Put 10 economists in the same room and you will get 11 different opinions, the joke goes. But most agree that it’s unwise to be slamming the brakes on fiscal policy while revving up the gears via monetary policy.
Such is the dilemma facing Australia’s federal Labor government, as it cuts spending to achieve the "holy grail" of a budget surplus, while simultaneously encouraging interest rate cuts by the central bank.
Economics is known as the “dismal science,” and for Australia’s policymakers, with an economy battered by falling commodity prices, the growth figures announced Wednesday made for a very dim reading.
Real (inflation-adjusted) GDP expanded by only 0.5 percent in the 3rd quarter, the smallest increase in six quarters and an annual rise of 3.1 percent.
The lower growth was blamed by Treasurer Wayne Swan on a “pretty savage” 13.7 percent annualized fall in the nation’s terms of trade, with lower prices for the key exports of coal, iron ore and other commodities.
However, budget cuts also had an impact, with public spending dropping 4.4 percent and public investment 18.8 percent due to tightening by all levels of government.
Apart from mining, the only sectors to show positive growth were manufacturing, social and healthcare services.
For Swan, achieving the government’s planned AUD$1.1 billion budget surplus this financial year – the first such surplus to be delivered under his watch – may become an impossible dream.
“None of us believes the government is going to meet this surplus fantasy,” JPMorgan economist Stephen Walters told local media.
Former Reserve Bank of Australia (RBA) governor Bernie Fraser has described a return to surplus under current conditions as “plain dumb.” Former RBA board member Warwick McKibbin agreed, telling the Australian Business Economists (ABE) annual conference on Wednesday that achieving a surplus could prove “very dangerous” for the economy.
“There is no need to cut spending and raise taxes to get a particular surplus in a particular year. There is just no need for that, it is a political promise,” he was quoted saying by the Brisbane Times.
“That is OK when you can afford to make it, but when you can't afford to make it – and I think we're in that point right now – it's very dangerous for the economy.”
The ABE’s annual survey found most economists believe the federal government’s surplus prediction to be overly optimistic, forecasting lower growth in 2013.
However, Swan pointed to record planned business investment of $173 billion in fiscal 2013, higher exports and improved housing investment, arguing that “the government’s fiscal consolidation continues to be more than offset by growth in the private sector”.
"Emergency" interest rates
While Swan has argued a tighter budget allows for looser monetary policy, economists are starting to question the effectiveness of lower interest rates in boosting demand.
On Tuesday, the RBA cut the official cash rate to 3 percent, its lowest level since the “emergency” reductions during the global financial crisis, although bank lending rates remain up to 0.8 percentage points above their 2009 lows.
Further rate cuts are anticipated by most economists, as the central bank attempts to also weaken the strong Australian dollar
However, with banks warning of “subdued” business lending and households reducing debt, the impact of lower rates is expected to be less than normal.
In a research note, AMP Capital’s chief economist Shane Oliver said the RBA had more work to do to pick up the slack, saying that the key recent economic driver of mining investment was “peaking at a time when the rest of the economy is still subdued.”
“…Growth will slow further to around 2.5 percent over the year ahead, which is well below trend growth of around 3 – 3.25 percent. The risks are on the downside,” he said.
Asked prior to the latest growth figures whether a surplus was still achievable, ANZ economist Justin Fabo told The Diplomat, “We suspect it will, but it doesn't really matter as they've had to employ so many 'tricks' to achieve it that it's only on paper.”
Yet having made a budget surplus key to its economic credibility, the federal government is loath to let it disappear.