Tuesday, May 05, 2009

Mr Rudd's budget deficit

Not at all well today. Eldest has had flue, I got a dose that came back. I came home at lunch time and slept.

Tonight just a few very short comments.

Tonight's Australian TV news was full of stories about the blow-out in the Australian Government's budget deficit. A reported deficit for next year of $60 billion, followed by six years of deficits. Frankly, this scared the living daylights out of me.

I will try to write a considered post tomorrow. This post just deals with gut reactions.

If you look at what I have written on the economy over the last eight months you will see certain consistent themes.

To begin with, I have not been worried about budget deficits as such, nor have I been worried about additional Government borrowings.

Making a distinction between cyclical and structural deficits, I suggested that it was perfectly appropriate at this stage of the cycle to go into deficit to support the economy. I also suggested that Australia could borrow a fair bit without creating a real net debt problem.

The difficulty with the latest comments by Treasurer Swan is that they suggest that the Government is building a substantial structural deficit. If so, the Government is creating a real problem.

I may be wrong here. I have not looked at the numbers. For reasons that I will outline in a moment, I feel that revenues will be higher than forecast. Further, some of the Government's capital spend items have long time horizons. It will be several years before they start to phase down. Even so, six years is a long time. It all begins to carry an uncomfortable 1970s' feel.

In writing, I have also tried to make the point that stimulation spend that adds to real productive capacity is better than spend designed to prop up consumption. I have also suggested that the lead times for capital spend will be longer than the Government (and other Governments too) allows.

I have not opposed the Rudd Government's short term stimulus measures, although I did have reservations about the latest round of payments. However, I have been worried about the Government's rhetoric because it seemed to suggest that just about anything could be justified in stimulus terms. I have also suggested that we would pay a real price in that practical budget considerations (there is no such thing as a free lunch) would end by dictating cancellation for other types of spend.

One of my real problems in reviewing both the economic outlook and Government policy responses is the apparent divergence between my own assessments and official commentary.

Very early on I suggested that the global downturn lay in a combination of structural and expectational factors. I did not expect the various short term stimulus measures to have great impact. Rather, growth would resume as Government capital spend started to kick in.

I also warned that the world was becoming awash with longer term liquidity. The key risk we faced was that this might lead to contractionary measures that would choke of growth. I did not expect the scale of the downturn, nor the extent of Government policy responses that are going to leave many western countries - the UK comes to mind - in an enfeebled position when it comes to subsequent Government actions.

At local level, I suggested that Australia was in a remarkably good position. We could not affect global developments. We could only manage our response to them. The key to this lay in positioning Australia to take advantage of the subsequent upturn.

I am coming to think that we have not done this very well.

In saying this, I am not suggesting that another Government would have done better. I just don't think that our current Government systems are responsive enough. I do think, however, that sometimes hysteria and war talk have added to problems.

I was not surprised at the decision of the Reserve Bank to keep the official cash rate on hold. I do not think that the Bank should have cut the rate at its previous meeting. Indeed, I suspect that it did so only because of the influence of its private sector Board members.

I said that I would discuss the reasons why I thought that Government revenues might be higher than expected later in the post. I will hold my comments here until I have had time to prepare a more detailed evaluation.

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