Australia needs ‘fiscal stimulus', but what does that actually mean?

Wed, 10 Jul 2019  |  

This article first appeared on the Yahoo Finance website at this link: https://au.finance.yahoo.com/news/australia-needs-fiscal-stimulus-but-what-does-that-actually-mean-203000918.html 

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Australia needs ‘fiscal stimulus', but what does that actually mean?

With the economy down in the dumps and the per capita recession now extending to nine months, there is a frenzied call for the government to implement some spending and tax policies to stem the bleeding.

The calls are coming from economists, journalists, the RBA Governor and a bevy of commentators who are demanding a fiscal policy boost from the government to support economic growth. This is all fine and there is a strong case for policy makers to work together to do something to lift the pace of economic expansion.

But there is a problem with the generic “fiscal policy stimulus” demand given that none of the calls have been accompanied by even vague details of what the stimulus means and the areas of spending that should be ramped up or what taxes should be changed.

Sure, there is a suggestion of more spending on ‘infrastructure’ but that is never defined or specified.

In the absence of any detail, the calls for fiscal stimulus are rather glib.

Here’s why.

Changing fiscal policy so that it has an immediate impact on GDP growth is difficult. If the government is to increase spending, including on infrastructure, exactly what spending areas should be increased? What infrastructure projects should be fast tracked? Which roads, railways, charging stations or whatever should be implemented, built or fast tracked? What date should these changes take effect? How long will the stimulus last? Six months? Two years? How much will it cost? What will be the impact on the budget, GDP and unemployment in 2019, 2020 and 2021?

The same basic questions need to be asked of any calls for tax cuts.

Without some of these sorts of specifics in the clamour for government economic policy action, it is not at all clear what it is those demanding some budget stimulus to boost the economy actually mean. With annual GDP growth floundering around 1.5 per cent, the unemployment rate rising and there being some doubts that the economy will be any stronger when the 2019-20 financial year starts on 1 July, we could work on an assumption that the fiscal policy boost needs to total about 1 per cent of GDP for the next year or two.

Unfortunately implementing such a policy stimulus in the next few weeks is impossible. What’s more, such a pro-growth strategy amounting to 1 per cent of GDP would probably wipe out the next 5 years of budget surpluses that just a few months ago were projected through to the mid-2020s. It would mean gross government debt would hit $600 billion and probably $700 billion in the next few years.

Note that 1 per cent of GDP is $20 billion per annum.

Of course, this would all be worth it if it helped to keep a lid on unemployment and supported economic growth.

But what policies can be changed with the specific purpose of boosting growth? Raising the Newstart allowance is one policy that has been mentioned, but the impact of raising Newstart by say $75 a week would add about 0.075% to annual GDP growth. It helps but it is small beer and Newstart should be raised for reasons other than supporting growth.

After that, the policy specifics cupboard is bare other than perhaps tax cuts over and above those already committed to by the government that would be expensive and inevitably permanent, compounding the problems in trying to return the budget to s sustained surplus.

The next time you hear one of the proverbial galahs in the pet shop squawking for fiscal policy stimulus, ask them exactly what they mean, how much will it cost, what will the impact on GDP and unemployment and how quickly can it be implemented.

Only then will the economic debate about stimulus have true credibility.

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“Bitterly disappointing”: We are seeing a once in a generation policy failure

Imagine having the power to promote economic growth, lower the unemployment rate and set in train the conditions to boost real wages growth and inflation?

It would be immensely satisfying to change policies to improve the living standards and quality of life for every day, hard-working Australians and their families.

Wouldn’t it?

Next imagine a harsh reality where economic growth is weak and slowing, the unemployment rate is rising and wages growth and inflation well below a satisfactory level, and you choose not to wield the power reverse these uncomfortable circumstances?

Doing nothing, unwilling to pump some much needed cash into the economy because of a political dogma wedded to a notion that budget surpluses are good and that holding interest rates unnecessarily high so you might dampen demand for houses – which is seen as a problem - and household debt overwhelms your power to make things better.

The RBA admits it stuffed things up – sort of

Mon, 22 Jul 2019

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The RBA admits it stuffed things up – sort of

The Reserve Bank of Australia needs to be congratulated for publishing research which implicitly confirms that it made a mistake when setting monetary policy in the period mid-2017 to early 2019.

Not that the research explicitly says that, but the RBA Discussion Paper, Cost-benefit Analysis of Leaning Against the Wind, written by Trent Saunders and Peter Tulip, makes the powerful conclusion that by keeping monetary policy tighter in order to “lean against” the risk of a financial crisis, there was a cost to the economy that is three to eight times larger than the benefit of minimising the risk of such a crisis eventuating.

The costs to the economy includes lower GDP growth and higher unemployment, that lasts for at least for several years.

A few terms first.

According to the Saunders/Tulip research, “leaning against the wind”, a term widely used in central banking, is “the policy of setting interest rates higher than a narrow interpretation of a central bank’s macroeconomic objectives would warrant due to concerns about financial instability”. In the RBA’s case, the “narrow interpretation” of the RBA’s objectives are the 2 to 3 per cent inflation target and full employment.

In the context of the period since 2017 and despite the RBA consistently undershooting its inflation target and with labour underutilisation significantly above the level consistent with full employment, the RBA steadfastly refused to ease monetary policy (cut official interest rates) because it considered higher interest rate settings were appropriate to “lean against” house price growth and elevated levels of household debt.