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Should surplus trump domestic growth?

As the RBA struggles to hit its inflation and unemployment targets, and unconventional monetary policy looms, the debate wages over whether or not the federal government should be stepping in.

The Treasury’s mid-year economic and fiscal outlook (MYEFO) results for the 2019-20 financial year revealed an expected budget surplus of $5 billion, with forecasted gross domestic product (GDP) growth of 2.25 per cent, both below initial estimates made by the Treasury in April.

While a surplus was achieved, the Australian economy still slugs along, with below-trend GDP growth, stubbornly stagnant wage growth and no meaningful change in unemployment levels, according to various economists.

According to Moody’s, in pursuance of an ongoing budgetary surplus, the federal government has made it clear that “expansionary fiscal policy of any substance” is off the table, which means the Reserve Bank of Australia (RBA) is “forced to do the heavy lifting” in order to get the economy moving.

Currently, the government is reliant on the RBA to implement monetary policy decisions to inflate the Australian dollar, lower unemployment levels and encourage consumer spending through the lowering of the official cash rate.


However, after three rate cuts made throughout 2019, which brought the official cash rate to a record low of 0.75 per cent, “there is not much room left for the central bank to provide additional stimulus to the economy” via traditional means, David Plank, head of Australian economics at ANZ Research, said.

The RBA continues its struggle to get inflation back to its preferred 2-3 per cent target (currently 1.7 per cent) and has made public calls to the Treasury to help achieve its goal.

As such, the debate on whether the government should sacrifice its surplus in favour of strong fiscal policy that would result in higher GDP growth and lower unemployment has waged throughout this period of economic stagnation.

Untraditional methods of monetary policy

In the absence of fiscal policy intervention, the RBA will continue its attempt to get the economy moving by cutting rates.

Economists are generally in agreement that the Reserve Bank is highly likely to cut the official cash rate to 0.5 per cent in its first meeting of 2020 in February, while AMP Capital chief economist Shane Oliver predicts back-to-back cuts in both February and March, which will see the official cash rate hit 0.25 per cent.

According to Mr Oliver, the RBA would then consider quantitative easing (QE) in the absence of fiscal policy stimulus in the federal government’s budget in May. 

Rates hitting 0.25 per cent are likely to shake consumer confidence further, and should the economy not see a meaningful turn upward, more drastic monetary policy measures such as QE or negative rates could take place.

The pro-fiscal policy position

While RBA governor Philip Lowe has said that it is “extraordinarily unlikely” that the central bank will turn to unconventional policies such as QE (unless there is an “accumulation of evidence” that it is unlikely to achieve its objectives of both full employment and inflation should the cash rate fall to 0.25 per cent), economists have highlighted that without fiscal intervention, it is highly unlikely that the RBA will hit its targets of full employment and 2-3 per cent inflation through slashing rates.

“Ideally, fiscal stimulus in the form of faster tax cuts, a boost to Newstart, investment incentives and a bring forward of infrastructure spending where possible is needed from here,” Mr Oliver said.

“However, in the absence of fiscal stimulus soon, the pressure remains on the RBA where we expect to see another 0.25 [percentage point] rate cut in December, quantitative easing (possibly designed to lower bank funding costs and allow banks to pass on more rate cuts) and more dovish forward guidance on rates.”

Other economists have publicly encouraged the government to sacrifice the surplus in order to step in and assist the RBA in achieving inflation and GDP growth.

Speaking to the media, Stephen Koukoulas of Market Economics, said that while achieving a budget surplus is “fine”, it should not be made at the expense of a weak domestic economy.

“If [the surplus is] coming at the cost of underspending in the economy, that is, less money going out into the economy through government spending, and taxes being raised... it means that the government is actually acting as a constraint on economic growth at a time when GDP is well below trend.”

Mr Koukoulas went on to say that the case for running at a surplus while the Australian economy is struggling “is a poor one”.

Commonwealth Bank senior economist Gareth Aird also argued that the case for more fiscal stimulus, either in the form of tax cuts or fiscal spending, is “pretty strong”.

“The RBA governor himself has publicly called for more fiscal expenditure, and that could come in the form of more government spending or bringing forward the tax cuts,” Mr Aird said.

He went on to say that achieving a budget surplus in a period of below-trend economic growth was quite unusual but can be attributed to higher-than-anticipated commodity prices.

“You could make the case right now that, given the budget is in a good position but the economy needs more stimulus, it’s not necessarily worth being wedded to that idea of running a surplus from here, [but] rather injecting a bit more money back into the economy.”

The case for surplus

As seen, there is an ongoing tension between the RBA and the Treasury when it comes to how to get the domestic economy moving, and, as Deloitte Access Economics partner Chris Richardson argued in his Budget Monitor report, the debate is not so black-and-white.

In such a low interest rate environment, Australia does not have the same “recession insurance” that it had ahead of the GFC, said Mr Richardson.

“Healthier fiscal finances help protect prosperity by providing more ‘recession insurance’ than we’d otherwise have,” he said.

The surplus is therefore important, as it now serves as the necessary insurance for the country should the global economy take a turn downwards and Australia head into a recession, and allocating finances into growing the economy might not be appropriate given international economic conditions.

However, Mr Richardson stated: “[T]he budget surplus of the moment is a means to an end, not the end itself.”

He highlighted that the government must not be shy in spending the surplus if and when it becomes necessary.

“If something bad happens and a recession heads our way, then we should sacrifice the surplus in a heartbeat.

“A healthy starting point for national fiscal finances can and should make a material difference to Australia’s ability to limit the size of any recession that threatens us.”

[Related: RBA to ‘reassess’ environment in February]

Should surplus trump domestic growth?

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