MICHAEL KEATING. When should the budget deficit be unwound?

Australia’s present budget deficit is unprecedented, but it represents an appropriate response to the recession. The resulting debt does not present a future problem, and the deficit should only be unwound as private demand recovers.

Credit – Unsplash

Clearly Australia is in a deep recession. But with interest rates already as low as they can get, monetary policy has essentially been sidelined. Instead, and unusually, the government is totally reliant on fiscal policy to stimulate the economy, although the Reserve Bank continues to play an important role in ensuring the availability of credit to business and households.

The key fiscal initiative has been JobKeeper and without it, unemployment would be much worse. This success in ameliorating the severity of the recession has, however, come at a substantial cost to the Budget deficit.

Somewhat to the surprise of many of us, the Coalition Government has been prepared to put aside its previous sloganizing against “debt and deficits” and has adopted Keynesian stimulus policies. But looking ahead that still leaves questions about how big a budget deficit can we expect, and how concerned should we be about the accumulating debt?

The size of the expected budget deficit

No official answer about the size of the future budget deficit is yet available, although the government has promised to release updated Budget figures from the Treasury next month. In the meantime, however, we have to rely on private forecasts about the size of the budget deficit, both now and in the future.

A bit more than a month ago (14 April), I posted projections for the budget deficit that showed a deficit for this financial year of around $87bn, and as much as $196bn next financial year. Of course, much of this increase in the budget deficit is temporary, as it mainly reflects the impact of the time-limited JobKeeper and JobSeeker programs.

Nevertheless, the impact of the recession on budget revenue is more enduring. Thus, according to my projections, on present policies the budget deficit would still be as high $96 bn two years later, in 2022-23.

There is inevitably considerable uncertainty attaching to these budget projections; not least because we do not know how long the virus will last. But on my figures the budget deficit could be as much as 10 per cent of GDP in 2020-21; a huge stimulus compared to the deficit of 4.2 per cent of GDP incurred in 2009-10 in response to the GFC.

In addition, there are good reasons to think that these projections may turn out to be an understatement of the size of future budget deficits. The present projections assume that spending on the present major programs, JobKeeper and JobSeeker, will cease as legislated at the end of September. However, realising the full extent of this saving is likely to have quite damaging consequences.

Many industries will still be feeling the effect of the recession, even if most of the restrictions have been removed. Increased debt will make businesses and consumers very cautious and the economy will likely remain depressed for some time.

It would therefore be counter-productive to wind the JobKeeper and JobSeeker programs down and tighten the budget too quickly. In particular, higher education, international tourism, and the arts and entertainment industries may well require further assistance. In addition, there are good social reasons why it would not be fair to return to the previous rate of $40 per day for unemployed persons under Newstart.

In sum, it seems desirable that the budget deficit next year should increase a bit further above the present projection of 10 per cent of GDP, and that will have consequences for the deficits in subsequent years as well.

Can Australia afford the increase in public debt?

Perhaps it is not surprising that the government’s reversal of its previous ideology about budget deficits is concerning some of its backbench members who are already calling for savings to be made, starting with JobKeeper.

The important point to remember, however, is that the budget deficit is not and should not be an objective of economic policy. Instead, the budget deficit is an instrument which can be used to achieve the true objectives of full employment and improved living standards.

Accordingly, a budget deficit is appropriate if it balances any shortfall between aggregate demand and the supply capacity of the economy. Equally, if there is excess demand relative to supply, then a budget surplus is called for; otherwise interest rates and the exchange rate will tend to rise, and we would become more dependent on imports to service the excess demand. Only in that case would the country then be living beyond its means.

However, a budget deficit which offsets a shortfall in aggregate demand relative to the economy’s supply capacity should not put any upward pressure on real interest rates. This is because this deficit can be financed out of the excess private savings which are available, as any shortfall in aggregate demand is (by definition) equal to the excess of private savings over actual investment.

Also, as the total of public debt represents the sum of previous budget deficits, then if each of these deficits has offset the excess of private savings, there should not be any problem in financing the debt out of the surplus savings that are available.

Indeed, the problem for many advanced economies over the last decade prior to Covid-19 was secular stagnation caused by inadequate private demand. Unfortunately, however, too many of these countries implemented austerity policies in response to the pressure on their budgets following the GFC. These austerity policies just prolonged the agony and were largely unsuccessful in meeting their ostensible objective of reducing the debt.

On the other hand, a country, like Japan, continued to run budget deficits to equilibrate demand, without any pressure on interest rates, notwithstanding that its public debt was high as 225 per cent of GDP in 2019.

By comparison, Australia’s public debt in 2019 was only 41 per cent of GDP, and is not expected to rise much above 50 per cent, so it is hard to see that we will have a problem financing the present budget deficit that corresponds to a shortfall in aggregate demand. Indeed, last week the government conducted the biggest sale of ten-year bonds in Australia’s history – $19 bn – and received bids for more than twice as many.

Furthermore, history shows that when demand is low because there are excess savings, then interest rates are typically less than the nominal rate of growth in GDP. This means that unless the economy deteriorates much further, and with a ten-year borrowing rate of less than 1 per cent, there is a reasonable chance that the ratio of public debt to GDP will fall over time as the economy grows, without even running future budget surpluses.

Of course, as private demand and consequently economic growth recovers, it can be expected that interest rates will rise again, but that is when it will be appropriate to tighten the budget to achieve a surplus, and not before.

Some people, however, only seem to be happy if the public debt is incurred to finance infrastructure. Their argument is that infrastructure investment is analogous to private investment. It will therefore add to productive capacity and thus eventually pay for itself.

But much public infrastructure investment is presently not subject to proper cost-benefit appraisal and there can be no such guarantee that it will eventually pay dividends. While the charges for even economically justified infrastructure projects frequently do not fully recover their costs over their lifetimes.

On the other hand, assistance that supports demand will help retain the productive capabilities of both employees and their businesses, whereas if they were to close for an extended period, those capabilities may well be lost forever. Similarly, investment in education will enhance human capital, and increased expenditure to foster research and development and innovation will also add to future productive capacity.

In short, there is no good reason for distinguishing between so-called productive investment and other financial assistance in judging whether the budget deficit is appropriate.

The final concern about the prospective budget deficit is that the resulting debt will represent an unfair burden on young people who will have to pay that debt off. But first, it is young people who have especially benefited from the assistance from the JobKeeper and JobSeeker programs because they are typically far more at risk of becoming unemployed.

Second, as I have said, it can be expected that the debt will fall relative to GDP over time while interest rates remain low. And when interest rates eventually rise again, it will be because the economy is richer, tax revenue will have risen accordingly, and it will be possible to service the debt comfortably.

Third, there is no reason to assume that public debt should ever be reduced to zero. All that is necessary is to ensure that it can be comfortably serviced. Indeed, public debt is no different to business debt, which can be rolled over so long as the business remains viable. Furthermore, when public debt has been dramatically reduced historically, it was due to very rapid inflation. This was most unfair to the bondholders, and we don’t want to repeat that experience.


The present budget deficit is an appropriate response to the present recession, and the biggest risk to the recovery would be premature action to reduce that deficit. As that orthodox journal, The Economist, put it recently: “rich-world governments will make a big mistake if they succumb to premature and excessive worries about deficits”.


Michael Keating is a former Secretary of the Departments of Prime Minister and Cabinet, Finance and Employment, and Industrial Relations.  He is presently a visiting fellow at the Australian National University. 

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10 Responses to MICHAEL KEATING. When should the budget deficit be unwound?

  1. Avatar Kien Choong says:

    I agree we have no reason to be concerned that public debt is excessive.

    However, we need an independent Parliamentary Budget Office to provide guidance on debt levels and when it is appropriate to raise or reduce public debt. Currently, we don’t have an objective basis to assess public debt levels, and so it is easy for politicians with “small government bias” to manipulate fear about excessive public debt.

  2. Avatar Gregory John Olsen says:

    Michael, you write, “The final concern about the prospective budget deficit is that the resulting debt will represent an unfair burden on young people who will have to pay that debt off.” This is a false concern and has no basis whatsoever in the way modern money works.

    There is NO debt. A sovereign, currency-issuing government, like Australia’s creates AUD whenever it wants to. This happens every day. It doesn’t “borrow” AUD elsewhere because only the Australian Government creates AUD. No other government can create AUD, nor can AUD be spent in any other country.

    Can you please explain why you think AUD needs to be repaid to the currency issuer? Thanx. 🙂

    • Gregory, thanks for the comments.

      My concern is the Treasurer’s ‘Back to the Black’ re-commitment where future generations will be required to repay the ~$300 Billion Covid-19 recovery expenditures. This will negatively impact on a decent Newstart allowance, health, education, infrastructure and social housing programs.

      I agree that fiat money can be made with a few keystrokes by the Reserve Bank of Australia.

      How about the amazing coincidence that the UK Goverment and the Bank of England are issuing ‘Covid-19’ Bonds with a negative interest rate?

  3. In a world where Quantitative Easing is part of monetary policy, how about ‘Covid-19 Bonds?

    The Federal Government issues 33 1/3 year Covid-19 Bonds that the Reserve Bank purchases. Money required for recovery flows into Consolidated Revenue and is used to fund programs like JobSeeker supplements, JobKeeper, Child Care and Economic Support Payments.

    The deal is that the Bonds will have a 3% per annum negative interest. The Government will not repay the Bonds which diminish in value, reaching zero after 33 1/3 years. At that time, the Reserve Bank writes the Covid-19 Bonds off its balance sheet.

    Future generation will avoid the cost of reducing the deficit – there won’t be one.

    And inflation might get aback to the RBA target range of 2-3% per annum.

    • Avatar Gregory John Olsen says:

      Chris, bonds of any kind are only sold if there is a need to remove liquidity from the economy. Selling bonds doesn’t give money to a sovereign, currency-issuing government. They can create their own currency whenever they like. They can NEVER run out of it, nor can it go “bankrupt”. 🙂

      Money required for recovery is simply created as needed by a keystroke or two in a spreadsheet. That’s how the Morrison did it a couple of months ago. That’s how it’s done all the time. 🙂

      “Future generation will avoid the cost of reducing the deficit” because there is nothing borrowed from anyone, anywhere. There is NO DEBT to be repaid. 🙂

    • After this comment was posted, the Bank of England announced it was considering bonds with negative interest rates in response to the coronavirus pandemic:


      The Bank of England governor, Andrew Bailey, has paved the way for negative interest rates in a dramatic move that illustrates concerns inside the central bank that the impact of the coronavirus lockdown will be longer and deeper than expected.

  4. Avatar Cameron Leckie says:

    Michael, your explicit assumption is that the economy will return to growth on a sustained basis once the current recession ends.

    There are numerous reasons that suggest that the global economy is at/has reached the limits to economic growth. The future of oil is one reason. Even before this downturn there was a major under-investment in oil relative to what is required to meet projected (pre-COVID19) demand. This situation will only be worsened by the current recession/depression.

    If we have reached the limits to growth most of the debt currently on issue, both private and public, will never be repaid. This is a very real risk that this article, and previous articles, has totally ignored.

    • Avatar Gregory John Olsen says:

      Repaid by whom to whom, Cameron? The money was never borrowed from anyone. It was created by the Federal Government by a keystroke or two on a computer keyboard in a spreadsheet. If there is too much money in the system, it can be taxed out or bonds can be issued. However, in all cases, there is no “debt” to be repaid by anyone. The money was never borrowed, it was created. As Michael said in the opening paragraph, “The resulting debt does not present a future problem, and the deficit should only be unwound as private demand recovers.” 🙂

      • Avatar Cameron Leckie says:

        Hello Gregory. Money/credit/debt is an abstraction. I entirely agree that government’s in control of their own currency need never become bankrupt however ‘every action has an equal and opposite reaction.’ Printing money has perverse impacts as shown in the US where at the same time as millions of jobs are being lost the stock market is going up and inequality grows. Money/credit/debt is a call on wealth, it is not wealth in and of itself. Thus printing money will not address the underlying limits to growth.

  5. Avatar Bill Harrower says:

    Could all those in the current parliament espousing so-called neo-liberal economic principles be given homework to write this essay out 100 times?

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