A recent Op Ed originally published in the business pages of the Melbourne Age, 15th December 2010.

The re-emergence of the mining boom, temporarily de-railed by the global financial crisis, as a key driver of Australia’s economic prospects has been accompanied by a revival of the talk about a ‘two-speed’ economy that became commonplace during the first phase of the boom. This talk holds that the mining sector is booming while the rest of the economy is “struggling”; and similarly that the north and west of the country are powering ahead while the south-east (where the bulk of the population lives) is stagnating – and, inevitably, that the Government ought to do something about it.

This talk was simplistic then, and it is simplistic now.

Significant divergences in the economic fortunes of different regions or sectors of an economy as large and diverse as Australia’s are by no means unusual.

In the last two decades there has never been a gap of less than 2 percentage points between the annual growth rates of the fastest- and slowest-growing States or Territories. And that gap has actually been smaller in recent years than it used to be. Over the past five years, the margin between the growth rates of real gross State product of the fastest- and slowest-growing States or Territories has averaged 3.7 percentage points – 1.5 percentage points less than this margin averaged during the 1990s, and again during the first half of the past decade. Continue reading →

Saul’s recent column in the Age – I’m responsible for the headline (NG).

For a country which accounts for less than 0.25 per cent (that is, less than one four-hundredth) of the world economy, Ireland has attracted a disproportionately large share of world attention over the past couple of weeks, as it confronts the massive cost of cleaning up its failed banking system (which has blown the budget deficit for this year out to a mind-boggling 32% of GDP) in the midst of a recession which is now in its third year, during which its economy has shrunk by 17% and its unemployment rate almost trebled, from less than 5% to nearly 14%.

Ireland is now implementing another round of swingeing expenditure reductions, tax increases, and a raid on its national pension fund, in order to comply with the requirements of the bailout package from the IMF and the European Union announced last weekend. Not only is that causing considerable unrest among the Irish people at the implied erosion of national sovereignty, but it is also likely to prolong the current recession.

Ireland’s woes illustrate a point, which I have made before, that one of the principal lessons of the global financial crisis is that inappropriately low interest rates can be as damaging as inappropriately high interest rates.

Once Ireland joined the euro area at the beginning of 1999, short-term interest rates in Ireland were no longer set in Dublin in accordance with Irish conditions, but rather in Frankfurt in accordance with conditions across the euro zone as a whole. Thus Irish short-term interest rates fell from the 5½-6% range in which they had remained during the second half of the 1990s (which the Central Bank of Ireland had deemed appropriate for an economy that had been growing at rates of 8-11% per annum) to 3.0% (which the European Central Bank considered appropriate for an economy that had been growing at around 2½% per annum). And from then until the onset of the financial crisis, short-term interest rates averaged 3¼% per annum in Ireland, as they did across the euro zone, even though Ireland’s economy grew at an average annual rate of almost 6% (compared with less than 2% for the euro zone as a whole) and Irish inflation averaged 3½% per annum (compared with 2¼% per annum for the euro zone as a whole).

Because Irish interest rates were substantially lower than they should have been for an economy growing as fast as Ireland’s was, Irish households and businesses borrowed (and Irish banks lent) far more than they would otherwise have done, resulting in (among other things) an unsustainable property boom in which Irish house prices more than doubled in less than seven years (they have since fallen by almost one-third).

Much the same thing happened in Portugal, Spain and Greece. Continue reading →

The Henry Review is an ambitious document, conceived early in the life of a new government at a time when budget surpluses stretched as far as the eye could see, surpluses which could be used to ease the tensions between winners and losers that are the inevitable consequence of any tax reforms worthy of the name.

Hence the Review aspires to a tax system which ‘is oriented towards supporting strong and sustainable economic growth’, one which has regard to the pressure which strong population and economic growth will put on our ‘increasingly fragile ecosystems’, and one which ‘fully exploits the opportunities of the new digital age’.

More specifically, it proposes that Australia’s tax system should rely primarily on four revenue sources – personal income, business income, private consumption, and ‘economic rents’ from natural resources and land – with all of these tax bases being as broad and comprehensive as possible. Apart from taxes which ‘efficiently address social or economic costs’ (such as those on tobacco, alcohol and gambling, environmental taxes and ‘efficient road user charges’), it suggests that other taxes (including payroll and insurance taxes, and stamp duties) should be abolished. And it recommends that all pensions and benefits should be comprehensively means-tested, but tax-free.

In contrast, the Government’s response to the Henry Review comes at a time when those budget surpluses have disappeared, and when, with around six months (at most) until the next election, vaulting ambitions inevitably take second place to ‘political realities’.

Continue reading →

(Originally published in the business pages of the Melbourne Age and Sydney Morning Herald on 21 April 2010)

One of the sillier propositions which has been propagated on the internet and in a range of investment newsletters over the past couple of years is the idea that the ‘quantitative easing’ strategies pursued by central banks such as the US Federal Reserve or the Bank of England in response to the financial crisis amount to ‘printing money’ in order to finance mushrooming budget deficits, and must inevitably lead not merely to higher inflation at some point in the future, but (in the more extreme variants) to the sort of hyper-inflation experienced in Weimar Germany in 1923, or more recently in Robert Mugabe’s Zimbabwe.

It’s certainly true that central banks in most of the major advanced economies have pursued a variety of unorthodox strategies since the onset of the financial crisis in order to provide liquidity to the banking system, to support particular financial institutions or markets, and to get around the problem created by the inability to reduce interest rates below zero. These strategies have generally entailed central banks making loans or purchasing securities that they ordinarily would not, in much larger amounts than they ordinarily would, and for longer periods than they usually do.

Before the onset of the financial crisis, the US Federal Reserve’s balance sheet was of a size in the order of about US$900 billion, with the vast majority of its liabilities comprised of US dollar notes on issue, and most of its assets being holdings of US Treasury securities (that is, debt issued by the US Federal Government). After the collapse of Lehman Brothers in September 2008, however, the Fed’s balance sheet expanded rapidly, to around US$2¼ trillion (US$2,250 billion), by November 2008, and has remained at around that level ever since.

At no time since the collapse of Lehman Brothers has the Fed had more US Treasury securities on its balance sheet than the US$790 billion it had in mid-2007, when the financial crisis initially erupted. As of early this month, its holdings of US Government debt stood at just under US$777 billion. Thus, it is simply not true to say that the Fed has financed, or ‘monetized’, any part of the increase in the US Budget deficit since the onset of the financial crisis.

Rather, the money ‘created’ electronically by the Fed has gone largely to provide liquidity to parts of the US or global financial system that were critically short of it. For example, beginning shortly after the collapse of Lehman Brothers it provided as much as US$500billion worth of US dollars through swap facilities with foreign central banks (including the Reserve Bank of Australia). These facilities have now closed. The Fed provided liquidity to the US banking system and to various markets within the broader US financial system (such as that for commercial paper) in excess of US$1,000 billion on several occasions late in 2008. This support is now down to less than US$60 billion. It also provided over US$100 billion for the bail-outs of Bear Stearns and AIG; most of this is still outstanding. Continue reading →

I should emphasize at the outset that my participation in this Inquiry is strictly in a personal capacity and that the views I express here should not be interpreted as being those of my employer or any of its executives.

In the last few months it has become increasingly apparent that, notwithstanding its resilience during the first year of the global financial crisis, the Australian economy faces a much bleaker outlook in 2009. The sharp downturn in the world economy, including in particular China and other Asian economies, in the second half of last year and the grim outlook for the major advanced economies in 2009 has greatly increased the risk that Australia, too, will experience a recession this year.

Continue reading →

The US National Bureau of Economic Research an academic body which is regarded as the arbiter of American business cycles defines a recession as a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.

Significantly, the NBER does not set any great store by the widely quoted proposition that two (or more) consecutive quarters of negative growth in real gross domestic product (GDP) is a necessary and sufficient condition for identifying a recession. The last US recession, in 2001, did not feature consecutive quarters of negative economic growth (real GDP declined in three separate quarters, none of them consecutive); and the current US recession was formally declared to have been under way before consecutive quarters of negative real GDP growth had been reported. Indeed, if the NBER had waited until this condition had been satisfied before declaring that the US was in recession, we would still be waiting for it until next Friday.

Despite this, commentators in Australia and other countries continue to regard consecutive quarters of negative real GDP growth as the defining characteristic of a recession. This can lead to perverse consequences. Continue reading →