Normally governments offset their spending through either taxation or borrowing. But taxation is deflationary so is not an appealing option at the moment and there is a concern (largely exaggerated) about increasing government debt.
Keating has essentially called for the federal government to increase its spending without taxation and without further increasing the debt.
How does this work?
When the government borrows it does this by issuing government bonds. Bonds pay their purchaser a fixed interest rate upon maturity. There are also smaller periodic payments known as coupons. Bonds are normally bought by large institutional investors- banks, super funds, and the like, though individuals can also buy them through the stock market.
Sometimes when the economy is weak the central bank buys up government bonds from the financial sector. It funds these purchases by creating new money out of thin air increasing the overall supply of money in the economy as a whole. The process increases bank liquidity so the banks can lend money to the private sector at lower interest rates, in the hope that this will spur productive investment. This process is known as quantitive easing (QE). But QE does not necessarily result in productive investment. Businesses may still be reluctant to make those types of investments in a weak economy. So the money can end up in share buybacks inflating share market prices even though the real economy remains very weak. This is what is currently occurring in the USA where the gap between the stock market and the real economy is larger than ever. The gap has been fuelled still further by the Federal Reserve buying corporate bonds (debt) for the first time in its history.
But Keating is not calling for QE. His proposal is for the Reserve Bank to buy up the government on a permanent basis. The government gets the money for the bonds but the interest and coupon payments are returned to the government by the Reserve Bank. The government gets to spend the money for free. Economists call this process debt monetization. The problem with it is that it is potentially inflationary. But if the money is spent by governments on initiatives that increase the overall productive capacity of the economy then that increase capacity can produce more goods and services which absorb the increase in the supply of money without causing inflation.
A risk is that this process may result in a devaluation of the currency. But the effects of this are not all negative. Imports become more expensive and exports become cheaper. This could be a problem for Australia because we import a lot of machinery we then use for productive activity. But exchange rates are always relative to each other. There is no common gold standard. So the extent to which devaluation is likely to occur under international economic conditions where many governments eventually engage in debt monetization is not known. Another risk is that increases in inflation if eventually result, political constraints may prevent governments from dealing with this through increased taxation. But as Keating says at the moment you’d need a microscope to spot any inflation.
Keating has directed his comments to the Reserve Bank suggesting it should help out the current government. But his comments might well be surreptitiously directed to Federal Labor. Federal Labor finds itself in a terrible bind.
Labor went to the 2018 election promising to deliver a bigger surplus more quickly than the Coalition. And it did this in the context of a national economy which was already weakening. The responsible economic course was actually stimulus not surplus. It was Labor’s commitment to a bigger surplus sooner that led it, at least in part, to advocate tax reform on negative gearing and franking credits, policies which, although highly worthy, gave political ammunition to the Coalition for a highly successful scare campaign. Lesson 1- learned by John Hewson in 1993-do not propose big tax changes from Opposition.
Federal Labor has recently criticized the Coalition for its lack of a comprehensive jobs plan. It is a good criticism. But Labor is yet to announce a jobs plan of its own. It has given three clues as to components its plan might contain- a stimulus to the building sector through construction of social housing, energy policy (which will require it to overcome apparent divisions around gas), and increased funding for care sectors. At the same time, it appears unlikely to oppose Coalition tax cuts which the Australia Institute has described as poorly targetted. The tax cuts would reduce income tax revenue by $300 billion, on top of the billions in company tax cuts the Coalition has already passed. Back in August Jim Chalmers hinted that Labor would support bringing forward the Coalition’s second round of tax cuts:
“If they came to us and said that they wanted to bring forward stage two of the legislated tax cuts, then we’d engage with them in a pretty constructive way. We’ve said that for some time.”
Labor will need to come out with a job plan that appeals to voters as clearly bigger and better than the Coalition to have any chance of winning the next election. How will it fund such a plan? How can it do so if it supports the tax cuts and continues to maintain the 2018 election approach that it must be more fiscally conservative than the Coalition in order to persuade voters it is economically responsible? It is an awkward equation, to say the least.
Keating has put another funding option on the table.