Monday, 25 February 2013

Fiscal Policy now

We have talked before about how if nominal GDP growth remains below trend then the budget will not get into the black. ( see this for example).

One of the more savvy operators believes the final budget outcome could be $16b deficit.

As it is this is no bad thing. The budget bottom line is NOT an end in itself , it is a means to an end. That end is stronger GDP growth.

It is highly ironic that most critics of the government not achieving a balanced budget advocate solutions which would make the deficit higher. They wish the government make greater spending cuts. This is what Wayne Swan was originally trying to do. However he was obviously advised to change his mind. ( Martin Parkinson and Glenn Stevens have recently made comments to Parliamentary comments to this effect.)
( see this for example.)

Why is this?
To understand this you need to comprehend two things.
1) The structural part of the budget has a much greater effect on the economy.
2) The cyclical part of the budget has a much greater effect on the budget bottom line.

Thus if the government tried to cut further to achieve a balanced budget they would in fact achieve the opposite. They would further slowdown the economy. ( Remembering of course the present budget is already contractionary and thus detracting from GDP growth.)
A contracting economy means increased expenditures and reduced tax revenues. In other words the European disease.

Before nominal GDP growth slowed to go below trend fiscal policy was quite appropriate ( and keynesian).
contractionary fiscal policy is what is needed when the private sector 'powers up'. however once nominal GDP growth went below trend fiscal policy was contributing to a slowing economy.

When nominal GDP growth comes back to trend the budget will be in balance. Whilst it isn't then leave the automatic stabilisers to do their job and hope monetary policy eventually turns things around.
It is also highly ironic that the other reason to impose a contractionary effect on the economy is the $A. It is ironic because overseas investors just want to buy our bonds. If they didn't nominal GDP would not be hit as hard and of course nor would the budget bottom line.