Goldilocks economy has a few tricks in case bears turn nasty

Jessica Irvine | Sydney Morning Herald | January 18, 2012

http://www.smh.com.au/opinion/politics/goldilocks-economy-has-a-few-tricks-in-case-bears-turn-nasty-20120117-1q4iz.htmlRotting

Christmas trees still line our streets, emitting a pungent reminder of festive days past, but a fresh season of economic doomsday-ism is already upon us.

By now you’re probably familiar with the Armageddon scenario: the collapse of the euro zone; a messy default by the Greek government on its debts; a freezing of the global credit system; and the dawning of a new economic ice age.
Happy New Year, everyone. So what exactly does 2012 hold in store for the Australian economy?
It’s true, there’s no shortage of things to worry about. There is a persistent risk things will go spectacularly belly-up for the world economy. More on that later.
On the home front, there are fears too as banks shed jobs amid slower borrowing and the high Aussie dollar hurts manufacturing and tourism. But here’s a tantalising thought: What if the Australian economy, while not poised for a stellar year, is nonetheless well poised for a relatively solid performance in 2012?
Amid all the gloom and doom about Europe, the Reserve Bank was at the end of last year still tipping economic growth to return to its historic average with inflation smack bang in the middle of its target range of 2 to 3 per cent. The official forecast is for a Goldilocks economy – one running neither too hot nor too cold.
Back when mining boom mark I was firing up in the mid-2000s, then Reserve Bank governor Ian Macfarlane predicted the end of the Goldilocks period of high growth and low inflation. He warned that, after a decade-and-a-half of uninterrupted growth: ”I think we will have to get used to seeing GDP growth rates starting with the numbers 2 or 3 rather than 3 or 4 for a time.”
When it comes to the macro-economy, economists have long observed a trade-off between growth and inflation. Too much growth and you get price pressures. Too much inflation and it becomes necessary to raise borrowing costs to slow growth and cool inflation, thereby preserving the value of incomes and savings.
Goldilocks economy is one growing fast enough to generate jobs, but not too fast as to create skills shortages and excessive wage demands and inflation. Not too hot, not too cold. But just right.
When it looked like the porridge bowl was boiling over in the mid-2000s, the Reserve lifted mortgage rates to an eye-wateringly high 9.5 per cent in 2008.
Inflation still crept up, hitting 5 per cent in the September quarter of 2008, just before the collapse of Lehman Brothers forced a quick reversal of strategy.
By contrast, we begin 2012 with the inflation genie back in the bottle. Underlying inflation over the year that ended in December is forecast to be 2.5 per cent (excluding the impact of the carbon price, 2.75 per cent with it). The economy is expected to grow roughly in line with its historic average at about 3 per cent thanks to continued strong mining investment and a rebound in production from the floods of a year ago.
In truth, however, unlike Goldilocks’s bowl of ”just right” porridge, the Australian economy is more like a bowl of piping hot porridge (the mining sector) covered liberally with fresh-from-the-fridge milk (manufacturing, tourism et al).
Unlike the previous mining boom when inflation pressure abounded, this time a turbocharged Australian dollar is acting as a significant restraint on other parts of the economy. A more cautious attitude by households to debt is also putting pressure on the retail and banking sectors. This is tough on employers and employees in these sectors, but, in the eyes of the Reserve, necessary if we are to avoid the inflation pressures of the first mining boom.
There is a tantalising possibility that this could be a relatively good year for the Australian economy, one in which we eke out moderate growth but without the inflation threat that has dogged us for so long. Importantly, the absence of price pressures leaves the Reserve Bank with more room to cut interest rates if needed.
Because – make no mistake – this is a Goldilocks economy slumbering under the shadow of some rather large market bears.
The papa bear in this picture is Europe and the potential for a messy default by any number of struggling European nations, Greece foremost among them.
An uncertain political and economic year also looms in the United States. A slowing in Chinese economic production also remains a big threat to orders for Australian mineral exports. Chinese growth figures released yesterday reveal the Chinese economy is growing at its slowest pace in 2½ years, albeit still at an annual rate of 8.9 per cent.
Perhaps the most important thing to grasp about the global economy in 2012 is that we face a situation of asymmetric risk. There is a good possibility the Europeans will muddle through and global growth, on average, will be simply tepid. But there is also a non-negligible possibility that turmoil in Europe could spark a global recession.
If it’s good, it’ll be moderately good. If it’s bad, it may be horrid.
If the latter proves to be the case, Australia will still be cushioned to some extent. Interest rates here are at about their historic average, providing plenty of firepower to stimulate activity with rate cuts.
Australia’s budget situation also remains the envy of the world. If economists’ worst fears were becoming reality, and jobs were under threat, you could be sure the Gillard government’s dedication to delivering a surplus would be the first overboard.
There remain reasons for optimism amid the gloom.
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