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Copy No. ..

C A B I N E T

4..3

M I N U T E

Expenditure Review Committee

Canberra, 2 March 1989

No. 12273 (ER)

Submission No. 6227 - Economic and Fiscal Policy Strategy
The Committee noted that:(a)

a continued firm fiscal policy stance is

required;

(b)

monetary policy will need to be conducted in a

flexible way so as to achieve a sufficiently
marked slowing in demand and imports to reduce
the current account deficit to acceptable
levels; and

(c)

new asset sales proposals may possibly be

developed.

2.

The Committee agreed to:(a)

endorse the objective of achieving a further

real reduction in Commonwealth Budget Outlays in
the 1989-90 Budget;

... /2

This document is the property of the Australian Government and is not to be copied or reproduced

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2.
No. 12273 (ER)(Contd)
(b)

endorse the objective of achieving a zero or

better net Public Sector Borrowing Requirement
in 1989-90; and

(c)

resolve to address policies, especially those of

a structural kind, which reinforce and
contribute to the Government's broader economic
objectives.

Committee Secretary

This document is the property of the Australian Government and is not to be copied or reproduced

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CABINET-IN-CONFIDENCE
Submission No.

FOR CABINET
Title

Copy No.

ECONOMIC AND FISCAL POLICY STRATEGY

Minister

The Hon P.J. Keating, MP - Treasurer

"

i'l

To provide an overview of economic policy

strategy in the context of determining the
approach to the 1989-90 Budget processes.

Relation to
existing policy

Not applicable.

Sensitivity /Criticism

Not applicable.

Legislation
involved

Not applicable.

~ ency:

Not applicable .

.,,l'tica 1/sig n ifica nt

dates

r sultation:
Ministers/Depts
consulted

Is there
agreement?

Timing/handling of
announcement

Cost

Finance

Yes.

See ATTACHMENT A.

Not applicable.

Fin Yr (

Fin Yr (

Fin Yr (

Not applicable.

This document is the property of the Australian Government and is not to be copied or reproduced

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- 6227----

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CONSIDERATION OF THE ISSUES
The Government's macroeconomic and structural policies have
achieved considerable success in a number of areas. We have
an economy with many of the features we have sought:
a structural transformation in the fiscal position;
f~at public spending;
moderate private consumption;
sustained real wage restraint and very healthy
corporate profits;
strong private investment across the board, with a lot
happening in tradeable activities. Indeed, investment
is stronger relative to GDP than in either of the two
major resource development cycles in the 1960s and
1970s; and
outstanding employment growth, overwhelmingly in the
private sector.
The global economy has also proven very robust and the
already long expansion phase is forecast to continue for some
time yet.
2.
The main problem facing the Australian economy is, in a
nutshell, that it has been too buoyant:
so, despite a very welcome recovery in export prices
and the terms of trade, the current account deficit has
not narrowed as it must; and
price inflation has not come down anything like we had
hoped.
3.
While some of the budget's forecasts are now not going
to be met, this does not mean that our broad policy strategy
or framework is wrong. It isn't. Rather it is a question of
doing more within that framework to ensure that a protracted
period of overly strong demand pressures does not eat into
the fundamental changes that our policies have wrought and
jeopardise the continuation of our strategy. If that can be
avoided Australia can emerge from this ove~ly strong
investment boom with fundamentals which will underpin
prosperity through the 1990s.
4.
As 1988 unfolded our policies were indeed adjusted in
just this way and, at the time of the 1988-89 Budget, there
was a good chance that with the Wage/Tax Trade-Off (WTT) in

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prospect for 1989-90, the final pieces - inflation and the

external accounts - would fit into place. Since then,
however, the buoyancy of the economy has been much stronger
than envisaged. As evidence of the additional strength of
demand pressures has come to hand, we have tightened monetary
policy. Its progressive tightening since the June quarter
last year is now such that 90 day bills are around
17 per cent compared with an average of 10.? per cent in
February last year.
5.
The pronounced tightening in monetary policy is
beginning to have some effects in slowing demand in the
housing and construction sector. The full effects of past
monetary policy tightening will be coming through with
growing force as 1989 progresses, and we can expect an easing
in demand pressures during the course of 1989. However the
strength of demand and its ability to date to weather a
marked tightening in monetary policy has been surprising and
there must be some uncertainty as to whether the current
degree of tightness will slow demand sufficiently.
6.
On the other hand we need to be alert to the fact that
monetary policy operates with a lag and that much of the
tightening has occurred very recently.
7.
In any case monetary policy needs to be operated in a
flexible manner so as to secure a slowdown in demand and
imports which will be sufficiently marked to generate an
acceptable current account deficit for 1989-90.
8.
Fiscal policy has been tightened very dramatically over
recent years and is now strongly contractionary with the
Commonwealth budget in heavy surplus. In these circumstances
it is appropriate that monetary policy deal with a surge in
demand that is not broadly based and which is concentrated in
those areas of the economy which are interest rate
sensitive. Private consumption remains moderate and public
outlays continue to decline and it would be inequitable and
unnecessary for fiscal policy to be tightened further in any
dramatic way at this time.

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9.
Nevertheless it is very important that fiscal policy
continue to act as a restraining influence on demand and we
must maintain fully the strength of fiscal policy and
possibly do a little more.
10.
For some time, we have recognised that this year would
be pivotal in terms of seeking major improvements in wage
determination arrangements. The growing pressures evident
throughout most sectors of the economy have now clearly
reduced the prospects for securing a significant step-down in
inflation from the WTT this year. Indeed, the WTT must now
concentrate on helping to prevent a serious acceleration in
wages. This would be a significant achievement in historical
terms. Beyond that, of course, we must concentrate on
getting in place an award restructuring framework which can
withstand pressures for a rapid and large general wage round
and which makes a lasting improvement in the industrial
relations system.
11.
The need to spread out the impact of the award
restructuring so as to achieve a wages outcome next year no
greater than that for this year must be a prime consideration
in our wage tax negotiations.
12.
A hallmark of our policy approach has been to look to
integrate macroeconomic policy and structural reforms.
Macroeconomic policies can help to provide the best
environment for structural reform - by maintaining growth of
employment and investment, but demand should not be so
buoyant as to reward also the least efficient and fan
inflation. It is the structural characteristics of the
economy which ultimately determine its performance
potential. I believe that we must aggressively continue to
pursue opportunities for structural reform across a broad
front. We must maintain momentum so that business and the
workforce continue to respond. Key opportunities - in terms
of public perceptions and economic effects - will arise in
the next few months with reports on the waterfront and
coastal shipping and continuing governmept _business_

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enterprise reforms.

Reform in each of these areas offers

scope for considerable improvement in competitiveness.

There

will be major IAC reports to which we will have the

opportunity to respond:

on government (non-tax) charges,

international trade in services, travel and tourism, and food

processing.

Consideration needs to be given to announcing

further initiatives from our structural reform agenda as part

of the April Statement.
13.

Before addressing more specifically the 1989-90 Budget

outlook, I reiterate that the task ahead does not require a

change to the thrust of our economic policy framework.

But

it does require a flexibility and determination on our part

to ensure that our structural policies proceed and that we do
not allow the recent surge in demand to destabilise our
macroeconomic framework.

In a nutshell our task is to avoid

a wages blowout and return the current account deficit to an

acceptable downward trend.
PRELIMINARY 1989-90 BUDGET OUTLOOK
14.

The table below presents the results of the mid-year

review of the 1988-89 Budget together with some very

preliminary estimates for 1989-90;

the latter estimates are

based on economic parameters that could change significantly

over the months ahead:
1988-89
1989-90
Mid-Year Review
Preliminary
($ billion)

% real growth

Outlays

82.4

86.2

-0.1

Revenue
tax
non-tax
total

83.7
4.8

.8JL...5.

92.8
4.1
li.S

5.9
-18.5
4.6

6.1
1.9

10.7
3.0

Surplus

% of GDP
15.

Those estimates suggest we are starting this year's

budget round from a satisfactory position . . This relects the

favourable outyear effects of previous budget decisions to
contain outlays and to restore the integrity of the tax
system.

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16.
That starting point will be very substantially reduced,
of course, by the foreshadowed tax cuts and associated
increases in family assistance. The acceptable scope of
those costs to the Budget will, within limits, be dependent
on what can be obtained on the wages front and our own
expenditures. In any event, the fiscal outcome after the WTT
must contribute to lower pressures on the external account
from excessive domestic demand, as well as to reducing the
burden on monetary policy. It will not be easy to balance
all these objectives. However, at this stage, I consider
that we should be aiming for:
a further real reduction in budget outlays; and
this year's zero net PSBR must be repeated or bettered.
17.
So far as the Commonwealth sector is concerned, a zero
net PSBR would require continued restraint in Commonwealth
authorities' borrowing programs in the face of ongoing
aircraft and other re-equipment programs. There will also be
an overwhelming requirement to seek to match new policy
initiatives by offsetting savings. Indeed, we should begin
the Budget round looking to achieve further savings on
Commonwealth outlays; not least to counter the prospective
large increase (currently at 2 1/2 per cent) in the forward
estimates for 1990-91.
18.
There is merit in announcing some expenditure saving
decisions for 1989-90 in the April statement on the WTT,
which could affect some of the new family assistance
spending. Such decisions would provide a further signal to
the community that the Government has not shifted in its
resolve to maintain the fiscal consolidation process of
recent years, and that the period of restraint is not over.
Some positive references in that Statement to assets sales
would also help in the same way.
19.
In recent years, the Commonwealth has achieved
significant savings in payments to the States and has also
achieved significant reductions in the States' global
borrowing limits. I have already indicate4 to the ~tates
that this restraint will continue to be applied by the
Commonwealth next financial year. However, savings in
payments to the States next financial year will not be as
great as they have been in recent years. That only serves to
underline the importance of not easing-up on the
commonwealth s

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CONCLUSIONS AND RECOMMENDATIONS

20.

The months ahead will require further hard economic

policy decisions not only in preparation for the 1989-90

Budget but across the full range of monetary, wages and
structural policies.

Progress in facilitating external

adjustment and combatting inflation must remain paramount.

That will necessarily require policies directed at moderating
domestic demand pressures and enhancing our productive
capacity.

Against that background, I

recommend that

Ministers:
(a)

note the need for a continued firm fiscal policy stance;

(b)

note that monetary policy will need to be conducted in

a flexible way so as to achieve a sufficiently marked
slowing in demand and imports to reduce the current
account deficit to acceptable levels;

(c)

note the possibility of developing new asset sales

proposals;

(d)

endorse the objective of achieving a further real

reduction in Commonwealth Budget outlays in the 1989-90
Budget;

(e)

endorse the objective of achieving a zero or better net

PSBR in 1989-90;

(f)

and

resolve to address policies, especially those of a

structural kind, which reinforce and contribute to our
broader economic objectives.

P.J. KEATING

1 March 1989

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ATTACHMENT.A

The Department of Finance is in general agreement with the

submission's recommendation.

In particular, it strongly

supports the need to achieve a real reduction in budget

outlays and a net PSBR at a zero or negative level and
notes that such outcomes are likely to leave little or no
scope for net new policy in the 1989-90 Budget.
Finance supports also the conclusions of Memorandum 5228
which seeks continued restraint at State level.

Finance

notes that this objective will be more readily achieved if

restraint in outlays on the Commonwealth's own behalf is in
line with that expected for the State sector and for public
sector demand generally.
Finance notes that the better the outcome achieved on the
net PSBR,
policy and

t~e

better the balance between fiscal and monetary

t~us

the lower the potential for monetary policy

unduly to suppress much needed investment.

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