Why is Kevin Rudd set on running a budget surplus of somewhere around $17 billion?
The conventional economic theory is that governments should run surpluses in good times so that they can spend them in bad times as a way of stabilising swings in the economy. But after 15 years of expansion and with negligible government debt, there is plenty of fat to nurse us through the next recession.
The other reason for governments running a surplus is to damp demand in the economy to head-off inflation. Australia’s CPI is at the top end of the Reserve Bank’s targeted range, but in today’s deregulated economy, with a weak union movement, it’s not clear that inflation is the problem that it was when price rises could be compensated for by increased wages which then fed back into price rises. Too high an increase in prices tends to lead to import substitution which dampens price pressures because a more flexible economy passes the effects on quickly.
In any event, even if inflation is an issue, it would appear that it is not our biggest problem. Today’s news that shares on European exchanges fell by up to 7.2% (Germany) yesterday, suggests that the greatest risk facing the economy is a US recession.
Australia has a history of mishandling financial crises. The Great Depression was worse here than anywhere else in the world because of the credit crunch imposed by the Bank of England. Similarly, the 1987 sharemarket crash was worse in Australia than elsewhere, largely because of a subsequent credit crunch. Austerity is not the right dish to serve up when the economy turns down.
US central bankers and governments have learnt that the best thing to do when you have a financial crisis is to increase credit, not ration it. When everyone is worrying about the next fall in their personal wealth, inflation is not a big problem, and you can wait until sentiment picks up to deal with any inflationary potential you may have caused by increasing money supply. Under Greenspan and his successors these practices have delivered enviable economic stability.
The Goss government came undone because it uncritically followed “expert” advice and was so desperate to establish its conservative credentials that it tried to out-conservative the conservatives. Rudd appears to be following a similar line with his government. The only reason that makes any sense for running a $17 billion budget surplus is desperation to impress financial market participants and financial journalists. While they might be impressed, they only get one vote each. If Rudd wants to be a long-serving prime minister he has to impress voters. A 59% approval rating today can drop tomorrow faster than a European bourse if your results don’t meet your promises.
It’s time to lay down the law to the Reserve Bank and take evasive action. Proving that he is a “financial conservative” is only a problem in Rudd’s mind – the debate has moved on.