There are many misunderstandings and misinterpretations of the fiscal policy strategy of Treasurer Wayne Swan and the Government. That strategy is summed up in the notion that the Government will return the budget to surplus in 2012-13.
A lot of it is coming from people and commentators who should know better.
Much of the commentary questions the economic imperative of returning the Budget to surplus when the economy is muddling along at a below trend growth rate, when employment is weak and inflation so well contained. This focus is where the misunderstanding occurs. It is as if fiscal policy as is the only policy lever in town. It isn’t.
Monetary policy is usually not discussed by those bagging the Government’s economic objective in delivering a surplus next year.
It must be considered.
In the most basic of basic terms, the tighter fiscal policy is, the easier monetary policy can be. Simple. And vice versa as Peter Costello knows form his last few years as Treasurer when government spending grew at a rate that would make Frank Crean blush.
The Government at the moment is part way through delivering the most dramatic bottom-line turnaround in fiscal policy since at least the 1960s. It is cutting real government spending for the first time since the 1980s.
And think about this context. Recall the 2010 Budget. It was the one where the Government announced the return to the budget to surplus in 3 years (2012-13 as it was then) and 3 years early (the earlier path was to get back to surplus in 2015-16).
This bring forward in fiscal restraint was announced at a time when the RBA had set the cash rate at 4.5%. The futures market was pricing in a cash rate around 5.5%. With the Government doggedly holding on to the fiscal objective in the 2 years since, the RBA hiked interest rates once (in November 2010 to 4.75% as global conditions improved); and since then has cut rates twice to the point where they currently sit at 4.25%.
It is no accident that interest rates are lower now than when the government announced its decision to turn the screws on fiscal settings. It is also no accident that in the wake of the fiscal tightening going on right now and confirmed by Swan yesterday, that the interest rate futures market is pricing in 3 more rate cuts – to a level of 3.5% - by early 2013.
The trade off is there for all to see.
So beware looking at the fiscal policy approach of the Government in isolation. There’s much more to lfe and managing the economy than a few spending and taxing decisions.