US Recession: Implications for Australia

The news that the unemployment rate in the United States has risen from 5.0 to 5.5 per cent makes it clear that the US economy is now in recession, even allowing for all the usual qualifications about one months’ data, possible revisions and so on. Unemployment tends to be a lagging indicator, and the housing downturn still has a long way to go before it turns around. The long-overdue downgrading of the main mortgage insurers, MBIA and Ambac, and of course the further depreciation of the US dollar and increase in the price of oil add to the picture. Not surprisingly, this produced a big drop on Wall Street last Friday. What are the implications for Australia.

The most direct, I think, is for the Reserve Bank. It’s now virtually impossible for the US Fed to raise interest rates, so the prospects for US inflation staying low depend on the assumption that high prices for food and oil, and increasingly for US imports, won’t be reflected in prices more generally or in wages. The Australian economy is sufficiently fragile that it seems sensible to take a similar view here and not increase interest rates further (of course, that still leaves Australia with much higher interest rates, and lower inflation, than the US).

The second is for the sustainability of the economic model pursued by the whole English-speaking world for the last couple of decades with large trade and current account deficits and low to zero rates of household savings in traditional terms, offset by capital gains on housing and equity investments. Australia has followed this model even more enthusiastically than the US in some respects, and so far has not suffered any serious consequences. But a sudden loss of confidence in the US could easily spread here. I’d be a lot happier if our current account deficit was declining as a result of the mining boom. Instead, it’s now at record levels.

24 thoughts on “US Recession: Implications for Australia

  1. I worry when people stat talking about targeting the current account deficit cause so often they’re solution is protectionism. What we really need is to increase household savings but what policies can be used to achieve that.

  2. With many countries possibly facing their own financial calamity why not resurrect the world’s greatest treasurer; Paul ‘travel allowance’ Keating. Instead of turning out the odd newspaper column attacking his enemies and his colleagues he could save the world. A man with his record of delivering us to our own cockaigne will have people from around the world banging on his door seeking his help. Let’s all pray in the hope that Paul comes to our rescue.

  3. High interest rates are a very blunt instrument to curb inflation. A lot of innocent people get hurt along the way.Anecdotally things are very quiet. It has the feel of 89/90 about it.

  4. “the assumption that high prices for food and oil, and increasingly for US imports”…

    Excuse my ignorance, but why would US imports be subject to increasingly high prices, given that the $A has been steadily rising in value against the $US? Am I missing something?

  5. as an interesting join to that thought,

    i was talking to someone who knows a bit about miming the other day,
    and he told me that the squeeze is well and truly on now with costs for mining companies and to maintain value over the next five years something is going to have to be reduced,
    and that something is wages

    fast or slow downward pressure on mining wages would have a tremendous effect throughout the wider economy

  6. Hal900 @ 4:

    I think JQ meant that because the US dollar is dropping, the cost of imports to the US is rising. HTH, HAND.

  7. I would disagree with Prof Quiggin’s statement that ‘the Australian economy is sufficiently fragile…’ such that a further increase in the cash rate would not be warranted.

    If one looks at the various measures of underlying inflation, it is clear that they have been building for some time, indicating the presence of fundamental inflationary pressures. In addition, though they are lagging indicators, GDP data are strong, and the unemployment rate remains low, and the growth of China and India is still very strong. All of these factors mean that inflationary pressures will only tend to rise in the future, not subside (weakness in the U.S. not withstanding).

    In addition, there is the potential concern of rising oil prices. Although monetary policy should not respond to transitory inflation caused by rising oil prices, it should respond to changes in inflationary exepctations induced by such oil price changes. That is, if people begin to expect higher inflation, that provides an additional reason as to why the RBA should increase the cash rate.

    I would say that things are more like the early to mid 1970s, rather than 89/90. Chrisl, you are forgetting the role that monetary growth plays in creating long-term inflation. The only reason wy a country can experience a long-run increase in its general price level is due to monetary growth. As such, a rise in the cash rate, which is achieved via a reducation in monetary growth, is the only way to combat inflation in a long-run sense. That is a well established and accepted proposition and is standard monetary theory today.

    That is not to say that other policies, such as productivity enhancing microeconmic reform, or reductions in government spending, cannot affect aggregate demand in the short-run, and hence, affect inflation for a short time. These would be welcome moves. However, from the quantity equation, M.V = P.Y, it is money growth that causes inflation in the long-run, hence it is most appropriate that monetary policy focus on stablising inflation.

    Comments such as ‘innocent people get hurt along the way’ is the type of thinking that leads to lax monetary policy, and hence, high inflation, which would be a most unwelcome event.

  8. Fair points Greg, but aren’t higher fuel costs, and drought(leading to higher food prices) inflationary as well. I can’t see how raising interest rates would have any effect there.What I see happening is demand being choked off, leading to less work/sales and prices being readjusted.Effective but brutal

  9. Targeting the current account seems to be one of those ideas that gets recycled every few years, gets demolished with well-known arguments (current account measures net capital inflow, a bonus) then gets revived and recycled after a suitable period.

    To some extent the current account deficits are being driven by the minerals boom as a vast expansion of this sector puts pressure on local investment resources. The large deficits reflect the economic strength of the Australian economy.

    Rates of savings are low because governments have institutalised savings via superannuation schemes. The next step is to institutionalise large areas of investment in the economy via various futurefund arrangements for infrastructure, education and health and such things as the green car scheme.

    I agree that further interest rate hikes at this stage are unwise but the focus of policy at present should be on limiting inflationary expectations and their impacts on interest rates and wage demands. Food and fuel price increases are not necessarily inflationary – they are if they are accommodated by expansionary monetary actions and acted upon thus by participants in labour and capital markets. Otherwise they are juist relative price changes that influence the value of our real incomes.

  10. El Mono wrote “What we really need is to increase household savings but what policies can be used to achieve that”.

    I wrote about that in this article, nearly ten years ago. Of course, this much later it would need far more of a jolt to get us turned around fast enough. That is, it would need a wider initial age range applying the incentive for savings, getting started in third gear so to speak.

  11. Yes chrisl, you are correct about fuel costs and drought. I apologise if I gave the wrong impression, so let me make this clear. Monetary policy cannot do anything to lower fuel prices or drought, and thus, cannot do anything about the temporary rise in inflation that such events would bring. If monetary policy were tightened just because oil prices increased, that would force down some prices relative to others, to maintain a given rate of inflation, but there is no justification for doing that if the oil price shock is only a transitory phenomenon.

    My point however, is that if the oil price increases bring with them, not just temporary inflation, because of higher transport costs, etc, but also cause expectations of inflation to increase, then that is something monetary policy can address.

    When expected inflation rises, actual inflation tends to follow. Thus, a rise in the cash rate in such an environment can be warranted, because it may quell inflationary expectations and ensure the inflation target is maintained, transitory disturbances from drought, oil prices, and such factors which are outside the RBA’s control aside.

  12. PML, I like your 1999 article. The careful discussion of the notion of ‘application of theoretical models’ (to gain insights rather than prescriptions) is something that I’d like to put on readig lists. Very hard to come by these days.

  13. I think when the US started running huge current account deficits a decade or so ago (until then it was just big fiscal deficits they ran), Australian pointy-heads decided CADs are quite cool actually, nothing to worry about. If the greatest country in the world does it, then we’re in good company.

    Maybe the next world war will be between the high CAD countries and the countries they owe money to – China, Japan etc.

    We’ll be with the Americans again.

    I can’t wait.

  14. EG, if that was a request, feel free to use or adapt my materials while giving credit, subject to what News Weekly has to say, of course. They may even be able to give you hard copies.

  15. I’d be a lot happier if our current account deficit was declining as a result of the mining boom. Instead, it’s now at record levels.

    That’s very unfashionable ProfQ. I didn’t think anyone cared about current account and trade deficits anymore.

    Australia is transitioning from a mixed economy to a coal economy. This is inevitable, nothing can stop it. Non-resource exporters are being crushed by the dollar, import-competing manufacturers have all but given up, and tourism operators are being smashed by the double-whammy of high oil prices and the super strong AUD.

    These businesses will soon be gone forever, and they won’t be coming back. Believe me, I know.

    As for the US economy, speaking as someone who exports 70% of my product to the U.S. sales fell in a hole in January, and they’re still falling with no bottom in sight.

  16. I thought it was the trade deficit that mattered, and that has shown sign of picking up recently, hasn’t it? I mean, I thought I heard optimistic talk of a trade surplus ‘real soon now’…

    Can’t we finance a current account deficit permanently so long as we grow?

  17. Dont worry about the US, our own RBA has induced a recession in the construction industry – the last 12 months has been tough and things will get progressively worse.

  18. There are two ways to fix the balance of payments deficit.Increase the royalties on minerials and fuel.Secondly,rationalise the processes of Govts and the Public Service.There is just too much waste and duplication.

  19. The budget is allready in surplus, it is the private sector which is causing the currrent account deficit

  20. The budget is allready in surplus, it is the private sector which is causing the currrent account deficit
    Granted, but whether that is a problem depends on whether you agree with Professor Pickford or not.

  21. So Australia’s unemployment is at 4.2% while America’s is at 5.5%.

    I remember for years (decades?) America’s unemployment rate was consistently well below Australia’s. I was surprised several years back when our unemployment rate fell below America’s but I don;t think the differential has ever been this great.

  22. Today’s particular emerging recession is not the issue. We have always had recessions, and it is good for the illuminati to prattle on about some need to:

    fix interest rates
    fix CAD
    fix savings
    fix wages
    microeconomic reform
    etc.

    This generates nothing but a placebo effect.

    The fact is that the current economy always self destructs and, in the current case, the OECD nations have been artificially putting this off by; 1) population increase, 2) per capita debt increases and by 3) moving exploitation into the Third World (or Third World conditions into Western cost structures).

    If we could only find another Third World and plateau per capita debt and population – all will be well.

    However this is not so, so the standard process identified by Economic Prospects Division of OECD must re-assert itself.

    The key long-term scenario was depicted via their charts at page 40 [Llewellyn, Potter, Samuelson (1985) – ISBN 0710206003 – Economic forecasting and Policy ]

    The underlying problem is a generalised macroeconomic imbalance.

    The more politicians and bankers but their faith in silly things and try to spin their way out of recession, the more likely they will be frustrated by their own failures and will turn to military solutions for their own national interests.

    This is the only way similar situations have been solved in the past.

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