Australia: Stimulus 'off the table' in next crisis

Treasury plans for next crisis with Rudd-style stimulus off the agenda

TREASURY has warned that the European crisis is "spiralling out of control" and indicated it expects the government to dump its commitment to a budget surplus if a new crisis sweeps the world.

The Australian,

1 June, 2012

Treasury secretary Martin Parkinson revealed yesterday that his department had been conducting intensive contingency planning for a new crisis since before last Christmas and said the policy response would be very different from that of the Rudd government following the collapse of Lehman Brothers in September 2008.

"Almost certainly we would not deal with the next one the same way we dealt with the last one," Dr Parkinson told the Senate's economics committee yesterday.

Treasury expected that a crisis caused by Greece's insolvency would primarily affect financial markets.

"That can be managed more easily for us because of the health of the banks," Dr Parkinson said.

Financial markets steadied yesterday after a torrid night in Europe where investors dumped Italian and Spanish bonds, pouring money into Germany - where government bond yields fell to zero - and Switzerland, where government bonds went negative. That meant investors were paying the Swiss government to borrow their money.

The Australian market was supported by new business investment figures showing the resources boom was still on track, with spending by mining companies over the next year expected to reach $118 billion, up 47 per cent.

However, the Australian Bureau of Statistics' investment report also highlighted the weakness of business investment elsewhere in the economy.

The challenge facing the non-mining economy was also shown by a sharp fall in the number of new building approvals, with fewer private houses gaining council approval in April than in any month since the GST was introduced in 2001.

Dr Parkinson said Treasury had been intensively planning for what it would do in the event of Europe generating a new crisis.

He qualified Wayne Swan's comment to the National Press Club after the budget that if Australia's economy were to soften, he would cut further to maintain a surplus, saying this would not apply if there were a global crisis.

"We could if necessary go back into deficit to support activity," Dr Parkinson said.

Whereas the Rudd government launched a fiscal stimulus package and banking guarantees within less than a month of the Lehman collapse, Dr Parkinson suggested the different circumstances now would allow a more measured response.

"Were there to be a shock now, the first thing to do would be to rely on monetary policy," he said.

He noted that interest rates had already come down by a full percentage point since late last year.

The government would then allow the deficit to rise. This is known as the "automatic stabilising" support that government provides in a downturn as spending on unemployment benefits rises while the tax the government takes out of the economy falls.

"Would we (then) move to discretionary fiscal policy? That's where a lot of the additional debt has emanated from," he said. "That would depend on the magnitude of the issues."

Dr Parkinson made it clear he still believed in the power of discretionary budget spending, and said Australia had "very extensive capacity to respond". However, he implied that it would be more of a last resort. "Fiscal policy now has a medium-term focus," he said.

In a financial crisis, Dr Parkinson said, it was vital to give people confidence in the financial sector.

"There is a range of things we can do," he said. "Some we could do early and some reluctantly (later). We've mapped out all the instruments available to us and thought about what we might use and when."

Although he did not spell it out, Treasury's reluctance likely relates to the sweeping wholesale and retail banking guarantees that were adopted around the world in the wake of the 2008 crisis.

He said the new financial claims scheme, under which the first $250,000 of all retail bank deposits is guaranteed, would help, as would the fact that Australia's banks had already raised all the money they needed to support lending for a six-month period.

Dr Parkinson noted that Australian banks were so strong foreign investors were asking them to issue more international bonds. Normally banks have to go to investors to sell bonds. He said Australia's financial regulation system had proven equal to the 2008 crisis and had been strengthened since then.

Dr Parkinson said he expected Australia would be helped through a financial crisis by the continuing strength of the Chinese economy.

China would still be affected by a sharp downturn in Europe - its biggest export market - however, Dr Parkinson said, the investment that consumed Australia's raw materials was increasingly devoted to servicing China's domestic market.

The head of the Treasury's macro-economic division, David Gruen, said the recent run of weak Chinese economic reports had not upset budget forecasts that China would achieve growth of 8.25 per cent or more this year and next.

Treasury also believes the recent weakness in commodity prices, with iron ore falling by 10 per cent since the budget, remained consistent with the budget forecasts. However, it is increasingly pessimistic about Europe.

"Financial markets have lost confidence in the ability of the political classes to reach a resolution," Dr Parkinson said.

He was sharply critical of the European Central Bank's low-interest loans to banks, amounting to more than E1 trillion ($1.27 trillion), saying the money had been used by the banks to buy their government's bonds.