Fred Argy in Monday's Canberra Times:
The Reserve Bank Governor could "endorse in principle the idea of a fiscal stimulus and give Treasurer Wayne Swan the moral authority to run significant deficits for a period".
The strong monetary intervention of central banks, especially the Federal Reserve, may help restore confidence. But many economists doubt it will be sufficient to prevent a serious economic slowdown in North America and Europe and perhaps later in Asia. There is usually a lag of 12 months or so before interest rate changes have a significant impact on the economy, but the more fundamental concern is that monetary policy may not have its usual punch. This is because the paralysis in credit markets is not due to the high cost of money or the incapacity of banks to lend. It stems from the lack of trust in capital markets and intense risk aversion...
It is unlikely that monetary policy can do the required job on its own. Economists in the United States are therefore urging the Bush Administration to back up monetary policy with changes to tax and spending policies. Federal Reserve chairman Ben Bernanke has now added his considerable voice to the others by supporting the idea of a fiscal stimulus because, he said, ''fiscal and monetary stimulus together may provide broader support for the economy than monetary policy actions alone''.
Bernanke has also hinted at the kinds of stimuli that might be most appropriate. Money, he said, should be put in the hands of ''low and middle-income households that would spend it in the near term''. He is not worried about a temporary blow-out in the fiscal deficit and is hopeful that inflationary pressures will soon ease. This is a risky strategy, but in my view, the right one in the circumstances.
What are the lessons for Australia? Australia is, of course, at a different phase of the business cycle from the US. But the world slowdown is bound to have an impact on our exports and the share market slump (which is much worse than in the US or Britain) is likely to shake business confidence and have a ''wealth effect'' on consumers.
On top of that, concerns about inflation are so strong that we are bound to see a continuation of restrictive monetary and fiscal policies for some time.
Reserve Bank of Australia governor Glenn Stevens has hinted that the ''equilibrium'' unemployment rate the jobless rate consistent with the RBA's underlying inflation target of 2 to 3 per cent on average may be higher than the current rate of 4.3 per cent and that Australians may need to accept a scaling-up of unemployment as part of the price for containing inflation. The implicit message is that monetary policy will remain tight for some time. Despite all this, we may still end up with a mild economic slowdown in 2008-09, with unemployment stabilising around 5 per cent. If so, it would help relieve the skills shortages and damp wage-price pressures and leave us in a stronger position.
But we cannot rule out the possibility of a more severe economic slowdown one that threatens a rise in Australian unemployment to 6 per cent or 7 per cent. What should the authorities do then? The bank may switch gear and ease monetary policy but, for the same reasons as in the US, this might not be enough on its own to revive the economy.
Monetary policy would need to be backed by fiscal policy.
In such circumstances, how would the Rudd Government respond? Having staked its reputation on fiscal conservatism, it may be reluctant to inject a discretionary fiscal stimulus. However, the politics could be defused if Stevens decided to endorse in principle the idea of a fiscal stimulus and give Treasurer Wayne Swan the moral authority to run significant deficits for a period. In doing so, Labor would not be breaching its promise whichis to run surpluses ''on average over the course of the economic cycle''.
If a fiscal stimulus were needed, it should be capable of quick implementation and fairly quick withdrawal when economic conditions changed. And it should aim to achieve longer-term economic and social benefits over and above short-term stabilisation. This suggests that as well as measures such as temporary tax credits, the Government could take the opportunity to rectify the neglect of infrastructure investment such as in education, health, low-cost housing, urban roads and freeways, public transport, ports, energy, rivers and water.
Hopefully, by the time urgent action is needed, the Infrastructure Australia body will be in a position to recommend short-gestation infrastructure projects with high benefit-cost ratios that could be put immediately into action and help to relieve bottlenecks in the economy. If the authorities play their hands well, the Australian economy could come out a winner. If we get a mild slowdown it would simply reinforce the work of the Reserve Bank. If the slowdown threatened to be severe, it would give Australia a golden opportunity to fix up some of its infrastructure problems.