it’s not too hard…

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Many of the (economic) objections to my argument that we ought to be cutting spending faster, and saving more of the proceeds of the boom are in some way linked to the following two propositions:

1/ the economy is too fragile just now

2/ it’s not possible to do more, given the lingering effects of the crisis

I don’t buy argument one. The economy is set to boom – thanks to mining investment.

Besides, recession is comparatively rare – it most typically comes from external shocks of some type.  In the present case, it’s most likely to come to Australia due to some exogenous global shock – and if/when that does occur, the best thing we can do is to have our fiscal house in order.

The world is uncertain, so it’s good policy to have as tight a budget as possible. If the fiscal house is put in order during the good times, fiscal policy can be used to buffer the economy when shocks arrive.

Those who had been careful and prudent prior to the GFC tended to obtain better outcomes than those that were not so careful. I think this demonstrates  the value of keeping one’s books in order.

As for argument two – that the economy is too fragile due to the lingering effects of the GFC: well, Iceland is trying harder than we are. It’s startling to note that despite our economic differences, the cyclical deterioation during the GFC was similar, and that Australia is lagging in the repair job.

The above chart is of the General Government Cyclically Adjusted Overall Balance (%GDP) – it’s from the IMF’s April Fiscal Monitor. The IMF does not adjust for the terms of trade when they make their structural budget balance calculations, so this understates the size of the Australian structural budget deficit.

It’s sobering to see that Australia’s fiscal trajectory has been similar to Iceland – despite the fact that we did not have a financial crisis and did not have a recession.

Part of the reason Australia had better economic outcomes is because we had the fiscal space for aggressively counter-cyclical policy when the GFC arrived. At the time, that was the correct policy.

Now that the crisis is past, and that we are on the edge of a boom, the Government ought to be pulling back and making space for the private sector. There is no better time to aggressively tighten fiscal policy than during a once in a 150yr terms of trade boom, when the economy is at full employment.


  1. We are a federation unlike Iceland.

    We cannot tighten enough to offset the the effects of the mining boom as
    Ken Henry shows.

    Tightening becomes very problematic given what Treasury said about Revenue. After all if Swan had revenue coming in like Costello the budget would be in black already

    1. it is a very good speech, and in my view Henry makes the case for tight fiscal policy by pointing out how large the economic / revenue shock is. as you note, Henry points out that the shock is too large to be fully sterilised by fiscal policy – however it does not follow from this observation that the fiscal position is irrelevant. The fiscal position remains important as a determinate of the mix of tightening we obtain (between fiscal and monetary). It is also important, in that the tighter we are now, the more space we have to cushion the economy against shocks.

      I don’t think the present government’s greatest crime is their slack budgeting – i think it is their burying the prospect of real reform by bungling the politics of the mining tax.

  2. Firstly, let me say I have no arguments about cutting spending. A rollback of the stimulus is well overdue and should have happened as soon as it was clear China (and commodity prices) were recovering … and that’s been pretty obvious since the beginning of last year. We definitely need to have our fiscal house in order before the next external shock.

    Where I take issue with you is here:

    The economy is set to boom – thanks to mining investment.

    Lets just say I agree that mining is set to boom, whether or not a downturn in the rest of the economy offsets that boom is up for debate. What’s of HUGE political importance however is this boom will be very narrowly focused , and most voters live and work in the slow part of the economy. Some voters are unfortunate enough to work in work in the non-resources tradeables sector, which at best is sluggish, at worst in full recession. Indeed, I dare say more voters live and work in the sectors that are in recession than those that are (or will be) booming.

    Now up in your ivory tower you may think the RBA should ignore politics — and I agree — but I also believe that this boom will drive such a wedge between the fast and slow lanes of the economy, there will ultimately be implications for the independence of the RBA. If we see another (say) 75bps this year, the Australian economy ex-mining will definitely go into recession (put your house on it!) and the resentment in the electorate will be palpable. Demands to reign in the RBA and tax the bejesus out of the miners will intensify.

    Is this is the scenario you want for Australia? I know you’ve tried to push the case that manufacturing, tourism etc are actually doing ok — and your motivations for presenting this view are obvious — but have you considered the possibility you might be wrong? What of the wider economy? What would another 75bps do for house prices and consumer confidence?

    What on earth does the RBA do if mining investment is going gangbusters while 80% of the economy is in recession? I know what the politicians will do!

    1. i’m going to address those points in due course. i agree these questions are the key to getting policy and politics right in the coming years.

      fwiw i’m not trying to protect the Bank. i honestly believe that if we try and trade off a little higher inflation for a few years that it will be the more costly option in the long run.

  3. I think that the drop in commodities prices and pull back in equities is indicating that the market thinks monetary policy is too tight – particularly in the US. Perhaps it also reflects the pullback in AD in China. I think downside risks are growing quite fast and that the tight monetary policy being run in the US, China and EU is at risk of driving the world back into recession. that eventuality will (temporarily) deal with our two track economy. Both will then be in the same gear – slow.

  4. I haven’t looked at tips break evens recently but know they ticked up since QE2 was leaked. What would be interesting is to see whether they have pulled back over the last two weeks. Therein could be a data point against the scenario in my previous comment.

    The other thing that I think you don’t mention in your post is the part that monetary easing had to do with keeping us healthy through the GFC. Stevens saved Australia’s bacon. Rudd’s cash splash did something, but I don’t think much.

    1. as you know mate, i am less sceptical than you regarding the efficacy of fiscal policy — or should i say more ambivalent about equivalence :) i just think that the rate of return on govt spending is generally low, and so it should be minimised.

      re breakevens — TIPS breakevens have been crushed, just like commodity prices. as i often say, the TIPS market is a bit of a joke – it trades like equities!

  5. I believe what we are arguing about is not that fiscal tightening should not be tightened but how much.
    My guess it could/should be tightened a tad more more however I am mindful of how hard that is given the House of Representatives.
    Also bear in mind if Revenue changes for the better and becomes Costello like the structural deficit miraculously improves by some 3-4 percentage points.

    1. Hmm that depends on the cause of the change. If revenue changes for cyclical reasons that won’t impact the structural position. At present the CGT depression and depreciation costs are most probably cyclical.

      I think the bigger risk is that the recently weak productivity performance is actually structural.

      Sent from my iPad

  6. You need to catch up with what Martin Parkinson said at the ABE about this.
    Because most of the structural deterioration was because of revenue considerations it was pointless looking at that.
    If you read this IMF Publication then all will become clear.

    What was previously thought cyclical is now structural.

    This is how Ireland structural deficit went from 0.5% to over 6% without the government doing anything!

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