Voodoo economics and budget mayhem
According to The Australian, leading economists warn that the government must cut spending to take pressure off interest rates. How many were part of the Ken Henry cheer squad supporting the reckless and wasteful stimulus spending in the first place, is a good question to ask. Whichever way the wind blows there I’ll go.
Two recent pieces of economic information bear on the issue. One was the release of the minutes of the 7 September Reserve Bank board meeting; the other was the final federal government budget position for 2009-10. While the former caused a bigger stir than the latter; they were, in fact, part of the same story of economic mismanagement.
With all of the caveats carefully spelt out – it could go this way or it could go that – the board came down, tentatively of course, on predicting further rate rises: “members considered that if the central scenario came to pass it was likely that higher interest rates would be required, at some point, to ensure that inflation remained consistent with the medium-term target”.
The banks rubbed their hands in anticipation. Unabashed, the CBA economics team forecast that the present 4.5% cash rate will be 6% by the end of next year. Oh joy! Banks offshore funding costs are being driven higher so they need a publicly acceptable rationale to increase their lending rates, particularly housing rates. Maybe some of them will also use the next 25 basis points rise in the cash rate to deliver a 35 basis points rise in their lending rates. Wait for it, if the Reserve Bank increases rates, as the markets expects, after its next board meeting on 5 October.
I noticed in the minutes that that the board expected public demand ‘to subtract from growth over the next few quarters as stimulus projects were gradually completed’. The import of this was that stimulus spending would no longer put upward pressure on interest rates. Surely not I thought; the Governor gave the distinct impression last year when appearing before the Senate Economics Reference Committee on 28 September that government borrowing had no crowding out effect. When asked whether government borrowing risked crowding out the private sector, he answered:
… there is some potential for that risk … The question really is, quantitatively, how big it is. My point is that the thing which is most likely to crowd out Australian businesses and other businesses by pushing up the long-term global interest rate … is not going to be the Australian government’s borrowing, unless it is a lot bigger than it looks like being – it will be the huge run up in public debt in the major countries, which are quantitatively so much larger.
Unfortunately, this is voodoo economics designed, or otherwise, to confuse senators. Government spending, and consequential borrowing from whatever source, always tends to crowds out private sector activity, as the board minutes correctly import. Hopefully, Glen Stevens answer was not tailored for political purposes to prevent embarrassment to the government. Perish the thought. Wayne Swan continues to parrot the voodoo economics story but who can blame him; he has it from authority.
This brings me to the budget outcome and to the amazing turnabout in Australia’s budgetary position over the past two years. This undoubtedly has contributed, and is still contributing, to upward pressure on interest rates.
The deficit in 2009-10 was $54.8 billion, following a deficit in 2008-09 of $27 billion; a total of $82 billion with much more to come this financial year and next. And maybe it will continue into 2012-13 (the promised surplus year), if the government fails to raise enough mining tax revenue to fund its spending commitments to the dynamic trio.
To put the $82 billion, and growing, into perspective; it took Hawke and Keating (1984-85 to1995-96) twelve years of mainly deficit budgeting to cumulative a deficit of $75 billion. In stark contrast, in Howard’s twelve years (1996-97 to 2007-08), the cumulative surplus was $97 billion. Though Swan with chutzpah unparalleled, even among politicians, claims credit for this outcome; as he goes about crowing that government debt is still so low by international standards. Perhaps, in that alternative universe that Swan occupies, he sees himself as having been an undercover inspirational force of fiscal rectitude throughout the Howard and Costello years? Who knows what politicians think when spin totally replaces truth.
The government should be held to account if the Reserve Bank increases interest rates. To have the coincidence of a resources boom and deficit financing of the current magnitude shows how recklessly extravagant the spending has been. It doesn’t stop there.
The spending has also been glaringly wasteful and unproductive. It will it generate no revenue, either directly or indirectly, to make interest and capital repayments. This too means that interest rates, and also taxation, will need to be higher than otherwise, at the cost again of crowding out private sector activity. And the Labor Party was allowed to fight the election on its economic record? There surely must be a message in there somewhere for the Coalition.