Australian exceptionalism

That the Australian economy has performed much better than other advanced economies is discussed in the book. Overall, however, the authors are quite pessimistic about Australia’s prospects. I don’t share that pessimism.

Economic outcomes in Australia in the global recession of 2008-09 have been very different from those of other developed countries, for a variety of reasons. Indeed, the Australian economy is the only advanced economy to have grown over the year to the June quarter of 2009.

GDP growth in advanced economies
(through the year to June qtr 2009)

Source: EcoWin

There are many references in the book to a boom in consumption and housing in the Anglosphere countries (including Spain) before the Great Crash of 2008. Part of the story in the book is that countries in the Anglosphere opened up substantial current account deficits over this period, and used them to fund consumption and/or dwelling investment. Looking to the future, it is likely that the share of output devoted to these activities will have to fall, perhaps significantly. In presenting this analysis, the authors include Australia as one of the countries in which this happened.

Private consumption and dwelling investment
(nominal)

Source: ABS Catalogue Number 5206.0, US Bureau of Economic Analysis,
Office of National Statistics, UK and EcoWin.

The proportion of economic output being directed to either household consumption or dwelling investment has been rising significantly in both the US and UK over the past thirty years. Outcomes for Australia were very different, however. In this respect, Australia does not look at all like the other members of the Anglosphere.

Private consumption
(nominal)

Source: ABS Catalogue Number 5206.0, US Bureau of Economic Analysis,
Office of National Statistics, UK and EcoWin.

Although dwelling investment as a share of GDP did rise for a time, the share of output devoted to consumption and dwelling investment together did not experience a trend rise as it did in the US and UK. Australia did not use its current account deficit to fund a boom in household consumption. Rather, robust consumption growth in Australia over recent years was accompanied by equally strong, or stronger, nominal income growth.

Let me turn quickly to Australia’s house price boom. It was fortuitous that Australia’s house price boom peaked in 2003. The ratio of dwelling prices to disposable income in Australia had fallen considerably before the crisis hit.

Australian house prices

Note: House price to income ratio series is the ratio of the weighted average of capital city median house prices to average household disposable income; Household disposable income is after tax and before the deduction of interest payments.
Source: ABS Catalogue Numbers 5206.0, 8752.0, REIA and Treasury.

Things might have been different had the global crisis hit in 2003. At that time, Australia was more vulnerable than it was in late 2008, by which time significant adjustment had already occurred. It was Australia’s good fortune that the economy segued neatly from a housing price boom to a terms of trade boom before the global financial crisis hit.

The Great Crash discusses some of the factors that the authors argue will count against countries’ economic prospects in the aftermath of the crisis. It argues that Australia has two strikes against it: the large current account deficits, and the fall in the terms of trade.

There is no question that Australia has run large current account deficits for a long time. However, for much of that time, and certainly in the last five years, the deficits have been funding very significant investment in the traded sector, particularly the mining sector. Presuming that China and India continue to grow strongly – and I think that is Ross’s central forecast as well as my own – then this mining investment is likely to have substantial pay offs, and Australia will be in an extremely advantageous position as a consequence of it. If this proves true, the current account will have funded productive investment.

On the terms of trade, what stands out for me is not that the financial crisis generated a fall, but that the terms of trade have remained as high as they have – more than 50 per cent above their average of the 1990s on the latest reading.

The consenting adult’s view of the current account

The book draws attention to two other macro issues. The first is the consenting adults’ view of the current account—the idea that we need not worry about the current account because it is the outcome of decisions by private individuals and they will pay the costs if things go wrong.

The Great Crash makes the point that if there is a financial crisis in which global capital markets effectively close down temporarily, and Australian banks borrow large amounts from these markets, requiring the government to come in and guarantee those borrowings (in extraordinary circumstances), then that changes the debate about current account deficits. I agree that the financial crisis should cause us all to reflect on the consenting adults view of the current account. Ultimately, however, I’m not sure how much it does change the debate — provided that such events remain extremely rare.

Asset price bubbles

The other macro topic the book draws attention to is the problem of asset price bubbles. The Great Crash concludes that monetary policy should take more interest in asset price bubbles. I agree that asset price bubbles are a huge issue. They were a serious contributing factor to the global financial crisis and, had the crisis turned up five years earlier, Australia might have been in a worse place than it is now.

Asset price bubbles are, potentially, a serious problem. Whether you can use monetary policy to deal with them is a thornier question. I have no objections in theory. My objections are practical ones. When investors are expecting double digit rates of return on assets whose prices are rising fast, and are perhaps not in their most rational frame of mind, then it is unclear whether raising interest rates by 0.5 per cent, or 1 per cent, or even 1.5 per cent is going to make much difference.

Furthermore, monetary policy lags make the whole operation very fraught. More work must be done here. The other relevant question is whether there are macro-prudential instruments that might be used to respond to suspected asset price bubbles in a more targeted way.

This post is part of a special series on The Great Crash of 2008 written by Ross Garnaut and David Llewellyn-Smith.

David Gruen is Executive Director, Macroeconomic Group, in the Australian Treasury.