Will Budget tax cuts fuel inflation?Â (click here for the MP3 file)
PM — Wednesday, 9 May , 2007Â 18:14:52
Reporter: Stephen Long
MARK COLVIN: Now, will the tax cuts in the Budget cause inflation?
Some leading economists argue that the Reserve Bank could be forced to lift interest rates down the track because Government spending and tax cuts will increase consumption and prices.
But others disagree. They argue that debt levels are so high that many people will be handing their tax cuts straight to the bank.
Debt levels have also soared across the Tasman, and the Reserve Bank of New Zealand today warned that unsustainable home lending was placing the entire economy at risk.
It foreshadowed tighter controls on banks to curb the growth in risky loans.
Economics Correspondent Stephen Long reports
STEPHEN LONG: Who doesn’t want a tax cut, especially if you’re struggling on low to middle wages?
But is it a case of what the Treasurer giveth, the Reserve Bank will taketh away?
CHRIS RICHARDSON: In the coming financial year the Government will be spending $12 billion extra — $5 billion… more than $5 billion of that will be tax cuts, and that will be particularly aimed at lower paid people. They will spend. They will take that money and they will spend.
STEPHEN LONG: That’s the view of Chris Richardson, a Director of Access Economics.
CHRIS RICHARDSON: So there’s well over one percentage point of national income being put, one way or another into punters’ pockets.
The extent to which they spend means that we will pressure an economy completely at full stretch, with unemployment at 32-year lows. That would have to make the Reserve Bank sweat, and it might make them sufficiently worried to be raising rates ahead of the election.
STEPHEN LONG: But will they spend the money?
Conventional economic wisdom says the poor tend to spend their tax cuts, while the rich save them.
But Dr Steve Keen from the University of Western Sydney says it’s bunkum.
STEVE KEEN: It’s the usual story of economists ignoring the role of debt.
I mean, some years ago, when the money was handed out in tax cuts, it went into the deposits, it went into the massively geared mortgages, and it drove the whole housing bubble.
Now people have got themselves so deeply in the doo-doo with having repayments they can’t quite manage that that extra $15 to $21 a week is going to go to the bank manager, it’s not going to go to the supermarkets.
So I can’t see it driving inflation. I can see it playing a useful role in dragging some people away from the precipice of unpayable debt.
STEPHEN LONG: Thousands have fallen over that precipice, with unprecedented rates of home repossession in the poorer suburbs of some of the major cities.
And its the battler households — in work but on below average earnings — who are paying the biggest share of their income to service debt.
The tax cuts are designed to benefit them the most.
Workers earning $30,000 to $40,000 will get a tax cut of more than $21 a week.
Dr Steve Keen says its no coincidence.
STEVE KEEN: Clearly this is directed to putting money in their pockets now and hopefully taking the pressure away, so they won’t think they have to vote for Kevin Rudd to relieve the debt pressure.
STEPHEN LONG: Across the Tasman household debt is also at record levels, and the Reserve Bank of New Zealand is worried.
Today it issued a report warning that home lending practices are becoming risky and unsustainable.
Grant Spencer is the New Zealand central bank’s Deputy Governor.
GRANT SPENCER: We have seen a tendency towards more risky lending. So the risk profile of mortgage lending has increased. And also we’ve seen potentially unsustainable reductions in margins and pricing.
And we just don’t think that’s a particularly sensible thing to see when we’re somewhere near the top of that credit cycle.
STEPHEN LONG: Banks are issuing more loans to borrowers who have little or no deposit.
And the Reserve Bank of New Zealand says credit is so cheap, some banks are lending on margins that can no longer even cover their operating and capital costs.
It also warned that the current account deficit is blowing out because of the huge volume of borrowing offshore to finance home lending — a situation that would eventually hit breaking point.
GRANT SPENCER: It’s a bit like a rubber band. The further a rubber band gets stretched, the more likely it is that you’re going to have a sharp correction at some point down the track.
STEPHEN LONG: New Zealand’s Reserve Bank has foreshadowed capital controls on lenders, designed to rein in riskier loans.
Steve Keen says this is a major step with global implications.
STEVE KEEN: It’s huge. It’s the biggest move in terms of Reserve Bank ideology in 20 or 30 years.
For that length of time they’ve been basically saying, ‘Let’s leave it all to the market,’ and now they’re finally saying, ‘We’ve left it to the market, and what actually has happened is an unsustainable borrowing binge which the only way to… seems to be stoppable is by bringing back regulation.’
And that’s an enormous shift in Reserve Bank theory and practise over the last 30 years.
STEPHEN LONG: But don’t expect the Reserve Bank of Australia to follow New Zealand’s lead.
At the height of our housing boom, the option of imposing tougher credit or capital controls on lenders was debated and dismissed.
MARK COLVIN: Stephen Long.