Thursday, May 14, 2009

Rory Robertson: "Canberra’s approach sensible, defensible"

"Let me explain why. For starters, officials across the world are not making it up when they say that the global economy is the weakest it’s been since the 1930s: global GDP is set to shrink in 2009 for the first time since the Great Depression.

"Given that bleak economic backdrop, Canberra’s fiscal policy clearly is aimed in the right DIRECTION.

While one can debate the size of the stimulus and the efficiency of particular measures (if you have the time), the critical fact is that recent fiscal initiatives – mostly involving debt-funded increases in spending - have been strongly COUNTER-CYCLICAL in nature, tending - helpfully - to stabilise the economy. That contrasts with the run of pro-cyclical tax cuts delivered during the economic boom earlier this decade, which it turns out left the Budget in “structural” deficit...

Media commentary has made much of the record size of this year’s $58b deficit, the slow projected progress back to surplus over the coming decade, and the sizeable build-up of government debt in the meantime. Some observers appear to be very concerned about these things, while others are not.

To the extent that investors still care, rating agencies Standard & Poor’s and Moody’s appear relaxed about Australia’s projected deficits and rising government debt: contrary to some chatter, Canberra’s triple-A credit rating apparently is under NO real threat.

"We believe the deficits and associated borrowings do not alter the sound profile of the country's public finances," S&P credit analyst Kyran Curry said in a statement. “This is underpinned by the strength of the government's balance sheet, which provides flexibility to absorb debt levels and cyclical deficits of this nature."… Moody's also said it would maintain Australia's triple-A credit rating. "In a relative sense Australia still looks good to other triple-A rated governments and therefore we are comfortable maintaining the rating where it is," Moody's lead analyst for Australia, Steven Hess, told AAP from New York. "In a relative sense, Australia still looks relatively strong from a fiscal point of view compared to other countries so we're not concerned about the rating."

Global economic cycle is the big driver of recent Budget developments

"When thinking about things like interest rates, Budget deficits and public debt, it’s important to keep in mind that much of what happens – good and bad - simply reflects the power of the economic cycle.

That is, when an economy grows strongly year after year, interest rates go up, Budget revenues rise faster than expected, Budget surpluses emerge and grow, and public debt disappears, largely painlessly, sometimes even with tax cuts year after year.

By contrast, when an economy turns down sharply, interest rates fall, revenues surprise sharply on the downside, Budget deficits emerge and grow, and government debt balloons. If an economy goes from boom to recession quickly, as ours just did, the turnaround in these variables can be dramatic:

"The point I’m making, obviously, is that recent extraordinary developments in the main Budget aggregates – the sharp turnaround from prolonged surpluses to prolonged deficits and ballooning public debt – largely reflect recent extraordinary developments in the economy – the sharp turnaround from expansion to recession. Even recent explicit policy decisions to spend more can be labeled “cyclical” in the sense that they were a response to emerging economic weakness.

As is well-known, what has happened in Australia recently is far from unique. Most economies around the world just went deeper into recession. Most Budgets around the world just went deeper into deficit. Thus most governments around the world just went deeper into debt.

Moreover, with today’s “Great Recession” already the sharpest global downturn since the 1930s, the IMF is cheering the efforts of central bankers everywhere to ease monetary policy and of governments to ease fiscal policy, particularly by increasing spending on infrastructure. The bottom line is that Canberra is doing broadly what most macroeconomists around the world think is sensible.

The IMF’s and G-20’s grand plan, of course, is to avoid a re-run of the Great Depression. And, happily, there is growing optimism in global markets that emerging signs of economic stabilisation are – fingers crossed - in the process of limiting the economic damage to a fraction of what was suffered in the 1930s.

Would Budget story really be much different if Coalition still in power?

"With the economic backdrop having deteriorated so sharply since the mid-September collapse of Lehmans, Australia’s sharp swing from Budget surpluses to deficits clearly has little to do with who happens to be holding the reins in Canberra at present.

Given that the Coalition was keen on tax cuts and increased spending during the boom earlier this decade, it’s hard to think it suddenly could resist more of the same in the current recession. After all, recall Canberra’s quick expansionary fiscal-policy response to sudden economic weakness back in 2000-01.

While most of the bad news on the economy and the Budget has indeed emerged in the 18 months since the baton in Canberra passed from the Coalition and Treasurer Costello to Labor and Treasurer Swan, this merely reinforces the old story that - in politics as in life generally - “timing is everything”.

Note to the ambitious: if you choose to be the Treasurer, the RBA Governor or the CEO of a bank, it’s better to choose to start the job in the 1990s - when the “Great Moderation” (featuring solid and steady growth, falling unemployment and rising asset prices) still has a decade to run - than to choose to start in the late 2000s – when the “Great Recession” is just around the corner.

That is, if your timing is poor, the job can be much, much harder. Woody Allen would have been cleverer if he had said “70% of success in life is showing up at the right time”.

'Tough Budget' would have been inappropriate

"One common criticism of last night’s Budget is that it’s “not tough enough”. After all, it involves a further modest net stimulus to the economy (featuring a $33-per-week increase in the aged pension for singles).

This criticism misses the point that the aim of the game at present is to get the economy growing again, to minimise unemployment (the ultimate aim of macroeconomic policy).

"Moreover, there are some important initiatives in this year’s Budget that work to reduce Canberra’s structural Budget deficit (that previously had been masked by extraordinary boom-time revenues).

These measures include reducing the benefits accessed by the relatively well-off in the areas of health, family payments and superannuation. Also, the Treasurer announced a future increase in the pensionable age (from 65 to 67), a move that for decades has been an obvious and sensible policy step, given the quarter-century increase in longevity over the century since it was introduced.

There will be plenty of time for tougher Budgets – involving a steady withdrawal of fiscal stimulus – when the economy starts growing solidly again. In the meantime, those who are worried that public debt is ballooning can console themselves with the fact that – on current projections – Canberra’s net debt will remain modest when compared with that of countries in the G7 and Europe.

Yes, babies in coming years will be born “owing” their share of Australia’s (still-modest) public debt; at the same time, however, they immediately will begin to enjoy the benefits of the extensive public infrastructure - hospitals, roads, bridges, schools, etc - that Australian governments have put in place over the past two centuries.

Official family’s latest forecasts are as plausible as anyone else’s

"Another high-profile criticism is that Canberra’s deficit-reduction plan over coming years is based on 'optimistic' growth forecasts. But is there a deficit-reduction plan in the world at present that doesn’t rely on stronger growth down the track (and assumed spending restraint from thereon)?

Yes, Canberra’s forecasts may turn out to be optimistic. But how would anyone know with confidence at this point? I’ve made the point regularly over the years that forecasts, by their very nature, are inherently unreliable.

As reported in the media over recent days, Canberra now expects the unemployment rate to peak near 8-1/2% After a series of upward revisions, many naturally will be skeptical that unemployment will stabilise below double digits. We’ll see.

In any case, the forecast 4-1/2pp rise in this cycle would be smaller than the 5pp increases Australia suffered in both the early 1980s and the early 1990s. While an RBA unemployment rate (point) forecast remains conspicuously absent, it too now is guessing that our late-2000s recession will be less-severe than its two predecessors.

That is, the RBA last Friday forecast a peak four-quarter decline in GDP of 1-1/4% this time around, smaller than the peak four-quarter decline of 1.6% in the early 1990s and 3.4% in the early 1980s.

Like some others, I worry that Australia’s recession will be deeper and the recovery weaker than Canberra assumes, but I wouldn’t pretend to have a much bigger clue about the economy two or three years down the track than anyone else.

At this point, the latest economic scenarios published by Canberra and the RBA – both featuring recession followed by an eventual return to above-trend growth – probably are as reasonable as any alternative set of forecasts."