Keynesian fallacy an economic threat

The fiscal response to the Covid-19 pandemic leaves an economically threatening legacy of high budget deficits and public debt.

Australian governments should take action to reduce the burden the stimulus measures have placed on the future economy and taxpayers.

Unlike emergency monetary responses to increase liquidity and loosen credit availability, panic government spending binges — particularly of the cash splash and welfare support kind — cannot be readily withdrawn once announced, and have lasting negative macroeconomic consequences.

The idea that copious government spending necessarily mitigates the macroeconomic impact of a crisis is a Keynesian fallacy.

Suddenly injecting government spending is not akin to injecting liquidity and bank credit via emergency monetary easing, because government spending has to be funded from elsewhere; in Australia’s case, mostly from abroad.

Announcing bonus cash payments and bolstering welfare payments under crisis conditions with public debt already escalating rapidly due to revenue loss is not unlike a household deciding to spend more each week at pricey restaurants while under pressure to meet the mortgage payments.

The size of Australian government pre-pandemic was already above its optimal level. Hence, cutting government spending should take precedence over raising taxes as the priority fiscal repair option.

Reduced public spending — particularly on industry assistance and the overlap in spending at federal state levels — should therefore be central to the recovery program.

This should be accompanied by tax reform (including to internationally competitive company tax rates) as well as business deregulation and industrial relations reform.

Another budget option for reducing the level of public debt is greater privatisation of federal government assets, including its sizeable land and property holdings, but this is not an ongoing solution. “Though once-only sales proceeds could be used to pay down public debt, this option would not provide a lasting solution to the structural budget deficit problem.

Australian governments should therefore focus on reversing the increased size of government over the past decade by reducing spending, while also reducing business regulation and company tax, as well as undertaking industrial relations reform to boost the supply side.

Tony Makin is professor of economics at Griffith University and author of the CIS paper, A Fiscal Vaccine for Covid-19