GDP data released today shows the Australian economy grew at a disappointing -0.5% over the last quarter or 1.8% over the year. This was the largest quarterly fall in growth since the GFC in 2008.
The pessimists are out in force today saying the economy is collapsing. The optimists say this is a one-off blip that we’ll bounce back from next quarter. The truth is in the middle. Today’s negative number isn’t as much of a crash as it seems … but that’s only because Australia’s economy has been weaker than we thought for some time.
This data is a wake-up call that must shake the complacency of our policymakers and cause them to change the direction of economic policy.
Strong growth in the first half of 2016 was too good to be true
Australia’s GDP growth in the first half of this year was too good to be true. A solid 2.8% in December 2015 lifted to a strong 3.0% in March 2016 and hit a red-hot 3.3% in June 2016.
But the devil was in the detail. The June numbers were flattered by bumper public spending (the listing of a new drug for hepatitis C and the purchase of Chinook helicopters) and the accounting implications of state government privatisations. Swings in inventories and weather related trade impacts affected several previous quarters. Seasoned economists normally take these anomalies in their stride because GDP statistics are not an exact science and irregularities normally wash each other out.
But this time the anomalies conspired to trick Australians into thinking that GDP was booming in the first half of 2016.
We unpicked each of these abnormal impacts on reported GDP growth over the past several quarters to create a view of economic growth adjusted for anomalies (orange line in the chart above). Rather than crashing in the last quarter, this adjusted view of GDP growth has been tracking mildly down for some time.
Australia’s economy has been tracking sideways through 2016
This weakening profile is far more consistent with the other data coming out of the economy through 2016 – including soft labour markets, rising budget deficits, weak wages growth and falling inflation.
For example, the most comprehensive measure of labour market health – the total number of hours worked in the economy – slowed down markedly in early 2016 around the same time as our adjusted GDP growth softened. Inflation also weakened at the same time. All of this is evidence that the economy wasn’t as strong in the first half of 2016 as the headline GDP numbers led us to believe.
Time for a policy U-Turn
The ‘strong but wrong’ GDP numbers in the first half of 2016 lulled Australia into a false sense of security. Now it’s time for a wake up call: our current policy settings aren’t working, it’s time to change direction.
The heart of the problem is that Australian policymakers have relied too heavily on monetary policy to stabilise the economy and, for the most part, basically ignored fiscal policy and put structural reform in the too hard basket. This stems from an old shibboleth in Australian politics that supporting the economy with fiscal policy is expensive – resulting in nasty deficits and burdensome debt – but stimulating through monetary policy is somehow ‘free’.
But monetary policy isn’t ‘free’ – it has real costs.
For a start, monetary policy works (in part) by encouraging the private sector to take on more debt. As interest rates have fallen to record-lows, Australian households have leveraged up to the eyeballs. Fiscal policy, on the other hand, works by taking on more public sector debt. So when it comes to supporting the economy through future weakness, should we be using monetary policy to encourage households to lift their debt even higher than the current 125 per cent of GDP they are currently holding; or should we use fiscal policy which would push up gross public debt currently sitting at just 40 per cent of GDP. It seems obvious that the public balance sheet is the safer option to take on more leverage if that is required to support a weakening Australian economy.
The second cost of monetary policy is its growing drag on productivity. We have long since passed the point where lower interest rates are stimulating entrepreneurship. In fact, low rates are having the opposite effect, inducing Australians to pour their funds into existing assets like housing and equities on the hope that lower rates will increase their value. By contrast, effective fiscal policy can increase productivity through investments in infrastructure which improve growth over time.
The third cost of monetary policy is its impact on inequality. As interest rates have fallen, asset prices have surged – delivering a windfall gain for the wealthy owners of equity and property assets. But low rates have slugged younger people with higher house prices and reduced the weekly budget of older people on fixed incomes. Fiscal policy, by contrast, can be targeted to reduce inequality.
Everyone is getting fiscal
For precisely these reasons, the world is moving to embrace fiscal policy in almost every country – except it seems Australia.
In the US, the incoming Trump administration is pivoting from monetary to fiscal policy. One of Trump’s key economic advisers, Anthony Scaramucci, said recently the incoming administration would be “replacing emergency-level rates with fiscal stimulus”. Trump himself is proposing large fiscal expansion to fund tax cuts and a trillion-dollar infrastructure program.
In the UK, Teresa May has been openly critical of low interest rates, saying they have caused “some bad side-effects”, while her Chancellor Philip Hammond has reversed previous Tory austerity policies and is now ramping up borrowing to invest and spend.
What does MYEFO need to do?
The IMF last week encouraged Australia to take a more active fiscal policy, including increased public investment, to “support demand, take the pressure off monetary policy, and insure against downside growth risks”.
What would it mean to implement the IMF’s advice in the forthcoming MYEFO?
First, we have to take a broader view of Australia’s credit rating. The government’s fiscal paralysis is partly motivated by fear that we’ll lose our AAA rating. But if that does happen, it will have as much to do with Martin Place as it does with Treasury. Standard and Poors has clearly said that the major threat to Australia’s credit rating is high household debt (supported by easy monetary policy), not high government debt (from expansive fiscal policy). The best way to safeguard Australia’s rating would be a balanced policy approach.
Second, we have to recognise that there is a difference between government spending on recurrent expenses and investment in assets. Australia needs a short term plan to increase spending on infrastructure and other productive public assets (especially while interest rates are so low) and a medium term plan to reign in recurrent spending over time.
Finally, we need to think of fiscal policy as more than just a means of buying votes from interest groups, or stabilising demand. Effective public investments can boost GDP over the long term by creating demand, boosting business confidence, lifting growth and ultimately reducing, not increasing, the debt/GDP ratio over time.
A more mature role for fiscal policy would take the pressure off the RBA, give us a healthier policy mix, reduce risk in financial markets and take some froth off the housing market.
Whatever your politics, unmooring Australia from its historic aversion to fiscal policy is a worthy goal.
* Dr Andrew Charlton is founder of AlphaBeta, an economics consultancy based in Sydney and Singapore. He was previously senior economic adviser to the Prime Minister and Australia’s senior official to the G20. He is the author of Fair Trade for All (OUP) with Joseph Sitglitz, Ozonomics (Random House), Man Made World (QE44) and Dragon’s Tail (QE54).