Budget Analysis Part 1

Another election budget comes around and another cunning political move is made at the expense of much needed reform. More portfolio specific information is to come but here are my macroeconomic policy views on this disaster:

Macroeconomic policy

Coming from an economics background, and someone who strongly believes that the most effective mechanism Government has to manage the economy is fiscal policy, the budget has to be seen first from its strategic macroeconomic value. At this stage in the economic cycle (ie peak boom), Keynesians would argue that fiscal policy would need to be very tight. In other words, the budget would need to be deflationary with large surpluses. At first glance Costello has delivered a deflationary budget with a budget surplus of $10bn, about 1% of GDP.*

However, the beauty of fiscal policy is that it is very flexible in that it allows targeted spending and even targeted taxation (rather than the sledgehammer of interest rates). This means that particular aspects of the spending pattern of Governments can have differing impacts.

The government is raking in a huge amount of tax, more than was ever expected. For example, in the last 6 months the treasury had to upwardly adjust revenue by more than $60bn. Why? The minerals boom has meant that corporate tax has exploded the Governments coffers.

So the extra money is being raked in but where does the money go? This budget is throwing money away to anyone who breathes; a purely political tactic. So here's the economic mismanagement: the budget is putting more money in the pockets of those people who are more likely to spend it and not save it. Moreover, the tax changes are also putting more money into those pockets of people who are more likely to spend it and not save it. The extra cash to spend will lead to inflationary pressures, further putting pressure on an interest rate hike to contain inflation.

So when we take into account the inflationary pressures I just described together with the deflationary pressures of a budget surplus, I would argue that the budget is either balenced or moderately inflationary. Either way it is an inappropriate fiscal stance given the stage of the economic cycle we are in.


*I would bet that Keating, a true Keynesian, would say that we need higher surpluses for this stage of the economic cycle.