After last night’s budget, what do you think will be the most important factor for the economy this year: the budget, last week’s interest rate cut or the value of the Australian dollar?
This is not an effort to be cute or get meta about the budget in a sea of coverage about it — we should be thinking about the importance of the budget and the relevance it and those in Canberra (politicians, press gallery, consultants, etc) claim it has, but which, perhaps, it doesn’t really possess.
That’s not to say fiscal policy can’t be important — it was massively important in 2008 and 2009 in supporting the economy, more than the RBA’s emergency rate cuts. And it’s also important that fiscal policy be kept sustainable over the medium and long term, so that it can be used when crises arise in the future.
But what about now?
The Reserve Bank’s rate cut last week still stands out as the single most important decision for the economy this year. And the continuing strength of the dollar (even just below parity) stands as the enduring factor that has changed the budget, and perhaps helped change RBA thinking on interest rates simply because of the much more powerful downward pressure on prices that it has had (longer and stronger than the RBA was thinking for much of 2012).
Last night’s budget is predicated on a softer Australian economy next year, growing below trend at 2.75%. That’s mostly — though not entirely — consistent with the RBA’s forecast for the economy to run a little below trend this calendar year and then grow closer to trend through 2014. Unemployment is expected to edge up, and inflation is expected to continue to run at a very low level. Given the government is preferring to let the budget run at a deficit of 1.1% of GDP and the RBA has rates at what were previously called “emergency lows”, that suggests the transition to the post-mining investment boom is still precariously poised.
But last week’s rate cut also reflects the success of the RBA and the government in keeping inflation in check.
Never before in Australian history has a resources boom ended without an inflation break-out — until now. The RBA and Treasurer Wayne Swan have delivered a low-inflation end to a boom, and done so without crunching the economy — a “soft landing” for those who remember that infamous phrase from the last end of the ‘80s. Nor has their been a wages breakout — despite the incessant whining of business about the Fair Work Act. The strong dollar has also helped keep inflation in check, of course, as well as other external factors like the rise of online shopping. But policymakers in Sydney and Canberra deserve credit for what in Australian terms is a historic achievement, not merely in preventing an inflationary break out but actually securing low inflation.
That outcome allowed the RBA to produce its surprise rate cut last week, which even if not directly aimed at engineering a lower dollar, has helped push it down toward saner levels.
In that context, the relentless focus on the deficit is misplaced. Debt is still expected to peak at under 12% of GDP. Ratings agencies have reaffirmed the government’s AAA rating. The key issue is that the government sensibly declined to match nearly $20 billion in revenue writedowns with the same amount of spending cuts in order to preserve a surplus. Shadow treasurer Joe Hockey can huff and puff, but it is unlikely that he would have done so either — indeed, Hockey has commendably rejected austerity as a workable model.
At the moment monetary policy may well be more important than fiscal policy in the day to day performance of the economy. In terms of where the centre of power now resides — it’s in Sydney, not Canberra, no matter how much the budget lobby in the nation’s capital argues for its relevance and pre-eminence. The RBA remains the most influential of all, and it is based in Sydney.
By the way, on another budget issue: we’ve often noted that business lobby groups are always demanding the government take tough spending cuts, but never actually offer any praise or support when it does. Well, last night, talking to Fairfax’s online budget coverage, the Australian Chamber of Commerce and Industry’s Peter Anderson did exactly that. Partway through discussing his concerns about the budget, of which he had many, Anderson paused and made a point of praising the government’s decision to dump the baby bonus and acknowledged it would have been a tough call.
It’s easier to take business seriously when they acknowledge the realities in which governments operate.