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One of my friends had to do a job interview where it was possible he would be asked to talk at length about a public policy issue of his choice. Since he still had finals, I offered to help him do research. I figure, now that he’s done the interview, there’s no harm in simply publishing the email I sent him.

This implies no warrant of certainty in the accuracy or thoroughness of my research, I did it in an hour or so at about 11pm. Any citation of SMH is not an endorsement of the quality of that paper.

It’s a bit more discursive than what I usually write and describes the basic macroeconomic theories more thoroughly than I might otherwise have done, but I think its informative. The first topic is “How should governments fix massive budget deficits”. I thought the US v UK approach was particularly interesting – since the UK was taking a more thoroughly supply-side approach.Since writing that email, I found this article by Malcolm Maiden in the SMH. It attributes the differences between the US/Australian approach with the Eurozone approach to a historical difference during the Great Depression (the US faced recession and is unafraid of inflation, whereas the Germans faced hyperinflation are fear debt more). More interestingly, he highlights differences between how market confidence might act differently between the continents for this reason.

Topic 1: Budget deficits:

I’m not sure how much time you’ll really have, so I’ve decided its easier just for me to summarise the information you need to know, then to give you the links to read yourself. The important links are bolded, read all of them if you have time, but I think reading this email is sufficient.

Budget deficits and recessions can be complicated because there is disagreement between Keynesians and supply siders. Keynesians believe that economies can be fixed by stimulus packages and the government pumping money into the economy. Supply siders believe that you need to pump money into the economy, but for the economy itself to decide how that money should be spent. Therefore, you should use tax cuts, which put money in the hands of consumers. They will either save it or spend it – either way, they know best what they need, which means they can allocate it between saving/spending most effectively. The response of most governments post-GFC was Keynesian – and there is evidence that it does work ( The problem was that most of those stimulus packages were not big enough.

It is important to add that we are in (sort of) unprecedented territory because in many countries, they threw large amounts of stimulus money at the problem and it wasn’t quite enough. That means we both have weak budgets and weak economies. Both theories sort of assumed that once the problem was fixed, the economy should start running again. And when that happens, taxes flood in and fix the problem.

So, if you can’t rely on that, then governments have two choices.

1) They can choose to take on more debt. BUT this undermines the government’s AAA rating. When you have a huge amount of debt, and your rating goes down, your interest rates skyrocket and all sorts of problems occur.

2) You can use austerity measures (reduce spending, increase taxes, sell assets) but these have their own problems. Under a Keynesian analysis, austerity measures, if introduced too soon can starve the economy. [But of course, not under a supply-side analysis, which suggested you should have done that in the first place].

Exactly which of the two choices you should take depends on exactly how close you are to losing your AAA rating. Let me illustrate with a few real world examples. (See the Moody’s article for details)

1) NSW and Qld

NSW has long been the tight-ass of the fiscal community. Bob Carr really wanted to preserve the State’s AAA rating – but as a result, he didn’t spend enough on crucial infrastructure. As a result, hospitals are crumbling etc etc. And when it came time to use that AAA rating during the GFC, the government found out that it was quite useless. In other words, NSW should have spent more earlier. As a result, NSW was forced to privatise many assets (or attempt to) to fix the budget crisis – the electricity system, various roads and the Ferries. (Qld is in a similar position, flogging off $8bn of assets – see the John Quiggin article below).

2) California

California is the State to watch in terms of fiscal incompetence. By sharp contrast to NSW, it has always been a reckless spender. In fact, it is mandated by its Constitution which has been amended countless times through the horrid proposition system. (People can vote to pass laws – eg. to mandate that 25% of the budget must be spent on education). The Governor is actually only able to change about 25% of the Budget because the Constitution (and various laws passed through propositions) mandate the other 75% be spent on X. When the time came that he needed to spend even more money to fix the economic crisis, Arnie had less than no money left. He had no savings, and taxes were falling (because a lot of State taxes are land property taxes – and of course the GFC was caused by falling land prices).

3) US

The US is in a special case. I don’t think its in danger of losing its AAA debt rating (but don’t quote me on that) but it is in a special position because so much of its debt is owned by China.

4) Greece, Spain, Portugal

These countries actually have had their debt ratigns downgraded, so their only choice is to take austetiry measures (or be bailed out by the EU).

If you look across all these countries, you’ll find that (generally) two things caused these budget crises.

A) structural budget deficits

Budgets go up and down. The average budget, so to speak is the point that the budget hovers around. Some countries, like Australia have strong economic discipline and excellent economists. Thanks to Keating and Costello, we do not have structural budget deficits (though we may have temporary budget deficits for a year or two during recessions). Other countries – Greece, the US, California have structural budget deficits. They spend so much that even when the economy is really strong, and taxes are flowing in, they can only just get into the black.

B) Bad luck

Some economies are based around one thing, and if the downturn hits that one thing very hard then your economy collapses. If the downturn had destroyed the metal price, we would be in big trouble. As it happens, it hit property and financials. Which means California and Spain (property) were in big trouble, as well as London and the US (financials).

Very short term policy

This NYT article on the very short term US dilemma on whether to cut rates this month has some excellent analysis:

It should be all you really need, but just in case, here is an article from the NYT’s Dealbook blog (which is the blog which finance markets read – very good, technical information, but conveyed in terms normal people can understand:

Moody’s (debt rating agency) warns the US debt rating is not certain

For more generally how to fix deficits:

Here is an Australian perspective (Club Troppo is a well respected economics and politics blog):

And here is a US perspective from Paul Krugman (Nobel Laureate and hardcore left-wing Keynesian):

QUT Economist, John Quiggin on why Qld’s assets sales to fix its budgetary positin makes no sense

The NYT on the novel approach of the UK which we discussed (basically following supply-side theory)

The UK has been problematic because much of London’s budget depended directly or indirectly on the Financial sector (through bankers salaries or through the money they spent which stimulated the economy). When that collapsed, so did a major portion of the UK budget.

This is another very good article placing the UK in the context of deficit cutting in the EU generally. It also goes deeper into the economics of things.

NSW Budget:

Most of the analysis said that it regained the surplus because tax revenues increased along with the economic recovery (rather than economic brilliance).

Recovery helped by privatisation of Lottos:

Recovery helped by rebounding property sector:

Ross Gittin’s analysis (to much the same effect)–and-what-they-didnt-20100608-xs6m.html

The majority of articles talk about stuff in he budget that improves infrastructure and housing (like the stamp duty rebate). Personally, I rather liked the NSW Budget for that reasons. Here’s an article generally on the NSW Budget: and

Update: Since I wrote that email, I saw this article by Malcolm Maiden in the SMH.


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