Perils of the new Keynesians

This week’s weak retail figures add momentum to the emerging intellectual consensus: that in order to kick start the sluggish economy, governments must stimulate activity through expansionary fiscal policy financed at ultra-low borrowing costs. The balanced budget fetish belongs to another era, we are told, and governments should loosen the purse strings.

Call it the ‘secular stagnation’ thesis, popularised by former Obama White House economist Larry Summers. In Australia, the school’s leading advocates include former RBA deputy governor Stephen Grenville and former Labor prime minister Paul Keating, while RBA governor Phil Lowe also displays hints of this analysis in his public statements.

However, the policy prescriptions from the new Keynesians — including entrenched public borrowing — are not convincing.

Loosening the purse strings would almost certainly lead to wasteful spending, more cost over-runs in infrastructure projects, and a bigger tax burden down the track as government inevitably is forced once again to pull in its horns.

To the extent that government can stimulate growth, it’s through structural reforms that improve the investment climate: Cut red tape. Reduce workplace regulation. Fast-track tax cuts. Fix the state-based payroll taxes and stamp duties on property that stifle labour mobility. Make the 30 per cent company tax rate more internationally competitive. Break the construction union’s monopoly power. Restore monetary policy to its appropriate role of maintaining price stability. And if governments indulge in more infrastructure spending, ensure it is money better targeted: for instance, more user-charging on the roads.

With the right policies, an investment boom will drive productivity gains and job creation that will flow to higher wages and lift consumer spending. Government pump priming and more deficits and debt will not deliver secular growth. As Gary Banks, a senior fellow at CIS and former Productivity Commission head, argues, only structural supply-side reform can unleash what Keynes called animal spirits and give our long bull run a second wind.

This is an edited extract from an opinion published in the Australian Financial Review as Keating finds his inner Keynes