Budget deficit "bad", budget surplus "good". The misunderstand of fiscal policy

Mon, 30 Apr 2018  |  

The following is an extract from my opening remarks to the Senate Committee on the Audit Commission in February 2014.

The full document is at this link: https://thekouk.com/blog/the-kouk-s-opening-remarks-to-the-senate-committee-on-the-audit-commission.html 

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It is somewhat alarming to see the increasingly popular view that budget deficits are bad and surpluses are good. Alarming because it may encourage policy makers to take the wrong decisions when managing fiscal settings without paying attention to the business cycle. There was a risk of this with the previous government with its commitment to return to budget surplus in 2012-13. It was a worthy objective but thankfully it did not stick to that strategy when it became apparent that the decline in the terms of trade and high value for the Australian dollar had impacted negatively on national income growth and therefore government revenue.

Had it cut spending to meet its surplus goal, the economy would have weakened appreciably and the unemployment rate would inevitably be higher than it is now.

The government and the economics profession needs to work hard to change the misconception that surpluses are always good and deficits always bad.

There should be no value judgement that suggests budget deficits are good or bad without context being placed around the economic and fiscal position.

I have used the analogy elsewhere, but I think it makes the point – is a warm and sunny day good or bad?

Most obviously, it depends.

For a holiday maker at the beach, a warm sunny day is clearly good. But for a farmer on marginal land in the midst of a drought, another warm and sunny day is clearly bad.

A similar judgment should be applied to budget deficits and surpluses.

It would be an economic policy failure, in the extreme, for any government to be aiming to run a budget surplus if the economy was in recession and the unemployment rate was rising. Here a budget surplus is unquestionably bad, while a deficit would be good, even if it was merely the result of the government allowing the automatic stabilisers on revenue and expenditure to kick in.

Similarly, if the economy was in a well established period of above trend growth, with very low unemployment and inflation pressures evident, a budget surplus would be good and a deficit bad.

When I look at the business cycle in Australia over the last four decades, I see quite clearly that this approach has been in place, more or less, from both sides of politics. I note the Howard government running a budget deficit in 2001-02 as the economy slowed markedly, if only temporarily, in the wake of the ‘tech wreck’ in the US and aftermath of the terrorist attacks on the US in September 2001.

This was appropriate.

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Or irrelevant. 

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