The budget facts that Canberra isn't telling you

It's a sad state of affairs when good sense about the budget emanates from commentators on the sidelines rather than the Treasurer and shadow treasurer. Yet such is the case, because of the opposition's consistently opportunistic approach to fiscal policy and the Labor government's chronic failure to stand up to the nonsense its opponents have been peddling.

So let me be the adult and tell you what Chris Bowen and Joe Hockey should be telling you, but aren't: the more anxious we become about the economy losing speed before we make the transition to non-mining-led growth, the less urgent it becomes to get the budget back to surplus.

You'd never know it when you think of how furiously the two sides have been squabbling over "debt and deficits" for the past four years, but Labor and the Liberals have a bipartisan fiscal policy. Both sides have essentially the same "medium-term fiscal strategy": to achieve budget balance on average over the medium term.

Everything I say here is consistent with that strategy - meaning much of what Bowen and Hockey say on the topic is inconsistent with it.

That clever strategy needs a lot of unpacking for non-economists. Because budget balance (or, in Labor's formulation, surplus) needs to be achieved only on average over a period of, say, a decade, it's saying there's nothing inevitably bad about deficits or inevitably good about surpluses.

So there'll be times when deficits are appropriate and times when surpluses are. Which is which? Deficits are appropriate when the economy is growing well below its medium-term "trend" rate of about 3 per cent a year; surpluses are appropriate when the economy is growing near, at or above trend.

Stick to that approach and, in the end, the deficits and surpluses will cancel each other out, leaving no lasting debt burden to be borne by our "children and grandchildren".

The next bit to be unpacked - which non-economists seem incapable of keeping in their heads for longer than five minutes - is that the process of the budget dropping into deficit when the economy is weak, then climbing back to surplus when the economy strengthens, happens automatically without the government raising a finger.

This is because of the operation of the budget's built-in "automatic stabilisers" which, when the economy is weak, cause tax collections to fall and welfare spending to grow and, when the economy is strong, go into reverse and cause tax collections to boom and welfare spending to fall.

So provided the government of the day doesn't make changes of its own volition that work in the opposite direction to the stabilisers, they can be relied on to leave the budget balance just where it ought to be as the economy moves through the business cycle.

The strategy doesn't prevent the government from adding its own "fiscal stimulus" at times when the economy is particularly weak, just as long as that stimulus is temporary.

As for other spending or taxing measures taken by the government, they need to be fully funded (by offsetting spending cuts or tax increases) if the operation of the automatic stabilisers is to ensure we end up with no lasting debt as a result of annual deficits exceeding annual surpluses.

All of this stands in stark contrast to the opposition's populist, economically illiterate line that deficits and debt are always a bad thing, always proof of economic mismanagement and (see above) always the result of things the government chose to do rather than things the state of the economy did to the budget (via the automatic stabilisers).

In his major speech this week, Bowen noted that the great challenge facing the economy over the next year or two is "rebalancing" - making the transition from growth led by the mining investment boom to growth led by the rest of the economy.

The question, he said, is whether the transition will be "smooth or bumpy". Bang on. That's exactly the question worrying the econocrats behind the scenes. Maybe it will be smooth, but maybe it won't. We know that, already, the economy is growing well below trend, causing unemployment to drift up.

Should it slow down much further, the rise in unemployment would quicken and become more worrying. And should mining investment fall off rapidly, before the acceleration in home building and non-mining business investment got going, it's conceivable the economy could slow to the point of contraction.

Trouble is, Bowen in his speech misdiagnosed the problem. He said the answer was Kevin Rudd's seven-point plan to get productivity improvement back up to 2 per cent a year.

Wrong. This confuses micro-economic policy (aimed at raising the medium-term trend rate of growth) with macro-economic policy (aimed at keeping the actual rate of growth as close as possible to the existing trend rate, thereby smoothing the business cycle). The point is that our main instrument of macro management, monetary policy (the manipulation of interest rates by the Reserve Bank), may not be enough to ensure we avoid a serious downturn. It may prove necessary to use fiscal policy as an emergency back-up.

If the economy suddenly slowed in a way that threatened to seriously shake business and consumer confidence and start a self-perpetuating downward spiral in private sector spending, the answer would be to step in quickly with a confidence-boosting "cash splash". We know from the global financial crisis how remarkably effective such measures can be.

Should that opportunity be missed, the next response would be to be ready with well-advanced plans for a program of heavy infrastructure spending to fill the vacuum left by the retreating mining investment boom. Even now the budget's growth forecasts are looking unachievable. If Bowen had any sense, he'd be toning down the rhetoric about getting the budget back to surplus in 2016-17 and making the point I began with.

If Hockey has any sense, he'll back off from the nonsense about debt and deficits, just in case he has the good fortune to inherit Bowen's problem.