Sensible economists accept that, because they’re determined by politicians, budgets are more about politics than economics. Pre-election budgets are more political than other budgets. And budgets coming before an election a government fears it may lose are wholly politically driven.
Welcome to this week’s budget. But here’s the point: whatever the motivation driving the decisions announced in the budget to increase this or reduce that, all the decisions have an effect on the economy nonetheless.
It’s a budget’s overall effect on the economy that macro-economists care about, not so much the politicians’ motives. So good economic analysis involves leaving the politics to one side while you focus on determining the economic consequences.
A glance at this week’s budget says that, with all its vote-buying giveaways, the budget will impart a huge further stimulus to an economy that was already growing strongly, with unusually low unemployment, but rising inflation.
What on earth are these guys up to, ramping an economy that doesn’t need ramping just to try to buy their re-election? But glances are often misleading, and the story’s more complicated than that.
You can’t judge the “stance” of fiscal (budgetary) policy adopted in a particular budget – whether it will work to expand aggregate (total) demand (spending) in the economy or to contract demand – just by looking at the few of its many “measures” (policy changes) that hit the headlines, while ignoring the other hundred measures it contained.
And, as with many concepts in economics, there are different ways you can measure them, with the different ways giving you somewhat different answers.
The simplest way to judge the stance of policy adopted in a budget – it’s expansionary, contractionary or neither (neutral) – is the way the Reserve Bank does it. You just look at the direction and size of the expected change in the budget balance from the present financial year to the coming year.
Treasurer Josh Frydenberg expects the budget deficit for the year that will end in three months’ time to be $79.8 billion, and the deficit for the coming year, 2022-23, to be slightly smaller at $78 billion.
In an economy as big as ours, that decrease of $1.8 billion is too small to notice. The difference between how much money the budget is expected to take out of the economy in taxes and how much it puts back via government spending is expected to be virtually unchanged.
So, judging it the Reserve’s way, the budget will neither add to aggregate demand (total private plus public spending) nor subtract from it. The stance is neutral.
However, there’s a two-way relationship between the budget and the economy. The budget affects the economy but, by the same token, the economy affects the budget.
The size of the budget’s deficit or surplus is affected by where the economy is in the business cycle. When the economy’s booming, tax collections will be growing strongly, whereas government spending on unemployment benefits will be falling, thus causing a budget deficit to reduce (or a surplus to increase).
On the other hand, when the economy’s dipping into recession, tax collections will be falling and the cost of benefit payments will be rising, thus increasing a deficit (or reducing a surplus).
The Keynesian approach to deciding the stance of policy adopted in a budget is to distinguish between this “cyclical” effect on the budget balance – what the economy’s doing to the budget – and the “structural” effect caused by the government’s explicit decisions.
So, many economists believe that when assessing the stance of a new budget, you should ignore the cyclical component and focus on the change in the structural component – what the government has decided to do to the economy.
You can determine this by looking at what the great budget-expert Chris Richardson, of Deloitte Access Economics, calls “the table of truth”, table 3.3 of budget statement 3 in budget paper 1, page 18 in the PDF (page 86 in the printed version).
The table shows that in the few months since the mid-year budget update last December, the economy has strengthened more than expected - mainly because of the growth in consumer spending and employment but, to a lesser extent, because of the rise in the prices we get for our exports of coal and iron ore.
This means the cyclical component of the budget deficit (what Treasury calls “parameter and other variations”) is now expected to be $28 billion less in the present financial year, and $38 billion less in the budget year, 2022-23.
Adding in the “forward estimates” for three further years to 2025-26, gives a total expected improvement of $143 billion – all of which comes from higher-than-expected tax collections.
So, had the government done nothing in the budget, that’s by how much the string of five budget deficits would have been reduced, relative to what was expected last December.
However, the table also shows that the new policy decisions announced in the budget (and in the few months leading up to it) are expected to reduce that cyclical improvement by $9 billion in the financial year just ending, and $17 billion in the coming year.
These are additions to the expected “structural deficit”. Over the full five years, they should total $39 billion, with more than three-quarters of that total coming from increased government spending.
So, relative to where we expected to be in December, the government’s spending in the budget won’t stop the next five budget deficits – and the government’s debt – being more than $100 billion less.
Even so, judged in Keynesian terms, the government has added to the structural deficit, so the budget is expansionary.
The independent economist Saul Eslake calculates that the budget involves net stimulus equivalent to 0.4 per cent of gross domestic product in the present financial year, and 0.7 per cent in the coming year.
So, he concludes, “the budget does put some additional upward pressure on inflation...but it’s fairly small”.
