11
Feb
2012

>A Message To Everyone Who Talks About Fiscal Policy and the Budget

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I’m getting sick and tired of seeing people write about fiscal policy, tax, government spending and the Budget without any appreciation of the facts.

“Labor addicted to tax; feeble fiscal policy; painful side-effects of the fiscal stimulus”.

Has anybody who has uttered or written these words bothered to do a cross-check on the historical data?

So to one and all, here it is.  It’s no secret.  Print off this link, read the tables.  If you need help to interpret the numbers, give me a call and I’ll gladly help.

http://www.budget.gov.au/2011-12/content/myefo/html/13_appendix_d-01.htm 

Focus mainly on Tables D1, D2 and D4 and you’ll never make a silly error again about the biggest taxing government or which side delivers spending cuts or whatever.

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9
Feb
2012

>Judith Sloan Misses Some Key Data

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The Australian’s Judith Sloan’s article today looks at fiscal policy management in the last few years.   But for some reason that is not clear, her article today, http://tiny.cc/fa4a0 stops looking at the hard data on Government spending beyond 2008-09. 
There are two full years of data available beyond 2008-09 plus the updated forward estimates out to 2014-15 in the MYEFO documents.  Sloan quite rightly picks up the massive increase in government spending associated with the textbook implementation of stimulus in the wake of the onset of the Lesser Depression or GFC in 2008-09 but then ignores the unwinding of the stimulus since 2009-10.
Ms Sloan’s article notes quite rightly that as the global economy tipped on the brink of depression:
  • the government quickly sent out cheques to most citizens and embarked on a dizzying array of spending programs in the name of fiscal stimulus.”

It was indeed a stunning fiscal strategy that saw Australia avoid recession, cap the unemployment rate below 6% and leave a legacy of upgraded school infrastructure among other things.
Sloan then emphasises her point:
  • “Government spending increased by more than $44 billion in one year or over 16 per cent. As a percentage of GDP, spending rose from 23.8 per cent in 2007-08 to 25.9 per cent in 2008-09.”

The numbers she uses here are for government “expenses” and not total “payments” – the difference effectively being purchases of non-financial assets and net acquisitions of assets under financial leases.  These matters are relatively small, but can be significant.  It is not clear why she chose this narrower definition of government spending, but that is not all that important.
What is important is that even using this narrower definition of government spending, the hard data for 2010-11 showed expenses falling to 25.4% of GDP.  Ms Sloan omits the Treasury estimates for 2011-12 which show a further fall in expenses to 25.0% of GDP and yet a further fall to 24.3% in 2012-13, when the Budget returns to surplus.
It is important to note that as a reference, the average “expenses” to GDP ratio under the 12 Howard Government Budgets was 24.7%.  In 8 of the 12 Howard Government Budgets, government expenses equaled or exceeded 24.3% of GDP, the estimate of what will be delivered in 2012-13.  SO the Government spending like drunken sailors?  You be the judge.
Clearly then, in just four and a half months when 2012-13 starts, government expenses will be lower than the average under the Howard government and 2.0% of GDP ($30 billion per annum!) down from the 2009-10 peak.
Ms Sloan goes on to note:
  • “We are being told by Julia Gillard that “our fiscal policy must be disciplined. Putting the budget into surplus means that we are well positioned to deal with further global financial and economic uncertainty and crises if that should occur.”
  • “Of course, lecturing the Europeans is always good sport, even if they do not take notice. “If anything of value can be retrieved from the wreck of failed economic approaches in Europe pre-2008, it is the lesson to the world: fiscal discipline matters,” our Prime Minister pontificates. The only problem is that it is Peter Costello who should be giving the lecture.”

Just to reiterate, as Treasurer, Mr Costello delivered 12 Budgets where the average expenses to GDP was 24.7%, a result higher than in the forward estimates for 2012-13, 2013-14 and 2014-15.  The peak Costello expenses to GDP ratio was 25.6%, delivered in 2001-02 when the economy was growing at a solid pace and only 0.5% of GDP lower than the peak delivered in response to the GFC.

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9
Feb
2012

Interest Rates and Politics. Which side of politics does "best"?

When should a new government take responsibility for current economic conditions? Or rather, when does the implementation of new policies have a meaningful influence on the economy, inflation and even interest rates?

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8
Feb
2012

Is Something Brewing in the Economy?

In the last few days, we’ve seen a hardening in the commitment to a 2012-13 Budget surplus from the Prime Minister, Ms Gillard, the Treasurer, Mr Swan and the Finance Minister, Ms Wong.

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7
Feb
2012

>Deposits, Bank Funding Costs and Bank Bashing

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That $400,000 you were just loaned by your friendly bank to buy that new house didn’t come out of thin air.
The bank had to raise the capital to lend to you and since the GFC, about half of these funds come from deposits, about 40% from wholesale funding with the other 10% from odds and sods.
For this note, I will focus on deposits.
Prior to the GFC, deposits rates paid by the banks to savers were around 100 to 200 basis point BELOW the official cash rate (using 6 and 12 month term deposits as the benchmark).  The banks were stingy and miserable in their deposit interest rates because they were raising plenty of capital in the wholesale market cheaply and easily so they didn’t need to be too aggressive in bidding for funds from depositors.
Now, in the post-GFC environment, things are very different.  Deposit interest rates range from being around the cash rate to around 100 basis points ABOVE it.  Banks are obviously trying to get capital to lend to you and me buy paying more to get their funding from deposits.  They are not doing this to be good corporate citizens.  They are doing it because the cost of raising funds in the wholesale market has risen and it pays them to pay up for deposits.  It’s great news for savers and may well explain the drop in money being put into the stock market is recent times.
The bottom line of all this is to show that the cost of being a bank that lends money to consumers and small business has gone up.  It’s why the margin between the cash rate and retail interest rates has changed so much in the last 4 or 5 years.
And it’s why we are likely to see one or more banks hiking lending rates in the next few weeks.  
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7
Feb
2012

RBA: You got to know when to hold ‘em, know when to fold ‘em…

The RBA has shocked the world by holding official interest rates steady at 4.25%. It is a surprise because the economy is growing a little below trend, inflation is low and falling, the labour market is softening and global conditions are problematic.

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7
Feb
2012

>If the RBA cuts today…

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It’s only a few hours till we see whether the RBA cuts official interest rates or not.  I hope this post is not the kiss of death to the interest rate cut that is needed to tackle lower inflation and sub-trend growth.  As mentioned, we’ll see.

If the RBA does cut 25 basis points, the official cash rate will be set at 4.0%.  This will be significant from a few different angles.

Not least will be the fact that official interest rates* will have NEVER been this low under any of:

  • the Howard Government (March 1996 to November 2007 – low point 4.25%);
  • the Fraser Government (November 1975 to March 1996 – low point 7.65%);
  • the McMahon Government (March 1971 to December 1972- low point 4.30%);
  • and probably the Gorton Government (January 1968 to March 1971 – low point 5.70%).

I say “probably” the Gorton Government because the RBA data base only goes back to July 1969 and at that time the 90 day bank bill yield was 5.80%.

Interest rates will always be lower under ……….

* 90 day bank bill used prior to 1990.

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6
Feb
2012

>Selling a Dead Dog or Lobster?

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One observation about the political environment right now, is that it is not about what each side is “selling” to the electorate, but rather, how they are selling it.

On that score, Mr Abbott and his Coalition colleagues are doing a fantastic job in touching the nerve-ends of the electorate with their messages.  The Coalition holds a commanding lead in all opinion polls and they are the hottest of hot favourites to win the 2013 election.  This is despite the fact that what there are selling is a dead dog.  That dead dog includes unfunded promises which would usually humiliate anyone with an understanding of economic policy; their numbers don’t add up; policies that conflict and an agenda that it impossible to define because either it does’t exist or what is there, is subject to change.  Mr Abbott is promising to unscramble an omelette even though it can’t be done without causing economic and market upheaval.  Company tax hikes, pension cuts, lower superannuation contributions are all part of the Coalition’s agenda.  How can they win an election with this agenda unless they continue to run the best political marketing scheme ever seen?

The Prime Minister, Ms Gillard and her team are presiding over something close to economic nirvana.  There is a near perfect balance of fiscal and monetary policy settings, the never-before-seen triple-A rating from all three ratings agencies and despite a mini-cyclical slowdown, unemployment is low.  A budget surplus next year is an amazing achievement and reform on carbon pricing, the mining tax, education, skills, workforce participation, disability insurance, company tax cuts, superannuation increases are things that most voters should warm to.  So too lower interest rates which are set to be even lower in the months ahead.  It’s the lobster thermidor, drizzled with truffle oil.

But the Government are clearly doing a less than average job selling this message.  Polls still show a big lead to the Coalition as “better economic managers”, by way of example.  Maybe that will change and there seems to be a shift in the messages from the PM, Treasurer and others in recent weeks.

Looking ahead, there is no doubt that an ordinary sales job is fixable when you have something great to sell.  It’s still lobster you are selling, just try a different means to get the message through.

But selling a dead dog is selling a dead dog.  This may yet be a problem for Mr Abbott and the Coalition right through to the election in 2013.  There is little room for error if the dead dog starts to smell. 

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6
Feb
2012

>Monthly Inflation Stops Decelerating

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Correction:  The CPI recorded zero change in December quarter, not September quarter.
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The TD-MI Monthly Inflation Gauge recorded a rise of 0.2% in January to be 2.2% above the level of a year earlier.  The Gauge rose 0.5% in December.
While there is nothing in these data to stop the RBA from cutting interest rates at its Board meeting tomorrow – it’s close to certain it will – there is just a smidge of early evidence in the last two months that suggests inflation may settle in the bottom half of the RBA target range rather than fall below the bottom of the target range as looked likely a month or two ago.
Admittedly, there is a lot of seasonality in the inflation results and the new year usually captures a range of once-a-year price rises.  This will be adjusted away with the seasonal adjustment when the official CPI and the underlying measures are released in late April.
That said, with the January monthly inflation data now out, it is possible to make a reasonably well-founded estimate of the March quarter CPI.  Based on the last four months of TD-MI data, it looks like the March quarter CPI will rise by around 0.8%.  This estimate will inevitably be modified with the February results in four weeks time and also when we get information on things like petrol prices in March, but for now, the current estimate is a 0.8% rise.
0.8% for the March quarter CPI may seem high.  But it probably isn’t too bad due to seasonal issues mentioned above, but also the underlying measures calculated by the RBA suggest – at this very early stage – an increase of 0.6%.  If realized, this would see through the year underlying inflation dip to around 2.3 or 2.4%.  Don’t forget the CPI recorded zero change in the December quarter.
Tomorrow, the RBA Board will be sitting down to its Iced Vovos and Monte Carlos knowing inflation is well contained.  It can cut 25 points, sit back, see what the banks do, see how much jobs bounce back next month and wait for the next monthly Inflation Gauge to see if there is anything more than noise in the data.  Global conditions may also be a little clearer in March. 
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5
Feb
2012

Politics and Interest Rates

Three or four months ago, the opinion polls had the two-party-preferred vote for the Coalition at around 57 or 58%, with Labor at around 42 or 43%.  In the last few weeks, the polls have moved around 4% with the Coalition down to around 53 to 54% with Labor up at around 46 or 47%. 
In almost all of the analysis of this not-insignificant move, one factor has been strangely ignored.
Interest rates.
The RBA surprised most by starting an interest rate cutting cycle in November.  It followed up with another rate cut in December and if the current market pricing is even vaguely correct, there will be a series of 3 or 4 more interest rate cuts through 2012.
It is no surprise that the turning point in the polls occurred at around the time of the first interest rate cut.  It is obviously an important cost of living issue.  While many factors influence voter’s whims and preferences, interest rates are important.
Just look at the demise of the Howard government in 2007.  While many factors contributed to the change of government and Prime Minister Howard’s humiliating loss of his own seat, interest rates were no doubt one factor – including in Bennelong.
Some still wonder how the Howard Government could be beaten so badly with the economy strong, unemployment near 4.5%, the Budget in substantial surplus and tax cuts and spending being thrown around with gay abandon.
Interest rates were a factor.
Recall at that time, the RBA had been hiking interest rates progressively into the lead in to the November 2007 election and it was so worried about the inflation outlook, that it hiked during the election campaign.  That hike took mortgage rates to a wallet-squeezing 8.6%.

Some 15 years after interest rates hit 17% under the Labor government, the Coalition used to tag Labor as the Party of high interest rates.  Whatever the facts, it was effective politics and hurt Labor for years.
On this issue, the Gillard Government is economically and politically smart at the moment, doing whatever it can to keep downwards pressure on inflation and with that, downward pressure on interest rates.  That’s why the commitment to a budget surplus in 2012-13 is not only good economics but it is good politics.
If it can keep a tight grip on government spending and stick more or less to the numbers in the MYEFO, government demand will be cutting away at GDP, cutting away at inflation, freeing up capacity in the economy and giving a degree of freedom to the RBA to cut rates.  Ideally, it would trim a few billion extra off outlays, but that’s another issue.
Spending Ministers would be wise to consider this in the lead into the Budget in May.
If the Government can stick to its guns on economic policy and the RBA delivers a few more interest rate cuts over the next year or so, a powerful mix of good economic management – “we delivered a surplus and there are more to come” – and lower interest rates will be electorally popular.  

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