Don’t fret the debt

I’m one of 21 authors (signatories?) of a Nicholas Gruen-instigated opinion piece in today’s AFR, arguing that modest levels of government debt are a perfectly appropriate response to a major downturn. Full text over the fold.

Debt for Development Makes Sense say 21 Prominent Australian Economists

Australian Financial Review, 3 June 2009 

In Paul Krugman’s words, right now, “knowledge is our only defence against catastrophe”. A natural reaction would be to retreat into timidity. But that would repeat mistakes that exacerbated the Great Depression by giving in to our fears and phobias. IMF Chief Economist Olivier Blanchard has a similarly blunt message. “Above all, adopt clear policies and act decisively. Do too much rather than too little.”

Of course other things being equal it’s better for governments to be debt free. But as any homebuyer knows, debt can help us build assets now that we couldn’t otherwise afford, and repay the costs when the assets bear fruit. Australia entered this crisis relatively well placed to weather the storm. In addition to the recent mineral boom, for twenty five years Australian governments have consistently stressed fiscal responsibility and taken large political risks doing what they thought right for Australia, for instance with tax reform and fiscal austerity during the mid 1980s and again in the mid to late 1990s.

Many developed countries were already running cash deficits and had substantial public debt before the financial crisis. However all of them have accepted one lesson of the Great Depression – that during a downturn we should let the ‘automatic stabilisers’ work by loosening budgets temporarily as revenue falls and outlays on welfare relief increase.

Given Australia’s relatively stronger balance sheet, it’s been in a better position to engineer additional discretionary fiscal stimulus than most comparable countries. Cash handouts of nearly two percent of GDP are being paid to middle and lower income Australians. There is no more effective way to stimulate the economy quickly. The success of this measure can be seen in the relative strength of Australian retail sales compared with almost any of our peers. In addition the Government plans to spend many billions more on infrastructure.

All this has converted a sizable expected cash surplus next financial year into a deficit of nearly 5 percent of GDP. This compares with the average of our peers of nearly 9 percent. On current Treasury projections, which seem as plausible as any (though like all such forecasts, they are only ‘best guesses’), net debt will stay below 14 percent of GDP compared with an average of over five times this in comparable countries which nevertheless retain their creditworthiness in capital markets. Ultimately if other countries run weaker balance sheets than us, that’s no reason to relax our own standards. But the comparison does provide some context. It illustrates that even after the stimulus, we remain within a very healthy margin of safety in our Government’s reputation for economic prudence.

None of this is to suggest that Australia should rest on its laurels. There’s a fair chance (but no more than that) that our economy will recover strongly within two years. But just as we don’t know today how far or fast interest rates should be increased then, we don’t know today precisely how fast we should be returning towards budget surplus then. So these debates need to go on and there will come a time when we need to change direction, from supporting economic growth to restraining it, perhaps with great vigour. But that time is certainly not now.

Further, as Australia’s population and infrastructure needs grow, Australians must decide whether they prefer a balance sheet more suited to genteel decline or one that supports investment, dynamism and growth. In addition to building genuinely valuable assets in R&D and carbon abatement, our education, health and transport systems and housing stock, the stimulus will, in Treasury’s words keep up to 210,000 Australians in work who would otherwise be out of jobs. Major infrastructure projects should also pass independent and transparent benefit/cost assessment.

Deploying our strong balance sheet to use otherwise idle resources – or to put it more compellingly, deserted factories and unemployed workers – to build assets that improve our lives and our economy in the future, seems much more appealing; much more commonsensical than retreating into phobias.

Fred Argy, Former Head of EPAC.

Paul Binsted, Company Director and Economist

Tony Cole, Former Secretary to the Treasury

Max Corden, Emeritus Professor, Johns Hopkins University

Owen Covick, Associate Professor, Flinders University

Steve Dowrick, Professor of Economics, ANU

Saul Eslake, Chief Economist, ANZ Bank

John Foster, Professor of Economics, University of Queensland

Bernie Fraser, Former Governor of the Reserve Bank of Australia and Secretary to the Treasury

John Freebairn, Professor of Economics, University of Melbourne

Joshua Gans, Professor of Economics, Melbourne University

Paul J. Gollan, Associate Professor, Macquarie University

Roy Green, Professor, Dean, Faculty of Business, University of Technology, Sydney

Stephen Grenville, Former Deputy Governor, Reserve Bank of Australia

Nicholas Gruen, CEO, Lateral Economics

Tony Harris, Former Auditor General of NSW

Stephen Koukoulas, Global Strategist, TD Securities

Andrew Leigh, Professor of Economics, ANU

John Quiggin, Professor and ARC Federation Fellow, University of Qld

Mike Waller, Former Chief Economist, BHP Billiton

Glenn Withers, Adjunct Professor, Australian National University

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12 Responses to Don’t fret the debt

  1. Mitch says:

    Somehow don’t think mortgage debt makes the best analogy given recent events in that area.

    That said, I agree with you that the proposed level of debt isn’t uncalled in the current economic climate. However, Labor is proposing that we’ll be out of debt by I think it was 2022.

    Since it’s quite likely that we’ll have another downturn between the end of this one and then, I think the issue of Labor’s ability to pay off the debt becomes the issue rather than the debt itself. This is where the Liberals seem to be coming from.

    The logical answer, if the best Labor can do is cap real spending at 2% pa, seems to be the compromise of still running up debt to smooth out this downturn, just not as much. Instead I think they’ve basically shot themselves in the foot in a political sense. Now we get all these jobs and infrastructure; in the future we get higher taxes, more inflation and lower productivity.

  2. AndrewN says:

    Nice work Andrew. I have never understood why most people are entirely comfortable borrowing to buy their house (and comfortable for companies to borrow for investments), but can’t stand Government borrowing for the same reason.

    Andrew: is anyone proposing an independent ‘asset/investment’ Cost/Benefit Analysis unit? Does something like it already exist?

    Mitch, I don’t understand. Wouldn’t we get higher inflation now (and potentially lower in the future)? Why do we have lower productivity in the future? I would have thought the infrastructure would lead to higher future productivity. It’s not like the bridge or school won’t last past 2022.

  3. Thinking In Old Ways says:

    A good statement except for “or to put it more compellingly, deserted factories and unemployed workers”.

    Why resort to the ‘deserted factory’ cliche – which does nothing other than open the door for populist protectionism?

    Manufacturing accounts for just 9.4% of jobs in Australia – and 14.4% of male full-time employment. (Although I do accept it has been hit a bit more strongly than some other sectors over the past year).

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  5. Pat K says:

    Did you explain in your letter that you’re conflicted having accepted a political appointment with the present government?

  6. C.L. says:

    Didn’t the AFR report recently that Nick Gruen has been the recipient of nearly $300,000 in consultation fees from the government? If so, couldn’t this letter be seen as something less than disinterested? As something resembling, indeed, an opinion stimulus package? And isn’t it especially laughable that John Quiggin should add his name to this list? Professor Quiggin, after all, has been known to dismiss and ridicule “global warming” sceptics for comparably objectivity-compromising financial linkages. If Big Tobacco’s cash renders one man’s reputation null and void, how does Big Kev’s bolster another’s?

  7. Mitch says:

    “Mitch, I don’t understand. Wouldn’t we get higher inflation now (and potentially lower in the future)? Why do we have lower productivity in the future?”

    Not sure of your reasoning on inflation, but productivity requires spending to be well thought out (actual competition is handy too), not simply more stuff: infrastructure or otherwise. Spending and jobs on the part of the government means less from the private sector.

    On that note, I think we will see increased productivity in the statistics to come, since it’s measured as an aggregate. Since most of the workers who lose their jobs will be entry level, and therefore less productive, on that alone aggregate productivity will increase.

  8. donna says:

    A person only takes on debt when there are clear price signals and data. Price signals help a person establish a decision regarding demand and supply of goods and services, require by consumers, within an economy. Central banks set the price of money by “open market operations” manipulating the quantity of money and hence interest rates and/or inflating the money supply” quantitative easing. Firstly, does a Central Bank Policy tools interfere with the natural price signals, leading people into making decisions that are not viable? Secondly, John Williams of Shadow States in the United States, shadows the government statistics, which leaves questions. How data is measured, can lead to a conflict of interest; is the new measurement assisting Politian’s enabling political advantage; or the people so they are able to make informed decisions? Please watch fuzzy numbers which shows the history of the CPI measurement in the U.S.A. and how these measurement changes assist the government of the day. Wake up Western World!

  9. Lincoln Fung says:


    With due respect, I think that letter is full of nonsense. I sent part one of my comments on that letter to AFR, though the letter facility, but I don’t know if they will publish that. I have posted in a blob as:

    I am preparing part two of my comments on that letter which will focus on more specific points of that letter. I will advise you when it is finished.

    I think that letter has problems with simple logic. It is confusing at the best and deeply misleading at the others. The first part of my comments deals with the letter’s quote of Krugman and Blanchard. To quote from famous economist to start off the letter is weak at the best and to use them as supports for own illogical arguments is laughable. You and other can have a look how those quotes are problematic, from part one of my comments.

    I provide the following brief comment, to give you a flavour why that letter is wrong. The main point is that the letter misses the point of the current debate on the government debt. The main issue is not about whether it is necessary to have a debt, but what level of it. Related to it is whether every government fiscal measure is necessary and effective in stimulating the economy and cost effective.

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  11. David says:

    I am deeply disturbed at the level of basic economics that is understood by most professional economists and academics. The nobel prize awarded to Paul Krugman illustrates that one can be considered an eminent economist in western counties, without having an understanding of basic economic principles.

    The fact is that wealth is generated through SAVINGS and INVESTMENT, not borrowing for consumption and spending. Without savings there can be no capital. Borrowing for consumption, especially on products produced overseas destroys wealth. There is no way around this.

    Many Western countries are going to face a major economic depression while people such as this have the ears of governments. Australia’s economic problems are not as bad as that of the United States, yet this does not mean that we should be following their mistakes.

    The United States is going to face a hyper-inflationary depression once China and Asian countries pull the pin on their buying of US treasuries and the US has no option other than to print money to finance their deficits. Is the the type of economy that we wish to emulate?

  12. Sukrit says:

    John Quggin, Andrew Leigh, and most of the people on this list are on the government payroll. I don’t blame them necessarily, since the academic profession in Australia is basically state run and regulated. So they can’t help being parasites and having a conflict of interest here.

    But of course, they could at the least call for dismantling the current university system where everyone lives off the public teat.

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