2 December 2019

Australia’s long smooth ride may get bumpier

Amongst observers of the Australian economy there is a lively debate about whether the economy has had a long boom or not. And, if so, why it has happened and whether it will continue?

Much of the debate stems from differing views on two key metrics.

On one hand, GDP growth recently clicked past 28 years without a technical recession. This is the longest period of expansion in Australia’s history and of any OECD economy, based on the available numbers. On the other hand, per capita GDP has fallen on three occasions during this period.

This issue has also attracted some high-profile international attention recently. In November 2018, US Fed chairman, Jerome Powell, said in response to a question after a speech: ‘Business cycles don’t last forever, unless you’re Australia, where they’re in year 27.” In contrast, the St Louis Fed published a note in September suggesting that Australia’s expansion is not that long when measured in per capita terms.

So, is it a long boom? The answer is, it depends.

Population growth a key driver

Clearly, by definition, these numbers suggest that population growth has been a key driver of the expansion in GDP.

However, this should not necessarily cast doubt on the value of the achievement. Being able to sustain strong migration without too many political and social challenges is an economic strength.

More importantly, Australia’s long boom is also due to very low economic volatility, which has made contractions in GDP less likely.

The volatility of local GDP is both at its lowest level ever and is the lowest of any OECD economy over the past quarter of a century. During that period, Australian GDP growth has been between 1.1% and 5.6%, whereas in the previous 25 years it ranged from -3.4% to 8.3%.

The smoothing of the business cycle is the main achievement that warrants attention and explanation. After all, it is not obvious that a medium-sized, commodity-exporter that has faced many global shocks, including the Asian Financial Crisis, Global Financial Crisis and the commodities ‘super-cycle’, should be the most stable economy in the OECD.

It is undeniable that good luck, including the geographic gifts of a large resource base and high exposure to fast-growing Asia, has played a role in supporting overall growth. However, this does not necessarily explain the reduction in volatility.

Economic flexibility

The key strength of the Australian economy is that it has proven to have the flexibility to absorb large shocks without recessions.

Part of the reason for this flexibility is the many market reforms of the 1980s and 1990s, including floating the currency, an independent central bank with an inflation target and powerful policy tool, a flexible labour market and a deregulated financial system.

Paul Bloxham, Chief Economist, Australia, New Zealand and Global Commodities, HSBC

However, some of these key strengths are now under threat. Very low global interest rates and fundamental changes in how prices and wages are set, as a result of globalisation and technology, are combining to make the RBA less powerful than it has been in the past.

For the first time in living memory, the central bank is running out of room to take constructive action by using its conventional policy rate. The cash rate is already at a record low of 0.75%, growth is sluggish, while inflation is below target. There are unconventional policy options, such as quantitative easing, but these are untested in Australia. Even the RBA Governor, Phil Lowe, has admitted that monetary policy is reaching its limits and has spoken about fiscal options in public more than ever before.

Although the Australian dollar should still be expected to act as a shock absorber, in a world where many central banks are using quantitative easing it is not clear that the currency will move as effectively as it has done in the past.

Fiscal policy in focus

This will mean greater reliance on fiscal policy to manage the economic cycle. Part of this will come as a result of the so-called fiscal ‘automatic stabilisers’. For example, when the economy slows, households typically receive greater social benefits and pay less tax. However, the recent fall in social benefits and rise in income taxes, despite slowing growth, calls into question the current effectiveness of these automatic stabilisers.

Another possibility is that the government makes discretionary changes to fiscal policy to manage the cycle.

Here is where a big challenge lies. Fiscal policy settings are not determined by an independent authority with the aim of smoothing the economic cycle, which is the RBA’s role. Fiscal policy is set with both political and economic imperatives in mind.

The government is currently sticking by its May 2019 campaign promise to deliver budget surpluses, which means it is running fiscal policy that is too tight in an economy that could do with support. The political imperative already appears to be overriding the economic imperative, at least in terms of managing the economic cycle.

Without a fiscal re-think, Australia's 28 year-long smooth ride may be about to get bumpier.

Paul Bloxham is HSBC’s Chief Economist for Australia, New Zealand and Global Commodities. This article originally appeared in The Australian on Monday, 2 December 2019.