If you take the figures at face value, this week's budget is deeply contractionary, delivering a blow to demand at a time when parts of the economy aren't at all strong. But in economics, it's rarely wise to take things at face value.
There are different ways to assess the "stance" of fiscal policy - to work out the direction and size of the effect a budget will have on the economy. Settle back.
There's a two-way relationship between the budget and the economy. The decisions announced in the budget have an effect on the economy but, at the same time, the economy has an effect on the budget.
The budget contains elements - such as the progressive tax system and the availability of the dole to people without jobs - that have the effect of helping to stabilise the economy as it moves through the business cycle.
When the economy turns down, tax collections fall and more people go on the dole, which automatically worsens the budget balance. This worsening, however, helps to prop up (stabilise) the economy.
Then, when the economy starts to recover, these "automatic stabilisers" change direction. Tax collections grow faster than the rise in incomes and people find jobs and go off the dole. This improves the budget balance and also acts as a brake on the economy, stopping it from growing too fast and causing inflation problems.
These things happen automatically and their effect on the budget balance is called its "cyclical component". But governments can and do make their own decisions about increasing or decreasing taxes and government spending. The net effect of these discretionary moves on the budget balance is called its "structural component".
Now, when you assess the stance of budgetary policy the strict Keynesian way, you focus on the explicit policy decisions made in the budget (the structural component) and ignore the effect of the budget's automatic stabilisers (the cyclical component).
These days, however, the Reserve Bank and many economists tend to do it a simpler way that ignores the distinction between cyclical and structural. You just compare the budget balance for the old year with the planned balance for the new budget year.
The Treasurer, Wayne Swan, is expecting an underlying cash budget deficit in the financial year that's coming to an end, 2011-12, of $44.4 billion, but budgeting for a surplus of $1.5 billion in the coming year, 2012-13.
That's a turnaround of almost $46 billion. From one year to the next, the budget's net effect is to extract $46 billion from the economy - if it happens, the biggest one-year turnaround for almost 60 years.
It's equivalent to about 3 per cent of gross domestic product, which makes it absolutely huge. And since it's an extraction, you could only conclude it makes the stance of fiscal policy adopted in the budget highly contractionary. It would knock the stuffing out of the economy.
But here's where we mustn't take things at face value. Swan has had to move a lot of things around between years to make it possible to keep the Prime Minister, Julia Gillard's, election promise to get the budget back to surplus in 2012-13. When he's taken spending and pulled it forward into the last few weeks of the old financial year, that's not genuine for our purposes. For the government's accountants, whether something happens on June 30 or on July 1 makes all the difference in the world. You've got to draw the line somewhere, and that's where we draw it.
From the perspective of the budget's effect on the economy, however, a difference of a few days or a few weeks is a difference that doesn't make any difference.
And it turns out a big part of the $46 billion turnaround is explained by Swan's decision to draw spending forward into the last few weeks of the old year. There's compensation for the carbon tax (which doesn't start until July 1) of $2.7 billion, advance payment of natural disaster relief funds to Queensland of $2.3 billion, a bring-forward of infrastructure spending of $1.4 billion, the new "schoolkids bonus" cash splash of $1.3 billion, and financial assistance grants to local government of $1.1 billion.
That long list adds up to $8.8 billion. But here's the trick: when you take money out of one year and put it into the year before, you have twice the effect on the difference between the two years. So Swan's bring-forward of that spending explains $17.6 billion of the $46 billion turnaround.
Another thing to take account of is that the new year's budget is expected to benefit from increased revenue from resource rent taxes of $5.7 billion (that's from the existing petroleum rent tax as well as the new minerals rent tax). The point is that these taxes are explicitly designed to tax "economic rent", so they have no effect on the incentive to exploit petroleum or mineral deposits and thus have no effect on economic activity. A further factor is that, thanks to a quirk of public accounting, Swan's underlying cash surplus of $1.5 billion takes no account of the government's spending on the continuing rollout of the national broadband network.
The budget item "net cash flows from investment in financial assets for policy purposes" is expected to involve increased spending of about $6 billion in 2012-13. Not all of that would be the broadband network rollout. But to the extent it involves the government funding economic activity, it has the effect of reducing the budget's adverse effect on economic activity.
Put these three arguments together and you conclude the budget's drag on demand would be less than half the 3 percentage points of GDP we started with.
Even so, it's still a big effect. There's no denying the stance of fiscal policy is contractionary.
But the budget is only one of the factors affecting aggregate demand. It's also only one of the instruments available to the macro-economic managers to influence demand.
So if fiscal policy proves to be too tight, the obvious remedy will be to further loosen monetary policy - to cut the official interest rate, in plain English. The stance of monetary policy is already mildly expansionary and, if necessary, it can be made more so.
Is it a good thing to have the two arms of policy working in opposite directions? Sure it is - if you're hoping lower interest rates will lower our high dollar a little.
Such a lowering may have already occurred. If so, the effect will be expansionary.
