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Is Australia prepared for a crisis?

May 9th, 2012

I spent yesterday in the Budget lockup for Crikey. There’s little real need for a lockup these days. The original justification was to stop people taking advantage of inside information on things like higher tax on cigarettes, but these taxes are now indexed, and changes are mostly either backdated or applied from well after Budget night. Then, for a while, the Budget was the central statement of economic policy. But nowadays, policies are put out all through the year, and most of the Budget measures are leaked in advance. Still, it’s a traditional piece of theatre and no-one seems to mind.

The first piece I wrote, over the fold, was about the implications of the European crisis

Is Australia prepared for a crisis?

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 Rudd and 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.

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 market liberal era, in which governments aimed for consistent balanced budgets, leaving macroeconomic management 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 spelt 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 speak 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.

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  1. sdfc
    May 13th, 2012 at 19:58 | #1

    Export revenue slumped in late 08 / early 09 and with it real gross domestic income. That Makin seems unaware of this bizarre.

  2. May 16th, 2012 at 22:34 | #2

    Jim Rose, I have no idea whether the Argentinian government is cooking the books on inflation. However, if they are they seem to have not only fooled their own people (de Kirchner having been re-elected in a landslide) but sources such as the CIA World Factbook.

    But then we all know they’re lefty dupes.

  3. Jim Rose
    May 16th, 2012 at 23:03 | #3

    stephen, the CIA estimates the Argentine annual CPI inflation rate to be 22% in 2010. this is twice the government figure of 10%.

    Foreign investors report presentations by the Argentine Central Bank mentioning an inflation-adjusted exchange rate that implies annual inflation of around 20%. The Argentine government has often granted unions pay rises of that order.

    Latin voters may not be surprised to learn that their political leaders are less than honest.

    The people of Argentina have suffered enormously from political mismanagement of
    their once-robust economy during most of the past 80 years.

  4. JB Cairns
    May 17th, 2012 at 08:21 | #4

    Just to add to SDFC Treasury has looked extensively at this period ( it is one of their Treasury roundup papers).
    What Makin doesn’t not seem to realise is that exports dropped BUT Imports dropped EVEN more.

    you do not get a stimulus from an accounting identity. you need to follow it through.
    He didn’t. He is merely a partisan hack

  5. Chris Warren
    May 17th, 2012 at 08:39 | #5

    @Jim Rose

    You may be channeling capitalist theory. There appears to be an underlying issue around how you measure inflation. According to the “Economist”;

    Argentina will no doubt say that (Western measures) measure consumption by the rich rather than the poor, who may not shop online.

    If you index consumer prices for the consumables for poor, you may get a different result than if you index the prices of the consumables for the rich.

    Different sectors in any economy will always have different inflation rates.

  6. JB Cairns
    May 17th, 2012 at 09:10 | #6

    Chris,

    the economist dumped official statistics on Argentina as they were obviously at odds with what was happening there.

    They now use a different series which shows a much higher rate of inflation.

    People who attempted to do this in Argentina were targeted by the government there in very unpleasant ways.

  7. Chris Warren
    May 17th, 2012 at 10:32 | #7

    @JB Cairns

    Yes precisely. But according to the “Economist” the Argentinian judgement as to:

    what was happening there

    appears different from the Economist point of view.

    And possibly inflation of poor peoples’ budgets can be lower than inflation of rich peoples’ budgets.

    Anyway I am not aware of the Argentinian explanation. The point about rich and poor was only admitted at the very end of the Economists propaganda piece at:

    http://www.economist.com/node/21548242

    There are always two types of inflation: – 1) socialist lubrication which is mundane and 2) additional inflation to allow capitalists to realize their ‘expected’ monetary profits.

  8. Chris Warren
    May 17th, 2012 at 10:44 | #8

    @JB Cairns
    Yes precisely. But according to the “Economist” the Argentinian judgement as to:

    what was happening there

    appears different from the Economist point of view.
    And possibly inflation of poor peoples’ budgets can be lower than inflation of rich peoples’ budgets.
    Anyway I am not aware of the Argentinian explanation. The point about rich and poor was only admitted at the very end of the Economists propaganda piece at:

    http://www.economist.com/node/21548242

    There are always two types of inflation: – 1) socialist lubrication which is mundane and 2) additional inflation to allow capitalists to realize their ‘expected’ monetary profits.

  9. JB Cairns
    May 17th, 2012 at 10:55 | #9

    Chris,

    if you want to measure the rise in prices you do it openly and honestly. The ABS here is one of the best in the business.

    This is not happening in Argentina. Moreover the government targets whomever wishes not only to point out how dishonest they are but actually wish to make a honest and open series on prices.

  10. Jim Rose
    May 17th, 2012 at 11:24 | #10

    Chris Warren, if the rich can shop online, would that not make their inflation rate lower, not higher than that of the poor?

  11. JB Cairns
    May 17th, 2012 at 11:48 | #11

    This is irrelevant.

    you construct a series for the country.

  12. Chris Warren
    May 17th, 2012 at 11:55 | #12

    Jim Rose :
    Chris Warren, if the rich can shop online, would that not make their inflation rate lower, not higher than that of the poor?

    As you are no doubt aware – this depends on the basket of goods they consume and whether their online expenditures are substitutions.

    If the rich purchase online latest gizmo’s they would not have purchased domestically, and they purchasing using some new credit, then this can feed into “inflation from the rich”.

    If the rich purchase pizza’s and hamburgers online (cheaper) – which they substitute for the same they would have purchased on the street – then the effects may be different and confused – what would they do with their surplus cash?

    But in general, however a transaction occurs – it is reasonable to expect better returns selling to the rich than selling to the poor. The rich generate more debt than the poor.

    If by some circumstance, online shopping lowers inflation for the rich, I see no mechanism leading to necessarily making:

    their inflation rate lower, not higher than that of the poor?

    This assumption is unsustainable.

  13. socrates
    May 17th, 2012 at 13:08 | #13

    Returning to the topic of this thread, I sincerely hope somebody in Canberra is asking how we might prepare for another global recession right now. With the news that Greece will go back to the polls on June 17, and China growth is slowing down (though in my view temporarily), the prospects of another world recession seem pretty good right now. Such expectations may be self-fulfilling even if the causes are temporary. Combine that with an anemic Australian budget and BHPB cancelling large mining projects, and I suspect our economy will need stimulating again very soon.

  14. John Quiggin
    May 17th, 2012 at 13:27 | #14

    Again, re Jim Rose DNFTT. From long experience, he offers a combination of concern trolling and deliberate, though relatively subtle, misrepresention. This lengthy comments thread shows plenty of examples of both

    http://www.harryrclarke.com/2012/04/20/latham-on-denialism/

  15. JB Cairns
    May 17th, 2012 at 14:42 | #15

    Socrates,

    if it occurs and credit markets do not freeze like last time then monetary policy can take most of the heavy work as Keynes believed.

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