The economic challenges

It should also be acknowledged that no other central bank has faced as much criticism of nearly every decision to raise rates as has the Reserve Bank of Australia.

Finally, it should also be noted that no one else foresaw the magnitude or duration of the commodities boom to the point where, in the Bank’s assessment, “capacity constraints” are contributing as they are to inflationary pressures.

Nonetheless, because monetary policy does concentrate the burden of dealing with rising inflation on a minority of Australians, it is reasonable to ask whether other instruments of economic policy could not play a greater role in containing and reversing inflationary pressures.

I believe that the role played by fiscal policy in recent years has contributed to the inflationary pressures which have built up in the Australian economy, and thrown a greater burden on monetary policy than would otherwise have been necessary.

Fiscal policy has, by recycling part of the income thrown off by rising commodity prices from the business sector to the household sector, unnecessarily boosted domestic demand. After each of the last four Budgets nearly all of the upward revisions to estimates of revenue have been used to fund personal tax cuts and increases in personal benefit payments, leaving the projected Budget surpluses at about 1 per cent of GDP.

Shortly before the 2007 election I estimated that, since the 2003-04 Budget, so-called “parameter variations” had added some $457 billion to the resources available to the Government over the nine years to 2010-11; and that, of this amount, $435bn had been or would be spent or given away in tax cuts, and only $22bn “saved” in the form of Budget surpluses. And of this $435bn, at least $270bn had taken or would take the form of personal income tax cuts (including those the Labor Party has pledged).

My argument has always been that fiscal policy should have been doing more. It should have been exerting a restraining influence on domestic demand by allowing the so-called “automatic stabilisers” (the natural tendency for revenue to rise as a share of GDP as the business cycle continues and resource utilisation increases) to operate.

I’ve also argued that, because the corporate sector typically saves the equivalent of 3-4 per cent of GDP while the household sector, until very recently, dis-saved the equivalent of about ½ per cent of GDP, a policy of redistributing income from the corporate sector to the household sector through the budget must inevitably boost total aggregate demand - as it has done in recent years.

While it would have been politically naïve to imagine that all of this $457bn should or could have been “saved” in the form of bigger budget surpluses, I did say, and I still do, that a lot more of it should have been saved than actually was.

Windfall revenue gains associated with the commodities boom, and with strong economic growth, should have been allocated to “buckets” or “pools” to be drawn down over subsequent years, as economic conditions allowed, to meet longer-term goals; goals such as:

• meeting the fiscal costs associated with demographic change;
• ameliorating the costs of the climate change which will inevitably occur, and cushioning the impact of the measures required to prevent further climate change;
• education and skills formation;
• reducing Indigenous disadvantage;
• improving and extending economic and social infrastructure;
• improving water security, and addressing salinity and soil degradation; and
• providing for tax cuts at a stage of the economic cycle when some form of fiscal stimulus might actually be appropriate.

Imagine what a difference we could have contemplated making if half of the $457bn accruing over the nine years to 2010-11 had been dedicated in this way.