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Managing the Growth Shock Warwick J. McKibbin Director, ANU Research School of Economics Presentation to the 2011 Economic & Social Outlook Conference, Melbourne 30 June, 2011 Focus • What are the sources of Australia’s terms of trade boom? • Is this boom likely to continue? • What Policies should be followed? Overview • Global Drivers of Growth • China and India • Loose global monetary policy • Risks – Fiscal Risks – Euro Crisis – Global Inflation and policy response • Implications for relative prices of commodities • Appropriate Policy Responses The Beginning of the Great Convergence? Source: Angus Maddison, The world economy: historical statistics, 2003 and IMF World Economic Outlook database (September 2006) – Mark Thirlwelll, The Lowy Institute Summary • Global growth will be dominated by long term trends from – The emergence of the BRICS into the global economy – Large demographic changes – Productivity and technical innovation – Impact and response to environmental problems • BUT short term risks World GDP Growth* Year-average % % 6 6 4 4 2 2 0 0 -2 1970 1977 1984 1991 IMF forecasts * Weighted by GDP at PPP exchange rates Source: IMF 1998 2005 -2 2012 The Risks: Fiscal Adjustment A slow motion train wreck Government Debt to GDP Source OECD Economic Outlook 88 Database (November 2010) Required change in underlying primary balance to stabilise debt by 2025 in per cent of potential GDP Source OECD Economic Outlook 88 Database (November 2010) The Risks: A Euro Crisis Euro Area – Industrial Production 2005 average = 100 Index Index Germany 110 110 Italy 100 100 Euro area Portugal 90 90 France Spain 80 70 Greece 2006 2008 Source: Thomson Reuters 2010 2006 2008 2010 80 70 ECB Lending to Banks* By national central bank €b €b Fixed-rate tenders from October 2008 onwards Ireland Spain 120 120 80 80 Greece 40 40 Italy Portugal 0 2007 2008 2009 2010 * Lending provided through monetary policy operations only Source: central banks 2011 0 The Risks: Global Inflation Fed Holdings of Securities Weekly US$b US$b Agency MBS Agency debt US Treasuries 2 000 2 000 1 500 1 500 1 000 1 000 500 0 500 l J l S D 2008 l l M l J S 2009 l l D l M l J S 2010 l l D l M 2011 0 IMF Food Price Index SDR, 1995 = 100 Index Index Level 160 160 130 130 100 100 % % Year-ended change 30 30 0 0 -30 1980 1985 Sources: IMF; RBA 1990 1995 2000 2005 -30 2010 Consumer Price Inflation Year-ended % US 6 % Euro area 6 Headline 4 4 2 2 Core 0 0 -2 -2 -4 -4 2005 2007 2009 Source: Thomson Reuters 2011 2007 2009 2011 Asia – Policy Interest Rates % % 12 12 Indonesia India 9 9 6 Philippines China South Korea 3 0 3 Malaysia Taiwan l l 2005 l l 6 Thailand l 2008 l l 2011 l l 2005 l l l 2008 l l 2011 0 Commodity prices • Rising because of – Real growth in emerging economies (Chindia) – Loose monetary policies raising nominal demand Australia’s Terms of Trade • Likely to fall from current highs because – Global supply response – Withdrawal of loose global monetary policy – Rise in non commodity price inflation • Other factors – Global climate response will tax our comparative advantage Policy Responses • Key is whether the boom in the terms of trade is permanent or temporary • Optimal response should not be based on our ability to forecast but should manage the risks of alternative futures Policy Responses • Need not need to be a contracting sector – Expand effective labour supply – Allow foreign capital and labour to flow in • Create a Sovereign Wealth Fund – Reduce excess demand which is increasing Dutch Disease problems • Less relative price adjustment in the short run – Creates a pool of foreign currency assets that can be used when the cycle turns Conclusion • Difficult but important to distinguish between relative price changes and global inflation – the 1970s is an important lesson • Even though the terms of trade of commodity exporters is likely to decline, the overall income gains will be positive for the world as developing countries becomes wealthier