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Monday, 7 November 2005
Page: 15

Mr BRENDAN O’CONNOR (1:22 PM) —After informing the House last month that petrol prices had surpassed the cost of milk, I wish today to float the idea of cutting the fuel excise tax. Aggregate economic activity has been strong and inflation under control for some time. The house price bubble has not imploded and probably will not, at least for quite a while. Many households are heavily indebted and a significant proportion precariously so. The primary threat is rising wholesale and retail prices of oil and its derivatives. The shock is not novel; macro-economic ideas on this are well settled. The consequences are some combination of a rising general level of prices and falling economic activity.

Four policy responses have been suggested, either directly or by the terms of the debate or by the circumstances: first, do nothing; second, cut income taxes; third, tighten monetary policy; fourth, cut fuel excise taxes. What are the respective views of the Prime Minister and Treasurer? Tightening fiscal policy is none of their business because the Reserve Bank of Australia is independent. Option 4, cutting fuel excise tax, seems unnecessary. If the government were going to pursue option 4, it would seem to prefer option 2—namely, lowering income tax rates—but this seems to have been dismissed by the Treasurer and the Prime Minister. The apparent policy option preferred by the government is to do nothing, gambling that the shock is small or temporary and that it can be accommodated by lower household discretionary disposable income and lower business profit margins. In the context of the arguably good prospects for the Australian economy, this may be neither as callous nor as negligent as it appears. But—and this is a big but—if the gamble is wrong-headed, this is bad for economic activity and for inflation.

The second option is cutting income taxes. This has not been suggested as a solution to the shock. Rather, it is an option which might be closed off if the fourth option that I am proposing—cutting the fuel excise tax—is adopted. The problem is that income tax cuts put further upward pressure on prices. The third option is to tighten monetary policy, as I said. Again, this differs qualitatively from the alternatives. If there is a big, sustained oil price shock, if there are no counteracting forces deriving from government or elsewhere and if the Reserve Bank takes its price stability responsibility seriously, then monetary policy will tighten.

This may well be disastrous. If real and nominal interest rates were moved up by the Reserve Bank to squeeze out inflationary pressure, there is a double whammy to economic activity. The first channel of influence is the standard one, via the increased real cost and lower volume of business lending and by corporate bankruptcies induced by higher debt servicing costs. The second channel is the effect of higher nominal interest rates on household floating rate debt burdens and, consequently, on personal bankruptcy rates.

The final option, as I proposed, is to cut fuel excise taxes. Let us imagine for the sake of the argument—and nothing hangs on this simplifying assumption—that there are two salient policy objectives: namely, price stability and buoyant economic activity. The problem for policy makers is that, as with archery, you need two arrows to hit two targets. The standard argument usually is that it is best to leave price stability to central bankers and to pursue buoyant economic activity with fiscal policy settings. In general, the argument is coherent and compelling. There is one exception, and the exception is precisely the present Australian situation. There is no doubt that monetary policy can deal with any inflationary consequences of an oil price shock. Monetary policy can squeeze away any inflation. It is slow but sure. The difficulty is that if that is the sum total of the policy response—as is implied by the government’s doing nothing—the consequences for economic activity are very painful.

The magic bullet here is something which simultaneously alleviates the need for tighter monetary policy and which offsets the worst consequences of any tightening which occurs. A cut in fuel excise taxes may be that magic bullet. One way of describing the argument for cutting fuel excise duty is that, if the government does not do something, the Reserve Bank surely will. The economy faces stagflationary pressures. The sensible response is some policy change which is price decreasing and which also encourages economic activity. A fuel excise tax cut does that. None of the other policy options does so. The essential conceptual problem which the government view entails is that if it acts as if it is independent it means it is irrelevant. Just because the Reserve Bank is independent does not mean that its likely actions and reactions can be ignored.

If a macro-economic shock is large or sustained, the consequences are known. There is a policy response which is effective, macro-economically responsible and powerfully superior to the main alternative. This last point bears emphasis. The government proposes to do nothing, with a view to later cutting income taxes. No doubt the Treasurer would like to delay any further tax cuts to coincide with his replacement of or challenge to the Prime Minister. If doing nothing does not work, monetary policy will tighten. So the four policy options considered here are not mutually exclusive.—(Time expired)