Working Papers

The Revenge of the Revenue Hoarders

The legislation to implement the government’s promised tax cuts will be introduced to parliament next week, but like a zombie army immune to intelligent argument, the advocates of increased Commonwealth revenue hoarding are not beaten yet:

WAYNE Swan has called an end to the Howard government policy of returning excess budget surpluses as tax cuts, saying the Reserve Bank had been allowed to shoulder too much responsibility for controlling inflation with interest rate rises.

The Treasurer said that under the Rudd Government, any windfall revenue would be allowed to mount up as a larger budget surplus and would be quarantined, either with the Reserve Bank or the Future Fund.

“We will be banking any upward revisions to revenue, if they occur,” he told The Australian.

Mr Swan said the previous government placed too much emphasis on the use of interest rates - or monetary policy - to control inflation, and did not do enough to control the budget with fiscal policy.

“Monetary policy is a blunt instrument and that is why it is really important that fiscal policy plays a bigger role,” he said.

This has things exactly backwards.  It is fiscal policy that is the blunt and unwieldy policy instrument and Australia’s current inflation problem is first and foremost a failure of monetary not fiscal policy.

Increased Commonwealth revenue hoarding also runs counter to Treasury advice, which points to the positive implications for labour supply and potential output of lower taxes.  If the previous government had not cut taxes, labour market constraints would be an even greater threat to inflation and interest rates than they are now.  By contrast, Commonwealth revenue hoarding has no pay-off in augmenting the supply-side of the economy.

posted on 08 February 2008 by skirchner in Economics, Financial Markets

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What surprises me is not that there are economists who are backward enough to imagine that fiscal policy has any effect on prices these days, but that it seems to be the majority opinion (outside of Treasury and, erm, this blog).

Is that really the majority opinion, or is just the Richardson-Eslake-Oliver axis hogging the press?

Posted by benson  on  02/08  at  01:09 PM

Among the retail/sell-side talking heads, it probably is. Unfortunately, the notion that tax cuts are spent and that this leads to inflation is one much better suited to a media grab than the more complex reality that tax cuts are just as likely to be saved as spent and have implications for supply side dynamics. 

I made these arguments as concisely as I could in the AFR:


But who reads the AFR these days?

Posted by skirchner  on  02/08  at  02:24 PM

The small readership of the AFR is due, in part, to its pay-by-view policy.

Anyway, from today’s ‘The Australian’ (free):

Access Economics director Chris Richardson said budget cuts could have a significant effect on the rate of inflation. He said a reduction of government spending equivalent to 1 per cent of GDP would lower interest rates by about 1 percentage point.  ``The trade-off between monetary and fiscal policy is very effective,’’ Mr Richardson said.

Is this right??

Posted by .(JavaScript must be enabled to view this email address)  on  02/08  at  06:33 PM

ED, I think that is patently false.  I report what the empirical literature has to say on this question here:


Posted by skirchner  on  02/09  at  11:41 AM

I find the monetarist argument logically appealing, i.e. that inflation is caused by an increase in the ratio of money to goods & services.  However, when I recently examined RBA data on monetary aggregates, I discovered there are several measures (i.e. M1, M3, currency, broad money).

Is there a ‘standard’ definition of money supply? And if there is, how closely does this track the mainstream measure of inflation, i.e. CPI?

Posted by .(JavaScript must be enabled to view this email address)  on  02/10  at  01:04 AM

Monetary aggregates in themselves don’t have much short-run explanatory power for inflation.  De-trended velocity works better, but really depends on the country and time frame you are talking about.  The other use for monetary aggregates is to take real values and use them to explain real variables. 

As to which aggregate you should use, I use the ones that work, ie have explantory power for other variables.  Unfortunately, Australia’s monetary aggregates have a lot of structural breaks in them, but the growth rates reported by the RBA are adjusted for these breaks.

In any event, inflation is ultimately a function of how much of it the RBA chooses to validate over time.  You don’t need to be a monetarist to hold the central bank accountable for inflation outcomes.

Posted by skirchner  on  02/10  at  01:06 PM

Sure, the RBA is accountable, but nonetheless I find it frustrating that an objective measure of the money supply is apparently unavailable.  If such a measure existed, the RBA’s failings would be more transparent and therefore we would see less of the current blame-shifting going on.

Actually, the blame-shifting is quite serious and potentially damaging to the economy.  For example, there will be a moratorium on future tax cuts.  Also, the banks are likely to be re-regulated, ironically in order to “increase competition”?!?

And there is also the prospect of some kind of regulation of petrol and grocery prices. All in the name of “fighting inflation”.

Again, perhaps I am naive, but if an objective and reliable measure of the money supply existed, some or possibly all of these bad policies might be avoided.

Posted by .(JavaScript must be enabled to view this email address)  on  02/10  at  03:28 PM

“In any event, inflation is ultimately a function of how much of it the RBA chooses to validate over time.”

This is an intriguing comment that I’m sure contains an important truth. Could you please unpack it for me, outlining your reasoning? My monetary economics is quite rusty.

Posted by .(JavaScript must be enabled to view this email address)  on  02/19  at  08:51 AM

Jeremy, if you accept that inflation is “always and everywhere a monetary phenomenon”, then there is no inflation without monetary accommodation.  This is why the RBA should be held accountable for inflation outcomes.

Posted by skirchner  on  02/20  at  03:41 PM

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