January 22, 2008 | Graham

Surplus of fashion risks economic growth.

Why is Kevin Rudd set on running a budget surplus of somewhere around $17 billion?
The conventional economic theory is that governments should run surpluses in good times so that they can spend them in bad times as a way of stabilising swings in the economy. But after 15 years of expansion and with negligible government debt, there is plenty of fat to nurse us through the next recession.
The other reason for governments running a surplus is to damp demand in the economy to head-off inflation. Australia’s CPI is at the top end of the Reserve Bank’s targeted range, but in today’s deregulated economy, with a weak union movement, it’s not clear that inflation is the problem that it was when price rises could be compensated for by increased wages which then fed back into price rises. Too high an increase in prices tends to lead to import substitution which dampens price pressures because a more flexible economy passes the effects on quickly.
In any event, even if inflation is an issue, it would appear that it is not our biggest problem. Today’s news that shares on European exchanges fell by up to 7.2% (Germany) yesterday, suggests that the greatest risk facing the economy is a US recession.
Australia has a history of mishandling financial crises. The Great Depression was worse here than anywhere else in the world because of the credit crunch imposed by the Bank of England. Similarly, the 1987 sharemarket crash was worse in Australia than elsewhere, largely because of a subsequent credit crunch. Austerity is not the right dish to serve up when the economy turns down.
US central bankers and governments have learnt that the best thing to do when you have a financial crisis is to increase credit, not ration it. When everyone is worrying about the next fall in their personal wealth, inflation is not a big problem, and you can wait until sentiment picks up to deal with any inflationary potential you may have caused by increasing money supply. Under Greenspan and his successors these practices have delivered enviable economic stability.
The Goss government came undone because it uncritically followed “expert” advice and was so desperate to establish its conservative credentials that it tried to out-conservative the conservatives. Rudd appears to be following a similar line with his government. The only reason that makes any sense for running a $17 billion budget surplus is desperation to impress financial market participants and financial journalists. While they might be impressed, they only get one vote each. If Rudd wants to be a long-serving prime minister he has to impress voters. A 59% approval rating today can drop tomorrow faster than a European bourse if your results don’t meet your promises.
It’s time to lay down the law to the Reserve Bank and take evasive action. Proving that he is a “financial conservative” is only a problem in Rudd’s mind – the debate has moved on.

Posted by Graham at 6:35 am | Comments (4) |
Filed under: Australian Politics


  1. I think its early days yet – but clearly Rudd and his team are very keen to establish their economic credentials early, in a way that the average voter understands. This mindset will probably gradually drift as the new government gets more confident and the public no longer associate the economic bogeyman with the Labor Party.

    Comment by Guy — January 22, 2008 @ 8:07 am

  2. That’s my point Guy, if they preside over a recession because they are trying to keep financial markets and commentators happy, punters won’t reward them as good economic managers! Voters aren’t interested in the government’s surplus, they’re interested in their own!

    Comment by Graham Young — January 22, 2008 @ 9:39 am

  3. This is a good post!
    I am very bothered that the surplus is the focus of attention, not least because of the impact on the provision of social infrastructure (though Rudd keeps talking about productivity and infrastructure bottlenecks).
    To the extent that there is an attempt to restrain inflation (and I note and agree with the fundamentals in your post on this – in difficult times don’t be restrained), I thought it had been made clear (by a former Reserve Bank Governor) that it was the tax cuts which were particularly fuelling the increase.
    Richardson from Access Economics issued a statement some weeks ago which mentioned tax cuts and their contribution to inflation but then on the 7:30 Report Ali Moore “trapped” him into trying to work out how much the cuts to the budget would have to be to restrain inflation. He was at it again last night. (This is the man who said there was a statistical correlation between individual contacts and productivity!)

    Comment by Des Griffin — January 22, 2008 @ 11:36 am

  4. “It’s time to lay down the law to the Reserve Bank and take evasive action.”
    What evasive action are you talking about? Australia is still in the middle of a 15 year expansion. A declining economy is not the problem here (at the moment). Share market panic and a credit crunch in the US will have an effect here but not much beyond a slow-down in growth. Big-spending will only result in a stagflation situation – declining growth and increasing inflation.
    The bigger issue with budget surpluses is that it indicate that we are over-taxed, including businesses. It’s a transfer of wealth from private to government hands. The government should be running a zero deficit/surplus budget at the moment and use lending to increase spending when/if required.

    Comment by countryboy — January 22, 2008 @ 2:08 pm

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