Monday, December 21, 2020

Book chapter: Australia had sound economic leadership through the crisis, the challenge now is managing the recovery

Of all the baseless claims made as coronavirus struck, the most dangerous was that there was a trade-off between lives and the economy.

The Conversation’s cartoonist Wes Mountain illustrated it perfectly.  

The idea, raised early and not so much later on, was if we did too much to save lives from coronavirus, we would damage others in ways that were harder to see.

It was wrong in part because lives are what the economy is. 

Australia’s treasury, using a framework developed by Nobel Prize winner Amartya Sen, describes the aim of economic policy as maximising a person’s “freedom to lead a life they have reason to value”.

Deaths destroy that freedom. Deaths matter for economics.

The idea was also wrong because it failed to take account of the pernicious way the virus spreads. Assessing a lockdown is not simply a matter of weighing up lives saved versus lives disrupted. It is a matter of adding to those lives saved all of the future disruptions that will be avoided and the future lives that will be saved if the lockdown stops the virus spreading.

The government rightly imposed huge and otherwise unconscionable costs on the economy in order to get on top of the virus.

Each time it backed them with support for the people and businesses those measures would hurt.

Mid-March 2020, as the government banned public gatherings of more than 500 people (killing the Grand Prix and the footy) it doubled JobSeeker and related payments and gave Australians in need early access to their super.

In late March, as it tightened the limit on gatherings to just two people (forcing much of the population to stay at home), it unveiled JobKeeper, guaranteeing to pay the wages of millions whose jobs were at risk until at least September.

It would be wrong to say all the costs were government-imposed. Well before the big lockdown in late-March 2020 large numbers of Australians were staying away from restaurants, cinemas and the like of their own accord. The recession began during the months those venues were free to trade.

In the face of an unavoidable reality the government decided it was responsible to spend as much as was needed to survive with the least possible damage.

Gone was the carping about the “debt and deficit” Labor ran up to get us out of the global financial crisis.

When he was parliamentary secretary to Prime Minister Tony Abbott in 2014, Josh Frydenberg berated Labor for “intergenerational theft”. It had saddled “every man, woman and child” with thousands of dollars in government debt.

As treasurer, in a crisis on his own watch, Frydenberg doubled government debt with scarcely a mention of children.

His finance minister Mathias Cormann said the strategy was to deal with debt by running up more debt.

As he put it, “the way to get on top of this debt is by growing the economy more strongly and by creating more opportunity for Australians to get ahead, get into jobs, get into better paying jobs. Stronger growth leads to more revenue and lower welfare payments. That’s the way we can go back to where we were.”

We’ve known this works for more than half a century. Government debt was more than 100% of gross domestic product at the end of the second world war. It came down each year as a proportion of GDP, not because the Commonwealth ran budget surpluses it could use to pay it down (with one exception it ran deficits all the way through to the 1980s), but because GDP grew, fuelled in part by annual budget deficits that necessitated more borrowing.

The best way to grow GDP is to avoid or escape a recession. If it achieves that, borrowing can pay for itself.

Borrowing to pay interest on debt can be bad advice for a household, but for the Australian government it is different, especially in an crisis.

Reserve Bank Deputy Governor Guy Debelle resorted to an equation to explain the mechanism at a seminar organised by the Economic Society in June.

He said so long as the interest rate charged (r) was less than the future economic growth rate (g), the burden of interest payments would shrink as a proportion of GDP over time.

Australia’s average rate of real economic growth has been more than 2% per year. More importantly, over the past decade actual annual growth (not adjusted for inflation, which is what matters for debt repayments) has averaged 4.5%.

Right now the government can borrow for ten years at 0.9% per year. In late July it issued a rare 31-year bond that won’t have to be repaid until the middle of the century. It locked in 1.94%, for $15 billion. It had $36.8 billion of bids.

It has arranged interest payments that are likely to be much less than the annual growth in its ability to pay them.

Foreign and Australian investors including super funds are bidding against each other for the right to lend for next to nothing in return for a guaranteed government income.

And the government would have no problem financing its coronavirus programs even if they were not.

Erased from the consciousness of mainstream economists from the 1990s onwards has been the knowledge that governments such as Australia’s can fund as much of their spending as they want by issuing currency – “printing money”.

Britain, Japan, the United States and Europe resumed doing it during and after the global financial crisis. Australia held out for longer, clinging to the myth that the only ways governments could fund programs were taxing and borrowing.

It’s been a useful myth for those wanting to restrain government spending. Martin Wolf of the Financial Times talked about the value of propagating the myth this year when he wrote that while the myth was wrong, once politicians believed it was wrong it would “prove impossible to manage the economy sensibly”.

A branch of economics with strong roots in Australia’s Newcastle and Adelaide universities never doubted that it was wrong. It’s called “modern monetary theory”, which is odd because it is neither modern, nor a theory. It’s reality. Governments can fund spending by creating money – the only real downside being the risk of inflation, which isn’t a risk during a recession.

Since March the Reserve Bank has been doing it by buying government bonds. A bond is a piece of paper on which is written a promise to repay and to pay interest.

The bank has been paying for those bonds by creating Australian dollars, literally, through a process known as balance sheet expansion. On one side of its balance sheet it records the bond it has bought as an asset, on the other it records a matching liability, which is the deposit it has placed into the account of the institution it has bought it from.

To put some (largely cosmetic) distance between creating money and funding government spending, the bank has promised to buy only as many bonds as are needed to keep bond rates low, and to buy them from intermediaries rather than from the government itself. But the effect is the same as if it had handed the newly-created dollars directly to the government, except that it hasn’t needed to do it much.

So keen have been private investors to buy government bonds that, apart from creating and spending $50 billion early on to show that it could, the bank has been able to sit back and watch other investors fund the government, and outbid each other in order to do it.

Despite the government’s (probably premature) announcement of plans to wind back JobKeeper and JobSeeker at the end of the year, there’s no sign of big spending stopping.

After the coronavirus crisis has passed the government will need to spend still more to fund the recovery.

Borrowing at way less than the predicted rate of economic growth means it can fund projects whose prospects were once considered poor, such as high speed rail and widespread tax cuts. But it remains important to pick projects wisely.

The best ones will set Australia up to thrive in the decades to come, decades marked by climate change and (quite possibly) repeated pandemics.

Rarely has a government had such an opportunity to shape Australia.

It has handled the crisis well. The next test will be sculpting the recovery

Chapter in 2020: The Year That Changed UsThe Conversation, Edited by Molly Glassey