The Treasury's Non-Modelling of the Stimulus

By Humphreys, John | Agenda: A Journal of Policy Analysis and Reform, April 1, 2012 | Go to article overview

The Treasury's Non-Modelling of the Stimulus


Humphreys, John, Agenda: A Journal of Policy Analysis and Reform


In late 2008 the global financial crisis (GFC) sparked a boom in Keynesian economic commentary and activist fiscal policies. The Australian government responded with an immediate $10.4 billion 'cash-splash' to households (Commonwealth Treasury 2008), followed by a $42 billion 'Nation Building and Jobs Plan', which was to include $12.7 billion more hand-outs as well as a $28.8 billion increase in government capital investment.2 In total, the government 'stimulus' was estimated to be about $52 billion. If we included all discretionary government spending that happened after the GFC then the number would be far higher.

And as it happened, Australia came through the GFC without much trouble. While the GDP/capita did shrink by 0.8 per cent in 2008/09, this was hardly noticed since the government and most media failed to discuss the per-capita statistics and instead reported that total GDP grew by 1.4 per cent. However you report it though, Australia did better than many other countries.

The proponents of the Keynesian policies and the politicians and bureaucrats who implemented them were quick to claim success. The American micro-economist Joseph Stiglitz said of Australia: 'What your government did was exactly right'.3 Our Treasurer, Wayne Swan, proudly claimed 'rapid fiscal stimulus measures shielded our economy and jobs from the worst consequences of the global financial crisis' (Swan 2010).

In part, these glowing reports are based on modelling done by the Commonwealth Treasury, which is often treated by the media as the gold-standard of economic advice in Australia. The government says that Treasury modelling shows thousands of jobs saved and billions in extra tax revenue (Peatling 2009), and Keynesian commentators have used Treasury as their evidence to justify the stimulus.

It is therefore alarming that Treasury never released any proper modelling of the stimulus package. The best it offered was a short note outlining the methodology for their budget forecasts (Treasury 2009), which will be discussed below.

Treasury 'modelling'

In modelling fiscal policy it is necessary to factor in a number of different impacts. These issues will be explained and discussed shortly, and include:

* The impact on private savings

* The impact on net exports (that is, international crowding out)

* The impact on domestic investment (that is, domestic crowding out)

* The response of monetary policy

* Costs of government debt.

Of these different impacts, the Treasury methodology only considered two, and one of those it got totally wrong. Its methodology was so simplistic that a critic can walk you through it in about a minute.

* To calculate the private savings response, Treasury estimated that 30 per cent of cash transfers would be saved, while the direct government investment would not lead to a private savings response. Given the roughly equal split between transfers and investment, this equates to a total savings offset of only 15 per cent of the total stimulus. The calculation is somewhat simplistic and low compared to many studies, but it is possible.

* Second, Treasury considered the impact on net exports. To quote from its report: 'We apply an import share of 0.15 which is the economy-wide average share of endogenous imports in Gross National Expenditure.' This methodology is dead wrong, and creates a drastic underestimate of the impact on net exports.

* Based on the above two assumptions, Treasury then calculated its fiscal multipliers. For transfer payments, it concluded that 70 per cent would be spent and 85 per cent of the spending would go on domestic production, giving a multiplier of 0.6 (=0.7*0.85). For direct government spending, it concluded that the multiplier would be 0.85, with the other 0.15 being spent on imports.

* The total stimulus package is adjusted for the fiscal multipliers above to calculate the apparent benefit from the stimulus (see right-hand column in Table 1 below). …

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