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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

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Focus

What are the sources of Australias terms of

trade boom?

Is this boom likely to continue?

What Policies should be followed?

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Overview

Global Drivers ofGrowth 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

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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

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Summary

Global growth will be dominated by long term

trends from

The emergence of the BRICS into the globaleconomy

Large demographic changes

Productivity and technical innovation

Impact and response to environmental problems

BUT short term risks

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-2

0

2

4

6

-2

0

2

4

6

%

World GDP Growth*Year-average

%

IMF forecasts* Weighted by GDP at PPP exchange ratesSource: IMF

2012200519981977 199119841970

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TheR

isks: FiscalA

djustment

A slow motion train wreck

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Government Debt to GDP

Source OECD Economic Outlook 88 Database (November 2010)

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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)

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TheR

isks:A

Euro Crisis

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Eur Area In ustrial r ucti n2005 r = 00

70

80

90

100

110

70

80

90

100

110

Sourc : Thomson R ut rs

2010

Fr nc

Index

Greece

Euro rea

Germany

200820062006 2008 2010

Index

Italy

Spain

Portugal

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0

40

80

120

0

40

80

120

ECB Len ing t Banks*

* Lendingprovided throughmonetarypolicyoperations onlySource: central anks

Greece

Fixed-rate tenders fromOctober2008onwards

b b

Ireland

Portugal

Spain

Italy

2010200920082007 2011

Bynational central bank

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TheR

isks:G

lobal Inflation

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l l l l l l l l l l l l0

500

0

500

Fe H l ings f SecuritiesWeekly

Agency BS Agencydebt USTreasuries

US$b US$b

20002000

15001500

10001000

J

2008

S D M J S D M J S

2009 2010

D M

2011

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IMF Food Pric I d xSDR, 1995 100

Sources: IMF; RBA

Index

Year-ended change

100

130

160

100

130

160

-30

0

30

-30

0

30

LevelIndex

%%

2005 201020001995199019851980

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Consumer rice InflationYear-ended

-4

-2

0

2

4

6

-4

-2

0

2

4

6

Source: Thomson Reuters

2011

Headline

%US

Core

Euroarea

200920072011200920072005

%

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Asia olicy Interest Rates

2011

India

%

l l l l l l l0

3

6

9

12

l l l l l l l 0

3

6

9

12

%

2008201120082005

China

TaiwanThailand

Malaysia

Philippines

Indonesia

SouthKorea

2005

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Commodity prices

Rising because of

Real growth in emerging economies (Chindia)

Loose monetary policies raising nominal demand

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Australias 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

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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

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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

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Conclusion

Difficult but important to distinguishbetween relative price changes and globalinflation the 1970s is an important lesson

Even though the terms of trade ofcommodity exporters is likely to decline, the

overall income gains will be positive for theworld as developing countries becomeswealthier