Invisible Insider: The Poor Public Debate about Weak Public Demand
One problem many market economists and some political journalists writing about economics have is a distinct lack of understanding of the role and influence of public (government) demand in the economy.
This ignorance is understandable (but not excusable) because there are so few partial indicators on underlying trends in public demand. There are no regular updates other than in the quarterly national accounts, there are no funny little models that can be used to track or forecast public demand and therefore, it is given almost no attention.
Except at Budget time. And this is where the analysis is often misguided.
Public demand is around 25% of GDP. Housing, in contrast, is 5% of GDP. For housing, there are monthly updates on finance approvals, building approvals, prices, credit and consumer sentiment about buying a house. There are also auction clearance rates, affordability measures and other things I have no doubt forgotten. Yet witness the flood of analysis of this smallish part of the economy. [Ed: hear, hear!]
In all of the write-ups that were critical of the Budget for not doing enough to withdraw stimulus, none appeared to look at the economic data. The focus was the fact that the Budget deficits in 2010-11 and 2011-12 were larger than projected at MYEFO with the surpluses thereafter little changed.
This analysis made the high-school economics error saying this was a reflection of ‘loose’ fiscal policy. Funny thing about the fiscal slippage in those two years was that it was caused by a weaker economy! Get it? GDP for 2010-11 was revised 0.75 percentage points down and this spilled over into revenue losses in 2011-12.
What does a good policy maker do when there is a period of unforseen economic weakness? Tighten policy? Not even a dunce would do that.
Think about what an otherwise hawkish RBA would do if it revised its GDP forecast down 0.75 percentage points? The answer should be obvious – it would reassess the need for interest rate hikes. And low and behold, that is exactly what the RBA has done. Interest rates have been on hold since November last year and even after recent RBA Statements, it doesn’t look to be in a rush to raise them. [Ed: Bold call; this is an empirical question.]
What is also needed is a look at the detailed economic forecasts in the Budget. How many market economists or journalists bothered to look Budget Statement 2? Not many it seems. If they did, they would notice that public demand is forecast to grow just 1.25% in 2011-12 and then fall 1.25% in 2012-13. That is a public sector recession!
Finally, the school child [Ed: You PC wimp, it is "schoolboy"] error of looking at the $22 billion of savings being undermined by $17 billion of extra spending ignores another aspect on the Budget. Or rather Budgets past.
Programs that come to an end actually subtract from economic activity. If everyone is used to getting, say, $100 every week and then one week they don’t get that $100, that policy change is contractionary. There will be no $100 to spend that week.
During the GFC, the cash hand outs were temporary. They were paid out and that was that. The BER was fast tracked when implemented and those school building projects are almost all finished. It was a temporary stimulus. There will be no more school building programs.
Pink batts and green loans are not longer being rolled out so that addition to GDP is no longer in the mix. What's more, the automatic stabilisers are being allowed to work. This is unlike in 2007 with the last dismal and irresponsible Budget of Peter Costello. [Ed: Oooh, Aaaah, Glenn McGrath!. That was a bit partisan, was it not?]
Look at these facts. Between the MYEFO in late 2006 and the Budget in May 2007, parameter variations – that is, the change to the budget bottom line from a stronger than forecast economy - added a total of $47.8 billion to the government bottom line over the next 3 years.
In other words, the automatic stabilisers from the overheated economy were kicking into the budget bottom line. A good economic manager would have seen this inflation risk coming through and let the budget surplus rise. This would have limited the inflationary impact from the unexpectedly strong economy and limited the extent of future interest rate hikes.
But what did Costello do? How much of that $47.8 billion windfall was taken out of the economy to cool it down? Almost none. 98% of the windfall was spent in the (pre-election) Budget. All but $575 million was sprayed around the economy in one of the most extravagant and ill-directed spending sprees in Australian economic history. [Ed: Cossie is reeling right now]
$47.2 billion of the windfall gain was injected back into the economy. No wonder the inflation rate surged to 5% and no wonder the RBA was forced to hike interest rates to 7.25% when most of the rest of the world started cutting rates.
No wonder Costello will go down as the weakest and most profligate economic manager Australia has ever had and Swan will inevitably be judged as a prudent, tough and flexible economic manager. [Ed: Cossie just tapped-out, while there are reports Swannie is standing three inches taller]
One problem many market economists and some political journalists writing about economics have is a distinct lack of understanding of the role and influence of public (government) demand in the economy.
This ignorance is understandable (but not excusable) because there are so few partial indicators on underlying trends in public demand. There are no regular updates other than in the quarterly national accounts, there are no funny little models that can be used to track or forecast public demand and therefore, it is given almost no attention.
Except at Budget time. And this is where the analysis is often misguided.
Public demand is around 25% of GDP. Housing, in contrast, is 5% of GDP. For housing, there are monthly updates on finance approvals, building approvals, prices, credit and consumer sentiment about buying a house. There are also auction clearance rates, affordability measures and other things I have no doubt forgotten. Yet witness the flood of analysis of this smallish part of the economy. [Ed: hear, hear!]
In all of the write-ups that were critical of the Budget for not doing enough to withdraw stimulus, none appeared to look at the economic data. The focus was the fact that the Budget deficits in 2010-11 and 2011-12 were larger than projected at MYEFO with the surpluses thereafter little changed.
This analysis made the high-school economics error saying this was a reflection of ‘loose’ fiscal policy. Funny thing about the fiscal slippage in those two years was that it was caused by a weaker economy! Get it? GDP for 2010-11 was revised 0.75 percentage points down and this spilled over into revenue losses in 2011-12.
What does a good policy maker do when there is a period of unforseen economic weakness? Tighten policy? Not even a dunce would do that.
Think about what an otherwise hawkish RBA would do if it revised its GDP forecast down 0.75 percentage points? The answer should be obvious – it would reassess the need for interest rate hikes. And low and behold, that is exactly what the RBA has done. Interest rates have been on hold since November last year and even after recent RBA Statements, it doesn’t look to be in a rush to raise them. [Ed: Bold call; this is an empirical question.]
What is also needed is a look at the detailed economic forecasts in the Budget. How many market economists or journalists bothered to look Budget Statement 2? Not many it seems. If they did, they would notice that public demand is forecast to grow just 1.25% in 2011-12 and then fall 1.25% in 2012-13. That is a public sector recession!
Finally, the school child [Ed: You PC wimp, it is "schoolboy"] error of looking at the $22 billion of savings being undermined by $17 billion of extra spending ignores another aspect on the Budget. Or rather Budgets past.
Programs that come to an end actually subtract from economic activity. If everyone is used to getting, say, $100 every week and then one week they don’t get that $100, that policy change is contractionary. There will be no $100 to spend that week.
During the GFC, the cash hand outs were temporary. They were paid out and that was that. The BER was fast tracked when implemented and those school building projects are almost all finished. It was a temporary stimulus. There will be no more school building programs.
Pink batts and green loans are not longer being rolled out so that addition to GDP is no longer in the mix. What's more, the automatic stabilisers are being allowed to work. This is unlike in 2007 with the last dismal and irresponsible Budget of Peter Costello. [Ed: Oooh, Aaaah, Glenn McGrath!. That was a bit partisan, was it not?]
Look at these facts. Between the MYEFO in late 2006 and the Budget in May 2007, parameter variations – that is, the change to the budget bottom line from a stronger than forecast economy - added a total of $47.8 billion to the government bottom line over the next 3 years.
In other words, the automatic stabilisers from the overheated economy were kicking into the budget bottom line. A good economic manager would have seen this inflation risk coming through and let the budget surplus rise. This would have limited the inflationary impact from the unexpectedly strong economy and limited the extent of future interest rate hikes.
But what did Costello do? How much of that $47.8 billion windfall was taken out of the economy to cool it down? Almost none. 98% of the windfall was spent in the (pre-election) Budget. All but $575 million was sprayed around the economy in one of the most extravagant and ill-directed spending sprees in Australian economic history. [Ed: Cossie is reeling right now]
$47.2 billion of the windfall gain was injected back into the economy. No wonder the inflation rate surged to 5% and no wonder the RBA was forced to hike interest rates to 7.25% when most of the rest of the world started cutting rates.
No wonder Costello will go down as the weakest and most profligate economic manager Australia has ever had and Swan will inevitably be judged as a prudent, tough and flexible economic manager. [Ed: Cossie just tapped-out, while there are reports Swannie is standing three inches taller]
