Budget’s easy future: no more surpluses, lots more tax cuts

Last week’s budget quietly brought about a historic shift in the fiscal policy “framework”: we moved from the Treasury puritanical view of what constitutes responsible budgeting, to the more licentious Republican view.

Until now, the Liberals have been committed to ending “debt and deficit”, but now they’ve decided they can live with both. The coronacession has left them with little choice, but there’s more to it.

America’s Republicans adhere to two fiscal principles: first, budget deficits are terrible things - but only because those appalling, big-spending Democrats are in charge. Second, once the Republicans are back in power, deficits are of less concern and no barrier to us granting our supporters big tax cuts.

Treasuries – including state treasuries – have a lot of firmly held views about what constitutes good public policy, but what they care about most – their sacred duty – is to keep the budget in balance.

Every time a recession pushes the budget into deficit, they fight untiringly until the economy’s recovery and much “fiscal consolidation” has returned the budget to balance. Their rationale for this obsession is that if they don’t care about balancing the budget, who will? The vote-buying politicians?

Early in the term of the Howard government, when the budget had still not fully recovered from the recession of the early 1990s, Treasury persuaded the Libs to enshrine this objective as their “medium-term fiscal strategy” - to “maintain budget balance, on average, over the course of the economic cycle”.

Successive Labor and Liberal governments have adopted that strategy with minor alteration.

After the Rudd government’s use of fiscal stimulus to avoid the Great Recession in 2009, it added a “deficit exit strategy” which committed it to “banking” any recovery in tax receipts and avoiding any policy changes (that is, tax cuts), as well as limiting real growth in government spending to an average of 2 per cent a year (a commitment Labor only pretended to keep).

In Tony Abbott’s first budget, the Libs’ “budget repair strategy” committed them to more than offset new spending measures by reductions in spending elsewhere, and to bank any improvement in the budget bottom line until a surplus of at least 1 per cent of gross domestic product had been achieved.

In Malcolm Turnbull’s first budget in 2016, however, he broke the commitment by deciding to cut the rate of company tax while the budget was still well short of surplus.

With that commitment out the window, it was easy in last year’s pre-election budget for Scott Morrison to promise a three-stage tax cut, spread from July 2018 to July 2024 and costing $300 billion over 10 years, purely on the strength of projections showing that tax collections would otherwise exceed the government’s ceiling of 23.9 per cent of GDP and keep soaring to 25.6 per cent by 2029-30. Immediately after its miraculous re-election, it rushed the plan into law.

It was always folly for any government committed to eliminating its debt to enact tax cuts five years into an uncertain future. The projections were overly optimistic at the time, but then the coronacession blew them away.

Tax collections are now expected to be only 21.8 per cent of GDP this financial year, and are projected only to have recovered to 22.9 per cent by 2030-31 – still way below the ceiling formerly said to justify a round of tax cuts.

Any government still committed to getting the budget back to surplus as soon as reasonably possible would have cancelled the legislated tax cuts – which now would be funded by borrowing – when further targeted-and-temporary government spending would be far more effective in creating jobs. Rate-scale tax cuts (as opposed to the one-year extension of the middle-income tax offset) are a continuing drag on the budget balance.

But no, rather than cut his coat according to his cloth, Scott Morrison has doubled down, bringing the second-stage tax cuts forward two years under the pretence it will do wonders for “jobs and growth”. The budget is projected still to be in a deficit of 1.6 per cent of GDP in 10 years’ time.

To make it all legit, however, the commitment to achieve budget surpluses on average has been junked and replaced with a new medium-term fiscal strategy merely to “focus on growing the economy in order to stabilise and reduce debt”, which will thereby “provide flexibility to respond to changing economic conditions”.

As the budget papers explain, and Josh Frydenberg has said, “with historically low interest rates, it is not necessary to run budget surpluses to stabilise and reduce debt as a share of GDP – provided the economy is growing steadily”.

Which is true. And the new, weaker medium-term strategy also provides the flexibility for governments to act like the Republicans and give a tax cut in response to changing political conditions. Happy days.

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The Liberal Keynes moves back into Treasury

For a man who, just months ago, was too prudish to say that dirty word “stimulus”, there’s now no doubt Treasurer Josh Frydenberg has become a card-carrying Keynesian. This week’s budget administers a huge Keynesian boost to our recessed economy. But he’s done it in a very Liberal way.

And, although the budget papers prefer to say “support” rather than “stimulus”, the man himself is always tossing off Keynesian jargon such as “aggregate demand” and burbling about the budget’s “automatic stabilisers”.

(John Maynard Keynes, BTW, was an avowed supporter of the British Liberal Party – although it was a different animal to our party of that name.)

According to the budget papers, the budget announced a further $73 billion in stimulus (plus $25 billion in virus-related health measures) over the next four years, on top of earlier spending of $159 billion.

Another way of judging the budget’s effect on aggregate (total) demand in the economy is to say the government expects the underlying cash deficit to increase from $85 billion last financial year to $213 billion this year.

This increase of $128 billion is equivalent to more than 6 per cent of gross domestic product. Unlike a strict Keynesian analysis, however, this takes the stimulus’ addition to the “structural component” of the budget balance, arising from the government’s explicit decisions to increase government spending or cut taxes, and combines it with the addition to the “cyclical component” made by the operation of the budget’s automatic stabilisers.

As the budget papers explain, “automatic stabilisers are features of the tax and transfer system that dampen the size of economic cycles without the need for explicit actions by policymakers. The government has allowed the automatic stabilisers to operate freely to dampen the effect of the COVID-19 shock.

“In a downturn, household and business after-tax income falls by less than before-tax income (for instance, due to progressivity in the tax system and [provisions for companies to deduct their losses from future - and now past – profits for tax purposes]) and transfer payments increase (due to increases in unemployment benefit payments and income-testing of other transfer payments).

“This provides an economic stimulus [whoops] that can reduce the magnitude of the downturn,” the papers say.

But Frydenberg wants to be clear that he’s embraced Keynesianism on his own terms. The budget papers say the economic recovery plan “is consistent with the government’s core values of lower taxes and containing the size of government, guaranteeing the provision of essential services, and ensuring budget and balance sheet discipline”.

And, as Frydenberg has said many times, the goal is to use budgetary stimulus to bring about a “business-led recovery”. I’d have thought that spending a lot of public money makes it a government-led recovery, but I think what he means is that most of the public money should be given to businesses, rather than being spent directly or given to punters.

Once you realise this, Frydenberg’s choices of what measures to include in the budget are easier to understand.

For instance, by far the most expensive measure – costing $27 billion over four years – is a temporary concession allowing businesses to deduct the full cost of all the new equipment they buy in the first year, rather than apportion the cost over the life of the asset.

Next are the personal income-tax cuts, costing $18 billion over the budget year and the three years of the “forward estimates”.

Then there’s infrastructure grants to the states of $7 billion, plus $2 billion for road safety improvements and upgrades. Then the $5 billion cost of letting loss-making businesses get an immediate tax deduction for their loss.

Only now do we get to the budget’s other centrepiece beside the tax cuts, the JobMaker hiring credit (wage subsidy) for employers who hire jobless young people under 35, which is the government’s replacement for the $101 billion JobKeeper wage subsidy scheme when it finishes in March. The new scheme will cost just $4 billion over three years.

Then we come to the cash splash payments to pensioners ($2.6 billion), $2 billion in new spending on aged care and $2 billion on a research and development tax incentive.

You see from this incomplete list how many of the budget’s measures seek to direct money into the hands of businesses: $34 billion in tax breaks and $4 billion in wage subsidies, compared with $20 billion in personal tax cuts and the pensioner cash splash.

Most of these measures are intended to get businesses investing and employing, but they do so by cutting the cost to them of capital equipment or labour. Those who would have invested and employed anyway are left better off, without taxpayers getting any value.

(And remember that one reason the government was happy to pay what it thought would be $130 billion for the JobKeeper scheme was that the money went to workers via their employer. This left businesses better off to the extent that their workers kept working.)

You do have to wonder whether all this spending would have done more to get the economy moving and unemployment falling if more of it had gone on job subsidies and less on investment incentives. Trying to get businesses investing in expanding their production rather than trying to get more people in jobs and spending on the things businesses produce seems to get things the wrong way round.

And you see that this “Liberal values” business-directed, tax-reducing approach to fiscal stimulus explains why the budget didn’t include the two measures economists most wanted to see because they’d do most to boost consumer spending and jobs: a big spend on social housing (a no-no under the rules of Smaller Government) and a permanent increase in unemployment benefits (almost every cent of which would have been spent).

The risk with Frydenberg’s politically correct stimulus is that too much of it will be saved. He needs to bone up on Keynes’ warning about the “paradox of thrift”.

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Morrison's new goal: tax cuts adding to higher debt and deficit

This is the hanged-for-a-sheep-rather-than-a-lamb budget. Realising the coronacession means it will be ages before he can make good his premature claim to have the budget Back in Black, Scott Morrison has decided to go for broke (if you'll excuse the expression).

Many people have been anxious to see just how big Josh Frydenberg's expected budget deficit will be (a record $213 billion, dwarfing anything produced by the free-spending Kevin Rudd) and how much public debt it will leave us with (almost a net $1 trillion by June 2024, and continuing to grow every year until at least June 2031).

Mr Frydenberg is right to say that, if we want to get the economy moving and unemployment falling, he has no choice but to spend in giant licks. More concerning is whether all the money added to the debt has been chosen to deliver the greatest possible gain in jobs.

That's the problem. It hasn't. Although the plan to subsidise the wages of newly employed young people in their first year gets a big tick, the brought-forward and back-dated tax cut that is the centrepiece of this budget is among the least effective ways to create jobs.

That's because much evidence shows that a high proportion of tax cuts is saved rather than spent. This is particularly likely at present, when so many people fear they may be next to lose their job.

To be fair, Mr Frydenberg has not brought forward the third stage of the tax plan – still scheduled for July 2024 – which is slanted heavily in of favour high earners. It's well established that high income-earners save a higher proportion of tax cuts than lower income-earners.

If you remember, when stage one of these tax cuts allowed people getting the new "low and middle income tax offset" to receive a flat $1080 refund in July and August last year, Mr Frydenberg confidently predicted it would give a fillip to retail sales. Didn't happen.

Summarising, the new tax cut will be worth the equivalent of almost $21 a week to those earning between $50,000 and $90,000 a year, but about $47 a week to those earning more than $120,000 a year.

Mr Frydenberg justifies the tax cut by saying "we believe people should keep more of what they earn". Fine. But such a belief has little to do with this budget's stated goal, nor the justification for adding to the deficit: it's "all about jobs".

This tax cut is much more about political popularity than getting the economy out of recession.

The government has made much of its efforts to limit the rise in deficits and debt by keeping new spending measures temporary. But the cost of the changed tax scales will roll on forever.

When the Economic Society of Australia surveyed 49 leading economists recently, asking them to choose the four programs that would be most effective in supporting recovery, only 10 of them nominated bringing forward the legislated tax cuts.

So what measures did they favour? More than half wanted spending on social housing (which creates employment in the housing industry, adds to our stock of homes and helps the disadvantaged).

Half the economists wanted a permanent increase in JobSeeker unemployment benefits (because $40 a day is below the poverty line and any increase is almost certain to be spent).

But those two top preferences have been ignored in this budget.

By contrast, some of the measures that are in the budget didn't raise much enthusiasm. An expanded investment allowance for business got support from only 29 per cent of the economists – presumably because it wasn't expected to be very effective. At best, it's likely to draw forward some of the spending on capital equipment that would have been spent in later years.

And even spending on infrastructure projects was preferred by only 20 of the 49 economists – perhaps because too much of it goes on wasteful projects.

The government's two main stimulus measures – the JobKeeper wage subsidy and the JobSeeker temporary supplement – have been most successful in breaking the economy's fall.

But they were cut back from the end of September, and this budget doesn't change the plan to end them from March and December respectively.

If the measures in the budget prove insufficient to fill the gap their withdrawal leaves, and so keep the recovery progressing, it will be because the government has been too quick to limit its spending and replace it with tax cuts.

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It won’t be just the budget that sets our speed of recovery

 In Scott Morrison’s efforts to get us out of the coronacession, lesson No. 1 is that it’s up to the government to produce the increase in demand we need by spending an absolute shedload of money. But this week the boss of the Productivity Commission interjected with lesson No. 2: while you’re at it, don’t forget the role of the supply side.

In every recession, “aggregate demand” (gross domestic product) goes backwards, and unemployment shoots skywards, because the private sector – households and businesses – have cut their spending on consumption and physical investment in new houses, business equipment and structures.

To get the private sector going again, the public sector has to more than make up the gap by greatly increasing its own spending. That’s particularly true in this recession because, with the official interest rate already close to zero, there’s been almost no scope for the authorities to do the other thing they usually do to get the private sector spending again: slash interest rates to encourage spending on borrowed money.

Because this government has made so much of the evils of “debt and deficit”, however, it’s been tempted to limit its budget spending by using economic reforms to pursue “jobs and growth”. The response of me and others has been to say “not so fast”. Reforms aimed at making our production of goods and services – the “supply side” of the economy - more efficient are no substitute for boosting the demand side of the economy when that’s what’s causing high unemployment.

After all, what could be more inefficient and wasteful than having hundreds of thousands of people who could be working and producing things sitting on their bums?

But in a virtual speech to the Australian Business Economists this week, Productivity Commission chairman Michael Brennan argued that the state of the supply side of the economy would be highly relevant to our success in having the economy recover as quickly as possible.

He made some good points. Note, he wasn’t challenging the fundamental importance of ensuring adequate growth in aggregate (total) demand. He was saying that the state of the supply side also matters. It’s not a substitute for adequate demand, but is an important supplement to it.

“Supply-side policy is an important enabler of the recovery, without which demand-side stimulus is incomplete or compromised in its effectiveness,” he says. It’s not so much about correcting inefficiency in the allocation of resources (labour, capital and land), as about “dynamic efficiency” – the speed with which the economy can move from one state to another, and how we minimise the various “frictions” that slow it down.

He says there are three main reasons why we should focus on micro-economic policy even in the midst of a recession. First, the coronacession is not just a demand shock, it’s also a reallocation shock. It will involve many workers, and much capital and land-use moving between industries and locations. Some industries will get bigger, some smaller.

Change in the industry structure of the economy is happening continuously, but a lot more of it happens during and after recessions. Many more businesses go out backwards, while new ones spring up. As well, firms use the impetus or excuse of the recession to stop doing unprofitable things they should have stopped doing years earlier.

Classic example: all the firms in this recession slashing the amounts they’re prepared to pay for sport broadcast rights and sponsorships. They’re blaming the tough times, but they’re also correcting their own error in allowing bidding wars to push the salaries of professional sportsmen (but few sportswomen) way above their commercial value.

So recessions involve much reallocation of resources. The economy won’t have fully recovered from the recession until that process is complete. But how long it takes will be heavily influenced by the frictions that slow it down.

Brennan quotes research showing that reasons for delay in reaching the new allocation “include the time needed to plan new enterprises and business activities, the time required to navigate regulatory hurdles and permit processes to start or expand businesses, time [to acquire new financial and physical] capital . . . and [time to seek out] new relationships with suppliers, employees, distributors and customers”.

His point is that some of these delays are caused by government regulation, so there are things governments could do to speed up the reallocation process and thus cause unemployment to come down faster.

Brennan’s second reason for arguing that micro-economic policy is relevant to the recession is the need to facilitate the forming of new businesses, and the possibility that recent experience of the pandemic leads entrepreneurs to overestimate the risk of future disruption to any business they start.

Governments can try to offset such “belief scarring” by streamlining the approvals process for new businesses, improving the culture of regulators, reforming insolvency rules, and in other ways.

Brennan’s third reason for arguing the relevance of micro policy is that reforms can help reduce the disruption caused by macro-economic shocks by making the economy more resilient – able to roll with the punches. (I believe this was one of the big but unexpected benefits of the Hawke-Keating government’s many micro reforms, which helps explain why we went for 29 years between recessions.)

But though Brennan makes good points, let me make two. As he envisages them, the reforms he advocates would leave us better off. But economists’ grand plans have to be implemented by fallible politicians and, as we’ve seen too many times in recent decades, by the time the pollies have engaged with the lobbyists what emerges is often more akin to rent-seeking than good policy.

Finally, unlike macro measures, micro reforms usually take some years to be brought into effect and then have their affect on behaviour. So, unless we take years to recover from this recession, any micro reform we begin now will be in time to help us with the next one.

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It'll be a long haul to get the economy going properly

If you’ve been away on Mars for the past five months, it will have been a huge surprise to learn this week that the economy is now "officially" in recession. For the rest of us, the news is the size of the recession, how it compares, what contributed most to the contraction, and the cloudy outlook for recovery.

The Australian Bureau of Statistics’ "national accounts" show real gross domestic product fell by 7 per cent in the June quarter, on top of the 0.3 per cent fall in the previous quarter. This is by far the largest fall in any quarter since we began measuring quarterly GDP in 1959.

The next biggest was a fall of 2 per cent in the June quarter of 1974. As Callam Pickering, of the Indeed global job website, reminds us, our total fall since December compares with peak-to-trough falls of 1.4 per cent in our previous recession in the early 1990s, and 3.7 per cent in the recession of the early 1980s.

So, no doubt this is indeed the worst recession since the Great Depression of the 1930s. Why so bad? Because, as David Bassanese of BetaShares tells us, "this is a recession like no other," being caused by the almost instantaneous spread around the world of a deadly virus and the consequences of our efforts to suppress the virus by ceasing much economic activity.

This coronacession is distinguished by its very front-loaded and cruelly uneven nature. “Unlike past recessions, which usually evolve over a year or so, most of the contraction in the economy took place within two short months,” Bassanese says.

The sudden need to lock down much of the economy and get people to leave their homes as little as possible raises the hope that, as the economy is re-opened, much of that activity will be resumed. And if we switch the focus from what’s happening to GDP – the economy’s production of goods and services – to the more important issue of what’s happening to jobs, we see this is already happening.

Treasurer Josh Frydenberg reminds us that, of the 1.3 million people who either lost their job or were stood down on zero hours following the outbreak, more than half were back at work by July.

This suggests we should be able to expect a significant bounce-back in production in the present September quarter, which has less than a month to run. Sorry, Victoria’s second wave and return to lockdown have put paid to that fond hope.

With the rest of the nation re-opening, but Victoria accounting for about a quarter of GDP, the optimists in Treasury are hoping for a line-ball result, but most business economists seem to be expecting a further (though much smaller) fall.

With any luck, however, Victoria should have started re-re-opening by the end of this month. So, a big recovery in production in the run up to Christmas? Sorry. Unless the government changes its tune by then, the economy will be struggling to cope with the withdrawal of much of Scott Morrison’s budgetary support.

Time for some good news. Remember that, no matter how tough things are looking in Oz, they’re looking better than in the rest of the developed world, with the United States losing 9 per cent during the June quarter, the Europeans down 12 per cent, and Britain down 20 per cent.

Why have we been hit less hard? Because we closed our borders earlier and had more success at containing the virus. We didn’t have to lock down as hard and were able to re-open earlier.

Now back to the details of how our 7 per cent contraction came about. The great bulk of it came from consumer spending - accounting for well over half of GDP – which fell by a remarkable 12.1 per cent during the quarter.

Consumption of goods fell a bit, while consumption of services fell hugely. Why? Because staying at home and social distancing slashed our spending on services such as hospitality, recreation and transport (public, car and air).

To the fall in consumer spending we must add falls of 6.8 per cent in new home building and 6.2 per cent in business investment in new equipment and structures. Note that this continued the declines in these two areas that began well before the virus arrived, showing the economy was weak even before the crisis.

This collapse in private sector spending was partly offset by growth in two parts of the economy. First, public sector spending grew by 2.5 per cent, mainly reflecting greater health care costs. (Note that, being "transfer payments", the huge spending on the JobKeeper wage subsidy scheme shows up as an addition to wage income, while the greater spending on JobSeeker unemployment benefits also shows up as an addition to household disposable income.)

This increased government assistance, at a time when job losses meant wage income was falling, actually caused household disposable income to rise by 2.2 per cent. Combined with the remarkable fall in consumer spending, however, this helps explain why the rate of household saving leapt from 6 per cent of household income to almost 20 per cent.

Second, our international trade made a 1 percentage point positive contribution to growth because, although the volume of our exports of goods and services fell, the volume of our imports of goods and services (which subtract from growth) fell by more.

(Just so you know, partly because of this we recorded our largest quarterly current account surplus on record of $18 billion, or 3.8 per cent of GDP. This is our fifth consecutive surplus, the longest run of surpluses since the 1970s. For a financial capital-importing economy like ours, this is actually a sign of economic weakness.)

Remembering that the outlook for coming quarters isn’t bright, I leave the last, sobering word to the ANZ Bank’s economics team: “Significant further stimulus over the next few years is likely to be required to generate growth and jobs and drive the unemployment rate down.”

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Pandemic: inconvenient for the privileged, rough on the poor

The popular coronavirus refrain that "we're all in this together" is a call for everyone to pull together and be more conscious of the interests of others, not just our own. What it's not is a statement of fact.

Far from it. When you take a closer look, what you see is inequality and injustice – on many dimensions. Some of these have been created by the way our governments have decided who gets help to cope with the pandemic and who doesn't.

But others are the consequence of our politicians going for years pushing problems under the carpet because fixing them would just be too expensive for taxpayers.

You and I have generally been content for these problems to be kept out of our sight. But the virus has drawn these injustices to light. In some cases, the victims have continued to suffer in silence. In others, they've continued going about their business in ways that have undermined our efforts to limit the virus's spread.

Like many of us, no doubt, I've been aware of much of this. But the recent writings of Dr Stephen Duckett, of the Grattan Institute, have brought it together in a way that's shocked me. Duckett is the nation's leading health economist. Most of what follows comes from him.

His account begins at the beginning. We congratulate ourselves that we were quick to block the arrival of foreigners who could be bringing the virus with them. We closed our borders to China early, and soon added Iran and South Korea to the list. A planeload of repatriated Chinese Australians from Wuhan was quarantined well away from us at the Christmas Island detention centre.

"However, we baulked when countries like us – white and wealthy – began to show higher levels of infection," he says. "Italy had higher levels of infection than the Asian countries, but our borders remained open to Italians."

The United States was the next source of infections. "Some Aspen skiers, returning home, brought the infection with them. They were asked, probably politely, to self-isolate in their Portsea beach houses. They did not, and the virus spread. The first wave of infections was mostly these international transmissions, returning travellers, probably wealthier than the average Australian."

At that time we didn't know much about the virus, except that it seemed to have started in China. With people of Chinese appearance being vilified in the streets, Australians were not shown at their best (or brightest).

Look at Victoria's second wave, however, and you see people at the other end of the income scale helping to spread the virus and being its greatest victims. Low-paid and poorly trained hotel-quarantine guards, with precarious job security, were the human channels from supposedly quarantined travellers to the guards' families and friends.

It was not by chance that the first areas in the renewed lockdown were social housing towers where immigrant families lived cheek by jowl. "Communication problems with residents were exacerbated by the authorities' failure to adequately recognise the need for cross-cultural communication. And the authorities in turn seemed not to trust the residents, with whom they had little contact," Duckett says.

Generations of neglect of public housing have caused overcrowding in the estates and created the conditions for rapid transmission of disease. The same could be said of jails, where our enthusiasm for locking up offenders has not been matched by our enthusiasm for building new prisons. Then, of course, there's our neglect of residential aged care.

When you think about it, the device of limiting the spread of the virus by locking down large parts of the economy and encouraging people to stay in their homes inevitably hurts the poor more than the well-off.

As a general rule (to which there will always be exceptions, without that stopping the rule from holding much truth), the more skilled, better paid and permanent jobs can be done safely from home, whereas jobs that involve the face-to-face delivery of services are more likely to be less skilled, less well-paid and less secure.

Many of these jobs – particularly in hospitality and tourism – just disappeared, while others kept going, but with greater risk of becoming infected. Health workers were particularly exposed, often with inadequate access to personal protective equipment. Disgracefully, this sometimes led to them being shunned in public.

The "flexibility" afforded by the growth in part-time and casual work has been of great benefit to employers and some benefit to young parents and full-time students. But when casuals work multiple jobs to make ends meet, any infection spreads further. And when they lack paid sick leave, their temptation to keep working despite symptoms is great.

Then there's our treatment of overseas students and others on temporary visas. The moment their costs exceed their benefits to us, we cut them adrift without a shilling.

"The privileged among us have been inconvenienced by the pandemic; the vulnerable have suffered and in some cases died because of its unequal health and economic effects," Duckett concludes.

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We're edging towards a change in economic management

We must be in a recession because I’m getting a lot more letters from readers telling me they’ve figured out how to fix the economy in a way the economists haven’t been smart enough to discover.

Their solutions can be weird and wonderful, but a lot of them boil down to a simple proposition: if the economy’s in recession and unemployment’s high because people aren’t spending enough money, why doesn’t the government just print a lot of money and spend it itself?

But here’s the scoop: the idea that, rather than borrowing to fund their budget deficits – thus incurring big debts and interest bills – governments should just create the money they need has been anathema to economists for the past 40 years, but this may be changing.

There is a growing debate among economists, between the proponents of what they call “modern monetary theory” and more conventional economists and econocrats over whether governments should just create the money they need.

The defenders of the conventional wisdom have had to concede a lot of ground. Whereas a decade ago MMT was lightly dismissed as a crackpot idea, as this radical idea has gained more attention its opponents have had to admit it would be perfectly possible to do. They just think it would be a really bad thing to do.

Trick is, the “unconventional policy” of “quantitative easing” – where the central bank buys second-hand government bonds and other securities and pays for them merely by crediting the seller’s bank account – is quite similar to what the radicals are seeking.

All the major advanced economies – the US, the Eurozone, Britain and Japan - began doing this in big licks in the aftermath of the global financial crisis in 2008, once their official interest rates were so close to zero that they could be pushed no lower.

And now, once this coronacession had prompted our Reserve Bank to drop our official rate to its “effective lower bound” of 0.25 per cent in March, it too has resorted to quantitative easing, promising to buy as many second-hand bonds as necessary to keep the interest rate on three-year government bonds no higher than 0.25 per cent.

So, how exactly would what the Reserve is already doing be very different to what the MMT advocates say it should be doing?

The greatest proponent of MMT is an Australian, Professor Bill Mitchell, from my alma mater, the University of Newcastle. Internationally, its highest profile salesperson is Professor Stephanie Kelton, of Stony Brook University in New York, author of the big-selling The Deficit Myth.

Our leading commentator on the debate is Dr Stephen Grenville, a former deputy governor of the Reserve. And our most vocal opponent of MMT is present Reserve governor Dr Philip Lowe.

Those opponents are right to say there’s nothing new about “modern” monetary policy. In the days before the loss of faith in simple Keynesianism, it was common for governments to fund their budgets partly by selling bonds to the Reserve Bank, rather than to the public.

So the fatwah on governments “printing money” dates back only as far as Milton Friedman and his monetarists’ semi-successful attack on Keynesian orthodoxy in the late 1970s, when all the developed economies had a big problem with high inflation.

Friedman argued that inflation was “always and everywhere a monetary phenomenon” which governments could control by limiting the supply of money. Governments eventually realised that the quantity of money was “demand-determined” and that setting targets for growth in the money supply didn’t work. They switched to using the manipulation of interest rates to target the inflation rate.

As sensible economists always knew, it was never true that creating money always leads to greater inflation. It does so only when the demand for “real resources” – land, labour and physical capital – exceeds the supply of real resources. Only then do you have “too much money chasing too few goods”.

This has been confirmed by the failure of all the money created by quantitative easing since the global financial crisis to cause much, if any inflation, contrary to the predictions of the world’s few remaining monetarists.

The opponents are also right to say, quoting Friedman’s most famous aphorism, that “there’s no such thing as a free lunch” and it’s a delusion to imagine MMT offers one.

As Lowe argued vigorously at his appearance before the Parliament’s economics committee earlier this month, in reply to questions from Greens leader Adam Bandt, it may seem that by creating money rather than borrowing it you’re avoiding a lot of debt and interest payments but, in reality, all you’re doing is delaying and hiding the bill to the government and its taxpayers.

It’s also a delusion (as the leading proponents of MMT acknowledge) that governments would be free to create (or “print”, to use a misleading metaphor) as much money as they needed, without restraint. The restraint is the same one it always was: the limited supply of real resources.

While ever the demand for real resources – the things we use to produce goods and services – is falling short of the supply of those resources, creating money should lead to increased demand for them (provided you do it more effectively than the big central banks did it after the financial crisis).

But once demand was growing faster than the supply of real resources, any further money you created would simply cause inflation. This is what’s really worrying the opponents of MMT (and me). If you let the politicians off the leash to spend as much as they liked up to a point, how would you ever get them to stop once that point was reached?

While ever all we’re doing is quantitative easing, the independent central banks do the deciding, not the politicians. Which brings us to Lowe’s “advanced negotiating position”: why risk letting the pollies start creating money when the government can borrow from the public at interest rates that are pathetically low. And Lowe’s promising to keep them low for as long as necessary.

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The young will carry the worst scars from this recession

When Scott Morrison spoke to the first day of the National Youth Commission's virtual "youth futures summit" on Monday, he sought to assure the young people that, difficult as the pandemic and the economy are at the moment, there is another side to it, "where Australia emerges once again, where we actually do go back to the life that we loved".

I'm sure that's true. But if past recessions are any guide, most of us will have recovered from the coronacession and be back enjoying the life we love long before most of the present crop of youngsters leaving education have found themselves a decent job.

If the past is any guide, the government won't do nearly as much as it should to help those youngsters who, "through no fault of their own", as Morrison would say, had the immense misfortune to be born in the wrong year or three.

And, quite apart from the pain so many young people will suffer, the money the taxpayer saves from that neglect is likely to be exceeded by all the subsequent cost to the budget in healthcare, unemployment benefits and workers whose reduced incomes mean they don't pay as much tax as they might have.

The greatest burden of recessions always falls on the young for the simple reason that employers' automatic response to a recession is to cancel their annual intake of school and university leavers. The deeper the recession, and the slower the recovery from it, the more years that entry-level hiring is postponed.

This was the case for many years after the global financial crisis of 2008 even though, for the rest of us, a recession was avoided.

You've heard that, unusually in this recession, the greatest burden has fallen on women rather than men. But this can be true while it remains true that the young are the greatest losers. That's because a disproportionate share of the women is young.

As summarised for the summit by the independent economist Saul Eslake, recent research by Treasury has found that people who enter the jobs market for the first time during a recession are less likely to change jobs – which means they're more likely to miss out on one of the main ways by which people get pay rises during their first 10 years in the workforce (that is, by changing jobs).

This matters because almost 80 per cent of lifetime wage rises occur during the first 10 years of someone's working life. So the "scarring" effect of leaving education in a bad year lasts for 10 years.

Treasury finds that the scarring effect has been bigger since 2000 than it was in earlier recessions, so that the most recent generations of young people have been affected more than previous generations. And it's worse for women than for men.

All this is consistent with the interim findings of a nationwide inquiry into youths' transition from education to employment, which the National Youth Commission published on Monday. It finds that unemployment for 15- to 24-year-olds is consistently higher than for 25- to 64-year-olds. And that traditional pathways to employment for young people have eroded over the past couple of decades.

One thing that's changed over the years is the growth of underemployment. To the present unemployment rate of 7.5 per cent and rising must be added the underemployment rate of 11.2 per cent, representing those who have some paid work but want more.

Just remember it's the young who dominate the underemployed. Many of them have multiple jobs, but still can't make ends meet. Many are in the "gig economy", whom governments have allowed to be defined as "independent contractors", thus permitting those wonderful innovative outfits that run app-based fast-food delivery and all the rest to sidestep the legal obligations of an employer.

Remember, too, that the seeming epidemic of "wage theft" – which, by their neglect, governments have done too much to allow and too little stamp out – would be perpetrated particularly on the young.

Unsurprisingly, the inquiry found the (pre-pandemic) levels of the youth allowance and unemployment benefits – which successive governments have frozen in real terms for 25 years – are inadequate. It's the young who suffer most from this parsimony.

Morrison and his ministers have repeatedly defended the $40 a day by saying people are on the dole only temporarily before they find a job. That was certainly the reasonable expectation in the past. Now, however, it's one of the respects in which the inquiry found the system no longer fit for purpose.

Another respect is, it's no longer true that most jobs for young people are full-time. Only in the past month has the government temporarily changed the means test to encourage the unemployed to look for part-time jobs. Pity so few of them are on offer at the minute.

The youth commission has proposed a detailed "youth futures guarantee" laying out reforms and measures that would better support our young people in meeting the challenges they face. Challenged to respond to the proposal, Morrison was masterfully noncommittal.

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Pandemic could kill off governments' credit rating bogeyman

I guess we shouldn’t be surprised that an economic shock as big as the pandemic is breaking down longstanding rules – written and unwritten - about how the national economy should be managed.

One rule is the rigid demarcation between fiscal (budgetary) policy and monetary (interest-rate) policy. Another is that the states leave management of the macro economy to the feds, and stick to a Good Housekeeping approach to their own budgets. A third is that there should be free trade and movement between the states.

A corollary of the strict separation of fiscal policy and monetary policy is that the federal government and its Treasury should leave all public comment about the appropriate levels of interest rates and the dollar to the independent Reserve Bank, while the Reserve makes no public comment on the appropriate levels of government spending, taxation and budget deficits.

On that convention, Reserve governor Dr Philip Lowe has been stretching the friendship almost since the day he took the job in 2016. His problem is that macro management works best when both arms of policy are pushing in the same direction: either moving the economy along or holding it back.

But whereas his goal has been to use low interest rates to stimulate a weak economy and get unemployment down, the Abbott-Turnbull-Morrison government’s goal has been to tighten fiscal policy and turn the budget deficit into a surplus.

Lowe hasn’t been able to resist the temptation to note - repeatedly - that he could do with more help from fiscal policy. And as the level of interest rates has fallen further and further towards zero, he’s been more and more outspoken. Now the official interest rate has reached the “effective lower bound” of 0.25 per cent, he’s been even more importuning.

But in his evidence to the House of Reps economics committee a fortnight ago, he moved to putting the hard word on the premiers. Replying to a question about fiscal stimulus, he said: “I think we need both the federal government and the state governments carrying their fair share.

“The federal government, I understand, has announced measures so far equivalent to roughly 7 per cent of gross domestic product ... The measures to date from the state governments add up to close to 2 per cent of GDP ...

“The challenge we face is to create jobs, and the state governments do control many of the levers here. They control many of the infrastructure programs. They do much of the health and education spending. They’re responsible for much of the [regular] maintenance of much of Australia’s infrastructure.

“So I would hope, over time, we would see more efforts to increase public investment in Australia to create jobs, and the state governments have a really critical role to play there.”

At the national cabinet meeting on Friday, we’re told, Lowe told the premiers they should collectively spend $40 billion over the next two years – equivalent to 1 per cent of GDP per year – on job creation measures, including infrastructure, social housing and training.

Trouble is, the states have already done about as much as they can without exceeding the borrowing limits set by the credit-rating agencies, and so endangering their triple-A ratings. So what’s Lowe’s solution to that problem? Dooon worry about ’em.

At the parliamentary hearing, he said: “From my perspective, creating jobs for people is much more important than preserving the credit ratings. I have no concerns at all about the state governments being able to borrow more money at low interest rates. The Reserve Bank is making sure that’s the case.”

At one level, this is a sign of the momentous times we live in. Governments around the world are borrowing massively as the only way they can think of to overcome the coronacession. With interest rates on long-term government borrowing at unprecedented lows, what have they got to fear?

In effect, they’re daring the three big American for-profit rating agencies to downgrade them. And so far, those supposedly righteous judges haven’t accepted the dare. Perhaps they’re remembering the time after the global financial crisis when one of them had the temerity to downgrade US government bonds. No one took any notice.

The presumed penalty for being downgraded is that the bond market increases the interest rate it requires to lend to you. But what if the market has stopped listening? In any case, with interest rates ultra-low, why should anyone fear having to pay a tiny fraction more?

At another level, however, this is Lowe telling Treasuries, federal and state, that the jig is up. Ever since the mid-1980s, they’ve used the threat of a rating downgrade as a stick to wave over the heads of the spending ministers, to limit their spending. They’ve used the rating agencies as the ultimate policemen enforcing Smaller Government.

Not any more, it seems. Right now, apart from the appalling prospects for unemployment, Lowe has bigger worries: the push from the proponents of “modern monetary theory” urging governments to stop funding their budget deficits by borrowing from the public and just print the money they need.

In Lowe’s mind, this would be the ultimate breach of the separation of fiscal policy and monetary policy. The elected government would be telling the independent central bank how much money to create.

Lowe would be willing to bend the rules a lot to avoid this ultimate breach. He certainly wouldn’t want the rating agencies adding to the pollies’ temptation to print rather than borrow. But he would be willing to resort to “unconventional measures” and buy big quantities of second-hand Commonwealth and state government bonds and so ensure their interest-rates stay ultra-low.

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It may be a terrible recession, but it could have been worse

In economics, everything is relative. Relative to you, the coronacession is likely to be the worst economic disaster you’ll experience in your lifetime. Relative to Australia, it is – as the media (including yours truly) keep telling us – the worst recession since the Great Depression of the 1930s.

But, as a report published this week by the Lowy Institute reminds us, there’s another side of the story. Relative to what we were expecting initially, the recession isn’t as bad as feared. And relative to many other developed economies, we’ve got off lightly.

The report is by Dr John Edwards, a former member of the Reserve Bank board. Perhaps in reaction to his former career as a journalist, Edwards has a penchant for highlighting the aspects of an economic story his former colleagues have tended to gloss over. Which means he finds the not-so-bad bits – and so is always worth hearing from.

How badly a country is suffering economically is largely a function of how well it responded to the pandemic. Those that followed the medicos' injunction to "go early, go hard" have done better than those that procrastinated. Fortunately, and thanks in large part to Scott Morrison’s leadership, we’re in the former group.

Edwards says that, because of our early success in controlling the virus, the "pandemic in Australia is fading sooner and with less economic damage than expected. While the secondary wave of infection in Victoria is a big setback and there may yet be other regional or local outbreaks, the economic recovery already evident is set to continue."

The pandemic "from which Australia is now emerging was the most abrupt, savage and frightening economic shock in the lifetime of most Australians. But the jolt was also short and unexpectedly shallow."

If you judge it by the progress of the economy’s output (real gross domestic product), you may not be convinced the recovery has begun. But judging it by the state of the jobs market, which is what matters most, leaves little doubt.

The best measure of the immediate employment response is the total number of hours worked in the economy. Between March and April we experienced an astonishingly swift fall of 9 per cent. The following month it fell by less than 1 per cent. In June, however, it rose by 4 per cent. The 1.3 per cent rise in July signals a slowdown in the rate of the jobs recovery.

So in July we were still down 5 per cent on July 2019. But here's Edwards’ other way of looking at it: "Through the four months of what was widely portrayed as a general economic cessation, a large proportion of Australian employees kept working.

"New networking technologies permitted most office work to be performed at home. Mining and farming continued. So did much of manufacturing and construction. Electricity, gas and water utilities employees kept their jobs.

"Throughout Australia, public servants continued working, often at home. Tradespeople, cleaners and gardeners more often than not were working. Most health employees remained on the job, busier than ever. Childcare facilities remained open in most places and, where necessary, classroom teaching continued remotely. Media workers struggled to keep up with the demand for news and entertainment.

"The economic cessation, such as it was, centred on restaurants, clubs, pubs and accommodation, discretionary retail such as clothing and furniture, local and international travel, sports, entertainment, and the arts.

"Take-up of the JobKeeper program, which helped businesses retain employees, was far lower than expected because the economic damage was less than expected. All up, most of the Australian workforce remained on the job, either from their usual place of work or from home."

Surprisingly, most of the economic downturn took the unusual form of a sudden cessation in household consumption.

While it’s true that colleges and universities have been hurt by the suspension of foreign student arrivals, Edwards says the majority of international students living in Australia before the pandemic stayed. Indeed, many of them had little choice. Quarantines will remain necessary, but plans are now being made to permit the resumption of student arrivals.

More than nine million foreigners, mostly tourists, visited Australia last year. The number arriving since March this year is “scarcely worth counting," he admits. The resumption of mass foreign travel, unimpeded by quarantine, awaits not only the discovery and approval of a vaccine, but also its worldwide distribution in millions of doses.

But get this: in the short term, however, the suspension of normal international travel actually adds to Australia’s gross domestic product. That’s because Australians’ spending abroad exceeds foreigners’ spending in Australia.

Now, compare how we’ve fared with how the other rich countries have. Taking total coronavirus deaths as a proportion of the population, Edwards calculates that our rate is less than a thirtieth of the rates for the United States and Britain.

So it’s little wonder our economy hasn’t been as badly hit. Using the forecasts of the International Monetary Fund, the economic contraction in the United States, the whole of the Euro area, Britain and Canada will be twice the size of our contraction.

Global economic growth will be lower than it would otherwise have been for years to come. And, "while unemployment will be the principal domestic problem, the changing global context will also shape the Australian economy for years to come", Edwards predicts.

Doesn’t sound good. But he has found a silver lining: “The impact for Australia of lower global demand and production is mitigated because three-quarters of its goods exports are to East Asia, a region that is growing faster than Europe or the United States and which, in most cases, has handled the pandemic well.

"While world output [gross world product] will contract nearly 5 per cent in 2020 on IMF forecasts, developing Asian countries will contract by less than 1 per cent."

For us, it all could have been much worse.

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Tribal prejudices about wages guarantee a weak recovery

Neither side of politics wants to admit it, but it’s a safe bet that the economy’s recovery from the coronacession will be weak and slow until we get back to strong growth in wages.

Scott Morrison and the Liberals can’t admit it because it flies in the face of their tribe’s view that the unions have too much power, that wage rises are always economically damaging and that public servants are underworked and overpaid.

Meanwhile, Anthony Albanese and Labor can’t admit it because they live in fear of being portrayed as anti-business and because tribal loyalties mean they’ve taken on the union movement’s vested interest in ever-increasing compulsory super contributions.

Last week we learnt that, as measured by the wage price index, after growing by a weak 0.5 per cent or so per quarter for the past six years, wages grew by just 0.2 per cent in the June quarter, the first virus-affected quarter. This took annual growth down to 1.8 per cent.

Worse, wages in the private sector grew by just 0.1 per cent in the quarter. This included actual falls in some wage rates, those negotiated by individual arrangement with people in senior executive and highly paid jobs.

The Reserve Bank sees annual wage growth falling to 1.25 per cent by the end of this year, and staying there until the end of next year. By the end of 2022, it will have recovered only to its present well-below-par rate.

Wage growth is the key to recovery because wages are the greatest single driver of economic activity and employment. But rather than thinking of ways to get wages up, both sides are working on ways to slow them further.

Not that private sector employers will need any help. They always skip pay rises during recessions because, afraid of losing their jobs, workers know they’re in no position to argue.

But, while as individuals, firms benefit from cutting the real value of the wages they pay, when all of them do it at the same time, they all suffer because the nation’s households have less money to spend on the products of the nation’s businesses.

So what can governments do? Well, they can at least avoid doing anything that makes real wage growth any weaker. Federal and state governments can resist the temptation to cut the real wages of their own employees.

This helps sustain household income directly, but also indirectly because employer and employee judgments about what’s “a fair thing” are influenced by what other employers are doing – that is, by wage “norms”.

State Labor governments have been as bad as Coalition governments in using weak growth in private sector wages as an excuse to slow the growth in their own wages. They haven’t, however, been as muddle-headed as the NSW government in freezing its public servants’ wages so as to “stimulate” their economy by using the saving to pay for additional infrastructure spending.

Robbing Peter to pay Paul ain’t stimulus. And the Australia Institute has used the Australian Bureau of Statistics’ “input-output tables” to show that whereas every $1 million spent by consumers (including public servants) generates 1.79 jobs directly, every $1 million spent on construction generates only 0.97 jobs.

But federal Labor is worse. It’s thrown its weight behind the for-profit and industry superannuation funds’ campaign to ensure the rate of compulsory employer super contributions is raised from 9.5 per cent of wages to 12 per cent over the next few years.

Labor and the unions have turned a blind eye to the theoretical and empirical evidence that employers largely recover the cost of super contributions by granting pay rises that are lower than otherwise.

So, at a time when we need workers to be spending as much as they can, and the rate of household saving is way too high, the labour movement wants workers to save an even higher proportion of their wage – even though the more we save the less jobs growth we get.

(The Grattan Institute’s Brendan Coates has demonstrated that the present contribution rate of 9.5 per cent is sufficient to yield workers a comfortable income in retirement, and that the Morrison government’s early release of super to distressed workers will have little effect on this because most of it will be made up by part-pension payments that are higher than otherwise.)

Finally, Morrison and the Liberals are working on plans to further “reform” the wage-fixing system by making changes that the employers want but the unions oppose. This would leave everyone better off, we’re told, by making the system more “flexible”.

At a time when the system is, if anything, too flexible – witness: so much part-time and casual labour, labour-hire, phoney self-employment, the “gig economy”, almost non-existent strikes, and six years of chronically weak wage growth – this could only increase employers’ power to keep wages low.

See what I mean? Wage growth looks set to stay even weaker than it was before the coronacession.

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Technology is amazing, but human nature is unchanging

When momentous events such as the coronavirus pandemic occur, it's tempting to conclude they'll change our lives forever. Even if we don't think it, you can be sure there'll be some overexcited journalists saying it. Just as there were after the attack on the Twin Towers on 9/11 in 2001.

Even then I was too old to believe it would "change our lives forever" and – although it did have lasting effects on international relations and our fear of terrorism – it didn't really.

This time people are telling us we'll all be working from home (with city office blocks and streets turning into ghost towns), doing our shopping online, learning online, seeing doctors online, and no longer doing business travel.

Somehow, I doubt it will be that radical. But I don't doubt there'll be change in all those directions. Most of them were already happening as part of the continuing digital revolution, and this will accelerate those trends.

The revolution's usual pattern is to bring modest benefits – greater "functionality" (machines that do more and better tricks) and convenience – to an industry's customers, while turning the industry on its head, with considerable disruption to the lives of many of its workers.

There was a time when watching television meant seeing only what the few available channels happened to be showing at the time. These days, recorders and catch-up apps and a multitude of free-to-air and for-the-small-fee channels and streaming video have given us vastly more choice.

This has meant huge upheaval for the industry, but improved our lives only to a small extent – something we've soon come to take for granted.

Some people (and not just Victorians) are finding it hard to imagine the pandemic will ever be over. But, though we can't be sure when, it will end. And when it does, far more aspects of the way we live and work will go back to the way they were than will change forever.

Truth be told, and unless we do a lot more to correct it, the biggest and baddest continuing effect of the pandemic will be on the careers of young people leaving education during the recession and what looks like being a long and weak recovery.

Staying serious, we can expect more concern about problems in health than in education. More concern about physical health than mental health. More concern about the problems of the old than those of the young.

Nothing new about any of that – except that Scott Morrison's heroic condemnation of those on his own side of politics suggesting that the lives of the elderly should have been "offered up" in the interests of the economy sits oddly with his and all federal politicians' tolerance of decades-long neglect and misregulation of aged care.

(As economists make themselves unpopular by pointing out, every time politicians decide to spare taxpayers the expense of fixing a level-crossing or in some other way saving "just one person" they are implicitly putting a dollar value on human life. They do so on our behalf and we rarely tell them to stop doing it. The term "cognitive dissonance" comes to mind.)

But I'm determined to keep it light this week, so on with happy chat about the pros and cons of new technology.

It's worth remembering that advances in digital technology have made the lockdown and social distancing tolerable – indeed, doable – in a way that wouldn't have been possible 20 years ago. Far more of us work as "symbolic analysts" (people who spend all day making changes on a screen) these days. Get access to all the office's programs on your laptop at home? Easy. Zoom to endless and unending meetings? Feel free.

The virus is likely to hasten technology-driven change because the crisis has broken through our fear of the new and unfamiliar. Both workers and bosses now understand both the pros and the cons of working from home relative to working from work.

We've tried buying groceries online. Doctors, departments of finance and patients have overcome their hang-ups about telemedicine. Online learning suits uni students better than school pupils.

But all these things do have their advantages and disadvantages. And most of the disadvantages are social. For the human animal, social distancing is a deeply unnatural act. We get a lot of our emotional gratification from face-to-face contact.

We communicate more efficiently and we learn things we wouldn't otherwise learn that help us do our job better. Relationships with suppliers, customers and consultants work better when we come to know and like each other.

So I think we'll do more digital remote working, but not turn our working lives over to it. Surveys show most people would like to work from home some days a week, but not all week. Business people may do less travel between capital cities – it could easily become the latest business cost-cutting fad – but it would be amazing if executives stopped wanting to shake hands with the people they deal with.

Technology can change what we do, but it won't change human nature.

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'Extreme uncertainty' causes RBA's bright-side mask to slip

I can’t be sure, but the econocrats seem to have become uncertain about what they’re uncertain about. The one thing about which they’re not uncertain is how uncertain they are. And, of course, they’re no longer pretending to be certain it’ll all be fine.

Central bank governors take a professional pride in concealing whatever doubts and fears they have. Which is as it should be. Treasurers, on the other hand, have become so ruled by their young spin doctors they’re perpetually in bulldust-your-way-through mode.

Economists (and media economic commentators) always exude confidence about their knowledge of what lies ahead because they know that’s what the customer’s paying for. They’re like doctors who dispense pills not because they’ll work but because they’re what will make the patient feel good. At least until they’re out of the surgery.

Psychologists tell us the human animal is eternally seeking “the illusion of control”. We want to know what the future holds so we can – we fondly hope – control how it affects us. People ask me questions about the financial future. I explain why it’s not possible to know. They say: “Yes, I know that, Ross, but whaddya reckon?”

The new forecasts the Reserve Bank issued on Friday were significantly different to those it issued three months ago. Worse, they laughed at Treasury’s forecasts in the economic update just two weeks earlier.

The general story is that, thanks to the setback in Victoria, the upturn in the economy’s production (real gross domestic product) will now come later than expected, and be weaker. When Reserve governor Dr Philip Lowe says the recovery is “likely to be both uneven and bumpy” you can be confident he’s not exaggerating. “Uneven” means stronger in some states than others. “Bumpy” means not every post will be a winner.

Reading between the lines, the lockdown's full contractionary effect on GDP was expected to come in the June quarter (for which we’ll see the figures in three weeks’ time), with the recovery starting in the present September quarter.

The first quarter after the contraction should always be pretty strong (and, this time, particularly because the end of the lockdown meant people could get out, visit shops and restaurants and pubs), even if subsequent quarters aren’t as strong.

This time last week, the smart money was expecting the recovery in the September quarter to be followed by a contraction in the December quarter, as demand was hit by the wind back in the JobKeeper wage subsidy and the JobSeeker supplement.

Now, the September quarter recovery in the other states is likely to be overwhelmed by the effects of Victoria’s move to a harder lockdown. This, in turn, probably means there's less likely to be a further contraction in the December quarter – just continuing weakness. We do know that, in response to Victoria’s problems, Scott Morrison has modified JobKeeper at a cost of more than $15 billion.

Friday’s statement on monetary policy acknowledged “extreme uncertainty” about the course of the pandemic and, hence, its economic effects. In response to this uncertainty, the Reserve has moved from a single set of forecasts to three scenarios: baseline, upside and downside.

As explained by the Reserve’s assistant governor (economic), Dr Luci Ellis, in a webcast for the Australian Business Economists, the baseline scenario assumes that the rate of infection subsides, the tightening of restrictions in Victoria succeeds, there are no new lockdowns elsewhere, and restrictions are eased progressively over the rest of the year.

The upside scenario assumes the pace of decline in the number of cases is a bit faster than in the baseline, so the restrictions are eased a bit faster – like recent experience in the smaller states. People take more comfort from this and so confidence recovers faster than in the baseline.

Households are thus willing to spend more of the savings they accumulated during the first half of this year, compared with what’s assumed in the baseline scenario.

The downside scenario assumes that infection rates continue to escalate around the world this year and next. Australia faces a series of outbreaks and periods of stage three and four restrictions in some states. The result is further near-term weakness in economic activity. Confidence is damaged and so the recovery is much slower as well.

The other main point of variation between the three scenarios is how long Australia’s international borders remain closed. Three months ago, the Reserve was assuming travel restrictions would be lifted by the end of this year. In the new baseline and upside scenarios, it’s assumed that the borders reopen mid next year. In the downside scenario, it’s assumed continuing spread of the virus overseas causes our borders to be closed for the whole of next year.

There is, of course, another major source of uncertainly that the econocrats are too polite to mention: whether Morrison retains his pragmatic approach and keeps the government-spending tap open to fill whatever gaps emerge during the slow and troubled recovery, or succumbs to his ideological instincts and eschews further spending. My scenario: he’ll do more, but not enough.

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People on the dole don't want a job? Don't believe it

When Scott Morrison introduced the "coronavirus supplement" that temporarily added $275 a week to the dole’s $40 a day, he explained this was to help those who’d be losing their jobs "through no fault of their own". But it wasn’t long before he was finding fault.

"We are getting a lot of anecdotal feedback from small businesses, even large businesses, where some of them are finding it hard to get people to come and take the shifts because they’re on these higher levels of payment," Morrison told 2GB radio.

"What we have to be worried about now is that we can’t allow the JobSeeker payment to become an impediment to people going out and doing work."

These views would explain his decision to slash the supplement to $125 a week after September, and continue it only to December. What happens after that is still to be decided. But recipients will be required to prove they’ve looked for at least one job a week and will have their dole suspended if they refuse to take a job offer considered suitable.

Of course, it wouldn’t have escaped Morrison’s notice that this "treat ’em mean to keep 'em keen" approach would also help with his worries about the ballooning budget deficit.

I can’t say I’m surprised to hear small business people saying that, despite all the talk of high unemployment, they can’t get people to take the jobs they need to fill. I've heard that in all the previous recessions I’ve worked through.

And, indeed, the practice of denigrating the jobless goes back at least as far as the Great Depression of the 1930s. Then, there were newspaper reports of huge dole frauds that threatened to cripple the system and of a lazy, chicken-eating family living in luxury on the dole.

There’s just one problem with all this. There’s no hard evidence to support these anecdotes, and growing evidence that paying decent rates of unemployment benefit doesn’t discourage people from taking jobs.

These anecdotes don’t fit with a survey of employers conducted by the federal Department of Employment in June, which found just 6 per cent of employers said they were having difficulty recruiting due to a lack of applicants.

The trouble with anecdotes is that they’re anecdotal. The people telling you the stories never give particulars of why they had no takers. Were the vacancies well advertised? Were they paying below the legal award wage or wanting to pay in cash under the table? Were they wanting people to work overtime or at weekends without getting penalty rates? Was the job dangerous or especially unattractive – split shifts, for example.

In recent years, many casual jobs paying less than the law requires have been accepted by overseas students and others on temporary visas. Since the coronavirus hit, many of these people, being denied unemployment benefits or the JobKeeper wage subsidy, have been told to go back home, and have done so. Is that the problem?

In my experience, small business people can see their own perspective very clearly, but other people’s not so much. Many people who seek part-time work do so because they have other commitments that the work must be fitted around – full-time studies, for example, or young children. Maybe that extra shift Morrison refers to would have required people to pay more for childcare.

Then there’s the special circumstances of the virus. It’s likely many single parents have given up casual or part-time work to stay home with their kids when schools are closed. Some older people would have stopped working for fear of catching the disease.

I’ve met many business people (big and small, so to speak) who fall for the economists’ occupational hazard of assuming that, because money is a powerful motivator when it comes to work, money is the only motivation.

They can’t imagine that anyone would want to work rather than sit around at home because they like working, because they like being busy, like seeing their workmates, feel that healthy people should work, or even just to avoid the stigma many unkind people attach to being unemployed.

Many people have the attitude that anyone who really wants a job can find one. But while ever the number of unemployed exceeds the number of vacant jobs, this is a “fallacy of composition” – what may be true for the individual isn’t true for everyone.

Between February and May, the number of people on the JobSeeker payment (formerly Newstart) and the youth allowance rose by more than 90 per cent to 1.8 million whereas, according to the Australian Bureau of Statistics’ quarterly survey, the number of vacant jobs fell by 43 per cent to 129,000.

So there are about 14 jobseekers for every vacancy. Which means that, no matter how punishingly low you set the unemployment benefit – say, $40 a day – you can’t incentivise people to take jobs that don’t exist.

Even when the coronavirus supplement had almost doubled the dole to $550 a week, that’s just 73 per cent of the national minimum full-time wage of $754 a week. This percentage is one measure of what economists call the “wage replacement ratio”.

It’s also the most “conservative” measure - that is, likely to overstate the problem – since most full-timers would earn more than the minimum wage. In any case, the planned $150 cut in the supplement to just $125 a week will reduce the replacement ratio to just 53 per cent.

Not much of a disincentive to take a job there, I’d have thought. But this great fear of temporarily increased unemployment benefits being a great disincentive to work is a big issue in the United States and an argument Republicans have used to refuse to renew the supplement.

But as Catherine Rampell has written in the Washington Post, no fewer than five different academic studies have concluded the same thing: the Americans’ supplement does not appear to have adversely affected jobs growth.

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Virus reminder: governments need to be better, not smaller

One good thing the coronavirus has done is slow the pace of our lives, leaving us more time to think about them. And since the main device being used to stop the spread of the virus has been to reduce physical contact between people, it hasn’t been hard to see that what matters most to us is face-to-face contact with family and friends.

People of middle age fret about not being able to visit elderly parents. The great Dr Brendan Murphy, flat out advising the Prime Minister, really misses being able to hug his granddaughters. (Grandsons and granddaughter, in my case.) Teenagers take their family for granted, but miss their friends. Younger kids realise they actually like going to school and mixing with others.

The virus has also thrown into relief our rights as individuals versus our obligations to the group. The prevailing political and economic ideology highlights the individual and plays down the group, but in emergencies like this even our squabbling federal and state politicians see that the only way of coping is to co-operate rather than compete.

Looking at the Americans and the terrible disaster they’re making of it – including people refusing to wear masks because it’s a violation of their personal freedom – it’s not hard to see that individualism can go too far, and playing your part as a loyal member of the group has its virtues.

The virus reminds us that many of the problems we face can’t be solved by individuals acting alone, but by all of us acting together. For this we need leadership; we need the government to govern. To tell us what needs to happen, to issue instructions, provide support for those who need it, and then have all of us falling into line and pulling our weight.

That’s easy to see – and accept – in a crisis, but harder when we’re muddling along as normal. Fact is, however, our world abounds with problems that can’t be solved by individuals and businesses acting on their own initiative.

For these we do need somebody – or some body – with the authority to act on our behalf, calling the shots, fixing things, spending money and requiring us to cough up that money according to our ability to pay.

And yet the rise of individualism has been accompanied by the denigration of the role of government. It was the now-canonised Ronald Reagan who famously said that the nine most terrifying words in the English language are "I’m from the government and I’m here to help".

Obviously, governments can be far from perfect. Government agencies can be unhelpful, they can push us around for no good reason, be inefficient and waste our money. And yet the prevailing ideology’s response – influencing the behaviour of both sides of politics – hasn’t been to improve the functioning of government, but to chop it back as much as possible.

Any government business that can be sold, should be. Industries should be deregulated so private enterprise is given maximum freedom to be enterprising. There are services that governments need to pay for from the public purse, but their provision should be contracted out to private firms.

The trouble is, the advocates of Smaller Government have never persuaded the public of the wisdom of this approach, nor received a mandate. When governments try to cut back government spending in big licks – as Tony Abbott, despite promises to the contrary, tried to do in his first budget – they get repudiated.

So they end up forever trying to keep the lid on government spending – quietly cutting money going to politically unpopular causes (the unemployed, public servants), and ignoring all the people warning them to start preparing for possible problems in this field or that (a bad bushfire season, for instance).

They justify all this short-sighted penny pinching by saying no one wants to pay more taxes. Which is the message we so often send them, partly because we’ve grown distrustful that our money will be spent wisely.

See where this is leading? All the denigration and distrust of government does much to explain why we haven’t responded to the pandemic as well as we should have. National planning for a pandemic was discontinued after 2008 and it’s likely that the recommended national stockpile of personal protective equipment was a victim of successive "efficiency dividend" cut backs.

The ironically named efficiency-dividend cuts to the public service may help explain the inadequacy of Victoria’s contact tracing arrangements. There’s an inquiry into the failures of Victoria’s quarantine of returning travellers, contracted out to private firms.

Deregulation of wage-fixing has encouraged the growth in casual workers, whose lack of paid sick leave tempts them to go to work while at risk of having contracted the virus. Governments are scrambling to fill this dangerous gap.

Finally, the decades of wilful neglect and misregulation of aged care facilities, “left out of sight and out of mind” and “fragmented, unsupported and underfunded” – to quote the latest of many inquiries. All to keep taxes low.

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Weak inflation tells us: it's the demand side, stupid

Despite the remarkable 1.9 per cent fall in the consumer price index in the June quarter, we face no imminent threat of deflation. But it’s not as improbable a fate as it used to be.

Apart from in headlines, one negative quarter does not deflation make. Deflation occurs when price falls are modest, widespread and continuous, the product of chronically weak consumer demand. Businesses cut their prices as the only way to get people to buy what they’ve produced. Their goal is not to make a profit, but to reduce their losses.

Paradoxically, deflation – which was dogging Japan not so many years ago – is to be feared. Why buy now if prices are falling? Why not wait until they’re even lower? But the longer consumers wait, the more prices fall. And the faster they fall, the more businesses cut production and lay off workers. The economy implodes.

By contrast, our fall was produced by cuts in two key government-controlled prices – for childcare and pre-schools – plus petrol prices. We already know these falls will largely be reversed in the present quarter.

Even so, all the other prices in the CPI basket of goods and services rose during the quarter by just 0.1 per cent. People are reluctant to buy during recessions, so businesses don’t raise their prices for fear of selling even less. It’s a safe bet inflation will stay negligible for as long as the recession lasts and for as long as it takes the economy to recover.

Trouble is, we had unduly weak price growth long before the coronasession. Our rate of inflation’s been below the bottom of the 2 to 3 per cent target range for almost six years. The Reserve Bank has been struggling to get it up into the target, "Goldilocks" range without success.

Point is, when you have a problem with high inflation, you have a problem with the supply side of the economy. Supply isn’t keeping up with demand, so something needs to be done to get the economy’s production growing faster and more efficiently.

Conversely, when inflation isn’t a problem but high unemployment is, you have a problem with demand side of the economy. Consumers aren’t spending enough and businesses aren’t investing enough.

But too-low inflation isn’t the only indicator that demand and supply are out of whack. Another sign is record low interest rates. They’re low not just because inflation is so low, but also because “real” interest rates – the lenders’ above-inflation reward for letting other people use their money – have also fallen.

Why? It can only be because the amount of money savers have available to lend (the “supply of funds”) exceeds the amount home-buyers, businesses and governments want to borrow to cover their investment spending (the “demand for funds”). That real interest rates have been falling for years is another sign that our problem is chronic deficient demand, not inadequate supply.

One consequence of this is that the authorities’ ability to encourage borrowing and spending by cutting interest rates has been exhausted. So “monetary policy” has done its dash, leaving “fiscal policy” – the budget – as the only instrument left for the government to use to support the economy during the recession and then to stimulate growth.

If it wants more spending in the economy, the government must do it itself.

There’s just one difficulty. During the period in the 1970s and ‘80s when it was clear the developed economies had a major problem with inflation – meaning the supply side was chronically unable to keep up – the conventional wisdom emerged that the short-term management of the economy should be left to monetary policy, with fiscal policy reserved to help with other, medium-term issues.

This approach fitted neatly with the conservative side of politics’ preference for Smaller Government. Our Liberals have come to view macro-economic management in largely party-political terms: we use monetary policy; Labor uses fiscal policy. We follow neo-classical economics; Labor follows Keynesian economics. We cut government spending and taxation; Labor loves to spend and tax. We worry about deficient supply; Labor worries about deficient demand.

This political ideology approach to macro management can’t cope with the developed economies’ tendency to switch from long periods when supply and inflation are the big problem to long periods when demand and unemployment are the big problem.

You can see this in the Morrison government’s obvious reluctance to spend enough to limit the economy’s contraction to two successive quarters, despite our continuing struggle to contain the virus. You see it in Morrison’s desire to move on to “reforms” aimed at improving the supply side.

Both political sides see that wage growth is too weak at least partly because the productivity of labour is improving only slowly. But the Liberals’ ideological approach to macro tells them the answer to low productivity is more supply-side reform, whereas a pragmatic, more contemporary analysis says it seems obvious that if consumer demand is weak, business investment will be weak and if business investment in the latest technology is weak it’s no surprise that productivity improvement is slow. It’s the demand side, stupid.

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Morrison’s not doing nearly enough to secure our future

It was obvious this time last week, but even more so a week later: Scott Morrison and Treasurer Josh Frydenberg are taking both the continuing threat from the coronavirus and the need to restore the economy far too cheaply. Figuratively and literally.

One thing another week of struggle by Victoria and NSW to contain the virus’s second wave has shown more clearly – plus the realisation of how vulnerable the neglect and misregulation of our aged care sector have left us – is the unreality of the government’s expectations about the effects of the pandemic.

Last week’s economic and budget update assumed Victoria would be back on track in six weeks and NSW’s struggles were too minor to matter. And also that we’ll start opening to international travel in January.

A more realistic assumption would be that the larger, virus-prone half of the economy (NSW and Victoria) will need to stay sealed off from the healthier, smaller half (the other states and the Northern Territory) indefinitely. Half a healthy economy is far from ideal, but it beats none.

Surely we should have realised by now that the pandemic will be a long-haul flight. Speaking of which, our barriers against the rest of the world are likely to stay up long after the 12th day of Christmas.

Economically, we must make the best of it we can – which won’t be anything like as good as we’d like. Forcing the pace on lifting the lockdown and removing the interstate barriers could easily end up setting us back rather than moving us forward.

What economists seem yet to understand is that, psychologically, what we have to do to keep the virus controlled is the opposite to what you’d do to hasten an economic recovery. To ensure people keep mask-wearing, hand-washing, sanitising, social-distancing and filling out a form every time they walk into a cafe for month after month, you keep them in a state of fear, afraid the virus may bite them at any moment.

How will this give them the confidence to get on with spending and investing? It won’t. Quite the opposite. But it’s the first indication Morrison and Frydenberg will need to spend more for longer.

The second thing that’s more obvious now than it was a week ago is that the setback in Victoria and NSW has put a question mark over the signs of an initial bounce-back in the economy as the lockdown has been lifted. The new payroll-based figures for the week to July 11 show jobs falling in all states, not just Victoria and NSW.

All this casts further doubt on the wisdom of the changes to the JobKeeper and JobSeeker programs announced last week. The initial reaction of relief that the government had not gone through with its original plan to end them abruptly in September has given way to the realisation that this threat of dropping the economy off a “fiscal cliff” has been delayed rather than averted.

The new boss of independent think tank the Grattan Institute, Danielle Wood, has estimated that the changes to the two job schemes will reduce the government’s support for the economy by close to $10 billion in the December quarter and thus “leave a substantial hole in the economy”.

In an earlier major report, Grattan argued that the government needed to spend a further $70 billion to $90 billion to secure a recovery. The measures announced last week amount to only about an additional $22 billion.

According to calculations by the ANZ bank’s economics team, the withdrawal of budgetary support amounts to the equivalent of about 10 per cent of quarterly gross domestic product during the December quarter.

In consequence, although the bank agrees with Treasury that real GDP will grow in the present September quarter, it sees the economy returning to contraction in the December quarter. What would that do for business and consumer confidence?

In its earlier report, Grattan said the government should aim to get the unemployment rate back down to 5 per cent or below by mid-2022. Why the hurry? To “reduce the long-term economic pain and avoid scarring people’s lives”.

Particularly young people’s lives – as this week’s report from the Productivity Commission has reminded us.

But the economic update last week forecast the unemployment rate would peak at 9.25 per cent in the December quarter and still be sitting at 8.75 per cent in the middle of next year.

That’s simply not good enough. It puts the interests of the budget deficit ahead of the interests of tens of thousands of Australians thrown out of work through “no fault of their own”, to quote a Mr S. Morrison.

Grattan’s Wood stresses that she has no problem with making the JobKeeper wage subsidy scheme better targeted. But that’s not all the government did. It cut back the size of payments and extended the scheme only for another six months.

After the cutback in income support for the jobless and potentially jobless was announced two days before the presentation of the budget update, she hoped the update would include announcements about the new spending programs that would fill the “substantial hole” the cutback left.

It didn’t. Not a sausage.

“The missing piece of the puzzle,” she now says, “remains a plan to stimulate the economy and jobs growth as the income supports are phased out and social distancing restrictions are eased in many parts of the country.”

So what should the government be spending on? She suggests measures that would both create jobs and meet social needs. “Social housing, mental health services, and tutoring to help disadvantaged students catch up on learning lost during the pandemic would deliver on this double dividend.

“Boosting the childcare subsidy to support family incomes and workforce participation should also be in the mix,” she says.

To that you could add fixing aged care, spending more on research and development and universities, not to mention renewable energy.

There’s no shortage of good things worth spending on.

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Thatcherism: our conservatives prefer punishment to 'reform'

If your citizen-strength bulldust detector isn’t pinging like blazes, you need a new one. And if Scott Morrison and Josh Frydenberg have a fraction of the courage of Margaret Thatcher and Ronald Reagan, I’ll eat the hat I’m not yet bald enough to need.

Speaking from experience, Frydenberg is like the fat man whose eyes are bigger than his belly and orders more than he can eat. He wanted to give his hardline Liberal backbenchers a thrill by invoking the holy names, but he and his boss don’t have the appetite for tough “reforms”.

The truth is that only conservatives of a certain age (and failing memories) hanker after the glory days of Thatcher and Reagan. No one else wants to return to the halcyon era of privatisation and deregulation because by now most people realise how lacking in halcyonicity those things are.

In any case, all the obvious reforms have already been made. When you’ve privatised Telstra, Qantas, the Commonwealth Bank, the Commonwealth Serum Laboratories and much else, what’s left? Selling off Australia Post?

The further you go down that road, the more dubious and distasteful your sell-offs become. The more recent privatisation of Medibank has effectively opened private health insurance provision to profit-seeking companies, adding a further problem to all that sector’s other life-threatening ailments.

The states’ privatisation of the electricity industry has turned five state monopolies into three big money-hungry oligopolists and raised electricity prices far higher than a carbon tax ever could.

The admission of for-profit businesses to childcare and aged care has hardly been a roaring success (on the latter, just ask Victorians). Bringing private companies into vocational training has turned technical education into a disaster area that’s still to be cleaned up.

The public is strongly opposed to privatisation. When the Coalition was considering privatising Medicare’s back-office processing, Labor portrayed this as a plan to privatise Medicare proper which, apparently, cost Malcolm Turnbull a lot of votes in the 2016 election.

Speaking of which, remember that Thatcher’s initial reforms were so unpopular she needed a war with Argentina to get re-elected. John Howard’s goods and services tax was so unpopular he went perilously close to losing the 1998 election.

I was puzzled to see Frydenberg associating Thatcher and Reagan with removing red tape. They aren’t remembered for anything so minor. Then I realised removing red tape was his euphemism for “deregulation”. The word now has such negative connotations he didn’t even want to say it – much less do it.

No, I don’t think we have anything to fear from Morrison’s inner Maggie.

For another thing, she wanted to close Britain’s inefficient coal mines, not defy economic reality and keep them going at all cost. And she, being a scientist, never had any doubt about the reality of climate change and the need to stop it.

The historian Manning Clark argued that, thanks to the circumstances of white settlement, Australia’s leaders could be divided into two groups: the “enlargers” and the “punishers and straighteners”. The enlargers wanted to get on with exploiting this land’s huge opportunities, whereas the punishers and straighteners, successors to the governors and prison guards, just wanted to go on running the place and keeping the lower orders in line.

If today’s Liberals were enlargers, they’d be resisting the temptation to help our coal and gas industries postpone their inevitable demise, and embracing this great opportunity to transform Australia into a global superpower in the production and export of renewable energy.

The Libs’ continuing role as punishers and straighteners is seen in their penchant for playing friends and enemies. Honourable friends and disreputable enemies. Honourable friends get rewarded with big tax cuts, which probably need to be brought forward – in the national interest, of course.

Although the Libs have lacked the mandate to cut government spending generally, they’ve selected various enemies whose lack of public sympathy means their money can be cut with impunity. Amid the massive government spending to counteract the lockdown, they’ve still singled out the universities for exclusion from the JobKeeper wage subsidy scheme or any other help of consequence.

But the people the Libs have most wanted to punish are the unemployed. When the lockdown caused unemployment to more than double, they had no choice but to increase the dole. But they kept their measures temporary, and introduced a two-class system.

Those travelling second class – who’ve lost any link to an employer – were given the JobSeeker unemployment benefit of $558 a week, about a quarter less than those in first class on JobKeeper.

We learnt last week that, after September, this will drop to $408, about a third less than the reduced JobKeeper payment. Means-testing will be resumed, as will penalties for failing to search for jobs. JobKeeper has been extended for six months, but the JobSeeker supplement only for three, with no guarantee it then won’t revert to $40 a day.

Why so tough? Because the unemployed aren’t like you and me. They’re shirkers. If you want them to work, you have to threaten punishment.

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