Australia’s budget debate is getting curiouser and curiouser, not least because it is still more likely than not that there will be a surplus in 2012-13 and those suggesting fiscal policy be loosened seldom take account of the consequences of their suggestion to run a deficit.
In terms of the deficit proponents, there is a mix of views that range from suggestions there be a boost to government spending to make sure the economy remains firm, to others suggesting the government go further and take advantage of record low borrowing costs to ramp up infrastructure spending and worry about the budget position later.
Thankfully the cooler heads remain of the view that the government should maintain its fiscal approach and deliver a surplus – given the economy is expanding at a decent pace – and at the same time, make room for the Reserve Bank to cut interest rates if inflation stays low.
Unfortunately, the arguments for abandoning the surplus or worse still, ramping up infrastructure spending, are presented without much, if any, analysis of the consequences of such actions nor with an acknowledgment of how the economy is performing at the moment.
While there is something of a soft patch being felt now, the fact is that GDP growth is 3.1 per cent and the unemployment rate is 5.2 per cent. This is an economic double that suggests fiscal tightening, not stimulus, is entirely appropriate. The current air-pocket on economic growth is actually being dealt with by the Reserve Bank with its monetary policy easing cycle. It would be folly for the government to get in the way of those plans.
Most forecasters, including Treasury, are expecting GDP growth to hold around 3 per cent over the next few years, not far from the current growth rate. If this is correct, any injection of fiscal stimulus would inevitably overheat the economy, kick into higher inflation and force interest rates higher.
The minutes from the December meeting of the RBA board released yesterday noted that "globally, economic news over the past month had a slightly more positive tone than was the case a few months earlier” and that "the Australian economy had expanded at around trend”. And they also note that interest rates were "clearly below their medium term averages”.
In other words, monetary policy is acting in concert with the fiscal strategy to rebalance policy and the economy.
To be sure, the 2012-13 budget may yet end up in a deficit, but this should only occur if the automatic stabilisers kick in if the economy undershoots Treasury forecasts. A budget deficit based on a revenue shortfall due to unexpected economic softness is appropriate and would be neither here nor there, provided the government held a tight grip on the areas where it does have fiscal control.
In such a scenario it needs to be remembered that the Reserve Bank would inevitably begin cutting interest rates further which paradoxically would underpin growth, revenue and help the return to surplus in a low-cost way.
This scenario would also see the major credit rating agencies comfortably maintain Australia’s triple-A credit rating, a point that is not even on the radar if a surplus is delivered.
As for infrastructure spending, the economy would not cope with a fast tracked development of roads, ports, railways or buildings. It would be economically irresponsible to see a pick-up in borrowing to fund infrastructure simply because borrowing costs are low. The reason is the economy is too close to full capacity to accommodate any unexpected upswing in government demand.
Here are some other facts.
For 2012-13, private demand growth is forecast by Treasury to be a red hot 4.75 per cent, with a slight cooling to a still strong 4 per cent in 2013-14. With the private sector having such momentum, it is incumbent on the government sector to scale back its demand for scarce workers, resources and capital. If government demand were even neutral and not contractionary as it is now, inflation would be a huge problem with GDP growth nearer 4 per cent. Inevitably, the Reserve Bank would be hiking interest rates, which would see the Australian dollar skyrocketing near $US1.20 rather than holding at current levels around $US1.05 (Australia's in a cannon war with a popgun, December 19).
Fiscal consolidation has been the unwavering strategy of the government for the last two and half years and to abandon those plans now is unthinkable politically but worst still, it would be reckless economic policy.
The hard economic data so far in 2012-13 suggest the surplus objective is still on the cards. Employment growth in the first five months is running close to the 1 per cent forecast in the Mid Year Economic and Fiscal Outlook, while the unemployment rate is probably a touch lower than Treasury was assuming. Wages growth is likely to be near the forecast 3.5 per cent. All of this suggests income tax payments are holding up well.
At the same time, the commodity price fall evident when MYEFO forecasts were put to bed in October is being reversed. While overall commodity price indices are generally flat, the commodity prices most relevant to Australia have picked up, with the iron ore price up around 50 per cent in just 10 weeks. This bodes well for not only the revenue flow from the mining tax, but for company profits more generally.
With the ASX up a nice 5 per cent or so from the levels around MYEFO, there may even be some upside for capital gains tax receipts.
The one area where there is an obvious erosion of revenue is in the deflation risks coming through the fall in the terms of trade and also nominal GDP growth. This may undermine company tax payments and dampen income growth more generally.
There is little risk the government will do anything other than keep a tight reign on fiscal spending and it will keep that surplus in its sight.
It is good policy and it makes sense.
Stephen Koukoulas is managing director of Market Economics and was former economics advisor to the Prime Minister Julia Gillard.