Date: May 12 2012
IF YOU take the figures at face value, this week's budget is deeply contractionary, delivering a blow to demand at a time when parts of the economy aren't at all strong. But in economics it's rarely wise to take things at face value.
There are different ways to assess the ''stance'' of fiscal policy - to work out the direction and size of the effect a budget will have on the economy.
Doing it the strict Keynesian way is a bit complicated. These days, however, the Reserve Bank and many economists tend to do it simply by comparing the budget balance for the old year with the planned balance for the new, budget year.
Wayne Swan is expecting an underlying cash budget deficit in the financial year that's coming to an end, 2011-12, of $44.4 billion, but budgeting for a surplus of $1.5 billion in the coming year, 2012-13. That's a turnaround of almost $46 billion. From one year to the next the budget's net effect is to extract $46 billion from the economy - if it happens, the biggest one-year turnaround for almost 60 years.
It's equivalent to about 3 per cent of gross domestic product, which makes it absolutely huge. And since it's an extraction, you could only conclude it makes the stance of fiscal policy adopted in the budget highly contractionary. It would knock the stuffing out of the economy.
But here's where we mustn't take things at face value. As you've no doubt heard, Swan has had to move a lot of things around between years to make it possible to keep Julia Gillard's election promise to get the budget back to surplus in 2012-13. Where he's taken government spending that was to have occurred in 2012-13 and pushed it off into some future year, that's a genuine change for the purposes of assessing the budget's effect on economic activity.
But where he's taken spending and pulled it forward into the last few weeks of the old financial year, that's not genuine for our purposes. For the government's accountants, whether something happens on June 30 or on July 1 makes all the difference in the world. You've got to draw the line somewhere, and that's where we draw it.
From the perspective of the budget's effect on the economy, however, a difference of a few days or a few weeks is a difference that doesn't make much difference.
And it turns out a big part of the $46 billion turnaround is explained by Swan's decision to draw spending forward into the last few weeks of the old year. There's compensation for the carbon tax (which doesn't start until July 1) of $2.7 billion, advance payment of natural disaster relief funds to Queensland of $2.3 billion, a bring-forward of infrastructure spending of $1.4 billion, the Schoolkids Bonus cash splash of $1.3 billion, and financial assistance grants to local government of $1.1 billion.
That long list adds up to $8.8 billion. But here's the trick: when you take money out of one year and put it into the year before, you have twice the effect on the difference between the two years. So Swan's bring-forward of that spending explains $17.6 billion of the $46 billion turnaround.
Another thing to take account of is that the new year's budget is expected to benefit from increased revenue from resource rent taxes of $5.7 billion (that's from the existing petroleum rent tax as well as the new minerals rent tax). The point is that these taxes are explicitly designed to tax ''economic rent'', so they have no effect on the incentive to exploit petroleum or mineral deposits and thus have no effect on economic activity.
A further factor is that, thanks to a quirk of public accounting, Swan's underlying cash surplus of $1.5 billion takes no account of the government's spending on the continuing rollout of the national broadband network.
The budget item ''net cash flows from investment in financial assets for policy purposes'' is expected to involve increased spending of about $6 billion in 2012-13. Not all of that would be the broadband rollout. But to the extent it involves the government funding economic activity, it has the effect of reducing the budget's adverse effect on economic activity.
Put these three arguments together and you conclude the budget's drag on demand would be less than half the 3 percentage points of GDP we started with.
Even so, it's still a big effect. There's no denying the stance of fiscal policy is contractionary. But the budget is only one of the factors affecting aggregate demand. It's also only one of the instruments available to the macro-economic managers to influence demand.
So if fiscal policy proves to be too tight, the obvious remedy will be to further loosen monetary policy - to cut the official interest rate, in plain English. The stance of monetary policy is already mildly expansionary and, if necessary, it can be made more so.
Is it a good thing to have the two arms of policy working in opposite directions? Sure it is - if you're hoping lower interest rates will lower our high dollar a little.
Such a lowering may have already occurred. If so, the effect will be expansionary.
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