Why Australia moved too quickly on the stimulus

The Australian stimulus bill is mostly a mistake. Firstly, it is (as yet) an unnecessary measure for our economy, as there is still adequate control through monetary policy. Furthermore, the stimulus of a direct hand-out is an ineffective method of boosting the economy compared to other options. These errors are slightly mitigated by the international political benefit of the stimulus.

The stimulus is unnecessary at this stage because Australia can still actively change monetary policy. Our central bank interest rates are as of writing at 3.25%, leaving a lot of room to adjust them downward without hitting the 0% boundary. Because we still have access to this simple and effective tool for economic adjustment, we don’t need to rely on a fiscal policy of government stimulus.

This is unlike the situation in the United States and Europe. There, a fiscal stimulus is justified as an economic measure, due to the lack of ability to strongly affect monetary policy. Currently both the US and the EU have central bank rates so close to zero as to effectively allow no possibility of stimulus by a downward adjustment of interest rates.

Lack of control over interest rates is why the US has tried unconventional expansionary monetary policies, such as the direct purchase of corporate debt by the Fed. Unfortunately, this has had less effect than Ben Bernanke might have hoped, leaving little ability to increase the supply of money. For these reasons, a large stimulus bill can legitimately be justified in the US (and EU countries) as the only way to significantly boost demand.

Within Australia, as noted, we don’t have the same constraints on our policy. The Australian Reserve Bank prudently adjusted rates upwards during the boom years. This has allowed sufficient room for adjustment for the current crisis, preventing the need for unconventional stimulus methods.

The error of implementing a stimulus now is emphasised by the nature of the decline in the Australian economy. We haven’t yet had a significant collapse in our domestic demand. Instead, the majority of decline has been due to the collapse of the international commodity markets, affecting our mining and resources sector. This has lead to loss of jobs in mining and associated consulting work, but we haven’t seen a decline in employment of the order experienced overseas. While this may yet feed back into the rest of our economy, causing more job losses, it isn’t yet justification for unconventional policies.

The sole advantage provided by the current government’s stimulus bill is the effect internationally. When other countries implement stimulus policies, we implicitly benefit from their spending, due to a boost in demand for our exports. Because the current financial crisis truly is global in scope, and is likely to be offset by stimulus in many countries, we can work with our international partners towards a global stimulus. While this may not be necessary on a domestic level, the political benefits may justify this.

However, the approach to stimulating the economy through direct hand-outs is an ineffective one (and a shamelessly populist move), as some will always be spent paying off debt instead of boosting demand and supplying jobs. If and when stimulus is really necessary, a better method than cash hand-outs would be well-planned government projects in infrastructure, health, and education. These options would do better at providing jobs and boosting long-term economic growth.

This is even more important if the global downturn is sustained for a number of years, as appears to be predicted by many prominent economists. Then, the money wasted on the current stimulus would have been better aimed at providing meaningful employment for those who lost their jobs in the resources, construction, and finance sectors.

The government hasn’t properly explored the options available. For example, an increase in funding for technical retraining and professional education would have fed back equally into the economy, but would have sped up the rate at which those who have lost their jobs to retrain in skills that are in demand.

The current stimulus bill has too many risks currently to be justified. It risks being unnecessary spending for the Australian economy when we have other economic policies available. It may prove to be an ineffective way to boost demand due to the nature of the stimulus. And as with all large increases in deficit spending, there is increased reliance on the good perception of our economy by international investors, a particular concern in times of such volatility. Finally the rush to pass a stimulus now runs the risk that when this poorly-planned piece of legislation proves ineffective, it removes this policy tool from our options in the future, when it could be truly necessary.