a neat summary of the issues associated with the Reinhard and Rogoff fiasco for Business Spectator last week – it is worth rereading it in the wake of the G20 assessment (Egg on the face for macroeconomic heavyweights, April 19).
The critical point in all of the discussion comes back to the very basic concept of how fiscal policy, national budgets and government debt should be managed over the medium to long run.
It remains the case that fiscal policy has a critical role to play in the business cycle in every country. The problems many countries are confronting now are linked to ridiculously loose fiscal policy in the five to 10 years or so up to 2007. In the UK, the US and most of Europe, those years of strong economic growth, falling unemployment and general economic good times witnessed inept fiscal settings with tax cuts and spending increases that should not have been delivered.
The quite catastrophic fiscal settings of George W Bush in the US and Tony Blair and Gordon Brown in the UK are perhaps the highest profile recent example of fiscal incompetence.
In the US, where economic growth was so strong, to the point where the unemployment rate ticked below 4 per cent, net government debt went from 55.9 per cent of GDP in 2001 to 63.9 per cent of GDP in 2007, before the housing and financial crisis hit. Debt should have fallen.
In Australia, by way of example and counter-check, net government debt fell from 6 per cent of GDP in 2000-01 to a position of net financial assets of 3.7 per cent of GDP.
The situation in the UK was less severe but was still problematic. In 2001, net government debt was 41 per cent of GDP and while it only edged up to 43.4 per cent of GDP in 2007, the boom economy should have delivered bigger budget surpluses and significantly lower government debt.
This is the background to the current problem, and why the G20 and other sensible economists are rallying against the current fiscal austerity pressures.
These times of strong growth in the US and UK should have seen large budget surpluses locked in and debt levels reduced.
Over time, of course, governments should aim for balanced budgets, on average, over the cycle and to strive for reducing debt levels fall when times are good so that debt can rise when times are less good or down-right glum.
The G20 noted this by reiterating its view that over the medium term, fiscal policy acts as a counter-cyclical policy instrument.
This theme of anti-austerity when economic conditions are soft has also come strongly into the policy debate in Australia. It started late last year when Treasurer Wayne Swan decided that the revenue shortfall in the budget from weaker nominal GDP growth should not met with more fiscal tightening. As a result, he simply noted that a budget surplus in 2012-13 was unlikely.
In recent days, Opposition leader Tony Abbott and Shadow Treasurer Joe Hockey has also backflipped on their pledge to return to budget surplus, should they win the election in September. There have been times when they have indicated an objective for a surplus of 1 per cent of GDP, which equates to something over $15 billion. Reality of the shortfall in revenue means this pledge has gone.
This assessment firstly from Swan and subsequently Abbott and Hockey is a belated acknowledgment that fiscal policy is a means to an end not an end in itself.
Two cheers for some common sense.