KEY POINTS:
Michael Cullen must deliver a Budget this week in the most difficult economic conditions he has faced in nine years as Finance Minister. The credit crunch in the United States has had reverberations worldwide. New Zealand's economy shed jobs in the year's first three months and retail spending suffered its largest quarterly drop in more than a decade.
We may not be in recession but growth is bumping along the bottom of a trough. At the same time inflationary pressures were high even before fuel and food price rises began to bite hard on household budgets. Counter-inflationary interest rates are still required as wages are rising and a shortage of labour persists. High interest rates keep the dollar high and reduce export earnings.
Dr Cullen's dilemma is that if he cuts spending to encourage the Reserve Bank to lower interest rates he limits the help he can give households to cope with those food and petrol costs and he risks a further slowing of the economy this year. Neither consequence would assist Labour's already bleak election prospects.
But if he boosts the economy with higher spending or significant tax cuts he runs the risk that the Reserve Bank will not be able to lower interest rates and might even raise them to counter the inflationary effects of his stimulant.
In his speech to a poorly attended Christchurch business lunch last Thursday, Dr Cullen made a strong hint he would stimulate the economy nevertheless. He said the Budget would have three broad aims: relief for workers "finding it difficult to make ends meet", "strong investment in infrastructure and public services", and a plan for the future of the economy "looking through this cycle towards greater sustainability and greater prosperity".
In simple terms that means more welfare for the lower paid, more spending on hospitals, schools, railways and broadband cable, and a refusal to reduce or postpone costly projects until the economy picks up. Dr Cullen has always proclaimed a belief the public finances should be used to counter cyclical slumps in economic activity and he has backed this claim by running big fiscal surpluses when times were good.
Now is the time, he says, to use what he has put away. This year is the rainy day.
If his Budget on Thursday bears out his belief then he is putting the country at high risk of worse conditions than it has felt lately. So far this may not be a seriously rainy day. The economy is getting a boost from exceptionally good dairy prices. The labour market remains tight; wages have risen. Further afield there is cause for hope the US crisis is over the hump and developing markets, led by China, are maintaining world economic growth.
This is not the time for a profligate Budget, no matter how tempting it might be for a Government that is probably going out of office. A splurge on Thursday would have the double benefit for Labour of rewarding its constituency, perhaps securing some support for the future and, not least, limiting National's room to offer tax cuts at the coming election.
But good government is usually good politics, which National should know as well as Labour. Tax policies at the election will not be assessed in isolation from their impact on spending, budget balances and the economy.
Dr Cullen thinks the Reserve Bank has some "headroom" right now to lower interest rates before the election. He will not want his Budget to change the bank's mind. His revenue will be down and his surplus squeezed but his generosity will have to be contained if we are to get through the winter with the economy intact.
