Wednesday, February 10, 2010

Australia's financial outlook February 09

In November 2009 in its mid year estimates, the Australian Treasury was forced to alter its its projections to take into account better than expected economic performance. Even then, Treasury was forecasting that unemployment would still peak at at 6¾ per cent in the June quarter 2010.

Since then, the economy has continued to strengthen. As a consequence, the Australian Government financial statements for December 2009 show  a further strengthening in the Government's financial position with expenses lower, revenue higher than expected. That's good.

There were two especially interesting things in all this.

The first was the increasing probability that the Government would run up against the 2% real spending cap far sooner than anyone had expected. As I understand it, once Australian economic growth returns to trend, then the Government has committed to capping increases in real Government spend at 2% to speed the return of the budget to surplus. Given other pressures, this is going to be interesting to say the least!

Quoting Peter Martin from the Sydney Morning Herald:

Speaking to central bankers from around the world gathered to celebrate the Reserve's 50th birthday Happy Birthday RBA), Mr Stevens speculated about how monetary policy should be handled if governments restrained spending to pay off debts, creating a drag on economic growth. ''The straightforward answer is presumably that it would remain more accommodative than otherwise,'' he said.

Apparently in this speech, the RBA's Stevens mused about the problems that might arise should the combination of Government fiscal restraint, low inflation and consequent low interest rates encourage future asset bubbles. Perhaps the RBA should take this into account in setting rates, taking pre-emptive action?

I remember a speech a number of years ago from Australian economist Don Stammer in which he suggested that now we had entered a period of sustained low inflation, we could no longer expect the increased asset values of the past. Ha!

Don's arguments actually made a lot of sense. It was a bit hard to forecast the way in which plentiful liquidity in combination with low interest rates might lead instead to asset bubbles. Mr Stevens' comments make a degree of sense.  

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