Wednesday, 22 May 2013

The Structural balance of the budget

Yesterday was a momentous day.

First the Parliamentary Budget Office ( which is independent) issued a paper on Estimates of the Structural budget balance of the  Australian Government 2001-02 to 2016-17. It is here. It was peer reviewed. ( Ricardian Ambivalence reviews it here. It is of course high class stuff )

Treasury also released a paper on the same topic here. Treasury is not independent and this was not peer reviewed.  My internet mate Ricardian Ambivalence writes about this here and very well too!

The PBO paper can be understood by laypeople whereas you do need a reasonable understanding of economics to understand the treasury paper.

However they both tell a similar story.

Why is the structural balance important? If there is a structural deficit when the economy is at full employment then we will see crowding out. This means interest rates will be higher than they would otherwise be. However if inflation is low ( as in either the Reagan or Bush years in the USA ) then this effect will be minimal.

The Structural budget balance started to deteriorate around 2002. It cannot be precise because it is an estimate. (It is not temporary as the stimulus was. It will stay around unless you take actions to rid yourself of it.)
It got into deficit just before the change of government .

The main reason but not the only reason for this was the reduction of personal income taxation which was based on the assumption of ever higher company tax revenues from the mining boom.

When should we attempt to rid ourselves of the structural deficit.
My answer to that is when nominal GDP is around trend rates alah Keynes. This way GDP rates are not negatively affected and so we d not get an unnecessary rise in unemployment.

Ricardian Ambivalence says we have to start on fiscal consolidation now. I do not agree for the reasons I have already outlined. I should add assumptions made when times seems dark sometimes turn out to be to pessimistic!

This  is very pertinent!

Read about Ireland and their problem of structural deficits after the GFC hit them. Very interesting!

I should have also added it will be interesting to see if the fiscal incompetents at Catallaxy now admit they got everything wrong on the structural  budget balance in the Howard era and the reasons why.
I won't hold my breath.  I could say I told you so on the topic however