What Price Fiscal Conservatism?


Remember the J-Curve? How important the terms of trade were to Australia’s future and the anticipation that would await the release of current account deficit numbers? These apparently arcane economic terms were part of Paul Keating’s conversation with the voters. According to the orthodox story of Australian political economy as told by Paul Kelly in The End of Certainty, Keating raised the economic sophistication of the electorate and sold us all on necessary measures which would take the nation out of its pre-globalisation slumber.

Of course, Keating the fiscal wizard – whose sleights of hand were much admired both by the then Treasurer himself and his fans in the press gallery – led us, with the help of the Reserve Bank, into the "recession we had to have" in the early 1990s. John Howard rode that horse all the way to Kirribilli in 1996.

Strangely, the economic debate seemed to disappear from consciousness almost entirely during the Howard years. We were relaxed and comfortable with the land of milk and honey we lived in. Or so it was thought, until Labor found some credible messengers to point to the "squeeze" on "working families", and we were told that Peter Costello had been asleep at the wheel when he should have been putting in place policies to ensure "prosperity beyond the mining boom".

We’re still in the midst of a mining boom, of course, but with 12 interest rate rises in a row, and the declaration of war on inflation, the prospects don’t look so flash. Naturally, Labor has been accentuating the negative in order to dramatise the need for a tough budget and to point the finger of blame at their profligate predecessors. But it’s looking more and more like this is a dilemma of the ALP’s own making.

What we’re basically seeing in the revived economic policy debate is the collision of election year politics with the hard realities of government.

Labor very deftly took tax cuts out of play in the first week of last year’s election campaign, by essentially photocopying the Liberal policy, with a tiny tweak to redirect funding from the top end of town to education. This was clever politics, but it’s hard to find anyone who doesn’t regard it as the epitome of dumb policy. Ross Gittins has been the most eloquent voice making that case.

But tax cuts are only part of the puzzle. The big picture was Labor’s branding of Kevin07 as a "fiscal conservative". If the intent was to convince voters that Labor wouldn’t be a bunch of irresponsible spenders, it worked a treat.

Rudd and Swan also very successfully pinged Howard and Costello for spending like drunken sailors: the Howard government’s reputation for "economic management" lies in tatters
because of new evidence of massive and profligate increases in spending in the Treasury’s Economic Roundup Summer 2008. Big business has also joined the
chorus, despite their reticence before the election. All to the good, you might think, from a political perspective.

But there’s a big problem: the war on inflation itself.

Here the story goes way back to the Keating era. The mission of the Hawke and Keating governments was to integrate Australia into the international economy, and to handle the consequent "structural adjustment" with a minimum of political pain. They get a big tick from history in the first box, but not in the second. Almost everyone would agree now that the bludgeoning of the economy with the interest rate baton in the late 1980s was a big mistake.

Economic orthodoxy, it’s not always realised, is something of a moveable feast. Nowadays not many people remember what the J-Curve was, and although Professor John Quiggin is a lonely voice still arguing that our terms of trade pose troubling issues, the current account number is no longer being splashed on the front page.

In the Howard era, the definition of "fiscal conservatism", was entrenched – including the 2-3 per cent inflation band the Reserve Bank uses as its guide for targeting monetary policy. Rudd has willingly signed up to this definition – hence the two interest rate rises this year.

But there’s an increasing number of economists who fear that the Reserve Bank is inflicting unnecessary pain, and in particular, acting in such a way as to ratchet up unemployment. Canberra Times economics editor Peter Martin spoke to two such pundits in his column last week – the article should be compulsory reading for all politicians.

Fred Argy nailed the essential problem in On Line Opinion yesterday:

"If I had to single out one big issue which deserves the highest priority at the 2020 Summit, it is the capacity of the Australian economy to sustain low unemployment – say in the range of 3 to 4 per cent – without running into inflationary demand pressures. If the Rudd Government cannot solve this basic problem, its noble vision of a fair and productive society will be tarnished."

The funny thing about the current debate is that many of the same voices of economic orthodoxy – broadsheet pundits and economic editors – who were such vocal advocates of neo-liberal globalisation, appear blind to the fact that some of the inflationary pressures now plaguing our domestic economy have international causes. Here’s UBS economist Adam Carr writing in Crikey and providing an invaluable corrective to the spectre of wage push inflation:

"Domestic demand, and in particular consumer demand, is not the driving force behind the inflation problem at present. The facts are pretty clear. Take the December quarter CPI showing headline inflation rising by 0.9 per cent. Of this, 0.7 per cent per cent (or 77 per cent of the increase) was due to four components: fuel, housing, rents, ‘alcohol and tobacco’ and financial services. Over the last two years food alone has accounted for about 40 per cent of the increase in inflation.

"Price increases in these components aren’t being driven by strong domestic demand. They’re being driven by factors largely outside the control of monetary policy – global demand/supply issues, the drought, the liquidity crisis, tax and excise and a shortage of housing. With a number of these factors set to unwind over the year given the global economic slowdown and recent rainfall, there is a very serious risk that the RBA will lean too hard against the economy as it waits for evidence that domestic demand is slowing. This at a time that the US economy is in recession. The risks to Australia’s prosperity are consequently material."

It’s interesting, in one way, to see the debate on economic policy revived from its Howard era somnolence. In part that’s probably because – as the party of business – the Liberals get a free pass on economic management from most media commentators. In part it’s also because Wayne Swan was right – in a globalised economy the action is on the supply side – and we should be putting in place policy to increase our productive capacity and our labour productivity.

Investing in education and infrastructure will take a long time to have an effect. In the short term, the Government should junk the tax cuts. It should also listen carefully to economists who are arguing that a 4 per cent rate of inflation wouldn’t spell doom, and would be an appropriate price to pay for continued employment and economic growth.

But here Kevin Rudd’s inflexibility may be his own worst enemy.

It’s laudable to keep faith with the voting public and deliver election promises. But, as Gittins and others argue, it’s nuts to tie yourself in to huge tax cuts over successive years when economic conditions have changed. Among other indicators that the interest rate rises were slowing the economy
before last week’s increase, the Olivier Job Index of internet advertisements
released yesterday showed the first fall in three years. ABS unemployment data
for February will be released on Thursday.

If fiscal policy combines to send the economy into reverse and destroy jobs and businesses, then no matter whether the Howard government got us to this pass, Labor will have only itself to blame. The PM needs to ask himself the question: what price fiscal conservatism?

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