The Commonwealth Government’s 2021-22 budget presented this week is characterised by a sea of red ink and a curious penchant for controversial Modern Monetary Theory.
This theory posits that debt does not matter so long as real constraints in the economy are not reached, because governments that hold a monopoly over their currency can spend freely and always create more money to pay off their debts in their own currency.
Proponents of this theory argue that in a world of record low interest rates with relatively low debt servicing costs, governments at all levels should embark on a borrowing spree from the future to increase the productive capacity of their economies today.
In this view, a stronger, growing and more productive economy will generate higher revenues to pay down borrowings across future years.
As a leading Queensland economist and former federal treasury official, Gene Tunney has acknowledged in his interview with former Queensland Government Transport Minister Craig Emerson on the 4BC Drive program, the “Go for Growth” budget strategy is straight out of the classical Keynesian Economic Theory playbook.
Moreover, Gene points out how unorthodox this Liberal National Party (LNP) budget is compared to others before it, as he laments his time in Commonwealth Treasury where the Turnbull Opposition opposed the Rudd Government’s “proposed increase in the debt limit to $200 billion in February 2009 following the release of the Nation Building and Jobs Plan, the second stimulus package during the GFC”.
It is certainly a bold and extraordinary LNP budget; but we are living in extraordinary times, with many conventional economic models having indeed lost their currency in recent years with respect to such developments as negative interest rates and counterintuitive international relationships between key economic variables such as employment, output, inflation, currency values and interest rates.
Nevertheless, the budget has been generally well received publicly and embraced as a reflection of the times as the economy expands out of the COVID-19 pandemic, while at the same time the Commonwealth Government lurches toward an unprecedented $1 trillion of gross debt.
While Australia’s net debt position (30% in 2020-21) is relatively low compared to other developed countries and is forecast to peak at 40.9% of Gross Domestic Product (GDP) at 30 June 2025 falling to 37% of GDP by the end of the medium term, the Commonwealth Government’s strategy is not without risks.
It does raise concerns with respect to the potential impact this level of budget spending will have on Australia’s fiscal position if borrowing costs rise due to a downgrade of Australia’s coveted AAA credit rating or there is an unexpected increase in inflation, and what implication this may have on the government’s ability to stimulate the economy in the case of a further economic shock.
Furthermore, given that Australia is a relatively small, open, export-orientated economy so heavily dependent on foreign investment and trade, is the size of the Australian Reserve Bank’s balance sheet sufficiently large enough to control its own currency with respect to the activities of global financial institutions and other countries? Unlike Japan, for example, the majority of government debt issued in Australia is not held by the national public.
Looking at the bang for buck of the budget, the budget aims to stimulate employment growth leading to an unemployment rate of 4.75% in 2022-23, which will be supported by a resurrection of private business investment that has been historically low over the past decade since the GFC.
To support an increase in private business investment, key measures since the 2020-21 MYEFO include:
- “Extending temporary full expensing for 12 months until 30 June 2023. This will allow eligible businesses with aggregated annual turnover or total income of less than $5 billion to deduct the full cost of eligible depreciable assets of any value, acquired from 7:30pm AEDT on 6 October 2020 and first used or installed ready for use by 30 June 2023. This measure is estimated to decrease receipts by $17.9 billion over the four years to 2024-25
- Extending temporary loss carry back to allow eligible companies to carry back tax losses from the 2022 23 income year. Companies with aggregated annual turnover of less than $5 billion will be able to carry back tax losses incurred during the 2019-20, 2020-21, 2021-22 and now the 2022 23 income years to offset tax paid in 2018 19 or later years. This measure is estimated to decrease receipts by $2.8 billion over the four years to 2024-25.”
It is anticipated that taxation policy will further support household spending that is anticipated to increase as a tightening in the labour market and rising housing prices stimulate consumer confidence and in turn household spending.
Interestingly, real wage growth is expected to remain subdued this year as growth in the consumer price index outpaces growth in nominal wages.
The impact of the budget spending on the Commonwealth Government’s fiscal position is that the underlying cash balance is expected to be a deficit of $161.0 billion this year (7.8% of GDP), which represents an improvement of $52.7 billion since the 2020‑21 Budget thanks largely to record high iron ore prices, which have been at their highest level on record during recent months.
Despite a fall in iron ore prices anticipated in coming years, the underlying cash balance is expected to improve to a deficit of $106.6 billion in 2021‑22 (5% of GDP), falling over the estimates to $57.0 billion (2.4% of GDP) in 2024‑25.
Importantly, the Commonwealth Government’s underlying cash balance is forecast to remain in deficit to the tune of 1.3% of GDP a decade from now in 2031‑32.
Economists have pointed out that the conservative forecasts for iron ore prices to fall from $230/t to $55/t over the estimates may suggest that, on the upside, Treasury are leaving some room for pleasant surprises or rather, on the downside, they may be anticipating further trade tensions to develop with respect to exports to China over the near term.