There’s an important point to learn from this week’s mid-(financial)-year’s budget update: in the economy, as in life, there’s more than one way to skin a cat.
The big news is that, after turning last year’s previously expected budget deficit into a surplus of $22 billion – our first surplus in 15 years – Treasurer Jim Chalmers is now expecting this financial year’s budget deficit to be $1.1 billion, not the $13.9 billion he was expecting at budget time seven months’ ago.
Now, though $1.1 billion is an unimaginably huge sum to you and me, in an economy of our size it’s a drop in the ocean. Compared with gross domestic product – the nominal value of all the goods and services we expect to produce in 2023-24 – it rounds to 0.0 per cent.
So, for practical purposes, it would be a balanced budget. And as Chalmers says, it’s “within striking distance” of another budget surplus.
This means that, compared with the prospects for the budget we were told about before the federal election in May last year, Chalmers and Finance Minister Katy Gallagher have made huge strides in reducing the government’s “debt and deficit”. Yay!
But here’s the point. We live in the age of “central bankism”, where we’ve convinced ourselves that pretty much the only way to steer the economy between the Scylla of high inflation and the Charybdis of high unemployment is to whack interest rates up or down, AKA monetary policy.
It ain’t true. Which means Chalmers may be right to avoid including in the budget update any further measures to relieve cost-of-living pressures and, rather, give top priority to improving the budget balance, thereby increasing the downward pressure on inflation.
The fact is, we’ve always had two tools or instruments the managers of the economy can use to smooth its path through the ups and downs of the business cycle, avoiding both high unemployment and high inflation. One is monetary policy – the manipulation of interest rates – but the other is fiscal policy, the manipulation of government spending and taxation via the budget.
This year we’ve been reminded how unsatisfactory interest rates are as a way of trying to slow inflation. Monetary policy puts people with big mortgages through the wringer, but lets the rest of us off lightly. This is both unfair and inefficient.
Which is why we should make much more use of the budget to fight inflation. That’s what Chalmers is doing. The more we use the budget, the less the Reserve Bank needs to raise interest rates. This spreads the pain more evenly – to the two-thirds of households that don’t have mortgages – which should be both fairer and more effective.
Starting at the beginning, in a market economy prices are set by the interaction of supply and demand: how much producers and distributors want to be paid to sell you their goods and services, versus how much consumers are willing and able to pay for them.
The rapid rise in consumer prices we saw last year came partly from disruptions to supply caused by the pandemic and the Ukraine war. There’s nothing higher interest rates can do to fix supply problems and, in any case, they’re gradually going away.
But another cause of the jump in prices was strong demand for goods and services, arising from all the stimulus the federal and state governments applied during the pandemic, not to mention the Reserve’s near-zero interest rates.
Since few people were out of job for long, this excessive stimulus left many workers and small business people with lots to spend. And when demand exceeded supply, businesses did what came naturally and raised their prices.
How do you counter demand-driven inflation? By making it much harder for people to keep spending so strongly. Greatly increasing how much people have to pay on their mortgages each month leaves them with much less to spend on other things.
Then, as demand for their products falls back, businesses stop increasing their prices and may even start offering discounts.
But governments can achieve the same squeeze on households by stopping their budgets putting more money into the economy than they’re taking out in taxes. When they run budget surpluses by taking more tax out of the economy than they put back in government spending, they squeeze households even tighter.
So that’s the logic Chalmers is following in eliminating the budget deficit and aiming for surpluses to keep downward pressure on prices. This has the secondary benefit of getting the government’s finances back in shape.
But how has the budget balance improved so much while Chalmers has been in charge? Not so much by anything he’s done as by what he hasn’t.
The government’s tax collections have grown much more strongly than anyone expected. Chalmers and his boss, Anthony Albanese, have resisted the temptation to spend much of this extra moolah.
The prices of our commodity exports have stayed high, causing mining companies to pay more tax. And the economy has grown more strongly than expected, allowing other businesses to raise their prices, increase their profits and pay more tax.
More people have got jobs and paid tax on their wages, while higher consumer prices have meant bigger wage rises for existing workers, pushing them into higher tax brackets.
This is the budget’s “automatic stabilisers” responding to strong growth in the economy by increasing tax collections and improving the budget balance, which acts as a brake on strong demand for goods and services.
There’s just one problem. Chalmers has joined the anti-inflation drive very late in the piece. The Reserve has already raised interest rates a long way, with much of the dampening effect still to flow through and weaken demand to the point where inflation pressure falls back to the 2 per cent to 3 per cent target.
We just have to hope that, between Reserve governor Michele Bullock’s monetary tightening and Chalmers’ fiscal tightening, they haven’t hit the economy much harder than they needed to.
