Someone has been listening

And that someone is in far-away Australia, a country that has avoided recession for a quarter century. Things started going wrong for the past few years, when it ignored its NGDP level target and started worrying about home prices.

Read this: The new RBA governor should target [nominal] growth, not inflation:

If you had told Australians 10 years ago that official interest rates would fall to 1.5 per cent, many would have jumped for joy.

Aside from homeowners, Australians are not feeling much joy these days. This is despite the lowest interest rates in 70 years, low inflation, economic growth close to normal and the unemployment rate – though not ideal – still lower than it was during the Sydney Olympics.

So why are we feeling so miserable? The reason is that most Australians’ incomes are going nowhere.

Wages are growing at recessionary levels, profits for small and medium-sized businesses are flat and the budget deficit constrains government spending.

Overall, Australia’s “nominal” growth rate –  the growth in actual money in our pockets – has fallen from 7 per cent per annum in the decade before the GFC to only 2 per cent today.

A large part of it is also due to the out-of-date inflation target that the Reserve Bank of Australia has been tasked with hitting.

A better option would be for the RBA to target a reasonable rate of growth in Australia’s nominal GDP.

In other words, we should replace the RBA’s existing inflation target with a nominal GDP target.

Stronger growth in nominal GDP would provide workers and businesses with greater means to pay their debts, hire more staff and invest in new plant and equipment.

Amen

HT Virgílio

Australia tries to find “balance”

Being one of the very few countries (two others are Poland and Israel) whose monetary policy managed to avoid a recession on the heels of the 2008-09 crisis, Australia is a natural object of Schadenfreude!

Two recent articles “wish harm” on Australia

1 Is Australia Sliding Into Recession?

Recent data prompt economists to warn Australia may be ripe for first recession in 24 years

2 Goodbye to the lucky country

What if our economic growth stalls altogether? Worse still, what if we slip into recession?

These are not farcical questions. Figures released this week recording just 0.2 per cent growth in Gross Domestic Product for the June quarter, and just 2 per cent for the year to June, were extremely weak. Indeed, without a one-off increase in government defence spending, the quarter would have recorded zero growth.

There´s as usual some luck involved. In the case of Australia, it did no harm that immediately before the crisis hit, it was effecting an “excessively” expansionary monetary policy, as indicated by NGDP growth and it´s level relative to the trend path. The two charts illustrate.

Australia tries for balance_1

Australia is the prototype commodity exporting country. In such cases, the exchange rate should move to offset commodity price or terms of trade changes. That´s what´s reflected in the next chart, with two notable exceptions. In 2004-07, the exchange rate doesn´t move, while commodity prices are rising. That boils down to an expansionary monetary policy. In the first set of charts that is reflected in the upward trend taken by NGP growth and the rise in NGDP above trend.

Australia tries for balance_2

In 2001-13, the RBA tightened policy. That is implied by the fact that falling commodity prices were not accompanied by a depreciation (fall) in the A$ relative to the dollar. In the first set of charts, we observe a strong fall in NGDP growth.

We note that NGDP growth has done a lot of “swinging” after the crisis hit. Scott Sumner thinks that the RBA has “chosen” a lower growth rate for NGDP. That may be right, and I put that new trend growth at 4%. If that´s correct, we may soon find Australian NGDP growth settling around that level, implying that NGDP will evolve close to a level path that will be below the previous one.

There´s, however, always the risk that the RBA, if it starts worrying about debt levels and house prices, will make the mistake the Riksbank made in 2010. Let´s hope that doesn´t occur!

Update: In Australia, the post crisis “NGDP growth swings” are reminiscent of the “Volcker NGDP growth swings”. What Volcker was trying to do was find a stable path for NGDP. That was “bequeathed” to Greenspan, and the “Great Moderation” ensued, until Bernanke lost it!

Australia tries for balance_3

Revisionist Thoughts: Was Australia just luckier than most?

This post was motivated by Scott Sumner´s musings about Australia: Australia´s Great Stagnation:

It looks like the Great Stagnation has hit even Australia.  In an earlier post I pointed out that Australian NGDP rose at a 6.5% rate from 1996:2 to 2006:2.  Then we had the Global Financial Crisis, and Australian NGDP growth slowed to . . . er . . . it stayed at 6.5% from 2006:2 to 2012:2.  No tight money and no recession in Australia.

Some important facts about Australia:

1 NGDP and Trend

Revisionist Thought_1

2 RGDP & Trend

Revisionist Thought_2

Notice that when NGDP climbs above trend, RGDP falls below trend!

Zooming in (circles explained later)

Revisionist Thought_3

Revisionist Thought_4

What explains the counterintuitive fact that RGDP falls below trend at the same time commodity prices take off?

Revisionist Thought_5

The rise in NGDP translates into a rise above target in core inflation.

Revisionist Thought_6

The 200 basis points increase in the cash rate (equivalent to the Fed´s FF rate) just goes to show that interest rates are bad definers of the stance of monetary policy. Despite the increase in the cash rate, inflation and NGDP were moving up, indicating monetary policy was “too easy”!

Revisionist Thought_7

With Australia being a commodity exporter, another way to gauge the stance of monetary policy is by comparing the move in the exchange rate to the dollar and commodity prices. Monetary policy is “just right” if a rise in commodity prices is accompanied by an appreciation of the Aussie Dollar (USD/A$) and a fall in commodity prices goes hand in hand with a depreciation of the exchange rate.

The chart below shows that in 2004-07 monetary policy was too loose, consistent with NGDP climbing above trend (and inflation increasing). Monetary policy was tightened in 2011-13, consistent with NGDP converging to trend and inflation decreasing (see circles in NGDP & Trend chart above).

Revisionist Thought_8

At present, NGDP is back on trend (actually just a “whisker” below it). What happens next? Will Australia go the way of Sweden, Israel and Poland, or will it get “smart”?

In the case of Sweden things started unraveling when the Riksbank decided to “prick” a housing “bubble”. According to the FT:

Sweden’s central bank has been lambasted by critics for trying to use interest rates to combat signs of a housing bubble. It lifted rates in 2010 and 2011 as it publicly worried about what it saw as high household debt levels.

In the case of Israel, it may not be coincidence that NGDP began a systematic deviation from trend when Ms Flug took over at the Bank of Israel. Maybe she prefers the role of Finance Minister:

Speaking at a Calcalist conference, Governor of the Bank of Israel said today, “Exceeding the 3% fiscal deficit target will expose the Israeli economy to significant risk and will be liable to harm us citizens. We must show responsibility and take into account the consequences of our decisions over time. Israel’s structural deficit, the deficit not subject to one-time shocks, is already one of the highest in the western world.”

This is what happened:

Revisionist Thought_9

In the case of Poland, it took three years, but in late 2011 Poland finally botched up and went the way of the majority of countries, letting NGDP fall way below trend. They didn´t (correctly) react to the 2007-08 oil price rise, like the US, UK, EZ, etc. and fared well, but didn´t resist when oil prices picked up again in 2010-11, when, among the initial group, only the ECB was dumb enough to react.

Revisionist Thought_10

By talking about house prices, the RBA is tempting the “fate” that hit Sweden and Israel. Scott links to an article in a subsequent post:

The Reserve Bank of Australia’s surprise decision to defer its widely anticipated April rate cut for at least another month might have been influenced by the increasingly pricey housing market, which it regards as posing a real “dilemma”.

This, unfortunately, has been going on for some time. Last September, RBA Governor Glenn Stevens was warning of bubble risk 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.

And the next chart compares two “bubbles”.

Revisionist Thought_11

Please, Governor Stevens, start thinking smart!