Normally at this time of year, the federal and Victorian governments would be bringing down their budgets, outlining spending and tax initiatives, and also detailing the economic outlook for the coming fiscal year.
At federal budget time last May, the government predicted a budget surplus (spending less than tax receipts) of $7.1 billion in 2019-20. The expectation was that there would be much celebration by the Liberal Party if the magical surplus was in fact delivered, and much criticism from the Labor Party if it was not.
The federal government was probably on track to deliver that surplus until the bushfires in eastern Australia put it in doubt, then COVID-19 killed off any prospect of it in this financial year, and into the foreseeable future.
Should we be concerned?
Now, spending associated with the JobKeeper and JobSeeker programs, along with other initiatives, will lead to what will likely be Australia’s largest ever federal deficit this year and next.
But should this be cause for concern? The short answer is no. More years ago than I care to remember, I worked in the federal treasury, and one research task that I was given was to try to find in the economics literature references to the optimal size of government surplus or deficits, or public debt.
Despite the obvious importance of this topic, there was no real agreement on such numbers, and very few principles for attacking these questions.
One idea was that governments should run small surpluses to build a war chest in case of a war!
More recently, many economists have argued that governments should be borrowing and spending a lot more on infrastructure, because the costs of borrowing are low relative to economic growth.
However, some research by Harvard economists Carmen Reinhart and Ken Rogoff suggests that when government debt levels get above 80 per cent of GDP, there will eventually be some kind of economic disaster and default by government.
While this research has been somewhat controversial, it does seem pretty sensible to keep debt below this kind of level. At 80 per cent of GDP, the interest costs on the debt are high, and one economic crisis could send it to unsustainable levels, as was experienced in Greece not so long ago.
What does this say for Australia in the current environment?
Australia is extremely fortunate to have had good public policy (or at the very least much better than the majority of OECD governments) over the past 40 years. Both political parties have been responsible fiscal managers while in government, and our public debt is at the very low end among OECD countries. This puts us in a very strong position to spend money now that we need to. Indeed, this is a war, and we ought to spend to try and limit the damage that COVID-19 is doing to our economy.
In fact, my main criticism of the many good policies to be introduced by the government in the past two months is that they're not open-ended enough.
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In terms of the amount of money that should be spent this year and next to limit the economic consequences of COVID-19, a quick estimate would be 30 to 40 per cent of GDP – enough to prop up the private sector of the economy for long enough until things get back to relatively normal by the end of 2021, when hopefully there are treatments or a vaccine for the disease, or we learn to live it with more normally.
There are some economists who are assuming that the economy will “snap back” at the end of this year, when all the current restrictions are undone. I think that's extremely unlikely – the economy is not like a rubber band that snaps back when stretched.
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When businesses are severely stressed, they usually don’t bounce back. Similarly, when workers are laid off and the unemployment rate rises, it takes a long time to fall back to previous levels.
For these reasons, minimising business failures and unemployment increases during the next 12 to 18 months is the most critical task for the government at the moment.
This is why I believe that the support given so far needs to be more open-ended – the government should be committing to support businesses and employees for as long as is necessary. In addition to supporting the economy directly in the short term, the confidence impacts from open-ended support are likely to also support the economy in the short to medium term.
This level of debt is manageable in the longer term through the kind of sensible fiscal management we have seen from both political parties in Australia in the past.
Imagine that the government did spend 40 per cent of GDP between now and the end of 2021 to support the economy – should we be worried about such a rise in debt?
While I think that such a rise would be unfortunate, the alternative of not spending at the moment is much worse.
Such an increase in spending would see our net public debt to GDP ratio rising to about 50 per cent of GDP, a level still below the current level for the majority of OECD countries.
This level of debt is manageable in the longer term through the kind of sensible fiscal management we have seen from both political parties in Australia in the past.
We're very fortunate to live in a country that has dealt with COVID-19 very effectively, and is also in a strong position to manage the economic impacts.
COVID-19 is a war to fight. Some countries are very likely to see their economies devastated by an inability to spend to support them at this very difficult time. The major economies of Europe, Japan, and the United States are all in this dire economic position.
