The Morrison government has unleashed stimulus worth more than $200 billion in a bid to save Australia from a very deep and prolonged coronavirus-induced recession.
Announcing this week’s $130-billion wage subsidy for workers, Treasurer Josh Frydenberg justified the spending by declaring: “Extraordinary times call for extraordinary measures.”
But where is all this money coming from? Was it sitting there all along? Who will we have to repay when all this is over? And will we ever get the budget back into black?
How does the federal government get money?
Understanding what is about to happen to the government’s budget requires a basic knowledge of a few things.
The federal government has a commitment, over the long run, to balance incoming money from tax collections with outgoing spending on welfare, health services etc.
When the government raises more revenue than it spends in a year – for example because a mining boom has turbocharged company tax collections – its budget is said to be in surplus. These surplus funds can then be used to pay down any existing debt.
When the Morrison government boasted of getting the budget “back into black”, it only ever meant that it was going to start running annual budget surpluses – not that it had eliminated debt altogether.
In fact, Australian governments have never completely paid off debts accumulated in previous downturns and crises, according to Deloitte Access Economic’s Chris Richardson. It’s just that economic growth has been so rapid as to dwarf the size of the debt relative to our national income.
“We have always had debt,” says Richardson.
Debt is incurred when government spends more money than it raises in a year – either because revenue has fallen short or spending demands have risen, or both – and the budget falls into deficit. In order to be able to keep paying its regular incoming bills – such as public service wages – the government must borrow to fund any shortfall, adding to any existing pile of debt.
How much debt is the government already in?
Prior to the global financial crisis, the Howard government had managed to reduce Australia’s net debt to effectively zero, thanks to the mining boom.
After a decade of running big deficits, however, Australian government debt today is, in dollar terms, higher than at any other time in history.
As a percentage of our economy, however, net debt is about where it was in the mid-1990s in the aftermath of the early ’90s recession.
Last financial year, Australian government net debt stood at $373 billion or 19.2 per cent of gross domestic product.
This compares favourably to other nations. Both the United Kingdom and the United States carry net government debt worth about 80 per cent of their economies.
At the time of the last budget, the Australian government was forecasting it would achieve a budget surplus this financial year and use the surplus funds to pay down net debt to $360 billion, or 18 per cent of GDP.
Now, however, net debt can be expected to top half a trillion dollars.
How does the government borrow?
On level three of the Treasury building in Canberra’s parliamentary triangle, sits a group of people known as the Australian Office of Financial Management (AOFM).
These people are the government’s debt managers. Essentially, they act as intermediaries between the government and its potential lenders.
Every couple of days, depending on requirements, they set up online auctions for things called government bonds. These bonds are essentially government promises to repay borrowed money, plus interest, to investors. Investors lodge bids to buy these bonds by indicating what interest rate they will accept, and it’s all over in minutes.
As of April 3, the AOFM had $579.2 billion of these bonds on issue to investors. We call this the level of Australia’s gross debt, with net debt figures much lower, reflecting the offsetting value of various assets also held by the government.
In order to fund the stimulus package, the Australian government will simply instruct the AOFM to conduct more frequent and larger auctions of these bonds. As a result, the level of outstanding government debt will go up and so too will the total interest bill that must be paid out.
Who does the government owe money to?
So who buys these bonds? According to the AOFM, just over half of Australian government bonds are held by non-residents. These include foreign banks, central banks and investors, including big pension funds.
Even during a crisis, big global pension funds continue to receive a steady stream of contributions from workers and they need somewhere to park the money.
The remainder is held by Australian entities, including banks, super funds and other institutional investors.
The Reserve Bank has also started to purchase Australian government bonds. It is seeking to keep interest rates low by adding to demand for such bonds.
The Reserve has said it will not buy bond directly at the AOFM auctions, to avoid crowding out other lenders, but will instead pick them up in the secondary market.
Ultimately, however, we can expect the central bank to become a bigger owner of Australian government bonds.
How much does it cost the government to borrow money?
The good news is that debt is very cheap at the moment because interest rates are low.
It has been observed that the world has a savings glut of money looking for attractive investment returns, of which, given increased risk aversion in the post-GFC era, there have not been a lot. So far, AOFM auctions for Australian government bonds have tended to be oversubscribed.
So, while the value of Australian government debt in dollar terms is historically high, the interest bill on that debt as a proportion of the broader economy is not.
The government paid $14 billion in net interest payments on its borrowings last financial year.
But as a per cent of GDP, net interest payments were just 0.7 per cent of GDP, compared to 1.7 per cent in the aftermath of the early 1980s and early 1990s recessions.
With interest rates as low as they can go, however, and debt set to soar, that interest bill will rise.
How will we pay the money back?
Slowly, over time.
When the virus has run its course, and particularly if the stimulus has been successful in protecting jobs, we can expect spending needs to subside and economic activity to lift, producing more tax revenue.
When we start to run budget surpluses again, we can start to pay down the accumulated debt. This may take a very long time.
But it is not impossible. The mining boom of the 2000s helped the Howard government restore the budget to balance after the 1990s recession.
Will our grandchildren pay the price?
Chris Richardson is keen to dispel the idea that borrowing today will impose an unfair burden on future generations.
With interests rate so low, the interest bill on the additional $213 billion of borrowings will be just $1.6 billion a year.
“That’s not nothing,” says Richardson. “You’d much prefer not to have to pay that much extra in interest every year … Yet these costs are far from scary.”
Were, however, the government to fail to act to counteract this economic crisis, Richardson fears the budget – and nation – could end up in a much worse state, as joblessness soars, revenue plummets and welfare costs soar.
Richardson says Australia must now be on a war footing: “Australia’s economy will grow again on the other side of this war. So, here’s a simple suggestion: let’s just let our debts from this new war simply become a smaller share of our growing economy over time. That’s what we did with the war-time debts of the past. And it’s probably the smart play this time too.”
“There are lots of things to be scared of,” concludes Richardson. “The fight for our health is a long way from being won. But don’t be scared of the debt – its costs aren’t that bad. And chances are that taking on this debt will be a great investment in Australian livelihoods.”
Jessica Irvine is a senior economics writer with The Sydney Morning Herald.