29 July 2019

Does Australia need a new fiscal authority?

The following article by Paul Bloxham, HSBC’s Chief Economist for Australia, New Zealand and Global Commodities appeared in The Australian Financial Review on 26 July 2019.

An optimal policy outcome requires increased monetary and fiscal policy coordination

One lesson from Australia’s long boom is that an independent central bank has helped to reduce the volatility of the economic cycle. With this in mind, policymakers could consider setting up an independent fiscal authority as the cash rates reaches record lows.

Having cut its cash rate to a record low of 1 per cent recently, the Reserve Bank of Australia (RBA) is rapidly running out of room to provide further support for growth, if it is needed. While the central bank could, arguably, cut its cash rate to 50 basis points, this is probably the lowest the policy rate could go before further cuts would be of little use.

Although the RBA could also consider using unconventional policy tools, such as buying government bonds, that is, “quantitative easing”, this would be entering uncharted territory for the country and the local efficacy of these policy options is untested.

Rather than consider these options, using fiscal policy to support the economy makes a lot more sense. After all, the budget is already back in surplus on a monthly basis, public debt is low and the government has a triple-A sovereign rating from all of the major rating agencies.

Most importantly, the government can currently borrow at the lowest interest rates ever, with the ten-year bond yield falling to a record low of 1.30 per cent recently.

As a result, fiscal policy should now have a much bigger role to play in supporting demand, and managing the cycle, than it has in the past few decades.

To start with, low rates decrease the interest charges the government faces on debt that is rolled over, thereby boosting the budget bottom line.

In addition, low rates should decrease the “hurdle rates” on public investment projects. At very low interest rates it makes sense for the government to consider borrowing more to build useful infrastructure, or invest in education or health, or deliver tax reforms, any of which if done appropriately should deliver a “growth return” of more than the cost of finance. This spending would boost demand as well as supply capacity (productivity growth).

The key point is that very low interest rates have changed the game for policymakers.

The alternative, of forcing the central bank to use unconventional policy tools, such as quantitative easing, at a time when the government is running budget surpluses, would be a truly strange policy mix.

At its extreme, the government could be running surpluses, thereby lowering its debt and issuing less government bonds, at the same time that the RBA was buying a shrinking pool of these bonds to support growth. In colloquial terms, the RBA would be “printing money” for the government to then save.

In short, while very low interest rates are limiting the central bank’s options, they are significantly increasing the fiscal policymaker's options.

To achieve a closer to optimal policy outcome what is clearly needed is increased (and perhaps unprecedented) monetary and fiscal policy coordination.

Helpfully, Australia has shown this sort of coordination in the past. However, to do this, a strong catalyst has generally been needed. For example, during the global financial crisis, in 2008, Australian policymakers delivered a large easing of both monetary and fiscal policy in a short period of time.

Knowing that the central bank’s policy options are becoming more limited, RBA Governor, Phil Lowe, has been actively seeking for the government to deliver greater support for growth using fiscal policy.

Given these coordination challenges, it is worth considering that an institutional change could help.

After all, amongst the many lessons from Australia’s long boom has been that having an independent central bank, within the constraints of an agreed mandate (the 2-3 per cent inflation target), has been a key institutional framework that has helped to reduce the volatility of the economic cycle.

With this in mind, policymakers could consider setting up an independent fiscal authority.

That is, a separate institutional entity, with independence from the political system, akin to the RBA, and a mandate to use countercyclical fiscal spending measures to manage demand. It could do this through an allocated budget that allowed the entity to manage some part of the government’s fiscal spending, constrained by an agreed mandate.

Although there are few examples of such authorities in other countries, this should not constrain Australia from being innovative. One example that may offer lessons could be Chile’s copper stabilisation fund, given the big role that commodities also play in driving Australian government tax revenues.

An alternative is for policymakers to adjust the roles of existing authorities. For example, the Parliamentary Budget Office could be given a stronger mandate to take action, or make recommendations that are more binding. More authority could be ceded to agencies such as the Productivity Commission or Infrastructure Australia, particularly for reform in areas such as transport infrastructure, energy or tax policy.

Although there has been some local discussion of the idea of an independent fiscal authority in the past, it has not got much traction, in part, because the RBA has had such considerable scope to manage the cycle using it cash rate setting. With the RBA running out of room to move, now may be the time for a more serious discussion.