Does an election really matter to the Aussie dollar?

Whilst many are passionate about their politics, I am sure there are just as many, well probably more, people that don’t really care. Given this campaign has been in play for so long, most people switched off long before the parties ramped up their PR programs.

But what influence does a government have on the value of the Australian dollar? Does the currency market care who is in charge?

The Aussie dollar after the election

People always want to know the impact an election may have on the currency. There seems to be some hype that a change in government, which appears likely at the moment, will be seen as a positive for the Aussie dollar. Whilst I believe there would be some initial strength, I doubt this will last very long at all – any rally could be over with within a few hours on the Monday morning, or at best, it will perhaps last a day or two at most.

Given our free-floating exchange rate, the government has little direct influence on the Australian dollar. They can, however, have a big indirect influence depending on the policies they adopt in order to manage the country’s budget. These policies, collectively, form what is referred to in economic circles as fiscal policy.

The long-term indirect influence of government policy, however, will have an impact – and regardless of who is in government the outcome will be the same – a large government deficit is here to stay, so I say get used to it.

Fiscal policy – tight or loose?

Just like running a business means one must manage both income and expenses, so too does the government through its fiscal policy, which can be considered to be either contractionary (tight) or expansionary (loose). Economic theory says it is considered to be good economic management to run different policies at different parts of the economic cycle.

So in times of tough, slow economic growth such as a recession, governments should be applying loose fiscal policy in order to try and stimulate the economy to create opportunities. To do this, they can either spend more money or cut taxes. But what it does is create a budget deficit if there isn’t an increase in income to offset the spending – which is often the case in a slow economic environment.

On the flipside, when times are good and there is a booming economy it can create inflationary problems, making life unaffordable and creating bubbles. During these periods the government sees an increase in tax revenue spurring a budget surplus – if spending doesn’t increase at a higher rate than income.

Rocky road ahead

The Australian economy has performed well since 2009; however, there are some concerning signs ahead. In more recent times, our terms of trade have peaked, inflation remains subdued and economic growth has slowed; which all points towards lower government tax revenue.

If the unemployment rate rises as predicted by many then this will provide a double whammy, in that it will reduce tax revenue and increase spending, further exacerbating the situation.

One of the problems at the moment is that the government is running a deficit as we come out of a booming economy and so have been caught on the wrong side of the economic cycle. The next few years are likely to be years where spending will need to increase in order to offset an economic slowdown; however, if politics prevails, we may find the opposite occurring.

This would increase the burden on the RBA and its management of monetary policy, putting more downward pressure on interest rates. So the budget deficit may not only persist but it could get even larger, which in turn would put more downward pressure on the Australian dollar – regardless of who is PM post September 7, 2013.

Jim Vrondas is chief currency and payment strategist, Asia-Pacific at OzForex, Australia’s leading international money transfer service.