Scott Morrison got the government re-elected on the back of a budget built on an illusion: that the economy was growing strongly and would go on doing so for a decade. The illusion allowed Morrison to boast about getting the budget back into surplus and keeping it there, despite promising the most expensive tax cuts we’ve seen.
The illusion began falling apart even while the election campaign progressed. The Reserve Bank board responded to the deterioration in the economic outlook at its meeting 11 days before the election.
It’s now clear to me that it decided to bolster the economy by lowering interest rates, but not to start cutting until its next meeting, which would be after the election – next Tuesday.
If that wasn’t bad enough for Morrison, with all his skiting about returning the budget to surplus he may have painted himself – and the economy – into a corner.
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In a speech last week, Reserve Bank governor Dr Philip Lowe made it clear that cutting interest rates might not be enough to keep the economy growing. He asked for his economic lever, “monetary policy” (interest rates), to be assisted by the government’s economic lever, “fiscal policy” (the budget).
He specifically mentioned the need to increase government spending on infrastructure projects, but he could have added a “cash splash” similar to those Kevin Rudd used to fend off recession after the global financial crisis in 2008.
See the problem? Any major slowdown in the economy would reduce tax collections and increase government spending on unemployment benefits, either stopping the budget returning to surplus or soon putting it back into deficit.
That happens automatically, whether the government likes it or not. That’s before any explicit government decisions to increase infrastructure spending, or splash cash or cut taxes, also worsened the budget balance.
And consider this. The Reserve’s official interest rate is already at a record low of 1.5 per cent. Its practice is to cut the official rate in steps of 0.25 percentage points. That means it’s got only six shots left in its locker before it hits what pompous economists call the “zero lower bound”.
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What happens if all the shots have been fired, but they’re not enough to keep the economy growing? The budget – increased government spending or tax cuts – is all that’s left.
The economics of this is simple, clear and conventional behaviour in a downturn. All that’s different is that rates are so close to zero. For Morrison, however, the politics would involve a huge climb-down and about-face.
My colleague Latika Bourke has reported Liberal Party federal director Andrew Hirst saying that, according to the party’s private polling, the Coalition experienced a critical “reset” with April’s budget. The government’s commitment to get the budget back to surplus cut through with voters and provided a sustained bounce in the Coalition’s primary vote.
The promised budget surplus also sent a message to voters that the Coalition could manage the economy, Bourke reported.
Oh dear. Bit early to be counting your chickens.
The first blow during the election campaign to the government’s confident budget forecasts of continuing strong growth came with news that the overall cost of the basket of goods and services measured by the consumer price index did not change during the March quarter, cutting the annual inflation rate to 1.3 per cent, even further below the Reserve’s target of 2 to 3 per cent on average.
Such weak growth in prices is a sign of weak demand in the economy.
The second blow was that, rather than increasing as the budget forecast it would, the annual rise in the wage price index remained stuck at 2.3 per cent for the third quarter in a row. The budget has wages rising by 2.75 per cent by next June, by 3.25 per cent a year later and 3.5 per cent a year after that.
As Lowe never tires of explaining, it’s the weak growth in wages that does most to explain the weakening growth in consumer spending and, hence, the economy overall. Labor had plans to increase wages; Morrison’s plan is “be patient”.
The third blow to the budget’s overoptimism was that, after being stuck at 5 per cent for six months, in April the rate of unemployment worsened to 5.2 per cent. The rate of underemployment jumped to 8.5 per cent.
Why didn’t Labor make more of these signs of weakening economic growth during the campaign? It had no desire to cast doubt on the veracity of the government’s budget forecasts because, just as they provided the basis for the government’s big tax cuts, they were also the basis for Labor’s tax and spending plans.
Labor was intent on proving that its budget surpluses over the next four years would be bigger than the government’s – $17 billion bigger, to be precise.
Think of it: an election campaign over which side was best at getting the budget back to surplus, just as a slowing economy and the limits to interest-rate cutting mean that, at best, any return to surplus is likely to be temporary.
Morrison’s $1080 tax refund cheques in a few months will help bolster consumer spending, but they’re a poor substitute for decent annual pay rises.
Ross Gittins is economics editor.