We can run deficits forever – Australian edition

As Evan Soltas neatly puts, a government can run deficits forever and at the same time reduce their liabilities relative to GDP. All that is needed is for GDP growth to be larger than the growth in government debt (in percentage terms). If we can get this point across to the general public we might avoid some of the misguided backlash caused by governments running deficits. Governments should be running deficits through the troughs of business cycles and funding this by running surpluses through the good times. Consider it the same as dipping into your savings if you’ve been made unemployed while you look for another job. With Australian GDP ≈ $1.4tn and a conservative GDP growth estimate of 2% we can currently run budgets deficits around $25bn without suffering any deterioration in our debt/GDP. Of course our nominal position will be worse but with inflation at 2-3% our real deficit will actually be shrinking as well.

On balance, I see the media engaging the issue of budget deficits as a positive as it increases political accountability, though I think the main point of focus of the media is wide of the mark. Spending too much of the windfall (thereby running smaller surpluses) in the boom years is the biggest crime here. The incentives are such that presiding governments will spend extra money that flows into their coffers during the boom time as showering the public with cash is a fast track to popularity. If the government instead saved the money it reduces their likelihood for re-election (relative to showering the public with cash) and tops up the coffers for the winner of the next election which may well be an opposing political party.

Soltas claims that the US has run deficits in 70 of its last 84 budgets. Even looking at the US Govt debt/GDP line on the chart below it is still surprising to think that 83% (!) of their budgets since 1929 were in deficit.

Fortunately for us, govt debt relative to GDP is much lower in Australia than the US and most other developed countries as the chart below shows*.

Debt-GDP Aus vs US

While the underlying Australian Govt cash position isn’t the current  ‘budget position’ measure it is similar, and there is a bit of historical data on it unlike the current measure which hasn’t been back-cast very far after recent changes. While it would be good to compare like for like, I can’t find data for the last 84 Australian budgets so data from 1970 will have to do. On page 6, this budget summary shows that Australia has run cash deficits for 23 of its last 42 budgets. From 1992 to 2012, only 10 of 21 budgets were in surplus however our debt/GDP ratio was 27% in 1992 and is at 27% now. The deficits were on average, larger than the surpluses. The fact that GDP was constantly expanding is the reason the debt position didn’t deteriorate.

Underlying Cash Position

With positive GDP growth Australia can run small budget deficits for a very long time (theoretically forever). If needed, we have room (especially relative to other developed countries) to allow larger deficits. Australia needs to focus on running surpluses and paying down debt in the during times of economic prosperity.

*Data sources for Debt/GDP are all over the place. US Treasury data on the US budget position is very different to the IMF data. Any pointers on which figures are most trustworthy/comparable across countries would be appreciated.