A Budget that reduces growth and increases joblessness – for no sound reason

Last night, the Federal Government brought down the – 2013-14 Budget – claiming it was a responsible response to the circumstances it faced (declining world growth, declining terms of trade and persistently high exchange rate) and that it emphasised growth and jobs. Neither claim is remotely correct. It is a pro-cyclical budget – that is, a contractionary budget that builds on the contractionary fiscal shift in 2012-13, which by its own arithmetic reduces growth and causes the unemployment rate to rise. It will damage employment growth and increase poverty rates. It reflects a failure to acknowledge the state of the economy (4 per cent output gap) and to implement the correct counter-cyclical fiscal response (a significant rise in the projected budget deficit). It might have some education and disability spending in it. But even in those areas the spending is inadequate and, in the case of education, based on a neo-liberal view that the federal government should be funding the private schools, which, in general, educate the children from wealthy and high-income families. Overall, a destructive fiscal plan given the state of the economy.

When assessing a budget the actual numbers are somewhat irrelevant without context. I haven’t seen any commentary overnight that seriously attempted to assess where this budget stood in the context of the current economic cycle.

It was very disappointing to review the media coverage. Even the more measured commentators in the media seem to have lost the plot. For example, Tim Colebatch (The Melbourne Age economics editor) article today – More pain than gain as repair job starts – contained things like:

This is like no other pre-election budget. In the old days, when governments had money, these budgets would lure us with fistfuls of dollars.

Which old days were they Tim? During the convertible currency era the government had to tax and borrow to spend. Its spending capacity was damaged if there was a major revenue shortfall such as we have seen over the last two years.

I should add that the term “shortfall” is loaded because it relates to the ridiculously optimistic forecasts that the Government used in past budgets as a way of justifying their fiscal contraction.

Since 1971 though (in Australia a bit later because we floated later), government have not been constrained by their tax or borrowing potential. Today, tomorrow and the next day, the Federal government has all the “money” it needs to close whatever output gap there is.

It might be a political issue given that it has backed itself into a corner telling us that deficits are bad and surpluses are good. But as an economics commentator, Tim Colebatch should make it clear if he is making political assessments or economic assessments. Readers will think the government has run out of money, which is a patent lie.

Further on we read:

And one of the things to admire in this budget is the mixture of economic responsibility and political rat cunning that has gone into designing the dramatic shift from deep budget deficit to small budget surplus within three years.

Note the wording “deep”. What the hell is a deep deficit? Even by conventional standards the projected deficit in 2013-14 of $A18 billion will be 1.1 per cent of GDP. That is a historically low deficit.

In the years that the Federal government ran deficits between 1970-71 to 2012-13 (23 occasions) the average deficit to GDP ratio was 2.1 per cent. If we took a a much longer time period we would find a deficit of 1.1 per cent is not “large” by historical standards.

So what does deep mean? Other than to buy into the neo-liberal obsession that has reached hysterical proportions in recent weeks as the Budget approached that budgets of any size are bad.

Where is the context Tim?

I should add that his commentary was one of the better attempts. Things are bleak out there in media land.

The Government’s line is that things have changed beyond its control since it formulated the last budget a year ago and that is why the budget outcome has shifted from a projected surplus to a $A19.4 billion deficit (more about which later).

The reality is that nothing has changed that was not obvious even 12 months ago.

The Government produced an ideological document last year full of ridiculous forecasts that allowed them to claim they would get a surplus, which satisfied its perverted view of its political imperative.

As a piece of political strategy, that document was a disaster, which suggests they really don’t know what is going on. But as an economic document it was far-fetched.

Everything that has happened in the current year was fairly predictable and avoidable.

We knew the austerity in Europe and the UK was going to damage growth. We knew that the mad politics of the US was going to damage its growth rate albeit not by as much as the Europeans have managed to visit on themselves through policy incompetence.

We knew China was slowing and the terms of trade had peaked. We knew that the mining investment was tapering. We knew that households were attempting to reduce their massive debt exposure and restore historical saving ratios.

Nothing that has occurred in the last year has been surprising given the policy settings around the world.

Further, the Australian government has all the capacity it needs to insulate the domestic economy from these world events. But the problem really is that it joined the chorus – the austerity refrain – and undermined its own revenue base by attempting an historically unprecedented fiscal shift from a deficit that was not large enough to a projected surplus that would have been obscene, given the circumstances.

It was obvious they would fail in their mission. To say now that circumstances changed just means they got it terribly wrong because their advisers in Treasury are using flawed economic models and providing grossly erroneous economic judgements.

To understand why context matters, please read the following blog – MMT Budgetary principles.

There you will see that a responsible fiscal policy requires two conditions be fulfilled:

1. The discretionary budget position (deficit or surplus) must fill the gap between the savings minus investment minus the gap between exports minus imports.

2. When filling that gap, the government has to ensure that the saving, import and investment levels are at their full employment levels.

These conditions specify a strict discipline on fiscal policy. The 2013-14 Budget fails badly when judged against these conditions.

In terms of context, even the Government’s own reasoning tells us that there is an output gap of some proportion – they are forecasting real GDP to be 2.75 in 2013-14, which is heroic at best. They are also forecasting unemployment to rise even further to 5.75 per cent. With the rise in unemployment will also be a rise in underemployment and hidden unemployment.

At present the broad labour underutilisation rate is around 13.9 per cent. On the Treasury’s own reasoning this could go to 14.5 or even 15 per cent in 2013-14. That is massive excess capacity.

So let’s just imagine the forecasts are correct (they won’t be but but we are imagining).

To review my estimates of the incremental output gap please read this blog – Australia output gap – not close to full capacity

The implied quarterly trend real GDP growth rate from that regression (using the formula 100*[exp(b) - 1], where b is the estimated coefficient on the trend trend in the regression equation) is 0.76 per cent (or 3.05 per cent per annum). This is a very conservative estimate of trend growth in Australia.

It allows us to compare actual real GDP with the trend level to compute the shortfall. The resulting incremental output gap is the percentage shortfall of real GDP from its trend expressed as a percentage of trend.

As I have noted in the past, the gap between real GDP and trend GDP is not strictly an output gap because that would require the additional assumption that trend growth always defines the potential growth of the economy. An economy may be held in a state of austerity for years (as we are seeing in Europe at present) and its trend will be much lower than its potential – given that tens of thousands to millions of people might be persistently unemployed or underemployed.

That is why I think it is more accurate to call the gap between real GDP and trend GDP to be an incremental output gap because it does not presume that the trend output upon which the forecast was based coincided with potential output or full employment.

In other words, the incremental output gap depicts the increase in whatever gap existed at the time the forecast began (March-quarter 2013).

The following table compares the GDP forecasts from the Budget (3 per cent 2012-13 and 2.75 per cent 2013-14) and my own (more realistic) guesses (2.8 per cent 2012-13 and 2.2 per cent 2013-14) with the predicted trend rate of growth.

Even if the Budget forecasts are correct there will be a $A64,471.4 million (4.1 per cent) incremental output gap by the end of this fiscal year (2012-13) rising to $A71,837.3 million (4.5 per cent) in 2013-14. My estimates suggest the incremental output gap will be larger – $A67,375 million (4.3 per cent) and $A83,028 million (5.2 per cent), respectively for 2012-13 and 2013-14.

The Government might reject the estimates of trend growth which are standard and conservative. I would think they would be foolish to do that. It is clear the trend has fallen in recent decades but my estimates are consistent with RBA estimates and even Treasury estimates.

So what do we make of that?

The question then that needs to be asked (no journalist is asking it) and answered (the Government studiously avoids referencing this) is if the economy is to contract and the output gap is widening then why is the fiscal shift contractionary?

Even though the government failed to achieve its surplus dream the scale of the fiscal tightening has been historically unprecedented. The deficit was reduced by $23.9 billion at a time when the economy was contracting.

The following graph shows the recent history (from 1970-71) of fiscal shifts. You can see that the forward estimates imply a tightening of fiscal policy.

Pro-cyclical fiscal policy changes are the anathema of responsible fiscal management. Discretionary changes in fiscal policy should typically be counter-cyclical – to manage output gaps. The only time an expansionary discretionary fiscal change should be pro-cyclical is when growth is positive but not strong enough to achieve full employment. Once capacity is reached, fiscal policy should counteract non-government spending changes.

Here are some further questions the journalists should be asking:

1. What reason does the government give for contracting net spending while the real GDP growth rate is falling (well below trend) and the unemployment rate is rising (well above even what the Government claims is full employment)?

2. Why would a government deliberately impose massive daily national income losses on the economy, which are disproportionately endured by the poorest members of our society?

It is also clear that the Treasury was not even remotely correct in its economic assessment. What is going on there? The simple answer is that their model frameworks are based on flawed macroeconomic theory – the same theory that led to policies around the world that caused the financial crisis.

The following graph compares the evolution of budget forecasts (in $A billions) from last year’s (2012-13) May Budget Paper No 1, through the Mid-Year Economic and Financial Outlook (published October 2012) and this years (2013-14) May Budget Paper No 1.

The scale of the errors are staggering and beyond what you would get from normal stochastic variation in econometric models. In the same way that the IMF forecasts are systematically wrong, which reflects the ideological bias inherent in their models, the Treasury forecasts also fail because they have adopted a flawed macroeconomic framework.

The Treasury wasn’t alone in its poor forecasting.

At the start of this year, I was invited to participate in the 2013 BusinessDay Survey which was run by the Fairfax Media (publishers of the Australian Financial Review, Sydney Morning Herald and the Melbourne Age, among other leading newspapers in Australia). You can find the make-up of the panel and the forecast tables at – Peter Martin’s site – (he is the national economics correspondent for Fairfax).

At Peter’s site you will read that:

The BusinessDay economic survey uniquely incorporates the views of financial markets economists, academic economists and two working in industry groups – the Australian Industry Group and the Australian Workers Union.

Among the many aggregates that were up for prediction, we were asked to forecast in $A billions the budget deficit outcome for 2012-13. The following graph shows the range of forecasts produced at the start of the year by the panel of so-called experts.

I have added the November 2012 forecast by Access Economics, a Canberra-based economic consultancy firm (the Director of which seems to be the only person the ABC flagship evening program 7.30 asks for expert economic opinion these days – a former Treasury official).

The panel was divided between so-called market economists, academic economists, consultants and peak bodies but economists in only the first three categories provided forecasts. You can put names against the forecasts if you visit Peter Martin’s site.

I have included the average for the whole group (some of the panel declined to forecast this aggregate). I have also put the average for the three categories in the graph and sorted the data in order of size of deficit predicted.

Last night’s Budget data revealed that the 2012-13 budget deficit will be $A19.369 billion. Although it is still 6 weeks out from the end of the forecast horizon, this estimate is likely to be very close to what we find out to be the actual result. The red column is thus listed as actual in that regard.

My forecast was for a budget deficit in 2012-13 of $A20 billion. This forecast was clearly an outlier in the forecasts provided by the panel. I am happy to be an outlier when there are such huge mistakes (in both size and direction) coming from the mainstream.

Its only one aggregate but when you see forecast errors that are so large then you have to wonder whether the forecaster (or their model) really understands what is going on out there.

How anyone could have predicted a surplus doesn’t bear thinking about. They really didn’t know what was going on or how the macroeconomy works.

The last observation for today relates to our national broadcaster – the ABC. It is publicly-owned and professes balance. However, it is clear that over time it has become yet another mouthpiece for the neo-liberal ideology.

The ABC urgently needs to do something about its economic coverage. The flagship evening current affairs program 7.30 is a disgrace when it comes to economic matters.

The presenter, Leigh Sales, thinks she is a hard-hitting interviewer. Perhaps she is. But she knows nought about macroeconomics and her questioning (or lack of relevant questioning) is an embarrassment.

Last night, she had the Treasurer in an exclusive post-Budget interview and kept raving on about budget surpluses, without knowing what they meant in economic terms. She didn’t ask him once to comment on the size of the current output gap and the role of deficits to fill them.

She allowed the Treasurer to run the “things have changed” line.

The ABC also seems to give privileged access to the Director of Access Economics, which sings from the neo-liberal hymn sheet. It is continually telling us about how bad deficits are, that the government is broke, that the deficit is broke and all the rest of it.

Late last year (November 2012), the ABC news sprayed the following headline across the daily news – Access Economics forecasts budget deficit.

Yes and so what. The only news at that time was that Access had changed their minds, which of-course the ABC didn’t choose to report.

On September 28, 2011, News Limited carried the story- Access Economics’ Budget forecast is pessimistic, says Wayne Swan.

We read:

Access expects a surplus of $3.8 billion in 2012/13 compared with Treasury’s forecast of $3.5 billion, but a $1.8 billion deficit in 2013/14 against an official prediction for a $4.5 billion surplus.

So they too had bought the surplus myth.

When the ABC confronted the Treasurer with the Access Economics Report that a small deficit was more realistic he rejected the claim and said:

Access Economics doesn’t always get it right …

Well, that is one thing the Treasurer got right last year.

By late 2011 (November) they were predicting a small deficit for 2012-13 (Source) and progressively altered their forecasts as each previous forecast looked to be an incompetent assessment.

The ABC continually ran interviews with the Access Director where he talked about their “modelling” (they produce a regular subscription Budget report) but never once asked the most obvious question: If you are continually changing your forecasts yet nothing much has changed doesn’t this tell you that your “model” is deficient, at best?

Each update from Access was treated as if it was an insightful expert commentary on the state of affairs when in fact it was the speculative assessment of a group of neo-liberal economists who have an inadequate grasp of the operations of the macroeconomics of the nation, as evidenced by their appalling forecasting record.

The ABC should really broaden their coverage and go back to the days where it presented a debate. It should also engage presenters who know what they are talking about or who are prepared to defer to those that might.

Conclusion

Overall, a very predictable budget.

It will reduce growth and increase joblessness. And why? For no substantive economic reason. The Budget is not an economic statement. It has become an annual statement of dogma from one deeply flawed economic paradigm.

The same paradigm that cause the mess is dominating the so-called solution.

That is enough for today!

(c) Copyright 2013 Bill Mitchell. All Rights Reserved.

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14 Responses to A Budget that reduces growth and increases joblessness – for no sound reason

  1. Esp Ghia says:

    “To understand why context matters, please read the following blog – .”

    You left out the link, Bill.

  2. John Hermann says:

    It seems that almost everybody has been hoodwinked into accepting the mantra “deficit bad, surplus good” as an article of faith. What this highlights is that very few people, including many of those who profess to be economists, possess even a modest understanding of financial economics insofar as it relates to macroeconomic principles.

  3. Senexx says:

    Yes indeed, Bill.

    Good politics, bad economics.

  4. John Hermann says:

    Economics commentator Michael Pascoe has it half right in his short article “Thanks for the deficit, really”:
    http://au.pfinance.yahoo.com/our-experts/michael-pascoe/article/-/17152554/thanks-for-the-deficit-really/
    Michael rightly decries the current mindless obsession with achieving a budget surplus. However I disagree with his statement that “Pursuing a surplus (as we should over time) a little bit more slowly just means we’ll pay off our not-all-that-large net debt one year later”. The reality is that the public debt of a sovereign currency-issuing government never needs to be paid off, EVER. And arguably one should aim to maintain a budget deficit commensurate with the desired growth in GDP. Historically, deficits are the norm and surpluses are the exception. Statistically we find that the magnitude of the annual deficit (measured as a percentage of GDP) is about equal to the annual rate of growth of productivity — currently in the range 2 to 3 percent.

  5. ParadigmShift says:

    Why do we assume that the purpose of the media is to inform the populace? The nonsense that is paraded as truth in the media these days makes perfect sense when viewed as simple propaganda for elite interests. If anybody in Australia thinks that shows like ABC’s Q&A are indicative of democratic media, rather than a cleverly disguised exercise in thought control by an autocratic state, then I have a bridge or two to sell them.

    The Australian ABC, just like the British BBC, is state propaganda.

  6. ParadigmShift,

    Certainly some so called news organisations are propaganda organisations financed by and designed to benefit the elite: e.g. Fox News.

    But the BBC is very much left of centre: i.e. not particularly pro the elite. So why does the BBC spew out nonsensical “Rogoff-compliant” economic policies? I think that Bill has given the right answer here, which is that the political left is plain stupid: it cannot do anything more than ape the economic illiteracy of the political right.

  7. Neil says:

    “The Australian ABC, just like the British BBC, is state propaganda”
    Not quite, the BBC has Stephanie Flanders, Robert Peston and Jeremy “ankle biter” Paxman. OK, they are still neo-liberal apologists in some senses but their analysis isn’t as bad as the ABCs and at least they (Flanders and Pesto) have some serious Economic training. The BBC (through Newsnight) at least gives voice to Economic paradigms that do not fit the neo-lib Strait Jacket (Krugman for example demolished a couple of treasury ministers arguments recently on that programme). I might add that it is a matter of record that many British politicians (of all persuasions) fear being interviewed on the early morning “Today” programme (BBC Radio 4). The BBC is constantly under attack from both left and right for being “biased” which, I think, tells you something about how well they position themselves. That is not to say they are beyond criticism, their view of economics is clearly orthodox but simply vehicles of propaganda they are not.

  8. John says:

    “But the BBC is very much left of centre” Move with the times Ralph, the BBC hasn’t given “the left of centre” air time for many years. It toes a slightly right of centre path as it doesn’t know any different. In the UK we have slightly right of centre, right of centre, the cons and then UKIP and beyond. Not a lot of oxygen given to the left of centre I am afraid.

  9. larry says:

    Neil, Stephanie Flanders is an economic illiterate. Her economic series on the crisis was unimpressive. Peston is another thing altogether. His view of himself is that you either love him or hate him. I don’t feel that strongly about him but don’t always find his commentary compelling. Acknowledging their faults, I prefer Newsnight and Channel 4 news. Question Time is sometimes a dog’s breakfast.

  10. CharlesJ says:

    Larry,
    Stephanie is aware of chartalist ideas, but she is constrained in that she cannot be seen to be promoting any one particular idea. You’ll note she never uses the neocon term “taxpayer”, and has described the budget deficit as a “subsidy” for the economy, which is consistent with MMT. Wherever someone in position of authority has discussed MMT-like ideas, she has covered it, albeit in a low tech way – because she is not allowed to be too technical.

    She has used the phrase “printing money”, but then so did Abba Lerner. I use it too when talking to ordinary people.

  11. Ikonoclast says:

    It is clear that neoclassical economists don’t know what money is. That is a frightening thought when they are running the economy or rather attempting to run it. They think fiat money has some reality beyond what the government gives it by demanding it in taxes and by (more or less) enforcing legal tender by laws.

    It seems to me, MMT has trouble gaining traction because;

    (a) People are still trapped in a commodity money mindset and haven’t progressed conceptually from the days when money was backed by gold.

    (b) It suits the Capitalist Oligarchs to promote these false views of money. Their power comes from mystifying and obscuring (“smoke and mirrors”) oppression, exploitation and money manipulation.

  12. Robert says:

    Some vehicles for state propaganda can be useful – like Russia Today (RT).

  13. John Hermann says:

    Ikonoclast said: “It is clear that neoclassical economists don’t know what money is.”

    Not only do they not understand what money is, but also they have little understanding of how it is created and destroyed.

  14. Some Guy says:

    Ikonoclast: People are still trapped in a commodity money mindset and haven’t progressed conceptually from the days when money was backed by gold.

    Something to tell those trapped people: There never were such days. Gold was always backed by money. If it ever looked like the reverse, it was because money-backed gold was so common and ancient a bubble that there were enough countries and people in them, greater fools, who would trade their scarce and valuable commodities, debt and labor for gold. And such countries could mercantilistically achieve full employment through export.

    But gold miners and gold exporting countries always knew what was valuable and what was not. When they got gold, they sold it for something of genuine value: money.

    CharlesJ:She has used the phrase “printing money”, but then so did Abba Lerner. I use it too when talking to ordinary people. Nothing wrong or misleading about the phrase. IMHO, avoiding it is a spectacular and illogical rhetorical-pedagogical mistake that Lerner did NOT make.
    My apologies if I repeat myself.

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