IAN McAULEY. Reclaiming the ideas of economics: Debt and deficits

An obsession with “balanced budgets”, promoted by successive Coalition governments, is having serious economic consequences.

The Coalition owes much of its electoral success to a public belief in its capacity to manage the economy, even though its record in economic management speaks otherwise. In its terms in office it has neglected structural reform – in some cases reversing economic reforms. This neglect is manifest in stagnant and declining real incomes, widening inequality in wealth, weakening labour productivity, high household debt and unaffordable housing.

The Coalition has deliberately nurtured the myth of its competence by a focus on one aspect of economic management – the deficit or surplus in the Commonwealth budget. As Paul Keating says the Liberal Party has a “surplus virus” in its bloodstream.

The political appeal of the budget outcome lies in its simplicity. It’s the government equivalent of our own domestic bank accounts. We also know of instances where hyperinflation has resulted from fiscal recklessness by desperate or populist governments – the US Confederacy, the Weimar Republic, Zimbabwe, Venezuela.

But even within the conservative traditions of mainstream economics, there is nothing “bad” about a budget deficit, and nothing “good” about a budget surplus. To continue with the domestic analogy, most of us have gone into debt at some stage to buy a house. And we would surely not judge someone to be a good economic manager if they had accumulated a big surplus in their bank account while neglecting to spend to fix the brakes in their car or skimping on spending on food.

So too with government; running its bank account – fiscal management – is one small, but over-emphasised, aspect of economic management.

One of the basic responsibilities of government is to stabilise the economy – to counter the swings of the business cycle. If the economy is in a downturn with rising unemployment the government steps in with a stimulus; if it’s overheating with high inflation and shortages, the government should step back.

That’s how governments, Coalition and Labor, have been managing economic stabilisation for the last fifty years (and longer), as shown in the graph below.  The red line shows outlays, the blue line shows receipts (mainly taxation), and the deficit or surplus is the difference between the lines.

Unsurprisingly it shows that governments, in line with orthodox theory, have engaged in stimulus spending following economic shocks. The Whitlam Labor Government had the bad luck of holding office just when the fixed exchange rate mechanisms of the Bretton Woods order fell apart and as the first oil crisis sent shockwaves through the world economy: it would have been grossly irresponsible for it not to have run a deficit in response. In 1983 it was the Coalition’s turn for bad luck, for the “Volker shock” occurred on their watch when the US Federal Reserve raised interest rates from 11 per cent to 21 per cent.

In 2007, after barely a year in office, the Rudd Government had to deal with the GFC. As the graph shows there was a sharp drop in revenue, and thanks to quick and decisive action, a sharp rise in spending. Some economists criticise the Rudd-Gillard Government for not having withdrawn its stimulus sooner, but whatever they did, there would be a run of deficits during their time in office allowing the Coalition to associate Labor with deficits. It was easier and more politically convenient to demonise Labor than to explain the mechanisms of conventional Keynesian counter-cyclical management.

The Coalition’s claim to economic responsibility was helped by its run of surpluses during the 13 long years of the Howard Government, a government that enjoyed the benefits of a huge gain in revenue resulting from the Hawke-Keating reforms (notice the sharp rise in the blue revenue line) and a surge in commodity prices.

The consequences of the deficit obsession go well beyond its use in the Coalition’s anti-Labor armoury. It has also meant that while public sector debt has been kept in check, private sector debt, particularly household debt, has accumulated. The graph below shows how household debt has risen over the last thirty years: Australians held back for a couple of years following the GFC, but as wages stagnated and as households had to dig into their own finances to compensate for cuts in government expenditure, household debt climbed once more, and is now being encouraged by low interest rates and by the government spruiking the real-estate market.

In short, as a result of the obsession to balance the books, debt has been privatised. Through their taxation and spending powers governments have more capacity to absorb shock than households – that’s what Keynesian stabilisation is all about, but for the sake of impression management that debt has been shifted off the government books and on to those with least capacity and competence to deal with it.

The government debt obsession has even wider consequences. Trapped by its own rhetoric and a promise to bring the budget back into surplus, the present Coalition Government is politically unable to engage in fiscal expansion, even as the economy is showing signs of hard times ahead.

It is also trapped by accounting standards that apply in our federation, because any capital grants the Commonwealth makes to the states for capital purposes – a new road or rail line, even a new dam for the National Party – shows up as an expense on the Commonwealth’s books, rather than as a capital expenditure to be offset on the balance sheet. That’s one reason our infrastructure is not keeping up with our population growth. A firm enjoying assured growth would borrow to finance new and replacement assets, particularly when interest rates are low. But successive Coalition governments have chosen to talk only about cash budgets (with only minor accrual adjustments), rather about public balance sheets.

A mature public discussion on government finances would be in the context of the wider economy. It would be about stabilisation policy. It would be about all debt, not just federal government debt but also state government and private sector debt. It would be about the use of debt: is it being used to fund productive public assets? It would be about opportunities for public investment, particularly at times such as the present when corporations are holding back and governments have the opportunity to borrow at historically low rates.

(As an endnote I acknowledge that I have not mentioned the theory of Modern Monetary Theory, a point raised by many readers of this series in Pearls and Irritations. I have deliberately stuck to economic orthodoxy, although I know that the orthodox model is not quite coping. There is nothing in MMT that contradicts the basic prescriptions of traditional Keynesian economics, however. If anything it strengthens them.)


This is the eighth of a series of articles in Pearls and Irritations  on reclaiming the ideas of economics. Others so far have been:

General introduction (September 19)

Aspiration (September 26)

Jobs and Growth (October 3)

Society, economy and the environment (October 10)

Regulation and deregulation (October 17)

Taxes (October 24)

Globalisation (October 31)


Ian McAuley  is a retired lecturer in public finance at the University of Canberra and a Fellow of the Centre for Policy development


Ian McAuley is a retired lecturer in public finance at the University of Canberra and a Fellow of the Centre for Policy Development.

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6 Responses to IAN McAULEY. Reclaiming the ideas of economics: Debt and deficits

  1. Avatar Colin Cook says:

    ‘Through their taxation and spending powers governments have more capacity to absorb shock than households.’
    This is a wonderful understatement and together with the earlier statement, ‘It’s the government equivalent of our own domestic bank accounts.’ perpetuates the myth that the Federal Budget is like a Household Budget and so helps with the Coalition line.
    But the Federal Government can and does issue/create currency and a Household can only use or borrow it – a world of difference.
    If a Household gets its budget management wrong it can end up in the street; would that it were so for this Federal Government!

  2. Avatar Rob Stewart says:

    Totally agree Ian. The privatisation of debt comment is particularly pertinent. The linkages between public and private sector debt are generally ignored. As I understand it Australia currently has the second highest level of household debt in the world.

    With a cowered, quivering bureaucracy no one will tell the Government the truth that a surplus per se, no matter what, is at best meaningless, and at worst highly destructive vandalism.

    Young Josh Frydenburg is out of his depth as Treasurer – following in the inept tradition of his predecessors, Morrison, Hockey…..Josh wouldn’t know the difference between a Marshallian Cross and a hot cross bun.

    Agree with your point about MMT as well.

    In terms of dereliction, Costello and Howard’s fiscal recklessness in using temporary, windfall revenues to lock in structural long term fiscal imbalances, largely favouring the well off, proved the LNP is not a fit economic manager, and it hasn’t learnt any lessons. Although it has a surplus fetish the Coalition doesn’t know what to do with them.

    • Avatar Charles Lowe says:

      I agree.

      The Liberal Party’s membership is crudely and wilfully ignorant. It cannot – nor would it wish to – engage in some contemplation as to how a household budget differs from a Governmental budget. Not only does that wilful ignorance emotionally and narcissistically self-satisfy but, worse, it turbos that self-satisfaction by the electorate’s apparent endorsement of the crudity of that simplistic “reasoning”.

      Labor must educate. That’s Jim Chalmer’s job (and Anthony Albanese’s). He has some formidable assistance. Chris Bowen, Bill Shorten, Wayne Swan, Andrew Leigh – even Dr Craig Emerson (not to mention Paul Keating) – these people must dedicate themselves to persuading and convincing the electorate of at least half of Economics 101: that Governments can – and should – sometimes invite deficits when households cannot.

      This education is exceptionally – critically – important. Not just for academic reasons. But because the pathetic and inexcusable ignorance of electors (for example in Central Queensland and north-east Tasmania) is essential for it to win Government.

      I trust that such deeply experienced politicians are aware of this and are prepared to act on it.

      But we shall see.

  3. Avatar Alasdair Wardle says:

    It is not just the Liberal Government that is fixated on surpluses. The ALP is also, as well as Jeremy Corbin. It has become an arms race to see who can have the biggest surplus. We were fortunate that when the GFC occurred there were some enlightened minds guiding the Labor Government.

  4. Avatar Wayne J McMillan says:

    Thanks Ian for at last recognising Modern Monetary Theory (MMT).

    Lets be honest the Orthodox Keynesians weren’t Keynesians but “bastardised Keynesians” as the great Post-Keynesian Joan Robinson aptly named them. Orthodox Keynesians and I include Paul Krugman in this group, ignored or gradually downplayed the radical insights from John Maynard Keynes and Michal Kalecki. Only the Post-Keynesians remained loyal to the radical insights that Keynes and Kalecki illuminated.

    The Orthodox Keynesians made the tragic mistake of trying to meld the neo-classical framework of General Equilibrium microeconomics to macroeconomics and in addition used the IS-LM model of Hicks to gain macroeconomic academic ascendancy. Note Hicks later refuted that his IS-LM model reflected what really happened in the macroeconomy.

    MMT developed from the heterodox camp of Post-Keynesianism, Marxism, Institutionalism, the Functional Finance of Abba Lerner and the macro-financial insights of Hyman Minsky. It has developed a powerful lens to view the monetary operations of an economy, that has a sovereign government with a free floating exchange rate fiat currency, not having amassed debt in any foreign currency. (Australia fits this category.) MMT understands and can explain how the macroeconomy actually works in REALITY, Orthodox Keynesianism sadly is unable to do this.

  5. Avatar John Boyd says:

    Trying to navigate the debate about MMT, it seems to me that it is not so much a new theoretical approach, but is more a description of what actually happens.

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