samsonhohoho
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- 2013
GIVEN the attention it receives, you would think the federal budget deficit was the only macroeconomic deficit that mattered. But there's another sizeable deficit we soon may have to worry about if federal budget deficits in coming years continue to be underestimated to the tune of this year's $21 billion blunder.
The other deficit is the current account deficit, the measure of Australia's overseas borrowing. According to the latest International Monetary Fund forecasts, Australia's current account deficit is expected to rise to 6 per cent of gross domestic product next year, a level Treasury once (wrongly) considered unsustainable under any circumstances. In the 2013-14 budget papers, Treasury forecasts a rise in the current account deficit closer to 4 per cent of GDP. It remains to be seen if this is another underestimate.
Unlike the budget deficit, which indicates the government's borrowing from any source, the current account deficit measures the entire economy's borrowing from abroad. Each quarterly external deficit adds to the stock of Australia's foreign liabilities, which are mostly in the form of debt rather than equities.
There are strong theoretical grounds for believing that budget deficits, consolidated for all levels of government, and current account deficits for economies such as Australia's are closely related. Under certain assumptions, these deficits can be twinned. International empirical evidence for the twin deficits hypothesis is mixed for a range of countries, revealing in many cases they are more like siblings.
Yet in a paper to be published in Empirical Economics, Deakin University's Paresh Narayan and I provide evidence that the Australian deficits are more likely twinned, taking the consolidated budget balance for all levels of government into account.
National accounting relations dictate that the current account deficit reflects the difference between national saving and investment. Hence the current account deficit must increase if increased government consumption reduces national saving, for given investment. Or if government investment adds to total investment, then for given national saving, the current account deficit must rise accordingly.
The nature of government spending and the overall budget balance critically determine whether current account deficits should be interpreted positively or negatively. When the budget is balanced, it is safe to assume new foreign borrowing reflects only private, not public, sector activity.
If the external deficit reflects private sector borrowing for investment, it could well be sustainable at 6 per cent or higher, provided the investment is productive, as it generally has been through much of Australia's history, including recent foreign funded mining sector investment.
In economese, the external accounts under such conditions are self-equilibrating and hence not a policy problem.
There's another way of explaining how the budget and current account deficits are linked, recognising that higher government spending, other things equal, increases demand for goods and services that are not internationally tradeable. Think for instance of increased spending on health, public services or school halls.
Such spending raises the prices of non-tradeable goods and services in the economy relative to the prices of internationally tradeable goods and services. Reserve Bank data shows this has been the case, with non-tradeables inflation persistently above the 3 per cent inflation ceiling. This has worsened international competitiveness and indirectly contributed to the current account deficit by increasing imports and attracting resources away from tradeable sector production.
Foreign debt that funds government spending in the form of productive infrastructure should not be worrisome if the cost of servicing the public debt owed to foreigners is less than the return on the infrastructure it funds.
But when foreign debt primarily finances government transfers or consumption spending and the sizeable deficits that result are unmatched by income-generating assets, it's a different story.
Yet this is the situation in which Australia finds itself at the federal level, since the bulk of federal government spending is on transfers and services that yield no economic return. For instance, the 2013-14 budget estimates social security and welfare, the biggest single expenditure category by far, will cost $138bn, health $65bn, general public services $23bn and defence $22bn.
Foreign investment statistics show that since the era of large budget deficits began in 2008-09, the government sector accounts for a significant portion of borrowing from abroad. The servicing cost on foreign debt incurred to fund unproductive expenditure is a net drain on national income and on future budgets, and potentially can spark a vicious circle of deficits and debt.
This was a key lesson of the European sovereign debt crisis.
Since 2010 each of the southern European economies in most trouble - Greece, Portugal, Italy, Spain - plus Ireland has been economically unhappy in its own way. But unlike their northern euro neighbours, before their respective crises all experienced large current account deficits reflective of foreign borrowing for unproductive spending.
Australia's public debt to GDP ratio still may be relatively low by international standards but, like these southern European countries, Australia has relied heavily on foreign borrowing to fund its budget deficits.
The economy also now has a net foreign liabilities to GDP ratio in the vicinity of the 50 per cent limit that a recent empirical study by IMF economists concludes is a predictor of financial crises, especially when external liabilities are predominantly in the form of debt.
The contribution of the states' budget deficits to the current account deficit is arguably of less concern than that of the commonwealth's because the states have greater responsibility for infrastructure development. In contrast, the consumption focus and huge welfare component of federal government spending implies a speedy return to surplus at federal level remains paramount.
Clouds are massing on Australia's economic horizon after new data showed a sharper-than-expected slowdown in GDP growth over the year to March.
The national economy, which is in its 22nd consecutive year of expansion, grew 0.6 per cent in the first quarter of 2013, taking the growth for the year to 2.5 per cent, according to figures from the Australian Bureau of Statistics.
But economists' predictions had forecast gross domestic product (GDP) growth of 0.8 per cent for the March quarter and year-on-year growth of 2.7 per cent.
"The overall tone of the release is pretty soft," said UBS chief economist Scott Haslem.
GDP data from the ABS for the March quarter, 2013.
"We saw some improvement in consumer [consumption] and trend improvement in housing, but at this stage. It's not sufficient to offset the pull-back we've seen in [capital expenditure] in this quarter.
"When we take away the net export contribution of about 1 per cent in the quarter, the domestic economy was clearly negative."
Mr Haslem said while the latest figures reflected a increase in consumption boosted by lower interest rates, other data for the second quarter of the year showed that business investment and activity was not yet improving.
ANZ's chief economist for Australia, Ivan Colhoun, said the latest figures also highlighted the weakness in domestic demand.
"It's actually lower than the level that it was at in the June quarter of 2012," Mr Colhoun said. "While production is quite strong, demand is quite weak and we think the later is consistent with the soft labour outcomes that we see in Australia."
Federal Treasurer Wayne Swan said the new figures showed that the Australian economy was remaining resilient despite continued international economic uncertainty and a transition away from mining-dependent growth locally.
"Australia has also managed to achieve solid growth when around half of all advanced countries that have released March quarter results contracted over the year," Mr Swan said this afternoon.
Interest rates implications
Commonwealth Bank senior economist Michael Workman said the data showed that the transition to non-resources led growth as the mining boom peaks was still "fairly hesitant and slow", and would support calls for another Reserve Bank rate cut soon.
"Annual growth running at 2.5 per cent is well below the trend outcomes that could be occurring of about 3.15 per cent," Mr Workman said.
Yesterday, the Reserve Bank kept the the cash rate on hold at 2.75 per cent but said it retained the "scope for further easing, should that be required".
Financial markets were pricing in a 35 per cent of a July interest rate cut, Credit Suisse data showed.
RBA governor Glenn Stevens said yesterday that growth over the past year was "a bit below trend".
"The outlook published by the Bank last month is for a similar performance in the near term and recent data are consistent with this," he said in a statement, adding that the unemployment rate had risen over the past year while labour cost growth was moderating.
Consumers still saving
The finance, mining, transport and retail industries drove growth in the March quarter, the ABS data showed. But the growth was offset by a 0.9 per cent fall in public investment a 0.4 per cent drop in inventory changes.
The savings ratio remained high at 10.6 per cent, while dwelling investment remained unchanged.
"That fits with what we're seeing," Mr Colhoun said. "We are seeing consumers remaining reasonably cautious and trying to reduce debt. ... There's a modest recovery in building approvals but not really much of a pick up as yet."
GDP rose by 0.6 per cent in the December quarter and 0.5 per cent in the September quarter, Bureau of Statistics data showed.
Some economists had revised down their GDP forecasts following the recent run of soft data, which has seen sluggish retail sales, falling job ads and weakness in the manufacturing sector.
The Organisation for Economic Co-operation and Development (OECD) last week cut Australia's growth outlook about 2.5 per cent this year before picking up to about 3.15 per cent next year.
The global body said the Australian economy would take a temporary hit as the mining slowdown kicks in.
"The expected weakening of the boom in mining investment will be only gradually offset by the sector’s increasing export capacity and the strengthening of the non-mining sector," the OECD said.
"The persisting high exchange rate and still fragile confidence are inhibiting the emergence of new drivers of growth."
What could be the evaluation question that examiner might ask? Thanks
The other deficit is the current account deficit, the measure of Australia's overseas borrowing. According to the latest International Monetary Fund forecasts, Australia's current account deficit is expected to rise to 6 per cent of gross domestic product next year, a level Treasury once (wrongly) considered unsustainable under any circumstances. In the 2013-14 budget papers, Treasury forecasts a rise in the current account deficit closer to 4 per cent of GDP. It remains to be seen if this is another underestimate.
Unlike the budget deficit, which indicates the government's borrowing from any source, the current account deficit measures the entire economy's borrowing from abroad. Each quarterly external deficit adds to the stock of Australia's foreign liabilities, which are mostly in the form of debt rather than equities.
There are strong theoretical grounds for believing that budget deficits, consolidated for all levels of government, and current account deficits for economies such as Australia's are closely related. Under certain assumptions, these deficits can be twinned. International empirical evidence for the twin deficits hypothesis is mixed for a range of countries, revealing in many cases they are more like siblings.
Yet in a paper to be published in Empirical Economics, Deakin University's Paresh Narayan and I provide evidence that the Australian deficits are more likely twinned, taking the consolidated budget balance for all levels of government into account.
National accounting relations dictate that the current account deficit reflects the difference between national saving and investment. Hence the current account deficit must increase if increased government consumption reduces national saving, for given investment. Or if government investment adds to total investment, then for given national saving, the current account deficit must rise accordingly.
The nature of government spending and the overall budget balance critically determine whether current account deficits should be interpreted positively or negatively. When the budget is balanced, it is safe to assume new foreign borrowing reflects only private, not public, sector activity.
If the external deficit reflects private sector borrowing for investment, it could well be sustainable at 6 per cent or higher, provided the investment is productive, as it generally has been through much of Australia's history, including recent foreign funded mining sector investment.
In economese, the external accounts under such conditions are self-equilibrating and hence not a policy problem.
There's another way of explaining how the budget and current account deficits are linked, recognising that higher government spending, other things equal, increases demand for goods and services that are not internationally tradeable. Think for instance of increased spending on health, public services or school halls.
Such spending raises the prices of non-tradeable goods and services in the economy relative to the prices of internationally tradeable goods and services. Reserve Bank data shows this has been the case, with non-tradeables inflation persistently above the 3 per cent inflation ceiling. This has worsened international competitiveness and indirectly contributed to the current account deficit by increasing imports and attracting resources away from tradeable sector production.
Foreign debt that funds government spending in the form of productive infrastructure should not be worrisome if the cost of servicing the public debt owed to foreigners is less than the return on the infrastructure it funds.
But when foreign debt primarily finances government transfers or consumption spending and the sizeable deficits that result are unmatched by income-generating assets, it's a different story.
Yet this is the situation in which Australia finds itself at the federal level, since the bulk of federal government spending is on transfers and services that yield no economic return. For instance, the 2013-14 budget estimates social security and welfare, the biggest single expenditure category by far, will cost $138bn, health $65bn, general public services $23bn and defence $22bn.
Foreign investment statistics show that since the era of large budget deficits began in 2008-09, the government sector accounts for a significant portion of borrowing from abroad. The servicing cost on foreign debt incurred to fund unproductive expenditure is a net drain on national income and on future budgets, and potentially can spark a vicious circle of deficits and debt.
This was a key lesson of the European sovereign debt crisis.
Since 2010 each of the southern European economies in most trouble - Greece, Portugal, Italy, Spain - plus Ireland has been economically unhappy in its own way. But unlike their northern euro neighbours, before their respective crises all experienced large current account deficits reflective of foreign borrowing for unproductive spending.
Australia's public debt to GDP ratio still may be relatively low by international standards but, like these southern European countries, Australia has relied heavily on foreign borrowing to fund its budget deficits.
The economy also now has a net foreign liabilities to GDP ratio in the vicinity of the 50 per cent limit that a recent empirical study by IMF economists concludes is a predictor of financial crises, especially when external liabilities are predominantly in the form of debt.
The contribution of the states' budget deficits to the current account deficit is arguably of less concern than that of the commonwealth's because the states have greater responsibility for infrastructure development. In contrast, the consumption focus and huge welfare component of federal government spending implies a speedy return to surplus at federal level remains paramount.
Clouds are massing on Australia's economic horizon after new data showed a sharper-than-expected slowdown in GDP growth over the year to March.
The national economy, which is in its 22nd consecutive year of expansion, grew 0.6 per cent in the first quarter of 2013, taking the growth for the year to 2.5 per cent, according to figures from the Australian Bureau of Statistics.
But economists' predictions had forecast gross domestic product (GDP) growth of 0.8 per cent for the March quarter and year-on-year growth of 2.7 per cent.
"The overall tone of the release is pretty soft," said UBS chief economist Scott Haslem.
GDP data from the ABS for the March quarter, 2013.
"We saw some improvement in consumer [consumption] and trend improvement in housing, but at this stage. It's not sufficient to offset the pull-back we've seen in [capital expenditure] in this quarter.
"When we take away the net export contribution of about 1 per cent in the quarter, the domestic economy was clearly negative."
Mr Haslem said while the latest figures reflected a increase in consumption boosted by lower interest rates, other data for the second quarter of the year showed that business investment and activity was not yet improving.
ANZ's chief economist for Australia, Ivan Colhoun, said the latest figures also highlighted the weakness in domestic demand.
"It's actually lower than the level that it was at in the June quarter of 2012," Mr Colhoun said. "While production is quite strong, demand is quite weak and we think the later is consistent with the soft labour outcomes that we see in Australia."
Federal Treasurer Wayne Swan said the new figures showed that the Australian economy was remaining resilient despite continued international economic uncertainty and a transition away from mining-dependent growth locally.
"Australia has also managed to achieve solid growth when around half of all advanced countries that have released March quarter results contracted over the year," Mr Swan said this afternoon.
Interest rates implications
Commonwealth Bank senior economist Michael Workman said the data showed that the transition to non-resources led growth as the mining boom peaks was still "fairly hesitant and slow", and would support calls for another Reserve Bank rate cut soon.
"Annual growth running at 2.5 per cent is well below the trend outcomes that could be occurring of about 3.15 per cent," Mr Workman said.
Yesterday, the Reserve Bank kept the the cash rate on hold at 2.75 per cent but said it retained the "scope for further easing, should that be required".
Financial markets were pricing in a 35 per cent of a July interest rate cut, Credit Suisse data showed.
RBA governor Glenn Stevens said yesterday that growth over the past year was "a bit below trend".
"The outlook published by the Bank last month is for a similar performance in the near term and recent data are consistent with this," he said in a statement, adding that the unemployment rate had risen over the past year while labour cost growth was moderating.
Consumers still saving
The finance, mining, transport and retail industries drove growth in the March quarter, the ABS data showed. But the growth was offset by a 0.9 per cent fall in public investment a 0.4 per cent drop in inventory changes.
The savings ratio remained high at 10.6 per cent, while dwelling investment remained unchanged.
"That fits with what we're seeing," Mr Colhoun said. "We are seeing consumers remaining reasonably cautious and trying to reduce debt. ... There's a modest recovery in building approvals but not really much of a pick up as yet."
GDP rose by 0.6 per cent in the December quarter and 0.5 per cent in the September quarter, Bureau of Statistics data showed.
Some economists had revised down their GDP forecasts following the recent run of soft data, which has seen sluggish retail sales, falling job ads and weakness in the manufacturing sector.
The Organisation for Economic Co-operation and Development (OECD) last week cut Australia's growth outlook about 2.5 per cent this year before picking up to about 3.15 per cent next year.
The global body said the Australian economy would take a temporary hit as the mining slowdown kicks in.
"The expected weakening of the boom in mining investment will be only gradually offset by the sector’s increasing export capacity and the strengthening of the non-mining sector," the OECD said.
"The persisting high exchange rate and still fragile confidence are inhibiting the emergence of new drivers of growth."
What could be the evaluation question that examiner might ask? Thanks