Policy Perfection? Isn’t It Great When Policy Plans Work!

 

A little more than a year ago, the Gillard Government locked in its view that the move to a Budget surplus in 2012-13 was an immovable foundation stone of its economic policy objectives.   The immovable nature of the commitment was predicated on several important issues.

Of itself, the move to Budget surplus was seen as prudent in a world where countries with budget deficits, high Government debt and a dependence on foreign capital could easily get smacked either economically or via a market disruption if things turned sour.  One only has to look to the Eurozone to see examples of how this is playing out for countries without decent fiscal settings.  The Government was smart to work to minimise the risks of this happening.  The tight budget would also cool demand in the economy which would help deliver a lower inflation rate than would otherwise be the case.

The other objectives of delivering a tight Budget and sticking to that plan were a little more subtle.

There has never been a clear, automatic and direct link between tight fiscal policy and easier monetary policy, and then through easier monetary policy to a lower currency.  But Gillard, Swan and Wong were judging that the tighter the Budget, the more room the RBA would have to cut interest rates if circumstances allowed and as a result of those lower interest rates, one of the critical underpinnings of the booming Australian dollar would be taken away.

Well, that was the theory and the plan.

Fast forward to today.

The Budget has indeed locked in the surplus for 2012-13 with the Government probably cutting spending a little harder than it wished, but either way, no one can credibly say that the Budget is anything but “tight”.

In terms of official interest rates, they are set at 3.75%, 100 basis points lower than a year ago and some 250 basis points below the level in place when the Coalition was last in Government.  The 3.75% cash rate is at a level rarely seen in the past 50 years and a rate that has seen mortgages rates fall to around 7.05% (on average) to be some 150 basis points below the level in place when the Coalition was last in Government.

So the strategy was working on that front.

Let’s look at the Australian dollar.  In recent times, it has fallen to around 0.9950 to the US dollar and more importantly, it is also weaker against most cross rates.

The results are a near perfect, near textbook quality outcome.

Lower interest rates are helping to rebalance the internal imbalances in the economy – they will boost the beleaguered housing sector, aid cash flows for households and business and encourage investment in the non-mining parts of the economy.

The trade exposed sectors and industries also get the benefits of lower interest rates, but they get a bonus of a lower exchange rate which adds to their international competitiveness.

All up, the plan is working extremely well and the economy is all the better for it.

Never, never before has Australia had, simultaneously, 2.1% inflation, 4.9% unemployment rate, budget surpluses, a 3.75% official cash rate, 2% growth in real wages and economic growth on track to hit 3%.

Long may these continue.