(Tony Dalton assisted me with the contents of this article)
Australia, like the rest of the world, faces a very serious situation. The coronavirus pandemic (CVP) and the ensuing economic crisis are unlikely to be short-lived.
Despite Australia’s remarkable success in limiting the spread of the virus so far, Covid-19 is extremely contagious with high lethality and can be transmitted by asymptomatic “super spreaders.”
It is likely to continue until an effective vaccine is invented and mass-produced—or until so many people are infected that herd immunity is conferred. The capacity of the disease to mutate casts doubt over the potential effectiveness of both vaccines and herd immunity.
Any vaccine is currently expected to take at least a year to find. And it could be a year and a half or longer before a serviceable serum is generally available to the public. But it is also possible no effective vaccine will be discovered. Reports suggest that survivors might be susceptible to reinfection. If so, we face the prospect of not just a single lockdown but quite possibly a succession of them.
At a time when there are strong political pressures for a unified response to the crisis, Federal Labor has understandably positioned itself as a ‘constructive critic’ by supporting the Coalition’s package but indicating that it was first to the table in support of wage subsidies and criticizing the gaps in government support for some casuals and all temporary migrant workers.
Labor has been relatively quiet to date on what should follow the wage subsudies. But Left-leaning individuals and think tanks have already advocated that economic stimulus will need to be in place for more than 6 months.
Andrew Charlton (former advisor to Prime Minister Kevin Rudd) has written that Australia requires a pipeline of economic activity beyond six months. Charlton says that the Rudd government implemented stimulus over three horizons: short term household support (cash payments), medium-term building programs (school halls, road maintenance, and social housing) and long term infrastructure projects (rail, major roads, and the NBN).
The Australia Institute produced a paper on the principles that should inform stimulus- ‘Design Principles for Fiscal Policy in a Pandemic- How to create jobs in the short term and lasting benefits in the long term’. The general principles are:
- Go early: Timeliness of the stimulus is key
- Go hard: The size of the stimulus is important
- Go households: Put purchasing power with households who are more likely to spend it
- Targets domestic production
- Targets activities with high direct employment intensities
- Targets those most impacted by the crisis
- Targets useful projects that deliver co-benefits
- Targets regional disadvantage
The paper goes on to analyze the application of these principles to a series of hypothetical economic stimulus measures. These include, for example, investment in public housing, paying scuba divers to kill crown of thorns starfish on the reef, local government infrasturcutre, better electricity grid for renewables and big business tax cuts. Big business tax cuts already touted by the Coalition scores poorly on each of the criteria.
Another Left-leaning think tank ‘Per Capita’ released a paper ‘Some Facts About Debt’ .The paper aims to dispel commonly held myths around public debt:
“Myth: Australian public debt is very high
FACT: By global standards, Australian public debt is very low
Myth: A budget surplus is always good; a budget deficit is always bad
FACT: Depending on the prevailing economic circumstances, budget surpluses can harm the economy, and deficits can help
Myth: High public debt means the economy will be weak
FACT: Public debt has very little impact on Australia’s GDP growth
Myth: Our children will be paying this off for generations
FACT: History shows this will not be the case
Myth: Australia has just spent $200 billion on the stimulus. We don’t need, and can’t afford, to borrow any more
FACT: The need for government spending has only just begun
Myth: Corporate tax cuts will allow businesses to invest and create jobs after the crisis
FACT: Corporate tax cuts have not let to investment, or to more jobs, for many years
Myth: Austerity measures will be needed to pay down the debt
FACT: Austerity measures hinder rather than help economic recovery, and make it harder to pay down debt.”
“The government can roll over its debt indefinitely, provided the nation’s economic activity continues. And as the nation’s economy grows, the size of the debt in proportion to national wealth, measured as gross domestic product, shrinks commensurately…
As we begin to emerge from the lockdown, there is likely to be a fierce battle waged over what comes next.
Already we are seeing arguments to raise the GST to pay off the debt. Some are calling for a delay to the annual increase in the minimum wage. And, predictably, we have seen a renewed push for further deregulation and tax cuts for business, on the promise that they will somehow, at long last, “trickle-down” to create jobs and boost household incomes.
These arguments presage a push for the Australian government to implement austerity measures to pay off public debt as soon as possible. Yet evidence from countries that took such an approach after the GFC shows that this leads to soaring poverty and inequality and stifles economic growth, reducing our ability to pay down debt.”
On the other hand, while supporting the Government’s borrowing to fund the wage subsidy scheme, Labor’s Treasury spokesman Jim Chalmers emphasized that “One of the consequences of this is that we will be saddled as a nation with a generation of debt”. And at a recent Fabian Society webinar, Chalmers emphasized the importance of a Federal Government eventually paying down the debt. He said he was sure everybody could think of better ways of spending the $16 billion interest payments on the debt.
Indeed, both mainstream political parties in Australia have consistently promoted an economic narrative in which:
- taxation and borrowing are regarded as the only options to fund government spending;
- federal government deficits and debt are pilloried as economically irresponsible;
- federal government budget surpluses are fetishized (a process largely encouraged by the media);
- federal government debt and household and state government debt are presented to the public as if they are equivalent in nature.
Thus, at the last federal election, Federal Labor, no doubt concerned at opinion surveys indicating that the Coalition is generally regarded as a superior economic manager, promised bigger budget surpluses to be delivered faster than the Coalition. This was in the context of an economy that was already weakening.
This approach was at least partially responsible for giving the Coalition vital scare campaign material in the budget savings initiatives Federal Labor was promoting around the changes to franking credits, negative gearing, and capital gains taxes. Whatever the merits of those changes in their own right, the record in Australia of parties advocating in favor of significant tax changes from Opposition is not good. And it is hard to see that in the current situation Labor will succeed will win many votes by promising a return to a bigger budget surplus sooner than the Coalition.
Labor runs the risk of taking the political strategy it now wishes it took to the May 2018 election to the next election. The analysis of its failure at the last election was that its program was too big. Little emphasis was placed on the lack of trust many Australians had in the then Labor leader. There is a possibility the Coalition may become unpopular if it embarks on company tax cuts and labour market deregulation before the next election. Labor strategists might hope this will facilitate a Labor win through a small target strategy. But I think the better view is that small targets and economic crises do not make for easy bedfellows.
Rather, Federal Labor is likely to need a new economic narrative around the funding of further economic stimulus.
There are two main options for funding the measures required to recover from the coronavirus economic crisis:
- Option 1- Adopt a Modern Monetary Theory (MMT) approach- under this option federal government spending does not need to be offset by either taxation or borrowing.
- Option 2- under this option public debt would be the primary means of financing new federal government spending for the immediate future. But the accompanying narrative would aim to dispel myths that are currently prevalent in the community about the consequences of public debt.
With interest rates so low the difference between these two options in economic terms is not as great as one might think. The cost of the wage subsidy program involved the Federal Government borrowing the equivalent of $130 billion at an interest rate of only 0.25 percent. It is almost free money. Economist Saul Eslake described this as “not huge. At the moment, it’s manageable.”
MMT describes the way government spending occurs. Most people imagine that taxes are collected and put into general revenue from where the government draws funds to finance its spending. Where there is not enough taxation revenue it borrows to make up the difference. But MMT says that when the Australian Government spends, it does so by through the Reserve Bank simply crediting the accounts of the recipients of government spending. In practice, taxing or borrowing occurs after the government has spent the money.
A government that can produce its own currency (like the Australian Government) only needs to borrow money if it wants to spend without increasing the overall supply of money in the economy and it does not wish to offset that spending through taxation (which is deflationary). It borrows back some of the money held in non-government sectors of the economy, normally by issuing government bonds.
Government bonds also perform the important role of providing investors with a secure (government-backed) investment against which they can benchmark investments in higher-risk, higher-yielding investment products.
According to MMT the central purpose of taxation is not to redistribute wealth or to provide incentives for or against certain types of spending. Taxation can and often is appropriately used in this way. But where so used, this is for promotion of other political values. The central economic purposes of taxation are to limit the ability of the non-government sector to spend and to create space within the productive capacity of the economy for the government to spend without causing inflation.
MMT holds that all spending (whether public or private) is potentially inflationary. But inflation results from spending which does not increase the productive capacity of the economy thereby resulting in too much money chasing too few goods and services. Provided new spending increases productive capacity, so that there are enough goods and services to absorb the additional spending, inflation does not result.
Rather than being an ideological position, MMT claims it is an alternative means of describing what appears to have already become new or emerging economic norms, despite whatever rhetoric to the contrary still persists.
Here is how the ‘Economist Magazine’ described recent developments:
“Central banks have in effect pledged to print as much money as is necessary to keep down government borrowing costs… The rise in borrowing caused by America’s stimulus may be matched, at least initially, by bond purchases by the Fed, which smells a lot like money-printing to finance deficits…”
Here is how the New York Times described recent developments:
“The traditional view of economic theory holds that governments and central banks have distinct responsibilities. A government sets fiscal policy — spending the money it raises through taxes and borrowing — to run a country. And a central bank uses various levers of monetary policy — like buying and selling government securities to change the amount of money in circulation — to ensure the smooth operation of the country’s economy.
But the relief package, called the CARES Act, will require the government to vastly expand its debt at the same time that the Federal Reserve has signaled its willingness to buy an essentially unlimited amount of government debt. With those twin moves, the United States has effectively undone decades of conventional wisdom, embedding into policy ideas that were once relegated to the fringes of economics.”
Here is what Percy Allan, former Secretary of NSW Treasury, wrote in the Australian Financial Review on 16 April 2020:
“After COVID 19, central banks will need to shift from manipulating monetary policy (quantitative easing and cash rates) to undertaking fiscal stimulus (public spending). Here is why.
Non-financial corporations worldwide ( and especially in America) are heavily over-indebted. Many listed companies borrowed to buy back their own shares so as to stoke their prices, which are now in freefall. In a depressed economy, they will now be reluctant to borrow for capacity expansion however low-interest rates fall.
Such a “liquidity trap can only be overcome by lifting aggregate demand not by making credit cheaper.
Government is expected to do this heavy lifting by boosting public spending. But most governments are also heavily over-indebted and will be more so after propping up companies and individuals during COVID-19…Consequently, only central banks will have the firepower through money printing to undertake fiscal stimulus post-COVID-19.”
Allan calls this type of direct government spending into the economy “quantitative investment”. This is presumably to distinguish it from quantitative easing (QE) where central banks usually pump new money into the private bank sector to encourage it to lend. A criticism of QE is that not enough of the new money ends up in the real economy because private banks prefer to lend for asset purchases or stock market investment, which become inflated as a result, exacerbating wealth concentration and inequality. Paul Kellog believes neoliberalism is attempting to save itself post GFC through QE. But it is failing to result in productive investment. He says:
“If the state can ‘push’ trillions of dollars into the economy through an intimate relationship with financial institutions, what is to stop it from developing an intimate relationship with other kinds of institutions (hospitals, schools, public housing authorities, green job collectives to name just four), and push those trillions into the economy directly – into health care, education, social services, sustainable economic development, etc.?”
Politically speaking, adopting a narrative based upon MMT would entail a greater departure from mainstream economic approaches. On the other hand, the approach would not require public opinion to be reconditioned as much on the issue of public debt because the MMT approach would facilitate spending without new debt, or as much new debt. This option could prove more beneficial for state governments because, instead of state government borrowing, the federal government should be able to provide them with newly created money to spend in agreed areas of the economy.
This option is mostly criticized on the basis that it involves too great a risk of inflation or hyperinflation. Examples of the Weimar Republic, Zimbabwe, and Venezuela are often cited to discredit the option. But these criticisms overlook the fact that the productive capacity of these economies had already been damaged by other causes.
A Cato Institute study of all 56 recorded hyperinflations found that hyperinflations only occur under extreme conditions such as war or a complete collapse in the productive capacity of a country. Hyperinflation has never been a consequence of monetary policy or politicians turning on the printing press just before an election; rather, hyperinflation is a symptom of a state that has lost control of its tax base.
The risk of inflation from not offsetting government spending through tax or debt appears to be minimal in the current environment. The environment looks to be highly deflationary for the foreseeable future, especially with the fall in oil prices. Further, inflation can be avoided provided the spending is directed to areas that enhance the productive capacity of the economy sufficient to absorb the additional money spent into the economy.
If inflation begins to occur, it is always an option to revert to more traditional means of offsetting public spending, for example by taxing or issuing bonds to take money out of the economy.
Public debt option
Alternatively, Labor could maintain the current policy setting that government spending must be always be offset by either taxation or debt. Politically speaking this option contains a lesser departure from mainstream economic approaches. But in this case, Labor will still need to drive an alternative narrative around public debt. If Labor continues with the current rhetoric around public debt “saddling future generations” etc it is hard to see how it will better position itself to as effectively criticize the Coalition for failing to fund sufficient economic stimulus. Labor runs the risk that it may ultimately make any case to use debt to finance further stimulus all the more difficult.
As with MMT the proponents of public debt financing also argue that it is important that debt spending should increase the productive capacity of the economy. They argue the resulting economic growth will decrease debt as a proportion of GDP. This enables the debt to almost “wither away”, to be gradually and painlessly paid down without major tax hikes or austerity (cuts in government spending).
So for MMT government spending new money in the economy must be productive so as to avoid inflation. For proponents of public debt finance, it must be productive in order that the debt can be paid down or acceptably managed.
Of course, whether or not government spending enhances the productive capacity of the economy depends on the nature of that spending, not on how the funds for the spending are raised.
The treasurer has also stated that the debt will be repaid through economic growth.
The period after WW2 is often given as an example of how high levels of public debt are diminished as a proportion of GDP by economic growth. For example, the Per Capita paper states that the war effort led public debt to triple in just six years, to over 120% of GDP by 1946 – its highest ever level. But as a consequence of economic growth, “it took just 10 years to reduce public debt as a proportion of GDP to the pre-war level, with incomes, welfare programmes and investment in economic capacity increasing simultaneously”.
The fact remains however that, even before the CVP, by September 2019, economic growth in Australia was the slowest it had been since the GFC. And immigration, which may have been a decisive factor in preventing the onset of recession to that point in time, has now halted. Also, household consumption played a very important role in post-war economic recovery. But levels of household debt are much higher now than they were in the immediate post-war years. This is true both in Australia and abroad. The ratio of household debt to GDP in the USA was around 40-50% in the 60’s and 70’s. It is now 106%. It is over 124% in Australia. Further, in a globalized world, achieving sufficient economic growth so as to be able to pay down debt depends not only on the performance of the Australian economy does but also on developments in the international economy.
If the economic growth is not achieved, or worse still, if the economic downturn means public debt continues to rise rather than decrease as a proportion of GDP, pressure may mount to deal with the debt in other ways. There are only limited ways. These include- increased taxation (which is difficult or impossible in an already depressed and highly deflationary economy), selling off government assets, reducing government spending (which risks the effects of austerity referred to by Ms. Dawson), or adopting the measures advocating by MMT and monetizing the debt.
How does the monetisation of public debt work?
“When a government is in real trouble, it sometimes resorts to printing money—in the old days, it would print actual money; today, of course, we don’t need the printing press to accomplish the same thing electronically. But this almost always leads to a collapse of the currency, since ever-larger quantities of money are set against the same amount of societal resources. But there is a sneakier way to accomplish the same thing, and that is for the government to borrow money, issuing bonds to represent the debt, and then to have the central bank exchange the debt for money, and thereafter retire the debt. In that case, the government need never pay back the debt, and the money remains in circulation. It is the same as printing money, in the end.
Of course, the sneaky bit is that we don’t know whether the debt has been monetized until after the debt matures. If the debt matures while the central bank is holding the bonds, then monetization has been accomplished. If the debt is sold back into the market prior to maturity, then the transaction has been reversed and no monetization has occurred.”
If, as appears likely, Labor wants to stick to traditional approaches and insist that government stimulus spending must be funded through increasing public debt, then one way it could seek to modify public opinion on public debt would be by reforming the bond market. It could give Australians who have some savings a stake in government debt by providing easier access to the purchase of government bonds.
Perhaps unbeknown to many of them, most Australians share in government debt through their superannuation funds, or banks, purchasing government bonds. But even among those Australians with surplus funds to invest, very few buy government bonds directly. Retail investors only hold a minimal proportion of Australian Government Bonds.
Australian government bonds can currently only be purchased through stockbrokers (licensed ASX dealers), thereby incurring brokerage fees, and purchasers need a licensed CHESS account to make purchases.
A high proportion of bonds tend to be bought mainly by large financial investors. Indeed, when Peter Costello delivered budget surpluses in the early 2000s the bond market shrank. It was bond market heavyweights that successfully lobbied the government to maintain the bond market.
Economists James Morely and Richard Holden have called for the introduction of the equivalent of the war bonds that could be easily purchased by non-institutional investors during wartime. War bonds were issued in Australia to raise funds for both world wars. The purchase of the bonds was promoted by the Government as a patriotic endeavour. The bonds had maturities ranging from three to 10 years in the case of the First World War and five to seven years in the case of the Second World War. Bond certificates were purchased at a discount, with interest being incorporated in the face value of the certificate payable at maturity. Unlike ordinary bonds war bonds were not transferable on a secondary bond market.
Morely and Holden suggest the bonds could be called ‘COVID-19 bonds”. But bonds might also be offered to finance projects that will assist the transition to a zero-emissions economy. They might be called ”Climate change bonds” or “Green bonds”. This will enable Australians with sufficient savings with a secure way of investing in the fight against climate change.
Further policy development would be required to analyze issues such as:
- Accessibility of the bonds (they should be easily purchasable perhaps through Australia Post offices or online);
- Impact on the existing bond market;
- Promotion of the bonds;
- Structure of the bonds- term, coupons, yield to maturity, inflation adjustment if any, transferability etc.