Is it time to loosen the purse strings and commit to a Coronavirus stimulus package?

Simon Cowan

29 February 2020 | Canberra Times

Before coronavirus, it was the supposed urgent need to boost Newstart, and the scourge of low wage growth. Surplus be damned, said the clamour – stimulus was needed.

When this didn’t have the desired result, the same coterie of Keynesian commentators, whose answer to every problem is government spending, called for the government to abandon the surplus to save the nation from the economic impact of the bushfires.

Unfortunately, it seems like they have finally found a trigger that will work.

To be clear on two things: it is completely proper that government act on public health concerns in relation to the coronavirus. Dealing with a potential pandemic is absolutely the role of the federal government, and these actions may require additional, unexpected government expenditure.

Moreover, there will almost certainly be negative economic consequences from coronavirus (and the bushfires as well, for that matter). Lower than expected tax revenues, and higher than expected expenses, will likely have an impact on the federal budget balance.

The budget may well fall into deficit as a result of the combined effect of the coronavirus and the bushfires, though it is not certain that this will happen.

That said, a government serious about delivering a surplus could easily find $10 billion or more in expenditure it could cut with little or no negative economic impact.

Those calling for government stimulus are really seeking to upend the political settlement that delivered decades of stable inflation.

After all, the government spends more than half a trillion dollars, and some of that money is an egregious waste (for example the duplication of state functions, providing financial assistance to industry or running programs with little or no evidence they work).

Notwithstanding this option, whether the budget falls into deficit because of the economic consequences of these external shocks is a materially different issue from whether the government should engage in deficit spending in the face of these challenges.

There is some fiscal sleight-of-hand going on. The negative budgetary consequences of external events are separate from the costs of a stimulus package. Even under the most optimistic predictions of the effectiveness of government stimulus, they would not offset each other.

And government stimulus announced in the May budget, likely implemented in the second half of the year, would have little or no impact on growth in the next few months. This suggests something else is actually going on here.

For decades, prior to the GFC, both major parties agreed that short-term stimulus, for the purpose of managing short-term fluctuations in aggregate demand, was not the role of the federal government.

It was a lesson hard-learned by years of suffering under economic mismanagement characterised by extremely high inflation, recession levels of unemployment and spreading poverty.

As a result, to the extent that management of aggregate demand is possible in the short term (and it is not actually clear that demand can be managed accurately and without serious side effects) such stimulus was the job of the Reserve Bank, who acted in accordance with agreed policy rules.

The role of the government was to address supply-side restrictions in the economy and keep productivity and economic growth on track in the medium to long term.

In the wake of the GFC, the Rudd and Gillard governments revived the idea of government needing to take a more active role in managing fluctuations in the economy. The then-treasurer, Wayne Swan, was openly Keynesian in his approach to fiscal policy.

Cynics among us might speculate that the GFC was merely the justification for pursuing a tax-and-spend approach that had always lurked in Labor’s institutional DNA – especially in light of the plans Labor took to the 2019 election.

Yet as the severity of the GFC’s economic fallout became apparent, and as central bank interest rates fell to zero, Keynesian ideas of activist fiscal policy experienced a significant revival globally, especially among political parties and thinkers on the left.

The appeal of such policies to those increasingly sceptical of markets, and progressively embracing larger government, is clear. Keynesianism gives a veneer of economic credibility to the kind of expansion of social welfare programs progressives were advocating anyway.

This way of thinking is starting to seep into the right as well, with some pointing to the “stimulatory” effect of Donald Trump’s massive – unfunded – tax cuts in the US as a good model for Australia.

Yet short-term stimulus is not the main reason for cutting tax. As my colleague, John Humphreys, observed in a publication last year: “The crucial point is that tax cuts will reduce the behavioural distortions caused by taxes … which increases productivity – resulting in sustainable increases in economic output, wages, and consumer wellbeing.”

Though Keynesianism began its revival in the wake of the GFC, increasingly the advocacy of Keynesian economics has become uncoupled from any idea of crisis management. However serious the impact of our potential crises, there is no current suggestion they will cause a recession.

This means that those currently calling for government stimulus are really seeking to upend the political settlement that delivered decades of stable inflation, low unemployment, and continuing economic growth.

This is a proxy debate over the role of government in the economy. Those urging stimulus are arguing – intentionally or otherwise – for a far more activist role for government in economic management.

When put this way, the need for government to explicitly reject the demands for stimulus – not merely on the grounds that stimulus is unnecessary, but that it is also inappropriate – becomes apparent.

The government is already showing signs of cracking, reportedly asking Treasury to develop stimulus contingency plans, and the continuance of bad economic news can only cause the pressure to do something to grow.

The government currently has the high ground in the economic debate, especially if it can finally deliver a surplus.

If it surrenders to the idea of stimulus, it will quickly find itself in a bidding war it cannot possibly win.

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