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Lessons still to learn as 10-year anniversary of GFC approaches

Jessica Irvine
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Where does the time go? This year will mark the 10th anniversary of the onset of the global financial crisis.

By the middle of 2007, the wheels had well and truly started falling off the US sub-prime mortgage market, eventually prompting the collapse of US investment bank Lehman Brothers in September 2008.

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Another important US earnings season

With US equity markets close to all-time highs, investors will be looking for a strong earnings season to justify rich valuations. It should also provide investors with a chance to assess how CEOs view many of the macro themes playing out, such as Trumps proposed fiscal stimulus. (This video was produced in commercial partnership between Fairfax Media and IG Markets)

As the world financial system froze over, the Rudd government unleashed the biggest fiscal stimulus in Australian history.

Two major packages totalling almost $100 billion were announced, including cash cheques, pension boosts, first-home buyer incentives, local council grants, school halls and pink batts. Everything but a kitchen sink.

Australia emerged as one of only a few advanced economies to avoid a deep and devastating recession. (In technical terms, at least – while national income shrank and joblessness spiked, we avoided two consecutive quarters of negative growth.)

Legacy debated

A decade later, economists are still squabbling about the role fiscal stimulus played in Australia's near miraculous economic escape from the worst ravages of the global crisis.

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In a bizarre twist, last month Treasury released a paper by Brisbane economist Tony Makin restating arguments about the ineffectiveness of fiscal policy which Treasury had, under previous Secretary Martin Parkinson, comprehensively discredited.

It is yet another example of the Australian fondness for hiding our light under a bushel.

Indeed, with the passage of time, it is increasingly clear that Australia has delivered a textbook response to the global financial crisis and its aftermath.

While other nations, such as the United States and United Kingdom, also unleashed stimulus, it was short-lived, giving way to austerity programs which prolonged the length and depth of their recessions – from which they are only just emerging a decade later.

They did so, initially, at the urging of international bodies such as the International Monetary Fund and Organisation for Economic Co-operation and Development, who saw little harm in encouraging countries to pay down debts.

Lucky deficits

Australian politicians, too, attempted to follow the advice, first through Treasurer Wayne Swan's failed attempts to steer the budget back to surplus, and then Treasurer Joe Hockey's failed attempt to usher large spending cuts through Parliament.

Viewed as failures at the time, Australia's inability to get back to surplus on schedule has, with the benefit of hindsight, served us well. The race to austerity was never a race we wanted to win.

By pure chance and total incompetence at achieving their stated goals, subsequent Australian governments have set the budget on a path – upfront stimulus, followed by tepid fiscal tightening – which is now winning the applause of international agencies.

The past few years have seen a new fiscal consensus emerge among global macro policy experts at international agencies, including the International Monetary Fund and the Organisation for Economic Co-operation and Development.

In the three decades before the GFC, consensus was that monetary policy – the manipulation of interest rates by central banks – was the primary tool for stabilising demand in economies.

This belief drove central banks during the GFC to drop interest rates to near zero per cent – the "zero lower bound", in the lingo – to try to revive economies.

Limits of rates

Governments too, unleashed bail-out packages and stimulus measures, which plunged their budgets into deep deficit.

But a lingering belief in the primacy of monetary policy remained. But monetary policy has reached its limit – and increasingly experts agree fiscal policy must step into the breach.

Views about the effectiveness of fiscal stimulus hinge on relative estimates about the size of what economists call the "fiscal multipliers" – essentially how much bang for buck governments get in terms of increased economic output for money spent.

About five years ago, officials at the IMF began revising their estimates of the fiscal multipliers. Turns out, when interest rates are very low and private sector – households and corporate – debt very big, the bang from government spending is higher.

Indeed, the leading-edge view among macro policy experts at the international agencies is now in almost complete disagreement with the views espoused – with the assistance of Treasury – by Makin and other, mostly American, new classical academics who argue against fiscal stimulus (including the Republican adviser John Taylor, whose opinions Malcolm Turnbull, as opposition leader, was keen on quoting during the GFC).

Finding space

Economists at the IMF have introduced a new concept of "fiscal space" to guide countries on their ability to increase government spending without hitting debt limits at which higher debts would become economically debilitating.

Turns out, they think Australia has a fair bit of fiscal space to burn should economic events take a sharp turn for the worst.

Based on their methodology, Australia ranks 6th out of 30 developed countries for the size of our fiscal space.

Of course, how you spend the money matters. While Keynes said you could pay people to dig and re-fill holes, clearly borrowing for worthwhile, productivity-enhancing infrastructure projects is superior.

Australia could do much better in this respect. Of the 21 transport projects worth more than $100 million committed to in last year's election, just five met the strict criteria for suitability applied by Infrastructure Australia.

Bad timing

Sharemarkets have spent the early days of 2017 toasting to Donald Trump's promise to spend $1 trillion on infrastructure projects and hundreds of millions more on tax cuts.

But again, the US looks set to lurch in a new direction on fiscal policy, just when it should be staying put. With the US economy emerging from recession and interest rates on the rise, the effectiveness of such spending is likely to be smaller than it would have been a few years ago.

It would have been better, in hindsight, for the US to have unleashed such a package to "make America great again" a decade ago.

The irony is that, with interest rates much closer today to the zero lower bound, monetary policy's ability to act as the primary tool for stabilising economies remains deeply compromised.

There has never been a more important time for well-structured and well-timed fiscal stimulus.

The question is, have politicians learnt the lessons of the past decade?

Australia's Treasurer Scott Morrison's outright rejection of fiscal stimulus suggests not.

Australia's ability to deploy fiscal policy to counter economic shocks now relies on our government being willing to backflip on previously announced positions.

Luckily, they're proving quite good at that.

Ross Gittins is on leave.