The more they spend, the more you pay
By David Hughes
First published in the MRC’s Watercooler newsletter. Sign up to our mailing list to receive Watercooler directly in your inbox.
If only it was that easy. The premise of this week's Budget is that Government spending to reduce rent and power bills will bring down inflation and in turn lead to lower interest rates. Our Treasurer presented this plan as a win-win for families. We set about analysing this claim.
When governments subsidise something it doesn't actually reduce the overall cost of the product, it just changes who is paying for it. In this case, the Government will help us cover the cost of our electricity bills. Yet the money we save won't just sit idle in our bank accounts. As family budgets are so tight, this extra cash will end up being spent on something else and push up the prices of other goods and services.
Also, these power bill subsidies are temporary. They will barely register a blip on the RBA’s radar as they scan for trends in our economy. While the subsidies may lead to a small reduction in one measure of inflation in 2024 they are likely to increase inflation by the same amount in 2025 when the subsidies stop. And after all, electricity prices are just one of around 128 different items considered by the ABS and RBA when they measure inflation.
Despite the Treasurer’s claim that these subsidies will reduce inflation, the RBA will be more focused on the bigger picture. They’ll take more notice of the fact that the Government is spending more and stimulating the economy, and this may make them more inclined to lift rates before they lower them.
At a time when we need spending restraint, the Government has injected an additional $22b of new spending into the economy ($11.9b this financial year and $9.9b across their last two budgets). If we compare spending levels before the last election and tally up the spending Labor have committed to up to 2027-28, we get an even bigger figure of $315b in additional spending. Our analysis has found that modest cuts to spending programs in this budget have been outpaced by new spending. For every $1 in savings identified by the Government they are spending an extra $4.
Conveniently hidden on page 415 of Budget Paper No.1 is a figure the RBA will take note of — the measure of government spending growth. We have plotted the trends in spending below.
As the above chart demonstrates, Labor has increased spending from 24.5% of GDP to 26.4% in the space of a few years. It might seem like a small increase but it is not. Outside of COVID, that's the highest level of spending as a share of the economy by any government since 1986. Even Kevin Rudd was more restrained with his stimulus immediately following the GFC, which only represented a 1% of GDP increase and that was at a time when we needed economic stimulus.
As I’ve previously pointed out, Chalmers’ first budget predicted interest rates would peak in early 2023 and we have endured seven rate hikes since.
This week we produced the below chart to demonstrate the complete failure in achieving the level of inflation that was forecast when Labor formed government.
Why have we failed to bring down inflation when many other countries have done a better job of achieving their forecast reductions? The lack of spending restraint by the Government has been a factor in this failure. Economist Chris Richardson estimates that for every $7 billion in additional government spending, the RBA needs to raise rates. And that is exactly what happened.
If we plot Government spending on the same inflation chart we can see that increased spending (as a proportion of GDP) has coincided with higher than forecast inflation.
You can’t spend your way out of a cost of living crisis. The failed approach over the last two years has punished families who are becoming more sceptical of handouts by the day. In times like these we need to remember: the more they spend, the more you pay.
If you want to read how others have responded to the Budget we have compiled a list of reactions here.