Senate Economics Legislation Committee, , 36:30 to 45:48
Senator Hume questions the Secretary on the relationship between government spending, aggregate demand, and inflation, referencing RBA modelling.
Topics: Government spending, Energy prices
Speakers: Jenny Wilkinson, Hon Jane Hume, Senator Lisa Darmanin
Thank you, Chair. Good morning. Uh Secretary, last month Reserve Bank wrote to the House Economics Committee stating that in its last paragraph, I'm assuming that you've seen this later. If you haven't, I'm quite happy to table it, but I think it's been published pretty widely. The last paragraph of this letter says, while the composition of a specific spending proposal matters, in general, lower government spending would reduce aggregate demand unless it was offset by stronger spending elsewhere. If this eased capacity pressures, it would also tend to reduce inflationary pressures. Secretary, can I ask if you agree with the RBA that in general lower government spending would reduce aggregate demand and tend to reduce inflationary pressures?
Senator, what I would say is that any questions like this have to be answered in the specific, not in the general. So it it does matter what the spending is on, but it also matters what the aggregate fiscal position is. So what generally the way in which generally when economists think about the impact of government on the economy, they think about it in two ways. One of them is to look at the difference between the contribution of public and private demand in a national accounts system or in national accounts context. And the other is to look at the underlying cash balance, so that the deficit, that's the net of what government is adding to or detracting from the economy, and how that changes over time. So it's actually important to look at the change in the underlying cash balance overall, whether that's between budget updates or that's across time in order to make an assessment of what the impact of government spending on aggregate activity is.
Can I ask in that same letter to the House Economics Committee? The Reserve Bank indicated that it has already undertaken some economic modelling of how changes in government spending may impact inflation. I want to ask where the Treasury has modelled the impact of lower government spending on inflation.
So, Senator, in every budget update, we take the projection of the underlying cash balance and the details of government spending, and we incorporate those in our macroeconomic forecasts. Those are one of the important elements that we consider as we are adjusting our macroeconomic forecasts every year. So not every year, I should say twice a year at every update. So that that is part and parcel of the macroeconomic forecasting exercises that we are doing on an ongoing basis. So we take into account how government, the government fiscal position, usually measured by the underlying cash balance, but also we can look at it more broadly, how that has changed in the most recent update. How that then flows through into how we are thinking about our macroeconomic developments. So that is that is just an ongoing part of the work that we do.
That's a comprehensive answer, but I'm not entirely sure it's a clear one. Have you modelled the impact of lower government spending on inflation?
As I said, Senator, I don't think that's a question that you can actually answer in the in the general. I mean, you have to answer, you have to look at it in the specific. What's the specific proposal? So, you know, what is the specific type of expenditure which is proposed to be changed? We'd have to consider what the imported component of that expenditure is. So, for example, if it was a significant fall in, let's say, I don't know, defence equipment, and most of that defence equipment was imported, then that wouldn't have a particularly significant impact on its own on demand in the economy. On the other hand, if the change in spending was also associated with changes in taxation, you need to take into account the net impact of all of those. That's why we look at the underlying cash balance in aggregate. That's what's the standard way of looking at the impact of spending, sorry, the expect the impact of government government spending and government uh conditions on the macroeconomic outlook.
So there is no macroeconomic model that would include specific proposals, surely, macroeconomic models by their very nature model macroeconomics, and they would look at government spending not as individual proposals but as in the in general as a whole.
So as I said, Senator, um, when we are preparing our macroeconomic forecasts, and Dr. Grant might like to add to this, um the the forecasting framework through which we operate is the national accounts forecasting framework, which means that we have to make assessments about what is is going to happen to public demand and private demand. We have to make assessments about what the net impact of government decisions are on both public and private demand, and those that that is the way in which that flows through into our macroeconomic forecasts. Is there anything else you'd like to add?
Alright, well, let me try another way. Is the current fiscal policy expansionary?
So, Senator, the way I think that the way the way I think you need to think about this is how have government decisions over time added to or detracted from activity in the economy. Now one of the things that we've observed over the last 12 months or so uh since the middle of 2025 is we have observed public demand growth coming off and private demand growth lifting. So public demand has made less of a contribution to economic growth in the economy over this last period than private demand, and certainly when I look at what, as I'm sort of mentioned earlier, what what the surprises have been over the past 18 months, that the thing that we have been surprised by that the economy that that private demand in the economy has been stronger than we expected. Business investment has been stronger than we expected, housing investment uh was stronger than we expected in the second half of last year and into the first half of this year, uh, and consumption was a bit stronger than we'd expected given the given the levels of sentiment. So all of those things are what have surprised us on the upside. When I look at what's happened to fiscal policy over this period, um the the underlying cash balance in 25.6 and 267 have both um fallen reasonably substantially from where they were predicted to be. So when I think about what the expected level of the deficit in 25, 6 and 26-7 was going to be. So if I think back to the end of 24, right? So let's compare what fiscal policy has done over the period since the since you know the end of 24 or beginning of 25. Over that period, the underlying cash balance has come in quite substantially, like by almost by almost a percent of GDP.
That's not due to reduction in expenditure, that's due to an increase in revenue.
So, Senator, it's actually been a function of that the broad range of decisions which have been taken by government and the changes in the underlying conditions. But it is the case. It's not unreasonable that the underlying cash balance as the net measure of the impact of government on the economy, that has come in. That has reduced.
Secretary, spending is at that highest level in 40 years outside of the pandemic. Surely you can agree that that is true.
Senator, what I'm saying is that if you're trying to think about what the net impact of government is on demand in the economy, you have to look at what the change in the underlying cash balance has done.
Okay.
I have lots more questions on this, Chair.