There's a lot of commentary about the results on Australian GDP for the June quarter, which compares it to very low levels of growth that we saw way back in the 1990s.
I think to understand what's happening, it's really good to look at the experience that the Australian economy has been through since 2019 and the enormous variation in growth that we've experienced. These variations in GDP are by far the largest variations in the Australian economy in my working lifetime.
We had, in 2020, a slump in activity as the economy was shut down, where GDP fell by 6.1%. This is easily the biggest slump since the 1930s. The economy then recovered. The growth rate for the year to June 2021 was 10.6%. This is overwhelmingly the largest growth rate in either wartime or peacetime recorded since the national accounts have existed in Australia.
What then happens is you'll see in the chart that 10.6% growth is the big bump, but what's really important is that the second bump you see is in 2022, which is actually in the third quarter of 2022. Two important things happened directly before that in that little low patch of growth just before that second peak.
What happens in the first quarter of 2022 is that Anthony Albanese is elected Australian Prime Minister. What happens directly after that is that the Australian commodity index published by the Reserve Bank of Australia (RBA) reaches its all-time highest level in the second quarter of 2022. That means not just resource earnings but the revenue that the government receives as a result of commodity exports reaches its highest level following that peak.
That's really important for understanding what then happens in Australian economic policy. So we have the re-acceleration of growth in the third quarter of 2022 to 5.8%. Then you have a budget the following year. In the budget the following year, you've got the highest revenues ever for the federal government.
What's actually happening here is that income goes up by about 2% of GDP, which is about $50 billion a year more than you would normally expect in a normal cycle.
Now, in a similar circumstance back in the early 1950s, when the Menzies-Fadden government was faced with the previous biggest-ever commodity boom in Australian history after World War II, some people call it the “Wool Boom,” some people call it the “Korean War Boom.” What the government decided to do was to run a budget surplus of 2% of GDP. When we scale that to the current size of the Australian economy, that extra $50 billion of revenue that the Australian government was getting from that all-time record peak in commodity prices would have been saved and gone into a surplus because, as everybody knows, long-term commodity peaks can't last.
What's actually happened is that the Albanese government decided to increase their spending to the level of the revenue. You can see that in the budget papers where Jim Chalmers announces that he's making a surplus, but if you look at it, it's a wafer-thin surplus. He's making all this money and he's spending all this money, and there's a very shallow, tiny surplus of a fraction of 1% of GDP.
Then what happens is that commodity prices start to fall, and as commodity prices start to fall, the revenue that the government is receiving also starts to fall as the economy slows. What happens is that the peak of 5.8% in the third quarter of 2022 is followed by year-on-year growth which falls very sharply to 2.6% for the full year 2022; in 2023, for the full year, growth is 1.6%, and for the year to June, which we've just seen, growth is only 1%.
So the economy has slowed down, commodity prices have fallen, and in the most recent budget papers, we've seen that Jim Chalmers is budgeting for a deficit of 1% of GDP. Now we have that debate opening up between the Treasury and the RBA. What's actually happening is because the Treasury has decided to spend the money as extra stimulus, at least 1% of GDP.
I think structurally that there is a long-term structural deficit built in of around 2% of GDP by the government. As we move forward, that structural deficit will start to appear in the budget papers. Which means that for an economist, this is a really interesting time to live in now in terms of what's actually happening in GDP.
One of the things I did during the beginning of the pandemic, together with another economist called Brendan Markey-Towler, was some research into what I call “nowcasting” the Australian economy or “nowcasting” GDP from employment numbers.
Now, I've shown over previous weeks charts of employment growth and how when it's higher than the long-term trend, you expect rates to go up; when it's lower than the long-term trend, you expect rates to go down.
Well, in terms of GDP, we're not using employment growth, but we're looking at the growth in or the movement—the increase in hours worked—because hours worked plus productivity is equal to GDP.
There's been a modest increase in hours worked of about 0.9% over the last year. When we build a model on that, and in chart number two, you can see the red line is the model based on all the nowcasts based on hours worked.
You can see what it's showing is that growth is slowing down to around 1% of GDP. This is a really good thing because even if some people criticise Jim Chalmers for not doing his job, it does show that the RBA is doing its job, because that very low level of growth that we have is what's called “The Narrow Path.”
Growth is very low, but it is not negative. That is what is meant by a “Soft Landing” or the “Narrow Path.”
Hopefully, what will happen is growth will continue at this low but slow positive level. As it does so, unemployment will ratchet up. We think unemployment will be around 4.8% by the end of the year.
That high level of unemployment will put downward pressure on prices, downward pressure on wages growth, and that will bring inflation down to a level of say 3% or less.
The RBA, which has the lowest interest rates in the English-speaking world—our rates are 1% lower than the Federal Reserve, 1% lower than the Bank of England, and lower than even the Reserve Bank of New Zealand. The current state of the Australian economy may feel very frustrating in terms of slow growth; this is certainly frustrating for some politicians, but this is the “Narrow Path.” This is the slight level of positive growth which allows you to get inflation down and avoid a recession.
