Treasurer Wayne Swan has confirmed, in his speech to the Australian Business Economists, that the government will deliver a strong contrationary bias to public demand in the budget. This contraction will not just be concentrated in 2012-13 but will continue into 2013-14, an important fact for the market and RBA board members to contemplate.
Of huge significance, Swan’s very clear message to the RBA is that it can easily cut interest rates knowing that government demand will be dampening demand and inflation pressures over the forecast horizon.
This message is now filtering through to foreign investors in Australian markets which is seeing the Australian dollar take a few steps lower as the carry trade loses some of its appeal. Here is some of what Swan said:
“Our fiscal strategy ensures we won’t be adding to the price pressures of a strengthening economy experiencing a once-in-a-generation investment boom …”
“The IMF also acknowledges a surplus, and I quote, ‘will increase fiscal room and take pressure off monetary policy and the exchange rate’.”
See the logic? It’s a near perfect application of economic policy: tighter fiscal policy which builds savings, giving even great fiscal flexibility for the future, allows for a lower interest rate structure and therefore a lower Australian dollar.
Recall the alternative is an easy budget with on-going deficits, higher interest rates and an even higher Australian dollar. Lovely.
It is often forgotten that government demand makes up around 20% of GDP. As such, it is four times bigger than all housing investment; it is not much smaller than all of retail sales combined. What happens to government demand has a big impact on the overall growth performance of the economy.
The budget measures will confirm Australia has a recession in government demand. This will free up resources to allow the private sector to grow and expand. The private sector will be aided by lower interest rates and a more competitive exchange rate. The government sector’s demand on workers, finance, resources will be lower with tight fiscal settings, which allows for those resources to be taken up by the private sector.
There are some commentators suggesting that the economy is so soft or vulnerable that the government should abandon its economic objective of returning to budget surplus. These calls are embarrassing for the proponents as they underscore a lack of appreciation of the policy objectives.
They must recall that the cash rate in Australia is 4.25% — a long way from the zero bound in so many other countries at the moment. There is plenty of scope for the cash rate to be lowered. The RBA could cut to 3.5%; 2.5%; 1.5% if needed. What’s wrong with this as a measure to support activity?
Those arguing for the budget surplus objective to slip are implicitly arguing for higher interest rates and an even higher Australian dollar. I suppose that is fair enough if they acknowledge the consequences of their suggestion, but given the terms of trade are falling and the Australian dollar is still high, such a move would drive an even greater imbalance within the economy.
If I was recommending market trading strategies — and I’m not in this instance — I would be getting set for the RBA to be cutting interest rates aggressively in the next few months. A 3.5% cash rate remains on the cards.
In this climate of what are currently unanticipated rate cuts, the Australian dollar is long overdue for a fall. With the carry trade losing some of its carry as the RBA cuts rates, a nice 5 to 10% fall in the dollar could be seen by year end.
*Stephen Koukoulas is Managing Director of Market Economics, a macroeconomic, policy and financial market advisory firm. This item was originally published on his blog.
The ll enompassing incompetence of Labor eonomic management at work.
Expect the Coalition respond with this statement in response.
Here’s how Wayne Swan can get his surplus in 2012-13:
(1) Announce that the 50% discount for capital gains will be scrapped for capital gains realized after 30 June 2013. This will cause a burst of realizations (hence tax receipts) in 2012-13, as owners take advantage of the discount before it expires. If they choose not to take advantage of it within that generous time frame, they have no cause to complain.
(2) Limit the First Home Owners’ Grant to new homes, causing not only a reduction in payouts but also a stimulus to construction, whose flow-on effects will increase receipts from income tax.
(3) Disallow negative gearing of a rental property unless it is actually tenanted (not merely “available” for rent). But exempt newly built properties from this rule for (say) 5 years after construction. The rule will reduce tax deductions, while the exemption will stimulate construction.
What about the States? The “burst of realizations” due to step (1) will increase stamp-duty receipts in 2012-13, while the stimulus to construction from steps (2) and (3) will increase receipts from payroll tax and GST. And note the implication that fiscal tightening is not incompatible with “stimulus”.
Yes Gutaur, Swan is incompetent. His spin doctors release parts of the speech to Fairfax and News yesterday, so the headlines can focus on incompetent Swan, who has now realised his policies are flawed and he needs to slam on the waste brakes.
Hoping the RBA hears his message and drops rates. Any RBA Directors up for re-appointment now or soon? Swan is sending you a message.
Gavin P;
I am not sure the GST is Commonwealth budget figure, it was designed to be a state tax collected by the Federal Government.
Whilst the stimulation of the building industry is laudable, the current gradual deflation of the housing market in all the economies that experienced the debt splurge of the noughties indicates it maybe perhaps contrarian and counter productive. Maybe an investment in State Housing for the under privilege may have the desired affect but it will be contrary to Swan’s ambition to balance the budget.
Corporate and middle class welfare transfer payment is where I think we will see the necessary pull backs to balance the budget.
Stephen’s above points are very relevant and we should see more advantageous impact from monetary policy with interest rate decreases of the degree he seems to be suggesting with a balanced the Fed Budget
Wayne Swan is a long way short of incompetent. The man has faced many hurdles and has a very good success rate . The best thing he has done? hand the 2010 premiership trophy to Ben Hornby!