This is an odd election. Most of the focus is on a time period after the next election and beyond, and most economic polices would have you believe the major concern is what will happened in 10 years’ time. It might be worth noting that right now, other than exports, the economy is pretty poor and could do with a jolt.
On Wednesday the ALP unveiled its 10-year plan and quickly the prime minister scoffed that it was meaningless because economic projections get pretty rubbery 10 years out.
He’s right but then he perhaps should look at his own government’s budget papers, which note that the centrepiece of the budget, the company tax cut, involves projections out to 2026-27.
Rather than scoff at such a time frame, the budget papers note, the tax cut “means higher living standards for Australians and an expected permanent increase in the size of the economy of just over 1% in the long term”.
Of course that “permanent increase” will come, at earliest, 10 years after the last tax cut (which is already 10 years away). But yeah, lock in the growth!
The prime minister, however, also noted that the budget only has projections for revenue and expenditure for the next four years and that “we recognise that there are risks associated with that”.
He ain’t kidding.
The four-year projections since 2000 have been out by, on average, about 2% of gross domestic product.
In the 1998-99 budget Treasury forecast the 2000-01 budget would come in with a surplus of 2.1% of GDP – instead it was a deficit of 0.1% of GDP (curse that dotcom bubble).
But the worst error was when, in the 2006-07 budget, Treasury predicted a surplus in 2009-10 of 1% of GDP. The actual result was a deficit of 4.2% of GDP:
The reason for the errors is a combination of “parameter changes’ – ie the economy ends up performing better or worse than expected – and policy changes:
Now this isn’t to say we shouldn’t have budget estimates four years out, or even that we should not have policy projections out to 10 years. Just that, when we start throwing figures around, no one should be suggesting they’re set in stone.
Economics is not physics. It is always good to read economic modelling projections with at least one eyebrow raised. Especially when the best you are getting for your spend of $8bn a year return is an extra 1.1% of GDP in 20 years’ time.
The problem is while we do need to worry about 20 years’ time, or even four years, what really should be in our focus is what is happening in the next 12 months.
For you might not realise it but you are currently living in an historic economic period. For the past seven quarters Australia’s annual real GDP growth has been higher than nominal GDP growth in trend terms. For that to happen the inflation measure used to calculate real GDP figures has to be falling – ie deflation.
This is fairly unprecedented. While it has now happened for seven consecutive quarters, from 1960 to 2013 it occurred in eight quarters in total:
We are in a period of very low levels of inflation growth. Annual underlying inflation growth in the March quarter was just 1.4% using the RBA’s “weighted median” measure – a record low.
We have had low inflation for so long now that many would scarcely remember what worrying about high inflation is like.
It never ceases to amaze me how sharply different our economy is from what it was when I was growing up. For the first half of my life inflation averaged 8.5% annual growth; for the second half it has averaged 2.5%.
That 2.5% is crucial because, from the middle of 1993, the Reserve Bank began for the first time targeting inflation. It set interest rates with the aim of keeping inflation between 2% and 3%.
So job well done on that score.
Yet now inflation is below that range but on Tuesday the RBA chose not to cut interest rates in an effort to get inflation back within the 2%-3% band.
Instead the governor basically suggested we should get used to below average inflation, noting “inflation has been quite low. Given very subdued growth in labour costs and very low cost pressures elsewhere in the world, this is expected to remain the case for some time.”
Back in 1997 inflation also dropped below 2% and, in response, the RBA cut rates by 1% point. But the economy was very different then and a heck of a lot healthier. Nominal GDP was growing at 5.9% compared with 2.2% now; real GDP growth was 4.8% compared with 3.2% and domestic demand in 1997 was growing at 6.6% compared with the pathetic 0.8% now:
But the biggest difference was at the start of 1997 the cash rate was 6%, and was cut to 5%, whereas thus 2016 saw the cash rate at 2.0% and has been cut to 1.75%.
Back then cutting rates to get inflation back within 2% to 3% was a no brainer. There was plenty of room to spare; now there is little. The RBA is clearly worried about locking in near zero interest rates – especially with uncertainties like the Brexit possibly coming.
It also has to worry about house prices – especially in Sydney, which took off when the RBA last started cutting rates at the end of 2011:
So we have a situation where demand in the economy is at historic lows, national income growth is essentially at recession levels, inflation expectations remain very low and, as a result, wage growth is also expected to stay at record low marks.
And in this situation we have a central bank wary of using its main weapon to stimulate the economy.
So all eyes turn to the fiscal side.
But there we have the media going into conniptions over suggestions the budget deficit projected by the ALP in four years’ time might be larger than that of the LNP and where critics of plans to give big business a tax cut worth $8bn a year are called anti-business.
And now it seems the whole purpose of the budget is to retain a AAA credit rating.
I’m all for long-term thinking; I’m all for policy that is well thought out and planned. But right now both parties seem to have more of an eye on the horizon and are ignoring the rocks immediately ahead.
