Most of the attention in discussion of the December quarter national accounts was focused on the negative sign of the aggregate GDP number, combined with the seemingly unkillable belief that there exists a “technical definition” of a recession, namely two consecutive negative quarters. An aggregate number anywhere zero is pretty good by comparison with the world economy as a whole, so the real interest is in the components. Ross Gittins The Brothers Grimm move has a nice piece going through the details, and concluding, unsurprisingly that we are in a recession. The aggregate number has some negative bits that should be temporary (inventory rundown and the statistical discrepancy) but against that, we are bound to get more bad news on exports over the coming year. Our terms of trade, which rose consistently during the term of the last government (one reason things turned out so well in terms of the macroeconomy) have started turning down, but there is a long way to go.
The (possibly temporary) good news is that household savings have risen greatly, to 8 per cent of income. It’s reasonable to assume that this reflects a combination of precautionary saving as the prospect of recession hits home, reactions to the huge capital losses of 2008 (reversing the process by which illusory capital gains prompted people to run down household savings), less home equity loans (can anyone find me some data on this?) and the fact that some part of the money handed out in the stimulus package was saved. Unfortunately, as the recession hits home we are likely to see lots of households with declining income, raising the question of whether the improvement in savings can be sustained.
There’s been a lot of confused discussion about the stimulus in this context. On the one hand, it’s obviously desirable that the stimulus should increase consumption. On the other hand, the resolution of a financial crisis requires, among other things that household balance sheets are made sustainable, that is, that household debt should be brought down to manageable levels relative to income (not relative to inflated asset values). This is a tricky problem, but its obvious that if households are going to increase savings, and aggregate demand is not to decline too much, someone else needs to increase their net demand. Since private investment and export demand are almost certain to shrink, that leaves government as the only candidate.
It seems pretty clear that, as well as providing cash to households governments are going to need to increase their own expenditure, and, given the fragility of the economy, these increases will need to be sustained for some time. That in turn requires a credible promise to service and repay the resulting debt, which means higher taxes. The obvious candidates for higher taxes are the upper income earners who did best out of the bubble. In this context, the government’s apparent determination to press ahead with the tax cuts, targeted at this group, promised in the radically different environment of late 2007 seems like a recipe for disaster.
(Nicholas Gruen has some more on this)