Why Australia hasn’t had a recession in 26 years

In previous posts I pointed out that Australia had avoided recession for 26 years by keeping NGDP growing at a decent clip.  Some commenters suggested that it wasn’t monetary policy; rather Australia was a “lucky country” benefiting from a mining boom.  That theory made no sense, because if your economy depends on highly volatile commodity exports then you should have a more unstable business cycle than countries with large and highly diversified economies.  In any case, recent data completely blows that theory out of the water:

Stephen Kirchner directed me to a very interesting article discussing the views of Warwick McKibbin, who used to be a governor at the Reserve Bank of Australia:

Former Reserve Bank of Australia board member Warwick McKibbin says the world’s central banks should switch to a system of using official interest rates to target nominal income growth to ensure huge household and government debt burdens are unwound safely. . . .

“Inflation has been a good intermediate step because it tied down price expectations and gave people confidence that central banks wouldn’t deflate away their assets,” he will tell a major economics conference in Sydney on Wednesday.

“That’s important when you have high inflation,” as was the case in the 1970s, 1980s and early 1990s.

“But you can still have the same credibility if you do have a very explicit income target, which is really growth plus inflation,” he says.

In Australia, he suggests, that would mean the Reserve Bank would attempt to keep nominal gross domestic product growth – which is essentially a measure of how much the economy is paid for the goods and services it produces – at about 6 per cent.

Australia has a population growth rate of 1.4%, and so there is no question that Australia’s NGDP growth rate should be higher than in the US rate (pop. growth = 0.7%), and much higher than in Japan (falling population).  Nonetheless, I think 6% is a bit high, I’d recommend something closer to 5% for Australia.  On the other hand even 6% would be far better than the sort of policy enacted by the Fed, ECB and BOJ since 2008.

Professor McKibbin, from the Australian National University’s Crawford School, acknowledges that in practice the Reserve Bank already pursues an “ambiguous nominal” income growth target because the formal 2-3 per cent inflation target is only applied “over the cycle”

This supports the claim of various market monetarists, who have suggested that Australia was a covert NGDP level targeter during the Great recession.

I’ve argued that the greatest advantage of NGDP targeting for countries like Japan is that it can reduce the burden of the public debt.  McKibbin makes a similar argument:

“What will matter over coming decades will be nominal income growth because the sustainability of high public and private debt-to-income ratios will need higher nominal income growth than in the past.

Interestingly, even a 6% target would seem to call for monetary tightening right now:

According to his proposed income targeting scheme today’s Reserve Bank cash rate of 1.5 per cent is probably too low given nominal GDP rose in the first quarter by 2.3 per cent from the previous three months, and by 7.7 per cent from a year earlier. “Right now the central bank has probably got loose monetary policy by nominal income standards and you’d expect they’d be tightening policy according to this rule because nominal income growth is rising quite quickly.”

Wait, that can’t be right.  My critics say Australia was just a lucky country benefiting from a mining boom.  It can’t possibly be doing well now that mining investment is collapsing.  Or am I missing something?

The Economist describes how smart countries handle re-allocation out of declining sectors:

As the mining boom petered out, the Reserve Bank cut its benchmark “cash” rate from 4.75% in 2011 to 1.5%. The Australian dollar fell steeply (it is now worth $0.76, compared with a peak of $1.10 six years ago). The cheaper currency and lower interest rates have allowed the older and more populous states of New South Wales and Victoria to keep the economy bustling. Property developers are building more houses, farmers are exporting more food, and foreigners (both students and tourists) are paying more visits: Australia welcomed 1.2m Chinese last year, a record.

Re-allocation doesn’t cause recessions, tight money does.

In the past, I’ve argued that Australia might want to target total compensation of employees, rather than NGDP.  That’s because changes in the price of mineral exports can cause big swings in NGDP, without having much impact on the labor market.  Over the past 12 months, employee compensation in Australia rose by only 1.4%, far below the 7.7% rise in NGDP.  You don’t see those sorts of discrepancies in the US.  So maybe Australia doesn’t need tighter money.

PS.  David Beckworth has a new policy paper on NGDP and the knowledge problem facing policymakers.  As usual, David includes some nice graphics.

 


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20 Responses to “Why Australia hasn’t had a recession in 26 years”

  1. Gravatar of Philo Philo
    18. July 2017 at 19:01

    “Re-allocation doesn’t cause recessions, tight money does.” What would Arnold Kling say?

  2. Gravatar of Benjamin Cole Benjamin Cole
    18. July 2017 at 19:56

    Nice post.

    I say go for 6% annual growth NGDPLT. Even in the U.S.

    Paraphrasing Barry Goldwater, “Timidity in pursuit of prosperity is no virtue.”

    The fancy word is hysteresis. I think. Anyway, demand creates supply. (I always think of hysterical economists when I see “hysteresis”).

    Supply lines are global too.

    The world is glutted with productive capacity in steel, cars, smartphones, copper, aluminum, food, everything. Gypsum, clothing, TVs, you name it. It would be almost impossible for the US to create demand-pull inflation.

    Housing is short in some parts of the U.S. due to property zoning.

    Fix that, and we obtain higher living standards, less inflation and room for years and years expansion.

    The Fed should let it rip. The right-wing should become as vociferous about property zoning as they are about the minimum wage. Actually, a lot more.

    The American Credo: I believe in free-markets (as carefully defined and circumscribed by my class and interest group)!

  3. Gravatar of Stuart Stuart
    18. July 2017 at 20:16

    I wouldn’t hold Australia up as a shining example of economic management, rather we really are the “lucky country”. We benefited enormously from two resources booms (2000-2006, 2008-2014), both driven by China, the first from economic growth, the second by post GFC stimulus.

    And reinforcing both is an equally large immigration-driven population ponzi.

    The second mining boom in particular inflated our currency, to the point where our domestic manufacturing industry has been wiped out (Dutch disease). Where our central bank should have cut interest rates to lower the currency they were hamstrung by a over-inflated property market. While our public debt is comparatively small our private debt is the 2nd highest in the world, after Denmark.

    Consequently Australia’s per capita GDP growth 2003-2016 of 16% is hardly better than the OECD average for the same period (15%). And since the second mining boom peaked the real average of employee compensation has FALLEN, even as labour productivity has risen (https://www.macrobusiness.com.au/wp-content/uploads/2017/06/Australian-workers-falling-income-share.jpg)

    Our real per capita growth has been in a downward trend since 2003 (https://www.macrobusiness.com.au/wp-content/uploads/2017/07/Real-per-capita-GDP-growth-660×509.jpg)

    Our real per capita wages have been falling since 2013 (https://www.macrobusiness.com.au/wp-content/uploads/2017/07/Real-per-capita-wages-and-salaries.jpg)

    The full quote, apt as ever, is:

    “Australia is a lucky country run mainly by second rate people who share its luck. It lives on other people’s ideas, and, although its ordinary people are adaptable, most of its leaders (in all fields) so lack curiosity about the events that surround them that they are often taken by surprise.”

  4. Gravatar of BP BP
    18. July 2017 at 21:27

    Um, Bill McKibben is an American environmentalist. Warwick McKibbin is an Australian economist. Different people. Otherwise, good article.

  5. Gravatar of Benjamin Cole Benjamin Cole
    18. July 2017 at 21:46

    BTW, Kevin Erdmann recently did a post that included a chart on Aussie and New Zealand house prices.

    Anyone who thinks foreign capital flows (born of trade deficits) do not affect house prices needs to ponder that chart.

  6. Gravatar of Alex Alex
    19. July 2017 at 00:12

    I think this is somewhat misguided, at least with respect to AU’s prosperity. Yes our GDP is pretty enviable, and indeed not wholly dependent on the mining boom. Yes the RBA was fairly quick to react and hasn’t pulled a Europe. But the main benefit has been population increases which have driven up Syd/Mel housing and both delivered capital gains (allowing debt to theoretically be retired) and housing construction booms in a few cities.

    And yet our GDP/capita is best described as ‘eh’; from 2003-16 we have ~16% rise vs 18% (GER); 11% (JPN); 13% (US) 15% (OECD average). Not bad, but not ‘once in a millennium mining boom’ either. And our population led growth has of course led to problems, not least of which is very high house prices and the associated mass of debt (compare AU @ ~120% GDP to US @ ~70%, JPN @ 60%, CAN @ 100%).

    This doesn’t invalidate anything the RBA has been doing, or even that it could have done better (note however that they are very much constrained – raising interest rates would lead to far higher repayment rates, well outside the poorly conducted stress testing done on our banks, and lowering rates further raises the question of how much these would pass through to consumers given that wholesale markets are a more important source of funds for AU banks). I would however suggest that the silliness of concentrating on GDP is not only because deflators are hard. NGDP has plenty of basic problems, and the RBA’s job is broader than making this 5% (as in they have encouraged the housing boom, despite the fact that this makes deleveraging harder – I know they don’t control population policy).

  7. Gravatar of Julius Probst Julius Probst
    19. July 2017 at 01:47

    So I think I read somehwere (The Economist, maybe?) that Poland also enjoyed an expansion that has lasted for 25 years now, at least they did not have a single year of negative GDP growth since 1992 (I don’t know about 2 consecutive quarters, which is the formal definition of a recession in the US, right?).
    Another “lucky” country then. No mining boom there, obviously.

  8. Gravatar of Benjamin Cole Benjamin Cole
    19. July 2017 at 01:54

    Intersintg pair of headlines, and back-to-back on news services…

    The US stock market is the world’s most expensive

    MarketWatch-17 hours ago
    There’s nothing new about U.S. stock market investors fretting about … (22.8), it is a far cry from China’s ratio of 7.4, which is second only to Russia (7.1) for being …
    Story image for china stock markets from CNBC
    China is increasingly becoming key for Israel’s high-tech industry

    CNBC-Jul 18, 2560 BE
    The first IPO (initial public offering) of an Israeli high-tech company on a Chinese stock exchange, Hong Kong, is expected within the year and Chinese …

    –30–

    And they say China is in a bubble?

  9. Gravatar of Benjamin Cole Benjamin Cole
    19. July 2017 at 02:45

    OT but interesting from CNN (Subtitle: Hockey has a big future in America)

    “The National Association of Realtors released a report Tuesday that said foreign buyers and recent immigrants spent an estimated $153 billion on American properties in the year ending March 2017. That was a 49% increase over the previous year and the highest level since record-keeping began in 2009.

    The purchases accounted for 10% of the total value of existing home sales in the U.S. The report did not include new homes.
    The breakdown of sales between foreigners and recent immigrants was about 50:50.
    Blame Canada
    America’s neighbors to the north were one big factor behind the surge.
    Canadian real estate investors nearly doubled their purchases of American homes over the period because of the relative affordability of properties in the States. Many Canadians have been squeezed out of property markets in cities like Toronto and Vancouver that have experienced rapid price gains.
    Canadians were the second biggest foreign purchasers of homes after the Chinese. Buyers from China shelled out nearly $32 billion over the period, while Canadians spent $19 billion.”

    —30—

    Add on: In my pen for hire business, I am exposed frequently to foreign buyers of US real estate but who operate through a JV with a local partner, or through US-based entities. I do not know if these foreign cash flows through US-based entities are counted as foreign buyers, but I doubt it.

  10. Gravatar of ssumner ssumner
    19. July 2017 at 03:32

    Stuart, Actually your data proves it’s not luck, If it was luck then Australia would have had a recession when the resource boom ended. Instead they adopted a monetary policy that weakened the currency, cut real wages, and maintained employment levels. Brilliant!

    BP, Yes, thanks. What was I thinking?

    Alex, Monetary policy doesn’t affect trend growth in RGDP, so no surprise there. What it can do is smooth out the business cycle. Population growth can’t do that, but monetary policy can.

    Australia has problems with it’s regulatory scheme for housing, too many high risk mortgages and too little new construction due to zoning. I wouldn’t be surprised if the property sector got into trouble if and when immigration slows.

    There is also no guarantee that monetary policy will continue to be sound, as the new RBA head seems to lean a bit too much toward the BIS school of policymaking.

    Julius, Yes, although that’s less surprising in developing countries. The same is true of China, India and many others.

    Ben, Interesting.

  11. Gravatar of Rajat Rajat
    19. July 2017 at 07:04

    Thanks for the post Scott. I think the RBA did very well in 2008-09 – they eased policy quickly and aggressively when needed and tightened again in late 2009 when the economy bounced back. But since 2011, I think they have been systematically too tight and not because they are targeting NGDP. In fact, until this year, NGDP had been growing at just 2-3% for quite some time and wage growth has been fallling. Accordingly, under NGDPLT, I think policy would remain loose now, despite the recent spurt due to higher commodity prices (which have partly retraced in recent months). It is frustrating to me that unemployment remains (5.5%) nearly as high as it got to in 2009, whereas it is below 5% in both the US and UK, which both experienced much more severe downturns in 2008-09.

  12. Gravatar of ssumner ssumner
    19. July 2017 at 07:47

    Rajat, I agree. I’d add that total employee comp has only averaged 2.6% growth over the past 5 years–that’s too low.

  13. Gravatar of Effem Effem
    19. July 2017 at 12:55

    Over the past 26 years per capita GDP in Australia has been nothing special. Further, the standard deviation of unemployment is significantly HIGHER than in the US.

    So what exactly do you accomplish by avoiding recessions other than the elimination of scary headlines?

  14. Gravatar of Lorenzo from Oz Lorenzo from Oz
    19. July 2017 at 21:28

    Effem: less severe bouts of unemployment and economic dislocation. Which are good things. Also, NGDP targeting is a way of flattening the business cycle, it doesn’t solve supply side issues (which drive long term trends in per capita GDP).

  15. Gravatar of Alex Alex
    20. July 2017 at 01:05

    Thanks for clarifying Scott, that makes sense.

  16. Gravatar of Effem Effem
    20. July 2017 at 13:12

    @Lorezo
    I don’t see how you can draw that conclusion. It’s only in this last cycle that Australia’s unemployment had less volatility so n=1. Over the entire period that scott references Austalia’s unemployment has had a higher standard deviation than that of the US. If i want a country with low unemployment volatility I would point to Germany and they are clearly not doing anything even remotely resembling NGDP targeting.

    If you want to change an entire central bank mandate which has taken decades to become credible, you need much much better evidence than pointing at australia. Based on your preferred metrics I would conclude we adopt Germany’s monetary policy.

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  18. Gravatar of John Papola John Papola
    23. July 2017 at 14:46

    Scott,

    I’m on board with NGDP level targeting. But this claim that it will help elevate public and private debt seems to be predicated on a bias towards higher inflation, right? I read this as “we can help debtors and screw creditors brought inflation… but it’ll be slow so it won’t bankrupt the creditors as bad”. Getting screwed in slow motion is still getting screwed.

    Seems to me like the only way to reduce REAL debt burdens is through real income growth. Nominal “help” is just default on your obligations by another name. Am I missing something.

  19. Gravatar of Cooper Cooper
    24. July 2017 at 12:25

    I would also note that Australia’s government spending as a share of GDP is much lower than in the bulk of the OECD, their government finances are in excellent shape with low public sector debts, their pension schemes rely on heavily incentivized private sectors savings rather than transfers and GINI-index measured income inequality is in line with the OECD average.

    All in all, Australia is doing a lot of things right.

  20. Gravatar of ssumner ssumner
    26. July 2017 at 06:54

    Effem, You don’t think smoothing out the business cycle would smooth out unemployment? Really?

    John, I want countries like Japan to stop redistributing money from debtors to creditors. NGDP targeting is neutral on that basis–check out the book “Less than Zero” by George Selgin.

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