Expansionary Budget’23 adds to interest rate risk

Contrary to all the talk of a surprise budget surplus for 2022-23, the 2nd Labor Budget under Treasurer Jim Chalmers is unambiguously expansionary, with a boost to GDP growth equivalent to around 1.5% over the next two years. This adds to the risk that the RBA will feel the need to raise interest rates at least once and possibly twice more in the coming months.

It’s very unusual for Treasurers to focus on the budget outcome for the current (almost ending) financial year when handing down the annual May Budget. Usually, the focus is on the projected budget outcome for the coming financial year, which is just about to begin. But in a classic smoke and mirrors exercise, the Treasurer has so far managed to successfully divert attention towards this year’s “accidental” surplus – caused by the late discovery of a lot more revenue than expected which the Government simply did not get a chance to spend in the remaining weeks of this financial year.

But the real news is not this (almost over) financial year, but the projected deterioration in the budget position over the next two years. The Budget balance is expected to move from a small surplus of $4.2 billion (0.2% of GDP) this financial year, to a deficit of $13.9 billion (0.5% of GDP) in 2023-24 and a much larger $35 billion deficit in 2024-25 (1.3% of GDP). That equates to an expansionary “fiscal impulse” – or shift in the budget balance from surplus to deficit – equal to 1.5% of GDP over two years. This, in turn, largely reflects $12 billion in new net spending in the coming financial year.

Of course, in one sense, the Budget is admirable in that most of the extra budget bounty from a resilient economy and higher export commodity prices is being saved rather than spent (unlike, say, during the commodity boom under then Treasurer Peter Costello). It’s also hard to argue over the areas in which money has been spent – mainly helping the least well-off in the community.

That said, the sad reality is that the 2nd Chalmer’s Budget again makes no real effort to tighten the budget to support monetary policy in helping to rein in inflation and tackle Australia’s now ingrained structural budget deficit. The disappointment is not that the Government has attempted to support some of the less well-off in the community, but rather that greater effort was not made at a still relatively early stage in the electoral cycle to introduce tougher measures elsewhere in the economy. And, however admirable is the provision of “cost of living” support to those less well-off, they also tend to have a higher propensity to spend extra income, which will add to the challenge of slowing consumer demand in the coming year. Hence, this is why it would have been beneficial to introduce other offsetting budget-tightening measures at the same time.

At the micro-level, moreover, most of the measures to support the housing sector are yet more demand-side stimulus programs, which will only encourage renters and first-home buyers to compete more vigorously for the limited supply of accommodation available in our major capital cities. And although various measures have been introduced to lower CPI inflation (energy and rental rebates), the expected 3.25% rate of CPI inflation over the year to June 2024 is more marginally (0.25%) lower than those in the October budget and current RBA forecasts.

As for the future, the challenge of budget consolidation will only get harder, not easier, from here.