A Keynesian Budget (reprint from Crikey coverage)

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For an economist, the most striking feature of the 2009-10 Budget is the reappearance of old-time Keynesianism, after more than three decades in which fiscal policy took a back seat and monetary policy was primarily based on inflation targeting. The rhetorical change from the ‘recession we had to have’, when ‘pump-priming’ was a dirty word, is striking.

And while the response to the 1989-91 recession eventually included a significant dose of fiscal stimulus, ‘eventually’ is the operative word. In 1989 the government and the Reserve Bank kept squeezing the economy long after everyone else could hear bones breaking. This time around, the first round of stimulus money was going into bank accounts before the contraction (as measured by quarters of negative GDP growth) had even begun.

The Budget claims success for the stimulus measures that have already been introduced, and its projections assume even more success for the measures that will take effect in the second half of 2009. On the first point, the government points to the resilience of Australian retail sales and a recovery in consumer confidence, in sharp contrast to the situation in most economies overseas. The budget claims stimulus has already raised 2008-09 GDP by 1 per cent, which seems plausible.

The critical test will come in 2009-10. In the absence of stimulus, the Budget projects, Australia’s GDP would contract by more than 3 per cent, the worst performance since WWII and only a little better than the advanced economy average of 3 3/4 per cent (though the latter number takes account of the projected effect of stimulus measures in those economies). The stimulus package is projected to raise the level of GDP by 2 3/4 per cent, with the result that the projected contraction in the economy will be long (two full years of zero or negative growth) but not as sharp as in previous post war recessions.
If the government can deliver on these projections, the impact on economic policy debate in Australia will be profound. Much of the thinking that has dominated policy for the past three decades will have to be discarded. Older concerns about the kinds of fiscal measures that are most expansionary or contractionary and the point at which necessary macroeconomic stabilisation becomes counterproductive ‘fine-tuning’ will be revived.

The political implications will be equally profound. Success in steering the economy through the crisis could see the Rudd government entrenched for a decade or more. Failure could add to Labor’s long list of short-term governments derailed by external crises.

All Dogs Go to Heaven

18 thoughts on “A Keynesian Budget (reprint from Crikey coverage)

  1. Old-style Keynesian budget – no wonder why it has crashed and burned in the commentary analysis.

    What does the budget documents say about the stimulatory effect of the monetary loosening?

  2. Interesting to see Ross Gittins criticising the budget for being ‘back to front’ (sorry can’t find the link). That is, the stimulus coming before the slump, and now (some) program cut-backs coming well before the recovery.

    This may well be a valid political point – it will make it harder for the government to sell their policies. As you say, however, the question of whether this is good or bad economic policy is yet to be decided.

  3. “The budget claims stimulus has already raised 2008-09 GDP by 1 per cent”

    But the stimulus must have cost more than 1% of GDP. And this doesn’t even factor in the additional costs of interest on government debt.

    It seems that for any stimulus to be economically sustainable it would have to generate a big multiplier of benefits to increase future tax revenues to pay it back.

  4. I invite browsers to read the review of the Budget I have given at the Left Focus blog…

    see:

    http://leftfocus.blogspot.com/2009/05/mixed-bag-budget-but-still-better-than.html

    Constructive discussion there is welcome too.

    My feeling after reading Ken Davidson’s analysis is that more stimulus is necessary to hold off a vicious cycles of unemployment/declining confidence in the economy…

    And surely the unemployed ought have received a fair go. (parity of base rate with Disability and Aged pensions)

    Turnbull, meanwhile, is playing an opportunist game – not standing for anything substantial – but inviting a compromise by demanding very little…

    I’m hoping the Greens and independents will win a just compromise for the unemployed and Sole Parents… I’ve gone so far as to write to Fielding on his website, as well as Xenophon and the Greens…

    I ask those who believe strongly in justice to write to these Senators also.

    sincerely,

    Tristan

  5. Tristan, had a look at your site and following discussion.
    Your comments system failed me, so will comment here that I beleive that Redgum was querying the need for capitalism any more, given the rationale and basis on which it has been built and continues to operate, which when understood makes its seemingly random cruelties, inefficiencies and inconstancies so easy to understand in retrospect.
    Glad to see you giving Ken Davidson given kudos, also.

  6. JQ,

    Previously you have said cap and trade is better than a carbon tax in part because it reduces revenue automatically during a recession. Given the current scramble (apparently by both the ALP and Liberals) to fill supposed revenue gaps with new taxes (current ideas include extra medicare tax, more cigarette tax, and even the alcopops tax) doesn’t this aspect of cap and trade seem somewhat moot. What is the point of having a tax that declines in recessions if governments just fill the revenue gap with other taxes.

    Surely a carbon tax would be less politically volatile than cap and trade. And not only does it offer more stability in revenue it also offers energy investors (both conventional and renewable investors) more certainty about price.

    p.s. Found this site that may interest others: http://www.carbontax.org/

  7. This is a bit peculiar – “Failure could add to Labor’s long list of short-term governments derailed by external crises.”

    Why conveniently prepare to blame some “external crisis”.

    This reflects the Keynesian refusal to face the general internal tendency for capitalism to increase its macroeconomic imbalances, seen (for example) in the long-run trend for unemployment to ratchet-up and per-capita debt to balloon.

    In the past we have achieved some Clayton’s stability but only through population increase, lowering wage costs (by increasing participation in OECD cost-structures of offshore slave wages), and increased per-capita debt.

    Today our Keynsians can only dream of (in Swan’s lingo) “an uptick”. Gittin’s is in full force in todays SMH asserting the most favourite of Keynesian dogmas – “…things that go up eventually come down”, “things that go down come back up”.

    They conveniently ignore the long-term global ratchet in unemployment and debt.

    I suppose the main issue is the Keynesian dogma that investment = savings. It doesn’t, because of capitalism (and lazy economists) we are trying to live in a world where investment = savings + debt.

    This is a fools paradise.

  8. “This time around, the first round of stimulus money was going into bank accounts before the contraction (as measured by quarters of negative GDP growth) had even begun.”

    That is incorrect. The first round of stimulus began in the December quarter of 2008, which is the first quarter where we had negative real GDP Growth. Therefore, the first round of stimulus began as the recession began. That seemed like pretty good timing to me.

  9. Some people saw the bubble developing in US house prices that ultimately led to the GFC clearly (and saw that the economic policy in use did almost nothing to restrain it).
    Its utterly ridiculous to ascribe the current deficit to Labors management – that is pure smokescreen, fog, mirrors, lies, magic and nonsense. If anything it was all republican economic mismanagement in the US and the shoe shine followers here – the Liberal Party.

    http://www.cepr.net/index.php/publications/reports/the-run-up-in-home-prices-is-it-real-or-is-it-another-bubble/

  10. Here is an interesting view on the cause of the mess and why we now have a budget deficit,
    30 years of letting inequality grow and just ignoring it…
    Thats why Rudd should not have honoured his election promise on tax cuts to the wealthy…its doesnt address the “elephant in the room” of rising inequality and the damage it does over time.

    http://yaleglobal.yale.edu/display.article?id=12327

  11. JQ

    When you say “old style Keynesian”, when was Australia ever really “Keynesian”?

  12. Alice,

    I know that this sounds shocking, but I actually agree that stagnating incomes lead to a “pull” of higher credit demand.

  13. #12 Sean,

    Well shocking things have happened to me in here too…I thought I was a true blue Keynesian…but then the Austrians got me on the idea that banks could be curtailed from lending what they dont have!!

    I guess its a learning curve and what better place?

    Alanna

  14. Sean#12 Ive got round the wrong way…banks lending too much of what they do have in reserves, I should have said!

  15. Oh wouldnt it be nice if we could take the best of all “economic schools”…and say OK, this idea isnt so bad (it might work), and this different economic schools idea seems logical too….and why not try a mix or marriage of economic policy?

    It seems to me there is genuine good intent in quite diverse schools of economic thought.

    What happens to good ideas, in the corridors of power is quite another matter entirely…arrrgghh! Quite beyond the control of a lot of economists I would suggest.

  16. When the Austrians start frothing at the mouth about fractional reserve banking then the social democrats are welcome to them. That is the one part of the Austrian school that really is in moonbat territory.

  17. Oh I don’t know Terje. Those who argue that a banking system that has all the hallmarks of a cartel is so much better that a competitive banking systems is up there in the moonbat stakes.

  18. My last comment here was a bit snarky. So what I should have probably done is link to this post by Steve Keen instead.

    It’s not so much the idea of fractional reserve banking that’s the problem Terje, it’s the way they go about it.

    In the real world, banks extend credit, creating deposits in the process, and look for reserves later.

    And this:

    Thus causation in money creation runs in the opposite direction to that of the money multiplier model: the credit money dog wags the fiat money tail. Both the actual level of money in the system, and the component of it that is created by the government, are controlled by the commercial system itself, and not by the Federal Reserve.

    I’d hardly call Steve Keen a rabid Austrian.

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