Assignment:
Summarize the movements in the exchange rate of the Australian dollar against the US dollar over the last 36 months. Using appropriate models, explain the various factors which have caused these movements. Considering current national and international economic conditions, critically discuss the impacts of the overall exchange rate outcome on the Australian economy and its implications for monetary and fiscal policies.
Article:
Cuts won’t stave off a recession
HENRY THORNTON (The Australian 2 Jul 2013 )
Numerous signs are pointing to a grim economic outlook
THE Gillard government and its treasurer ignored negative global developments and Australia’s dangerous lack of competitiveness. With our mining boom rapidly cooling and other sectors largely uncompetitive, the former ‘‘miracle economy’’ faces serious trouble.
AP Further cuts to interest rates by the Reserve Bank may worsen the main problem of a lack of competitiveness
There is little the Reserve Bank can do to address the main issue of lack of competitiveness — and further cuts to interest rates may worsen that problem.
Henry speaks to a wide range of economists and market commentators, and virtually all agree Australia’s economic prospects are grim. Some say there is a possibility that it will experience recession.
Signs of the coming economic firestorm are legion. Most important is the state of the labour market, often trumpeted by former treasurer Wayne Swan as proving Australia has ‘‘the best economy in the developed world’’.
Official employment statistics, and especially the headline rate of unemployment, are misleading, with the major flaw being the assumption that paid work of one hour a week means the person is classified as ‘‘employed’’.
But if one delves into the underlying numbers, one finds a very different picture. Since 2011, three trends have fostered a false sense of economic success in Canberra. The first is the reduction in full-time jobs and its replacement with more part-time jobs. The second is the reduction in hours worked, partly because of the above trend but also because of reduction of overtime for people in full-time jobs and actual cuts in standard hours of work offered by employers who are not cowed by unions. The third trend is a substantial fall in the number of people seeking work, and therefore dropping out of the workforce.
The cancelling or delay of many resource projects will have enormous adverse effects on employment in the resource sector. Indeed it already is having, with global miners shedding workers, a process that has been under way for some time at the junior miners.
Another source of adverse news for those who care to look is the number of small businesses struggling to survive or going under. Farmers bulldozing fruit trees, retailers offering stock below cost, manufacturers closing shop or reporting plans to close the business when they retire are all trends unlikely to filter to Canberra. The plain fact is that Australia is suffering a double-digit cost disequilibrium relative to both competitor and customer nations.
The broader economic statistics also reveal some alarming developments. Employment in manufacturing has been declining for decades, but retail jobs have recently joined the trend. Exports of wine and processed foods have fallen dramatically. Overseas enrolments in Australian universities have fallen sharply from the recent peak and the number of Australians travelling abroad now greatly exceed inbound tourists.
All these trends have been reported in an important paper by Ross Garnaut. He has calculated the real exchange rate, which adjusts the actual exchange rate for inflation in Australia relative to overseas inflation, and is therefore the best measure of the extent of the overall cost disequilibrium. This measure increased by 69 per cent from the end of 2002 to a peak in March. The currency depreciation since then has perhaps reduced this by 10 per cent, but this leaves a lot of adjustment still to come.
The excessive level of the dollar is widely blamed for trends such as those discussed above, along with ruthless behaviour by monopolistic retail chains and widespread imports of cheap goods purchased over the internet. The dollar looks like it has started a long fall and its level is likely to overshoot any sensible equilibrium level, as asset market often do. This will alleviate one source of pressure on businesses, but it will help only if cost increases are contained.
The economy is in effect highly indexed, meaning it is designed to compensate just about every significant group from the impact of inflation. A large fall in the value of the dollar will create serious inflation, and if this is passed through to income recipients, including welfare recipients, our double-digit cost disequilibrium will not be reduced much, if at all, by a falling dollar.
But a falling dollar will mean the RBA will have to modify or suspend its inflation target, with possibly severe consequences for its credibility. This is already strained by its relatively sanguine ‘‘glass half full’’ rhetoric, just as Treasury (and therefore the government) has been far too optimistic in its predictions about both the economy and its assumed return to surplus.
One hopes Treasury’s initial briefing for the incoming Treasurer has been more realistic about Australia’s economic conditions and prospects than those parroted by Swan, and also that Treasury has told Chris Bowen what it thinks should be done.
Henry’s view is that Australia cannot now avoid a recession and that in what I call a ‘‘realistic worst case’’ it will be a recession of at least the severity of those in the early 1980s and the early 90s, with double-digit unemployment even on the Australian Bureau of Statistics definition.
With unchanged policies, the budget deficit will blow out severely and budget tightening will be forced on Australia by global market vigilantes, whether we like it or not.
Claims that the coming recession will be caused by ‘‘mindless austerity’’ of an Abbott government, should the election be won by the Coalition, are simply hogwash. In the unlikely case of an election win by Rudd Labor, or another hung parliament, most politicians will be gobsmacked by the state of the economy and the national budget.
Cutting interest rates further may somewhat reduce distress, but will do nothing to relieve the cost disequilibrium, and may indeed worsen it. Only focused action by a fully informed and highly competent government can hope to steer Australia through the strong recessionary currents we are experiencing.
Henry Thornton in the nom de plume of an eminent, independent economist.