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
