Big budget test
The main test for the upcoming budget is whether it will take pressure off inflation. By Angus Taylor.
First published in The Australian
Nothing is biting harder around the kitchen table than inflation and interest rates. Cost of living issues dominate all else, including the voice, climate change, health, aged care and education.
It is not hard to see why. A family with a typical $750,000 mortgage is now paying over $20,000 more a year than they were before the election. Add higher costs of energy, groceries alongside almost everything else and the pain is extreme with more in the pipeline. Nor do forecasters give us much hope of returning to the target inflation level of 2-3 per cent any time soon.
Across the country families are being forced to work longer hours, cut back on their children’s activities and make tough financial decisions. Families are having to tighten their belts and yet the government refuses to do the same.
Next week’s budget is the time for the government to take responsibility after 12 months of hiding behind the Reserve Bank, Vladimir Putin, grim forecasts and any other excuse it can concoct. Most of all, the government needs to accept that inflation comes from Canberra – from its own policies.
We’re accustomed to the idea that the Reserve Bank is able to control high interest rates and inflation. The establishment of independent central banks with clear inflation goals has been a great success but that success has always been conditional on supportive fiscal consolidation by government. If the government fails to act, the Reserve Bank will need to impose much more pain.
Eric Leeper is a US economist who leads the world in looking at the links between fiscal and monetary policy. He makes clear the best way to beat inflation is a conservative central bank sharply focused on fighting inflation, combined with a government focused on strong budget repair (“fiscal consolidation”). Indeed, Leeper goes so far as to say that had this policy mix been in place during the 70s and 80s, we might have contained the ‘Great Inflation’ which saw interest rates approaching 18 per cent in Australia.
Economists John Cochrane and the legendary Robert Barro make similar points. Fashionable new Keynesian economic models used by central banks automatically assume that inflation fighting central banks are supported by governments focused on budget repair. These models are too optimistic about containing rampant inflation and interest rates in the face of a big spending government.
The answer is not higher taxes. Recent research shows increased taxes hits growth much harder than containing spending when governments consolidate their budgets. Analysing multiple countries, economist Alberto Alesina showed that increasing taxes instead of reducing spending just hits business confidence and stems private investment leading to longer and deeper economic pain.
The government inherited a strong starting position for fiscal consolidation. Australia emerged from the pandemic with lower unemployment, strong GDP growth, low interest rates, and our AAA credit rating intact and the Coalition had begun the work on budget repair without increasing taxes. The economic settings inherited by the government are producing historic revenue windfalls which mean it should be possible to run a surplus off the back of a strong jobs market and resources sector.
Economists John Cochrane and the legendary Robert Barro make similar points. Fashionable new Keynesian economic models used by central banks automatically assume that inflation fighting central banks are supported by governments focused on budget repair. These models are too optimistic about containing rampant inflation and interest rates in the face of a big spending government.
The answer is not higher taxes. Recent research shows increased taxes hits growth much harder than containing spending when governments consolidate their budgets. Analysing multiple countries, economist Alberto Alesina showed that increasing taxes instead of reducing spending just hits business confidence and stems private investment leading to longer and deeper economic pain.
The government inherited a strong starting position for fiscal consolidation. Australia emerged from the pandemic with lower unemployment, strong GDP growth, low interest rates, and our AAA credit rating intact and the Coalition had begun the work on budget repair without increasing taxes. The economic settings inherited by the government are producing historic revenue windfalls which mean it should be possible to run a surplus off the back of a strong jobs market and resources sector.
Economists John Cochrane and the legendary Robert Barro make similar points. Fashionable new Keynesian economic models used by central banks automatically assume that inflation fighting central banks are supported by governments focused on budget repair. These models are too optimistic about containing rampant inflation and interest rates in the face of a big spending government.
The answer is not higher taxes. Recent research shows increased taxes hits growth much harder than containing spending when governments consolidate their budgets. Analysing multiple countries, economist Alberto Alesina showed that increasing taxes instead of reducing spending just hits business confidence and stems private investment leading to longer and deeper economic pain.
The government inherited a strong starting position for fiscal consolidation. Australia emerged from the pandemic with lower unemployment, strong GDP growth, low interest rates, and our AAA credit rating intact and the Coalition had begun the work on budget repair without increasing taxes. The economic settings inherited by the government are producing historic revenue windfalls which mean it should be possible to run a surplus off the back of a strong jobs market and resources sector.
Instead, the government is softening us up for a more taxes and a big spending budget having added $115 billion of spending in its October Budget. Since then, it has flagged tax grabs on franking credits, self-managed super funds, work expenses, unrealised capital gains and the resources industry – all at a time where it has added $45 billion in off-budget spending and, no doubt, more to come.
Labor will talk a big game but is far less likely to act. The more Labor talks about restraint, the less it is focused on effective action. It is the government’s actual spending that adds fuel to the inflationary fire, regardless of the rhetoric.
The main test for the upcoming budget is whether it will take pressure off inflation. It must re-establish an objective of budget balance to take pressure off inflation; focus on lower taxes not higher ones while delivering real action on productivity to make Australians lives easier. Put simply, the government can’t spend its way out of a cost of living crisis.
Most importantly, for a government that promised cheaper mortgages, cheaper energy, higher real wages, no changes to super, no changes to franking credits, and no one left behind – the starting point for this government’s budget is to stop breaking promises. Inflation comes from Canberra and Australian families cannot afford Labor’s broken promises on cost of living.
Angus Taylor is Federal Shadow Treasurer.