This Budget is based on forecasts that unemployment would have grown considerably without future strong fiscal stimuli but that the economy will, in fact, turn around rapidly in 2011 and then grow at 4.5%. The debt that does stem from the Budget is significant but not overwhelming and probably unavoidable if one accepts the budget premises. The criticism that strong moves were not taken now to reduce the deficit are inconsistent with the premise that a further expansion of the economy now is warranted.
I don’t have much of a clue what will happen to the economy over the next 2-3 years and I cannot believe, on the basis of its recent unemployment forecasts, that the Treasury does either. The real risk is that the Budget is based on over-optimistic forecasts of local and international economic recovery.
This is risky because, at core, Australia’s current economic woes are due to a terms-of-trade shock which slashed the value of our exports. Apart from a decline in share market values we have not had major financial woes. Longer-term, stimulating the economy will not reverse this fact of life – we are poorer because the rest-of-the-world values our products less.
Longer-term too, unless the world economy recovers strongly, we must accept that we will need to live at lower living standards. Fiscal actions to try to thwart this decline will only create debt. The current stimulus can offset the immediate multiplier effects of the decline in export values but problems start if there are persisting delays in the world economic recovery. Then government will need to raise taxes and cut spending to prevent a debt explosion at precisely the time voices will be calling for further economic stimulation.
The politics are interesting. The Labor Party will become identified in the media as the ‘high debt’ party. If the economy begins to recover in 2010/11 this won’t matter much. But if the recovery is slower than expected then either the debt/deficits will blow out further or the government will need to savagely cut middle class welfare that was so readily disbursed in the Howard years. It will then, at best, become a two-term government. Indeed it may have to cut into this welfare heavily even if growth is moderate if long term debt increases if it is not to be seen as an ineffectual government which made things worse.