Australian Economy

Australia’s economy remains afloat – but there are choppy waters ahead | Greg Jericho

The OECD has released its latest outlook and, as with recent reports by the International Monetary Fund, Reserve Bank of Australia and the October budget, Australia is predicted to tread a very fine line over the next few years.

First the good news: the OECD expects next year that Australia’s economy will grow as well as any of the major economies. The projected 1.9% growth is better than Japan, Canada, France, the United States and Italy, and unlike Germany and the UK we are not projected to go backwards:

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In 2024, things get a bit tougher, but our projected 1.6% growth is still above the G7 economies, and doing a lot better than the UK, which is projected to be completely smashed over the next two years.

So that’s the good news. The bad news? Are we really trying to say that 1.9% and 1.6% annual growth is good? Hoo boy.

If at any other point in the past 70 years we were talking about such low growth, you would ask “so we’ll have a recession?”.

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Now, I am not saying we are about to have a recession, but it does bear noting that being better than most other economies is to clear a very low bar and we are in for a rough time.

In retrospect, the ructions we are facing now were inevitable. After you survive a heart attack, you are not shocked your 5km running times are a bit slower, so we should not be surprised our economy is dealing with a few issues.

However, no one anticipated Russia’s illegal invasion of Ukraine.

To get some idea of its impact – and also understand why mining companies are laughing themselves silly – the OECD estimates that the level of global GDP being devoted to energy use is now higher than it was during the oil crisis in the 1970s and 1980s:

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Gas companies are the big “winners” – the share of GDP spent on gas went from 1.8% to 3.7%. Coal expenditure also surged – up from 0.6% of global GDP to 1.5%.

Call me crazy but that sounds very much like a windfall.

That has very much exacerbated inflation.

Australia is not alone in seeing prices rise quickly. And, as with the GDP growth forecasts, here again we’re doing OK compared with other nations:

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One interesting note from the report is the estimate that demand factors as much as supply issues are driving Australia’s current inflation growth:

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There are a few caveats with this estimate – the OECD notes that it is rather tricky to separate the causes and that “the share of inflation classified as ambiguous rose somewhat in Australia, Canada, the United Kingdom and the United States, but not in other countries.”

But it does explain one reason why the RBA has been raising rates despite wages lagging well behind inflation.

The demand is not being driven by wages but by the ability to spend stimulus money now that lockdowns have ended. And one area we have really seen this is in the services sectors of transport and dining out:

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This experience is being replicated somewhat around the world, and so everywhere around the world central banks are hiking interest rates.

In the past six months more than half of the advanced economies have increased interest rates by at least 1.5 percentage points – a first in over 40 years:

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But the OECD notes one problem with this – when all countries hike rates, the impact on GDP is greater.

For a median-sized advanced economy such as Australia the impact on tight monetary policy over three years lowers GDP by around 0.9% if we are acting essentially alone. But in the current case where all nations are raising rates, the projected three-year reduction in GDP is around 1.3%:

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Worse, however, is that while the impact on economic growth is increased when all nations raise rates together, the impact of lowering inflation is reduced:

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The reason is exchange rates. If, for example, Australia raised interest rates while the US didn’t, our currency would get stronger, and things imported from the US would get cheaper – thus reducing inflation.

But when everyone is raising rates, that impact does not occur.

And one factor that might make Australia more at risk of a greater than average slowdown is that Australia holds more variable-rate mortgages than other nations:

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This means increased rates affect not only the level of new loans being taken out but the payments of existing mortgage holders, more than in other nations.

It does set up a worrying situation where all economies are racing to raise rates not to just slow inflation but because other nations are also doing so. This in turn hurts economic growth more and lessens the impact on inflation.

Worse, however, is as the OECD notes, “the combined shock from the additional rise in interest rates is greater in smaller, more open economies” – of which Australia is one – so we may find ourselves swamped by the waves from overseas.

The OECD currently sees our economy growing as well as other nations for now, but its report also highlights the big risks that lie ahead.

Greg Jericho is a Guardian columnist and policy director at the Centre for Future Work

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