Fiscal policy must belatedly step up to join the inflation fight

Young parents with children in daycare, overflowing supermarket trolleys and lost hopes of being mortgage-free before their toddlers turn into twenty-somethings are rightly miffed when they hear about the ‘bluntness’ of monetary policy.

They understand that interest rates couldn’t stay low forever. Inflation is too high. But it’s difficult for them to digest higher and higher mortgage repayments, while policy makers are failing to collectively defend them from yet another blunt whack. Equally, business can’t afford higher rates and tighter financial conditions.

Australia’s treasurers could do more to co-pilot with the Reserve Bank to navigate the very narrow soft landing and reduce the need for further interest rate hikes. Fiscal balances are powerful, and Jim Chalmers, NSW’s Daniel Mookhey, Victoria’s Tim Pallas and all our state treasurers should be right there in the cockpit with Reserve Bank Governor Michele Bullock.

On Wednesday, the Commonwealth will show additional revenue from the higher taxes paid by companies and individuals will equate to a lower deficit projection for 2023-24 than the -$13.9 billion it expected in May. Our hope is that they will bank the windfall from individuals and companies that have paid higher tax (as tempting as it may be to offer more support to struggling households).

To give credit where it’s due, there are some recent examples of good policy where both cost of living and inflation are equally assisted.

Ratcheting up the Commonwealth Child Care Subsidy has given some households help meeting day to day expenses, while also removing barriers to work for parents – increasing the productive capacity of the economy.

The migration policy announced on Tuesday will lower the flow of new migrants entering the country because they are not filling our genuine workforce needs, and instead increase our high-skilled labour force. In time, this policy will help control the demand for housing, and might also trim rental inflation (at least relative to where it might have been).

But there are still too many examples of Commonwealth and state governments not thinking enough about the economy’s ability to absorb their policies inflation-free.

Earlier this year, the Western Australian Government gave vulnerable households $500 of electricity bill relief. All other households were given $400 of bill relief. In other words, there was very little means testing of that benefit. WA state final demand grew by a whopping 2.4 per cent, and Perth CPI by 5.8 per cent in the year to the September quarter. So, it’s fair to ask whether that subsidy was appropriate for all households at this point in the cycle.

Last week, there was an extension of the complex, state-federal trade-offs to solve the short-term problems of NDIS funding. Updated figures in this week’s MYEFO and upcoming mid-year State budget updates will detail the figures, but it appears to just add dollars – not productive capacity to the economy.

And then there’s the bigger issue of infrastructure spending.

State governments may be projecting smaller operating deficits, and some even surpluses, which suggests fiscal rectitude. This is a common defence against their policy mix being inflationary. But these don’t capture all capital expenditure by governments, or their business enterprises, that are placing demand on our limited resources.

States have a total combined asset investment program of over $350 billion over the next four years – which is a record high. In 2023-24 alone, infrastructure investment for the Commonwealth and state governments is expected to total just under $120 billion.

Updated figures in this week’s MYEFO and upcoming mid-year State budget updates will detail how recent Commonwealth funding cuts will impact this infrastructure spend. But we expect the change will be barely noticeable. And some states have indicated that they will step in with the extra dollars where the Commonwealth has taken them away.

A dollar spent by a state government is as inflationary for the economy as a dollar spent by the Commonwealth, or a government business enterprise. Commonwealth and state spending is so interlinked that one cannot be judged in isolation from the others.

On this measure, we know that governments are collectively pouring a lot into the economy, including huge projects like Brisbane’s Cross River Rail, Western Sydney Airport and Melbourne’s Suburban Rail Loop.

According to the September quarter National Accounts, public sector investment was 5.5 per cent of GDP (the highest since post-GFC spending). Adding on public sector consumption takes that spend to over 27 per cent of GDP. That is the highest in the 65-year history of the National Accounts data, even though several parts of government have been privatised over that time.

The economy is struggling to absorb all of this activity because companies and workers are asking for higher and higher prices for their inputs and labour. The highest bidder wins, and so budgets are – collectively – still adding to inflation.

Tougher and tighter budget decisions are essential to landing inflation right now.

Budgets that focus on building productive capacity across the economy would keep us on the right track for years to come.

In the Australian print media, in the first 11 months of this year, monetary policy was mentioned six times more than fiscal policy. Our focus on monetary policy seems misplaced. There are also a broad range of targeted levers that all treasurers can pull relative to central bankers. And while that cockpit may be crowded, Governor Bullock would surely welcome a bit of help up there.