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Time to focus on the fiscal realitiesMay 18 2002

  1. 4,330 Posts.
    http://www.smh.com.au/articles/2002/05/17/1021544072414.html
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    Time to focus on the fiscal realitiesMay 18 2002
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    At the end of the day, this week's federal Budget will have minimal impact on Australia's economic future, even if its political significance is obvious enough.
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    I hate to admit it (because it's bad for economics writers' business), but the federal Budget's going through a period where it doesn't prove much. Its political significance is obvious enough, but its economic significance is increasingly elusive.
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    There was a time when the Budget - "fiscal policy", as economists call it - was the main instrument used by the Treasurer to manage the economy through the business cycle. He'd use it to (try to) stabilise the rate of growth in demand, so that weak growth didn't lead to rising unemployment or excessive growth to rising inflation.
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    For the past decade, however, the instrument that's been used to stabilise demand is "monetary policy" - the manipulation of interest rates - and monetary policy is run by the Reserve Bank independent of the elected government. The stark truth is the nation's macro-economists spend one week of the year focused on fiscal policy and the other 51 focused on monetary policy - and their efforts to second-guess the Reserve's next move in the official interest rate.
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    If that shocks you, try this: these days the financial markets manage to digest the contents of the Budget in just a few hours after the Treasurer gets to his feet on the Tuesday night.
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    Those contents rarely have more than a slight effect on the dollar or the bond rate, and the markets sweep on without a backward glance. (This cursory interest helps explain why the markets focus almost exclusively on the "underlying cash" version of the Budget balance. The knowledge that this version is the one most easily tampered with by the Treasurer bothers them not one bit.)
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    The Budget's irrelevance to macro management has increased further in just the past two or three years since the Howard Government reinterpreted its "medium-term fiscal strategy" - to maintain Budget balance, on average, over the course of the economic cycle - to mean nothing more than that the Budget balance should always be on the positive side of zero.
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    Until then, the role of the Budget and fiscal policy was clear. It was to achieve a reduction in the "structural" (ie, average) current account deficit by increasing national saving relative to national investment.
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    Though the term "national saving" remains enshrined in the Government's Charter of Budget Honesty Act, it didn't crack a mention in the part of this week's Budget Statement 1 purporting to explain the Government's "fiscal strategy".
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    Nor was there any mention of the current account deficit. The section did offer the pious observation that "a key goal of the medium-term fiscal strategy is to improve the level of public saving [my emphasis] over time", but it didn't really explain why.
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    The point is that, had the Government stuck with its original strategy of using the Budget to improve the current account, this would have required it to achieve ever-larger Budget surpluses while ever the economy was expanding.
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    But the Government decided it wanted to spend the surplus, and its econocrats decided they were no longer worried about the current account and the foreign debt, so the medium-term fiscal strategy was reinterpreted to mean nothing more than that Budget deficits were verboten unless the economy was in recession.
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    So what economic significance does that leave for the Budget? It's true that it does contain the Government's official and detailed forecasts for the economy. But how much does this prove?
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    For one thing, since the Reserve Bank manages demand, it's forecasts matter, not the Government's. (But, apart from giving us a rough idea of what it expects will happen to inflation, the Reserve prefers to keep its forecasts to itself - so it can change them at will.)
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    For another thing, economists' grasp on the state of the economy is so tenuous that the Government's forecasts are quickly outdated. But, if all this is the case, why do the media still make so much fuss about the Budget? Why all the multi-page lift-outs on the morning after?
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    Partly through force of habit (the public's as well as the media's), but mainly because budgets still contain loads of newsworthy "measures".
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    Budgets are still used to announce government decisions to start a new this, can an old that, cut something else and beef-up the other. They still affect people's pockets and the prospects of the industries they work for. That is, budgets still have lots of the things the media love: winners and losers.
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    Most of these changes are made for political reasons - governments busy playing favourites in their quest for votes - but, whatever the motivation, these rearrangements in government spending and taxation still have micro-economic consequences.
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    As they teach you in high school, budgets have effects on both the allocation of resources within the economy and the distribution of income between households.
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    And the distinction between motive and effect is important from a macro management perspective, too. Though the Budget isn't being used as an instrument of demand management (and won't be until the next recession), and though its measures are largely politically driven, it remains undeniably true that the Budget has an effect on demand.
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    For the most part, this happens automatically through the operation of the Budget's "built-in stabilisers".
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    Features of the Budget, such as the progressive income tax scale and the availability of the dole, have the effect of causing the Budget to prop up private sector demand when it's weak and restrain it when it's strong. But the explicit decisions announced in the Budget - the "discretionary measures" - will also have an effect on aggregate demand, regardless of whether that was the Treasurer's intention.
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    This week's Budget papers claim that the big income-tax cut and spending increases in the 2000 and 2001 Budgets imparted a stimulus to the economy equivalent to about 1 per cent of GDP over those two years, and thereby helped maintain solid growth during a period of weakness.
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    The papers also claim that the stance of fiscal policy adopted in this year's Budget will have a contractionary effect equivalent to "around 0.5 per cent" of GDP. But this figure comes as nothing more than a throwaway assertion. There's no indication of how it was arrived at, nor any discussion of it. So you're under no obligation to believe it - I certainly don't. It seems to involve Peter Costello claiming the credit for the operation of the automatic stabilisers. Their improvement in the "cyclical" component of the Budget balance swamps what I estimate is a $500 billion deterioration in the "structural" component.
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    Taking all the measures announced in the Budget (and since the midyear review in October), revenue will be increased by $500 million in 2002-03, but spending will be increased by $1 billion.
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    But whether this Budget is mildly contractionary (as Costello claims) or mildly expansionary (as my rough figuring suggests) hardly matters. Either way, this week's fiscal effort will have a negligible effect on the thing we'll spend the next 51 weeks focusing on: the extent to which the Reserve Bank judges it necessary to raise interest rates.
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    Ross Gittins is Economics Editor.
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