David Bassanese of the AFR today has a reasonable take on the current hand-wringing about Australian growth next year:
If the Australian economy suffers a recession in the next year or so, there will be one person responsible: federal treasurer-in-waiting Joe Hockey. And if Mr Hockey blows it, the policy error might just be bad enough to render the Abbott government a one-term wonder.
…But whether the economy succumbs or not, one thing I do know is that Australia does not need to have a recession. Recession can and should be avoided no matter what the global economy throws our way – provided policy makers are doing their job.
Why? Recessions usually happen due to a needed correction of macro-economic imbalances…But Australia does not have any obvious imbalances. Inflation and public debt in Australia are fairly low, and credit markets are far from speculative excess. There’s no trade crisis either – in fact we’re worrying about excessive capital inflow and an overly high Australian dollar.
…Should it be needed, the RBA can easily still cut the official interest rates at least a further 2 percentage points – which would greatly help lower borrowing costs for home owners and small business alike.
…What I’m less confident about is how Canberra will respond…For understandable political reasons, shadow treasurer Joe Hockey has relished bagging the Labor government for the run-up in debt during the global financial crisis…But if the polls are right and Hockey becomes Treasurer in September, he may well face the prospect of having to do exactly the same thing.
Let’s take each of these at face value. First, yes, Australia may have the tools to avert recession. A combined push of low interest rates, a low dollar, productivity directed infrastructure spend and reform would give us our best chance. Each of these would offset the quite obvious if unorthodox imbalances that we face. Low interest rates would offset very high private debt. A low dollar would in time resuscitate non-mining tradables, rebalancing our export base to a less unbalanced mix. Public spending would help ease the trajectory of the collapse of mining investment and boost productivity. All three would support incomes as productivity reform helped bring capacity up to our inflated income levels (rather than vice versa). That’s four major imbalances so far.
But, there are limits to each of these solutions. In my view, the RBA does not have 2% of cuts still in the bag. Markets are currently forecasting two rate cuts in the year ahead and that has most currency strategists forecasting a dollar at 85 cents. If the RBA were to cut, as it should (as well as installing macroprudential tools) a full 1%, then the dollar would fall at least another 10% and probably more. There is a point somewhere in taking rates so low that the RBA risks the falling dollar turning disorderly. We may right now have plenty of capital inflow but, as we know, when market sentiment turns virtue becomes vice very fast. We are still going to have to fund a current account deficit of 4% or so whatever we do.
Where these tipping points are is very difficult to know in advance but my guess is we would not want to go much lower than 1.75% (and that means there would be no need to from the perspective of the currency anyway).
On the fiscal side there is scope, yes. Especially if we got busy with off balance sheet bonds. But the kind of stimulus package we saw post-GFC is not what we need. We need a program of nation building infrastructure directed squarely at lifting productivity over a three to five year horizon. We’re likely to be running $10-20 billion deficits just on struggling nominal growth as the terms of trade keeps falling but we could probably add another 1% of GDP in a major infrastructure program without upsetting ratings agencies. It means running 2% of GDP deficits for three years but if it were couched in a long term narrative of lifting productivity, supporting growth through to the 2017 LNG ramp up and a long term plan to return to surplus then we may keep the AAA rating.
It would add $120-$150 billion in public debt and take our debt to GDP ratio to a more than respectable 30% or so. Again, it’s not easy to judge where the limits are and there is a tipping point for the AAA rating as well. Because the budget guarantees bank borrowings to the tune of a two notch upgrade in bank ratings, deficits cannot be pushed as far as in other nations. To go past that point is to simultaneously downgrade the sovereign and banks and accelerate the slow motion current account squeeze that is our fundamental macroeconomic imbalance in the post-GFC world. These are my guesses for how far we might go.
But would that be enough? If we reasonably assume mining investment shifts from the 2% of GDP boost it has provided for the past few years to withdrawing 1% from GDP in each of the next three years (which is bit better than most private forecasts imply), then we need to find at least 3% of growth elsewhere and preferably 4%. Assuming we get 1% per annum from mining net exports and 1% per annum from a combination of slowly rising domestic demand as well as housing construction (which is much better than we’re getting now) then an additional 1% in public spending would take us up to a 2% GDP trend. That’s still not enough to prevent an acceleration in the rise of unemployment that could feed back into asset prices and make life more difficult. But we’re at least getting close!
If we got the dollar down quickly, rising tradable investment and exports would fill the gap by 2015 but probably not before.
So it’s not just Joe Hockey or Labor for that matter. The RBA is also moving too slowly. It is trailing the weakness in the economy rather than shifting its policy mix to get ahead of it. If it does happen, this is truly the recession that our elites handed to us on a platter.
