Managing the Growth Shock

Warwick J. McKibbinDirector, ANU Research School of Economics

Presentation to the 2011 Economic & Social Outlook Conference, Melbourne 30 June, 2011

Focus

• What are the sources of Australia’s terms of trade boom?

• Is this boom likely to continue?

• What Policies should be followed?

Overview

• Global Drivers of Growth• China and India• Loose global monetary policy

• Risks– Fiscal Risks– Euro Crisis– Global Inflation and policy response

• Implications for relative prices of commodities• Appropriate Policy Responses

The Beginning of the Great Convergence?

Source: Angus Maddison, The world economy: historical statistics, 2003 and IMF World Economic Outlook database (September 2006) – Mark Thirlwelll, The Lowy Institute

Summary

• Global growth will be dominated by long term trends from – The emergence of the BRICS into the global

economy– Large demographic changes– Productivity and technical innovation– Impact and response to environmental problems

• BUT short term risks

-2

0

2

4

6

-2

0

2

4

6

%

World GDP Growth*Year-average

%

IMF forecasts* Weighted by GDP at PPP exchange ratesSource: IMF

2012200519981977 199119841970

The Risks: Fiscal Adjustment

A slow motion train wreck

Government Debt to GDP

Source OECD Economic Outlook 88 Database (November 2010)

Required change in underlying primary balance to stabilise debt by 2025 in per cent of potential GDP

Source OECD Economic Outlook 88 Database (November 2010)

The Risks: A Euro Crisis

Euro Area – Industrial Production2005 average = 100

70

80

90

100

110

70

80

90

100

110

Source: Thomson Reuters

2010

France

Index

Greece

Euro area

Germany

200820062006 2008 2010

Index

Italy

Spain

Portugal

0

40

80

120

0

40

80

120

ECB Lending to Banks*

* Lending provided through monetary policy operations onlySource: central banks

Greece

Fixed-rate tenders fromOctober 2008 onwards

€b €b

Ireland

Portugal

Spain

Italy

2010200920082007 2011

By national central bank

The Risks: Global Inflation

l l l l l l l l l l l l0

500

0

500

Fed Holdings of SecuritiesWeekly

Agency MBS Agency debt US Treasuries

US$b US$b

2 0002 000

1 5001 500

1 0001 000

J2008

S D M J S D M J S2009 2010

D M2011

IMF Food Price IndexSDR, 1995 = 100

Sources: IMF; RBA

Index

Year-ended change

100

130

160

100

130

160

-30

0

30

-30

0

30

LevelIndex

%%

2005 201020001995199019851980

Consumer Price InflationYear-ended

-4

-2

0

2

4

6

-4

-2

0

2

4

6

Source: Thomson Reuters

2011

Headline

%US

Core

Euro area

200920072011200920072005

%

Asia – Policy Interest Rates

2011

India

%

l l l l l l l0

3

6

9

12

l l l l l l l 0

3

6

9

12

%

2008201120082005

China

TaiwanThailand

Malaysia

Philippines

Indonesia

South Korea

2005

Commodity prices

• Rising because of– Real growth in emerging economies (Chindia)– Loose monetary policies raising nominal demand

Australia’s Terms of Trade

• Likely to fall from current highs because– Global supply response– Withdrawal of loose global monetary policy– Rise in non commodity price inflation

• Other factors– Global climate response will tax our comparative

advantage

Policy Responses

• Key is whether the boom in the terms of trade is permanent or temporary

• Optimal response should not be based on our ability to forecast but should manage the risks of alternative futures

Policy Responses

• Need not need to be a contracting sector– Expand effective labour supply– Allow foreign capital and labour to flow in

• Create a Sovereign Wealth Fund– Reduce excess demand which is increasing Dutch

Disease problems• Less relative price adjustment in the short run

– Creates a pool of foreign currency assets that can be used when the cycle turns

Conclusion

• Difficult but important to distinguish between relative price changes and global inflation – the 1970s is an important lesson

• Even though the terms of trade of commodity exporters is likely to decline, the overall income gains will be positive for the world as developing countries becomes wealthier