The international economic environment is as threatening as it has been at any time since the Global Financial Crisis. The Chinese and US economies are faltering, Britain is in recession, and the eurozone is threatened with complete breakdown. A new global crisis is real possibility for 2012-13. How well, or badly, does the budget help us to prepare for such a shock?
In purely fiscal terms, the strategy adopted by Kevin Rudd and Wayne Swan in the 2009-10 budget, of a large stimulus followed by a steady return to surplus in 2015-16, was designed to give us the “fiscal space” needed to allow another emergency response to a crisis like the one emerging in Europe. In that context, a more rapid return to surplus is helpful, since it gives us more room to turn around.
The problem is that the government’s rhetoric has shifted in ways that will make it much harder to achieve this turnaround.
The crisis response in 2008-09 involve a shift to strongly stimulatory fiscal and monetary policy in the short run, with the idea that fiscal and monetary policy would be tightened in parallel as the economy recovered.
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The idea that fiscal and monetary policy should work together represented a return to the policy orthodoxy of the Keynesian era, for good reason. The policies of the liberal market era, in which governments aimed for consistent balanced budgets, leaving macroeconomic management to central banks and monetary policy, had failed comprehensively, as Kevin Rudd acknowledged at the time.
Until about a year ago, the government’s policy and rhetoric were broadly consistent with this approach. The recovery turned out stronger than expected, and both monetary and fiscal policy were tightened accordingly. The announcement in the 2010-11 budget, that the return to surplus would be achieved three years ahead of schedule, made perfect sense at the time.
Since then, however, the news has been generally bad, but the government has been trapped by its commitment to a 2012-13 surplus. Instead of fiscal and monetary policy moving in parallel, we have a combination of fiscal contraction and monetary expansion. The contradictions became acute last week when the Reserve Bank cut interest rates by 50 basis point, an indication of deep concern (if not some degree of panic) about the potential for a sharp downturn.
Changes in Swan’s rhetoric have reflected these contradictions. As recently as a few months ago, he was maintaining the line that the expenditure cuts simply reflected the logic that “if you are Keynesian on the way down, you have to be Keynesian on the way up”. But as it has become clear that the economy, with the exception of the mining sector, is no longer on the way up, Swan has effectively abandoned this position.
Instead, he is now taking the pre-Keynesian view that, if weak economic growth leads to lower government revenue, the appropriate solution is to cut spending even harder. Rather than seeing the opposite movements of fiscal and monetary policy as an indication of incoherence, he has returned to the pre-crisis orthodoxy that tight fiscal policy is good because it makes room for interest rate cuts.
All of this has weakened the government’s capacity to respond to the populism of the Abbott-led opposition, which combines a pre-Keynesian opposition to fiscal stimulus with opportunistic criticism of any measure that might improve the budget balance, and particularly of the kinds of long-term structural measures that are actually needed.
The return to orthodoxy is spelled out both in the budget speech, where Swan advocates: “Surpluses that provide a buffer against global uncertainty, and continue to give the Reserve Bank room to cut interest rates for families like it did just last week.”
And in Budget Paper 1, which states:
“The return to surplus also recognises that fiscal policy should be set in a medium-term framework. In normal circumstances monetary policy should play the primary role in managing demand to keep the economy growing at close to capacity consistent with achieving its medium-term inflation target.”
There is some room to move in the qualification “in normal circumstances”, and in the observation in the budget Outlook that the buffer created by the surplus will “provide the Government with more options to respond, if necessary, in the most effective way to unexpected changes in the domestic and global economy.”
This may be read as code for the possibility of an emergency fiscal stimulus, should there be another crisis. But neither the Treasurer nor the officials I talked to was willing to actually say the “S word”.
Having effectively conceded defeat to the conservatives in the argument over the stimulus, the government will find it very difficult to flick the fiscal switch if we are faced with another global crisis. The problem is exacerbated by the government’s general loss of credibility under Julia Gillard’s leadership. Somewhat unfairly, that loss in credibility has extended to her leading ally, Wayne Swan.
Probably the best hope for the government is that any renewed crisis might coincide with the return of Kevin Rudd to the Prime Ministership, presumably with a new Treasurer. That would permit a return to the bold policy approaches that saved us from the global crises in 2009, and might even save the government from the crushing defeat that now appears inevitable.
*Professor John Quiggin is a Federation Fellow in economics and political science at the University of Queensland and the author of Zombie Economics: How dead ideas still walk among us.