Budget Wrap
The Labor government’s first budget had more in common with those of its predecessor than it would care to admit. The chief fiscal problem confronting policymakers is not fighting inflation, but finding a home for the revenue growth that continues to exceed Treasury forecasts and for which the government has no current use after delivering on its election tax cuts and other commitments. At 1.8% of GDP, the underlying budget surplus is larger than at any time since 1999-00, but still a trivial tightening on the 1.5% of GDP seen in 2007-08. The Commonwealth has now been running surpluses of 1% of GDP or more since 2002-03 and at least 1.5% of GDP since 2004-05. As Alan Wood notes ‘The cynicism born of many budget lock-ups says that this is a remarkably convenient pattern of surpluses.’
Peter Costello’s solution to the problem was a combination of tax cuts and hoarding revenue in the Future Fund, which is much the same approach taken by Labor with its Building Australia Fund and revamped higher education fund. Whether revenue is better used buying financial assets or invested in as yet unspecified infrastructure is far from clear. If infrastructure needs were so pressing, the government would not need a body like Infrastructure Australia to go in search of suitable projects and would instead have no problem drawing up a list and timetable of projects in the Budget itself. Investment spending has been at post-war record highs as a share of GDP, so there is no shortage of investment on the part of the private sector. The danger is that the BAF becomes a public sector white elephant fund.
At the same time, Labor has still not fully funded the ‘aspirational’ part of its election tax cuts, which aim to reduce the existing four tax scales to three by 2013: 15%, 30% and 40%. These aspirational tax cut commitments would have more credibility if they had been fully funded in the budget and could conceivably even have immediate supply-side benefits if the public were convinced they would be delivered. The failure to fully fund them suggests that the ‘aspirational’ part of the tax cuts will remain just that. Social democrats like John Quiggin are openly looking forward to the inflation tax that will claw back the tax cuts.
Ross Gittins and Chris Richardson still seem to think that the main role of the Budget is to save RBA Governor Stevens from having to do any work. According to Gittins:
Even if further interest-rate increases don’t prove necessary, the budget does nothing to bring forward the day when the Reserve Bank is able to start cutting rates.
Just as predictably, Chris Richardson said that:
Tax cuts are clearly inflationary and clearly dangerous in an economy that is still at full stretch. Much of them will be spent.
The budget has no relevance for inflation and interest rate outcomes, but even if it did, why would we prefer restraint in demand to come from higher taxes than higher interest rates? On political economy grounds, we should prefer higher interest rates. The interest rate cycle will eventually turn, whereas the expansion of government probably won’t. The real agenda of those who oppose tax cuts is to support the secular expansion of the state.
posted on 14 May 2008 by skirchner in Economics, Financial Markets
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Government versus Private Saving
David Uren highlights the private sector offset to increased public sector saving:
there is a good body of academic research showing that savings decisions by government and individuals are inversely related—that increases in government surpluses are financed, at least in part, by consumers running down their savings.
The superannuation industry, which has doubled its contribution to tax revenue to $10 billion in the past five years, has always argued that the Government’s surpluses are based upon sequestering the savings of households.
Research conducted by the OECD shows that for Australia, every additional dollar saved by the public sector results in a fall in private savings of about 50c. This is in line with the international average.
The OECD study looked at the savings performance of government and individuals in 21 countries, including Australia, over a 30-year period.
It suggested that the trade-off between individual and public sector saving would be greatest at times when public sector debt was low and private sector debt was high, as is the case now in Australia.
I review similar evidence here. This is just one of the reasons why budget surpluses don’t put downward pressure on interest rates, because dissaving by the private sector offsets the government contribution to national saving. In any event, the domestic saving-investment balance does not determine domestic interest rates given an open capital account.
posted on 12 May 2008 by skirchner in Economics, Financial Markets
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Raining on ‘Rainy Day’ Richardson
Terry McCrann poses some questions to Chris ‘Rainy Day’ Richardson:
What would have been - dangerously - fiscally irresponsible is to have not had the cuts each year. If Costello had listened to the twitterings of Access Economics, which opposed every single one of the yearly cuts, the budget would be groaning under surpluses of $70 billion a year or more.
Ceteris paribus - all other things being equal - as the economists like to say. When, of course, they wouldn’t have been, either in terms of the impact on the economy or the political process.
It was hard enough keeping the hands of his cabinet colleagues, from the prime minister down, off even the tax cut-reduced surpluses.
Even the team at Access would - should be forced to - concede the literal impossibility of letting those surpluses mount ever higher. But perhaps Access’s Chris Richardson could say when over the last five years and how such huge surpluses would have been spent.
And/or how they would be dispersed today and tomorrow. He objects to the current $31 billion of tax cuts over the next four years, at the supposed cost of higher interest rates.
I doubt, though, that he would be endorsing cuts of $100 billion over that time frame. Just to take the last three years of Costello’s tax cuts.
posted on 10 May 2008 by skirchner in Economics, Financial Markets
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Business Spectator Column
This week’s Business Spectator column. If you would like to receive an unedited version by email on Fridays, let me know and I will put you on the distribution list. Email info at institutional-economics dot com.
posted on 10 May 2008 by skirchner in Economics, Financial Markets
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Glenn Stevens’ 2010 Christmas Wishlist
The RBA’s quarterly Statement on Monetary Policy contained an inflation forecast consistent with the 2-3% medium-term target range, assuming you don’t mind waiting until Christmas 2010 to get it. This was achieved largely by way of a dramatically lower economic growth forecast. Non-farm GDP is now expected to slow to 1.75% by the end of this year, compared to the 2.75% forecast in the February Statement. This is an annual growth rate not seen since 2001 in the wake of the recession in domestic final demand that followed the introduction of the GST in the second half of 2000. In effect, the RBA has dramatically raised the bar on the weakness we will have to see in the activity data this year for the RBA not to further raise interest rates. The RBA’s forecasts highlight the growth sacrifice that will now need to be made to tame inflation. Even then, inflation will still be sitting at the upper-end of the target range.
posted on 09 May 2008 by skirchner in Economics, Financial Markets
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The Raisins of Mild Inconvenience
Gerard Baker on the Great Depression that wasn’t:
I don’t know about you but I feel a bit cheated. There we all were, led to believe by so many commentators that the sub-prime crisis was going to force the United States into a new era of dust bowls and breadlines, a slump that would call into question the very functioning of the capitalist system in the world’s largest economy. Carried away on the surging wave of their own economically dubious verbosity, the pundits even speculated that this unavoidable calamity might presage some 1930s-style global political cataclysm to match.
Well, it’s early days, to be fair, but so far the Great Depression 2008 is shaping up to be a Great Disappointment. Not so much The Grapes of Wrath as Raisins of Mild Inconvenience.
posted on 07 May 2008 by skirchner in Economics, Financial Markets
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US Housing Downturn All But Over
Traxis Partners MD Cyril Moulle-Berteaux argues the US housing downturn is all but over:
In the past five major housing market corrections (and there were some big ones, such as in the early 1980s when home sales also fell by 50%-60% and prices fell 12%-15% in real terms), every time home sales bottomed, the pace of house-price declines halved within one or two months.
The explanation is that by the time home sales stop declining, inventories of unsold homes have usually already started falling in absolute terms and begin to peak out in “months of supply” terms. That’s the case right now: New home inventories peaked at 598,000 homes in July 2006, and stand at 482,000 homes as of the end of March. This inventory is equivalent to 11 months of supply, a 25-year high – but it is similar to 1974, 1982 and 1991 levels, which saw a subsequent slowing in home-price declines within the next six months.
Inventories are declining because construction activity has been falling for such a long time that home completions are now just about undershooting new home sales. In a few months, completions of new homes for sale could be undershooting new home sales by 50,000-100,000 annually.
Inventories will drop even faster to 400,000 – or seven months of supply – by the end of 2008. This shift in inventories will have a significant impact on prices, although house prices won’t stop falling entirely until inventories reach five months of supply sometime in 2009. A five-month supply has historically signaled tightness in the housing market.
posted on 06 May 2008 by skirchner in Economics, Financial Markets
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Wages Breakout versus Imagination Land
Once-were-inflation-warrior turned inflation capitulationist ‘Henry Thornton’ concedes:
if wages begin to surge, all bets will be off and the bank will need to hit the economy with additional rate rises until people demanding wage increases get the message.
If you like record-breaking growth rates in the labour price index, then you are probably going to love next week’s March quarter release.
Meanwhile, over in Imagination Land:
BRENDAN NELSON will today challenge Labor’s first budget a week before its release by claiming there was no need for spending cuts because Australia’s inflation crisis was “imaginary” and “a complete charade”.
posted on 06 May 2008 by skirchner in Economics, Financial Markets, Politics
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Inflation and Monetary Policy
Regular readers will not be surprised to learn I’m in furious agreement with Don Harding:
The most egregious error occurs when people argue that the Reserve Bank has aggressively tightened monetary policy. It has done nothing of the sort. The relevant measure for assessing whether the RBA has tightened monetary policy is the real (inflation-adjusted) cash rate, which stood at 3.1 per cent in March 2005 and now stands at 3.0 per cent. The seven increases in the nominal cash rate over this period have just kept pace with inflation and do not represent a tightening of policy…
The danger is that if I am right and inflation accelerates because the RBA’s approach is too soft, then the RBA will need to move aggressively and hike rates several times.
We got the first bottom-up look at June quarter inflation today, with the release of Don Harding’s inflation gauge for April. It was a shocker at 0.5% m/m and 4.3% y/y, the strongest annual growth rate on record for this series. Core inflation (ex-volatile items) rose 0.5% m/m and 3.9% y/y compared to 3.3% y/y in March. The trimmed mean, which proxies for the RBA’s preferred measures of underlying inflation, rose 0.6% m/m and 4.3% y/y compared to 3.8% y/y in March.
posted on 05 May 2008 by skirchner in Economics, Financial Markets
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Business Spectator Column
This week’s Business Spectator column. If you would like to receive an unedited version by email on Fridays, let me know and I will put you on the distribution list. Email info at institutional-economics dot com.
posted on 03 May 2008 by skirchner in Economics, Financial Markets
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AussieMac? No Thanks
Alan Wood on the Gans-Joye proposal to harness government guarantees to under-write mortgage lending:
The creation of a government - that is, taxpayer - subsidised institution, largely for the benefit of non-bank mortgage lenders, would need to be justified either by the existence of a long-term structural problem in the provision of housing finance in Australia, or evidence of a short-term collapse in the availability of home loans.
Neither problem is evident, and in any case it would take too long to set up such a body for it to be of any use in the current credit crisis. Nor is it warranted as a hedge against future crises.
Interestingly, in his upbeat press release, Greg Medcalf was obliged to include the following sentence: “While the proposal has received encouraging feedback, Mr Medcalf said there was some concern the enhancements were addressing a short-term market issue that did not require a long-term fix”. Just so.
posted on 03 May 2008 by skirchner in Economics, Financial Markets
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US Recession Indicator Index
James Hamilton updates his recession indicator index following the advance Q1 GDP release:
Recent sluggish growth rates bring our recession indicator index for the fourth quarter of 2007 up to 26.9%. That’s its highest value since the 2001 recession, but still well short of the 65% reading that we require in order to make a declaration that the U.S. economy had entered a recession as of 2007:Q4.
The numbers are reminding us that if, for example, the tax rebates were to keep GDP growth positive in the second quarter, we would end up characterizing the most recent experience as a period of slow growth rather than a typical economic contraction.
Fed funds futures now imply a 78% chance the FOMC will leave the Fed funds rate unchanged at its June 25 meeting.
posted on 01 May 2008 by skirchner in Economics, Financial Markets
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The US Recession that Isn’t
US Q1 GDP is given a 69% chance of being positive, according to last trade prices on prediction market Intrade (contract expiry is based on the final GDP release, not today’s advance release). Intrade pricing suggests a better than even chance that US GDP growth will be positive for every quarter in 2008. The chance of a recession in 2008 is put at 44.9%, with recession defined as two consecutive quarters of negative GDP growth for the purposes of contract expiry. The absence of recession on this definition would not necessarily preclude a recession being declared based on the NBER Business Cycle Dating Committee’s methodology.
posted on 30 April 2008 by skirchner in Economics, Financial Markets
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Interest Rates & Housing Affordability: Mike Rann’s Blame Shifting
SA Premier Mike Rann writes to RBA Governor Stevens asking him not to raise interest rates in order to ‘maintain housing affordability.’ As RBA Deputy Governor Ric Battellino noted in his recent presentation to the Senate Select Committee on Housing Affordability, mortgage interest rates in Australia are no higher now than in the mid-1990s, when housing affordability was at record highs. Instead, Battellino suggests another culprit in record low housing affordability:
the rise in house prices has been much faster than that in construction costs, so the implication is that most of the increase in house prices has been due to increases in the price of land.
That would be the responsibility of state governments.
If APM are to be believed, higher interest rates are improving housing affordability as we speak.
posted on 30 April 2008 by skirchner in Economics, Financial Markets, Politics
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Once Were Inflation Warriors
Terry McCrann on former inflation hawks Hewson and Jonson:
OK, you drop the 2-3 target and replace it with . . . what exactly?
Hewson’s 3-4 per cent? Maybe 4-6 per cent? Perhaps a return to a 1970s: hey babe, whatever feels good? Or a vague, contradictory and confusing ‘check list’?
Whatever, the clear implication is that we should accept a “little more inflation”.
Apart from the fact that the RBA is already explicitly doing that - something most of the critics either don’t understand, or wilfully ignore.
posted on 29 April 2008 by skirchner in Economics, Financial Markets
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