<- Back

 Steadying us for the next wave

by Clement Lee | 14-Dec-2009 | Comments (1) Tags: debt, deficit, stimulus, macroeconomic policy  7 ratings. Please log in to rate and comment

As the first waves of the economic tsunami that is the Global Financial Crisis (GFC) crashed onto Australia’s shores over a year ago, there was bipartisan agreement on the need for a stimulus package to keep the Australian economy afloat.

However, a bitter argument over debt and deficit quickly developed as the government and the Opposition disagreed on the details of the stimulus. Was the stimulus package too large? Did the country take on too much debt? Should the stimulus take the form of a tax cut or a handout? Are we saddling our ‘children’ with an excessive debt burden?

In reality, we didn’t really have much of a choice on the issue of taking on debt. We could either choose to take on and have ‘our children’ live in the present in relative prosperity, or choose to leave ‘our children’ debt free, but have them grow up in poverty. The fact that both sides agreed on the need for stimulus demonstrated which was the better or ‘least worst’ option.

However, there are legitimate questions about the future effect of public debt. There is indeed the possibility that excessive government debt could choke off growth during the recovery for a number of reasons. These range from ‘crowding out’ private sector activity, to creating inflationary pressure, and to interest repayments that place an excessive drain on the nation’s resources which would divert funds away from growth supporting public investment projects.

However, these foreseeable future problems do not change the necessity of using discretionary fiscal policy to stimulate the economy during a sharp economic downturn in the short run. How then, can we reconcile our need to keep the economy going during a downturn without choking off the recovery with an overly large public debt burden?

Part of the answer may lie in establishing a ‘Stabilisation Fund’ that could provide macroeconomic stabilisation by pumping some life into the economy during downturns and taking some heat out of the economy during boom times.

Of course, an obvious question that springs to mind now is this: how is the Stabilisation Fund any different from what governments are expected to do anyway? Don’t governments already put aside funds from surpluses during the boom times? Aren’t there automatic stabilisers in the economy through the taxation and welfare systems that tend to generate surpluses during booms and create deficits during downturns?

The answer is yes to all of the above. The Stabilisation Fund would be similar to existing funds such as those managed by the Future Fund Board of Guardians in that they will be initially financed by government surpluses and windfall gains, such as royalties from the resources boom, or from the sale of government assets. However, unlike the existing funds managed by the Future Fund Board, which are designed for specific, longer term purposes such as public sector superannuation, and infrastructure investment, the Stabilisation Fund would be used for short run counter-cyclical macroeconomic stabilisation purposes. In other words, it would be used to finance stimulus packages during a major economic down turn.

Also, governments enjoying windfall gains from booms often have difficulty in resisting the temptation to squander surpluses in order to curry favour with the electorate through pork barrelling, overly generous cash handouts, and tax cuts. Not only does this misuse of surpluses reduce the ability of the government to deal with future downturns, but it also generates inflationary pressures in the economy during a boom by encouraging increased demand for goods and services in the economy. However, it is all too easy for the incumbent government, especially one that is fading in popularity, to consider the problems of having to deal with the next downturn as a problem for tomorrow, or better yet, for the next government. Indeed the former Howard Government has often been accused by its detractors of having squandered the resources boom of the past decade. The Stabilisation Fund that is set up with legislation mandating the depositing of a proportion of a surplus to the Fund would solve this problem by preventing such misuse of surpluses by the government of the day.

Other countries such as Norway, Russia and the United States all have stabilisation funds to meet different economic objectives. The Stabilisation Fund proposed here will simply apply this concept to achieving another economic policy goal.

During a boom, deposits to the Stabilisation Fund will reduce inflationary pressures by removing excessive spending power from the economy and complements the efforts of the Reserve Bank to rein in inflation through interest rates. During a down turn, the funds from a macroeconomic stabilisation fund can be used to stimulate the economy with a reduced or even possibly without government debt. The government would be able to finance deficit spending by drawing on the Stabilisation Fund first, allowing the government to conduct counter-cyclical fiscal policy without, or at least with a reduced debt burden. A fiscal policy instrument like a Stabilisation Fund is an additional tool in Australia’s macroeconomic policy armoury.

To prevent governments from misusing the Stabilisation Fund as a slush fund for pork barrelling, the Fund can be placed under the control of an independent board such as the Future Fund Board of Guardians, which already oversees four federal government funds, or perhaps a separate board. An independent board will also be given the responsibility of deciding whether or not the economy is experiencing a downturn of a scale that justifies the use of the Stabilisation Fund. The Fund can only be accessed by the government to finance deficit spending only with the board’s consent.

A Stabilisation Fund allows governments to engage in deficit spending to stimulate the economy during an economic downturn without creating a large debt burden on the economy. It also removes some heat from a booming economy by reducing inflationary pressures. A Stabilisation Fund would be an additional stabiliser in our economy that will prepare us for the next economic wave that crashes into Australia on the stormy seas of the global economy.

Things to Do

 More Entries

 17 ratings.

 8 ratings.

 16 ratings.