How can Josh Frydenberg spin a slowing economy into an election-winning budget?

The Reserve Bank has the luxury of waiting for new data to clarify the state of the economy, but Josh Frydenberg has had to prepare the budget amid general confusion about whether the economy is slowing.

When they’re framing budgets, treasurers have two roles: a political role, which everyone focuses on, and a far less prominent role as architect of the fiscal contribution to the economy. The roles should normally complement each other but can, bizarrely, end up at odds.

For example, the David Cameron Tory government in the UK, with George Osborne as chancellor, had a shocking reputation as an austerity government when it engaged in massive deficit spending to keep the British economy afloat. Joe Hockey and Tony Abbott did the same thing here in 2014: they massively increased deficit spending from the trajectory planned by Labor in 2013, and in doing so protected Australia from a serious downturn. But politically, they were all about slashing spending and ending the age of entitlement. And it killed them politically.

Different forms of budget spending have different stimulatory effects — increasing transfer payments to low income earners go straight into the economy, whereas handouts to the wealthy, or corporations, have far less effect because they get banked or sent overseas. But a key indicator overall is how much deficit spending the government is engaging in. And in recent years, the government has been slowly reeling in the deficit — that is, reducing the level of fiscal stimulus to the economy. And next year, notionally, the government is preparing to end any stimulus at all and move to a neutral setting, with a tiny surplus planned. Exactly how much stimulus the government provides to the economy, or withdraws from it, is a key question for the treasurer wearing his fiscal architect hat.

Last year, with the economy enjoying strong jobs growth and the Reserve Bank flagging that the next movement in monetary policy was going to be a tightening, the answer to that question was simple — just keep going with the return to surplus.

Now, the answer is more complicated. GDP growth declined significantly in the second half of 2018, mainly as a result of the government-endorsed war on wages-growth being conducted by business. The RBA is now talking about the possibility of a further cut in rates. Falling house prices are undermining consumer sentiment. The banks have tightened lending considerably. Financial markets are warning of a slowing economy: the yield on Commonwealth 10 year bonds fell to 1.78% on Monday, according to Bloomberg data (in December’s MYEFO, Treasury assumed an average cost of 2.5% on the nation’s future borrowings — down from 2.8% in the May budget). Internationally, the global economy has slowed, the US Federal Reserve has reversed its rate rise regime and won’t increase again for some time.

But jobs growth is still above average; NSW and Victoria had substantial unemployment rises in February but there were sharp falls in other states. Jobs are a lagging economic indicator but it’s also the RBA’s primary guide to whether further rate cuts are needed at the moment. Exports continue to run at record levels. The terms of trade are still higher than expected and nominal GDP is running at more than 5% — producing a flood of tax and other revenues.

This mixed economic data has undoubtedly made Josh Frydenberg’s job much harder. It has certainly troubled the Reserve Bank. In the minutes from its March board meeting, the bank added some words (in bold below) to its previous language about its monetary policy consideration:

Members agreed to continue to assess the outlook carefully. Given that further progress in reducing unemployment and lifting inflation was a reasonable expectation, members agreed that there was not a strong case for a near-term adjustment in monetary policy. Rather, they assessed that it would be appropriate to hold the cash rate steady while new information became available that could help resolve the current tensions in the domestic economic data.

Unlike the RBA, Frydenberg and Treasury don’t get to revisit their decisions every month in light of new data. They have had to make their big fiscal decision for the year — as well as their political decisions about how to win an election — with the same confusing data that the RBA has been struggling with.

That means the budget’s economic forecasts for the rest of this year and 2020 will be every bit as interesting next Tuesday as whatever spending and tax cuts Frydenberg deploys to try to save the government.