It is tempting to think the Australian government’s decision to spend big – bigger than ever before, an unprecedented 33% of GDP this financial year according to the budget update – marks an embrace of Keynesian economics after decades in which Australian authorities have looked the other way.
Keynesian economics – named after its founder, 20th century economist John Maynard Keynes – holds that when private spending is too weak to keep people in jobs the government should ramp up its own spending to fill the gap.
Conversely, when private spending is too strong, and pushing up inflation, the government should rein in its own spending to rein in inflation.
Taxes are the other side of the coin. When private spending is weak the government should cut taxes; when private spending is too strong it should push taxes up.
Other things can help, such as ensuring wages grow quickly enough to boost private demand and ensuring incomes are distributed evenly enough to allow this to happen broadly.
That’s pretty much how Australian governments of all types acted from the end of the World War II up until the mid-1970s, when a surge in the price of oil produced a combination of inflation and unemployment (“stagflation”) that Keynesian economics couldn’t easily explain.
In its place came a new orthodoxy in which governments tried to rely mainly on so-called monetary authorities, such as the Reserve Bank, to stabilise the economy and kept budget deficits low.
The past year’s dramatic switch back – a projected budget deficit of 9.9% of GDP, the biggest since World War II – has led many, including commentator Ross Gittins, to conclude Keynesian economics is back in favour with authorities because (most of the time) it works.
I’m more skeptical. Here’s why.
Not Keynesian yet
The reality is that with interest rates at rock bottom as we went into the coronavirus crisis, there was little the Reserve Bank could do to support the economy by cutting interest rates further.
It could, and did, buy government bonds. But that tends to support asset prices rather than employment. So the authorities have had little choice but to spend to support jobs, notwithstanding their qualms.
They are, however, giving every sign of still being guided by the growth model they’ve been relying on since the mid-1970s.
MYEFO’s unkeynesian underpinning
- ^ 33% (budget.gov.au)
- ^ Keynesian economics (www.investopedia.com)
- ^ demand (www.investopedia.com)
- ^ Memories. In 1961 Labor promised to boost the deficit to fight unemployment. The promise won (theconversation.com)
- ^ stagflation (www.investopedia.com)
- ^ Ross Gittins (www.smh.com.au)
- ^ Keynes: The Return of the Master (web.archive.org)
- ^ Big budget spending isn't new: it's a return to what worked before (theconversation.com)
- ^ three Ps (web.archive.org)
- ^ projections (budget.gov.au)
- ^ unchanged (budget.gov.au)
- ^ official advice (www.rev.com)
- ^ 1980s, 1990s and 2000s (fbe.unimelb.edu.au)
- ^ From here on our recovery will need more than fiscal policy, it'll need redistribution (theconversation.com)
- ^ has been falling (images.theconversation.com)
- ^ it has been doing (ministers.pmc.gov.au)
Authors: Michael Keating, Visiting Fellow, College of Business & Economics, Australian National University