The usual tear gas on fiscal policy

Budget Week should in principle be a great opportunity for an educated national discussion about issues of public finance and macroeconomic management. But unfortunately the budget debate is always shrouded in such a thick fog of political rhetoric and misinformation that it turns into the most tedious week of the year.

The greatest nonsense tends to surround the interpretation of the deficit. Not that the discussion of the ill-fated CPRS, the resource rent tax, or the healthcare funding arrangements have been very informative. But when it comes to the macroeconomic policy aspect, you might as well read a good comic as listen to a minister or shadow minister on the radio.

There are two basic questions about fiscal policy that should be posed at each budget:

1. Is the fiscal stance, that is, the discretionary change in spending and revenue, an appropriate contribution to aggregate demand?

2. Is the fiscal balance on a sustainable path given the state of the government balance sheet?

This is not the place to answer those questions, but I’ve copied a couple of graphs from Budget Paper No.1 that might serve as starting point for a discussion on them.

The first graph indicates where the gaps in spending developed and how fiscal policy could fill them, and the second one provides a handy benchmark for a discussion of sustainability. A critic might not agree with all the assumptions underlying the Treasury forecasts, but they’d be obliged to spell out which ones they disagreed with and provide their own alternative model if the disagreement was profound.

However, instead of an informed and informative discussion of these matters, we usually get a debate over the meaningless question whether or not budgeting for a deficit indicates a responsible management of the economy. Of course this presentation of the issue bypasses Question 1 altogether: the budget balance tells us nothing about the magnitude of any net injections into total spending — it’s mostly a reflection of the state of the economy.

The size of the deficit is pertinent to Question 2, but indicates very little if it isn’t placed in context. We need to know the whole story: How big is the current net debt? How big is too big? How big do want it (not necessarily zero)? Given our current location in the business cycle, is the evolution of the fiscal deficit consistent with a feasible path from one to the other?

Last year we came a little closer than usual to a sensible discussion of the issues. That might seem ironic given that the budget balance plunged precipitately from a forecast surplus to a deficit of around five percent of GDP. However, partly because of the seriousness of the crisis and partly because the Opposition was led by Turnbull, there initially seemed to be underlying bipartisan agreement on the inevitability of a blow-out.

But by the time the budget was handed down, Turnbull had become a shrill critic of the stimulus package, even if it was the magnitude of the deterioration in the balance that he emphasised, rather than the sheer fact of the deficit.

And we’re right back to it this year. Tony Abbot declared Rudd a ‘crazy spender’, Andrew Robb announced sorrowfully on Lateline that this is the biggest budget deficit since World War II, and Joe Hockey has been rehearsing his Neanderthal crowding out argument all day on radio stations. And Rudd himself, who only a year ago was boasting about his government’s courage in implementing the stimulus, has already resumed mouthing his mantra from Kevin 07 days about being above all else a fiscal conservative, whatever that means.

If only the crisis had deepened, we’d be seeing better debate. Fortunately at the moment the Treasury seems to know what it’s doing, despite the best efforts of our elected governors to keep us confused. But it may not always be that way, so it’s probably high time to make them an independent statutory authority.

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10 Responses to The usual tear gas on fiscal policy

  1. Paul Frijters says:

    Hi James,

    yes, fog as usual. Crisis over, no-one really needs-to-know anymore, so its back to jukebox-a-la-carte.
    I am not so sure about the independent statutory body thing though for the Treasury. The whole point of our hard-won democracy is that the population gets to choose the people making the big decisions, replacing the vain hope that unelected kings and barons do the right thing out of the kindness of their heart. Why tempt a slide back to the bad old days via more unelected statutory bodies manned with a new nobility? Is there something better than democracy after all?

  2. I’m with Paul. Independence can work when there is a very precise objective set by government – ie democratic government still sets the priorities – and another technically expert and credible body is left to do the implementation. But most of Treasury’s work is about what the priorities should be, and on that they are correctly only advisers with no independent authority. Read Fraser’s biography for a case study in how an arrogant and difficult-to-control Treasury can be an obstacle to the legitimate demands of the government of the day.

    And we should not put so much weight on the public ‘debates’ in Canberra. Politicians talk about politics; it has always been so and always will be so. The within-government discussions (and indeed, within party) are generally of much higher standards.

  3. Fred Argy says:

    James, if a Government is concerned about unemployment, it should run a less deflationary budgetary policy in the next financial year.

    Unfortunately, the RBA has made its position clear: it is so obsessed with inflation that only Rudd’s “fiscal conservatism” can deter them from further interest rate increases.

  4. Nicholas Gruen says:

    James, It’s not a link to an independent Treasury – but some other body. The govt still needs independent advice.

    Andrew, are you against the independence of the Productivity Commission or the Reserve Bank?

  5. James Farrell says:

    Yes, Nicholas, it would be a separate body, but to the extent that Treasury is advising the government on fiscal policy (in the narrow sense my Questions 1 and 2) your plan would make that function independent. Anyway, as you will have realised, the post wasn’t meant to be a careful examination of that proposal.

    When we get to that stage the objection Andrew and Paul made obviously has to be met: to what extent are we prepared to surrender discretion to unelected technocrats who answer to their own masters, whether these are misguided dogmas (John Stone) or organisational goals (Humphrey Appleby)? On the other hand, we do accept the role of independent authorities in the case of the judiciary and, more pertinently, as you say, the central bank. So it isn’t as simple as all that.

    Fred’s comment reminds us that whoever makes decisions about demand management has to harmonise its strategy with the RBA in any case.

  6. Edward Mariyani-Squire says:

    I suspect James’ last grenade – “it’s probably high time to make them an independent statutory authority” – was just a throw-away line … although born out of annoyance with the irresponsible rhetoric of politicians.

    1. The rhetoric is annoying not just because it is so dunderheadish, but also because 1st year business students (incl. those enrolled in economics degrees) seem to take it on board, parroting it in tutorials apparently on the assumption that if Someone Important said it, there must be some truth in it.

    2. As to the matter of making basic elements of fiscal policy independent of irresponsible politicians, as James suggested, statutory authorities don’t necessarily constitute the end of democracy as we know it. Properly set up statutory authorities can be, if anything, effective instruments and expressions of a well-functioning democracy.

  7. Paul Frijters says:

    I am still with Andrew regard James’ stray thought: it is hard to see where the precise objective is that could be encapculated in an independent treasury. Ensuring budget neutrality sounds great, but since it involves taxes (at commonwealth and state and even council level), regular expenses, and a whole variety of irregular expenses (governments appeal to unusual funds all the time depending on whether another war has to be fought, another drought has to be subsidised, or another hospital has to be bailed out), I find it hard to see how balancing a budget could be divorced from the essence of democratic government: deciding who has to pay taxes and who gets the proceeds for which goal.

    Apart from whether there is a specific goal, there is also the more general question of how much decision making power we entrust unelected bodies with. That’s a tough one for another day.

  8. Labor Outsider says:

    Treasury should remain as is. However, that doesn’t mean that there shouldn’t be a role for a separate independent authority. That independent authority need not have any power over fiscal policy as such (the arguments for an independent fiscal policy are in my view considerably weaker than the arguments for an independent monetary policy), but could provide independent advice to the legislature about the impact of government policy decisions on long-run fiscal sustainability, independent macroeconomic projections and proper cost-benefit analyses of new policies and programmes such as the NBN. The problem as I see it is that the Treasury is deeply politicised, which makes it difficult for outsiders to know whether projections/advice reflect the indpendent judgement of officials, or the influence of the government of the day. It isn’t surprising that the quality of debate about fiscal policy in Australia is so poor when the organisation with the most expertise on fiscal policy is a non independent arm of the executive. I’m not sure that the Australian and associated wing-nuts would have been able to get away with some of the rubbish that they have written about the impact of fiscal policy on macro outcomes if an independent organisation with the authority of the RBA had also been involved in the debate.

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