Despite all the hoopla, budget's extra economic stimulus isn't huge

Sensible economists accept that, because they’re determined by politicians, budgets are more about politics than economics. Pre-election budgets are more political than other budgets. And budgets coming before an election a government fears it may lose are wholly politically driven.

Welcome to this week’s budget. But here’s the point: whatever the motivation driving the decisions announced in the budget to increase this or reduce that, all the decisions have an effect on the economy nonetheless.

It’s a budget’s overall effect on the economy that macro-economists care about, not so much the politicians’ motives. So good economic analysis involves leaving the politics to one side while you focus on determining the economic consequences.

A glance at this week’s budget says that, with all its vote-buying giveaways, the budget will impart a huge further stimulus to an economy that was already growing strongly, with unusually low unemployment, but rising inflation.

What on earth are these guys up to, ramping an economy that doesn’t need ramping just to try to buy their re-election? But glances are often misleading, and the story’s more complicated than that.

You can’t judge the “stance” of fiscal (budgetary) policy adopted in a particular budget – whether it will work to expand aggregate (total) demand (spending) in the economy or to contract demand – just by looking at the few of its many “measures” (policy changes) that hit the headlines, while ignoring the other hundred measures it contained.

And, as with many concepts in economics, there are different ways you can measure them, with the different ways giving you somewhat different answers.

The simplest way to judge the stance of policy adopted in a budget – it’s expansionary, contractionary or neither (neutral) – is the way the Reserve Bank does it. You just look at the direction and size of the expected change in the budget balance from the present financial year to the coming year.

Treasurer Josh Frydenberg expects the budget deficit for the year that will end in three months’ time to be $79.8 billion, and the deficit for the coming year, 2022-23, to be slightly smaller at $78 billion.

In an economy as big as ours, that decrease of $1.8 billion is too small to notice. The difference between how much money the budget is expected to take out of the economy in taxes and how much it puts back via government spending is expected to be virtually unchanged.

So, judging it the Reserve’s way, the budget will neither add to aggregate demand (total private plus public spending) nor subtract from it. The stance is neutral.

However, there’s a two-way relationship between the budget and the economy. The budget affects the economy but, by the same token, the economy affects the budget.

The size of the budget’s deficit or surplus is affected by where the economy is in the business cycle. When the economy’s booming, tax collections will be growing strongly, whereas government spending on unemployment benefits will be falling, thus causing a budget deficit to reduce (or a surplus to increase).

On the other hand, when the economy’s dipping into recession, tax collections will be falling and the cost of benefit payments will be rising, thus increasing a deficit (or reducing a surplus).

The Keynesian approach to deciding the stance of policy adopted in a budget is to distinguish between this “cyclical” effect on the budget balance – what the economy’s doing to the budget – and the “structural” effect caused by the government’s explicit decisions.

So, many economists believe that when assessing the stance of a new budget, you should ignore the cyclical component and focus on the change in the structural component – what the government has decided to do to the economy.

You can determine this by looking at what the great budget-expert Chris Richardson, of Deloitte Access Economics, calls “the table of truth”, table 3.3 of budget statement 3 in budget paper 1, page 18 in the PDF (page 86 in the printed version).

The table shows that in the few months since the mid-year budget update last December, the economy has strengthened more than expected - mainly because of the growth in consumer spending and employment but, to a lesser extent, because of the rise in the prices we get for our exports of coal and iron ore.

This means the cyclical component of the budget deficit (what Treasury calls “parameter and other variations”) is now expected to be $28 billion less in the present financial year, and $38 billion less in the budget year, 2022-23.

Adding in the “forward estimates” for three further years to 2025-26, gives a total expected improvement of $143 billion – all of which comes from higher-than-expected tax collections.

So, had the government done nothing in the budget, that’s by how much the string of five budget deficits would have been reduced, relative to what was expected last December.

However, the table also shows that the new policy decisions announced in the budget (and in the few months leading up to it) are expected to reduce that cyclical improvement by $9 billion in the financial year just ending, and $17 billion in the coming year.

These are additions to the expected “structural deficit”. Over the full five years, they should total $39 billion, with more than three-quarters of that total coming from increased government spending.

So, relative to where we expected to be in December, the government’s spending in the budget won’t stop the next five budget deficits – and the government’s debt – being more than $100 billion less.

Even so, judged in Keynesian terms, the government has added to the structural deficit, so the budget is expansionary.

The independent economist Saul Eslake calculates that the budget involves net stimulus equivalent to 0.4 per cent of gross domestic product in the present financial year, and 0.7 per cent in the coming year.

So, he concludes, “the budget does put some additional upward pressure on inflation...but it’s fairly small”.

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The plague hasn’t wounded the economy, but the boom won’t last

The pandemic has caused much pain – physical, financial and psychological – to many people. But what it hasn’t done is any lasting damage to the economy and its ability to support people wanting to earn a living.

That’s clear from this week’s “national accounts” for the three months to the end of December, with the Australian Bureau of Statistics revealing the economy’s production of goods and services – real gross domestic product – rebounding by 3.4 per cent, following the previous quarter’s contraction of 1.9 per cent, caused by the lockdowns in NSW, Victoria and the ACT.

Despite those downs and ups, the economy ended up growing by 4.2 per cent over the course of last year. It was a similar story the previous year, 2020, when despite the nationwide lockdown causing the economy to contract by a massive 6.8 per cent in the June quarter, it began bouncing back the following quarter.

Over the two years of the pandemic, the economy’s ended up 3.4 per cent bigger than it was before the trouble started.

Be under no illusion, however. The economy would not have been able to bounce back so strongly had the federal government not spent such huge sums topping up the incomes of workers and businesses with the JobKeeper wage subsidy, the temporary increase in JobSeeker benefits, special tax breaks for business (including to encourage them to invest in plant and equipment) special incentives for new home-building, and much else. The state governments also spent a lot.

The Reserve Bank also cut interest rates – from next-to-nothing to nothing – and bought a lot of government bonds, but I find it hard to believe this made a big difference, except to house prices and home building.

It’s true that these figures for GDP and its components don’t include the effects of the Omicron wave, which came mainly in the first half of January. But by now it’s pretty clear its effect on the economy was fairly small. Of course, we may not be finished with the Greek alphabet.

None of this is to deny that the pandemic has done lasting damage to some individual workers, businesses and industries. Overall, however, the economy’s in surprisingly good shape. And this is confirmed by turning from the national accounts to the jobs market.

We have 270,000 more people in jobs than we did before the pandemic, and both unemployment and underemployment are at 13-year lows, while the number of job vacancies is at a record high.

This remarkable achievement is partly the consequence of shortages of young, less-skilled workers, caused by our closed border, however. Those shortages will gradually go away now the border’s been reopened.

Unsurprisingly, the detailed figures show that most of the growth during the quarter came from a rebound in the two unlocked states, NSW and Victoria, plus the ACT.

More surprisingly, most of the growth came from a rebound in consumer spending in former lockdown area, which rose by 9.6 per cent, compared with 1.6 per cent in the rest of the country.

The only other positive contribution to growth in the quarter was a rise in the level of business inventories – meaning the rest of the economy was holding it back.

Spending on new housing and alterations fell by 2.2 per cent in the quarter, mainly because of temporary shortages of workers and materials.

The government’s stimulus program has ended, but the industry still has many new houses in the pipeline. However, Thursday’s news of a 28 per cent collapse in the number of new residential building approvals in January makes you wonder how long the housing industry will keep contributing to growth.

Business investment in new equipment and construction also fell during the quarter. Businesses say they’re expecting to increase their spending significantly this year but, as Kieran Davies, of Coolabah Capital, has noted, “companies find it hard to forecast their own investment expenditure”. And the government’s tax incentives won’t last forever.

The jump in consumer spending came despite a fall in households’ disposable income, caused by a decline in assistance from government. Thus, to cover the increased spending, households had to cut their rate of saving during the quarter from almost 20 per cent of their disposable income to 13.6 per cent.

What’s been happening is that households save a huge proportion of their income during lockdowns (because they can’t get out of the house to spend it), but cut their rate of saving when the lockdown ends and spend much more than usual as they catch up on things and services they’ve been waiting to buy.

Even so, a saving rate of 13.6 per cent is about twice the normal rate - meaning households still have a lot of money stashed in bank accounts – more than $200 billion – that they’ll be able to spend in coming months.

Most of this is money they’ve earnt in the normal way, but much of it is also money that’s come to them in special assistance from the government.

It’s mainly because of all this extra money waiting to be spent that the Reserve Bank is forecasting that, after contracting by about 1 per cent in 2020 and growing by 4 per cent in 2021, the economy will grow by a bit more than 4 per cent this year.

Remember, however, that the economy usually grows by only about 2.5 per cent a year. So what looks like booming growth last year and this, is really just catch-up from the temporary effects of lockdowns.

We simply can’t – and won’t – keep growing at the rate of 4 per cent a year. That’s why the Reserve is expecting growth to slow sharply to a more-normal 2 per cent next year, 2023.

Most of the extra money households are holding may have been spent by the end of this year. And the forecast for 2023 assumes we’ll be back to wages growing a bit faster than the cost of living – which has yet to happen.

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Can we believe the great news on unemployment? Yes and no

Scott Morrison has a great re-election pitch: forget the problems with the pandemic, just look at how well the economy’s going. The rate of unemployment is already down to 4.2 per cent, and his goal is to get it below 4 per cent, the lowest it’s been in 50 years. Wow. What fabulous economic managers the Libs must be. But can you believe unemployment’s that low? Didn’t they fiddle with the figures some time back?

It’s good to be sceptical about the claims politicians make on the economy. Government politicians tend to tell us about the good bits and fail to mention the not-so-good parts of the story. Opposition politicians tend to do the opposite.

But not everything we think we know about the tricks politicians play is true. For instance, many people think they remember that, some years ago, a government changed the definition of unemployment to make the figures look better. They made it so that someone who worked just one hour a week was classed as employed.

This week I’ve had people asking me about this. In my experience, when a Labor government’s boasting about good unemployment figures, Liberal supporters remember Labor fiddled the figures. When, as now, it’s a Liberal government doing the boasting, it’s Labor supporters who remember a Liberal government doing the fiddling.

Which hints at the truth: actually, no government has changed the definition of unemployment. It’s an urban myth which, I suspect, has arisen because people get confused between who’s getting unemployment benefits and who’s unemployed.

The two are related, obviously, but they’re not the same. For instance, you can be unemployed and not get the dole because your spouse is working. On the other hand, single people working a few hours a week wouldn’t be earning enough to make them ineligible for the dole.

Governments can, and do, change the rules about who does or doesn’t get unemployment benefits. But who’s unemployed is measured by a huge monthly sample survey conducted by the independent Australian Bureau of Statistics.

It doesn’t let politicians decide who’s counted as unemployed and who ain’t. Rather, its definitions come from international conventions set by the UN’s International Labour Organisation in Geneva.

So it was the ILO that decided, decades ago, to define anyone doing as little as an hour’s work a week as employed. (I remember talking to an official of the Australian Council of Trade Unions who was an Australian delegate on the sub-committee that, a few years ago, decided to leave that definition unchanged. He vigorously defended the decision.)

Remember, you have to draw the line between being employed or unemployed somewhere – where would you draw it? Five hours work a week? Fifteen? Thirty-five? – and it was set so low ages ago when part-time work was much less common than it is today.

What’s true is not that the unemployment figures have been fudged, but that classing everyone working an hour or more as employed defines unemployment too narrowly. So narrowly as to understate the extent of the problem.

In fact, few people work as little an hour a week. But, though it’s wrong to imagine the only satisfactory jobs are full-time – it suits many students, parents of young children and retirees to work only a few days a week – it’s also true that many people working part-time would prefer more hours.

So for several decades, the bureau has supplemented the official unemployment figures by also publishing the number of people underemployed – those part-timers who’d prefer working work more hours. The latest figures show an unemployment rate of 4.2 per cent, plus an underemployment rate of 6.6 per cent.

Thus it is true the official unemployment rate of 4.2 per cent isn’t as good as it looks. It does understate the proportion of people who aren’t able to find as much work as they want.

And, since we know the proportion of underemployed workers is much higher today that it was 50 years ago, it’s also true that getting back to the lowest unemployment rate in 50 years isn’t likely to be as good as it was 50 years ago.

Even so, it’s quite realistic to expect that, since unemployment is already down to 4.2 per cent, and regardless of who wins the federal election, it won’t be too hard to get the rate down below 4 per cent sometime this year or next.

And whether you hate Morrison – or hate Anthony Albanese – don’t let any smarty pants tell you that will be anything other than a great achievement. If it’s not the best we’ve had the jobs market in 50 years, add in underemployment and it would be the best in maybe 40 years. Unemployment isn’t something you should wish on anyone.

No, the main reason for having reservations is the uncertainty about how long we’ll be able to keep unemployment that low.

We’ve had great success in creating extra jobs in the past year – most of which have been full-time – mainly because the government has responded to the pandemic with massively increased government spending. But the economy may slow if, as all that “fiscal stimulus” runs out, the private sector doesn’t take up the running.

The jobs market has also had a lot of help from an unprecedented (and temporary) source: for two years our borders have been closed to incoming workers. Skilled workers on temporary visas, and overseas students and backpackers doing unskilled and casual jobs.

You’ve heard employers complaining they can’t get workers and that job vacancies are at a far higher level than usual. The consequence is that many older workers who might have been pensioned off, haven’t been. And some of the jobs that haven’t been filled by overseas students and backpackers have gone to local young people.

But now our borders are re-opening to immigrant labour, we’ll see how tight the jobs market stays. I reckon it’ll be a fair while before we get back to the high levels of immigration pre-pandemic.

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Stop kidding: the 2024 tax cut will be economically irresponsible

It’s a safe bet that, once we’ve seen the mid-year budget update on Thursday, we’ll hear lots of economists and others saying the government should be getting on with budget repair: spending cuts and tax increases.

That’s despite the update being likely to show that the outlook for the budget deficit in the present financial year and the following three years is much better than expected in the budget last May.

It’s also true even though the case for “repairing the budget by repairing the economy” is sound and sensible. The federal public debt may be huge and getting huger, but, measured as a proportion of gross domestic product, the present record low-interest rates on government bonds mean the interest burden on the debt is likely to be lower than we’ve carried in earlier decades.

It’s true, too, that recent extensive stress-testing by the independent Parliamentary Budget Office has confirmed that the present and prospective public debt is sustainable.

It remains the case, however, that both this year’s Intergenerational report and the budget office project no return to budget surplus in the coming decade, or even the next 40 years – “on present policies”.

So, it’s not hard to agree with former Treasury secretary Dr Ken Henry that doing nothing to improve the budget balance is more risky than it should be, too complacent. It leaves us too little room to move when the next recession threatens.

And, indeed, the Morrison government’s revised “medium-term fiscal strategy” requires it to engage in budget repair as soon as the economy’s fully recovered.

But there’s no way Scott Morrison wants to talk about spending cuts and tax increases this side of a close federal election. Nor any way Anthony Albanese wants to say he should be.

Of course, that won’t stop Morrison & Co waxing on about how “economically responsible” the government is – especially compared to that terrible spendthrift Labor rabble. Nor stop Labor pointing to all the taxpayers’ money Morrison has squandered on pork barrelling, and promising an Albanese government would be more “economically responsible”.

But here’s my point. There’s a simple and obvious way both sides could, with one stroke, significantly improve prospective budget balances, and because it would be front-end loaded, disproportionately reduce our prospective public debt over years and decades to come.

There’s no way such a heavily indebted government should go ahead with the already-legislated third stage of tax cuts from July 2024, with a cost to the budget of more than $16 billion a year.

Those tax cuts were announced in the budget of May 2018 and justified on the basis of a mere projection that, in six years’ time, tax collections would exceed the government’s self-imposed ceiling of 23.9 per cent of GDP. That is, the government would be rolling in it.

It was said at the time that it was reckless for the government to commit itself to such an expensive measure so far ahead of time. It was holding the budget a hostage to fortune.

But so certain were Morrison and Josh Frydenberg that the budget was Back in Black that, soon after winning the 2019 election, they doubled down on their bet and insisted the third-stage tax cuts be legislated. Desperately afraid of being “wedged”, Labor went weak-kneed and supported the legislation.

If, at the time, a sceptic had warned that anything could happen between now and 2024 – a once-in-a-century pandemic, even – they’d have been laughed at. But they’d have been right.

Just last week, Finance minister Simon Birmingham righteously attacked his opponents for making election promises that were “wasteful and unfunded” – by which he meant that they would add to the budget deficit.

But the tax cut both sides support is now also “unfunded”. We’ll be borrowing money to give ourselves a tax cut. That’s economically responsible?

It might be different if you could argue that the tax cut would do much to support the recovery, but it wasn’t designed to do that, and it won’t. Stage three is about redistribution, not stimulus and not (genuinely) improved incentives.

The budget office has found that about two-thirds of the money will go to the top 10 per cent of taxpayers, on $150,000 or more. Only a third will go to women. So, the lion’s share will go to those most likely to save it rather than spend it. Higher saving is the last thing we need.

Now, I know what you’re thinking. Get real. There’s no way either side would want to repeal a tax cut, especially just before an election.

Regrettably, that’s true. But, this being so, let’s tolerate no hypocrisy from politicians – or economist urgers on the sidelines – making speeches about “economic responsibility” without being willing to call out this irresponsible tax cut.

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When judging recessions, depth matters more than length

With the publication this week of the latest “national accounts”, our situation is now clear: we’re not in recession, yet we are – but, in a sense, not really.

Confused? It’s simple when you know. One thing we do know is that the economy – as measured by real gross domestic product – will have contracted significantly in the present quarter, covering the three months to the end of September.

At this stage, the smart money is predicting a contraction – a fall in the production and purchase of goods and services – of “two-point-something” per cent, although there are business economists who think the fall could be as much as 4 per cent.

Recessions are periods when people cut their spending sharply, causing businesses to cut their production of goods and services and lay off workers. It’s mainly because so many people lose their jobs that recessions are something to be feared. But also, a lot of businesses go broke.

This means no one should need economists to tell them if we are or aren’t in recession. If you can’t tell it from all the newly closed shops as you walk down the main street, you should know from what’s happening to the employment of yourself, your family and friends. Failing that, you should know it from all the gloomy stories you see and hear on the media.

Have you heard, by chance, that NSW, Victoria and now Canberra are back in lockdown, leaving some workers with no work to do, and the rest of us unable to spend nearly as much as usual because we’re confined to our homes? You have? Then you know we’re in recession.

When the first, national lockdown began in late March last year, real GDP contracted by 7 per cent in the June quarter. That was the deepest recession we’ve had since the Great Depression of the 1930s.

But it was also the shortest recession we’ve had because, once the lockdown was lifted, the economy – both consumer spending and employment - immediately began bouncing back. As the Australian Bureau of Statistics revealed this week, the bounce-back continued in the June quarter of this year, which saw real GDP growing by a strong 0.7 per cent, leaving the level of GDP up 1.6 per cent on its pre-pandemic level.

All clear so far? The confusion arises only in the minds of those people silly enough to let the media convince them that, despite all the walking and looking and quacking they see before their eyes, a recession’s not a recession unless you have two consecutive quarters of contraction in GDP.

The size of the contraction is of no consequence, apparently, nor would be two or more quarters of contraction that weren’t consecutive. This is nonsense.

As my colleague Jessica Irvine has explained, this “rule” is repeated ad nauseam by the media, but has no status in economics. It’s a crude rule of thumb that’s frequently misleading. It’s in no way the “official” definition of recession.

But the consecutive-quarter rule is so deeply ingrained that it causes needless debate and uncertainty. Some business economists convinced themselves that this week’s figure for growth in the June quarter could be a small negative.

Oh, gosh! Since we know the present quarter will be a negative, that means we could be in another recession. Quick, get out the R-word posters.

But no. June quarter growth proved stronger than expected. Treasurer Josh Frydenberg couldn’t resist the temptation to declare there’d been no “double-dip recession”. Thank God!

But wait. The lockdowns could easily continue beyond the end of this month and into the December quarter. So we could have a second negative quarter on the way. Quick, bring back the posters and start writing the double-dip speech.

Sorry, this is not only silly, it’s got the arithmetic wrong. When the economy goes from growth to lockdown, you get a negative. But when, in the follow quarter, the economy merely stays in lockdown you get zero growth, not another fall.

The present lockdowns apply to a bit over half the economy. So, if the other half continues to grow, we will get a positive change in GDP during the quarter.

What’s more, if the lockdowns end sometime before the end of December, we’ll get a bounce-back in growth in that half of the economy, as everyone rushes out to start buying the things they were prevented from buying during the lockdown.

That’s what happened last time the lockdown ended; it’s safe to happen this time too. So it’s hard to see how we could get a second quarter of “negative growth” in the three months to New Year’s Eve.

We’ll learn what the figure was in early March, in good time for the federal election. Stand by for Frydenberg’s triumphant declaration that we’ve avoided a double-dip recession for a second time. He’ll turn the media’s consecutive-quarters bulldust back on them, and spin a story of great success.

But this will literally be non-sense. He’ll take a contraction in the September quarter of, say, 2 to 4 per cent – as big as the contractions that caused the recessions of the mid-1970s, the early 1980s and the early 1990s – and pretend it doesn’t count, simply because that massive contraction was concentrated in one quarter rather than spread over two.

He’ll con us into accepting that the depth of a slump doesn’t matter, just its length. More nonsense.

But there remains a respect in which, like the first dip, the second isn’t really a recession. What we had last year and are in the middle of right now aren’t recessions in the normal sense.

They’re artificial recessions deliberately brought about by governments to minimise the loss of life from the pandemic. They thus involve a degree of monetary assistance to workers and businesses unknown to normal recessions. This means they don’t take years to go away, but disappear in six months or so because of the speed with which the economy bounces back when the lockdown ends.

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The economy’s job is to serve our good health

What a tough, tricky world we live in. There we were, starting to think the pandemic – for us, at least – was pretty much over bar the jabbing, when along came a new and more contagious variant and knocked our confident complacency for six. It’s now clearer that getting free of the virus will be messier, more expensive and take longer than we’d hoped.

It’s natural to be impatient to see the end of this terrible episode in the nation’s life, but no one’s been more impatient to see the end of restrictions than Scott Morrison and the business lobby groups.

We should worry less about any continuing small risks and more about getting the economy working normally again, we were told. Why do those appalling premiers keep closing state borders? Don’t they understand how it disrupts businesses?

One theory that’s been blown away is the tribal notion that continuing problems keeping a lid on the virus were limited to dictatorial Labor states, not “gold standard” Liberal states. We’ve been reminded of what pride so often causes us to forget: success is invariably a combination of competence and luck.

Luck was running against Victoria, now it’s NSW’s turn. NSW did do better on contact tracing, but along came a variant that could spread faster than the best contact-tracing system could keep up with.

The nation’s macro-economists learnt some years ago that the best response to a recession is to “go early, go hard”. That’s something the exponential spread of viruses means epidemiologists have long understood.

The sad truth is, no matter how long NSW’s present lockdown needs to last before the virus is back under control, Premier Gladys Berejiklian’s critics are certain to say she waited too long and didn’t go hard enough.

And they’ll be right. If there’s ever a possibility of starting even a day earlier, it’s always right.

Is it a bad thing to want to limit the economic disruption caused by our fight against the virus? Of course not. But it’s a tricky choice. You don’t want to act unnecessarily, but the longer you take to realise you must act, the more disruption you end up causing.

Berejiklian’s problem is that she was being held up as the national pin-up girl of governments’ ability to cope with the crisis while minimising economic disruption.

The economy is merely a means – a vital means – to the end of human wellbeing. Health is also a means to achieving human wellbeing. But good health is so big a part of wellbeing it’s almost an end in itself. And prosperity isn’t much good to you if you’re dead.

So, as surveys show, most economists get what it seems many business people (and certainly, their lobby groups and media cheer squad) don’t get: in any seeming conflict, health trumps economics.

It’s also a matter of solving problems in the best order. Just as a war takes priority over material living standards, so does a major threat to our health. Fix the health problem, then get back to worrying about the economy.

To put it yet another way, “the economy” exists to serve the interests of the people who make it up; we don’t exist to serve the economy.

The people who want to exalt “the economy” tend to be those using “the economy” to disguise their pursuit of their own immediate interests, not the interests of everyone. “Keep my business going; if that means a few people die, well, I’m pretty sure I won’t be among ’em.”

Some economists estimate that the NSW lockdown will cost the economy (gross domestic product) about $1 billion a week. But don’t take that back-of-an-envelope figure too seriously. For a start, it’s not huge in a national economy producing goods and services worth about $2000 billion a year.

In any case, it’s misleading for two reasons. First, can you imagine what would be happening in the economy had St Gladys (or, before her, Dictator Dan) done nothing while the virus raged about us, getting ever worse?

Most of us would be in what Professor Richard Holden of the University of NSW calls “self-lockdown”. Which would itself be a great cost to the economy – not to mention the angst over the lack of leadership.

So don’t confuse the cost of the virus with the cost of the government’s efforts to limit its spread by doing the lockdown properly.

Second, remember that the economy rebounded remarkably quickly and strongly after the earlier lockdowns, making up much of the lost ground. Of course, the exceptional degree of income support for workers and businesses provided by the federal government does much to account for the strength of the rebound.

Which is why it’s good to see the federal-state assistance package announced on Tuesday, even though its cut-price version of JobKeeper, while being better than was provided to Victoria recently, isn’t as generous as it should have been.

Like Berejiklian, Morrison is still adjusting to his newly reduced circumstances.

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Smaller Government is dogging our efforts to beat the pandemic

It surprises me that, though the nation’s been watching anxiously for more than a year as our politicians struggle with the repeated failures of hotel quarantine and the consequent lockdowns, big and small, and now the delay in rolling out the vaccine, so few of us have managed to join the dots.

Some have been tempted to explain it in terms of Labor getting it wrong and the Libs getting it right – or vice versa – but that doesn’t work. Nor does thinking the states always get it right and the feds get it wrong – or vice versa.

The media love conflict, so we’ve been given an overdose of Labor versus Liberal and premiers versus Morrison & Co. But though we can use this to gratify our tribal allegiances, it doesn’t explain why both parties and both levels of government have had their failures.

No, to me what stands out as the underlying cause of our difficulties – apart from human fallibility – is the way both sides of politics at both levels of government have spent the past few decades following the fashion for Smaller Government.

Both sides of politics have been pursuing the quest for smaller government ever since we let Ronald Reagan convince us that “government is not the solution to our problems; government is the problem”.

The smaller government project has had much success. We’ve privatised almost every formerly federal and state government-owned business. We’ve also managed to “outsource” the delivery of many government services formerly performed by public sector workers.

But the smaller government project has been less successful in reducing government spending. The best the pollies have done is contain the growth in spending by unceasing behind-the-scenes penny-pinching.

And here’s the thing: pandemics and smaller government are a bad fit.

The urgent threat to life and limb presented by a pandemic isn’t something you can leave market forces to fix. The response must come from government, using all the powers we have conferred on it – to lead, spend vast sums and, if necessary, compel our co-operation.

In a pandemic, governments aren’t the problem, they’re the answer. Pretty much the only answer. Only governments can close borders, insist people go into quarantine, order businesses to close and specify the limited circumstances in which we may leave our homes.

Only governments can afford to mobilise the health system, massively assist businesses and workers to keep alive while the economy’s in lockdown, pay for mass testing and tracing, and flash so much money that the world’s drug companies do what seemed impossible and come up with several safe and effective vaccines in just months.

But when you examine the glitches – the repeated failures of hotel quarantine, the need for more lockdowns, the delay in stopping community spread, and now the slowness of the rollout of vaccines – what you see is governments, federal and state, with a now deeply entrenched culture of doing everything on the cheap, of sacrificing quality, not quite able to rise to the occasion.

As we’ve learnt, a pandemic demands quick and effective action. But when you’ve spent years running down the capabilities of the public service – telling bureaucrats you don’t need their advice on policy, just their obedience – quick and effective is what you don’t get.

The feds have lost what little capacity they ever had to deliver programs on the ground. They have primary responsibility for quarantine and vaccination, but must rely on the states for execution. Then, since both sides are obsessed by cost-cutting, they argue about who’ll pay – and end up not spending enough to do the job properly.

It took the feds far too long to realise that hotel quarantine was cheap but leaky. Every leak had the states closing borders against each other. The feds didn’t spend enough securing supplies of vaccines, then took too long to realise a rapid rollout wasn’t possible without help from the states.

Without thinking, Victoria initially staffed its hotel quarantine the usual way, with untrained, low-paid casual staff. It had run down its contact-tracing capacity and took too long to build it up – still without a decent QR code app. NSW let a host of infected people get off a cruise ship and spread the virus all over Australia.

The report of the royal commission laid much of blame for the aged care scandals on the feds’ efforts to limit their spending on aged care. They couldn’t demand providers meet decent standards because they weren’t paying enough to make decent standards possible.

One of the main ways providers make do is by employing too few, unskilled, casual, part-time staff, who often need to do shifts at multiple sites. Do you think this has no connection with the sad truth that the great majority of deaths during Victoria’s second lockdown occurred in aged care?

And now we discover the feds have failed to get the vaccine rollout well advanced even to aged care residents and staff.

Spend enough time denigrating and minimising government and you discover it isn’t working properly when you really need it.

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Top economists think much further ahead than Morrison & Co

If Scott Morrison and Josh Frydenberg are looking for ideas about what more they could be doing to secure our economic future – after all, they’ll be seeking re-election soon enough – they could do worse than study the views of the 56 leading economists asked by the Economic Society of Australia to comment on this month’s budget.

Two points stand out. First, almost all the economists were happy to support the budget’s strategy of applying more fiscal stimulus to get unemployment below 5 per cent. They were pleased to see the government abandon its preoccupation with surpluses and debt.

As Professor Fabrizio Carmignani, of Griffith University, said, “the good thing about this budget is that it was not about repairing the deficit and debt accumulated in 2020”. Professor Sue Richardson, of Flinders University, said: “the debt and deficit mantra was never justified”.

Second, with one notable exception, the economists were critical of the government’s choice of things to spend on. The exception was its big spending on the “care economy” – aged care, childcare, disability care and mental health care – which most respondents welcomed. Indeed, quite a few thought there should have been more of it.

After that, the economists had plenty of constructive criticism of the government’s priorities. For instance, quite a number were happy to see big spending on “infrastructure”, but critical of the government’s narrow conception of what constitutes infrastructure.

Carmignani said: “there is in this budget – as in the past – an almost blind confidence in the power of investment in physical infrastructure to drive future growth and development. In fact, the future prosperity of Australia depends on innovation that requires social rather than physical infrastructures”.

Professor Gigi Foster, of the University of NSW, said: “childcare should be viewed as the social infrastructure that it is, and invested in as such. Instead, when we heard ‘infrastructure’, it was mainly code for transportation”.

So even in the area of physical infrastructure, the budget shows a lack of imagination. Professor Michael Keane, also of the University of NSW, said very little of the infrastructure money was “allocated to such urgent needs as renewable energy, climate change adaptation, environmental sustainability, water resources, etcetera. This shows a real lack of ambition.”

Richardson agrees. “The future is one of zero net greenhouse gas emissions,” she said. “The transformation of the energy, agricultural, transport and manufacturing systems that this requires is enormous, will require unprecedented levels of investment and needs to start now.“

Now that’s interesting. Historically, treasurers and their advisers have regarded the budget as the place for discussion on finances and economics, not the state of the natural environment nor the challenge of climate change.

The economy in one box, the environment in some other box. The natural environment has been seen as of such little relevance to topics such at the budget and the economy that it has barely rated a mention in the five-yearly supposed “intergenerational report”.

But that’s not how our leading economists see it. At least a dozen of them have criticised the budget’s failure to respond to the challenge of climate change. Professor Warwick McKibbin, of the Australian National University, warned that “the world is likely to be taking significant action on climate change which will substantially impact Australia’s fossil fuel exports and the future structure of the Australian economy”.

Another topic barely mentioned in the budget – one of the industries much damaged by the pandemic – was universities. Unsurprisingly, more than a dozen respondents noticed the omission. They’re self-interested, of course, but they make a good case.

Dr Leonora Risse, of RMIT University, said succinctly: “investment in the university sector [is a] generator of productivity-enhancing skills, knowledge and research”. Meanwhile, McKibbin added that “a key ingredient is an investment in human capital”.

But the academics’ concern is wider than their own patch. Risse has called for more attention to the long-running drivers of growth, such as “investment in the workforce capabilities, resourcing, wages and working conditions of high-need, high-growth sectors” such as the care economy.

Dr Michael Keating, a former top econocrat, said restoring past rates of economic growth won’t be possible without addressing the structural problems in the labour market. “This will involve much more investment in education, training and research” but “the extra money in this budget for apprentices and trainees only makes up for past cuts.”

Notice a theme emerging? Budgets should be about investment – spending money now, for payoffs to the economy later – but investment needs to be in people, not just in physical and traditional things such as roads and railways.

It’s easy to accuse academics of pontificating atop their ivory towers, but they seem able see much further into the economy’s future needs than our down-to-earth politicians.

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Key reform needed to fix debt and deficit: ditch stage 3 tax cut

Scott Morrison and Josh Frydenberg won’t admit it. But most economists agree that at the right time, the government should take measures to hasten the budget’s return to balance, even – to use a newly unspeakable word – “surplus”.

Economists may differ on what they consider to be the right time. But, if we’re to avoid repeating the error the major economies made in 2010 by jamming on the fiscal (budgetary) policy brakes well before the recovery was strong enough for the economy to take the contraction in its stride, the right time will be when the economy has returned to full employment, with no spare production capacity.

At that point, the inflation rate’s likely to be back within the Reserve Bank’s 2 to 3 per cent target range, with wage growth of 3 per cent or more. Any further fiscal stimulus from a continuing budget deficit would risk pushing inflation above the target, and could induce a “monetary policy reaction function” where the independent Reserve countered that risk by raising interest rates.

So, better for the government to act before the Reserve acts for it. And if you take the econocrats’ best guess at the level of full employment – when unemployment is down to between 5 and 4.5 per cent – and take the budget’s forecasts at face value (itself a risky thing to do) the right time will be in the middle of 2023.

But the growth in wages and prices has been so weak for so long, that I wouldn’t be acting until it was certain wage and price inflation was taking off.

Even so, since its own forecasts say that point will come towards the end of the next term of government, Morrison and Frydenberg should be readying to give us a clear idea of the steps they’ll take to cut government spending or increase taxes when it becomes necessary.

And, in an ideal world, they would. But, thanks to the bad behaviour of both sides of politics, our world is far from ideal. Former Labor leader Bill Shorten is only the latest to be reminded of the awful, anti-democratic truth that parties which telegraph their punches expose themselves to dishonest scare campaigns.

But that’s just the most obvious reason Morrison and Frydenberg will avoid any discussion of the nasty moves that will be necessary to make the “stance” of fiscal policy less expansionary and, when needed, mildly restrictive, thus slowing the government’s accumulation of debt in the process.

The less obvious reason is that no pollie wants to talk about the policy instrument that’s played a leading part in all previous successful attempts at “fiscal consolidation” and will be needed this time.

It’s what Malcolm Fraser dubbed “the secret tax of inflation”, but the punters call “bracket creep” and economists call “fiscal drag”.

Because our income-tax scales tax income in slices, at progressively higher rates – ranging from zero to 45c in the dollar – but the brackets for the slices are fixed in dollar terms, any and every increase in wages (or other income) increases the proportion of income that’s taxed at the individual’s highest “marginal” tax rate, thus increasing the average rate of tax paid on the whole of their income.

A person’s average tax rate will rise faster if the increase in their income takes them up into a higher-taxed bracket but, because what really matters in increasing their overall average tax rate is the higher proportion of their total income taxed at their highest marginal tax rate, it’s not true that people who aren’t pushed into a higher tax bracket don’t suffer from what we misleadingly label “bracket creep”.

I give you this technical explanation to make two points highly relevant to the prospects of getting the budget deficit down. Both concern the third stage of the government’s tax cuts, already legislated to take effect from July 2024, at a cost of $17 billion a year.

Although this tax cut is, in the words of former Treasury econocrat John Hawkins and others, “extraordinarily highly skewed towards high income earners”, Frydenberg justifies it with the claim that, because it would put everyone earning between $45,000 and $200,000 a year on the same 30 per cent marginal tax rate, it would end bracket creep for 90 per cent of taxpayers.

First, this claim is simply untrue. For Frydenberg to keep repeating it shows he either doesn’t understand how the misnamed bracket creep works, or he’s happy to mislead all those voters who don’t.

What’s true is that the stage three tax cut would greatly diminish the extent to which a given percentage rise in wages leads to a greater percentage increase in income-tax collections, thereby sabotaging the progressive tax system’s effectiveness as the budget’s main “automatic stabiliser”. Its ability to act as a “drag” on private-sector demand when it’s in danger of growing too strongly.

In an ideal world, income-tax brackets would be indexed to consumer prices annually, thus requiring all tax increases to be announced and legislated. But in the real world of cowardly and deceptive politicians – and self-deluding voters – the stage three tax cut is bad policy on three counts.

One, it’s unfair to all taxpayers except the relative handful earning more than $180,000 a year (like me). Two, the biggest tax savings go to the people most likely to save rather than spend them. Three, by knackering the single most important device used to achieve fiscal consolidation, it’d be an act of macro management vandalism.

Think of it: by repealing stage three you improve the budget balance by $17 billion in 1024-25 and all subsequent years. Better than that, you leave intact the only device that works automatically to improve the budget balance year in and year out until you decide to override it.

Without the pollies’ little helper, fiscal consolidation depends on a government that’s still smarting from its voter-repudiated attempt in the 2014 budget, having another go at making big cuts in government spending, and a government that seeks to differentiate itself as the party of low taxes now deciding to put them up.

Good luck with that.

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Treasury boss confident big government debt is manageable

Whether they realise it or not – probably not – the people up in arms about the size of the federal public debt and criticising Scott Morrison and Josh Frydenberg for not doing more to get it down in last week’s budget are saying they should have made the same error the major economies made early in their recovery from the Great Recession.

If you’ve heard Frydenberg saying he won’t “pivot to austerity policies”, you’ve heard him vowing not to make the mistake the Americans, and particularly the Brits and Europeans, made in 2010.

After they’d borrowed heavily in response to the global financial crisis, their recoveries had hardly begun before they looked back at their mountainous debt and panicked, slashing government spending and whacking up taxes.

This policy of “austerity”, as critics dubbed it, proved disastrous. It stunted their recoveries and meant they didn’t reduce their deficits and debts much at all.

This is why, to prevent the budget’s support for the still-recovering private sector falling precipitately over the coming four financial years to June 2025, Morrison and Frydenberg decided to use most, but not all, of an unexpected improvement in forecast budget deficits to increase spending and cut taxes.

Even so, the net debt in June 2024 is now estimated to be $46 billion lower than expected in last October’s budget, as independent economist Saul Eslake has pointed out.

In a speech to the Australian Business Economists this week, Treasury secretary Dr Steven Kennedy defended the government’s two-phase economic strategy.

According to the budget papers, phase one is to promote economic growth through “discretionary fiscal [budgetary] policy and the operation of [the budget’s] automatic stabilisers” so as to “ensure a strong and sustained recovery to drive down the unemployment rate”.

We will remain in the first phase of the strategy “until the recovery is secured” and growth has driven unemployment “down to pre-pandemic levels or lower”.

“Only once the economic recovery is secured will the government transition towards [phase two and] the medium-term objective of stabilising and then reducing debt as a share of gross domestic product,” the budget papers say.

But some economists – the most well-credentialled of whom is former Treasury secretary Dr Ken Henry – are concerned this willingness to live with unusually high levels of deficit and debt for many years, and without mention of any effort to return the budget to surplus – which would reduce the debt in dollar terms, not just relative to GDP - is complacent and risky.

But, with one proviso, Kennedy argues strongly that the presently projected paths of our budget deficit, our debt and the interest bill on the debt aren’t particularly risky.

When I get to that proviso you’ll see that Kennedy and his old boss aren’t so far apart. And remember this: Henry is now free to give the government advice in public, whereas the Westminster system requires Kennedy to give all his frank advice in private, not in speeches to economists.

Starting with the budget deficit, Kennedy says it grew hugely in 2020, partly because the lockdown caused tax collections to collapse and the number of people getting the dole to leap (this being the operation of the budget’s “automatic stabilisers”), but also because of the unprecedented degree of “emergency support” provided to businesses and workers.

The deficit’s expected to peak at $161 billion (equivalent to 7.8 per cent of GDP) in the financial year soon to end, then fall to $57 billion (2.4 per cent of GDP) in 2024-25. This “relatively quick” fall happens mainly because all the emergency support was temporary.

“At this stage, [a hint that policies could change, and probably will] the deficit is expected to persist through the medium term,” Kennedy says, by which he means that, seven years later in 2031-32 (the “medium term”), the projected deficit is still 1.3 per cent.

Budget statement 3 (page 100) shows that’s about the projected size of the“structural” budget deficit – the deficit that’s left after taking account of the cyclical factors affecting the budget – by then.

Kennedy explains this as representing the government’s structural (lasting) increases in spending on what it calls “essential services” – particularly aged care, disability care and the tiny permanent increase in the rate of the dole – in this year’s budget.

Such a structural deficit isn’t huge, but its existence is a tacit admission that, if government spending isn’t going to be cut, taxes should be increased.

Turning to the projected path of the net debt, Kennedy says the budget projections suggest the government is on track to stabilise and begin reducing the debt as a share of GDP in the medium term (the next 10 years), given the present economic outlook “and policy settings” (hint, hint).

The net debt is expected to be 34 per cent of GDP at June 2022, rising to almost 41 per cent at June 2025, before improving to 37 per cent at June 2032. (Eslake reminds us all this is less than half the average for the advanced economies.)

Finally, “debt servicing costs” - fancy talk for the interest payments on the debt. As a proportion of GDP – that is, comparing the interest payments with the size of the nation’s income – net interest payments are projected to “remain low by historical standards at around 1 per cent over the medium term”.

Two eye-opening graphs in Eslake’s first-rate budget analysis show 1 per cent is much lower than we were paying throughout the last quarter of the 20th century (in the late 1980s it was above 2.5 per cent). And, in inflation-adjusted dollars per head of population, it’s much lower than we were paying in both the late ’80s and the late ’90s.

Responding to Henry’s concerns, Kennedy says “there remains fiscal space [room] to respond again with fiscal policy if the need arose”. But here’s the proviso Kennedy adds: “there will come a time where it is prudent to accelerate the rebuilding of our fiscal buffers”.

That’s as frank as Treasury secretaries get in public.

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Don't believe what lightweights tell you about debit and deficit

If you’ve gained the impression that in their pre-election budget Scott Morrison and Josh Frydenberg have gone on a wild, vote-buying cash splash spending spree, leaving us – not to mention our grandchildren – with a string of bigger budget deficits and much increased government debt, you’ve been misled.

Some of it’s simply not true, much of it’s exaggerated and the rest has been misunderstood by people who didn’t do economics at high school. They’re people who are led by their emotions and, when they hear frightening words like “deficit” and “debt”, don’t need to be told we’re all in deep doodoo. They don’t stop to read the details.

Let me give you some of those details, with help from the independent economist Saul Eslake and his first-rate budget analysis.

What would you think if you asked me my salary and I gave you a figure I’d first multiplied by four? You’d think I was big-noting. The politicians do this every budget time to make them sound more generous than they are.

They can do it because the budget shows the cost for the coming financial year, plus “forward estimates” for the following three years. The media go along with it because it quadruples their story’s impressiveness.

They told us the budget involved new spending and tax breaks costing $93 billion “over four years”, when it would have been less misleading to say the new measures will cost the budget about $23 billion a year.

Some have implied the new measures are profligate and motivated by vote-buying. Some measures are, no doubt. But the $3.8 billion a year to fix up our scandal-ridden aged care system? The $2.2 billion a year in increased support for the unemployed? The extra $2 billion a year in infrastructure? The $1.3 billion a year to subsidise apprenticeships? Another $1.3 billion in total to help hard-hit aviation and tourism? An extra $450 million a year on women’s economic security?

The extended tax relief for small business will cost a total of $21 billion in a few years’ time, but then will be clawed back. The “new” tax cut for middle-income earners costing $7.8 billion a year Frydenberg told us about is just a one-year extension of last year’s tax cut.

Doesn’t sound much of a splash to me. The increased subsidy of childcare costs doesn’t start for a year and is about a quarter of what Labor’s promised.

Next, if you’ve gained the impression all this spending will increase the budget deficit and add to the government’s debt, you’ve been misled.

At the time of last year’s delayed budget in October, Eslake points out, the net debt was expected to reach $966 billion by June 2024. In this budget the debt’s now expected to be $46 billion less by then.

How is this possible? It’s possible because the economy has recovered much more strongly than was expected even in October. So tax collections are a lot higher than expected, and dole payments a lot lower.

By design, the government’s new spending takes up most, but not all, of this improvement. The econocrats wouldn’t have thought it smart to withdraw too much of the public sector’s support for the private sector – households and businesses – before the recovery was well established and when unemployment was still so high.

The joke is, the people up in arms about the huge growth in debt are a year late. It was last April when all the damage was done. The pandemic was raging and governments decided to put our heath first and the economy second. They locked down the economy, causing the biggest collapse in the nation’s income since World War II.

But to hold the economy together so it could rebound after the lockdown was lifted, the government spent unprecedented sums on the JobKeeper scheme (that’s $90 billion right there), the JobSeeker supplement and a dozen other temporary programs.

It’s all worked far better than expected, but there’s no denying it’s come at a great cost. Should we have let all those people die of the virus? Should we have let the economy stay flat on its back? The debt panickers weren’t saying that a year ago.

The finances of national governments don’t work the way a family’s do. Eventually, parents die. They know they must have their debts paid off before then.

But though the faces change, governments and the populations they serve never die, they just keep growing. Meaning they – like big businesses – never pay off their debt. It goes down sometimes and up others, but still goes on forever.

What governments do is out-grow their debts, so it shrinks relative to the size of the economy and all the income it generates. That’s how the developed countries got on top of the massive debt they were left with after WWII.

They didn’t pay it back, they outgrew it. And the good news is, interest rates on the public debt are now lower than ever – and won’t be going back up in a hurry.

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The new normal: much more reliance on government spending

What this week’s budget proves is that fiscal (budgetary) stimulus really works, something many economists had come to doubt over the four decades in which monetary policy – the manipulation of interest rates – was the main instrument used to manage the economy’s path through the business cycle.

That potency’s the main reason the economy has rebounded from last year’s government-ordered deep recession far earlier and more strongly than any economist (or I) had expected.

It’s now clear that, by the March quarter of this year, the economy’s production of goods and services – real gross domestic product – had returned to its level at the end of 2019. The level of employment was a fraction higher than before the virus struck, and the rate of unemployment had gone most of the way back to its pre-virus 5.1 per cent.

And it was Scott Morrison’s massive boost to government spending – JobKeeper, the temporary JobSeeker supplement and all the rest – “wot done it”.

This week’s budget, coming on top of last year’s, confirms there’s been a lasting shift in the main policy instrument used by the macro economy managers, from monetary policy to fiscal policy.

Why? Short answer: because when the official interest rate – the lever monetary policy uses to encourage or discourage borrowing and spending – has fallen almost to zero, your instrument no longer works.

We, and all the advanced economies, are caught in what the great British economist John Maynard Keynes called a “liquidity trap”: there’s plenty of money around to be borrowed – and at very low interest rates – but few businesses want to take it. Cutting rates even further won’t change this.

The last time the developed world was caught in a liquidity trap was the Great Depression of the 1930s. Keynes immortalised himself by thinking outside the box and coming up with the solution: give up on interest rates and switch to using fiscal policy – government spending and taxation – to keep the economy growing until the private sector – businesses and households – get their mojo back.

Note that we were caught in our liquidity trap long before the virus came along. The pandemic’s just brought matters to a head. The problem the economic managers are responding to is “structural” – deep-seated and long-lasting – not “cyclical”: temporary.

So don’t imagine the switch from using interest rates to using the budget is temporary. It will continue for as long as very low interest rates keep monetary policy impotent. And for as long as the rich countries’ bigger problem remains unemployment, not inflation.

Low inflation and low interest rates go together. That’s why the Reserve Bank’s being cautious rather than brave in assuring us it’s unlikely to increase interest rates “until 2024 at the earliest”.

But why is fiscal stimulus more effective than economists realised? Why does a dollar of stimulus have a bigger effect on GDP – a higher “multiplier effect” – than they thought? Two main reasons.

One thing that reduces the size of fiscal multipliers is the “leakage” of spending into imports. But this doesn’t matter as much in a more globalised world, when all the rich economies are likely to be stimulating at the same time. As they did in the global financial crisis of 2008 and are doing now in response to the pandemic. My country’s leakage of spending becomes your country’s “injection” of exports – and vice versa.

A second factor that was keeping multipliers low is what economists call the “monetary policy reaction function”. If a government is spending big – whether for political or economic reasons – but the independent central bank thinks this will risk inflation going above its target, it will increase rates.

The two arms of macro policy will then be pulling in opposite directions. This is what we had before the arrival of the pandemic, when the Reserve was cutting interest rates to get the economy moving, but Scott Morrison and Josh Frydenberg were focused on eliminating debt and deficit.

Now, however, fiscal policy and monetary policy are both pushing in the direction of encouraging growth and lower unemployment. With fiscal doing most of the pushing, this means a higher multiplier.

Which brings us to the obvious question: is the “stance of policy” adopted in this week’s budget expansionary or contractionary? If you believed all the silly talk of a “big-spending budget” you’d be in no doubt that it’s expansionary.

But it’s trickier than that. If you judge it the simple way the Reserve Bank does, by looking at the direction and size of the expected change in the budget balance from the present financial year to the coming year, you find the budget deficit’s expected to fall from $161 billion to $107 billion.

That’s a huge $54 billion fall, suggesting the budget is contractionary. But that’s not right. Because last year’s budget underestimated the speed with which employment and tax collections would rebound and people would get a job and go off the dole, the additional stimulus measures announced in the budget stopped that fall from being a lot bigger.

And remember this: a lot of last year’s stimulus spending – something less than $100 billion-worth - won’t have left the government’s coffers by June 30 this year. And it’s been estimated that about $240 billion-worth of stimulus spending that did leave the government’s accounts is still sitting in the accounts of households and businesses, able to be spent in the coming year.

We do know, for instance, that the saving rate of households, which was 5 per cent before the coronacession began, was still up at 12 per cent of their disposable income, after peaking at 22 per cent at the end of June last year.

The government’s forecasters are expecting that a lot of the savings of households and companies will be spent on consumption and investment in 2021-22. This tells me it would be a mistake not to think of fiscal policy as still highly expansionary. Which is as it should be.

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Our closed borders have turbo-charged the economy's recovery

The economy’s rebound from the lockdowns of last year has been truly remarkable – far better than anyone dared to hope. Even so, it’s not quite as miraculous as it looks.

As Tuesday’s budget leads us to focus on the outlook for the economy in the coming financial year, it’s important to remember that the coronacession hasn’t been like a normal recession. And the recovery from it won’t be like a normal recovery either.

The coronacession is unique for several reasons. The first is that the blow to economic activity – real gross domestic product - was much greater than we’ve experienced in any recession since World War II and almost wholly contained within a single quarter.

The reason for that is simple: it happened because our federal and state governments decided that the best way to stop the spread of the virus was to lock down the economy for a few weeks. But because this was a government-ordered recession, the governments were in no doubt about their obligation to counter the cost to workers and businesses with monetary assistance.

So the second respect in which this recession was different was the speed with which governments provided their “fiscal stimulus” and the unprecedented amount of it: for the feds alone, $250 billion, equivalent to more than 12 per cent of GDP.

But there’s a less-recognised third factor adding to the coronacession’s uniqueness: this time the government ordered the closing of our international borders. Virtually no one entering Australia and no one going out.

The independent economist Saul Eslake points out that “an important but under-appreciated reason for the so-far surprisingly rapid decline in unemployment, from its lower-than-expected peak of 7.5 per cent last July, is the absence of any immigration: which means that the civilian working-age population is now growing at (on average over the past two quarters) only 8,300 per month, compared with an average of 27,700 per month over the three years to March 2020,” he says.

This means that, with an unchanged rate of people choosing to participate in the labour force by either holding a job or seeking one, a rate that’s already at a record high, employment needs only to grow at about a third of its pre-pandemic rate in order to hold the rate of unemployment steady.

So any growth in employment in excess of that brings unemployment tumbling down.

Get it? It’s not just that the bounce back in jobs growth has been much quicker and stronger than we expected. It’s also that, thanks to the absence of immigration, this has reduced the unemployment rate much more than it usually does.

To put it another way, Eslake says, if the population of working age continues growing over the remainder of this year at the much-slower rate at which it’s been growing over the past six months, employment has to grow by an average of just 17,000 a month to push the unemployment rate down to just below 5 per cent by the end of this year (assuming the rate of labour-force participation stays the same).

By contrast, if the working-age population was continuing to grow at its pre-pandemic rate, employment growth would need to average 29,000 a month to get us down to 5 per cent unemployment by the end of this year.

Now, it’s true that as well as adding to the supply of labour, immigration also adds to the demand for labour. So its absence is also working to slow the growth in employment. But this has been more than countered by two factors.

The obvious one is the governments’ massive fiscal stimulus. But Eslake reminds us of the less-obvious factor: our closed borders have prevented Australians from doing what they usually do a lot of: going on (often expensive) overseas trips.

He estimates that this spending usually amounts to roughly $55 billion a year. But we’re spending a fair bit of this “saving” on domestic tourism – or on our homes.

Of course, we need to remember that, as well as stopping us from touring abroad, the closed borders are also stopping foreigners from touring here. But, in normal times, we spend more on overseas tourism than foreigners spend here. (In the strange language of econospeak, we are “net importers of tourism services”.)

Eslake estimates that our ban on foreign tourists (and international students) is costing us more than $22 billion – about 1.25 per cent of GDP – a year in export income. Clearly, however, our economy is well ahead on this (temporary) deal.

Another economist who’s been thinking harder than the rest of us about the consequences of our closed borders is Gareth Aird, of the Commonwealth Bank.

The decision by Scott Morrison and Josh Frydenberg to “continuing to prioritise job creation” and so drive the unemployment rate down much further, has led to much discussion of the NAIRU – the “non-accelerating-inflation rate of unemployment” – the lowest level unemployment can fall to before wages and prices take off.

The econocrats believe that little-understood changes in the structure of the advanced economies may have lowered our NAIRU to 4.5 per cent or even less. But Aird reminds us that, for as long as our international borders remain closed, the NAIRU is likely to be higher than that.

“If firms are not able to recruit from abroad then, as the labour market tightens, skill shortages will manifest themselves faster than otherwise and this will allow some workers to push for higher pay,” he says.

“There is a lot of uncertainty around when the international borders will reopen, what that means for net overseas migration and how that will impact on wage outcomes.”

But “in industries with skill shortages, bargaining power between the employee and employer should move more favourably in the direction of the employee and higher wages should be forthcoming,” he concludes.

Higher wages is what the government’s hoping for, of course. Interesting times lie ahead.

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Morrison's budget task: stop the economy's roar turning to a meow

Scott Morrison and Josh Frydenberg look like they’re sitting pretty as they finalise what may be their last budget before the federal election due by the first half of next year. Look deeper, however, and you see they face a serious risk of the economy’s recovery losing momentum over the coming financial year. But, equally, they have a chance to show themselves as the best economic managers since John Howard’s days.

So far, the strength of the economy’s rebound from the “coronacession” has exceeded all expectations. Judged by the quantity of the nation’s production of goods and services, the economy contracted hugely during the three months to June last year. As our borders were closed, many industries were ordered to stop trading and you and I were told to leave home as little as possible.

But with the lifting of the lockdown in the second half of the year, the economy took off. It rebounded so strongly in the next two quarters that, by the end of December, our production – real gross domestic product – was just 1 per cent below what it had been a year earlier, before the arrival of the coronavirus.

The rebound in jobs is even more remarkable. The number of people in jobs fell by almost 650,000 in April and May, and that’s not counting the many hundreds of thousands of workers who kept their jobs thanks only to the JobKeeper scheme.

But as soon as the lockdown was eased, employment took off. By last month, it was actually a fraction higher than it had been in March 2020. We’d been warned the rate of unemployment would reach 10 per cent, but in fact it peaked at 7.5 per cent in July and is now down to 5.6 per cent. Before this year’s out, it’s likely to have fallen to the 5.1 per cent it was before the pandemic.

The confidence of both businesses and consumers is now higher than it has been for ages. Same for the number of job vacancies. Share prices are riding high (not that I set much store by that).

Little wonder the financial press has proclaimed the economy to be “roaring”. Hardly a bad place to be when preparing another budget. What could possibly go wrong?

Just this. The main reason the economy has rebounded so strongly is the unprecedented sums the government spent on JobKeeper, the JobSeeker supplement, HomeBuilder and countless other programs with gimmicky names. Spending totalling a quarter of a trillion dollars.

What it proves is that “fiscal stimulus” works a treat. Trouble is, all those programs were designed to be temporary and the biggest of them have already been wound up. So, though not all the stimulus has yet been spent, it’s clear the stimulus is waning.

And this at a time when there’s no other major force likely to drive the economy onwards and upwards. Business investment spending is way below normal. Growth in the wage income of consumers has been weak for six years or more and, for many workers at present, frozen.

Because all the stimulus programs are stopping, the government’s update last December estimated that the budget deficit for the next financial year will be $90 billion less than the deficit for the year soon ending.

This may sound good, but it means that, whereas last year the government put far more money into the economy than it took out in taxes and charges, in the coming year it expects the budget’s contribution to growth to fall by $90 billion – the equivalent of about 4 per cent of GDP.

So that’s the big risk we face: that before long the economy’s roar will turn to no more than a loud meow.

Now to Morrison and Frydenberg’s chance of greatness. Their temptation is to get unemployment back to the pre-pandemic rate of 5 per cent and call it quits. That’s certainly what previous governments would have done.

But let me ask you a question: do you regard an unemployment rate of 5 per cent as equal to full employment? Is that where everyone who wants a job has got one?

Hardly. And, as Professor Ross Garnaut has argued in his latest book, Reset, there’s evidence that we can get unemployment much lower – say, 3.5 per cent or less – before we’d have any problem with soaring wage and price inflation.

The good news is that the answers to the Morrison government’s risk of economic failure and its chance of economic greatness are the same: keep the budgetary stimulus coming for as long as it takes the private sector to revive and take up the slack.

That means finding new spending programs to take the place of JobKeeper and the rest. And here Morrison’s political and economic needs are a good fit. Making an adequate response to the report of the aged care royal commission will take big bucks.

And he needs to make this a hugely women-centred budget in marked contrast to last year’s. Obvious answer: do what the women’s movement has long been demanding and make childcare free.

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Unless Morrison does a lot more, the recovery will be weak and slow

I fear we may be changing places with the United States. I fear the economy’s rapid rebound may have misled Scott Morrison into believing we’re home and hosed. I fear the Smaller Government mentality may trip us up again.

In response to the global financial crisis of 2008, the Americans and Europeans spent huge sums and ran up big budget deficits and public debt. They had to rescue their teetering banks and get their frozen economies going again.

It worked. The financial crisis dissipated and their economies started to recover. But before long they got a bad case of the Smaller Government frights. Look at those huge deficits! What have we done? Our children will drown in government debt!

So they put their budgets into reverse and cut government spending – especially spending aimed at helping the poor and unemployed – to get their deficits down and slow the growth in debt. Critics dubbed this a policy of “austerity”.

Trouble was, it backfired. Their economies weren’t growing strongly enough to withstand the withdrawal of government support. Their growth slowed, their budget deficits didn’t fall much, and their premature removal of support contributed to the deeper, structural problems that caused the developed economies to endure a decade of weak growth.

Point to note: unlike the Americans (and the others) our Rudd-Gillard government didn’t take fright and start slashing government spending. But now we’ve come to the global coronacession, it seems this time the roles may be reversed.

The Americans – who, admittedly, are in a much deeper hole than us – have just legislated a third, $US1.9 trillion ($2.5 trillion) spending package.

So what are we doing? With the economy having rebounded strongly in the second half of last year, we’re concluding the recovery’s in the bag and proceeding to wind back the main stimulus measures as fast as possible.

In the budget last October, the government foresaw the budget deficit falling from a peak of $214 billion last financial year to $88 billion next financial year.

At the Australian Financial Review’s business summit on Wednesday, one speech was given by Morrison and another by Reserve Bank governor Dr Philip Lowe. Their contrasting tones really worried me.

Morrison’s self-congratulatory speech could have come with a big, George W Bush-like sign, MISSION ACCOMPLISHED. He said it had been a tough 12 months, “but here we are, leading the world out of the global pandemic and the global recession it caused”.

He recalled telling last year’s summit that the government’s economic response “would be temporary and have a clear fiscal [budgetary] exit strategy”.

And “thankfully, we are now entering the post-emergency phase of the . . . response. We can now switch over to medium and longer-term economic policy settings that support private sector, business-led growth in our economy.”

Get it? Now it’s the time for the government to pull back and for business to take the running. Why? “Because you simply cannot run the Australian economy on taxpayers’ money forever. It’s not sustainable.”

(Note the trademark Morrison argument-by-non-sequitur: since you can’t do it forever, you mustn’t do it for another few years.)

Trouble is, Lowe gave an unusually sombre speech, highlighting the key respects in which business wouldn’t be taking the running.

He warned that the better-than-expected rebound after the lifting of the lockdown “does not negate the fact that there is still a long way to go and that the Australian economy is operating well short of full capacity. There are still many people who want a job and can’t find one and many others want to work more hours”.

“And on the nominal side of the economy [that is, on wages and prices] we have not yet experienced the same type of bounce-back that we have in the indicators of economic activity [such as employment and GDP]. For both wages and prices, there is still a long way to go to get back to the outcomes we are seeking.”

One of the main ways we get “business-led growth” is by growth in its investment in expansion. But it’s clear Lowe’s worried that it’s not really happening and may not for some years.

“While there was a welcome pick-up in the December quarter, particularly in machinery and equipment investment, investment is still 7 per cent below the level a year earlier . . . Non-residential construction is especially weak, with the forward-looking indicators suggesting that this is likely to remain so for a while yet,” he said.

Since 2010, business investment as a proportion of gross domestic product has averaged just 9 per cent, compared with 12 per cent over the previous three decades.

“A durable recovery from the pandemic requires a strong and sustained pick-up in business investment. Not only would this provide a needed boost to aggregate demand over the next couple of years, but it would also help build the [stock of physical capital] that is needed to support future production,” Lowe said.

Next is weak wage growth. “For inflation to be sustainably within the 2 to 3 per cent [target] range, it is likely that wages growth will need to be sustainably above 3 per cent . . .

“Currently, wages growth is running at just 1.4 per cent, the lowest rate on record. Even before the pandemic, wages were increasing at a rate that was not consistent with the inflation target being achieved. Then the pandemic resulted in a further step-down. This step-down means that we are a long way from a world in which wages growth is running at 3 per cent plus.”

The financial markets need to remember that you don’t get high inflation without high wages. Business needs to remember that its sales won’t grow strongly if it keeps sitting on its customers’ wages.

And Morrison needs to remember that if he withdraws budgetary support at a time when business is unlikely to take up the slack, the economy will go flat and the voters will blame him.

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Funding the budget by printing money is closer than you think

Many people are alarmed by “modern monetary theory”, the seemingly radical idea that the government should cover its budget deficit simply by creating money. But in his new book, Reset, Professor Ross Garnaut, one of our most respected economists, has joined the young turks.

And that’s not all. Last Monday I wrote about the things Reserve Bank governor Dr Philip Lowe doesn’t feel he can say out loud in this era of unconventional “monetary policy” (the manipulation of interest rates). Something else he doesn’t want to say is that the Reserve is funding the budget deficit already.

(By the way, what follows ignores the present flurry in bond markets, where some players have leapt to the conclusion that inflation’s about to take off. I wish. Don’t worry, the market will return to reality soon enough.)

Until Garnaut’s intervention, this issue has seemed divided between two groups. One is younger economics graduates who think of this revolutionary new idea that the federal government shouldn’t bother borrowing to finance its budget deficits but simply print all the money it needs – thus avoiding all that debt and interest payments – as a breakthrough that would transform the management of our economy and hasten our return to full employment.

The rival group is older, more experienced economists – and a lot of ordinary citizens – who see it as a dangerous, even crazy, idea that would surely end in disaster. It would be the primrose path of indiscipline that led to ever-rising inflation, maybe even hyper-inflation – a dollar that was worth next-to-nothing – and unemployment that was worse, not better.

Ostensibly, the opponents of modern monetary theory (MMT) are led by Lowe, as boss of our central bank. At his appearance before a parliamentary committee last month, he replied to a question from Greens leader Adam Bandt that he would “push back” against any assertion the Reserve was “financing the government”. (Note the curious wording: not that it should, but that it already was.)

Debate between the two sides has established that MMT is neither as modern and revolutionary as its proponents imagine, nor as crackpot as many of its critics imagine. The fact is, until as recently as the mid-1980s, it was common practice for national governments (including ours) to cover their budget deficits partly by borrowing from the public and partly by “borrowing” from the central bank – which would create the money the government wanted.

This was when the developed economies were struggling with high inflation, and Milton Friedman’s “monetarists” were telling people that adding to the supply of money would inevitably lead to inflation.

So all the governments (including the Hawke-Keating government) decided to fund their deficits solely by selling government bonds to the public. Ironically, this meant the banking system (not an individual bank, but the system as a whole) could and did continue creating money, but the government – despite being the issuer and backer of the currency – couldn’t.

The monetarist dogma that creating money inevitably leads to inflation turned out to be wrong. It’s inflationary only if it causes the demand for the “real resources” – land, labour and physical capital – used to produce goods and services to exceed the supply of real resources. Until you reach that point, the creation of more money – whether by the banking system or the government – should give you stronger demand and more jobs without causing problems.

So the real reason for worry about MMT isn’t the theory, but the practice. If you give a bunch of vote-buying politicians a licence to spend as much as they like up to a certain point, how could you be sure they’d stop, and revert to borrowing, when they reached that point?

It’s this that Lowe is really on about, though he doesn’t want to say so.

Since last year he’s had little choice but to join the other, bigger economies in resorting to “quantitative easing” (QE) – the central bank buying second-hand government bonds, so as to lower the “yields” (interest rates) on such bonds, but paying for them merely by crediting the bond sellers’ bank accounts.

In particular, since March last year the Reserve has guaranteed that it would buy sufficient bonds to stop the yield on three-year Australian government bonds rising above 0.25 per cent (later lowered to 0.1 per cent). In practice, because the market believed the Reserve would honour its promise, it hasn’t had to actually buy all that many bonds – until last week.

Then, last November, the Reserve went further into QE, announcing it would buy $100 billion worth of second-hand federal and state government bonds with maturities of five to 10 years so as to force their yields down, too. The Reserve estimates that these purchases have lowered yields by about 0.3 percentage points.

Last month it decided to buy another $100 billion worth. Under questioning by Labor’s Dr Andrew Leigh at the parliamentary committee, Lowe and his deputy, Dr Guy Debelle, revealed that $80 billion of the first $100 billion had gone on federal (as opposed to state) government bonds, which represented about 10 per cent of the feds’ entire stock of bonds outstanding.

The further $100 billion would take the Reserve’s holding of the feds’ total debt to 20 per cent. If there was yet another $100 billion purchase after the second, that would take its holding to 30 per cent. With the Reserve buying second-hand bonds at the steady rate of $5 billion a week, it was buying more than the new bonds the government was issuing to fund its huge budget deficit, Debelle revealed.

In his opening statement to the committee, Lowe insisted that “the RBA does not, and will not, directly finance governments. The bonds we own will have to be repaid in the same way as if they were owned by others.

“We are lowering the cost of finance for governments – as we are for all borrowers – but we are not providing direct finance. There remains a strong separation between monetary and fiscal [budgetary] policy,” he said.

That last sentence is the key to why Lowe is drawing such fine distinctions. Fiscal policy is controlled by the politicians, whereas monetary policy is controlled by the Reserve, which is independent of the elected government.

The Reserve is buying all these second-hand bonds of its own volition, and doing so because it believes QE is part of monetary policy’s best contribution to getting people back in jobs. It’s not acting under any directive from the government to fund its deficit directly. So the problem of the pollies continuing to spend beyond the point where this becomes inflationary doesn’t arise.

All true. But Lowe can’t suspend the truth that money is “fungible” – all dollars are interchangeable. Funding the deficit indirectly rather than directly may be important from the perspective of good governance, but from the perspective of the economic effect, they’re the same.

Back to the views of Professor Garnaut: “The fiscal deficits should be mainly funded directly or indirectly by the Reserve Bank, at least until full employment is in sight.”

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We must stop making excuses and push now for full employment

In his new book, Reset, outlining a plan to get the economy back to top performance, Professor Ross Garnaut makes the radical proposal to keep stimulating the economy until we reach full employment within four years. Excellent idea. But what is full employment? Short answer: economists don’t know.

In principle, every economist believes achieving full employment is the supreme goal of economic policy, because it would mean using every opportunity to get everyone working who wants to work and so achieve the maximum possible rate of improvement in our material living standards.

In practice, however, we haven’t achieved full employment consistently since the early 1970s – a failure that few economists seem to lose sleep over. It’s like St Augustine’s prayer: Lord make me pure – but not yet.

The economists’ ambivalence starts with the truth that, contrary to what you’d expect, full employment can’t mean an unemployment rate of zero. That’s because, at any point in time, there’ll always be some people moving between jobs.

In the days when we did achieve full employment, from the end of World War II until the early ’70s, its practical definition was an unemployment rate of less than 2 per cent.

But then economists realised that the full employment we wanted had to be lasting – “sustainable”. And if you had the economy running red hot with everyone in jobs and using the shortage of labour to demand big pay rises, this would push up the prices businesses had to charge and inflation would take off. The managers of the economy would then have to jam on the brakes, and before long we’d be back to having lots of unemployed workers.

This was when economists decided that sustainable full employment meant achieving the NAIRU – the “non-accelerating-inflation” rate of unemployment. This was the lowest point to which the unemployment rate could fall before wages and inflation began accelerating.

This makes sense as a concept. So the economic managers decided they could use fiscal policy (increases in government spending or cuts in taxes) and monetary policy (cuts in interest rates) to push the economy towards full employment, but they should stop pushing as soon as the actual unemployment rate fell down close to the NAIRU.

Trouble is, the NAIRU is “unobservable” – you can’t see it and measure it. So economists are always doing calculations to estimate its level. But every economist’s estimate is different, and their estimates keep rising and falling over time for unexplained reasons.

In the 1980s, people thought the NAIRU was about 7 per cent. In the late ’90s, when someone suggested we could get unemployment down to 5 per cent, many economists laughed. But it happened.

For a long time, our econocrats had it stuck at “about 5 per cent”. But the rich economies have been stuck in a low-growth trap, with surprisingly weak growth in wages and prices, even as unemployment edged down. This suggests the NAIRU may now be lower than our calculations suggest.

Garnaut recounts in his book US Federal Reserve chairman Jerome Powell saying that, in 2012, the Fed thought America’s NAIRU was 5.5 per cent. In 2020, they thought it had fallen to 4.1 per cent. But this seems still too high because, before the virus struck, the actual unemployment rate had fallen to 3.5 per cent without much inflation.

In Australia, in 2019 the Reserve lowered its estimate to a number that “begins with 4 not 5”, or “about 4.5 per cent”. With wage growth “subdued” for the past seven years, and consumer prices growing by less than 2 per cent a year for six years, this downward correction is hardly surprising. Indeed, Garnaut thinks the true figure could be 3.5 per cent or less.

But Treasury secretary Dr Steven Kennedy said last October he thought the coronacession, like all recessions, had probably increased the NAIRU - to about 5 per cent.

Now get this. Treasurer Josh Frydenberg has said he won’t start trying to reduce the budget deficit – apply the fiscal brakes – until unemployment is “comfortably below 6 per cent”.

Really? That would be well above any realistic estimate of the NAIRU. So the Morrison government is saying it will stop using the budget to reach full employment well before it’s in sight, making reducing government debt its top priority. We’d love to get everyone possible back to work but, unfortunately, we can’t afford it.

So we’re prepared to let continuing unemployment erode the skills of those who go for months or even years without a job because the cost of helping them is just too high. Those likely to be most “scarred” by this will be young people leaving education in search of their first proper job.

But we’ll blight their early working lives in ways that will harm them – and the economy they’ll be making a diminished contribution to - for years to come. That’s okay, however, because we’ll be doing it – so we tell ourselves – to ensure we don’t leave the next generation with a lot of government debt.

Yeah sure. In truth, we’ll be doing it because, so long as I and my kids have jobs, we’ve learnt to live with a lot of other people not having them. We believe in full employment, but we’re happy to continue living without it.

This complacency is what Garnaut says must change. He’s right. He’s right too in saying that with the rise in wages and prices so weak for so long, we should stop trying to guess where the NAIRU is. “We can find out what it is by increasing the demand for labour until wages in the labour market are rising at a rate that threatens to take inflation above the Reserve Bank [2 to 3 per cent] range for an extended period,” he says.

And here’s something else to remember: the Reserve has begun warning that we won’t get back to meaningful real wage growth until we get back to full employment.

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Here's the unspeakable truth about the fall in interest rates

In these unprecedented times, Reserve Bank governor Dr Philip Lowe is having trouble explaining his actions and motivations because there are various things someone with his degree of influence feels he can’t admit. But I’m under no such constraint. So let me have a go at giving you the message he won’t.

Despite Lowe’s reticence, he’s a fundamentally honest person and if you study what he’s saying – and avoiding saying – you can join the dots.

Long before the coronavirus appeared on the horizon early last year, the rich economies had been caught in a low-growth trap caused by a global imbalance between how much people wanted to borrow and invest, and how much other people wanted to save and lend. Around the world, interest rates were heading close to zero.

With our economy growing at a rate well below its “potential” to produce more goods and services, Lowe slowly and reluctantly cut our official interest rate. He was reluctant because he knew that, with rates already so low and households already so much in debt, cutting rates further would do little to help.

But also because, with the official rate already down to 0.75 per cent, he was perilously close to running out of ammunition, while the Morrison government was totally focused on getting the budget back to surplus and so reluctant to use the budget to stimulate growth.

He didn’t want to follow the other, bigger central banks into the unconventional, uncharted and unhinged territory of “quantitative easing” (QE) – central banks buying second-hand government bonds and paying for them merely by creating money, so as to lower longer-term public and private sector interest rates – much less engineer “negative” interest rates (where the lender pays the borrower to borrow).

By the Reserve’s board meeting early last March, it was clear the virus would slow the economy a bit, so Lowe cut the official rate to 0.5 per cent. Within a fortnight it had become clear the pandemic was a much bigger deal.

So, after an emergency meeting, Lowe announced another cut, taking the official rate down to 0.25 per cent, the level he’d long told us was its “effective lower bound”. He also embarked on various forms of QE, including guaranteeing to buy sufficient second-hand Commonwealth bonds to keep the “yield” (interest rate) on three-year bonds at about 0.25 per cent.

The next big move came last November, when Lowe lowered the official rate’s effective lower bound to 0.1 per cent, lowered the target for the yield on three-year bonds similarly, and decided to buy $100 billion-worth of second-hand bonds with maturities of five to 10 years, so as to force their yields down, too.

Then, earlier this month, Lowe announced a decision to spend a further $100 billion buying longer-dated bonds once the first $100 billion had gone. But, he insisted, the board had “no appetite” to push interest rates “into negative territory”.

So what do all these moves prove?

It’s understandable that Lowe should want to maintain public confidence that the independent authority which has had most influence over the day-to-day management of the economy for the past three decades, the Reserve, is at the helm, actively wielding an instrument that’s still highly effective in keeping us on course.

To this end, he has denied that monetary policy (the manipulation of interest rates) has run out of fire power. As he’s stepped further and further into unconventional measures, he’s suppressed his former reservations about their effectiveness and possible adverse side-effects, and striven to give the impression that everything’s under control and going fine. Monetary policy is playing an important part in getting the jobless back to work.

The reality is different. Movements in interest rates – whether achieved by conventional or unconventional means – affect different aspects of the economy via different mechanisms, or “channels”.

The most front-of-mind channel – “intertemporal substitution” – tells us a cut in the cost of credit encourages households to borrow more and spend it on consumption, while encouraging businesses to borrow more for investment in expansion. But if you read his words carefully, Lowe never claims his measures are causing this to happen – because it’s unlikely much of it is.

Rather, he alludes to the “cash flow” channel, saying lower rates are lowering the interest bills of households and businesses with existing debts, thereby leaving them with more money to spend on other things. True – but not terribly powerful, particularly since most people with home loans leave their monthly payments unchanged and thus pay off their mortgage a bit faster, a form of saving.

In his evidence to a parliamentary committee earlier this month, Lowe vigorously denied that the Reserve was “targeting the dollar” or that he saw signs of “currency manipulation” by other central banks (also known as “competitive devaluations”). Strictly true – but misleading.

Lowe isn’t “targeting the dollar” at a particular level or as a goal in its own right. But he cares deeply about the level of our currency’s rate of exchange against the currencies of our trading partners because this greatly affects the international price competitiveness of our export and import-competing industries, and thus how much they produce and how many people they employ.

When discussing the benefits his recent interest-rate moves have brought us, Lowe never fails to mention that they’ve caused our exchange rate to be “lower than otherwise”. That’s true – but it’s not a lot to show for all the Reserve’s lever-pulling. Lowe isn’t actually denying that monetary policy is much less effective in boosting demand than it used to be.

There’s little evidence that QE does much to increase demand for goods and services – as opposed to demand for assets such as shares and houses (probably with adverse consequences for the distribution of income and wealth). But it does seem clear that QE gives you a lower exchange rate.

Trouble is, when the Americans use QE to make their exchange rate more competitive, this makes other countries’ exchange rates less competitive. So the Europeans and Japanese defend themselves and start doing it too.

Get it? Now all the big boys are doing it – and keep doing more – Lowe’s had little choice but to do it too. Had he resisted getting into the unknown waters of unconventional measures, our dollar would be a lot higher and hugely uncompetitive.

Which means almost everything he’s done over the past year hasn’t been making things better for the economy so much as stopping things getting worse. And it also suggests that, however much Lowe lacks an “appetite” for moving to negative interest rates, if the big boys choose to go further down that path, he’ll have little choice but to join them.

There are other issues on which Lowe has felt the need to be less than frank, but they’re for another day.

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