Fiscal facts vs. economic realities
I read an ABC article, published recently, on inflation that suggests government spending is NOT responsible for it.
The article claims that blaming inflation on federal government outlays is a political “blame game” that oversimplifies complex economic realities. The piece argues that government spending alone doesn’t generate or mitigate inflation. Instead, it claims that budget deficits – the shortfall between revenue and outlays – are the true fiscal culprit, alongside major external factors.
It might sound like splitting hairs because, of course, a deficit occurs when government spending exceeds revenue. So… back to government spending.
Specifically, the article offers three primary drivers behind Australia’s inflationary environment:
- Long-term deficits created by previous tax cuts* and the repeal of revenue measures (such as the mining tax and carbon tax).
- External forces like volatile international oil prices resulting from geopolitical conflicts.
- An unprecedented surge in private business investment, particularly massive infrastructure and data centre construction by global tech giants, which has squeezed labour and material supply chains.
*That really gets my goat – the suggestion tax cuts might be to blame for inflation rather than profligate and wasteful government spending of taxpayer money.
The other infuriating claim is that private data centres, rather than corrupt government infrastructure projects or the fraud-riddled NDIS, are driving inflation.
What’s correct
The ABC accurately points out that focusing solely on gross spending ignores the revenue side of the balance sheet. From a purely monetary standpoint, a government that spends $100 billion while collecting $100 billion in revenue creates a net-zero injection of new money into the broader economy, compared with a government spending $80 billion while collecting only $50 billion. Deficits inject net demand into the economy, whereas surpluses pull net purchasing power out.
The article also correctly identifies the role of private capital expansion. Massive private commercial investment projects – such as data centre construction – compete directly with other private sector demand for finite physical inputs, skilled tradespeople, electrical engineers, and specialised equipment. This concentrated private demand drives up resource costs across the supply chain, pushing up price levels regardless of public policy.
Finally, global energy disruptions and imported commodity price spikes are largely outside the direct control of domestic fiscal policy. The Reserve Bank of Australia (RBA) cannot adjust foreign oil prices with interest rates, nor can domestic budget cuts instantly resolve global shipping bottlenecks.
My problem with the first two suggestions is that the private sector is the whole point of an economy. The private sector is a far more efficient allocator of capital than government, whose leaders are handed portfolios based on loyalty and mateship and are rarely qualified by education or experience to run them.
Falling short
While the ABC offers some pushback against simplistic political soundbites, several of their broader assertions overlook core macro-economic principles:
- Spending volume matters in a capacity-constrained economy
The assertion that “government spending, on its own, doesn’t create or mitigate inflation” ignores basic supply-and-demand mechanics when an economy is running near full capacity.
Even if a budget is balanced or running near break-even, the absolute volume of public spending matters. When government programs pour hundreds of billions of dollars into construction, health care, infrastructure, and defence, public departments compete for the exact same labour pool and raw materials as the private sector. Bidding up prices for scarce resources drives cost-push inflation, regardless of whether that spending was funded by taxes or debt.
- Even a 1 per cent deficit in a high-inflation climate is expansionary
The article downplays current government outlays by noting that the fiscal gap sits at roughly 1 per cent of Gross Domestic Product (GDP). While this deficit is smaller than pandemic-era peaks, any deficit adds net stimulus.
When the central bank is actively raising interest rates to cool aggregate demand and tame inflation, a government running any deficit is effectively putting the ‘pedal to the metal’ while the central bank is slamming on the brakes. To assist in bringing inflation back to target, fiscal policy in an overheating economy needs to be actively contractionary, not just less expansionary.
- Public vs. private spending
The piece places significant emphasis on private data centre investment while minimising government outlays. However, public spending often displays a different structural impact on inflation than private investment.
Private investment into tech infrastructure creates productive assets designed to expand future supply capacity and productivity.
Public consumption outlays and transfer payments immediately bolster household and sector liquidity without expanding short-term supply capacity, keeping aggregate consumer demand elevated.
I think the article goes too far. It’s right to highlight that global supply shocks and private sector investment play a role in driving up prices. However, completely absolving government spending of responsibility ignores how public outlays compete for scarce resources and keep aggregate demand high when the economy needs to cool down.
You can read the full ABC article here: Interest rate hikes gather pace across globe as deficits and debt spiral.
Love to hear your thoughts.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
