Various estimates about the size of the federal budget deficit are starting to emerge. The Government has acknowledged that the data shows that tax receipts have fallen dramatically and now their budget is in deficit. For me that is a time of national rejoicing … finally … the federal government is doing what it should … resuming its crucial role in financing non-government (in this case) domestic private savings. Finally, there is a net injection of financial assets coming from the excess spending over receipts. Finally, the drain on private wealth that the creation of budget surpluses requires is at an end.
It would have been much better had the government gone back into deficit on their own volition and reversed the fiscal vandalism of the Costello-Howard years. The economy was always going to force them back into deficit through the so-called automatic stabilisers (tax revenue down and welfare payments up) even if they didn’t alter any of their discretionary policy parameters. It would have been much better though had the federal government abandoned the nonsensical neo-liberal rhetoric about the danger of deficits, and, instead, had used their fiscal discretion to revitalise public infrastructure; build a domestic renewable energy industry; fund a Job Guarantee so that unemployment (and time-related underemployment) would have been eliminated (apart from frictional joblessness – moving between jobs etc). Then the deficit would have been virtuous. Now they have a “bad” deficit on their hands – one that is forced on them because the economy if failing quickly. Yes they have injected some billions already in their pre-xmas expansion. But more … much more is needed … and it is needed now!
It isn’t too late for the federal government to turn the “bad” deficit into a “good” deficit by fast-tracking the sorts of initiatives I mentioned in the last paragraph. They should scrap the mean-spirited Work for the Dole immediately and announce an employment guarantee where anybody who wants a job can get one in the public sector at the minimum wage (and the rest of the statutory entitlements). If they can guarantee banks and shopping centres etc then they can surely guarantee jobs. Then they should get spending to repair the damage the surpluses wreaked on our public assets – hospitals, schools, universities, rivers, etc.
The general point is that there isn’t a financial or real crisis so deep that fiscal policy cannot fix it. It is just a matter of how large the deficit has to be to finance the savings desires of the non-government sector. When the latter stops spending and saves instead then the government sector has to fill demand gap. It has to go into deficit to do this. In normal times, if the non-government sector desires to save then the government sector has to remain in deficit.
All this nonsense today from the Federal Opposition about temporary deficits and the dangers of borrowing etc only beggars belief. They clearly haven’t a clue about how the monetary system operates; how the central bank operations desk works; how the fiscal balance interacts with the cash system to influence short-term interest rates and the rest of it. If only they understood that budget deficits actually put downward pressure on overnight interest rates (the short-end of the yield curve that the central bank targets) and that the central bank issues debt to “manage” the liquidity in the cash system so that commercial banks have an interest earning asset to buy with their surplus reserves. In this way, the central bank can maintain its target interest rate. If it didn’t issue the debt, competition between the commercial banks would drive the overnight rate towards the current support rate on excess reserves (below the target rate). In other words, the central bank would lose control over monetary policy. Debt-issuance thus has nothing at all to do with “financing” net government spending. After all, the federal government issues the currency as a monopoly and therefore has no financial constraint.
How big should the deficit be? Well in the 1982 recession – it was around 3.3 per cent of GDP. The recession lingered and unemployment remained very high throughout the 1980s which was a sure sign that 3.3 per cent was not large enough. In the more severe (deeper and longer) 1991 recession the deficit was around 3.9 per cent of GDP at is peak. The 1990s saw unemployment remain high and a new form of labour wastage – underemployment – emerge. Throughout the 1990s, the unemployment rate averaged around 8.8 per cent, hidden unemployment average about 3.3 per cent and underemployment averaged 3.8 per cent. Taken together, the total labour underutilisation rate throughout the 1990s (from 1991:1 to 1999:4) averaged 15.9 per cent. It was total insanity for the government of the day not to massively increase the deficit at the time given how much income was being lost every day, not to mention the human suffering that accompanied the joblessness.
Clearly the deficit was not large enough over the 1991 recession (GDP peak to trough) and was way too small during the weak recovery that ensued in 1993 and 1994. Then we encountered the surplus obsession of Costello which put paid to any significant role for federal government in reducing the labour wastage. They institutionalised high labour underutilisation and then started to attack and bully the victims (the unemployed, disabled, single parents etc) with a pernicious so-called welfare-to-work policy framework.
At present the deficit is probably just over 1 per cent, perhaps around 1.5 per cent of GDP. Things are going to get much worse over the next four quarters. I think the Government should be aiming for a deficit of over 5 per cent as soon as they can get the programmes going. Speed is of the essence if we are to prevent a rapid escalation of labour underutilisation which typically takes years to reduce. Remember we went into this downturn with around 10 per cent labour wastage.
And the Government should just ignore the neo-liberal trash coming from the Opposition and the vested interests in business. Its time to spend, spend, spend.