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.

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Lift the debt ceiling or lose liquidity

This is the article I had in the AFR today.

Link here:


A matter of public sector financial management is turning into a risky political stoush. The government’s plan to increase the debt ceiling to $300 billion is an essential element of maintaining financial stability, fully functioning capital markets and deep liquidity in the market for Commonwealth government securities (CGS).

The opposition is railing hard against lifting the debt ceiling for reasons that have nothing to do with governance or economics, but a lot to do with a political scare campaign. National Party member Barnaby Joyce says: “If you do raise the debt ceiling, you have a rather large train rolling off the edge of a rather large cliff.” This obscure metaphor and other unsubstantiated criticisms from the opposition on the debt ceiling rise highlight a misunderstanding of the role CGS plays in Australia’s economic and financial market stability.

The global financial crisis taught governments and investors alike that liquidity in government-guaranteed securities is paramount when market ructions are at their worst. Those with a deep knowledge of financial markets, such as JPMorgan’s interest rate strategist, Sally Auld, noted that raising the debt ceiling “is the prudent thing to do. I would hope it is an uncontroversial issue.”

Her hope reflects a risk that an escalation in the political hoopla from the opposition will spill over to a change in market confidence. For now, investors are content with the debt ceiling. Government bond yields are at record lows and more than three-quarters of CGS is held by foreigners. Liquidity must bemaintained to retain this confidence.

Last year, the government consulted market participants and regulators who said: “To maintain a liquid and efficient bond market that supports the three and 10-year futures market and the requirements of the new global bank liquidity standards, the panel agreed that the CGS market should be maintained around its current size – that is, around 12 to 14 per cent of gross domestic product over time.”

Linking government debt to the size of the economy means the debt ceiling will rise for at least another few decades. Reducing gross debt in a growing economy will stifle liquidity and risk scaring off foreign investors. Unfortunately, the opposition is willing to risk overseas investor confidence in Australia for the sake of a cheap political point.

If there is a change of governmentat the next election and the Coalition cuts government debt, bond market liquidity would be eroded and big investors would have good reason to sell their bond holdings. This risks market disruption not only for bonds but for the Australian dollar and official interest rates.

Stephen Koukoulas is managing director of market economics and a former adviser to Prime Minister Julia Gillard.

The Australian Financial Review

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A Short History of Government Debt in Australia


For anyone interested in government debt in Australia, I recommend spending some time looking at Table 3 in Budget Statement 10.  Here is the link: http://www.budget.gov.au/2012-13/content/bp1/html/bp1_bst10.htm

The numbers are the only guide on government debt trends in Australia and cover 46 years from 1970-71 through to the last of the forward estimates out to 2015-16.

Let’s start where the history starts.

In the early 1970s, governments had net financial assets – that is, net debt was negative.  The McMahon Liberal Government lost in December 1972 and handed over to the Whitlam Labor Government negative net debt of 1.6% of GDP.

Despite the massive growth in real government spending during the Whitlam years, the level of negative net debt was little changed when Whitlam was sacked in November 1975.  I am not sure whether to use the 1974-75 data which shows negative net debt at 2.7% of GDP or the 1975-76 data which shows negative net debt at 0.4% of GDP due to the timing of the change of government at that time, but either way, it doesn’t really matter other than to show that when the Fraser Government took control of the Treasury benches, net government debt was negative.

The Fraser Government was in power for 7 years.  By 1983-84, the level of net government debt had risen to 7.5% of GDP and would reach 9.3% of GDP in 1984-85 as Treasurer Howard covered up the Budget problems during the 1983 election campaign.  Such were the dynamics of the early 1980s domestic and global recession, that net debt rose a bit more over the next year and it peaked at 10.3% of GDP in 1985-86.

After that, the Hawke / Keating Government slashed government spending in the latter part of the 1980s and in 1989-90, the government spending to GDP ratio fell to 22.9% – a level that has never been matched since.  As a result of the fiscal prudence, net government debt fell to a trivial 4.0% of GDP in 1989-90.

Like the Fraser Government before it, the Hawke / Keating Government was hit with a nasty domestic and global recession in the early 1990s and as a result, net debt rose.  With global GDP recording the weakest three-year performance since the early 1980s, net debt peaked at 18.1% of GDP in 1995-96.

The Howard Government won the March 1996 election with the Budget in repair and with the global economy about to embark on a strong expansion.  By the end of the Howard Government in November 2007, net debt was again negative at minus 3.8% of GDP.  Aided by some of the strongest years for world GDP growth ever recorded and no global recession during its tenure, the Howard Government moved to negative net debt via a run of solid Budget surpluses.

In the period of the Rudd and Gillard Governments, net debt has risen and will peak at 9.6% of GDP in 2011-12.  The fiscal stimulus measures that were delivered as the world crumbled to its deepest recession since the 1930s plus a loss of revenue on the back of more subdued rates of economic growth were key in the rise in government debt.  This rise in net debt was similar (as a percentage of GDP) to that experienced by the Fraser government during its term as it dealt with an inflation problem, rising unemployment and near the end of his term, a global recession.

Last week’s Budget confirmed the move to surplus from 2012-13, and with it, a decline in net government debt.  By the end of the forward estimates, net government debt is projected to be 7.3% of GDP.

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Now It’s Amanda Vanstone Who Can’t Understand Debt & Economics


If anyone ever wants to see an example of why people should stick to talking or writing  about stuff they know something about, I strongly recommend Amanda Vanstone’s article in today’s Age.

Ms Vanstone has moved to comment on government debt and oh what a humiliating comment it is.  I assume Ms Vanstone and The Age will have to run some corrections to the factual errors in the article.

The first error is just a simple percentage change calculation.  Ms Vanstone said:

  • “In 2009 Labor sought to lift the Commonwealth statutory borrowing limit from $75 billion to $200 billion – a 133 per cent increase.”

The rise was actually 166.7%.

Ms Vanstone then goes on:

  • “By the time a new government takes office, net government debt will be close to $300 billion.”

If Ms Vanstone cared to go to page 10-8 of Budget Statement 10, she would see than net government debt was currently $142.5 billion or 9.6% of GDP. When the next election comes around some time in second half of 2013, net debt will be $143 billion or 9.2% of GDP and be on track to fall to $132 billion or a miniscule 7.3% of GDP by 2015-16.

Then there is this:

  • “Forget about the Treasurer’s pea-and-thimble surplus. It is a farce and everyone, probably including him, knows it.”

Well all three major credit rating agencies have affirmed Australia’s triple-A credit rating after the Budget, which suggests they don’t know the Budget contains a “pea-and-thimble surplus”.  Oh and by the way, the Howard government never had the 3 ratings agencies have Australia triple-A.  This is something only achieved late last year for the first time.  Bond investors, who have a ruthless attitude to budgets and government debt as we can see throughout Europe at the moment, have pushed the yields on Australian government bonds to all time lows in the days after the Budget.  I suspect they know something Ms Vanstone doesn’t understand.

Here is the article in full:


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Australia’s Fantastic Economic Fundamentals – A New Benchmark


A new benchmark in Australia’s economic history was reached in the last few weeks with the inflation and unemployment data.

Just to recap – the annual rate of underlying inflation fell to 2.1% in the March quarter 2012, while the April 2012 labour force data showed the unemployment rate falling to 4.9%.

It is not since the early 1970s that Australia has recorded an unemployment rate below 5.0% whilst simultaneously registering underlying inflation at 2.1%.  The only other times in the last 40 years that Australia has had the unemployment rate below 5%, underlying inflation has been at 2.7% or higher – sometimes considerably higher.

Achieving low unemployment with low inflation is rare.  It is also great news.  Low unemployment means jobs for those who want them, household income growth, additional production and all of the individual and social benefits that come when the economy is running close to full employment.

Low inflation means a strong likelihood of rising real wages for all of those people with jobs, additional purchasing power for other income earners and a boost to the overall productivity of the economy.

Australians live in fantastic economic times.  Long may it last.

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The Abbott Fact Check & Other Matters


The Leader of the Opposition Mr Abbott gave his response to the Budget a short while ago and while there were few facts relating to matters of the economy, there were a few assertions and judgments that should be put through the fact-check machine.

The lack of any detail about how the aspirations would be paid for is another matter, but at a quick glance, here is what came out:

ABBOTT:  People who work hard and put money aside so they won’t be a burden on others should be encouraged, not hit with higher taxes.

FACT: The tax to GDP ratio of the first 5 Labor Budgets averaged 21.1%.  The lowest ever tax to GDP recorded under the Howard government was 22.2% and the average was 23.4%.  The last time a Coalition Government delivered a tax to GDP ratio below 21.1% was in 1979-80. Cannot see where the “hit with higher taxes” statement fits these facts in the current Budget context.

ABBOTT:  And people earning $83,000 a year and families on $150,000 a year are not rich, especially if they’re paying mortgages in our big cities.

FACT:  Average annual earnings are around $53,500 in NSW and $51,500 in Victoria.  Maybe they are “not rich”, but someone on $83,000 is earning around 60% above the average wage whether they have a mortgage or not.

ABBOTT:  Madam Deputy Speaker, from an economic perspective, the worst aspect of this year’s budget is that there is no plan for economic growth; nothing whatsoever to promote investment or employment.

FACT:  After registering a 19th straight year of economic growth in 2010-11, the Budget shows Australia growing at 3% in 2011-12, 3.25% in 2012-13 and 3% in 2013-14.  Having risen a Chinese-type 18% in 2011-12, business investment is forecast to rise a further 12.5% in 2012-13.  Employment is forecast to rise by 1.25% in 2012-13, which will see the creation of around 175,000 new jobs from now until June 2013.   

ABBOTT:  With a growing economy, it’s possible to have lower taxes, better services and a stronger budget bottom line as Australians discovered during the Howard era that now seems like a lost golden age of prosperity.

FACT:  Despite the unbroken economic growth during the Howard Government era, which was a worthy achievement, the tax to GDP hit a record high of 24.2% of GDP, some 3.2% of GDP higher than in 2011-12 (that’s about $40 billion of extra tax in a single year!)

ABBOTT: I applaud the Treasurer’s eagerness to deliver a surplus – but if a forecast $1.5 billion surplus is enough to encourage the Reserve Bank to reduce interest rates, what has been the impact on interest rates of his $174 billion in delivered deficits over the past four years?

FACT:  The official cash rate set by the RBA averaged 5.42% during the Howard government.  Since Labor were elected in November 2007, it has averaged 4.73% and is currently at 3.75%.  The futures market, having seen the Budget, is pricing in a cash rate below 3% by early 2013. 

ABBOTT:  The forecast surplus relies on the continuation of record terms of trade even though growth in China is moderating and Europe is still in deep trouble.

FACT:  The Budget forecasts are for the terms of trade to fall by 5.75% in 2012-13 and to fall a further 3.25% in 2013-14.  Based on Treasury’s sensitivity analysis, if the terms of trade were to continue at a record high as Abbott asserts, the surplus would be over $5 billion in 2012-13 and over $10 billion in 2013-14.

ABBOTT: I know what it’s like to deliver sustained surpluses because I was part of a government that did; indeed, sixteen members of my frontbench were ministers in the government that delivered the four biggest surpluses in Australian history.

FACT:  As a share of GDP, they are not “the four biggest surpluses in Australian history”.  The two biggest surpluses as a share of GDP were actually delivered by the Gorton and McMahon governments, followed by the 3rd largest surplus from the Howard Government, the fourth largest at 1.9% of GDP was delivered by the Whitlam government.

The “four biggest surpluses in Australia’s history” in dollar terms, which fit Mr Abbott’s claim, were in fact driven by the highest tax to GDP ratio in Australia’s history plus there was an extra $5.2 billion in dividends in those four years from the RBA.

ABBOTT:  If the budget really was coming into surplus, it stands to reason that the government would have no further need to borrow.   If the government really thinks that a surplus can be delivered, as opposed to being merely forecast, why is it proposing to add a further $50 billion to the Commonwealth’s debt ceiling?

FACT:  The debt ceiling is rising due to the requirement to main a deep and liquid bond market and to allow for intra-year cash flow lumpiness in government accounts. See also: http://www.marketeconomics.com.au/1286-gross-debt-gross-ignorance-2


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Great News on Jobs – RBA to Hold in June


The employment data work strongly against an interest rate cut in June.   While the monthly numbers are always volatile, two zigs in a row, breaking the zig-zag patterns for employment data over the past year or so could well be a short-term game changer for the RBA.

Having cut 50 basis points in May, a follow up 25 basis points in June when there is fresh news showing good growth in employment and a sub-5% unemployment rate should see the RBA move back to hold.  For now at least.

To summarise, employment rose 15,500 in April after rising 37,600 in March to be 0.7% above the level of a year ago.  This is a nice pick up in job creation after annual employment growth fell to zero at the end of 2011.  The unemployment rate fell to 4.9%, rate not bettered since December 2008.

To be sure, there are still very valid reasons why interest rates are likely to move lower – global economic problems and market ructions figure large.  The contraction about to hit the economy from the fiscal tightening in the Budget will also see the RBA have room to cut if growth and inflation pressures dictate.

Global credit markets are as fragile as Tony Abbott with an economics textbook, with scope for ugly trends as Eurozone politics and policy swing ever-closer to a major disruptive event.

It is also interesting to note that house prices, as measured by RPData, are back in a downward funk, having fallen by 0.6% so far in May and this after falling 0.8% in April.  Recall these falls are on top of a 3.6% fall in house prices in 2011.  This risks undermining consumer sentiment and banking profitability – more significant falls would create a problem that the RBA would need to react to with easier policy.

But for now, the run of data on retail sales and employment is so much better than expected that the RBA can sit tight in June.

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Mr Hockey’s Budget Knowledge Exposed


It is a pity that Mr Hockey squibbed on his own challenge for a bet that the return to surplus in 2012-13 would “come from higher taxes instead of genuine savings.”

Here is the background: http://www.marketeconomics.com.au/1917-mr-hockeys-offers-up-a-bet-but-will-he-follow-through

A pity for me that is because the Budget last night embarrassingly exposed Mr Hockey’s misunderstanding about how the government is handling its finances in delivering the surplus.  In terms of “genuine savings”, one only has to look at the following facts:

  • Real government payments (spending) will fall by 4.3% in 2012-13.  In nominal dollar terms payments will fall by $7.1 billion.  In terms of “genuine savings”, the 4.3% fall in real government spending is the largest ever recorded, ever; and the fall in nominal spending is the first such fall ever record.

Blind Freddie can see that these savings in the Budget are quite massive.

  • On another level, the spending to GDP ratio falls to 23.5% in 2012-13, some 0.7% of GDP lower than under the Howard government and down from 25.1% in 2011-12.

See?  Genuine savings here.

I don’t know what facts Mr Hockey is looking at in making his claims – or is he just making up a story as he goes along?


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Who’s a low taxing government? This one!


Based on media reports today, the Treasurer Wayne Swan’s Budget will confirm that the tax to GDP ratio will be around 22.1% in 2012-13.   From a historical perspective, this level of the tax to GDP ratio is stunningly low, particularly with the economy in its 21st year of unbroken economic growth.

If we take the first five Budgets of the Labor Party as a whole, the average tax to GDP will be a tick above 21% which interestingly, is a rate never approached in any of the 12 Budgets delivered under the Coalition Government from 1996-97 to 2007-08.

In an embarrassing fact for the Coalition, the lowest tax to GDP ratio reached during their 12 Budgets was 22.2% and it averaged a chunky 23.4% of GDP for the duration of the Coalition’s time on the Treasury benches.  The tax to GDP actually peaked at 24.2% of GDP in 2004-05 and 2005-06 when the Howard Government took the gold medal for the highest taxing government in Australia’s history.

If a few tenths or an odd percentage point of GDP doesn’t sound much, you are wrong.

In 2012-13 terms, every 0.1% of GDP is worth over $1.5 billion to the tax take.  Clearly, 1.0% of GDP is more than $15 billion of extra tax, every year.  The 2012-13 tax take, at 22.1% of GDP, is therefore leaving around $20 billion per annum in the pockets of taxpayers relative to what they were being taxed on average during the dozen years of the last Coalition Government.

In today’s dollar terms, that’s an extra $400 million a week, every week for 12 years that was being sucked out of the pockets of tax payers with the Coalition’s higher taxes.  Looked at another way, that’s around $20 of extra tax per week for every Australian or around $80 a week just in extra tax for a family of four.

Looked at from a different angle, if the Budget tomorrow were to have a tax to GDP ratio at the average of the Howard Government, the Budget surpluses would be above $20 billion each year and cumulatively, be close to $90 billion over the total of the forward estimates.

In March this year, Shadow Treasurer Joe Hockey gave an “absolute guarantee” that a Coalition government “would deliver lower taxes than a Labor Government.”

This objective is curious given how low taxes are now and given the Coalition’s track record when in government.  If Mr Hockey and the Coalition are to deliver this guarantee, yet aim for Budget surpluses of 1% of GDP at the same time, which is also a Coalition objective, they are going to have to deliver net spending cuts of around $20 billion per annum.  Throw in the fact that they are rescinding the carbon and mining taxes and keeping the bulk of the measures that the revenue from these sources is funding (cut in company tax, extra superannuation, higher pensions, higher tax free threshold), there must be just massive spending cuts lurking elsewhere in Mr Hockey’s top drawer.  Either that, or the guarantee from Mr Hockey is not worth the cyber space it is taking up.


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Australia has monthly inflation – Use it!


In looking for reasons why the RBA was slow to cut interest rates, a few analysts have popped up to suggest the misreading of the deceleration in inflation was the critical point.  To that end, they suggest that Australia’s lack of an official monthly CPI was key in the RBA waiting and waiting before doing a two-for-the-price-of-one 50 basis point cut in May, a week after the quarterly CPI showed inflation in free-fall.

To be sure, the RBA did get the growth slow-down and with it the deceleration in inflation wrong.  But the tardy interest rate response was not for want of monthly inflation data.

A decade or so ago, Professor Don Harding, Dr Lei Lei Song and I got together to see whether it was possible to produce a monthly inflation gauge for Australia.  After some testing for sources of data, timeliness and cost, we thought we would go ahead and collect data on a near-to-as-possible methodology to the Australian Bureau of Statistics and see how it went for a couple of years.

This saw the birth of the TD-MI Monthly Inflation Gauge.

The early signs were encouraging.  In broad terms, the annual rise in the monthly numbers we collected generally matched the official quarterly CPI.  This was terrific news.  Occasionally, when the result diverged for a quarter or so, it quickly corrected with the CPI reverting to the Monthly Inflation Gauge.  This suggested we were getting the methodology broadly right although timing issues with price sampling may have accounted for the ABS getting slight and temporary differences to our numbers.

The point of all of this is to note the TD-MI Monthly Inflation Gauge has done a stunning good job in not only picking turning points in inflation, but also the orders of magnitude in the inflation rate for the past decade.

The eye-ball econometrics from the chart below shows very clearly that the correlation between the ABS quarterly CPI and the Monthly Inflation Gauge is better than strong.

In the most recent episode, the Monthly Inflation Gauge turned a little before the CPI and confirmed a sub-2% inflation rate well before the ABS printed the same result.  See the thin blue line in the chart below (the Monthly Gauge) and the thicker green line (the ABS quarterly CPI).

Had the RBA and dare I say the market paid more attention to the Monthly Inflation Gauge, it might have had a clue that the cooling in inflation was occurring and was significant.  As a result, it might have been happy to cut in February or March and avoided the requirement for the 50 point catch up in May.

The lesson of this episode is to watch the Inflation Gauge each month – it contains plenty of useful information on inflation.

Oh – and as a second “check” on just how reliable the Monthly Inflation Gauge is, look at the level of prices tracked by the Monthly Inflation Gauge versus the CPI.  As you can see, after 10 years of data, the fit is like a finger in a glove.



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