This is "the most inflationary budget since Whitlam". If the economy were expected to fall into a hole, that might be justified, but Treasury predicts only a modest slowing in GDP growth, with inflation under control and the current account improving.
The economy is undoubtedly strong - as the Treasurer was at pains to emphasise. Unemployment is at a 23-year low. Inflation is under control. Annual growth is above the sustainable rate at almost four per cent. The terms of trade are high. Asset prices have been strong, and until recently the Australian dollar was uncomfortably high – the recent drop from US$0.80 to US$0.70 has been welcomed by exporters and many other Australians.
To be sure there are some serious clouds in the world economy - oil is hovering at US $40 per barrel and US interest rates have begun what seems likely to be a steep rise - I suggest far steeper than assumed in Treasury forecasts. And China is trying to slow a run-away boom, and its main tools are old-fashioned controls over lending by banks. Economists know that such controls are a blunt instrument. Most importantly, certainly for the state of confidence in the developed world, the situation in Iraq seems to be going from bad to worse.
However, absent a major negative shock, 2004 and 2005 will see the strongest growth in the world economy for decades. China will continue to boom, the USA is growing strongly, Japan is recovering after 15 years of recession, east Asia is doing well while Euroland muddles along as usual.
In Australia, domestic demand is strong and expected to remain so unless the current modest reduction in house prices in the main cities turns into a rout. Domestic inflation is well above the Reserve bank's target range. Until recently overall inflation was held well below domestic inflation by low prices of imports and the rising currency – now global prices of those items we import are rising and our dollar is falling. If these trends continue, soon inflation will be rising, probably to a point that the Reserve bank will begin to feel distinctly uncomfortable, if that is not already the case.
Domestic inflation above the target range is a warning sign. So too is a current account deficit around six per cent of GDP. Often in the past this has signalled a withdrawal of international capital and the onset of economic crisis. So far this has not occurred, although the fall in the currency shows some loss of appetite for Australian assets by international investors. I am not privy to Treasury forecasts and as a general rule I believe they do the best job that can be done. But two facts about our current account deficit at six per cent of GDP worry me.
Australia’s international debt is very high but global interest rates are very low. Think what happens to Australia’s debt servicing payments as global interest rates rise (and, as noted, this rise may be sharper and occur sooner than generally thought). It is also the case that Australia’s terms of trade are high. Think about the effect on the current account deficit as Australia’s terms of trade deteriorate, as they seem likely to do from here. Rising global interest rates and falling terms of trade will both worsen the current account deficit from a position of substantial weakness.
Against this background, a conservative response would have been to tighten fiscal policy. But there is no doubt that fiscal policy has been eased, and eased substantially. The surplus in the current year (2003/04) was far stronger than generally assumed, and has been reduced by about $4 billion of additional handouts. The surplus for next year (2004/05) has also been reduced substantially and, to quote the Treasurer: “The Budget I am announcing tonight involves huge expenditures of nearly $200 billion.” It also involves some modest tax cuts, nicely judged to help those middle-income earners who have been squeezed most by bracket creep.
I am no politician but it seems to me that this is a great election budget, nicely wedging Labor in a number of issues. It also makes a serious contribution to the questions of balancing work and family concerns that bother many Australians - and it continues the Treasurer’s bold initiative in preparing Australia for the inevitable ageing of its population. So long as the economics holds together all will be well but I am seriously concerned that there is too much stimulus for an already overstretched economy. I hope I am wrong, but if I am even half-way correct the currency will fall further and the Reserve bank will need to pick up the pieces in the traditional way by raising interest rates.
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