Ideas@TheCentre
Fiscal activists can’t have their cake and eat it
It was not that long ago that many economic commentators were talking of a direct trade-off between fiscal and monetary policy. Tax cuts and smaller budget surpluses, we were told, would lead to higher inflation and interest rates (strangely, the argument was rarely applied to increased government spending). Some economists were even brave enough to quantify this supposed trade-off.
This argument never had much merit, not least because the actual (as opposed to the forecast) change in the budget balance as a share of GDP from one year to the next (sometimes called the ‘fiscal impulse’) was simply too small to matter very much for the economy. As former Reserve Bank Governor Ian Macfarlane told the House Economics Committee on 18 February 2005, ‘if you have a small surplus every year, as we have had in Australia, it is very hard to make a case that that is inflationary and therefore it is very hard to make a case that it has any impact at all on monetary policy.’
However, the current government has presided over an unprecedented fiscal easing of 4.4% of GDP in a single financial year. This is much harder for the RBA to ignore. The RBA’s recent statements on monetary policy suggest that it believes that fiscal stimulus is supporting economic activity, in sharp contrast to previous years, when fiscal policy rarely rated a mention in RBA commentary on the economy. This would argue against reductions in interest rates at the margin, even if it is based on an exaggerated view of the effectiveness of activist fiscal policy.
The proponents of discretionary fiscal stimulus can’t have it both ways. If activist fiscal policy is thought to be effective in supporting economic activity, then there is less work for monetary policy to do and official interest rates will be higher than if the discretionary fiscal stimulus had not occurred.
Dr Stephen Kirchner is a Research Fellow at the Centre for Independent Studies and co-author of Fiscal Rules for Limited Government: Reforming Australia’s Fiscal Responsibility Legislation.
