Cullen's two conundrums behind the 2007 Budget

Early in his parliamentary career Shane Jones, as newly minted chair of Parliament’s finance and expenditure committee, was manoeuvred by the National party into an inquiry into Television New Zealand.

The inquiry will be remembered not for a revitalised and bouncy TVNZ but for giving rise to a landmark “privilege” case in which Parliament, to its disgrace, fined the TVNZ board for disciplining outgoing chief executive Ian Fraser for bagging it at Jones’s committee.

The inquiry also delayed a tax bill and thereby delayed for a year some benefits for small business. (So much for National’s business priorities.)

Jones is now running another spurious inquiry, this time generated by his bosses: ostensibly to outdo the Treasury, Reserve Bank and OECD and find a non-monetary way to contain inflation without cutting government spending and regulation.

National’s four MPs on the committee will try to set hares running. But for now the inquiry is a useful diversion for Michael Cullen from two politically painful conundrums.

Cullen inherited an economy hot to trot, which initially rode up an export boom, then turned that into a domestic binge. That binge has made a dangerous external current account deficit of 9 per cent of GDP, which would long ago have brought foreclosure by the nation’s creditors if we spoke Latin American Spanish and grew bananas instead of kiwifruit.

Interest rate scavengers are still feasting on our high interest rates and betting our dollar won’t fall. So far they have been spectacularly right.

This is good politics and bad politics: good politics because employment is high, people are flush and governments usually get a benign nod from sated consumers; bad politics because it is screwing the bit of the economy that earns foreign exchange, which is our future.

The borrowing will stop when we can’t meet the interest payments. No one knows when that will be but the average household is paying half as much more of its after-tax income in interest than it was in 1999. As a senior Treasury official says, “what can’t go on forever, doesn’t”.

Cullen knows the economy’s long-term health requires a hugely lower external deficit and the longer the rebalancing from domestic splurge to export-led growth is delayed the rougher that rebalancing is likely to be.

That is, instead of gently subsiding, the risk is growing that today’s fat balloon will go pop very messily. Cullen’s conundrum is that he wants that flush feeling to last till election day next year but he doesn’t want, as a result, a ghastly mess (unless, of course, it is PM John Key who gets splattered).

But a fat balloon is an inflationary balloon and the fatter it gets the more inflationary it is. Which requires ever higher interest rates to rein back inflation. Which builds pressure for a pop.

Still, Cullen could live with this conundrum if he didn’t also have another one. He has a tight Budget that is behaving like a loose one.

As the surpluses mounted in his first two terms he stashed them away, letting his neo-keynesian “automatic stabilisers” impose a contractionary effect supposed to stop the economy overheating. The idea is that when the economy slows, the automatic stabilisers generate an expansionary effect supposed to stop the economy overcooling.

But the politics of big surpluses are abuse, not applause. So he splurged in and after the 2005 election, which turned the Budget expansionary, thus adding to the economic heat and stoking the inflationary embers. That in turn has kept revenue rolling in, stoking his surplus.

Even though Cullen is still running the sort of surplus most finance ministers can only dream of (and bigger than forecast even last December), in the arcane world of economics he is injecting a large fiscal stimulus because the surplus is smaller than it used to be.

That is, high interest rates are in part his fault.

So Thursday’s Budget has both to constrain spending and tax cuts for fear of adding to the fiscal stimulus, thereby increasing the possibility the balloon will go pop, and also to fend off expectations of a wide swathe of voters that they should get a cut of the surplus by way of tax cuts.

Ministers have complained for months that, except for pet projects, Cullen has been Scrooge, while Bill English has accused him of profligacy.

Cullen’s economic task is to get air out of the balloon — but so gently the punters don’t notice. His political task is to convince the punters he can’t spend more, either on tax cuts or services (though he will) because that will drive interest rates even higher.

That’s where Jones comes in handy. His job is to divert the politics until economic forces at last start unwinding the horrendous imbalances and we can all get our feet on the ground.

Except English, if Cullen has his way. A few weeks back he said English will on Budget day find himself standing on a (political) “trapdoor”. Those of you bored with Sudoku might try to work out what that might be.