Last night (March 25, 2025), the Australian government delivered the latest fiscal statement for 2025-26 (aka – The Budget – and, in doing so tried to win renewed electoral appeal given its waning popularity and a national election that has to be held in the next 6 or so weeks. So it offered the tax cuts and other inducements to the voters. But the underlying tenor of the fiscal position is unsustainable not because it is predicting on-going fiscal deficits out to 2028-19 but because those deficits will be too small relative to other trends that are likely to occur (external sector and household consumption spending). While the commentariat has been in conniptions about ‘eye watering red ink’ for a far as we can see (their eyes are poor), the fact is that the projected fiscal deficit is about the average level since 1970-71. But in the current environment, the forecasted government contraction will damage the economy and push unemployment up further than they are forecasting. Sure enough, the Government handed out some dollops of cost-of-living relief to low-income families – a few pennies in the scheme of things and that will probably help them retain votes. Bu with all the challenges ahead now is not the time to be in contractionary mode. Winning the election is one thing, but neglecting a host of existential matters in the medium term is not the way to go.
Government erases the unemployed from the public debate
In ‘Budget Paper No.1’, Statement 2: Economic Outlook, we observe the following forecasts.
| Aggregate | 2023-24 (Actual) | 2024-25 | 2025-26 | 2026-27 |
| GDP growth | 1.4 | 1.5 | 2.25 | 2.5 |
| Current Account (% of GDP) | -1.3 | -1.75 | -3.75 | -4.25 |
| Public Final Demand | >4.23 | 5.0 | 3.0 | 2.0 |
| Employment | 2.2 | 2.75 | 1.0 | 1.25 |
| Unemployment | 4.0 | 4.25 | 4.25 | 4.25 |
| Participation rate | 66.8 | 67.25 | 67.0 | 66.75 |
| Inflation | 3.8 | 2.5 | 3.0 | 2.5 |
The latest ABS estimates indicate that population growth “grew by 1.8 per cent in the 12 months leading up to 30 September 2024” (Source).
The Treasury forecasts that participation will be largely stable (slight decline).
Note also that the implied productivity growth in the above forecasts (GDP growth minus Employment growth) is around 1.25 per cent by the end of the forecast period.
The only reason that employment growth is initially strong then falling away is because productivity growth is assumed to be negative in 2024-25 before improving to 1.25 per cent in the last two years of the forecast period.
How does that influence the unemployment rate forecasts?
The famous US economist Arthur Okun developed a rule of thumb about the way unemployment reacts to GDP growth.
The rule of thumb has it that if the unemployment rate is to remain constant, the rate of real output (GDP) growth must equal the rate of growth in the labour force plus the growth rate in labour productivity.
Remember that labour productivity growth reduces the need for labour for a given real GDP growth rate while labour force growth adds workers that have to be accommodated for by the real GDP growth (for a given productivity growth rate).
If we assume the labour force grows in line with the assumed underlying population forecasts – so around 1.8 per cent (given participation is estimated to be stable) and productivity growth is around 1.25 per cent, then GDP growth has to be 3.05 per cent in each of the forecast years if the unemployment rate is to stay unchanged.
A cursory look at the Table above, shows the following if the forecasts turn out to be fact:
1. 2024-25 – GDP will be above the required rate by around 0.95 points because productivity growth is assumed to be negative.
2. 2025-26 – GDP will be below the required rate by around 0.8 points.
3. 2026-27 – GDP growth will be below the required rate by around 0.55 points..
The implication is that it is hard to see how the unemployment rate increase can be confined to a forecast 0.25 points over the forecast period.
The rule of thumb tells us that it will rise by around 0.4 points over the forecast period..
That is obviously an approximation.
But it suggests there is not consistency across the modelled forecasts used by Treasury.
The only way that the unemployment rate increase could be confined to 0.25 points over the next three years is if productivity growth stayed low or negative.
The other way of considering this is to simulate the underlying labour force aggregates based on the Treasury assumptions with respect to employment growth.
That simulation (using the ABS population growth data) and the Treasury employment growth forecasts, delivers an unemployment rate of 5.03 per cent by the end of June 2027 with unemployment rising from 612.6 thousand in February 2025 to 794.3 thousand by the end of June 2027.
Remember that the Treasury forecasts are for fiscal years so a rising unemployment rate will record a lower annual average than its endpoint in the month of June 2027.
My best guess is that the unemployment rate will rise closer to 5 per cent than 4.25 per cent as estimated by the Treasury.
It tells me that the fiscal position the government is choosing as its policy strategy is too contractionary.
Further, I have regularly indicated that the unemployed are forced to live on so-called Jobseeker benefits (unemployment benefits) which are increasingly below the recorded poverty line.
Successive federal governments have refused to address that increasing gap.
In last night’s fiscal statement, the Government did not include any measures to increase the income support payments for the unemployed (or any social support payments for that matter).
It is as though the Government has just erased the plight of the jobless that it is deliberately increasing from the public debate.
I find that an appalling prospect.
‘Red ink’ hysteria
Here is the fiscal position since 2000-01 with the red bars indicating the forecast values.
Over the forecast period there is a slight contraction planned, which is why the unemployment rate is forecast to rise.
Last night’s statement indicated that the federal government would be in fiscal deficit at last out to 2028-29, which has prompted the ‘red ink’ hysteria brigade to prophesise all sorts of impending disasters.
How many commentators can you count that use terms such as ‘eye watering deficits’ or similar.
Pathetic.
Since 1970-71, the fiscal deficit has averaged 0.9 per cent of GDP.
By 2028-29, it is forecast to be 1 per cent of GDP.
If commentators would just gain some historical knowledge, they might be less prone to these extreme hysterics.
As I noted above, the fiscal deficit is too low – not excessive and there are many ways to demonstrate that (see below).
The following graph shows the movement in these aggregates as a percent of GDP since 1970-71.
The dotted segments are the fiscal statement projections.
You can see that while payments are projected to fall from 27 per cent of GDP in 2025-26 to 26.4 per cent in 2028-29, receipts are projected to remain relatively stable and record 25.3 per cent of GDP in 2028-29.
Hence the projected shrinking fiscal deficit by 2028-29.
Both spending and receipts are slightly above their historical average at present.
But there is nothing wild going on here.
The fiscal support during the pandemic was substantial but now the aggregates are returning to ‘base’.
The fiscal shift from one year to another is the change in the fiscal balance as a percentage of GDP changes.
It provides an idea of how expansionary or contractionary the current fiscal position relative to the previous financial year.
It is the result of two factors – the fiscal balance itself (in $As) and the value of nominal GDP (in $As).
The following graph shows the recent history (from 1970-71) of fiscal shifts up to the end of the projection period (2026-27).
A positive value indicates a contractionary shift (even if the fiscal position is still in deficit) and vice versa.
I have coloured the current fiscal year (2024-25) green and the remaining red columns are the forward estimates for next year (2025-26) and those beyond.
The contractionary in 2021-22 was large (a 5 per cent of GDP shift) as the Government abandoned the pandemic support.
In the first two years of the current Government (elected May 2022), the contraction continued, with the Government relentlessly pursuing surpluses taking a further 2.3 per cent of GDP out of the economy in 2022-23 allowing two fiscal surpluses to be recorded.
But the contraction has killed economic growth and with a national election just weeks away, the Government has been forced to take an expansionary position this year before resuming its shift to contraction.
The RBA interest rate hikes that started in May 2022 combined with the fiscal shift this degree of fiscal contraction is the reason that GDP growth is now projected to be at levels where the unemployment rate rises significantly.
Where is the growth coming from?
As the Table above shows, the Government is presenting an optimistic outlook for economic growth which appears to be driven by a large ‘comeback’ in Household consumption expenditure.
The 2025-26 fiscal statement forecasts that real household consumption expenditure will grow by 0.75 per cent in 2024-25, then jump to 2.25 per cent in the next two years.
The following graph shows the annual Household consumption expenditure growth from 2009-10 to 2026-27, with the red bars capturing the Government’s projections (I deleted the pandemic outliers on both sides of the zero axis).
I suspect the forward estimates of household consumption expenditure will be excessively optimistic.
Why?
Because the projected wages growth is overly optimistic given current trends and the delayed impact of the RBA interest rate hikes and the fiscal contraction underway.
With the unemployment rate forecast to rise it is hard to see wages growth sustaining the growth predicted.
There will be some wages growth but nothing like that projected in the fiscal statement (see the next graph).
Even with those optimistic nominal wage growth projections, real wages growth is modest.
But if the wages growth is less than predicted then there is the possibility that the real wage gains will not materialise.
That leaves further credit growth to drive growth in consumption expenditure and with household debt at record levels and interest rates at elevated levels, I cannot see that happening.
Why the government strategy is unsustainable
Looking back at the first Table, we see that the expenditure drain from the external sector is predicted to increase rather substantially over the forecast period as the predicted terms of trade decline significantly (Fiscal statement – “sharper fall in the terms of trade).
The fiscal statement also notes that:
Growth in exports is expected to moderate to 1 per cent in 2024–25, with services exports growth slowing following the sharp rebound in education and tourism exports in recent years. Non-rural commodity exports are expected to remain subdued, reflecting ongoing weak conditions in the Chinese property sector.
Ally that with the knowledge that the fiscal balance is forecast to decline.
Taken together it means that private domestic demand will have to do the lifting and that suggests rising indebtedness.
We know that the financial balance between spending and income for the private domestic sector (S – I) equals the sum of the government financial balance (G – T) plus the current account balance (CAB).
The sectoral balances equation is:
(1) (S – I) = (G – T) + CAB
which is interpreted as meaning that government sector deficits (G – T > 0) and current account surpluses (CAD > 0) generate national income and net financial assets for the private domestic sector to net save overall (S – I > 0).
Conversely, government surpluses (G – T < 0) and current account deficits (CAD < 0) reduce national income and undermine the capacity of the private domestic sector to accumulate financial assets.
Expression (1) can also be written as:
(2) [(S – I) – CAB] = (G – T)
where the term on the left-hand side [(S – I) – CAB] is the non-government sector financial balance and is of equal and opposite sign to the government financial balance.
This is the familiar Modern Monetary Theory (MMT) statement that a government sector deficit (surplus) is equal dollar-for-dollar to the non-government sector surplus (deficit).
The sectoral balances equation says that total private savings (S) minus private investment (I) has to equal the public deficit (spending, G minus taxes, T) plus net exports (exports (X) minus imports (M)) plus net income transfers.
All these relationships (equations) hold as a matter of accounting.
The government is estimating that the negative global factors will continue to undermine Australia’s terms of trade.
They forecast a decline of 2.5 per cent in 2024-25, then for a massive contraction (-0.6 per cent) in 2025-6 and a further fall of 3 per cent in 2025-26.
In other words, the commodity price boom which has pushed the external balance into surplus recently is forecast to end and Australia will return to its usual position of a external deficit of around 3.5 to 4 per cent of GDP – a state that has been dominant since the 1970s.
The current ‘trade war’ that the US government is waging with the rest of the world will certainly add ripples into this picture – on the downside.
The following graph tells the story.
It shows the sectoral balance aggregates in Australia for the fiscal years 2000-01 to 2027-28, with the forward years using the Treasury projections published in ‘Budget Paper No.1’ in dotted form.
The projections begin in 2024-25 (although the current year’s results are probably going to be as forecast).
I have assumed that the external position in 2026-27 and beyond will be the same as the Government’s estimate for that year.
All the aggregates are expressed in terms of the balance as a percent of GDP.
I have modelled the fiscal deficit as a negative number even though it amounts to a positive injection to the economy.
You also get to see the mirror image relationship between it and the private balance more clearly this way.
So it becomes clear, that with the current account deficit (green area) projected to return increasing deficits, which drain net spending from the domestic economy and with the fiscal balance moving towards zero over the same period, the private domestic balance (red line) will head quickly into higher deficits.
Higher private domestic deficits mean higher levels of indebtedness.
The Household sector is already carrying record levels of indebtedness which is why household consumption expenditure has been slowing down appreciably.
So reflect on that in relation to the previous section on sources of growth.
You can see that the pandemic support from Government clearly allowed the private domestic sector to rebuild its saving buffers and reduce the precarity of its balance sheet (given the massive household debt).
In the earlier period, prior to the GFC, the credit binge in the private domestic sector was the only reason the government was able to record fiscal surpluses and still enjoy real GDP growth.
But the household sector, in particular, accumulated record levels of (unsustainable) debt (that household saving ratio went negative in this period even though historically it has been somewhere between 10 and 15 per cent of disposable income).
The fiscal stimulus in 2008-09 saw the fiscal balance go back to where it should be – in deficit – given the nation’s external deficit position.
This not only supported growth but also allowed the private domestic sector to start the process of rebalancing its precarious debt position.
You can see the red line moves into surplus or close to it.
That process was interrupted by the renewal of the fiscal surplus obsession in 2012-13.
The strong fiscal support during the pandemic overwhelmed all the nonsensical deficit scaremongering and allowed the private domestic sector to increase its overall saving (and pay down debt) which was a good thing.
But as the previous government withdrew its stimulus and the current government continued to pursue a contractionary fiscal position (see above), the private domestic sector has only one option given the trends in the external sector if it wants to maintain consumption expenditure – resume the process of accumulating more debt.
With a global recession threatening and with higher interest rates the norm, the strategy outlined in yesterday’s fiscal statement is once again placing the economy on an unsustainable path relying on household debt accumulation, which is a finite process.
Conclusion
There are many other aspects to the current fiscal stance which I could discuss if I had more time.
In general, I am unimpressed.
That is enough for today!
(c) Copyright 2025 William Mitchell. All Rights Reserved.
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