Following the collapse of Lehman Brothers in mid-September last year, global output, industrial production and trade cratered as almost never before. The US economy — still the biggest economy in the world — and many others have suffered their most severe recessions since the 1930s. The US unemployment rate is heading into double-digits and seems likely to remain painfully high for many years.
Until at least March or April this year, policy makers across the globe felt they were dealing with the threat of a severe global recession morphing into another Great Depression. Unlike some of the academic economists, I believe the threat of economic disaster was real, and that Australian policymakers — like most of their counterparts across the world — moved macroeconomic policy sharply in the right direction.
Simply, it made sense for policy makers everywhere to use all available counter-cyclical tools in an urgent attempt to lessen the serious risk of economic disaster. Moreover, the fact that the Australian economy is doing relatively well at present is not evidence that forceful stimulus measures were not necessary, but that a combination of good management and good luck has limited the damage so far. The timely and forceful easing of monetary and fiscal policies, the stronger position of Australia’s banking system, China’s impressive shift in 2009 from bust to boom, and our rapid population growth all appear to be important reasons why Australia has outperformed.
To some extent, timely and forceful action by policy makers “caught” the Australian economy before it hit the ground. The economic story, however, is not all good. Full-time employment and aggregate hours worked — variables that drive income and financial comfort in most households — have fallen by 3% and 3-1/2% from peak so far and still are trending lower.
With full-time employment yet to stabilise, the economic recovery under way at present still is rather weak, or at least is only in its infancy. February fiscal package structured to reduce severity of local recession. Back in early February, just before the announcement of the government’s $42 billion fiscal package — its “Nation Building and Jobs Plan” — the RBA cut its policy rate another full percentage point, to 3.25%. (It cut again in April to 3%.)
The four-percentage-point drop in interest rates in the six months to February is by far the most-aggressive easing of RBA policy on record. With the global situation having gone from bad to worse over our summer, the RBA’s fear of severe recession in Australia clearly had intensified. It made sense for policy makers in Canberra to ensure that fiscal policy also put its shoulder more firmly to the wheel.
Other economists can speak for themselves, but my guess is that the majority of financial-sector economists with public-policy backgrounds at the RBA and Treasury also felt that the February stimulus package made a great deal of sense. The basic idea, of course, was that monetary and fiscal policies should work to support confidence and demand while the financial panic ran its course, the private sector “hunkered down” and the global economy contracted for the first time in generations.
As now is well known, the February package involved a “cash splash” worth more than 1% of GDP, to be followed by the construction of a new building in each school, as well as a variety of other projects (including increased public and community housing, subsidies for home insulation and hot-water systems, funding to fix road and rail blackspots and tax breaks to prompt the bring-forward equipment investment).
The February package, designed as it was to support aggregate demand as quickly as possible, unavoidably was a “rush job”. The second “cash splash” of $13 billion (following a first-round $10 billion in December) provided immediate support to consumers, household balance sheets and general economic confidence, with thousands of small and large projects to follow.
With the main boost from the stimulus scheduled to be felt sooner rather than later (Treasury chart), February’s package seemed reasonably well-structured to limit the severity of Australia’s recession.
A new building in each of almost 10,000 schools — an approach designed to ensure extra economic activity in every community in Australia — appeared as sensible as any of the alternatives on offer, assuming — as most observers did — that Canberra should do something substantial. Happily, the economic backdrop today is much brighter than it was back in February. Global financial markets and the global economy have stabilised and the threat of Great Depression II has receded.
We will never know how close the global economy and financial system came to catastrophic collapse. I sense we were much closer to the abyss than many realised at the time, and many realise now.
Stimulus size, “value for money”, withdrawal
The economic outlook remains uncertain — as always — but it seems rather less dire than it was 6-12 months ago. Australia’s recession looks at this point to be somewhat smaller than our previous two recessions. Indeed, rather than shrinking, as earlier expected, GDP is estimated to have grown by 1% over the first half of the year. There would be a strong case to “withdraw the fiscal stimulus” if the economy were “too strong” and threatening to “overheat”. But that scenario remains some way off. Indeed, as noted earlier, full-time employment still is trending lower, and wages growth and underlying inflation still are decelerating.
Given the brightening of the economic outlook since February, however, it makes sense now to put greater weight on “value for money” from the many thousands of projects under way, and less weight on sheer haste to support aggregate demand. In short, there’s now more time available to ensure that the new buildings in our nearly 10,000 schools, and the 20,000 or so new homes set to be constructed, are close to what is needed. Similarly, a sharper cost-benefit pencil can be applied to the larger projects.
Reports of obviously wasteful spending should be investigated and judgements made. I’ll leave those judgements to the experts; it (almost) goes without saying that most
taxpayers would want to minimise wasteful spending. On the total cost of the February stimulus package, many have noted that the estimated $42 billion price tag is a lot of money. And so it is.
But everything is relative and with federal revenues now about $300 billion per annum, $42 billion represents less than 4% of revenue over the standard four-year time frame. Scaled against the overall economy, $42 billion amounts about 1% of nominal GDP over four years. Moreover, with one year’s GDP now worth well over $1 trillion and Budget measures typically costed over four years, fiscal developments in the $30 billion-$60 billion range no longer are particularly unusual.
For example, upside surprises to revenue were worth $50 billion-$60 billion in each of 2005-06 and 2006-07. The permanent income-tax cuts announced in May 2006 and May 2007 each were costed in the $30 billion-$40 billion range, for first four years. Other policy initiatives announced over 2006-07 totalled $38 billion, in what were good economic times. February’s $42 billion package was more clearly designed to fit the particular economic circumstances of the day, “custom made” as it was to be strongly counter-cyclical.
Importantly, the fiscal boost to growth from February’s package is scheduled to peak this year and wind down automatically over the next year or two.
The option of cancelling projects already announced — like reversing earlier tax cuts — would tend to improve the Budget bottom line at the cost of reducing future activity. That might be a good or a bad idea, depending on your assessment of the particular projects, and your guess on whether the economy will be strong or weak over the next couple of years.
RBA policy and the Australian dollar
It is notable that the RBA’s policy rate still is 3%, notwithstanding governor Glenn Stevens having highlighted a desire to start lifting rates back “towards” more-normal levels as soon as the recovery is sufficiently robust. Moreover, I’m expecting that policy rate will remain at 3% after the RBA board meets next week, as it would be a rather bold decision for policy makers to start hiking while full-time employment still is trending lower.
Finally, another factor that feeds into the RBA’s decisions on interest rates is the exchange rate. As the US dollar trended lower between 2002 and 2008, the Australian dollar trended higher, as did many other currencies. With the US dollar in recent months hitting new lows for 2009, the Australian dollar has been heading towards 90 US cents and towards 60 on the trade-weighted index.
The appreciating Australian dollar mainly is a function of the depreciating US dollar, the sharp bounce-back in the Chinese economy and global commodity prices, and the general outperformance of the Australian economy. The fact that the stronger Australian dollar hurts the growth prospects of our tradeables sector — in particular, parts of the manufacturing, agricultural and tourism industries — is one of the reasons why the outlook for employment growth is weak, and why it seems to me that any RBA tightening cycle over the next six months will proceed rather cautiously.