Managing the Growth Shock

Warwick J. McKibbin
Director, 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

World GDP Growth*

Year-average % %

-2 1970

1977

1984

1991  IMF forecasts

1998

2005

-2 2012

* Weighted by GDP at PPP exchange rates Source: IMF

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

Eur Area In ustrial r

2005 Index Germany 110 r = 00

ucti n
Index

110 Italy

100 Euro rea 90 Fr nc Spain 80 Greece Portugal

100

90

80

70

2006

2008

2010

2006

2008

2010

70

Sourc : Thomson R ut rs

ECB Len ing t Banks*

By national central bank b
Fixed-rate tenders from October 2008 onwards

b Ireland Spain 120

120

80 Greece 40 Italy Portugal 0 2007 2008 2009 2010 2011

80

40

* Lending provided through monetary policy operations only Source: central anks

The Risks: Global Inflation

Fe H l ings f Securities
Weekly US$b
 Agency BS  Agency debt  US Treasuries

US$b

2 000

2 000

1 500

1 500

1 000

1 000

500

500

S D 2008

J S 2009

J S 2010

M 2011

IMF Food Pric I d x

SDR, 1995 Index 160 130 100 % 30 0 -30 1980 Year-ended change Level 100 Index 160 130 100 % 30 0 -30 2010

1985

1990

1995

2000

2005

Sources: IMF; RBA

Consumer rice Inflation

Year-ended % 6 4 2 0 -2 -4 US Headline Euro area % 6 4 2 0 -2 -4

Core

2005

2007

2009

2011

2007

2009

2011

Source: Thomson Reuters

Asia olicy Interest Rates

% %

12 India Indonesia

12

6 China 3 Taiwan 0
l l l l l l l l l

Philippines South Korea Malaysia Thailand

l l l l l

2005

2008

2011

2005

2008

2011

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