Cushioning the economy

Like last week's 1 percentage point cut in the Reserve Bank's official cash rate and yesterday's announcement of a $10.4 billion fiscal stimulus package serves to remind Australians and the rest of the world (to the extent that it cares) that Australia has both considerably greater capacity to deploy the traditional instruments of economic policy in order to cushion the adverse economic consequences of the global financial crisis, and the will to do so.

Ideally, the Government should have provided, at least in outline form, some sense of the revisions to the economic outlook which led them to conclude that yesterday’s measures were necessary.

Although forecasting under conditions of such uncertainty as prevail at the moment is more hazardous than usual, and the government will bring forward to mid-November the release of the Mid-Year Economic and Fiscal Outlook (which contains a detailed re-assessment of the Budget-time forecasts), it surely could not have hurt to have provided some indication of the extent to which economic growth may have fallen short of the Budget forecasts, or unemployment may exceed them, with and without the measures announced by the Prime Minister and Treasurer.

Even so, yesterday's package was well-designed for its intended purpose, in three important respects.

First, the largest components of the package - the one-off payments to pensioners, carers and low and middle income households with children - will deliver a significant boost to spending at a time when the economy is most likely to need it. By contrast, though a strong case can be made, in principle, for additional infrastructure spending, it would be difficult to bring it on as quickly.

Second, these groups are far more likely to spend the payments which they will receive in early December than would have the likely recipients of tax cuts costing a similar amount. A large proportion of any tax cuts may well have been saved. And while higher personal saving would be a good thing over the long run, right now is not the best time to be seeking that result.

Third, because all of the major measures are either "one-off" or have a clearly specified expiry date, they avoid committing the government to multi-year expenditures which could be politically difficult to reverse when the economic rationale for them has passed.

Although the trebling of the First Home Owners' Grant for purchasers committing to buy a newly-constructed dwelling during the current financial year will undoubtedly stimulate additional housing activity in the short-term - principally by "pulling forward" demand from 2009-10 - I do have reservations about the wisdom of doubling the grant for first-time purchasers of existing dwellings.

I have long argued that money initially put into the hands of home-buyers ends up in the pockets of home-sellers, and results in higher house prices rather than improved housing affordability.

Unless the government is seriously concerned about the risk that home prices could fall sharply (which would of course be the greatest single favour would-be first-time buyers could ask for, although I think it is unlikely to happen on a wide scale), this component of the government's package is likely to be relatively ineffective in boosting activity, in the housing sector or elsewhere. It would have been preferable instead for the government to have directed the funds absorbed by this component of its package to expanding its National Rental Assistance Scheme (NRAS), which is specifically designed to induce construction of additional low-rental housing.

The decision to accelerate planning of infrastructure programs is also a good one, since they do entail lengthy preparation if they are to be implemented effectively, and if the global economic outlook does deteriorate further, such programs will be an important element of any additional policy response.

The budget surplus will be significantly smaller as a result of the measures announced yesterday, and of the (as yet unquantified) impact of the global financial crisis and falls in commodity prices on revenues from company tax, capital gains tax and taxes on superannuation funds. It is not inconceivable, even without further discretionary policy measures, that the budget could turn into deficit.

But this should be no cause for alarm. The whole purpose of running budget surpluses when the economy is faring well is so that the government can respond, with measures such as those announced yesterday, in the face of a potential economic downturn. It would amount to pointless self-flagellation to insist that the budget be kept in surplus in the face of an international economic downturn such as that which now seems highly probable.

Instead, yesterday's measures should re-enforce confidence that, although Australia is in no sense immune from the effects of the global financial crisis, we are better-placed than most to withstand them.