Anyone following the evolution of economic trends is well aware that the Australian economy is overheating, with unemployment set to fall to a 48-year low and inflation pressures building at an alarming rate.
Policy makers should be looking to adjust settings to rein in the overheating, which means, in simple terms, a need for higher interest rates and a significant winding back of the Government’s contributions to the economy.
Treasurer Josh Frydenberg has made a policy mistake in the Budget he just handed down.
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It is easy to understand the political pressures that have seen $37 billion of extra cash being pumped into the economy in just two years, 2021-22 and 2022-23.
The election will be held in May and the Government is well behind in the polls. Betting markets and Frydenberg are banking on this helicopter money to buy some votes, rather than frightening financial markets to expect earlier and larger interest rate increases.
For the economy, it is adding fuel to the fire. It is the wrong policy for the times.
We know that during the global financial crisis in 2008-10 and the COVID recession in 2020-21, extra government spending, lower taxes and broadly based budgetary stimulus were essential.
And we know they worked, by capping the rise in the unemployment rate, supporting business and returning the economy to sustained strength.
But when the economy is strong, such fiscal stimulus is not only obsolete, the reverse needs to happen.
Rather than spray cash on lump-sum payments, cuts to excise on petrol and the like, tighter spending and taxing is needed.
Prudent fiscal policy in 2022 would be looking to trim government spending and would tighten some tax policies. In other words, taking some heat out of the economy and, in the process, helping the Reserve Bank (RBA) to arrest the worrying surge in inflation.
Budget policy errors
In terms of some of the key budget numbers, the following information sets out the policy errors very clearly.
Since the time of the last budget, an unexpected improvement in the economy has seen the budget deficits over four years fall by a total of $126 billion.
At the very least, the Government should have allowed these automatic stabilisers to start to repair the Budget.
The Budget papers reveal that almost half of this windfall has been injected back into the economy from the decisions taken by the Government.
The hot debate in financial markets is when and how much the RBA will need to hike interest rates to rein in inflation pressures that were evident before the Budget.
The current financial market pricing is for the RBA to hike 1.75 percentage points by the end of 2022 and a total of 3 percentage points by the end of 2023. Interest rate increases of these orders of magnitude will withdraw cash from the economy, slow it down and dampen the troublesome inflation pressures being witnessed at the moment.
Had the Government been more prudent in the Budget, some of this interest rate pressure would have been moderated, at least at the margin.
There are two RBA board meetings between now and the May election.
A rate hike will be on the table for discussion at those meetings, and those after that too and, were it not for the election, there is no doubt the RBA would be hiking rates.
Recall the cash rate is currently 0.1 per cent and this with an outlook for a near-50-year low on the unemployment rate, wages forecast to accelerate and inflation set to be almost double the RBA target.
Politically, it is a good Budget. Some voters will warm to the sugar hit of extra payments and a cut in the petrol price.
Economically, it has pushed back the increasingly urgent task of budget repair and it adds to interest rate pressure.
Whichever side wins the election in May, a new budget will be needed to address these problems.