It’s not the government’s job to deliver stimulus to the economy

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.

So we aren’t even talking about emergency ‘stimulus’ to avert a financial crisis; the excuse Rudd and Swan used to open the floodgates in 2009.

On the contrary, this is an attempt to push government to take responsibility for short-term fluctuations in aggregate demand. That this approach previously led 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 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.

It must be frustrating for the Treasurer to see some at the RBA supporting calls for stimulus, when the RBA itself sat on its hands in 2017 and 2018 while growth slowed – because it had been concerned about house price rises.

This is completely backwards. The RBA wants to abdicate demand management to the government (notwithstanding the fact that the RBA has by far the more effective toolset) in order to manage rising house prices.

Yet, ironically, government has a far better chance of managing house prices than the RBA: the central bank’s own research from 2018 indicates that taxes, duties, and planning restrictions, are the main reasons why houses are so expensive.

Interest rates undoubtedly considerably influence house prices, but they are too blunt an instrument for managing the housing market. We will end up with two sub-optimal outcomes and risk compounding one failure with another.

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. It’s worth asking why we would want to divert from that?

There are two obvious, if cynical, answers. First, some stand to benefit directly from stimulus spending; so they don’t really care if the measures stimulate the economy or not.

The second is that the majority of those pushing change strongly favour more government spending, and their economic theory is simply a post hoc justification for spending they would advocate for anyway.

After all, perhaps the world’s most persistent (and famous) Keynesian, Paul Krugman, called his 2007 book on inequality The Conscience of a Liberal. And it’s why he backs US healthcare reform, but opposes Trump’s stimulus through tax cuts. They are progressives first and foremost.

It’s been nearly 50 years since Republican President Richard Nixon declared “we are all Keynesians now” – a declaration that was controversial on the right even then. But, much like Nixon’s presidency, this unified sentiment didn’t last: by the 1980s even the Labor government was all in on supply side reforms.

Yet Keynesian thinking persisted: In academics, who are unconstrained by real world failure of their ideas; and in politicians, who want to claim credit for all positive economic news and have a compulsive need to “do something” to solve every problem real or imagined. They instinctively like the idea they have control over the levers of the economy.

The Global Financial Crisis also shook faith in the current system.

And of course, the left has become increasingly enamoured with big government, and opposed to capitalism and markets, since Hawke and Keating left office.

That Labor is notionally constrained in its spending agenda by the need to occasionally balance the budget undoubtedly contributed to it adopting the unpopular tax increases that lost it the last election.

The left would love nothing more than a conservative government validating deficit spending as legitimate fiscal management. Maybe the left really does believe that increasing Newstart is the answer to slow growth (as Tanya Plibersek claimed), but their goal isn’t economic growth – it’s the spending that really matters.

Frydenberg deserves credit for his courage in standing against this harmful detour to the past. His complete answer to those asking what the government is doing for the economy should be “we are balancing the budget, and we are chasing microeconomic reforms to boost productivity”.

Stimulus isn’t the job of the government.

Simon Cowan is research director at the Centre for Independent Studies.