Government debt, inflation and interest rates.
August 5th, 2009 · Greg Atkinson · 15 Comments
The tentative signs of a global recovery (albeit a weak one) are becoming stronger each day and people who predicted a global depression have faded from view. So the Australian economy is poised for growth again and everything is back on track right? Well not quite.
As a result of the global financial crisis a number of governments around the world decided to embrace Keynesian economic theory (well the bits they liked that is) and have racked up huge amounts of debt so they could shore up their voter support, oops I meant help their economies.
In Australia the Rudd Government has been spraying around money via a number of somewhat questionable economic stimulus measures and these have plunged the nation into debt. As a result we will all have to chip in and pay back the few hundred billion the country will end up borrowing.
Many Australians may have appreciated the pre-Christmas Government cash handout but the truth is that this money and more will be clawed back over the years to come. In fact not only will taxpayers be giving back the cash handout, they will also be paying for a whole range of Government spending splurges in addition to making interest payments on the money Rudd and Co. have borrowed so they could make grandiose promises. (see: Rudd Economics 101 – When in doubt spend like crazy.
Therefore what we can safely say is that in the coming years the Federal Government will be looking to bring in extra dollars to pay down debt and also to fund billions in extra spending commitments. Without a doubt the National Broadband Network (NBN) will run over schedule and over budget, the reform of the healthcare system will become a budget black hole and the so called “Education Revolution” will suck up money while not providing any tangible results. (children will not become smarter because they have a new school hall)
But then we have the State Governments most of which has mismanaged their economies and are also in debt. In many cases State Government charges are already on the way up and you can be sure more increases are coming.
As all levels of government start to claw back money this will start to give inflation a nudge as everything from public transport fares to public health care costs will start to rise. In addition if the Emission Trading Scheme (ETS) becomes a reality then businesses will be hit with an extra tax and the consumer will end up paying for this via higher prices for a whole range of good and services. Into the mix add a higher oil price and the end result is likely to be inflation moving out of the Reserve Bank’s comfort zone.
The RBA has signalled that it is no longer inclined to cut rates further and in essence this means the RBA is moving into a position to keep inflation under control. So I guess the RBA also sees inflationary pressures building, but what does this mean for the Australian economy?
The main problem I see on the horizon is that unemployment is likely to still be creeping up at the same time that the Government and RBA will need to deal with rising inflation. The global recovery might slowly be taking hold but this does not mean new jobs will be created in Australia or that positions shed during the downturn will be reinstated.
The unpopular truth is that the roll-back of Work Choices has made the Australian labour market less flexible and less able to deal with an extended economic downturn. In fact the labour market in Japan is dealing better with a much more severe recession than Australia is even though Japanese exports have collapsed. Unemployment in Japan is still lower than Australia which has had the benefit of it’s exports holding up relatively well.
Unemployment Rates: Australia, United States, U.K. and Japan (Jun 09)
It is likely that Australian businesses will remain cautious for at least the 6 months and that further jobs will actually be lost. If the ETS legislation is passed the situation will probably be made even worse as companies look to move operations offshore to countries like India or China rather that expose themselves further to the ETS tax. (let’s call a spade a spade, the ETS is a tax)
So the most likely scenario I see at the moment is one where the Australian economy remains fairly weak and yet inflation rises. Jobs are unlikely to be created in any large numbers in the mining sector for quite some time and the ETS is hardly going to encourage businesses to put on new staff when they are uncertain of how this legislation will impact their bottom line.
The end of the extra handout to first home buyers will probably cause prices to soften a little in the housing market up to the $400-500K level but I do not see too many major property developers rushing to build new homes so supply side restraints should provide some support for home prices for a while.
The big unknowns are where the price of oil will go ( I am confident however that we will soon see oil over $80 a barrel soon) and how aggressively the RBA will raise interest rates. Things could get nasty if both of these rise quickly and we may find Australia lagging much of the world out of the global recession.
The recession in Australia is not over yet.Search terms: what might prompt the rba to change interest rates, aus government decrease interest rates for economy 2008/9, Australian government interest rate on borrowings, inflation effect asx 200, info sasaki-reform co jp loc:AU