Why the budget deficit is largely irrelevant

The budget is just a week away and no doubt there will be a lot of focus on the size of the deficit in 2016-17, the level of government debt and whether the return to a budget surplus will be in 2018-19, 2019-20 or 2020-21.

It will be the wrong focus and a reflection of how warped the economic policy debate has become in Australia over the past decade or so.

Budget policy, which incorporates the spending, taxing and revenue decisions of the government, is adjusted and tweaked as a means of promoting economic growth and employment in a fair and equitable way.

Also read: Budget a balancing exercise: Turnbull

If the aim is to maximise economic growth and keep the unemployment rate as low as possible, it should be all but irrelevant what the budget deficit or surplus is.

Look at it this way. Any government could deliver a budget surplus tomorrow if it slashed spending and hiked taxes. Hike the GST to 15 per cent tomorrow with no compensation or other measures and there would be a budget surplus.

But of course if a government does this when the economy is weak and the unemployment rate is too high, a hurried return to surplus would impose economic carnage, in much the same way many countries in Europe got policy wrong at the height of the global crisis. Spain and Greece are still suffering unemployment rates over 20 per cent.

Clearly the focus of analysis of the budget should be what Treasurer Scott Morrison is forecasting for the rate of economic growth and for the unemployment rate.

If economic growth is forecast below three per cent in any of the next few years and the unemployment rate above five per cent, the budget could be seen as a fail.

Policies should be in place that lift growth and with that, lower the unemployment rate.

To be sure, tax and spending policies act with a lag on the economy and can be difficult to fine tune. Importantly, account should also be taken of the monetary policy stance set by the Reserve Bank of Australia and any significant influences from global economic developments.

Also read: Budget rhetoric a test for confidence

The point is that every credible economics text book notes that fiscal policy is a tool to achieve an economic outcome – growth and jobs - and not an end in itself. If this means the budget needs to be in surplus so be it. Or a deficit - so be it.

Firefighters are never criticised for using too much water when fighting a fire, even if some of that water may be wasted or over-used just to be sure the fire is out. And when there are no fires, a surplus of water is accrued.

This is the way the upcoming budget should be viewed. What are the policies that are being implemented to support the economy is a fair, equitable and sustainable way. If this means the budget deficit is $35 billion or $15 billion, so be it.

When the economy is strong and is at full employment, the budget will return to surplus, as it should.

It should be as simple as that.

 

Stephen Koukoulas is a Yahoo7 Finance expert with 

more than 25 years experience as an economist in government, as Global Head of economic and market research, as Chief Economist for two major banks, and as economic advisor to the Prime Minister of Australia.