Federal budget Australia: Does Anthony Albanese have the courage to balance the budget?

Australians live anxiously under a volcano of economic disruption. We tremble at every rumble.

Are the cost-of-living gods angry? Is the volcano about to erupt again? Are interest rates about to go up again? What about the price of petrol?

Our anxiety is measured in the consumer confidence surveys and expressed in the political polls.

Illustration by Simon Letch

It’s no coincidence that only 6 per cent of Australians expect “good times” in the year ahead at the very moment when despair is leading us to Pauline Hanson’s siren call to self-destruction in record numbers.

The Albanese government, and the states too, offer us baubles and charms which are supposed to appease the volcano gods. They call them “cost-of-living support”.

We accept them, but we all know that they are voodoo. They do nothing to change the pressures building inside the volcano. Worse, we know that the cost of these trinkets goes directly onto the national debt. And that only fuels the problem further.

This week, Australia breathed a sigh of relief when the rate of inflation slackened a little, so interest rates are less likely to go up next month. At the same time, we brace ourselves for the end of the petrol price subsidy this weekend.

Nothing has been solved. Inflation is well above the Reserve Bank target. With every passing week, our money is worth less as inflation eats away at our purchasing power and living standards.

Treasurer Jim Chalmers pointed out the two-part problem. “We already had an inflation challenge in our economy before the war, but the war in the Middle East is making inflation higher than it would otherwise be,” he says.

The federal government can’t do anything about Donald Trump’s Operation Epic Fail and the oil price. But what about the homemade bit, the persistent inflation that was already under way and continues to this day?

The government’s only solution so far is to stay on the hunt for more trinkets to offer us while we cower in fear of the next convulsion. Is there another option?

Ken Henry thinks so. The former Treasury secretary says: “The government has an opportunity to grab this problem by the throat by putting the budget on a more sustainable trajectory that would provide insurance against future volatility.”

Former Treasury secretary Ken Henry says: “The government has an opportunity to grab this problem by the throat.”Alex Ellinghausen

And how would you do that? “Everybody knows the budget should be in surplus right now.” It’s not, of course. It’s exactly the opposite.

Even though Australia’s economy has grown for 134 of the last 136 quarters, shrinking for two during COVID before recovering. Even though unemployment is at near-record lows.

The Treasury projects that the federal budget will be in deficit by $31.5 billion in the current financial year – or the equivalent of 1 per cent of GDP. That goes directly onto the national debt. The Treasury projects that next year’s deficit will be another 1 per cent of GDP equivalent, and another 1 per cent the year after.

In other words, the Australian government is planning to live beyond its means by $97 billion. Is that fair and reasonable?

Henry tells me: “Everybody knows this generation should not be burdening the next generation with a debt burden.”

The Albanese government has been campaigning on the need to repair intergenerational inequity. Ken Henry’s preferred name for this inequity is “intergenerational bastardry”.

“We’ve got very good at intergenerational bastardy. We’re experts at it.” Credit to the Albanese government for trying to address this in the housing market. Henry proposes that the government also address it by eliminating the deficit.

He calls on Albanese and Chalmers to balance the budget. As the Hawke-Keating government did. And the Howard-Costello government did. Henry advised both governments. So he knows it’s hard, but he knows it’s but doable.

Anthony Albanese and Jim Chalmers can emulate the fiscal feats of the Hawke/Keating or Howard/Costello governments. Alex Ellinghausen

And, says Henry, “the government should be taking every opportunity to put downward pressure on inflation”.

How do you do that? The same way; if you balanced the budget in today’s circumstances, you’d be taking $31.5 billion out of government spending. In other words, reducing demand in the economy.

“If you cut the deficit so that you balanced the budget over several years, you would take considerable pressure off the demand contribution to inflation.”

In other words, you don’t try to appease the volcano gods with baubles and charms. You go to the source of the volcanic pressures by cutting back some of the magma building underneath. So the eruptions ease. Instead of dabbing at the symptoms, you attack the cause.

In any case, the government can’t keep paying for more trinkets, Henry says: “At some stage the cost-of-living measures have to stop. Some cost-of-living support is understandable, but clearly it’s not sustainable.

“If the government keeps going with these cost-of-living measures, it means higher interest rates than otherwise.”

Such measures are supposed to help the average wage earner, but, in truth, says Henry, “it’s the average wage earner conspiring with the government to put the burden on the next generation”.

So the logic runs that, by cutting the deficit, the government would be cutting demand in the economy, easing inflation, easing the debt burden and lowering interest rates too.

What’s not to like about this? If you’re the government, plenty. The hard implication is that the federal government can ease inflation by cutting spending. And the government, like all governments, loves spending. It’s why they fight so hard to win the treasury benches. To spend the treasure. And the people and industries which would lose funding or pay more tax would be guaranteed to scream.

Chalmers rejects the connection. He argues that government spending makes no material difference to interest rates.

The Reserve Bank governor, Michele Bullock, isn’t as colourful as Ken Henry, but she sides with him over Chalmers on this vital point.

As she put it in her speech to the charitable Anika Foundation this week: “We assess at the moment that we have demand in excess of supply,” in the economy, “generating that inflationary pressure.”

There are two ways to ease this inflationary pressure, she said: “Interest rates is one way of doing it.” Higher interest rates, that is.

The other way is to manage government budgets, known as fiscal policy: “Decrease aggregate demand, growth in aggregate demand, by using fiscal policy. As I’ve said on many occasions in the past those are matters for the government…

“So I refrain from offering advice on that, but mechanically, [fiscal policy] is part of aggregate demand … What do you spend less on? That’s for governments.”

But how much less would governments need to spend before it made any meaningful difference to interest rates? Chris Richardson, independent economist and fiscal expert, has an answer.

“The models broadly indicate a rough trade-off – if the government takes 1 per cent out of the ability of Australians to spend, you’d have interest rates that are 1 per cent lower.”

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In a neat coincidence, that equates with the size of the federal deficit. One per cent of GDP. “So”, Richardson spells it out, “the rough rule of thumb says that if the government cuts spending by $30 billion, you could lower interest rates by up to 1 percentage point”, with the notorious rider that this applies if all else remains equal.

What does Richardson say to the treasurer’s argument that it would make no difference? “He would say that, wouldn’t he?” Richardson replies archly.

The politics of cutting $30 billion from federal outlays, or, conversely, raising taxes by $30 billion, to balance the budget, would be fraught.

Ken Henry emphasises that it would not be achieved in a single year. “Whether it was Hawke and Keating in the second half of the 1980s or Howard and Costello in the second half of the 1990s and early 2000s, it’s a multi-year process.

“Both had really tough budgets to set it off to change expectations and change the political mood, but both committed to it as a multi-year process.” It would also, he points out, create more room for private sector investment “and help get the supply side of the economy working”.

Is the government capable of such a seismic shift in policy and rhetoric? Albanese has shown a leadership ability to adapt to change and to take risk. There’s also the new element – the challenge from One Nation.

Pauline Hanson has nothing but gimmicks to offer on the cost of living. So why not leave the gimmicks and the trinkets to her? The government has the opportunity to present itself as the responsible party of real solutions and transformative reform in the footsteps of Hawke and Keating.

The volcano will not be appeased by anyone. But a bold government could act systematically to reduce the risks, improve stability, and lift confidence.