The Very Timely Death of the Politics of ‘Debt and Deficit’
The Very Timely Death of the Politics of ‘Debt and Deficit’
It mostly led to bad public policy
The 2021 Budget is largely seen as putting an end to the politics of ‘debt and deficit,’ a narrative that defined good government in terms of driving the federal budget back into surplus. In the context of the worst economic shock in 100 years, this narrative is no longer relevant, although it is surprising how long it took many political actors to adapt to the new reality. The ALP and many in the media couldn’t help but give government stick on the issue, which they took to be symptomatic of government hypocrisy, as though that were more important than the substance of the fiscal response to the pandemic. Many found it hard to put away the old political playbook, assuming that what once worked for the Coalition politically would continue to work in a radically different setting.
I have long been an advocate of fiscal rules, including running balanced budgets over time, but well-specified fiscal rules should come with caveats about shocks. A pandemic-event should release governments from fiscal rules, at least temporarily, although the Commonwealth had a somewhat threadbare fiscal framework going into the pandemic. It is still committed to a ceiling on the tax share of GDP of 23.9% (currently 22.3%).
Fiscal rules are a natural complement to monetary rules, especially with an inflation targeting central bank and a floating exchange rate. By ensuring stable long-run debt dynamics, they preclude fiscal dominance of monetary policy in setting the price level, an institutionalised repudiation of MMT. They also provide a framework in which fiscal policy can focus on microeconomic issues, while monetary policy and the exchange rate take care of short-run macroeconomic stability.
In practice, however, the anti-‘debt and deficit’ narrative in Australia mostly led to bad public policy. Governments were deemed to be good managers if they could produce a forecast for an improving budget bottom-line, with bonus points for a surplus sometime during the forecast period. Actual budget outcomes were of secondary importance, announced sometime after the end of the financial year, with little fanfare.
Fiscal policy statements increasingly became exercises in window-dressing the forecast for the budget bottom-line. But this induced bad policy decisions. The problem got worse the closer we got to balance, because even small decisions could collectively have big presentational implications. The budget papers would be littered with these small decisions, many of which had perverse microeconomic consequences and added needless complexity.
It should also go without saying that the role of fiscal policy is not to help ‘keep interest rates low.’ The idea that low interest rates are a symptom of good economic management should be another well-deserved victim of the pandemic. The stance of fiscal policy never had much relevance to the determination of interest rates in Australia. However, essentially the same mistaken narrative has re-emerged with the notion that fiscal policy must now remain expansionary because monetary policy is constrained and needs to ‘rebuild its buffers.’
The mistake here, of course, is the notion that monetary policy is constrained because interest rates are low. Those constraints are a policy choice, one that has important implications for the effectiveness of fiscal policy. Fiscal policy is only expansionary in the presence of monetary accommodation. Monetary offset doesn’t require explicitly contractionary monetary policy settings to blunt fiscal policy. It can work passively too.
A recent piece by John Kehoe was refreshing in making the case for open economy crowing-out effects from fiscal expansion. He also argued that there would be no ‘monetary neutralisation’ of the current fiscal expansion, but that’s only true in terms of the direction of explicit monetary policy decisions. The effective stance of monetary remains tight.
We know monetary policy settings are too tight because Deputy Governor Guy Debelle told us so in his Shann Memorial Lecture last week: ‘Outcomes in the Australian economy have significantly exceeded even the optimistic expectations in terms of economic activity. But that is not the case on the nominal side of the economy in terms of wages and inflation.’ Guy’s chart of the RBA’s government bond holdings relative to the rest of the world tells the story of the lagged response of Australian monetary policy to the pandemic, with the RBA still playing catch-up. The period from March-October 2020 was textbook open economy crowding-out and passive monetary offset.
The RBA has flagged a review of its policy settings at its July meeting. While the RBA has set clear thresholds for a change in the cash rate that are far from being met, the yield curve target and the size and duration of its bond buying program are both potentially on the table. The RBA could still tighten monetary policy through either of these instruments without changing the cash rate. This is an otherwise little noted loophole in the RBA’s forward guidance. While I don’t think they will change these instruments at the July meeting, it will remain a live issue for subsequent meetings. The 3-year bond target will be shifted from the April to the November 2024 bond and another $100 billion in QE will be announced, so the notional stance of monetary policy will be unchanged.
It should also be noted that for all the talk of expansionary fiscal policy, the fiscal impulse (the change in the underlying cash balance as a share of GDP) turns ‘contractionary’ from next financial year and over the forecast period. The budget is more expansionary relative to the MYEFO forecasts for 2022-23 and 23-24, but I’m sceptical that anyone’s expectations for the macroeconomic outlook are conditioned on these counter-factuals. The difference between the two forecasts shows how hypothetical they are. While I don’t view the forecast negative fiscal impulse as negative for the economic outlook (it’s partly a function of assumed nominal GDP growth afterall), it seems odd to characterise future fiscal policy as especially expansionary. As always, when it comes to the stance of macroeconomic policy, monetary policy is still the only game in town and Governor Lowe is mostly still sitting on the bench.
For mine, the most important number in the Budget was the one left unstated: the approximately one million people that will be lost to other countries between now and the assumed normalisation of net overseas migration in 2024-25. Australia will be a permanently smaller place relative to a no-pandemic counter-factual in the absence of future catch-up migration. Policy choices don’t come much bigger than that.
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