"One of the key propositions made by those who argue that the Australian cash rate should be lower, is that the government is undertaking a sizeable fiscal contraction. This fiscal contraction will in turn contribute to soft domestic demand conditions over the next few years...
Nevertheless if you look more closely at recent budgets you can see this isn’t the case. Indeed the forecast improvement in the fiscal balance (fiscal contraction) occurs, not because of a cut in government expenditure, but because of a forecast sharp improvement in revenues. Specifically, the improvement in the fiscal balance largely comes from an expected $72bn lift, or rather surge, in revenues over fiscal 2012 and 13. It is this jump in revenue that accounts for the decline in the fiscal balance from 3.3% of GDP to a small surplus of 0.3%. It’s fairly misleading to then suggest this is a fiscal contraction. Check the below charts.
Thinking of it another way, during the GFC, expenditure rose by around 16% in fiscal 2009 as was appropriate – great economic management there from Ken Henry and Rudd – it was the right thing to do. The thing is, spending is still forecast to grow on average by 4.2% per year from fiscal 2012 on. There is no retrenchment here. Government will not detract from total economic growth. It’s just that that they are not going to fully spend sharply rising revenue. This does NOT represent contractionary fiscal policy under any reasonable assessment. Indeed, given the sharp rise in revenue, if the government was to maintain a constant fiscal balance as a % of GDP, this would in fact be highly stimulatory, in terms of actual expenditure, jobs and consumption etc.
Does it matter for overall GDP growth that government spending is growing at a slower pace? No, of course not. Take a step back for a minute and think about the fiscal strategy that was put in place during the GFC. These were measures put in place to buttress the economy at a time that global trade was shrinking, industrial production plummeting and much of the world in recession. To fill the void of rapidly retreating private demand in other words. As private demand recovered, less public support would be needed. This was a deliberate and highly successful strategy. The point is that private demand has recovered to such a point that we don’t need the same amount of government support. The crutch can be removed as it were without the economy falling over or slowing down – we didn’t need it pre GFC and we need less of it now.
The bottom line is that there is no real fiscal contraction underway in Australia – this is a misnomer and cannot be used to justify lower rates. Slower government spending growth does not detract from GDP. It may mean that government makes less of a contribution to growth, that’s true enough, but at a time that private demand is adding more, we will barely notice the difference. It is incorrect therefore for the RBA Board to speak along theses lines, implying that it is some negative to growth. This is highly misleading as even the government is forecasting solid growth in government spending going forward."
