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An inconvenient obsession

There was a glimmer of hope earlier today that, boxed repeatedly around the head by evidence that the economy isn’t really travelling so well and that slashing Government spending was only compounding the problem, Joe Hockey had a conversion of sorts.
The Treasurer talked in almost Keynesian terms of the need for the Budget to act as a “shock absorber” for the economy.
Was the political obsession with returning the Budget to surplus as soon as a possible and bugger the consequences for the rest of the economy to be consigned to the rubbish heap of history?
Unfortunately, it appears not.
Whatever Joe Hockey’s rhetoric, in its latest update on the economy, the Government remains obsessed about public spending, devoting a major slab of the Mid Year Economic and Fiscal Outlook (MYEFO) to its “Smaller Government” reforms, including cutting the size of the public service to levels last seen in 2007-08, holding down public sector wage growth to 1.5 per cent a year and axing 175 Government bodies.
None of these bode well for support for economic activity.
The fact is, in earlier times, governments could fiddle with the Budget and not worry too much about the effects on the economy.
But, as Reserve Bank of Australia officials pointed out in a research paper earlier this year, governments need to be a lot more careful now:
“The changes to the taxation system overall are likely to have increased the sensitivity of revenues to fluctuations in the terms of trade and economic activity in the current episode.[8] The larger size of government means that the operation of automatic stabilisers has a more significant effect on overall economic activity” – Australia after the Terms of Trade Boom, RMA Bulletin, March 2014.
There is no doubt that the Budget is looking pretty ugly.
Tax receipt estimates have been slashed by $31.6 billion since May, contributing to a $43.7 billion deterioration in the Budget position.
As a result, the deficit this year (2014-15) is expected to reach $40.4 billion (as opposed to $29.8 billion in May), and the books will stay in the red right through the forward estimates – a deficit of $11.5 billion is projected in 2017-18.
There is no return to surplus projected until very late this decade, at the earliest.
This outlook is hardly surprising given what we have been through, not least a global crisis that has left the international financial system badly shaken.
Overlaid on this has been the unsettling surge and ebb of the resources sector.
Booms, whatever their source, rarely end smoothly, and the economy was always likely to hit some rocky times as mining-related investment faded and other sectors were slow to pick up.
One of the features of this period – a rapid decline in the terms of trade – was hardly unanticipated. All along, it was expected that the massive worldwide investment in mining capacity, encouraged by soaring commodity prices, would drive a huge increase in supply that would drive prices down – and this is what has happened.
In the lead-up to releasing today’s Mid Year Economic and Fiscal Outlook, the Government has been enthusiastically briefing the media on what has been described as a “collapse” in the terms of trade (principally as a result of plunging iron ore prices) and what this has meant to Commonwealth revenues.
It has been keen to highlight a 50 per cent plunge in global iron ore prices since the start of the year, including 30 per cent since the May Budget.
“The extent of the fall in the price was widely unexpected,” the Government said in MYEFO – Treasury had estimated a drop from $US120 a tonne to $US92 a tonne by mid-2016, whereas it is currently at $US63 a tonne.
The result of these and other moves, the Government says in MYEFO, “would be the largest fall in the terms of trade in a financial year since the Australian Bureau of Statistic’s Annual National Accounts started in 1959-60”.
But, as one of this column’s correspondents, Property Insights principal Rob Ellis points out, claims of a record fall in the terms of trade are overblown.
True, the terms of trade have fallen sharply (the index has fallen below 160 points surging above 180 around the start of the decade), but they are still very high in historical terms (see chart).
Nonetheless, the Government has trimmed its real non-farm GDP growth forecasts. The economy is now expected to expand by 2.5 per cent this financial year (a 0.25 percentage point reduction from the May forecast) but still grow by 3 per cent in 2015-16.
And it expects household consumption to grow at a similar rate – a questionable assumption when many workers are seeing their pay go backwards in real terms, and rising unemployment and slowing house price growth are only making households even more careful about their spending.
Dumping even more off the public payroll and squeezing the incomes of those left on it is only going to make the task of achieving these growth forecast more difficult.
terms of trade

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Joe Hockey’s G20 secret: believe

Treasurer Joe Hockey appeared to be channelling the eponymous self-help bible The Secret as he talked up the significance of the G20 summit on Sky News last Friday.

“Australians and people around the world have to believe that tomorrow is going to be better and more prosperous than today,” he told interviewer Kieran Gilbert. “Therefore, if they do believe that – if it is going to happen – then they are prepared to invest and create jobs for others in the community.”

When the G20 finance ministers and central bank governors, prodded by Hockey, declared their commitment to raise their collective GDP by more than 2 per cent the existing five-year trajectory, they appeared to be adopting the sort of “believe it, and it will happen” logic that is the The Secret’s mantra.

Their declared intention to “significantly raise global growth”, accompanied only by vague commitments to cut unemployment and increase investment, sounded suspiciously like the The Secret’s advice to “see yourself living in abundance and you will attract it. It works every time, with every person.”

There’s nothing inherently wrong with setting ambitious targets. Just ask Wayne Swan and his commitment to a return to Budget surplus in 2012-13.

But the essentially naive and ignorable nature of the commitment presided over by Hockey was neatly encapsulated in a put-down by German officials, who dismissed Australia’s initiative as a “slightly antiquated form of economic planning”.

Ouch.

The great thing about a collective commitment to something like a growth target is that everyone – and no-one – has responsibility to make it happen.

Let’s look at the wording of the relevant part of the G20 communique:

“We commit to developing new measures, in the context of maintaining fiscal sustainability and financial sector stability, to significantly raise global growth. We will develop ambitious but realistic policies with the aim to lift our collective GDP by more than 2 per cent above the trajectory implied by current policies over the coming five years.”

Plenty of wriggle room for governments there if growth doesn’t turn out as hoped – just say the financial system was too fragile to push things harder, or budget pressures were too great.

Then there is the question of how this jump in growth might be realised.

To achieve this 2 per cent acceleration, the ministers and governors said they would take steps to increase investment, lift employment and participation, enhance trade and promote competition.

All worthy goals, but tell me the government who says they won’t take steps to boost investment, employment, trade and competition. Ask most governments, and they will say that is what they are doing every day (even if they are not really).

So where did Joe get this idea for an additional 2 per cent growth target?

Have a look at the briefing prepared for the G20 meeting by International Monetary Fund staff, go right past the Executive Summary and the first 10 pages, and read the 11-page Annex at the back, which is full of worthy suggestions for stronger growth and how to achieve it.

Specifically, IMF staff have modelled the effects of what they see are necessary reforms in six key areas where policy gaps have been identified: fiscal, rebalancing (of sources of growth), labour supply, other labour market reforms, product market reforms, and infrastructure investment.

According to IMF estimates, the “policies assumed in the [plausible reform] scenario raise world real GDP by about 2.25 per cent ($US2.25 trillion) in 2018, relative to the October 2013 World Economic Outlook baseline”.

The biggest gains, the IMF believes, will come from reforms to boost competition and improve the business environment, followed by investment in public infrastructure, getting more people into the labour force, other labour market reforms and rebalancing sources of growth.

As the Lowy Institute’s Mike Callahan points out, we have been here before.

At their Toronto summit in 2010, G20 leaders committed to work together on a set of policies which the IMF estimated would boost global output by $US4 trillion and create 52 million jobs.

What happened? As we now know, the requisite policies weren’t adopted and growth fell well short of the stated mark.

As Callahan says, having a growth target and a plan to get there is only meaningful if the plan is implemented.

He points out that the necessary reforms identified by the IMF and OECD are politically challenging.

In Australia’s case, they include improving the efficiency of the tax system by lowering corporate taxes and relying more on the GST; improving the regulation of infrastructure by expanding user charges and congestion charges; improving childcare support; and reducing the stringency of the scrutiny of foreign investment. As Callahan observes, this is “tough stuff”.

The Abbott Government has already made clear that it has no appetite for taking on the sort of economic reforms that the country is screaming out for, particularly an overhaul of the tax system.

The Commonwealth is over-reliant on income taxation for revenue, and the country needs a broader tax base, of which a higher consumption tax is a key part.

Former Treasury secretary Ken Henry developed a credible and valuable blueprint for tax reform that should be the starting point for the Government.

But, just like the G20 growth commitment, it is hard to see it happening.

Even invoking The Secret won’t make it so.

 

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Growth numbers suggest Abbott should be careful in cutting

As the Abbott Government’s Commission of Audit hunts for spending cuts and bureaucratic flab, the latest national accounts might give it some pause for thought about how zealous it should be.

The figures show that public spending added a hefty 1.3 percentage points to growth in the September quarter – without this contribution the already decidedly-anaemic GDP numbers (up 0.6 per cent in the quarter, 2.3 per cent for 12 months) would have been much worse.

As the numbers make clear, this is a fragile time for the economy, with a hesitant transition underway from mining investment toward other sources of growth.

Housing activity is strengthening, but the lift in the household savings ratio to 11.1 per cent is a fair indicator that although consumer confidence is improving, people remain cautious. (No doubt the urge to save was heightened by the air of uncertainty that surrounds any federal election, but the tepid labour market is probably a more lasting influence).

There are undoubtedly savings to be had in public spending, but in the zeal to make cuts, the Government needs to keep in mind that the public sector is not just a cost centre – it purchases goods and services, and it employs people, giving them the wherewithal to make their own purchases.

Australia is a long, long way from southern Europe, geographically and economically, but the experience of countries like Greece and Spain show that ill-timed austerity can make things far worse.

  

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A good week for the RBA

Every now and then you have a week when things seem to go right – your baby son suddenly begins sleeping soundly and copiously, you get the perfect park at work – twice! – and your bank gets in touch to say it has made a $100 mistake in your favour, and lets you keep it (ok, so that last one never happens, it is just a dream).

The Reserve Bank of Australia has just had such a week.

When the RBA Board sits down tomorrow for its monthly monetary policy meeting, it will see little reason to move the official cash rate.

All the signs are that the economy is behaving in ways that it has anticipated, and that are broadly in keeping with its monetary policy stance.

Low interest rates appear to be working to encourage activity in non-mining parts of the economy, particularly housing, while the dollar is depreciating and worrying price pressures are yet to appear.

Though there was a slip in building approvals last month (down 1.8 per cent), much of this was due to the volatile apartments segment of the market, and annual growth remains a healthy 23.1 per cent.

Of course, holding interest rates at historically low levels for an extended period carries with it risk, and some have started to fret that a bubble in the housing market, particularly in Sydney, is developing.

But the overblown talk of an over-heating property market, never well-founded, looks increasingly silly. Sure, house prices have surged in the major cities – most notably Sydney and Melbourne – but there are at least three good reasons to dismiss talk of a bubble at this stage. Firstly, there are signs that the market in established housing is losing some of its heat and price growth is easing. Secondly, and perhaps most importantly, credit growth remains modest – borrowing for housing grew by 0.5 per cent in each of September and October to be up 5 per cent from a year earlier, which is hardly what could be described as “bubble-like”. Thirdly, the nation’s population is growing at a solid rate of around 1.8 per cent, and the easing dollar makes Australian property an increasingly attractive proposition for foreign investors.

There are also encouraging signs that manufacturers and other businesses are starting to pick up the pace of their investment – a development that is coming none too soon, given the rapid deceleration in mining investment.

Official figures show that in the September quarter, mining companies cut their spending on plant and equipment by 7.1 per cent (while expenditure on buildings and structures increased 5.6 per cent). In the same period, manufacturers spent an extra 3 per cent on plant and equipment, and increased funds for buildings by 1.5 per cent.

Any investment plans should be well supported by healthy balance sheets. The Australian Bureau of Statistics confirmed today that business profits grew almost 4 per cent in the September quarter and are up almost 9 per cent in the past year. In the same period, wages have grown 3.1 per cent.

While GDP figures out on Wednesday are likely to show the economy was just ticking over in the September quarter, evidence that non-mining activity is building should push consideration of more rate cuts further into the background.

Instead, the RBA Board may soon begin to consider the timing of a rate hike.

Though it is unlikely to make such a move tomorrow, the central bank will be heartened by the dollar’s slide in recent days. Governor Glenn Stevens made it clear again last week that he thought its sustained strength against the greenback has been increasingly difficult to justify.

Inflation and wages appear well contained for now, but the longer the cash rate is kept at 2.5 per cent, the greater the risk prices could accelerate, which would in turn increase pressure for wage hikes.

As ever for a central bank, the trick is in the timing. Push up rates too soon or too fast, and the dollar could rebound, but leave them low for too long and potentially destabilising price pressures could accumulate.

 

 

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(Tell me why) I hate Tuesdays

The Reserve Bank of Australia rightly takes a considered approach to economic data.

While markets and the media are sent into a frenzy over small shifts in the dollar or the unemployment rate, RBA officials usually emphasise the importance of interrogating the figures and using an accumulation of information – rather than a single data point – to help assess what exactly is going on in the economy.

Such an approach is understandable – indeed, necessary – when each decision made will directly affect the economic fortunes of more than 23 million people, as well as having significance for the international economy.

Which begs the question – why does the RBA Board meet on the first Tuesday of every month (except January), rather than the Wednesday or – as Outlier suggests – the Thursday.

Many of the major data releases from the Australian Bureau of Statistics, including the national accounts, the consumer price index and the monthly labour market reading, are scheduled for Wednesdays and Thursdays, meaning that often the RBA Board meets without access to the latest ABS figures.

This week was a case in point.

The day after the RBA Board decided to leave interest rates on hold, the national accounts for the March quarter were released, showing gross domestic product increased by just 0.6 per cent in the March quarter, holding the annual growth rate down at 2.5 per cent for the third consecutive quarter.

The result was consistent with the observation made by RBA Governor Glenn Stevens after the Board meeting that growth in the past year had been “a bit below trend” (which is generally considered to be around 3.25 to 3.5 per cent).

But the soft growth number hasn’t helped convince people that the Reserve Bank is right when it says recent rate cuts will help push growth toward 3 per cent next year.

Instead, the growing expectation is that the central bank will have to cut the cash rate further.

All of which makes the RBA Board appear – rightly or wrongly – out of step with developments in the economy.

And, when it comes to monetary policy, appearances matter.

The demeanor of a central bank and what is says can be as influential as what it actually does with the cash rate. Just ask Ben Bernanke, Mario Draghi or Mervyn King.

So, even if having the March quarter national accounts figures at its fingertips would not have changed the decision of the RBA Board on Tuesday, the perception that it made its call without taking into account the most recent national growth data is not helpful for its cause.

If the regular Board meeting was shifted to a Thursday instead of Tuesday, it would mean that it would have access to the most recent data possible when coming to its monthly policy decisions.

And, every three months, it would have access to the latest official growth and inflation figures for its cash rate deliberations.

For the sake of perceptions, this would be reassuring for everyone.

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