MNI INTERVIEW: Fiscal Stance More Restrictive Than Rates-ExRBA

Australian fiscal policy remains contractionary and may do more to increase the country’s unemployment rate and slow the economy over next year than interest rates, which will likely hold circa 4.1%, a former Reserve Bank of Australia board member told MNI.

The government has increased its tax take this fiscal year, shifting the balance between fiscal and monetary policy, said Bob Gregory, emeritus professor at the ANU’s Research School of Social Sciences, who served on the RBA board between 1985-1995. “I think monetary policy’s impact on the economy, especially when the interest rate is so low in real terms, tends to be exaggerated because of the political sensitivity of housing loans,” he noted. “For the overall economy, contractionary fiscal policy is becoming more important and nobody's talking much about that. The RBA meets once a month to discuss monetary policy, which leads to considerable press comment and analysis, but we discuss fiscal policy and taxes less often, and usually only around budget time.”

The Australian Federal Government posted a A$4.2 billion surplus when it released its May budget, though the Department of Finance upgraded that to A$19 billion in July. A boom in commodities prices largely drove the gains. Finance Minister Katy Gallagher said in July the increased surplus would help the government “take some of the heat” out of inflation.

Gregory noted the RBA was focused on inflation, which lagged rate rises, but the central bank should also pay attention to fiscal policy as this will increasingly impact on unemployment next year. “Fiscal policy has tightened quite a lot – [the government] forecasted a large deficit 12-18 months ago and all of a sudden it disappeared,” he noted. “It didn’t disappear because they cut spending. It disappeared because the inflation process has raised tax revenue, along with expansion of the economy and exceptional mining industry profits.”

RBA Governor Philip Lowe has stated during recent senate estimate hearings that May’s budget had a neutral impact on inflation. (See MNI BRIEF: Rates Contractionary, Will Remain High - RBA's Lowe)

UNEMPLOYMENT OVER INFLATION

Recent Australian Bureau of Statistics figures showed unemployment rose to 3.7% over July, 10bp faster than expected (see chart). The RBA has stated it expects unemployment to rise to 4.5% over the next two years as it pulls inflation back to its 2-3% target band (See MNI BRIEF: RBA Targets NAIRU at 4.5% by Mid-2025).

Gregory noted the government likely believed, similarly to the RBA, that unemployment would not rise dramatically next year, so had taken the opportunity to allow taxes to increase. He added the private sector’s large savings buffer built up over the pandemic years was fast depleting, in response to increased post-Covid spending, and this source of stimulus had ceased and will have a significant impact on the slowing of the economy.

The ABS’s National Accounts released in June showed the household savings ratio had fallen to 3.7% over Q2, the lowest level since June 2008.