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INTERVIEWS
WITH ECONOMISTS
DR
PAUL O’MARA
As Specialist
Adviser: Forecasting in the Domestic Economy Division of Treasury,
Dr Paul O’Mara is responsible for overseeing Treasury’s
domestic macroeconomic forecasts for use in preparing the budget
and macroeconomic policy deliberations. In recent years, he has
also been responsible for Treasury’s analysis and advice
on monetary policy issues and other strategic macroeconomic issues
such as the interaction between fiscal and monetary policy, Australia’s
medium-term growth potential and the macroeconomic effects of
microeconomic reform.
What is
your evaluation of the role of fiscal policy in macroeconomic
stabilisation?
The evidence
points to changes in fiscal policy having some impact on aggregate
demand in the economy in the short term. These changes in aggregate
demand may, in turn, lead to changes in output and employment
in the same direction. But the effect is likely to be less than
one-for-one and will depend on the responsiveness of the supply
side of the economy.
Experience
also indicates that it is very difficult to use ‘discretionary’
or ‘active’ changes in fiscal policy to fine tune levels
of activity and employment in the economy. It takes time to formulate
and implement discretionary changes to fiscal policy settings,
and there are further lags before any such changes in fiscal policy
would start to have an impact on aggregate demand and, ultimately,
output and employment.
In general,
it seems that the best we can do with fiscal policy in a macroeconomic
stabilisation context is to allow the automatic stabilisers to
work. Active or discretionary changes in expenditure and tax rates
should only be considered for stabilisation purposes under circumstances
where there are very clear signs that economic activity is likely
to deviate very markedly from trend.
The current
government has been pursuing a policy of fiscal consolidation
in order to reduce and then eliminate the budget deficit and to
push the budget into surplus. Was the budget deficit so bad?
It may be
appropriate for governments to run temporary deficits under some
circumstances, such as when the economic growth rate falls below
its longer-term trend rate. For example, allowing the automatic
stabilisers to work during such periods, as mentioned in the previous
question, may cause the budget to move into underlying deficit
for a time. But this is quite different to running sustained underlying
deficits on average over a period of several decades. Allowing
such sustained deficits to go unchecked will result in public
debt accumulating, interest payments on that debt imposing an
increasing burden on taxpayers and, eventually, higher interest
rates as investors become concerned about the state of public
sector finances.
The fiscal
consolidation program adopted by the present government has now
largely corrected that problem. The Commonwealth budget returned
to underlying surplus in 1997/98, and is expected to remain in
underlying surplus over the next few years, provided that economic
growth in Australia remains around its longer-term trend rate.
Some economists
believe that the financial and economic crisis in Asia, and the
flow on effects of that to other parts of the world, will cause
a major slowdown in economic growth in Australia. Would this be
a reason for changing the fiscal stance?
The Australian
economy has, in fact, weathered the effects of the international
downturn remarkably well. Economic growth in Australia in 1997/98,
the first year of the international downturn, was a very strong
4.6 per cent. Most public and private sector forecasters expect
growth to remain relatively strong in 1998/99 and 1999/2000, perhaps
dipping a little below the longer term trend growth rate but remaining
well clear of a serious recession. Amongst other things, this
outcome highlights the benefits of the program of microeconomic
and policy reform in Australia over the last decade or more. Product
and labour markets are more flexible, adaptable and competitive
than they used to be. Importantly, the depreciation of the Australian
dollar, in response to market forces, has boosted the competitiveness
of Australian export- and import-competing industries. Unlike
many countries in Asia, the Australian banking and financial system
is very sound and stable, with that soundness and stability being
further enhanced by reforms that emerged from the recent Wallis
Inquiry.
In short,
to the extent that economic growth in Australia falls a little
below trend over the next few years, the automatic stabilisers
can be expected to kick in and do their job. But there would be
obvious dangers in embarking on a major discretionary loosening
of the fiscal stance.
Is public
debt bad? If so, why?
There are
many circumstances where some degree of public sector debt is
quite appropriate and consistent with intertemporal welfare maximisation.
As is the case with business and household debt, we need to look
beyond the absolute level of public sector debt per se and assess
it against a range of relevant benchmarks. These benchmarks might
include the level of public sector debt relative to GDP, public
debt interest relative to the size of the tax base, and public
debt relative to the value of public sector assets. It is also
important to consider whether these various ratios have tended
to go up or down or have been relatively stable over time.
In general,
it is difficult to identify an ‘optimal’ level for any
of these benchmarks and, indeed, any such optimal level may well
change over time as the structure of an economy changes and may
differ between countries. But, broadly speaking, the higher public
debt is relative to GDP and the value of public sector assets,
and the higher public debt interest is relative to the tax base,
the greater the likelihood that international investors will become
concerned about the state of public sector finances and drive
up the rate of return they require on their local investments
to compensate them for what they would perceive as greater riskiness.
Thus, it becomes more costly to raise finance in both the public
and private sectors.
Does the
current government use rules or discretion in pursuing fiscal
policy?
The government
does not operate fiscal policy within the context of very rigid
rules in either the short or medium term. However, it does have
an explicit medium-term fiscal strategy that, while leaving some
room for discretion, imposes a degree of discipline on fiscal
policy. That medium-term fiscal strategy is to achieve underlying
balance on average over the economic cycle. In an operational
sense, the strategy implies the maintenance of an underlying surplus
over the next few years, provided that economic growth remains
solid.
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