The government stimulus might look good now, but the long term consequence will be upward pressure on interest rates, fewer jobs in export industries and higher taxes.
The government just increased your interest rates - not on purpose but as a logical consequence of its policies.
Like Santa on cocaine, the federal government has been handing out money to taxpayers. But unlike Santa, the government doesn’t have an army of elves in the North Pole working without award conditions. So when the government wants to give away money, it first has to take it from somebody.
Taking a dollar from Jack and giving it to Jill doesn’t stimulate the economy. Of course the government can point to Jill, smiling and holding her dollar, and take the credit. But what about Jack?
This is how it works. To pay for its policies, the government is borrowing money from the financial markets. This has two consequences - either there will be less money available for the private sector to borrow, or we have to borrow more from international markets. Or, more likely, both.
When there is less money available for private borrowing, it will lead to upward pressure on interest rates to match the supply and demand for funds. This is one possible reason for the Commonwealth Bank’s recent decision to increase its variable interest rates by 0.1 per cent. The ultimate consequence has been a decrease in business investment over what it would have been. In the March quarter, business investment decreased by 6.1 per cent.
When we increase borrowing from international markets, it is necessary for the currency to appreciate to match financial inflows and outflows. And this is what we have seen, with the Australian dollar rising to US$0.81. The ultimate consequence has been a decrease in net exports over what they otherwise would have been.
This effect is known as “crowding out” - because government spending crowds out the private market.
The only way for fiscal policy (i.e. the stimulus package) to work is when banks increase the amount of credit they are offering. The Keynesian jargon is “the relationship between investment and interest rates is relatively inelastic and, hence, the increase in money demand leads to an increase in the credit multiplier”. The plain English version of this is “the banks will lend more”. But in the current economic environment, this isn’t likely.
Given the situation we are in, fiscal policy cannot increase the size of the economy. All it can do is shift money away from exports and private investment and into consumption and government investment. However, the main long-term driver of economic growth (and employment) is private investment. So not only will the current policies fail in their goal but they are actually damaging and will lead to lower growth in the long run.
There is another possibility - that the stimulus package is entirely impotent. There is a theory that more government borrowing simply leads to more private savings and no extra spending. Economists such as Sinclair Davidson and Stephen Kirchner have pointed out that government hand-outs haven’t led to a significant increase in spending. This means that instead of being damaging, the stimulus package is just irrelevant. Probably both stories are partially true. Either way, it is poor policy.
But it gets worse. Not only is the stimulus package damaging or impotent, but all the government borrowing has to be repaid some day. With interest.
The good news for the government is that it doesn’t personally have to pay the money. The bad news for ordinary people is that we do. While $900 in the bank and a painted school building look good today, paying thousands of dollars in extra tax tomorrow might not be as much fun.
And to rub salt into the wound, the long-term consequence of the stimulus package will be even bigger government. The Commonwealth government has increased its spending from 24 per cent to 29 per cent of GDP, which is the highest in Australian history. Every time the government grows, it weakens the private sector, resulting in higher taxes and lower wages.
Handing out gifts always makes you popular. Nobody hates Santa. But if Santa stole as much as he gave and still left you with a debt, he might not be so popular.
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