Since the COVID-19 outbreak, it would appear that there has been a paradigm shift regarding the tools available to economic policymakers.
Before the pandemic, the political rhetoric was that the government's fiscal position - the difference between its outlays and tax receipts - must be balanced, or preferably, be in surplus.
Yet since the outset of the crisis, we have borne witness to large fiscal deficits. This then begs the question: have the tools suddenly changed as a result of COVID-19?
To reconcile such matters, we must first unpack the government's armada. On the one hand, Treasury spends and collects taxes.
On the other hand, the Reserve Bank of Australia sets interest rates.
Working in tandem, the two arms operate in unison to promote the financial prosperity of all Australians.
But there are important caveats. To achieve such a goal, governments must abide by three rules, namely through (1) selling debt in the domestic currency, and (2) issuing a non-convertible currency (3) subject to a free-floating exchange rate.
Emphasis should be put on the direct needs of society, as opposed to achieving a strict fiscal outcome.
Why is this of paramount importance? Consider the Great Depression, whereby the majority of economies operated under a "gold standard".
Given that every domestic currency was directly convertible into gold, each central bank was required to back the domestic money supply with a fixed percentage of gold.
By design, this signified that all nations operated with a fixed exchange rate.
As the 1929 Wall Street crash perpetuated into a global financial crisis, governments were caught in a bind. In an attempt to preserve their gold reserves, each central bank increased interest rates, as opposed to cutting them.
Furthermore, as exchange rates were fixed, governments slashed social benefits (such as unemployment insurance) to put downward pressure on wages to boost export competitiveness. Both responses were effectively a zero-sum game.
The result? Chronic levels of unemployment and social instability. If aggregate household spending contracts, total incomes regress, and unemployment increases. The government must then step in to take up the slack to maintain full employment.
Fast forward to the present predicament. Although there has not been a paradigm shift in how economies function per se, what has changed since the Great Depression are the arrangements that dictate the tools available to the government, should they choose to use them.
Consider the facts in reference to the above rules. First, any debt issued after 1987 has been denominated in AUD. Second, the AUD is not convertible into a finite commodity, such as gold or silver. Third, since 1983, the AUD has floated on foreign exchange markets (it is not pegged to any other currency, such as the US Dollar).
Given that Australia is equipped with its own lender of last resort - the Reserve Bank of Australia - the government can always fulfil any liability denominated in AUD via a few strokes of a keyboard (no money printing), political constraints aside. Moreover, inflation does not currently pose a threat, nor will it in the foreseeable future. Also, our floating exchange rate acts as an automatic 'shock absorber', negating the necessity for austerity in order to boost our exports.
On the other hand, nations such as Greece sell debt in a currency (Euros) which is foreign to its Central Bank.
As a consequence, the Greek Government lacks a credible lender of last resort. In fully acknowledging the disparities between such differing institutional arrangements, financial markets can readily turn against their excessive fiscal deficits, and hence, force policymakers into a series of draconian austerity measures.
It is unfortunate that while equipped with the appropriate arrangements and tools in the modern context, our public debates continue to revolve around which side of politics will achieve a fiscal surplus first.
Rather, emphasis should be put on the direct needs of society, as opposed to achieving a strict fiscal outcome.
As economic policy is (and should be) subject to the democratic process, it is imperative then for all of us to appreciate that while there are certain blockades to economic policymaking (such as inflation), politics should not foreshadow the misery of many.
After all, economic policy is simply a means to an end.
