Tuesday, 18 May 2021

A practice run

We've got the Budget coming up on Thursday, so as a limbering up exercise let's have a look at how to figure out whether the Budget will be braking or boosting the economy. 

You'd think that would be one of the top things the media would cover, but in practice they don't, or not well. Far more attention goes on "the" deficit or "the" surplus, on the debt profile and fiscal sustainability over the longer haul, and on specific initiatives. They're all fine, and worth the attention, but they don't tell you whether the Budget will be helping the economy when it needs help, or tapping the brakes when it's threatening to get boisterous - the 'stabilisation' role for fiscal policy, as they say.

So as a practice run at figuring out what cyclical impact Budgets have, here's a graph of what happened in the Aussie Budget that their Treasurer Josh Frydenberg presented last week (taken from their big Budget document, Budget Paper No. 1: Budget Strategy and Outlook).

Start with the solid black line. That's the historic and forecast path of "the" deficit or "the" surplus, the headline figure commentators tend to obsess on. Indeed in both Australia and New Zealand it's become almost a macho indicator of "I can run the Treasury better than that other lot", and any Treasurer that can't point to an actual or forecast surplus must be doing it wrong. Infantile, but that's the politics of it for you.

Now have a look at the 2018-19 year, which I've helpfully identified with that green arrow.

You'll see that the headline outcome was effectively a balanced Budget, with no material surplus or deficit. But what actually happened was that the headline outcome was flattered by a stronger than usual Aussie economy. You can make a decent stab at calculating how much extra tax revenue (or how much reduced government spending on benefits) was down to the good times, and that's shown in the blue bar. It was about 1% of GDP. Without that temporary windfall, the reported headline balance turned into an underlying cyclically-adjusted deficit of about 1% of GDP (the red bar).

No great dramas either way, other than (a) illustrating the point that a Treasurer's "success" in putting a balanced or surplus Budget in the window may have nothing to do with their responsible fiscal management and rather more to do with the state of the economy and (b) reminding us all to watch what's happening to the cyclically adjusted balance as a better guide to what's really going on with the stance of fiscal policy.

Onwards to 2020-21 (the orange arrow). There's a headline deficit of a bit less than 8% of GDP, flattered a bit by cyclical conditions (including the Aussie Treasury clipping the ticket on record high iron ore prices), so the underlying deficit is actually a bit bigger, at a little over 8% of GDP.

The Aussies have quite helpfully split out the underlying deficit into two bits - how much is down to temporary anti-Covid measures (the teal-coloured bar), and how much is genuinely 'structural' (the red bar) and will still be there when things like their JobKeeper wage subsidy scheme have dropped away.

Them's the concepts. What do they tell us about the cyclical role of Aussie fiscal policy?

First of all, that in the current 2020-21 there will have been a stonking great 7% or so of GDP as anti-Covid fiscal support, on top of some 2% of GDP in the 2019-20 year. This is fiscal policy doing its stabilisation stuff, and then some. I have no problem with that: it's possible that Finance Ministers pretty much everywhere ended up overdoing it a bit, but that's okay. Providing too much counter-cyclical support is a hell of a sight better mistake to make than providing too little. 

It also shows, by the way, that fiscal policy when it puts its mind to it, can be deployed very forcefully and very quickly. That wasn't the accepted wisdom pre-Covid, but is now. 

Next thing you'll notice is that Freydenberg was in no hurry to take the Covid support away: it tails off gradually. That's probably right, too: some sectors dependent on an open border will still be hurting for quite a while yet (the Aussies' assumption in this Budget was their border not opening till mid '22). Frydenberg explicitly chose to put a higher priority on near-term cyclical support over the pace of eventual deficit reduction, and one of the key things I'll be looking for in our Budget was what choice Grant Robertson has made.

You can measure how quickly support is being taken away: it's a thing called the 'fiscal impulse', and it is the change from one year to the next in the size of the structural balance. Think of it this way: suppose this year you get $100K in wage subsidies, but next year you only get $50K because the package gets tightened up. You're still being supported, but less so. The fiscal impulse picks up that degree of tightening. For some reason the Aussies don't bother calculating it (search their Budget Paper No.1 for 'impulse' and you get nada), but we do. It's the very first figure I'll be looking for on Thursday.

Even after all the Covid support is gone, Frydenberg has also decided to take his own good time to deal to the non-Covid structural deficit, which will still be running at 1.5% - 2.5% of GDP in the later years of this decade. That's more debatable, but to the extent that an ongoing deficit reflects using once-in-a-lifetime low borrowing costs to provide infrastructure, I can live with that too. Again it'll be interesting to see what choice we make.

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