This budget marks a historic shift in how the macro economy is managed. After 30 years, the dominant influence has moved from monetary policy (interest rates) to fiscal policy (the budget). Which means day-to-day economic power has transferred from the econocrats back to the politicians.
And as Paul Bloxham, of the HSBC bank, has reminded us, that means we’re in for a bumpier ride. It’s a fair bet that our days of a long gap between recessions are over and we’ll return to having recessions about every seven years, not every 30.
With monetary policy having run out of puff, the coronacession has seen almost all the heavy lifting left to fiscal policy. Whereas before, the Reserve Bank could cut interest rates to get households and businesses borrowing and spending, now it has to be the government that spends our way back to recovery and lower unemployment.
To see how big this change is, we must go back in time. In the Golden Age of the 30 years after World War II, governments in all the rich economies used their budgets – changes in taxes and government spending – to smooth the economy’s path through the business cycle and keep it never far from full employment.
In some years a small surcharge was added to the rates of income tax; in others, a small discount was subtracted. The role of monetary policy was subsidiary and subordinate. Central bankers’ job was always to keep interest rates low.
But after the first OPEC oil price shock of 1973 (just before I became an economic journalist) it became clear the developed economies had a chronic problem with inflation, It stayed high even when the economy turned down.
It took some years – and much argument - for the world’s economists and econocrats to decide why economies had begun to malfunction and what to do about it. They had to find a way to get inflation under control.
A new conventional wisdom developed that monetary policy should become the primary instrument used to stabilise the economy’s path through the business cycle, with fiscal policy relegated to the medium-term role of ensuring levels of public debt didn’t get too high.
After the failed experiment of using monetary policy to target growth in the supply of money (a quantity), it was decided that central banks should use the manipulation of short-term interest rates (a price) to target the rate of inflation directly. To do this successfully, each country’s central bankers would need independence of the elected government, thus giving them a free hand on rates.
The major developed countries got inflation back in its box in the 1980s and we followed in the ’90s, after a deep recession had knocked the stuffing out of the economy, and the Reserve Bank had adopted its present inflation target in 1994, with the incoming Howard government formalising the Reserve’s independence in 1996.
I think turning the setting of interest rates over to the econocrats does much to explain how we managed to go for almost 30 years without a serious recession. Under the pollies, rates had been set more to fit the electoral cycle than the business cycle, and macro management had been erratic.
By contrast, former governor Bernie Fraser raised rates in the run-up to the Keating government’s defeat in 1996 and former governor Glenn Stevens raise rates during the 2007 election campaign, at which the Howard government was defeated.
Another factor contributing to our record period without a recession was the micro-economic reforms – particularly the move away from centralised wage-fixing – that made the economy less inflation-prone and thus easier to keep on a stable course.
But with the demise of inflation has come the impotence of conventional monetary policy. The central bankers will do what they can to still look relevant but, really, it’s the politicians who are back at the economy’s driving wheel.
And the sad truth is that politicians rarely manage to put the economy’s best interests ahead of their political objectives. This year’s one-year, fold-away budget is a good example. We’re told it’s “all about jobs” but, in truth, its measures will do far less to create jobs than they could have because they’ve been chosen to advance the Liberals’ “core values” of “lower taxes and containing the size of government”.
This translates as keeping new government spending projects temporary and brief (because government spending favours poor people less likely to vote Liberal) and keeping tax cuts and tax breaks permanent (because these favour people more likely to vote Liberal).
Trouble is, the Smaller Government push fitted well with macro management being left to monetary policy, but it’s a bad fit with our new-found dependence on fiscal policy to get people back into jobs.
The bumpy ride we’re in for is unlikely to mean a return to high inflation (sometimes I wish it did). No, it means weak economic growth and high unemployment while the Coalition – and the voters – learn the hard way that, in today’s world, Smaller Government and full employment are incompatible.
