Swan, Stevens and the budget botch-up

Wayne Swan's latest budget forecast could be prematurely negative, but if the Reserve Bank had cut rates by an extra 50 basis points this year a deficit may not have been on the cards at all.

It looks like the Gillard government will retain its status as the lowest taking government since the 1970s with news that a major revenue shortfall will likely see the 2012/13 budget slip into deficit.

I was wrong to think the return to budget surplus was about an even chance (Why Stevens can bank on budget surplus, December 19), with the monthly fiscal update from Finance Minister Penny Wong throwing a large bucket of very cold water on that view. It showed that government revenue was undershooting the budget time forecasts for the first four months of 2012/13 by $3.9 billion. Even though government spending was also undershooting the budget time estimates with a shortfall of $1.3 billion, the overall budget balance so far in 2012/13 is $2.7 billion short, which is larger than the surplus projection of $1.1 billion.

Obviously Treasury and the Department of Finance know a lot more than I do on the budget, but with a few genuine signs of stronger economic growth starting to emerge, including the sky-rocketing iron ore prices, Treasurer Swan may be prematurely extrapolating the first four months of 2012/13 over the rest of the fiscal year to doubt the return to surplus.

Swan was not willing to nominate the latest treasury estimate for the 2012/13 deficit. But if the average monthly undershoot for the first four months of 2012/13 is repeated over the final eight months, the starting point budget deficit will be around $7 billion. Once measures taken in the Mid Year Fiscal Economic Outlook update in October are accounted for, this deficit is reduced by about $1.4 billion in 2012/13 to something like $5.5 billion.

All of this suggests that when treasury presented a projected budget deficit of something near $5 billion for 2012/13 after the Joint Economic Forecasting Group meeting a week or so ago, the government felt that the fiscal austerity required to make up that shortfall would be just too much for the economy to bear. It would impose a contraction in an economy that is vulnerable to the terms of trade fall and global economic conditions more generally.

There is another element to the budget and economic policy.

The hawkish stance on monetary policy from the RBA and its poor reading this year of the deflationary impact on the economy from the terms of trade decline was likely an indirect factor behind the government’s decision.

For the government, it was either go hell for leather and further tighten the budget and risk the economy weakening too much into 2013 or back down on its surplus commitment and let the automatic stabilisers underpin growth.

But it would be less likely have been in this position had the RBA eased monetary policy appropriately and ended 2012 with the cash rate 50 basis points or so lower. This would without question have taken at least a little heat out of the Australian dollar and the economy would no doubt be a touch stronger that it is.

For many reasons, it is a pity the RBA was unable to recognise what the government did: the cooling economy, deflationary pressures from abroad and the need for a relaxation in policy if the economy is to grow at a decent clip.

Looked at another way, it shows very clearly just how fiercely independent the RBA is. Despite its mistakes, it stuck to its view.

It would be an interesting exercise to see how many words in 2012 the RBA has devoted to fiscal policy in its monetary policy statements, minutes of RBA board meetings, quarterly statements on monetary policy and speeches. I have read all of them and my recollection would be that maybe 1 per cent of the written analysis on the economy was on fiscal policy and the budget. And this, it must be remembered, is in the context of 20 per cent of GDP coming from public sector demand and the fact that it has been evident for around two years that the cuts in government spending in 2012/13 are the biggest ever recorded in Australia’s history.

So the question on managing economic growth in a low inflationary environment was neglected or misread by the RBA and it is now back to the government to let the automatic stabilisers kick in to provide support to the economy.

It remains the case that fiscal policy is very restrictive. Government spending is down dramatically and the only reason the surplus is now unlikely is a revenue shortfall.

And there is the legitimate question of whether budget surpluses should be a policy end.

The answer is obviously no, and over the business cycle, the budget should aim to be in small surplus. When the economy is strong, allow the surplus to occur and grow. When the economy is soft, allow the surplus to shrink and when there is a risk of recession, run a deficit to support economic activity and jobs. Most analysis seems to come out and strongly support a change to the fiscal strategy.

The Howard government sort of did this with a budget deficit in 2001-02 when the economy was on the cusp of recession. It was sensible to boost real government spending by a near record 9.1 per cent in 2000-01 and add a further 3.5 per cent in spending growth in 2001-02 to support economic activity.

A key point from yesterday’s budget shock is that the economy is likely to be at least a little stronger in the near term which will add to employment and activity. The market reaction over the past 18 hours or so has been to drive share prices and the Australian dollar higher, while bond yields are all but unchanged.

In my assessment of economic risks, it is not a long shot to envisage a slightly stronger economic outlook in the first quarter of 2013 and for the government to get a pleasant budget surprise in in the lead into the budget in May. That would be interesting.

Either way, the rating agencies suggest there is no threat at all to Australia’s triple-A credit rating after yesterday’s news, which says it all.

Stephen Koukoulas is managing director of Market Economics and was former economics advisor to the Prime Minister Julia Gillard.

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