Is Australia in danger of falling into the “Swedish Trap”?

This from Morgan Stanley via the WSJ:

“The economic transition in Australia from the resources boom to east coast recovery has stalled,” it said.

Morgan Stanley says most commentators are underplaying the impact of falling commodity prices on the economic outlook.

The price of iron ore, the country’s biggest export, has dropped 40% this year, and coal also is sliding. An end to an investment boom in mining has thrown many Australians out of well-paid jobs.

The bank notes the Australian dollar’s fall hasn’t kept pace with the decline in commodity prices.

The currency will need to fall to around 0.76 to the U.S. dollar, much lower than just under 0.90 now before it starts to support growth, Morgan Stanley said. It doesn’t expect that to happen until late 2015.

And if this wasn’t gloomy enough, the bank says weak wage growth and rising joblessness will keep a lid on household spending.

Morgan Stanley thinks unemployment will drift toward 7% over the coming year, up from a current 12-year high of 6.2%, making it one of the few commentators to expect things to worsen. The government will release employment data for October on Thursday.

So what should the government do?

The bank urges more rate cuts, from the current record low of 2.5%, and an end to belt-tightening by a government that’s worried about growing public debt.

Morgan Stanley says there’s a 50% chance the central bank will need to further cut rates, despite Gov. Glenn Steven’s public statements that monetary policy has done all it can do.

And this from RBA Governor Glenn Stevens:

Reserve Bank of Australia governor Glenn Stevens has warned about the creation of asset bubbles in the current low-interest rate environment.

Addressing members of the Committee for Economic Development of Australia (CEDA) lunch in Adelaide, he said monetary policy aimed at encouraging business investment and generating employment amid global economic weakness was in danger of creating a housing bubble in Australia.

Australia´s record is unique among the rich countries. It´s last recession was almost a quarter century ago! It weathered the Asia crisis of 1997/98 and the international crisis of 2008/09.

Will the RBA do now what the Riksbank did four years ago and “succumb” to “bubble afflictions”?

Some illustrations are in order.

The first chart shows that Australia avoided the 2008/09 worldwide slump because it did not let NGDP tank.

Australia Swedish Trap_1

Lately, NGDP has been converging to trend from above, while the US is content in keeping NGDP very much depressed,

In Australia the exchange rate behavior is key for nominal stability. The next chart shows how the exchange rate devaluation offset the fall in commodity prices during the 1997/98 Asia crisis.

Australia Swedish Trap_2

That has been true more generally as the next chart indicates (note how monetary policy was expansionary in 2008/09, when the exchange rate depreciated by much more than the fall in commodity prices)

Australia Swedish Trap_3

The next set of charts show that the more recent convergence of NGDP to trend was the result of tighter monetary policy in 2011-12, when the exchange rate did not follow the fall in commodity prices. But the “appropriate” exchange rate trend (i.e. adequate monetary policy) has since resumed.

Australia Swedish Trap_4

The world economy is in shambles. Australia´s economy (with few others) has been a “breadth of fresh air”. I hope it doesn´t surrender to “bubble foolishness” like Sweden did.

2 thoughts on “Is Australia in danger of falling into the “Swedish Trap”?

  1. You see, free enterprise does not work at low interest rates. You get bubbles. So to avoid bubbles you need tight money. But if you maintain tight money long enough you get very low interest rates. Which will give you a bubble…. so you have to tighten money even more.

  2. Pingback: Crimes against the economy and, by extension, against its citizens – NGDP Advisers

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