Treasury as top economic policy agent and Rudd/Swan political spins

Comments on Paul Kelly “Spun out”, 23/05/2009, http://www.theaustralian.news.com.au/story/0,25197,25523687-12250,00.html

Yes, everything can change and it is possible that Rudd/Swan government may be forced into fiscal discipline that will required any government for the next decade to return the budget into surplus and control the government debt into the supposed low levels in the end. However, most Australians will probably have to wonder whether the current government under Rudd/Swan stewardship will be capable of achieving that. So their records have not given the public any confidence.

The public’s memory will not be very short in terms of their too big cash handouts in the face of recession and ballooning federal government budget deficits. It is also yet to see the economic and budgetary wisdoms of their proposed national broadband network at the currently costs to the tune of $43 billion, a number confirmed by the Finance minister was picked up from the air. It is noted that this is at the time of the government turning a projected budget surplus to huge deficits and an optimistically projected government net debt of $188 billion. They may think they are being heroic and with a vision to build the grandiose infrastructure for Australia and may be puzzled why the public do not see that way. For that they will forever be bewildered.

Treasury may have done its best in sketch a path to surplus. Most people understand its difficulties in doing so. And it should be commended for forcing the government make a commitment to budget restraints, although the public doubt the Rudd/Swan Labour can achieve it based its recent records. However, it appears that Treasury has been in great pain to show the public that its best is good enough.

If the Rudd/Swan government’s cash handouts were problematic in terms of their effectiveness in achieving their policy objective, then one has to wonder what role Treasury has played in those two episodes of fiscal policy dramas, given that Treasury is the government’s top economic advisor, especially on fiscal policies and affairs. Was it also so naïve as Rudd/Swan in believing the effectiveness of the cash handouts? Or was it advised against them? What would have been Treasury’s best alternatives in those times? Remember, it was not just once, it was twice in a row and the second was done after it should have been known that the first was ineffective.

In terms of the often criticised medium term optimistic economic forecast, the Treasury could have done better than that. It should have stick with its traditional forecast methodology and used trend growth rate to underlie the budget trajectory and forced Rudd/Swan to make a commitment of more stringent budget constraints, something like only 1 per cent real growth. That would have been more credible and caused the politicians to think and work harder in future budget considerations. That will force them to act more responsibly in spending taxpayers money and make less policy blunders.

To be a little more academic in questioning Treasury’s macroeconomic modelling for this budget, one has to ask whether and how Treasury had considered Lucas’ famous critique of macroeconomic modelling. To put it simply, the Lucas critique was made more than 30 years ago, and called many macroeconomic modelling back then into question. The critique pointed out that most of the key parameters used or estimated in macroeconomic modelling were variable but not structural, as a result, forecast assuming those parameters as structural was not reliable.

Treasury secretary Henry’s public elaboration of the Treasury modelling during his defence this week did not improve public confidence in the Treasury’s recent forecast modelling. He simply fell into the fallacy that Lucas criticised about more than three decades ago. Given the current global great recession and damages that causes, given the long period of de-leveraging process of financial institutions as evidenced by the Japanese case in the wasted 1990s following the burst its asset market bubbles, given the rising government debts in most industrialised countries and the inevitable trim of government spending in the medium term following the recovery, given the imminent international adjustments surrounding US savings and consumptions, there is every possibility that the world will experience a period of slow growth. That is much more likely than the probable Treasury optimistic forecast. Given all those, why was that reasonable to assume above trend growth for so many years for Australia by simply using the same past parameters to underpin that forecast? Where was the consideration regarding Lucas critique of macroeconomic modelling? Why can the public with any intelligence believe that forecast to make the budget position trajectory look better than otherwise?

The change to more optimistic, or more practical as the government or Treasury call it, forecast for future may or may not have been Treasury’s preferred initiative. But it obvious agreed to and braced it. That does not increase Treasury’s credibility of competence, and possibly independence, given the fact that Treasury, as most public servant agencies, has to serve the government of the day.

The public is not questioning just the integrity of Treasury, but more importantly also its competency following these so obvious fiscal policy blunders. The public is entitled for that. After all it is the public/taxpayers money that pays for the politicians and top public servants to look after their welfares.