Labor’s current national platform provides:
“Labor will deliver sound public finances by adhering to a fiscal strategy that achieves a balanced budget on average over the economic cycle… Achieving a balanced budget is not an end in itself, but it is an appropriate medium-term objective, as part of sound fiscal policy and economic management which takes the economic cycle into account… Fiscal policy should support growth and employment when growth is below trend and unemployment is above trend, and should accumulate surpluses and pay down debt when growth is above trend.”
Whatever the situation prior to the pandemic, the damage it has caused to the economy means that a fiscal strategy that seeks to achieve a balanced budget over the economic/business cycle will be simply unachievable. Even the Coalition has recognized this fact having has abandoned its goal of eliminating net debt by the end of the next decade.
Accordingly, in supporting economic stimulus post-September 2020, Labor will need to alter media and public perceptions around the nature of federal government public debt. Seeking to argue, as it did at the last election, that it will deliver bigger budget surpluses sooner than the Coalition does not look like a winning strategy in the current environment. Rather the competition is likely to be around which party can best tackle the economic recession by creating jobs and increasing the economy’s productive capacity. Insofar as this requires reconditioning public and media views around public debt Labor could emphasize the following points:
- The important thing is not the size of the overall Federal Government debt but its size relative to GDP and the ability to service interest payments on the debt;
- Even after the Coronavirus rescue package, at 26% of GDP Australia’s public debt is very low compared to other OECD countries;
- Nobody can put a figure on how much public debt as a proportion of GDP is too much debt. At 236%, Japan, the world’s third-largest economy has the highest debt to GDP ratio in the world. Yet despite two decades of warnings about fiscal implosion, a debt crisis has never arrived;
- As a currency-issuing government, there is no risk that the Australian Government can become bankrupt;
- Because of its ability to issue currency, and its broad taxation powers, Australian Government debt is of a fundamentally different nature to state and local government debt and corporate and household debt. This is because these organizations cannot issue currency and lack the taxation powers of the Commonwealth;
- The way the Federal Government borrows (mainly through the issuance of bonds and other securities) provides an important source of investment for the private sector. The bond market provides a highly secure form of investment, including for superannuation funds, against which higher-yielding, riskier investments can be benchmarked;
- It is always an option for the Federal Government to reduce its debt through monetization. This can occur through a Central Bank creating new currency digitally, buying up government bonds on a permanent basis, and returning the interest to government on the purchased bonds. This means that the Federal Government can essentially borrow and spend the newly created money for free;
- Corporate and household debt is likely to pose a far higher risk to the economy that Federal Government debt;
- Historically, in Australia, there is a correlation between Federal Government deficit and private sector surplus and vice versa. The government’s debt has meant a surplus for the private sector. If the government produces a surplus by taxing or spending less into the economy this results in private sector debt.
Quantitative Easing (QE) and Quantitative Investment
Central Banks in the UK, USA and elsewhere engaged in QE following the 2008 GFC. For the first time in our history, the Reserve Bank of Australia is now engaging in QE by buying Treasury bonds on the secondary bond market.
The buying of bonds on the secondary market by a central bank is called ‘open market operations’. There is a rule against the Reserve Bank buying bonds off the Treasury directly as it is argued that this would interfere with Reserve Bank’s independence. But even where the Reserve Bank buy government bonds on the secondary market, the effect is still that one branch of government (Treasury) ends up borrowing money from another branch of government (the central bank).
The transaction results in the Treasury exchanging the debt (represented by the bonds) for new money created out of thin air by the Reserve Bank.
The stated aim is to stimulate economic activity by increasing bank liquidity, while at the same time putting downward pressure on interest rates. The aim is to get banks to lend to businesses despite the poor economic conditions. The problem is that businesses may still be reluctant to invest in capacity expansion in a depressed economy and that banks may still be reluctant to lend if there is a risk of insolvency/non-performing loans.
QE has sometimes been subject to the criticism that it has resulted in inflating asset and share market prices instead of investing in the real economy.
An alternative, or additional measure to QE, is Quantitative Investment (QI).
The former secretary of the NSW Treasury Percy Allan has written that central banks could move from manipulating monetary policy (QE and cash rates) to direct fiscal stimulus (QI). QI ensures newly created money is spent directly into the real economy and lifts aggregate demand through targeted investment in social and economic infrastructure.
Where a central bank simply creates new money and transfers it to the Treasury without repayment obligations, again monetization of debt is regarded as occurring. This is because the debt that would have arisen, if the Treasury had instead borrowed the money, has been avoided.
The risk with both QE and QI is that the new money created by the central bank results in inflation. The current environment appears to be highly deflationary. The immediate need is to stimulate aggregate demand. Nevertheless, some economic commentators are concerned about a risk of inflation or stagflation occurring in 2021, particularly due to disruption to supply chains caused by the pandemic and associated lockdowns.
One way of avoiding inflation is for new money created by the central bank to be invested in projects that increase the productive capacity of the economy. This might be more readily achievable by the government deciding the direction of investments through QI rather than by simply flooding the financial sector with liquidity (through QE) in the hope that market forces will lead the new money tp trickle down into investment in the real economy.