Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
The Australian government is digging a hole for itself at present. In the May Budget it talked (neo-liberal) tough to demonstrate what it claimed was “Responsible Economic Management” – and this meant it entered a battle with the Opposition about who would deliver the biggest budget surplus. This became one of the comical (in a tragic way) features of the August federal election campaign. The respective treasury boof-heads from the Government and Opposition boasting about the size of their future budget surpluses. They also tried to win the battle of who would get there the quickest. The whole discussion was definitely mindless. Now with the Australian dollar appreciating fairly strongly the Government has realised the reduced economic activity that seems to be occurring is reducing its tax revenue prospects and therefore undermining its surplus projections. So what do they do next? Answer: announce they will cut spending by even more than originally planned. They are going to deliberately undermine employment growth and force even more people to lose their jobs at a time that labour underutilisation sits at the obscene level of 12.5 per cent and inflation is moderating. It is sadly a case of the fiscal vandals chasing a dream. The dream however is a nightmare.
The ABC news today announced that High Aussie dollar threatens budget surplus. The nub of the story is that:
The Federal Government says the high Australian dollar is eating into its revenue and will make it more difficult to keep its pledge to return the budget to surplus in two years.
In the up-coming mid-year economic outlook the government will alter this stance and make it “tougher”. After all the surplus is their golden egg – given they are so entrenched in neo-liberal logic.
The Assistant Treasurer was quoted as saying “If exporters are making less profit they will be in a position of paying less tax.” Unless the government puts the tax rate up!
In the current climate where the RBA is once again hiking interest rates to quell the mining boom to prevent what it thinks will be a big inflationary surge and the government has already indicated it wants to impose a resource rent tax on the Mining industry for equity reasons (to spread the largesse) why wouldn’t a rise in tax rates be appropriate?
The problem with the current approach to the mining boom is that the interest rate rises, if they are effective in stemming aggregate demand, will damage the slow growth areas of the Australian economy – which considering the size of the mining sector (small) – is most of the economy. A fiscal response could be targetted and still allow for nominal demand growth in the sectors and regions which are still struggling post crisis.
But note also that the RBA thinks inflation is going to moderate first – more about which later.
You can read the Government’s stated plan (pre mid-term economic outlook review) for what they call “Responsible Economic Management” in the Economic Statement which is part of the 2010-11 Budget papers published last May and reaffirmed in the recent election campaign.
In that document you read of their boast:
The Government remains committed to delivering on its deficit exit strategy, and returning the Budget to surplus in 2012-13, well before any of the major advanced economies. This would represent the fastest fiscal consolidation in Australia since at least the 1960s and puts Australia at the forefront of global fiscal consolidation efforts.
The Government will continue to focus on its deficit exit strategy by:
* holding real growth in spending to 2 per cent a year until the budget returns to surplus; and
* allowing the level of tax receipts to recover naturally as the economy improves, while maintaining the commitment to keep taxation as a share of GDP below the 2007-08 level on average.
The focus of the fiscal strategy in future years will remain on returning the budget to surplus, including by continuing to reprioritise existing expenditure, consistent with 2 per cent real expenditure growth.
Once the budget returns to surplus, and while the economy is growing at or above trend, the Government will maintain the 2 per cent annual cap on real spending growth, on average, until surpluses are at least 1 per cent of GDP.
So they are going to impose a mindless fiscal rule without reference to the rest of the economy and if the rest of the economy doesn’t behave then they will tighten the rule! That is what I call mindless and reckless fiscal administration.
The changing outlook for tax revenue and spending – as a result of the automatic stabilisers – is a lovely demonstration of the endogeneity of the budget outcome and further why it is a futile economic strategy to budget a particular bottom line two years or whatever in advance.
The appreciation of the Australian dollar is starting to have sectoral impacts – the so-called Dutch disease effects. One of the new neo-liberal agendas that will open up soon is the claim that the solution for the declining competitiveness (as a result of the appreciation) is to cut real wages.
First, when there is an external cost shock (so an imported raw material rises in price), the national economy faces a real loss of income. This has to be shared out in some way among those who stake claims in real output. An equitable sharing arrangement would prorate the losses amongst profit margins and real wages. However, it is this sort of struggle that can provoke a wage-price struggle which may eventually manifest as inflation and depending on how the government manages the distributional struggle – as stagflation.
Second, when a currency is appreciating, you get sectoral effects with the traded-goods sector which is what the term Dutch disease refers to. The Australian problem is typically that mining booms push the dollar up but the same global demand buoyancy that mining enjoys is not shared by agriculture and manufacturing (both who also export). The latter two are then disadvantaged by the higher foreign price for their exports but no change in domestic (AUD) costs.
Productivity boosts will reduce real unit costs in those industries that enjoy it as will real wage cuts. But there are several problems with advocating this. How do you actually engineer real wage cuts in sectors which lose competitiveness? It is unlikely that you can cut nominal wages so you have to rely on inflation outstripping nominal wages growth. Given the mining boom, nominal wages growth in that industry will continue to outstrip average growth. You are then faced with suppressing nominal wages growth in agriculture and manufacturing.
Further, the import sector will start attracting labour and the disadvantaged export sectors (not including mining) face labour supply shrinkages. The changing terms of trade also promote dynamic efficiencies (productivity growth) in the areas that are facing cost squeezes.
It is not an easy problem to develop effective policy unless you want to propose significant interventions in the market via incomes policy etc.
But you shouldn’t confuse these relative price changes as being tantamount to inflation. Inflation is the continuous rise in the general price level (that is, all prices). So a rise in a particular asset class does not amount to inflation although it does alter relative prices (the prices relativities between individual goods and service). Relative price changes can be very disruptive if they also cause terms of trade changes and sectoral imbalances. The concept of the Dutch Disease is an example of this.
However, all of this is rather moot from the government’s perspective because it desired to put a brake on growth anyway. So at present there is a monetary policy tightening happening (with the commercial banks hiking faster than the RBA) and a significant fiscal contraction occurring.
Now you might want to question why the government would be wanting to curb growth anyway given that inflation is moderating (and low) and we have idle labour to the score of 12.5 per cent (at least) of available labour resources. In addition, many other indicators of growth (and future growth) are pretty flat at present (credit demand, housing, retail sales etc).
But even if you don’t question that, you would wonder about the economic logic of the following government mindset:
1. In May 2010 (Budget night) they announced these fiscal rules and budget surplus targets based on an expectation of growth in revenue at much lower exchange rates (and economic activity).
2. Our terms of trade booms and as is always the case in Australia (and for all primary commodity exporters) the exchange rate sympathetically follows suit. The appreciating dollar is now at the time of writing (late Friday afternoon) well established over the parity line (1.0154) and heading north. This is stifling economic activity in the traded-goods sector.
3. The reduced activity – which was the government’s aim – is reducing their tax revenue take and therefore the automatic stabilisers are delivering forces that will undermine the planned for surplus.
4. Government’s logic – they will have to tighten fiscal policy further than planned to “get the surplus”.
5. Problem: growth will be further stifled and they will chase themselves around in circles and damage the real economy in the shambles.
So you can see how a blind adherence to a fiscal rule is dangerous.
The Finance Minister tried to explain the logic to ABC News:
Obviously it is a matter of logic when you have a higher dollar and the dollar is significantly higher than it was when the forecasts were originally done … It impacts on some of our industries very significantly. Industries like tourism but it also has an impact on government revenue. A higher dollar can mean lower profits for certain companies that are exporting and that can translate to lower revenue to Government.
If the dollar is at parity, obviously you are going to get a different set of figures that flow from that compared to when the dollar was at 85 cents.
Okay that makes sense.
But then she told the ABC that the Government “remains determined” to achieving a budget surplus by 2013.
That doesn’t make sense
But the Opposition Finance spokesman is no better. He claims that the Government also has to cut even harder than they were considering.
If you want to see how more nonsensical an adherence to fiscal rules can be consider that early in October, the Commonwealth Department of Finance warned the government that they would need even tighter spending cuts if they wanted to “protect the surplus” (see article – Finance urges spending cuts to protect surplus).
What was the reasoning here? Answer: Revenue would fall because the world economy is in danger of slowing down. The briefing
… warned the Australian economy is not immune from the downside risks of the global economy … the persistent threat of a double-dip global recession strengthens the case for rapid action … the government needs to build a fiscal buffer to protect against further negative economic shock, singling out retiree benefits, health and defence spending as areas where savings could be found.
The people who wrote this briefing would have at least Bachelor’s degrees from our universities. It shows how our tertiary education system has failed us.
From the perspective of Modern Monetary Theory (MMT) the last thing the government should be doing is cutting its net spending if it fears a serious international slowdown will impact on our own growth fortunes. That is all mindless adherence to fiscal rules that bear no intrinsic relation to what is going around us.
Further, the idea that you need a “fiscal buffer” in case you need to introduce a fiscal stimulus in the future because of another global meltdown has no basis in credible monetary theory or the realities of the fiat monetary system.
There is no “Tin Shed” in Canberra or Washington or anywhere where the national government can put its surpluses away for later use. There is actually no storage because when a surplus is run, the purchasing power is destroyed forever.
A national government in a fiat monetary system has specific capacities relating to the conduct of the sovereign currency. It is the only body that can issue this currency. It is a monopoly issuer, which means that the government can never be revenue-constrained in a technical sense (voluntary constraints ignored). This means exactly this – it can spend whenever it wants to and has no imperative to seeks funds to facilitate the spending.
This is in sharp contradistinction with a household (generalising to any non-government entity) which uses the currency of issue. Households have to fund every dollar they spend either by earning income, running down saving, and/or borrowing.
Clearly, a household cannot spend more than its revenue indefinitely because it would imply total asset liquidation then continuously increasing debt. A household cannot sustain permanently increasing debt. So the budget choices facing a household are limited and prevent permanent deficits.
These household dynamics and constraints can never apply intrinsically to a sovereign government in a fiat monetary system.
A sovereign government does not need to save to spend – in fact, the concept of the currency issuer saving in the currency that it issues is nonsensical.
A sovereign government can sustain deficits indefinitely without destabilising itself or the economy and without establishing conditions which will ultimately undermine the aspiration to achieve public purpose.
Any financial target for budget surpluses or the public debt to GDP ratio can never be a sensible for all the reasons outlined above. It is highly unlikely that a government could actually hit some previously determined target if it wasn’t consistent with the public purpose aims to create full capacity utilisation.
As long as there is deficiencies in aggregate demand (a positive spending gap) output and income adjustments will be downwards and budget balances and GDP will be in flux.
The aim of fiscal policy should always be to fulfill public purpose and the resulting public debt/GDP ratio will just reflect the accounting flows that are required to achieve this basic aspiration.
Fiscal sustainability cannot be sensibly tied to any accounting entity such as a debt/GDP ratio.
Inflation will only be a concern when aggregate demand growth outstrips the real capacity of the economy to respond in real terms (that is, produce more output).
After that point, growth in net spending is undesirable and I would be joining the throng of those demanding a cut back in the deficits – although I would judge whether the public/private mix of final output was to my liking before I made that call. If there was a need for more public output and less private then I would be calling for tax rises.
This is not to say that inflation only arises when demand is high. Clearly supply-shocks can trigger an inflationary episode before full employment is reached but that is another story again and requires careful demand management and shifts in spending composition as well as other measures
All of this discussion was recently considered at Senate Estimates hearings in Canberra. The Treasury secretary Ken Henry was interrogated by the Senate Estimates Economics Committee about this on October 21, 2010. Here is the Full Transcript.
The discussion at the Committee started talking about a supposed trade-off between fiscal and monetary policy. The argument the conservative opposition is now making in Australia is that the fiscal deficits are the reason the RBA is pushing up interest rates because the net spending is fuelling inflation.
So it is crowding out but not in the usual way where the conservatives claim that interest rates rise because government borrowing exhausts allegedly finite savings. In this new version, the government spending drives economic activity too strongly and the impending inflation forces the central bank to push up rates – as the only buttress against inflation.
Note that today, the RBA released its – Statement on Monetary Policy November 2010 – where it concluded that inflation pressures were easing and would do so through to at least mid-2011. After that they claim that the mining investment boom that hasn’t happened yet will push up inflation and hence they need to hike rates now – a year before this alleged happening. Please read my blog – RBA makes the wrong decision – for more discussion on this point.
But the point is that there is considerable fiscal tightening going on at present and this will intensify during the next 6-8 months at a time when the RBA acknowledges that inflation will be moderating. So it is difficult to argue that the fiscal stimulus has had anything much to do with the recent rise in interest rates.
Anyway, back to Senate Estimates – on Page E105 of the transcript you pick up the following conversation. The players are Senator Bushby (a relatively new Liberal – that is, conservative – Senator from Tasmania); Senator Wong, the Minister of Finance and in this context being interrogated rather than asking questions as a Committee Member; and Dr Henry, the Treasury secretary (that is, boss of the Commonwealth Treasury):
Senator BUSHBY – a decision to proceed towards further fiscal consolidation. Applying that rule of thumb, could a decision not to proceed with the planned stimulus spending result in a reduction in interest rates in the order of some per cent?
Senator Wong – ‘Some’ per cent?
Senator BUSHBY – Depending on the accuracy of your rule of thumb and which rule of thumb you apply. But in the order of a per cent or two …
Senator BUSHBY – I would probably be very interested in the Treasury officials’ perspective on that.
Dr Henry – … I would not want to endorse any particular number, obviously. I think it is important to understand that this is not a simple trade-off between fiscal policy and monetary policy. The reason a more rapid fiscal consolidation – a more aggressive consolidation – would to some extent result in lower interest rates is because the economy would be weaker. Growth would be slower, the unemployment rate would be higher and the fact, therefore, that the economy would be further from its full capacity position would call for a more accommodative stance of monetary policy. It is not a simple choice between a particular size budget deficit and a level of the cash interest rate or mortgage interest rates.
So it is quite clear – the fiscal consolidation will make the economy weaker, growth would be slow and the unemployment rate higher. That is coming from the Treasury secretary.
At least he is prepared to say that which is not the case in say the UK at present where the Treasury secretary’s counterpart is claiming that fiscal austerity will increase growth and reduce unemployment. One is lying.
The point is that the direction of policy now is to reduce employment growth at a time when the labour underutilisation rate is persistently around 12.5 per cent and inflation is moderating. That cannot be responsible fiscal management. It is the result of an adherence to a blind neo-liberal ideology which cannot deliver acceptable outcomes.
Further, with the external sector still in deficit, the fiscal consolidation will slowly but surely undermine the private sector’s capacity to reduce its own excessive debt levels. That strategy – to further squeeze private sector liquidity and increasingly push it into debt (or else growth plummets) – also cannot be responsible fiscal management.
The Senate Estimates discussion then proceeded to interrogate the Treasury secretary about whether Australia was close to the NAIRU. Please read my blog – The dreaded NAIRU is still about! – for more discussion of this hoax of a concept.
The fact that the Australian economy is not delivering the tax revenue growth to justify the previous budget surplus forecast tells me that growth (even in the so-called booming mining sector) is not as robust as the RBA and other commentators and lobby groups are making out.
It indicates that the Government should continue to provide fiscal support for growth. All the signs are that growth is likely to taper off a bit in the coming months.
The last thing the Government should be doing is “sticking to its fiscal forecast” and attempting to deal with the declining revenue by further cutting spending.
In general, the imposition of fiscal rules places the government in a policy space where it cannot deliver flexible fiscal responses to ensure aggregate demand remains strong. The reason is that the announcement of these rules and the political rhetoric that surrounds the announcements – “surpluses are good” mantras – make it very hard for the government to admit that it needs to expand its discretionary budget deficit.
The regular Saturday Quiz will be back some time tomorrow.
That is enough for today!