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Jan 19, 2011

How Labor found itself in a surplus trap

Labor’s abandonment of economic reform after 1996 has left it adrift and the party's adherence to its promised 2012-13 surplus reflects how it let its enemies define its economic credibility.


Labor carries much psychological baggage from the Howard years. In fact, it’s got the political equivalent of post-traumatic stress disorder. And the greatest damage accrued around economic management.

That’s why we’re having this faintly weird discussion around whether the projected Budget surplus should be abandoned to “pay for” the cost of recovering from the floods.

Labor’s abandonment of economic reform after 1996, as I argued at the end of last year, has left it adrift. This is one of the key reasons why this Government, under both Kevin Rudd and Julia Gillard, has been so bad at framing debates in a way that favours itself. As Paul Keating said – ironically quoted by Wayne Swan after the election last year — politics is an ideas market and if you run the ideas, you run the market. Labor’s dearth of ideas, and its inability to communicate those it has, means its opponents are running the market.

Labor in its first term did a spectacular job of economic management (well, Treasury and the Reserve Bank get most of the credit, but Wayne Swan and Kevin Rudd had the good sense to do as they were advised). But they ended up letting the Coalition make the Budget deficit the de facto measure of its economic competence, particularly during the election campaign. That the Coalition so badly fumbled this exact issue in its post-election discussions with the independents is one of the ironic instances of justice occasionally served up by politics.

But the Government’s oft-repeated commitment to return to surplus by 2012-13 come what may is its admission that it is stuck with a debate defined by its enemies in the Opposition and the media. The projected surplus itself is trivial – a bare $3b – but is therefore of enormous symbolic importance to the government, as if that $3b represented a vast gap between incompetence and astute economic judgement.

You can thank Paul Keating – the “bring home the bacon” version of the dim, distant past – and more particularly Peter Costello for this fetishisation of Budget surpluses. But it’s Labor’s fault that the significant, though hardly massive, fiscal impact of the floods (bearing in mind that the stimulatory “cost” of the rebuilding phase is only part of the fiscal impact, given the lost revenue from farms, miners and businesses who have had to halt business) is being seen entirely through the prism of what it will do the surplus.

The number — a projection two years away, in any event — itself doesn’t matter a great deal. The surplus is simply a tool of political debate, for all sides – even for the business community suddenly changing its mind about the need to curb government spending. That’s why Tony Abbott produces nonsense like the line that the NBN is a luxury that we can now no longer afford. Strangely, he didn’t mention the tens of billions we’re spending on Defence procurement, or the many tens of billion of dollars a year of revenue foregone on tax expenditures, or the tens of billions spent each year, enthusiastically supported by both sides of politics, on middle-class welfare. Even the most cursory glance reveals that there are a whole lot of luxuries in the federal budget.

The Government has one part of its fiscal consolidation strategy correct – to cap extra spending at 2%b real growth and bank upward revenue revisions. What it has been poor at is actually cutting expenditure, for all its insistence that it has made “tough decisions”. Some blame for this lies with the Coalition, which blocked cuts to one of the worst middle-class welfare rorts, the private health insurance rebate, and it’s true that the Government had to balance an uncertain global environment in its first two budgets. But no one believes that in Penny Wong we have a new Peter Walsh ready to spring forth and assail spending ministers, or that she’d receive much support from her Treasurer and Prime Minister if she did so.

A more intelligent debate, led by a Government that had its wits about it, would be around the need to roll back expenditure in politically-sensitive areas to get the Budget on a sustainable footing over the long-term. And all the more so given that, under even the mildest climate change scenarios, the cost of recovering from extreme weather events is going to plague future budgets much more frequently than we’re used to.



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47 thoughts on “How Labor found itself in a surplus trap

  1. JamesH

    Deficit fetishisation. Bah. If the private sector wants to run a surplus (by saving) and export earnings don’t cover it then the government must run a deficit or we get a recession. It’s a bleedin’ accounting identity, innit. The debate should be about whether the spending is value-for-money or not.

  2. ronin8317

    The Australian’s government have a good reason to be a deficit hawk. This is illustrated by this chart from Paul Krugman’s blog.


    Our private sector is heavily indebted to foreigners, and we need to run a Government surplus to keep interest rate low. While it is nowhere near the monstrosity of USA, we have to consider the wisdom of borrowing so much money from overseas in order fuel our ever rising home prices.

  3. John Reidy

    As you mentioned previously the ALP hasn’t handled this well since ‘96 (and Beazelys Big Hole)…

    One line that occurred to me – that the coalition might run is that if the budget deficit is increased it won’t be because of the needed and good spending on the recovery but the bad wasteful spending on the NBN -even if between now and 2012 there isn’t much spending on the NBN.

    It is all about value for money, I am sure they could cut spending as mentioned above, still reach a surplus and pay for the recovery.

  4. geomac

    The medibank rebate like the funds to elite private schools achieves nothing of value to the public and should be scrapped. Every year they raise fees and premiums above the inflation rate. I,m in favour of schools struggling to provide basic facilities getting government funds but not schools getting an extra cricket pitch or chapel. Religious and extra sports facilities over and above basic requirements shouldn,t be the taxpayer funded. Its about education not look at me status. Abbott would be appalled if this was mentioned instead of the NBN but then he thinks politicians are under paid so whats his opinion worth ?

  5. C@tmomma

    And the best time to discuss a realignment in Budget and taxation priorities would be at the upcoming Taxation Summit. Especially in light of future provisions for Global Warming extreme weather events, if we are to take Climate Change at all seriously. I just wish that Julia Gillard would take the Training Wheels off Dr Andrew Leigh because what I have read from him thus far has been eminently sensible and put in such a way to counter the critics with unquestionable logic, which Keating was also able to do. Now is not the time for political niceties about political succession and seniority. The time to get the best economic talent for the government out front is now. The Opposition and the government’s opposition in the media and other areas of Private Enterprise in Australia sure won’t be waiting to put the boot in, justified or not. They have an election to win for the Conservatives. And with the Senate now in the hands of the Progressives, from July 1, they will be coming out all gund blazing to reverse the trend ASAP. So Gillard, the ‘Game On’ PM, will have to be on her game and do much better than she has thus far.

  6. John Anderson

    Bernard Keane is right to say that Labor is unable to effectively communicate its ideas. But I disgree that it doesn’t have ideas. Indeed, you could argue that it has too much on its plate, noting the delicate balance in the House of Representatives could scuttle some of them. What about the MRRT, the Murray Darling water trade-off, mental health, a price on carbon, the increase in the super guarantee and the related Cooper super reforms, rolling out the NBN, the health/hospitals reforms and the related GST trade-off and the plethora of education reforms that Gillard announced during the election campaign but largely ignored by the media? Some of these are huge economic reforms.

    Rather than Labor becoming a captive of the surplus fetish, Keane actually shows how Labor can have its cake and eat it too. That is to say, have a surplus and similtaneously fund the flood damaged infrastructure. For example, a reintroduced private health insurance reform package will pass the Senate with Greens support after 1 July 2011. There’s $2 billion over 4 years. All the MRRT proceeds [that’s billions of dollars] could be allocated to flood damaged infrastructure rather than just some of it. The company tax reduction could be deferred until the the flood bill s is paid for. There is some irony here given the pressure from business [the AIG] to spend up big to save jobs and small businesses and to hell with the surplus.

    As for middle class welfare, it will be a little easier to remove given the Greens’ opposition to most of it. It’s the House of Representatives that could be the stumbling block. So the flood costs are easily financed. What a budget surplus in 2012-13 depends is solid economic growth, the greatest threat domestically to which is the RBA’s penchant for lifting interest rates.

  7. Greg Angelo

    The problem with budget deficits is that they have to be funded, and that funding comes from borrowings and those borrowings have to be repaid. Counter cyclical expenditure financed from borrowings during a recession is sensible to take advantage of underutilised labour and capital resources with the benefits funded from future taxation where the beneficiaries of this expenditure happily repay borrowings whilst they enjoy the benefits. However deficit funding in a tight economy will only lead to inflation.

    As the United States is finding out you cannot run budget deficits forever. Eventually you fall into a debt trap were all you can do is fund the interest on the borrowings that you have made in previous periods. The borrowings to fund the profligate public expenditure on pink batts, the NBN, the BER and now the proposed disaster reconstruction will have to be repaid, and there are already indications that the Reserve Bank is having to offset inflationary pressure in the economy as a consequence of this expenditure.

    There is no problem with public-sector deficits in the short term, provided the capacity to repay is clearly understood. The projected return to surplus is only the beginning of process as the surplus is required to repay borrowings, should government set this as an objective.

    It is interesting to note that the US government has not run a balanced budget for decades and that over $13 trillion of debt has been built up as a consequence of a lack of concern for balancing public sector budgets. This is over USD 46,000 per capita, or about USD 120,000 per taxpayer. Australia’s federal net debt by comparison is relatively small at around $140 billion or about $6700 per capita or $20,000 per taxpayer. However the borrowings for the BER and the NBN will significantly impact on those values with net debt projected to rise to around $168 billion by 2013-14 or approximately 10% of GDP. This represents a net borrowings of around $150 billion under Rudd/Swan/Gillard stewardship with aprojected annual interest bill of somewhere in the vicinity of $10 billion per annum at current interest rates. Unless the budget returns to significant surplus enabling debt to be paid down, we will be saddled with this interest bill in perpetuity. Advocates of deficit funded (borrowing funded) spending without constraint should consider these matters carefully.

    Also those advocates promoting elimination of the health insurance rebate should note that in the past health insurance was tax deductible for income tax assessment purposes. and that elimination of this rebate would force many people out of private health insurance and into the public health system which would not be able to cope. Privately insured patients get a 30% rebate on their medical costs but are still funding the other 70% out of after-tax income.

  8. John Bruce

    It is so easy to throw around the concept of deficit. The fact that we could even consider it is due to not having a large outstanding debt while the rest of the world is going to pot. We should get serious about utilising our available funds to get the best value for the country. Rebuilding in all of the three eastern states which needs to happen now and is in the order of many tens of billions of dollars will provide a broad stimulus over a major part of the country. The odd $2billion saving here or there is almost insignificant compared to what the rebuilding and improvement required will cost. We should rechannel all funds from all non essential new projects including the NBN and any further school building other than for schools that have been devastated into this urgent immediate need and maintain fiscal responsibility. Further, we also to immediately enhance existing infrastructure such as roads and rail that were flood effected to ensure that our national arteries remain open. The next flood in Brisbane could easily be in the next 6 weeks before the end of this wet season.

  9. freecountry

    Budget surpluses are not a “fetish”. Like commercial entities, churches, and most large organizations in general, governments seek to expand themselves. Like most organizations, it is sometimes prudent for governments to spend more than they gain for limited periods of time.

    Unlike other organizations, governments hardly ever have to confront hard limitations on how much they can borrow, or how fast they can accelerate borrowing, because sovereign entities have almost limitless powers to defer the taxation of citizens until another day, or another generation, to pay it off. (Or so it seems, until Ireland or Iceland happens.)

    Also unlike other organizations, voters in a democracy crying out for more expenditure are usually under the mistaken impression that they can get something for nothing, by forcing a richer minority or foreign shareholders to take on most of the tax burden. Majority rules. Explaining that it’s nowhere near as simple as that requires economic explanations that most of the public, and even most journalists, either lack the patience or background to understand, or simply discredit as a bunch of “neoliberal” hocus pocus. To put it as simply as possible: the more uneven the tax burden, the more business tends to fail or move offshore, reducing tax revenue instead of increasing it, reducing the competition for goods available to consumers, and inflating away the value of real wages so workers become poorer even when their nominal wages are rising. (And John Anderson, that inflation is the reason the RBA has such a “penchant for lifting interest rates”.)

    I find it very strange the way the left insists that greed and reckless disregard of risk has broken the credibility of capitalism; while at the same time arguing that indulging people’s greed for public spending, and recklessly disregarding unknown risks to national solvency, is responsible economic management. Insisting that the call for surplus is a mere “fetish”.

    Public spending should shift urgently to areas which can demonstrably reduce costs and risks to the Australian public. Public transport, water management, soil management, energy supply, urban design, alleviation of export bottlenecks, and accumulating a strong capital fund of emergency money for a rainy day.

    All forms of spending should have sunset clauses, requiring periodic review in parliament. Tax revenue must be increased, not by increasing aggregate rates of taxation, but by increasing the base of taxation, through the above forms of spending, and through efficiency improvements in the way we tax. As I’ve said elsewhere, even a carbon tax might impose less deadweight distortion losses than some of the taxes we are using now (the worst of which is capital gains tax which is so dear to the hearts of anti-capitalists).

    Governments state and federal must wean themselves from their political addiction to implicitly guaranteeing house prices and suppressing the building of homes, because this causes a huge drain of people’s present and future income, into paying the interest for overseas loans from which banks fund their mortgages.

    In short, Labor has got to go, Wayne Swan is a bull in a china shop, and the Coalition needs a clean-out because Tony Abbott and de-facto deputy Barnaby Joyce show only a dim awareness of what needs to be done.

  10. ronin8317

    Not all debt are equal, and debt used to fund investment is different from debt used to fund consumption. In the case of housing, what used to be classified as consumption has turned into an investment, even though it doesn’t produce any goods or services. This is where the market fails. Unfortunately, it is not that easy to change course.

    Transfer payment via taxation is essential for social cohesion, and it is far cheaper to keep someone on the dole compared to imprisonment. It is however even better to create an environment where everyone has a job.

    In regard to the government retaining a ‘capital fund’, it is rather tricky. Buying government bond doesn’t make any sense, as you’re just shifting money from your left pocket to your right pocket. Buying bonds from another country introduce exchange and default risk, and you can’t put that amount of money in a bank account either. You could park it at the Central Bank as a last resort, however it is spend it on infrastructure (NBN, Murray Darling, Dams, etc), or not collect the tax at all.

  11. sickofitall

    It’s what happens when the party decides that power at any cost is better than good ideas. V G Childe got it exactly right in 1922 – at least every other ALP govt had ideas (though none of them were perfect – let’s not write hagiographies): Bernard is right in a sense, as is the poster above. Labor has too many good ideas, but no consensus (save what will get them power) – hence they have no ideas.

    Sad, really.

  12. freecountry

    Ronin8317 – Yes, productivity-enhancing public goods often make better risk-adjusted returns than capital markets. These public assets can then be used as specific collateral for loans if necessary–rather than collateralizing the labour of our children and grandchildren as we are in the habit of doing. A government might take more seriously the need to pay off debt if the alternative is China owning our railways. “Risk-adjusted returns” implies that returns on infrastructure that addresses quantifiable deficiencies are worth more than vague hand-waving about future unknowable benefits of NBN. Bond holdings should not be overexposed to major export markets, lest we suffer a double whammy if those export markets collapse.

  13. kennethrobinson2

    The whole problem, could be solved by good leadership, something sadly lacking in the current political system

  14. Ben Aveling

    On the one hand, zero dollars, the divider between deficit and surplus, is an arbitrary number, a line in the sand. On the other hand, without some line in the sand, how do you know when you’ve gone too far?

    If you’re a business, you’re allowed and required to distinguish between spending that has immediate benefit vs spending that has future benefits; capital expenditure, aka investment vs operational expenditure aka running costs.

  15. Ben Aveling

    PS. With everyone talking about ‘rebuilding’ we should remember that it doesn’t always make sense to rebuild the same thing in the same place in the same way.

    Sooner or later, what just happened will happen again.

    Have a look at ocean temperatures off the Queensland coast – the water is over 30 degrees in some places:


  16. SBH

    Oh my sainted aunt. Has there ever been a less capable government. If you can’t justify raising money or spending a surplus to fix damage caused by floods across three states you should gicve the game away. Hypothecated taxes enjoy a high degree of support and the simple answer to Abbott is that he is tight-fisted, mean-spirited, making political capital out of tragedy and doesn’t want to help flood victims. Talk about never letting a good crisis go to waste. jesus wept.

  17. JamesH

    Greg Angelo and Freecountry: Base or High-Powered Money is a creation of national sovereign (think for a moment about why that word means both “independence” and “coinage”) governments; in a modern fiat-currency system, it has no existence independent of the actions of governments. When governments tax, they withdraw money from circulation, they don’t “gain” anything by doing so. When they spend, they add money to circulation and don’t “lose” anything by doing so, because the money has no existence outside of government action. There is no law of conservation of money; there is no need for taxation to equal spending; there is no absolute need for national governments to borrow anything at all.

    What is important is that the total money stock (roughly, base + credit extended by banks) and the supply of real goods and services remain in more-or-less balance. It’s better for monetary expansion to lead real supply expansion rather than vice versa, because mild monetary expansion calls real goods and services into the market to match (creating jobs to supply them) while contraction leads to them being withdrawn, deflation, recession, etc; in other words, money supply is the independent variable. Since the money supply has to expand to accomodate economic growth, either governments must expand the base money supply (that is, run “unfunded” deficits) or the stock of private credit must constantly expand; that is, people must take on more and more private debt. The current western world-wide crisis is precisely because people took on more and more private debt until a Minsky crisis hit. Generally speaking, if governments attempt to run surpluses, that is, withdrawing more from circulation than they add, this will only exacerbate the deflation.

    It can be useful to fund infrastructure and other big public sector investments by “borrowing from” (that is, selling bonds to) the private sector because this drains funds from the private sector, thereby preventing the money spent up front on building the infrastructure from triggering inflation and/or an unsustainable boom, and puts the money back in later as the bonds are paid off. But this is an exercise in preserving monetary balance, very different from private sector borrowing which has no other way of raising funds.

    Exports and imports complicate this picture a bit because net exports effectively let us add other governments’ money to our money stock. Thus if we were to run strong net exports sufficient to cover the private spending deficit (from mining, say) the government could run a surplus to prevent the economy overheating. But our exports are basically dependent on other people (particularly the chinese) running deficits (or in China’s case, running down their reserves/surplus); and by simple logic it’s impossible for every country in the world to have net exports.

    Read up on Chartalism and Functional Finance if you want to know more about the basis for these statements.

  18. SBH

    All well and good, but this argument is about politics not economics and the (in)ability of the Government to prosecute any kind of argument.

  19. sickofitall

    Of course, what no-one mentions is that we were deeply in debt under the ‘surplus-driven’ Howard-Costello govt. Until the debt is paid off, it’s not really a surplus. (I know what accountants say… but if you have this much money, and this much debt – the debt should be paid off. The only dead money is interest paid.)

  20. peterg


    Im no expert, but re expanding money supply. to keep up with (or precede and stimulate) real growth, the government can print money, or credit can rise… in the latter case it is the interest on that debt that, over and above the nominal credit level, represents the increase in money supply , but the government will still have to print the money for that interest to be paid with real $, and that interest will have to be matched with real growth. so we can have the government’s (and citizenry) benefit from the trick, or the bankers.
    though in a digital age with so much funny money maybe its not so simple and all of the above assuming that the credit is matched with deposits (not so with fractional reserve banking), that one’s spending is reduced for the other’s lending except for that real growth.
    over that last few decades we’ve swapped public debt (blessed) for private debt (demonised). in Aus we currently see no problem with that private debt. stay tuned and watch for the bailouts, to ‘re publicise’ the private debts.

  21. peterg

    oops, having a bad typo day

    public debt (blessed) for private debt (demonised)
    should be
    private debt (blessed) for public debt (demonised)

  22. kennethrobinson2

    @James H, that post of yours, I found impressive, I am not up on the economy but what you said makes sense to me, keep up the good work.

  23. freecountry


    That’s all true but it has one flaw: it relies on government discipline to ignore all temptation to expand the money supply for political reasons. We addressed the monetary side of this with an independant RBA–independent but by no means omniscient or infallible–but that still leaves the fiscal side in the hands of politicians.

    Now here is the fly in the ointment: those politicians are immune to any criticism which the voting public does not understand. The consequences of abusing the value of money can be good for the government in the short term, leaving the downside to be borne by others down the track.

    And I ask readers here: How many of you understand what JamesH wrote there about the money supply? Or to rephrase the question, how many of you have, at the very least, studied monetarism at third-year undergraduate level? Not me. I can parrot the reasoning, but I can’t claim to really understand it. And there are competing economic theories about it: Friedman says the money supply should be held constant, like a sailor adjusting the sails to keep a steady course in a changing wind, while Keynes says a wise government should read the wind and change course, expanding or contracting the money supply as conditions dictate.

    The reason Hayek opposed Friedman and favoured a gold standard is not because of its “intrinsic value” (look at the gold markets today, there’s nothing intrinsic about its value) and not because of any mathematical superiority (he agreed with Friedman on that count) but because no government can be trusted not to debase money for the sake of short term glorification and re-election. It’s even easier when a government can shift opportunistically between monetary theory and Keynesian demand theory.

    Budgetary discipline is not a mathematically perfect way to assure workers that the wages they earn today will still be worth something tomorrow. But in the absence of the gold standard or any other objective standard, it is the only one we have. If budget discipline is publicly derided, then you have nothing but your trust in the inspired wisdom of government to assure you that your wages are not being stolen from you, and that your children are not being turned into indentured slaves whose destiny is to pay off our profligacy and have nothing of their own.

  24. Greg Angelo

    Is over 40 years since I studied economics, so my knowledge is at best fundamental and somewhat rudimentary. Whilst I recognise the need for expansion in money supplyto accommodate growth, it seems to me fundamental that governments should not withdraw more resources from the economy for public sector expenditure than it is prepared to generate from taxation in the long run. This includes repayment of borrowings used to fund deficits. I am also aware that expansion of the money supply by government as a stimulatory method provides short-term benefits, but people accepting currency expect it to be of intrinsic value some of the money supply exceeds the value goods and services available the net result is inflation.

    Short-term deficit finance is perfectly acceptable from a counter cyclical stimulus perspective but long-term structural deficits appear to be a significant driver of inflation. Returning the budget to surplus is merely an equilibrium point where the government stops spending more than it is generating in receipts in a specific accounting period. It does not in itself reduce the impact of prior period borrowing because interest is still being paid on the debt used to finance the deficit, on the presumption that government is matching its net consumption with net taxation withdrawals/borrowings from the economy, whilst allowing for timing differences funded by interest on debt.

    I am also aware that expansion of the money supply by government as a stimulatory method a short-term benefits, but people accepting currency expected it to maintain its intrinsic value. So if the the money supply exceeds the value goods and services available the net result is inflation.

    Based on the simple reckoning in my comments above, $150 billion or so to be spent bythe Gillard/Rudd Rudd government over five or six years (before any further outlays on disaster reconstruction) up to 2013 will add $10 billion interest per annum to government outlays. This is approximately $1500 pa per taxpayer. If my understanding is correct I am with Free Country in requiring governments to balance their budgets in the medium term. Accordingly this $150 billion will have to be repaid. There is no free lunch. Future taxpayers will have to cover this current expenditure through increased future taxation or reduced government expenditure to pay down debt. Alternately government can progressively extinguishes this debt in real terms by allowing inflation to increase to progressively rob the financially denominated savings of the community through inflationary erosion of liabilities.

    Also if you have the courage, look at the US debt clock website. The numbers are truly frightening.

  25. JamesH

    Freecountry: I think talking about “indentured slaves” is a bit excessive. More generally, governments here and elsewhere regularly mount election campaigns on the basis of how fiscally frugal they are going to be, how they are going to balance/drive into surplus the budget, etc; which suggests that the special interests who elect them have quite a healthy (or in fact, excessive) concern with “sound” budgetary policy.

    The sad truth is that politicians are only occasionally responsive to “the voting public” and far more responsive to monied interests – look at the spineless ALP backdown over the mineral resource rent tax. The political centre has shifted a long way to the right since Milton Friedman’s day when everyone was concerned about stagflation. (For that matter, Margaret Thatcher couldn’t make Friedman’s money supply policy work – and if maggie thatcher wasn’t able to impose a policy, then it’s basically unimposable).

    “No government can be trusted not to debase money for the sake of short term glorification and re-election” – au contraire, my friend, the major problem of Europe and the US is that they are not debasing their money enough in the current slump; the Euro is inflexible because it has to accomodate both Germany and Greece and so the PIGS are unable to competitively devalue, and the US can’t balance their trade with China because they won’t expand the monetary supply enough to force China to stop pegging the Yuan to the dollar.

    Greg, I think you have missed my point that it is not necessary for governments to “borrow” at all. They can expand spending up to whatever proportion of the real supply of goods and services they want, provided they then withdraw that money through taxation; its the taxation to withdraw money from circulation (or pay back the “borrowing” aka bonds) that prevents inflation.

    You say “Alternately government can progressively extinguishes this debt in real terms by allowing inflation to increase to progressively rob the financially denominated savings of the community through inflationary erosion of liabilities.” But on the whole the community and private sector are in net debt, not in net savings. Certainly my savings are smaller than my mortgage. Mild inflation, if it occurred, would help me more than it hindered me and the same goes for most mortgage and business owners. The losers from inflation are the rent-seeking “industries”: banking and real estate.

    You object to monetary structural deficits but this ignores that we currently run a major real structural deficit: the 12% of un- and under-employed australians who lack jobs to do and consequently are the causes of most crime and social dysfunction in this country. From 1945 until 1972 we had no problems running a more or less continuous structural deficit and guaranteeing 2% unemployment, with very mild inflation, under a far more stringent (because still partly gold-standard and fixed exchange rate) monetary policy than we do now. What we did once, we can do again.

    The US debt clock argument misses the fact that most of that “debt” is in US government bonds held by US banks and citizens. It’s actually a measure of private sector savings held as bonds. The US govt would not issue bonds if the private sector didn’t desperately want to buy them as a safe place to put their savings in the current dire economic circumstances.

  26. JamesH

    @ Kennethrobinson2: Check out Professor Bill Mitchell’s blog (http://bilbo.economicoutlook.net/blog/) which explains it all much more clearly than I can.

  27. Greg Angelo

    @JamesH – I think I understand the issue of government being able to rund deficit budgets without borrowing, but as you point out unless you withdraw the equivalent amount through taxation you have inflation. Presumably withdrawing the equivalent amount through borrowing has a similar effect on inflation, but in the long run the government has to repay the get a or continue to pay the interest on that debt in perpetuity.

    I see the ‘structural deficit’ of underemployment as being separate matter as it is not financially denominated in the budget although I am as concerned as you are about as the underemployed segment of the economy.

    In relation to the US government debt position I assume that the $14 trillion in government bonds (private sector savings) has been used to finance government expenditure or is there some other relationship between the $14 trillion and successive US Federal budget deficits? Is this USD 14 trillion comparable to the projected 170 billion Australian Federal government borrowings as outlined in the recent Federal budget? Perhaps if there is a ready source of information explaining this you could perhaps provide an appropriate reference.

  28. freecountry

    [Freecountry: I think talking about “indentured slaves” is a bit excessive.]
    A bit dystopian, you think? What if I suggested many Australians are already some way down that road, whether they know it or not. Those who pay rent in the capital cities, and those who’ve bought their own home in the last five or so years.

    In the heavily government-controlled land market, and in the absence of a sophisticated understanding of microeconomics in the era of easy credit, these prices have strongly outstripped wages. The excess prices mean that up to half of a worker’s after-tax income, rather than a long term trend closer to a quarter, goes to paying off the windfall gain of an earlier generation.

    The reason this is relevant is because there are various ways of storing the value of the work you do, of which the fiat money it issues is just one example. Land is another. And there have been a series of policies in which government chose to boost confidence in land at the expense of confidence in its own fiat money.

    Real estate is not one of the losers of inflation as you say; it gains from inflation, because most real estate is bought with credit and inflation is the best way to amortize a loan principle. The result has been an average official rate of inflation of around 3% for some people, but a dramatically different rate of inflation–in terms of living standard and alternative stores of wealth–for others, with the younger generations being on the losing side.

    Government gets away with this because the winners are voters, while most of the losers are either too young to understand, too young to vote, or not even born yet. This is just one example of how government undermines its own fiat money, not by conspiracy, but by having very little idea of what it’s doing, and having more pressing things on its mind, such as re-election. That’s why, as you say, “Margaret Thatcher couldn’t make Friedman’s money supply policy work – and if maggie thatcher wasn’t able to impose a policy, then it’s basically unimposable.”

    So I agree when you say, “it is not necessary for governments to “borrow” at all. They can expand spending up to whatever proportion of the real supply of goods and services they want, provided they then withdraw that money through taxation; its the taxation to withdraw money from circulation (or pay back the “borrowing” aka bonds) that prevents inflation.”

    Or to put it another way, yes we should help Queensland rebuild. But no, this does not excuse the government from a budget surplus–indeed, it’s hard to justify why the budget was not already in surplus in 2010 instead of still accumulating debt until 2013. Something has got to give. Please don’t vote for free lunches.

  29. JamesH

    Greg Angelo: The difference is that the amount of money withdrawn by taxation should be the amount necessary to keep inflation controlled, which is not necessarily equal to the amount extended by government. Government spending should complement private sector spending; if the private sector is net saving (as they are now, because everyone is trying to pay down debt) then the government should net spend (that is, run a deficit); if the private sector is net spending, then the government should save; but over the course of a cycle they should net spend, because the money supply has to expand with (and to produce) economic growth and employ the new people entering the workforce. Forcing the government to balance its budget with respect to its own spending, rather than the economy as a whole, is a great way to produce recessions. Indeed, that may be the point; see Kalecki’s classic paper “political aspects of full employment” which is now public domain.
    On your question about the relationship between debt, bonds and deficits I suggest reading this (and linked) webpages by Professor Mitchell, which explains it a lot more clearly than I can at my pretty basic level of understanding: http://bilbo.economicoutlook.net/blog/?p=10384#more-10384

    Freecountry: I think we are thinking about different bits of the real estate cycle; if one party is gaining from inflation amortising their loan, then the other party who extended the loan is losing, and landlords are also losing unless they raise rents faster than inflation. I’m quite in favour of relaxing many planning and zoning controls and replacing them with a land rent tax a la Henry George.

    On free lunches: If we don’t deficit spend to take advantage of underutilised resources (in particular, the unemployed), it’s not voting for free lunches, it’s wilfully refusing to eat a lunch we’ve already paid for; because one way or another, we pay for keeping people out of work.

  30. freecountry

    [The difference is that the amount of money withdrawn by taxation should be the amount necessary to keep inflation controlled, which is not necessarily equal to the amount extended by government.]
    For a given dx change in spending there will be a dy effect on inflation, regardless of whether individuals and companies spend it x or government does. The only way taxation can be used to control inflation is either to divert income into saving (which is better done by superannuation), divert income into paying down debt (in which case that should be the main purpose, not inflation control), or else drop it down the toilet in the form of taxation deadweight losses. In short, inflation control is not a legitimate purpose of taxation.
    [If we don’t deficit spend to take advantage of underutilised resources (in particular, the unemployed), it’s not voting for free lunches, it’s wilfully refusing to eat a lunch we’ve already paid for; because one way or another, we pay for keeping people out of work.]
    What about Laffer curve optimization? What about deadweight loss reduction? Many people are alienated by talk of taxation efficiency, but the thing to realize is, every dollar of deadweight loss is a dollar less of income for somebody, and every $50,000 or so of these is one less job. Workers tell their bosses they need more assistants, and the boss says, sorry but one more worker would cost slightly more than the benefit. No can do.

  31. David Hand

    Occum’s razor says that the Government is in a surplus trap because it was probably advised by it’s spin doctors and media managers (who are just learning to shave) that the mug voter would consider a surplus good government and make them more electable. So Julia blurted it out at a press conference and the rest is history.

  32. GocomSys

    TRUE. This debate is indeed defined by the governments enemies, the opposition and the media.

  33. Greg Angelo

    The term “surplus trap” is a misnomer. Returning the federal budget to surplus means in simple terms an end spending not funded through taxation through borrowings or some other money supply inflation methodology whereby the government spends more than it earns . True believers of course, like children believing in the “magic pudding”think the government should be able to spend as much as it likes without consideration of the source of funds or the ongoing impact of an interest burden arising from borrowings.

    In nominal terms balancing budgets over several annual cycles is considered to be good public finance notwithstanding timing differences involving countercyclical expenditure programs from year to year.. Implicit in the concept of of a deficit budget (spending more than you have earned in taxation receipts) is that in some time the wheel will turn and budget will go into surplus to repay the debt incurred. Forecasting return to budget balance is necessary to indicate to the community that the government is serious about long-term fiscal balance by showing a proposed time when the government intends to bring its it is annual expenditure into line with its taxation receipts. This is the necessaryfirst step before the budget goes into surplus to repay debt.

    As one would understand from reading the comments above the issues of financing deficits, creation of money by governments, budget surplus in deficit is a highly complex area of economic analysis which most people needs to be understood in relatively simple terms. However facile criticism of government intention to return the budget to surplus on the basis that it is some mistake attributable to immature fuzzy faced “spin doctors” or attributing criticism being derived from some category of “class enemy” underscores the shallowness of some contributors appreciation of this issue.

  34. David Hand

    The term “surplus trap”in this case, is a self inflicted political stuff up, at least from the point of view of this shallow contributor.

    Notwithstanding the merit of your points about how and why governments run defecits and the merits of returning to surpluses, along with the economic thinking behind them , this particular “surplus trap” is wholly political and we will not be served well by our government if it makes poor policy because of ill-thought and hasty statements at the height of the Brisbane flood.

  35. freecountry

    Here’s what’s commonly known as the “surplus trap” syndrome. I gather Mr Keane is familiar with this usage, and is using it as a metaphor for political addiction to surpluses, as David Hand says.

    I cannot agree. As Greg Angelo says, there’s nothing wrong with alternating surplus and deficit through different phases of the business cycle–in theory.

    My problem is the gap between theory and practice. First, it requires a clear signal on when the business cycle is up and when it is down. You would think it’s not that hard–when the RBA lifts rates to normal, it’s time for a budget surplus–but that happened in 2010, so why do we need another 3 years of deficit?

    Second, it requires politicians to decide who’s going to play Santa Claus, and who’s going to play Uncle Scrooge. Not surprisingly, even self-styled “conservatives” like John Howard and Tony Abbott cannot resist the democratic siren call of talking like Scrooge but spending like Santa Claus. Tony Abbott’s $75,000 baby bonus is a great example.

    As for Labor, they like to put on a Scrooge voice but they are very careful to aim it at just one sector, which becomes a scapegoat for everything, supposedly leading us all to ruin. For everyone else, it’s party time. As far as I’m aware, only one federal Labor government ever ran a budget surplus in the last 100 years and that was under Ben Chifley in 1946-49.

    The “business cycle” is a very insignificant thing compared to the election cycle. Governments push their luck as far as they can, then leave their successors to clean up their mess. You cannot trust elected politicians to alternate between surplus and deficit. You have to set a simple rule and train people to expect it will be followed in all but the direst emergencies.

  36. JamesH

    @ Freecountry:

    The statement “For a given dx change in spending there will be a dy effect on inflation, regardless of whether individuals and companies spend it x or government does.” makes several simplifications which I think mislead. For one thing, it ignores the velocity of circulation, which is lower in slumps and higher in booms. More generally, inflation will only result from a positive change in net spending across the economy if real goods and services don’t increase to match the spending. Governments are often better placed to do that because they can construct the infrastructure which enables real production expansion, and they can bring the unemployed into the workforce. History has shown that when the private sector is increasing its net spending, they go for asset speculation on sources of rent: stocks, land, etc; which drives the prices of these assets up without increasing the supply – hence inflation results from the knock-on of higher rents.

    The only way taxation can be used to control inflation is either to divert income into saving (which is better done by superannuation), divert income into paying down debt (in which case that should be the main purpose, not inflation control), or else drop it down the toilet in the form of taxation deadweight losses.

    The counter to this follows from the ideas above. If taxation is targetted so as to discourage rent seeking (e.g. land value taxes, wealth taxes, estate taxes, Tobin taxes, capital gains taxes) and encourage the expansion of production and consumption (e.g abolishing payroll taxes and transfer taxes, raising income tax threshold, R&D discounts) then lower inflation is very likely to result.

    Freecountry, I think your mistrust of politicians is not misplaced, but disproportionate. As Bernard’s article implies, far from Julia promising the world today and worrying about payment tomorrow, she is making the opposite mistake, refusing to pay for needed social programs because of an excessive (in the current context) concern for running a surplus – excessive because it is done for highly political reasons, not out of any economic responsibility.

    Furthermore, it assumes that politicians are the only political animals out there, whereas the private sector is no better and possibly worse. The idea that we have to have a simple rule which is somehow “immune from politics” in practice removes the politics from the public view (parliament) into a private financial capital club (the board of the reserve bank) – and as the recent film “Inside Job” and the obvious revolving door between the US Reserve, the US Treasury and the Goldman Sachs board make clear, this in fact means handing over monetary and fiscal policy to rent seekers without a fight. Look at the makeup of our Reserve Bank Board – do you think they would ever make a decision that threatened financial capital’s interests? Again, I would recommend Kalecki’s “the political aspects of full employment” on why certain capital segments will willingly create recessions in their own interests.

  37. freecountry

    First of all, Julia Gillard is not defending “a surplus”. She is defending a slovenly decision to stay in deficit for three years after the RBA has commenced contraction. By comparing this to a proposal for an even longer extension of deficit, she makes herself sound like a defender of “a surplus”. This is a smoke-and-mirrors trick.

    Second, there will be no surplus in 2013. This projection is contingent on the world behaving predictably, and an increase in mining tax having no effect on overall business investment and business tax revenue. If voters believe (a) 2013 is soon enough to return to surplus and (b) it will actually happen, then I’m sorry to say, Australia’s age of prosperity may well be over and it will follow a long line of once-prosperous countries into decay and decline.

    Third, you have based your argument on big-end-of-town rentseeking to counter my own argument about pork-barrel rentseeking. Which is bigger?

    Fourth, velocity theory is overused politically as a kind of magic trick, like Jesus feeding 5000 people with a few loaves of bread and two fish. More accurately, a worker’s exchange of, say, one day’s labour for a pair of shoes, may be efficient and involve associated trades between many people around him, or it may be inefficient and involve high deadweight losses when those trades do not occur. It may be delayed in time by an intermediate period of saving and investment, or it may be brought forward in time by borrowing, incurring an outflow of interest to the overseas financiers of his bank. Tweaking the system to persuade people to defer consumption less and borrow more than they otherwise would, is just reducing efficiency and lighting the fuse on a time bomb.

    One way or another, the ultimate purpose of all production is consumption. Of all the different ways of measuring the efficiency of converting production to consumption, velocity is the most error-prone and the least meaningful. No wonder Keynes based his whole aggregate demand theory on it. The only economic questions that should be used to assess economic policy are:
    (1) how efficient is it?
    (2) how equitable is it?
    (3) how sustainable is it?

  38. JamesH

    Keynes “whole aggregate demand theory” is not based upon the velocity of money. It is based upon the fact that the economy can arrive at an equilibrium that includes substantial unemployment due to demand not being realised or effective. See Krugman’s recent post for a quick recap: http://krugman.blogs.nytimes.com/2011/01/24/the-war-on-demand/

  39. freecountry

    Demand falling (more correctly, delayed) because the saving rate increases and velocity decreases. My point stands. Velocity theory has its place in academic discussions but its most common use is to confuse politicians and/or the public into thinking that they, like Jesus, can feed 5000 people with five loaves of bread and two fish.

  40. freecountry

    For an alternate view to that of Krugman, see Henry Hazlitt.

  41. JamesH

    Freecountry, I’m not clear on what point you are trying to make, and I don’t think that what you have said is in fact consistent with your Hazlitt article. He says that velocity is not a constant and I agree; a lot of the rest of his points stem from wilfully ignoring the role of credit, debt, central banks and tax and treating money as just another good, as if we were on a full reserve gold standard. I’m aware that mises.org would like us to be on a full reserve gold standard, but we aren’t.

    A shortfall in aggregate demand mechanically caused by increased savings and decreased velocity (which is in turn caused by people’s subjective desire to hold money rather than spend it) does not just “delay” demand. When people save rather than spend and pay down debt, sales drop. Production stops; stores run down their inventories; people get laid off from their sales and production jobs; those people then have no wages to spend so demand drops further; Those who are still getting incomes intensify their savings behaviour against themselves becoming unemployed or going out of business; deflation starts to occur, which increases the real value of debts and encourages further saving and hoarding behaviour, the value of assets plunges so banks start to fail because the assets against which they loaned are worth a fraction of what they loaned out, etcetera and so on down the spiral. There is no sufficiently powerful private market countervailing mechanism which encourages those with savings to stop saving and start spending. If all around you things are getting worse, you save against when they get worse for you.

    Such a slump can persist indefinitely, there’s no reason for demand to pick up again: e.g. the 19th century Long Depression. In the meantime, a lot of productive output and consumption is permanently foregone, not to mention a lot of lives destroyed. That foregone output and consumption doesn’t all come back when people who “delayed” their deman start spending again.

    Your biblical parable reference is rather hyperbolic and unhelpful. If output and consumption is being foregone, then the right action can actualise it – there’s nothing miraculous about it.

  42. freecountry

    This is all a theory, and Keynesian explanations of past depressions are not universally accepted. We are not all Keynesians now, no matter how shrill Krugman’s ad hominem attacks when he insists that we all should be. Quoting from your link:
    [Third, monetarists — old-style Friedman-type monetarists who focus on monetary aggregates, or the new style which says that the Fed can and should target nominal GDP — are, whether they realize it or not, part of the axis of monetary evil as far as the demand-deniers are concerned.]
    But my objection to Keynesian economic policy is not how well it accounts for the world, but the way it interacts with politics. Long term governments such as China or Saudi Arabia may be able to wield demand theory judiciously. But look what happens when the head of Treasury gives Kevin Rudd some advice so clear, and so simple, that he believes it to be politician-proof:
    [“Go early, go hard, go households.”]
    How was he to know that Rudd would go off on a tangent and make the boosting of house prices his biggest priority? What has that got to do with boosting aggregate demand? With jobs? If you think it through in Keynesian terms, it is a non-productive form of saving and the exact opposite of a boost to aggregate demand. Rudd then goes on to create an artificial building boom, carefully steering it well clear of housing (and thus inflating building costs) lest it increase the supply of houses, lower prices and get him voted out of office by home owners.

    Meanwhile everyone trying to buy a house drops discretionary spending almost to zero–not because their consumer confidence is down, but because that’s the only way they can afford the deposit and service the mortgage!

    And yet these acts of robbery of the Australian public have also been defended using Keynesian arguments. The theory is so easy to abuse for political gain. Like the bible, you can use aggregate demand theory to say whatever you want it to say.

  43. freecountry

    You can even make it say that fiscal government needs to keep on running a stimulus deficit for another three years after the monetary government (the RBA) has gone into contractionary policy.

  44. JamesH

    For someone styled “Free Country”, I find your repeated disparaging of democratic governments in favour of authoritarian ones disturbing – though totally consistent with Hayek & Friedman’s own political preferences of course.

    You have retreated to a position that there’s nothing wrong with Keynesian arguments except that politicians will lie about them. But why is this something unique about Keynes’ arguments? What economic theory hasn’t been abused for political gain? The Tea Party is full of gold bugs and extremist Austrians and they are, perhaps non-coincidentally, backed by the Koch brothers resource extracting interests. Thatcher used Friedman to justify crucifying the UK trade unions and David Cameron is currently using deficit hysteria to resume Thatcher’s war on the poor. The very latest economic theories were used in New Zealand in the 80s to justify demolishing their welfare state – that their application led to recession and poverty did not (and does not) appear to have bothered NZ politicians and economists at all.

    If there is no criteria than which side of politics or social class is served to judge theories by (a situation long recognised, e.g. Marx in “Capital”: “Thenceforth, the class struggle, practically as well as theoretically, took on more and more outspoken and threatening forms. It sounded the knell of scientific bourgeois economy. It was thenceforth no longer a question, whether this theorem or that was true, but whether it was useful to capital or harmful, expedient or inexpedient, politically dangerous or not. In place of disinterested inquirers, there were hired prize fighters; in place of genuine scientific research, the bad conscience and the evil intent of apologetic.”) then I will support the theory that enriches the many at the expense of the few rather than vice versa, thankyou very much. But in fact the weight of evidence as well as politics is on Keynes’ side.

  45. freecountry

    You misunderstand the theory of freedom, which suggests that both elite government and the democratic will of the people need to be restrained from having and abusing excess power. Freedom comes first and foremost from clear laws and clear expectations of government, not by giving any agency carte blanche.

    As I said on Thursday, the advantage of Austrian economics over other (perhaps mathematically more sophisticated) macroeconomic models is that it fixes the goal posts somewhere everybody can see them, so voters can judge whether elected government is meeting its responsibilities or not. In monetary theory the goal posts move with one degree of freedom, and in Keynesian theory the goal posts move with two degrees of freedom. Regardless of whether Keynes is “right” or not (and I don’t think he is) those moving goal posts make for some wonderful political illusionist tricks, and we have seen some great ones in the last two and a half years. Tricks to bring the house down.

    You’ve shown your colours with the recommendation of a Tobin Tax and the Marxist interpretation of the 1980s reforms, on which many people disagree with you. So I’ll close my side of this debate with a quote from Nobel Prize Laureate George Stigler. Stigler here is talking about a different topic, that of market competition, but the principle is the same.
    [A famous theorem in economics states that a competitive enterprise economy will produce the largest possible income from a given stock of resources. No real economy meets the exact conditions of the theorem, and all real economies will fall short of the ideal economy—a difference called “market failure.” In my view, however, the degree of “market failure” for the American economy is much smaller than the “political failure” arising from the imperfections of economic policies found in real political systems. The merits of laissez-faire rest less on its famous theoretical foundations than on its advantages over the actual performance of rival forms of economic organization.]

  46. JamesH

    I’m afraid that advocating Austrianism purely on the grounds of transparency and simplicity reminds me of Mencken: “For every complex problem there is an answer that is clear, simple, and wrong”.
    I’m quite happy to abide by the standard expressed by Stigler in his final sentence: we should judge policies on their actual performance. By that standard, the “hard money”, pseudo-laissez-faire policies of the 18th, 19th and early 20th centuries fail dismally in comparison to the New Keynesian era of 1948-1975, and even the monetarist/neo-Keynesian hybrid of 1980-2011. There is every reason to think that returning to the fiscal and monetary policies of the 19th century would also return a large part of the population to Dickensian poverty and its counterpart, violent political extremism (anarchism, communism, fascism, etc).

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