Hands off the stimulus lever - The Centre for Independent Studies
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Hands off the stimulus lever

There is something of a dark irony in the focus of the Treasurer’s speech to CEDA last week being on the challenges of an ageing population, given that he is also fighting off the spectre of economic ideas that should have been consigned to a nursing home long ago.

Specifically, Frydenberg is hard at work defending his budget surplus from the cold, dead hand of Keynesian voodoo economics. At the very least, those telling him that he should open the purse strings and indulge in some good, old-fashioned Keynesian stimulus are certainly not his friends.

Unfortunately, the Treasurer rejecting stimulus because of concerns over accumulating debt — not to mention the Prime Minister talking up the stimulus effects of infrastructure investment —validates the premise that stimulus is effective policy, just not a cost-effective one.

Conservative governments should be very wary of activist fiscal policy.

This is not only because credible evidence suggests it is at best ineffective — and more likely harmful — but also because, at this point, Keynesian economics is primarily a progressive political theory, not an economic one.

First, it is worth noting Australia is not facing an economic crisis, this is an attempt to push government to once again take responsibility for normal, short-term, fluctuations in aggregate demand.

That this approach had comprehensively failed in the past, leading to a prolonged period of economic failure highlighted by stagflation (simultaneous sky high unemployment and ruinously high inflation) in Australia and elsewhere is conveniently forgotten.

There are numerous other reasons why this is a bad idea. Fiscal policy is a blunt instrument, with potential for unintended consequences, and significant time lags (in terms of information reaching government, the government taking action, and then in response to government action). Governments also tend to influence the economy for political, not economic, reasons.

More fundamentally — as my former colleague Dr Stephen Kirchner and others have repeatedly argued — in a small open economy, with a floating exchange rate and an inflation targeting central bank (ie Australia), fiscal policy will be generally ineffective.

Exchange rate increases attenuate the impact of stimulus by diminishing any increase in net exports, and effective monetary policy actually offsets fiscal policy so that stimulus can only really be effective if the RBA isn’t doing its job.

Of course, Australia’s system — where fiscal policy focused on microeconomic reform and balancing the budget, while monetary policy was responsible for macroeconomic stability — has delivered economic outcomes the envy of the world. Why would we want to abandon that?

This is an edited extract of an opinion piece published in the Canberra Times as It’s not the government’s job to deliver stimulus to the economy.