Friday, February 06, 2009

The Treasury critique of Turnbull

The Treasury isn't adding much by saying that it supports Kevin Rudd's package and rejects that of Malcolm Turnbull. It would have designed the Rudd package and so, in essence, is saying that it stands by its design. In essence this means supporting a large package rather than a smaller one. The claim by Ken Henry that a dollar spent directly by government has bigger stimulatory power than a dollar in tax cuts given to households is correct - it reflects the balanced budget multiplier idea - because households will save some of the dollar. But this only again relates to a defence of a larger package - tax cuts will just have a smaller expansionary effect.

Ken Henry's claim that the smaller package runs the risk that the economy might fall into recession is also correct. But it is also the case that, since the Australian economy is operating in unchartered waters with an especially uncertain international economic environment, that the larger stimulus will have its own risks. It will certainly add more to debt and it will reduce the ability of policy makers to make further expansionary moves in the future if this crisis is prolonged. Fiscal actions are available options now basically because public debt was reduced under the Howard Government. Deficits and debt are difficult to control particularly when a populist social democratic party holds the reins of power and when a gaping public deficit adds to the constraints imposed on an economy by an already weak current account. The AFR this morning has it right:
"Right now the government's financing task looks manageable. But if the worst comes to the worst, it wikll be years before the deficit is brought under control, adding to the burden. If foreign demand for Australian goverrnment debt remains scarce, the government will have to pay higher yields or face a currency depreciation. It - and we - need everything to go right from here".
Moreover, I am completely unclear on how Henry derives the case for his $42 billion package. Econometric modelling will be useless in the current environment because the economy has deviated significantly from its past sample path. That the Labor Party were hedging a month ago on the issue of whether Australia would run a budget deficit and still hedges on the issue of whether a recession is imminent - views that would be motivated by background briefings from Treasury - suggests policy-maker uncertainty is huge.

Under these circumstances the case for moderation and for avoiding a strident policy defense is clear. Certainly the Turnbull proposals should be put on the table and debated intelligently. The hysterics of Kevin Rudd and his inept Treasurer Swan over the past couple of days have been a disgrace. Rudd's earlier talk about the case for greater civility in public life is revealled to be hypocrisy given his insistence on uncritical support for this massive package and for the unreasonable dishonest abuse about ripping up school programs and denying handouts to millions with which he has effectively threatened the Coalition without meeting its points.


Anonymous said...

have you seen the latest polls in the US showing support for the Obama spending plan is cratering? It's down to 35% from what I've read.

Henry and the treasury are political players now. It's clear that the first thing Turnbull should do if he won office would be to fire the entire senior team in the department.

Anonymous said...


that was an interesting article for the opposite case. It would be nice if some of our politicians could be so clear.

hc said...

I've got to say JC that few civil servants in Australia impress me more than Ken Henry. I am in no way questioning his integrity in what I write above.

Anonymous said...

No, i wasn't suggesting that you were questioning his integrity, Harry. I am.

He broadsided Howard towards the end of the term by making a speech to dozens of dept. staff then acted surprised it leaked. He's insulting our intelligence with that line of crap.

He now gives his approval on a spending binge when there is more than enough evidence that not only will it not work, but it could actually damage the nation's long-term prospects saddling it with large debt and the almost 100% probability of higher taxes down the road to pay it off.

There is actually enough evidence spending doesn't work and he's signing off on it.

Mark my words our debt when all this is said and done will be over $150=200 billion.

We don't have the luxury of having a reserve currency like the US that may just be able to get away with quantitative easing because other than gold there is no alternative to the dollar despite what some people say. The Euro could actually crash as a result of EU mismanagement and the imbalance between the north and south so the dollar wins first prize in the ugly "beauty" contest.

The point being, we may not be able to inflate our way out of it without causing a currency crisis as a result of our external leverage.

This is the point. The combination of loose monetary and fiscal policy (as a result of a spending binge) combined with a current account deficit and a large external debt position is absolutely lethal in the current world economic environment.

We can afford any policy mistakes with our highly leveraged position both domestically and externally. that's how Iceland tipped over.

Why has Henry signed onto this?

Anonymous said...

"Why has Henry signed onto this?"

Maybe he thinks it's good policy. That's what he told the Senate in any case.

The Treasury sure aint what it used to be. John Stone must wish he was dead, just so he could roll over in his grave.

Of course with bond rates at record lows, you can finance a lot of debt and it won't cost you much. That is the big difference between now and 70s. Then, bond rates were 14%. Now they are 4%. It makes a big difference. And issuing more government paper isn't going to drive those bond rates up. It's not as though investors have got a lot of alternatives these days.

Equity? No thanks. Property? You've got to be joking. Bonds? Yes, please.

"that's how Iceland tipped over."

They tipped over because their banks couldn't roll over their debts. The lesson is not to have banks with liabilities equal to 5 times GDP. Fortunately, we don't

Anonymous said...

I don't see how anyone would buy a bond at these rates for 10 years. It's mind blowing.

I also can't see how the massive issue of government paper around the world over the next 2 years is not going end badly.

1 1/2 weeks ago a German bund issuance went only 70% subscribed and as a result they pulled the rest of the deal. Germany is the EU benchmark to all intents and purposes.

Bonds could turn out to be the next bubble.

And what if the negative sentiment is not as bad as reality and the global economy does better. The infusion of all that spending will immediately force the RBA to raise rates quickly and then we're back where we were.

Anonymous said...

"And what if the negative sentiment is not as bad as reality and the global economy does better."

This is the $64 trillion question.

Right now, the sentiment comes in three types: really bad, disastrous and catastrophic. And it becomes self-fulfilling.

That's why governments are doing things big and they are doing them now.