The zero lower bound government

Another budget has been and gone. Instead of the steaming turd that was the last budget, which was largely blocked by the Senate, this time we have zero. The Abbott government has spent the intervening period announcing bad policies, extracting the maximum amount of negative reaction as the public gradually and painfully rejects them, and then quietly dropping them. What they are proceeding with are much the same settings as were left by Swan, but adding a bunch of conservative nudge items which blow the deficit out. Hockey is deliberately doing nothing in the hope that revenues will rebound naturally from historic lows under Swan.

For me, the most astounding stat from this year's budget is that despite a projected deficit of over $35B, it will actually create an annual lag on the economy of as much as 0.5% of GDP (read it somewhere yesterday, now can't find the link, grr), and will do nothing to help slowly creeping unemployment. From a Keynesian macro perspective, it is the worst outcome possible. Most worryingly, it is based on assumptions that are rosy at best.

I have been feeling for a while that it is only a matter of time before Australia joins the rest of the Western world in hitting the zero lower bound of interest rates. All it is going to take with the current budget settings is one big assumption to be wrong - China hiccuping, the iron price plummeting below $35 as Rio Tinto and BHP Billiton squeeze out competitors, opportunistic currency markets persisting in inflating the $A - for the RBA to be faced with the prospect, given that fiscal policy is so pissweak, of having to further cut rates down close to zero where it is in America, Japan and Europe. And once you reach the zero lower bound and bring on all of the weirdness that happens in an economy as a consequence, it's very hard to raise them again, as Japan showed us from the 1990s on.

Australia under zeroed interest rates would be a scary place, given how our economy is structured so strongly around housing as a speculatory tax haven. If, as some pundits are saying, this budget is a precursor to an early election, that may be the last chance to avoid the unhappy fate of the ZLB. The Liberals don't have any ideas.