Anthony Albanese and his Treasurer, Dr Jim Chalmers, have inherited many problems that won’t be solved quickly or easily. Nor will they be solved without the new government being willing to persuade voters to accept the sort of tax changes no pollie wants to talk about in an election campaign.
That’s the conclusion I draw from Treasury secretary Dr Steven Kennedy’s belated annual speech to the Australian Business Economists this week.
Election campaigns are times when we hear about all the wonderful things the politicians want to do to improve the public services we get and reduce the taxes we pay. It’s after the election that pollies present the bill.
Especially when the election has changed the government. This wasn’t Chalmers bringing us the bill, it was the waiter reminding us we’d eaten quite a lot and the bill was getting pretty long.
The economic story had “shifted significantly”, Kennedy said. Inflation pressures had emerged faster and more strongly than most people expected. These were likely to persist into next year “at the very least”.
This, of course, is why the Reserve Bank has been raising the official interest rate – to eventually bring inflation back to acceptable levels.
“Interest rates are at near-record low levels and therefore highly accommodative and should normalise”, Kennedy said. In other words, they need to be increased until they’re back to more-normal levels. If so, they have a lot further to go.
But, Kennedy says that “just as fiscal [budgetary] and monetary [interest-rate] policy worked together to respond to the pandemic, they will need to work together in managing the risks to inflation and the economy more broadly”.
Ah yes, the dreaded duo, Debt and Deficit. Not a subject to be dwelt on during election campaigns, but one to return to afterwards. Presenting the bill, remember?
Chalmers is, understandably, anxious to remind us that our trillion-dollar public debt is inherited from his predecessors. What Kennedy does is implicitly confirm that the previous government’s “medium-term fiscal strategy” - to “focus on growing the economy in order to stabilise and reduce debt” - is still the go.
With an important, after-the-election qualification: “a more prudent course would be for the budget to assist more over time”.
How? We’ll get to that. But first, he gave the best explanation I’ve seen of how a government can get on top of a big debt simply by ensuring the economy grows at a faster annual rate than the rate of interest on the debt.
To “get” the explanation you have to accept one proposition that many otherwise sensible people and media commentators can’t get their head around: that the government of a nation is in a radically different position to an individual household.
Households have to repay any money they borrow sooner or later, but governments don’t. That’s because every family gets old and dies, whereas nations are a collection of many millions of households that, though the faces change, goes on forever.
For a nation, what matters is not its ability to repay the debt, but just its ability to afford the interest payments on it. As long as the nation continues to exist, it can re-borrow by issuing a new government bond to replace an old government bond as it falls due for repayment.
Kennedy explained that strong economic growth and interest rates that are low compared with what’s been normal for the past 50 years are likely to ease the burden of the debt. This is by reducing its size not in dollar terms, but relative to the size of the economy, measured by the dollar value of all the goods and services the economy produces annually (nominal gross domestic product) in coming years.
Interest payments add to the amount of debt the nation owes, but growth in the economy (nominal GDP) increases the economy’s capacity to “service” (pay the interest on) that debt. “When the economy grows quicker than the interest payments add to the debt, the debt burden will decrease,” he said.
That’s the basic mechanism all governments in all the rich countries have relied on since World War II to get on top of their debt. It’s what the Morrison government was relying on, and it will be what the Albanese government continues relying on.
But – with Treasury there has to be a but – there was a weakness in the previous government’s strategy: their projections showed the budget remaining in deficit for the next decade and, indeed, the next 40 years.
That means it wasn’t just the interest bill that was adding to the debt each year, it was also the continuing deficits.
“The current projected reduction in the debt [relative] to GDP is unusual in that it is relying solely on favourable growth and interest-rate dynamics [that the average rate of interest on the debt will rise more slowly than the rising rate of interest on the new borrowing because the average government bond takes about seven years to fall due] to reduce the ratio [of debt to GDP],” Kennedy said.
So here’s the post-election But (which, since it’s the same Treasury, would probably have happened even without a change of government): “A more prudent course would be for the budget to assist more, over time,” Kennedy said.
How? By getting the budget deficit down a lot faster than the Liberals were planning to. Maybe even by running budget surpluses for a while – which would involve repaying a bit of the debt.
Sure, but how do you get the deficit down? The government will be reviewing all the spending programs left by the Coalition, looking for savings. But what savings it finds will mainly be used to pay for Labor’s promised new spending.
So the main way to improve the budget balance will be by “raising additional tax revenues”. Kennedy implied that this would be done by reducing businesses’ and households’ tax concessions.
The next three years will be interesting.
