Wiggle room in Abbott's 'no surprises'

If current growth momentum is not sustained over the next few years, Tony Abbott will need to renege on his 'no surprises' platform and make some tough policy decisions.

With the election result seemingly in the bag and an Abbott-led Coalition win all but a done deal, there are a number of important questions that his government will face when it moves to the Treasury benches to run our $1.6 trillion a year economy in the weeks, months and years ahead.

The global economic climate looks to be recovering with a raft of better than expected news flowing from as far and wide as the UK, New Zealand, the US, China and even Europe.

It must be said that a lot of that good news is the result of the super-stimulatory monetary policy settings currently in place and that as this is scaled back as conditions improve, the huge question is whether the current positive growth momentum can be sustained.

But what if things don’t pan out in this positive way? What would an Abbott government do if it is confronted by a shock to the economy, say, something akin to the 2009 Great Recession or even the 2001 US Tech-Wreck or the Asian crisis of 1997, or indeed the terms of trade collapse of the mid-1980s?

Tony Abbott has said that his will be a “no surprises, no excuses government”. That is fine and dandy if the big picture global economic environment itself throws up no surprises – that is, we see confirmation of the steady expansion in the US, China locking in GDP growth around 7 per cent, the eurozone getting off the mat and registering even moderate growth and amid all of this, Australia’s terms of trade ticking a few per cent lower as in the current Treasury forecasts.

That would be good news.

In these circumstances, Abbott will probably be able to go about his business as the new government with no surprises. As he has already noted, a Coalition government will follow the same fiscal strategy as the current government with a steady return to budget surplus by 2016-17 and debt consolidation over the medium term  (What does Tony's 'stronger economy' look like?September 2).

But what of a scenario where there is a significant economic shock in the form of unexpected weakness in China, or consecutive years of double digit falls in the terms of trade or sluggish global activity or a sharp house price fall locally?

On a no-policy change basis, Treasury would be telling Abbott that in these sorts of scenarios, many tens of billions of dollars have been wiped off government revenue and that the current glide path to surplus is being blown off track. It would also be a scenario where Treasury would say GDP growth was weakening, the unemployment rate might be on track to hit 7 per cent or more and that the risks of a hard economic landing would be very real.

Tony Abbott would need to face up to the threat of leading Australia into its first recession in a generation or taking a few tough policy decisions to steer the economy away from a recessionary mess.

This would involve policy ‘surprises’.

Politically, there would be no doubt that Abbott would blame the previous government for a structural weakening of the budget. He could probably get away with that for a while.

For the Australian economy, politics would count for little given there would be an urgent need for policy actions that no one can sensibly anticipate or promise not to do. To be sure, the Reserve Bank would be cutting interest rates. That is the policy no-brainer, but even then, the current 2.5 per cent cash rate is edging closer to the zero bound. Further, monetary policy can and often does work with a long and variable lag.

For fiscal policy in a scenario of a significant economic shock, would Abbott simply let the automatic stabilisers work and push out the return to surplus to 2020, have budget deficits of 2.5 per cent of GDP and lift the debt ceiling towards $500 or $600 billion? This would partly meet his 'no surprises' commitment, although he would obviously be left floundering for excuses about the budget blowout.

Or would he look for spending cuts, levies or tax increases to try to arrest the fiscal deterioration so that he could meet his promise for a budget surplus in 2016-17? Is his ‘no surprises’ idea related to the budget bottom line?

If he did that, he would be imposing fiscal tightness into a weakening economy and there would be little doubt that in such a scenario, the unemployment rate would be bursting above 7 per cent.

Or would he want to avoid recession, preserve employment and therefore take the advice of Treasury, which would undoubtedly be to implement fiscal stimulus? Would he agree to send out cheques and build some infrastructure to support growth? Lift the deficit to four per cent of GDP?

Or do these policies mean he would breach the 'no surprises' promise even if it meant prudent economic management at a time of severe economic risk?

It is pretty clear that there will be plenty of surprises in an Abbott government that will lead to plenty of excuses. For this, Abbott should not be criticised. Policy flexibility and dexterity is a worthy trait.

It is the 'no surprises' promise that is flawed. Even if economic conditions remain favourable, the economy will not move in a straight line and there will be bouts of uncertainty and volatility that will hit the economy from time to time (The sausage machine approach to budget estimatesAugust 30).

It is at these times you want policy makers who are pragmatic, flexible and aware of the risk that doing nothing to meet some political goal can be very damaging to the country as a whole.

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