Wednesday, December 16, 2015

Reflections on the 2015 Australian Mid Year Economic and Financial Outlook (MYEFO)

Yesterday, the Australian Government released its Mid Year Economic and Financial Outlook or MYEFO. As you might expect, it's been well covered in the Australian media (here, here, here and here from an academic perspective).   Much of the coverage has focused on the budget aggregates such as size of the deficit, the difficulties involved in getting back into surplus, as well as the specific expenditure changes built into the latest budget estimates. Expect to hear more on both! In this brief report I want to comment on a few things I noticed that have been perhaps less well covered.

The first thing is an apparent if probably minor difference in views between the Reserve Bank and Treasury.

In its Statement on Monetary Policy released on 9 November, the Reserve Bank said:
 Over the course of this year, the recoveries in the United States and euro area economies have continued but growth has slowed in the Asian region. The slowdown in the Asian region has been associated with lower growth of global trade volumes and industrial production and has contributed to a decline in the prices of Australia's resource exports. Core inflation has generally been steady in both the advanced and emerging economies, but at rates below central banks' targets. Globally, monetary policy remains very accommodative and finance remains readily available to creditworthy borrowers.
The Bank repeated this view on 1 December in announcing the decision to leave the cash rate unchanged at 2 per cent. 
The global economy is expanding at a moderate pace, with some softening in conditions in the Asian region, continuing US growth and a recovery in Europe. Key commodity prices are much lower than a year ago, reflecting increased supply, including from Australia, as well as weaker demand. Australia's terms of trade are falling.
The apparent difference between the Reserve Bank and Treasury lies the assessment of Asian growth, with the Bank pointing to the slowdown in the Asian region, while Treasury repeats the mantra about our trading partners growing at faster than the world average. The Bank also seems to have a more positive view on euro-zone growth than Treasury. 

I mention this one because I was actually slightly surprised at the Bank's November assessment. I hadn't realised the extent of the Asian slowdown.I was also interested in the weight placed on euro-zone growth.

The second thing I wanted to comment on was Treasury's work force analysis. The rate of Australia's population increase, and especially increases in the overall work force, depends very heavily on the level of immigration. That is well down. There have also been reductions in hours worked that Treasury now considers represents a structural shift. In combination, these changes mean that the economy has less spare capacity than previously estimated, leading Treasury to down grade its estimates of possible growth. There are all sorts of issues in this that I would like to come back  to later.

Capital investment is the third thing I wanted to mention. The numbers suggest that the unwinding of mining investment following the end of the mining boom has largely run its course. The building boom underway in certain places that has provided cushioning still has a a way to run because of the level of work in progress, but that too will end. Other capital investment has been slower to pick up than  expected because the re-balancing underway in the economy and particularly growth in services involves a shift towards less capital intensive activities as conventionally measured. I say as conventionally measured because this goes back to an earlier discussion on this blog about the definition of capital investment in services.  For the moment, the combined effect is soft capital investment for the immediate future.

Another interesting thing is the continued stagnation in both nominal and real incomes. At one level, you would expect this. The terms of trade effects that allowed rapid growth in real incomes have gone into reverse. Arithmetically, that depresses real incomes. Growth in nominal incomes has been suppressed by demand factors as well as by structural shifts. My impression is that the jobs that have been created are generally in lower paid areas, the jobs lost in higher paid occupations. The country has maintained employment better than expected, that's good, but there really has been an income recession.

The final thing that I wanted to note at this point are two explicit parameters built into the budget framework. The first is the continued emphasis on the requirement for any new expenditure to be offset by savings elsewhere.  This second is the stated requirement that any gains that come from parameter shifts, ie outcomes better than assumptions, should go to deficit reduction. In combination, the two place a considerable straight jacket on the Government's ability to act.  


Anonymous said...

second is the stated requirement that any gains that come from parameter shifts, ie outcomes better than assumptions, should go to deficit reduction

1) outcomes worse than assumptions - these go where?
2) any recent examples (of significance, on the national stage) of outcomes better than assumptions?

And also, a 'deficit reduction' would already (practically speaking) have occurred by the time the 'outcome' eventuated, surely. So do they mean 'debt reduction'?


Jim Belshaw said...

On 1, just into normal spend. On 2, if iron ore prices are higher than expected, then the extra revenue generated must be quarantined, cannot be spent. The classic case of outcomes better than expected was the recent mining boom when revenue constantly outrun forecasts.

On the last, you are right kvd. What it seems to mean, and I may be misquoting the exact wording, is that the the extra amount can then not be spent but must be quarantined in some way. There is some messy stuff in here, as there is in the stated target that that spend cannot increase as a proportion of GDP

2 tanners said...

Some of the commentators are saying that the Morrison has stated that it cannot go into spending but must go into tax (revenue) cuts or possibly into deficit reduction. It's pretty unclear to me.