Friday, November 13, 2009

Three wise economic monkeys

Michael Pascoe writes in BusinessDay:

"Who can forget the three wise monkeys that popped up with Kerry O’Brien after the May budget was delivered to criticise Treasury’s forecasts as being wildly optimistic, implying Ken Henry had been politically nobbled?"

Mmmm. Who were these "wise monkeys"? What exactly did they say?

The answer's here, on the 7.30 Report's website for May 12 under "Expert Budget analysis"

The experts were Chris Richardson, Michael Brissenden and Alan Kohler.

RICHARDSON: "Some of those growth assumptions are optimistic"

KOHLER: "A colossal turnaround that they’re forecasting which I don't think is credible at all"

BRISSENDEN: "The optimistic growth figures are are going to underpin the Government's argument about returning to surplus"

So. Did the Treasury forecasts turn out to be optimistic? Er.... No.

Was the "colossal turnaround" not "credible at all"? It should have been credible, it's happening.

In fact the Treasury's forecast of positive economic growth of 2.25 per cent this financial year now looks so credible it's been revised up.

The Treasury has deep expertise and brings a lot of resources to bear on forecasting the economy.

Wise monkeys do not.

Ken Henry gave a great speech on the forecasts and the monkeys immediately after the Budget.

An extract:

"When the country's best communicator of economic material — I am, of course, referring to our friend Ross Gittins — confesses that this is 'the most puzzling, back-to-front budget I can remember', it is clear that we have a communications problem. In his column the day after the Budget, Ross explained the communications challenge very well. 'It's as though we're planning the clean-up after the cyclone, even before the cyclone's hit', he said. And he went on to say, 'we seem to have been viewing the recession through binoculars. We were cutting interest rates and applying budget stimulus long before it arrived on our shores. And now the recession is yesterday's problem and we're planning what we'll do in the recovery.'

So, on top of the challenge of designing a budget for the most difficult macroeconomic circumstances in many decades, there is also the communications challenge. Some budgets speak for themselves. This one, apparently, does not.

The particular challenge identified by Ross is not an unexpected one. The challenge can be found in the Charter of Budget Honesty Act, legislated twelve years ago. All of you would know that the Act requires the Government to outline its fiscal strategy, specifying fiscal objectives and targets and expected outcomes for key fiscal measures. We have become accustomed to Australian budget documents containing that medium-term fiscal strategy material. But we don't have any experience of another requirement of the Act, and I'm not sure that many of you would even be aware of it: this is the requirement that the Government's fiscal strategy statement 'specify fiscal policy actions taken or to be taken by the Government that are temporary in nature, adopted for the purpose of moderating cyclical fluctuations in economic activity, and indicate the process for their reversal.'

Of course, this statutory requirement doesn't necessarily give us Ross' problem. If the temporary fiscal action were taken after the recession had hit, instead of being pre-emptive, there would be no communications problem. If the Government had waited for the recession to hit our shores before tackling it — and there are some who consider that this is precisely what they should have done — then you wouldn't have had anything like last week's document to confuse you. Things would have been much simpler.

That wouldn't have made Ross happier, of course.

In reading Ross' column I couldn't help but think about the relative simplicity of the communications challenge in that other area of macroeconomic policy – monetary policy. In that area, too, the practitioners who know their stuff seek to behave pre-emptively. But, having adjusted the cash rate in either direction, there is no expectation — and certainly no statutory requirement — that the monetary authority will also announce precisely how, and over what time period, it intends reversing that adjustment. Markets will make judgements, of course; and sometimes the monetary authority will see an advantage in saying something about the likely future course of interest rates, but it is under no obligation to do so.

Rather, we have become content to judge the monetary authority on outcomes, awarding credibility on the basis of actual economic performance over the medium-term. The Charter isn't so sanguine about fiscal policy. There might be good reason for that — although I would have to say that the historical record on fiscal policy is so distorted in the public mind that one should wonder. I'll have more to say about this in a moment.

In any event, it certainly wasn't because of the requirements of the Charter of Budget Honesty Act that the present Government, confronting the task of explaining a large budget deficit, came to the view that it needed also to explain how that deficit would be wound-in over time. With the budget going into deficit, the Government considered that it had to explain to the public how the medium-term fiscal strategy, of surplus on average over the cycle, was now going to be achieved. Indeed, not only did it see a need to tell a medium-term fiscal consolidation story in the same chapter in which it was talking about the need for fiscal stimulus, it also saw a need to relate both things to the 40 year fiscal sustainability issues raised in the 2002 and 2007 intergenerational reports. It even decided that the next IGR should be brought forward — to be released before the 2010-11 Budget.

This is story-telling of extraordinary complexity. And while it hasn't tested Ross, it clearly has exceeded the reading age of many.

Consider, for example, the reporting of the budget in the Wall Street Journal Asia last week. According to that reporting, in all of the decisions taken by the Government in response to the global recession, the only ones that will have any stimulatory impact on the economy are the 'tiny' personal income tax cuts announced in the 2008-09 Budget. The journal also informs its unfortunate readers that revenue downgrades alone would not have driven the Australian budget into deficit. And to cap it off, readers were told, in what is surely one of the most ironic sentences ever uttered in macroeconomic analysis, that '(t)his Keynesian revival comes at a particularly bad time, given that tax revenues are falling as the economy slows, a normal feature of economic downturns'. Apparently, the right time for a 'Keynesian revival', involving the spending of large amounts of public money, is when tax revenue is strong and rising, a normal feature of economic boom times.

As you know, I don't always agree with Australian commentators. But our newspaper readers can be thankful that they don't often have to confront material that is quite that bad."

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