OECD joins the optimists

Below find the OECD’s assessment of the Australian economy over the two years. It’s an exciting piece of fiction best enjoyed on a short plane flight.

Australia can be expected to keep reaping the benefits from the minig boom. Despite sharp sectoral disparities, economic growth should be around potential in 2012 and 2013. Mining expansion will continue, but some other sectors are having to adjust to the high level of the exchange rate and raise their productivity, which can be expected to weigh on the labour market. Faster fiscal consolidation will also weigh somewhat on demand.

Restoring fiscal leeway while macroeconomic conditions are still favourable, and the terms of trade high, is welcome. In the absence of inflationary pressures, the accomodating monetary stance which accompanies this budget-tightening should help limit the risk of weakening employment. The authorities should preserve the economy’s flexibility and facilitate the changes underway, rather than impeding those changes by, for example, subsidising certain sectors.

…In the absence of inflationary pressures, the Reserve Bank of Australia (RBA) reduced its cash rate by a full percentage point, to 3.75% in three steps between November 2011 and May 2012. Although this lower rate has not been fully transmitted to borrowers, because of the higher funding costs, the monetary stance has become accommodative. Long-term interest rates have also dipped since mid 2011, and the prices of financial and property assets tended to level off at the start of 2012, mitigating the impact on financial conditions of the Australian dollar’s persistent strength.

Bit behind the times, fellars. Financial and housing assets are still falling despite rate cuts. More easing may turn this around of course and let’s hope so. There is the hope that falling interest rates will provide more discretionary spending power for households, which could increase consumption-based sectors.

There is also the chance that Canberra’s hope comes through: that cheaper money will stimulate greater borrowing and spending. If this did stabilise asset prices then we might also see folks creeping back into home building, though I still think we’ll need to see rising prices to close the current gap between purchase prices and valuations before that can happen.

Thankfully, the OECD goes on to acknowledge the risks to its forecasts in a Chinese slowdown and/or a European accident. My view is that those risks are rapidly becoming a reality in the terms of trade and are already a reality in the minds of consumers. I see no obvious reason why Australians will resume borrowing at this point unless the rate cuts are much deeper. In fact, unless things improve suddenly, I think it likely than any extra cash will go straight into paying down debt even faster. If consumers aren’t borrowing then why would business do so given the slack demand? It is becoming a serious possibility that we have run into our own version of a liquidity trap.

The mining boom will certainly provide some impetus and a falling dollar some relief but I am skeptical of the OECD, Budget and the RBA forecasts for growth in the year ahead.