A Budget surplus in 2012-13: Good economics - Great Politics

A lot of economic pointy-heads suggest that a budget deficit of a billion or two in 2012-13 is for all intents and purposes the same result as a budget surplus of a billion or two. It's a rounding error, they say. As a result, the story goes, the Government shouldn’t get too carried away with its commitment to deliver a budget surplus in 2012-13, especially if the rate of economic growth is a touch slower than expected and is the sole reason for the budget shortfall.

This assessment is largely true given the context of government spending and revenue approaching $400 billion each each year and annual GDP in Australia will soon be over $1.5 trillion. A couple of billion is neither here nor there.

Even if this is true, it is politically naïve. The optics of not delivering a surplus in 2012-13 would be messy. Letting the surplus slip into a small deficit or waiting an extra year before returning to surplus frankly smacks of slackness. If it OK to let the Budget slip a few billion this year, why not the year after? And the year after? Or after that as well? Of a few billion more? A few billion on top of that?

Get the picture?

Fiscal rectitude and austerity are critical right now, even as the economy slows. It is also true with Australia a global economic star-performer. It is reinforced because our central bank (the RBA) can help out with a few or a lot of interest rate cuts if the economy slows a little too much. Most of the industrialised world does not have that luxury because their interest rates are effectively at zero and central banks are implementing a range of unconventional and whacky policy initiatives that Australia will never have to contemplate, especially with appropriately tight budget settings. Lower interest rates might also help to see the Australian dollar ease back a bit, aiding our exporters and import competing industries.

The politics of delivering a budget surplus in 2012-13 are also compelling. The government can further highlight its economic bona fides in the election campaign in October 2013. Prime Minister Gillard would undoubtedly parade the government’s skill, fortitude and foresight to not only stimulate the economy when an economic shit-storm hits, but stick to its plans and deliver a surplus when times improve.

This would also bring into focus the economic policies of the Opposition, who for the moment seem unable to work out the difference between the plus and minus signs in their fiscal spreadsheet. How would they deliver a surplus with no MRRT, no carbon price, yet deliver all of its promised spending?

Unlike many economic commentators who don’t understand the link between fiscal and monetary policy, the RBA understands that tighter (easier) fiscal policy means easier (tighter) monetary policy. That’s good news. When the RBA Board sits down to its monetary policy deliberations each month, it will know via Treasury Secretary and RBA Board member Martin Parkinson that government demand is on a tight reign. Accordingly, it can err on the easy side with interest rate settings and monetary policy will be set according to inflation and labour market conditions and will not be sideswiped by fiscal changes as it was in the period between 2005 and 2007.

The government is no doubt going through the equivalent of a mini-budget right now, looking for savings and ways to lock in a surplus in 2012-13. And so it should. As it does this, it will not only be rewarded with another massive win as an economic manager, it will also likely be rewarded with the RBA setting interest rates at a level lower than they are today.