The deputy governor of the Reserve Bank of Australia, Stephen Grenville, caused something of a stir late last week when he began to explain the causes of the current economic slowdown. He was at pains to point out that the Reserve Bank’s actions of 18 months ago to increase interest rates could not possibly have caused the downturn. He pointed out that interest rate changes, particularly those coming off a very low base, could not have had such a large effect. More controversially, he mentioned the GST in the same breath as the word slowdown.
Dr Grenville said that business confidence had been affected by a several sources of pressure on business costs and cash flow: the GST, exchange rates and oil. He said also that the transition to the GST had affected business confidence adversely on two counts: first, the general bureaucratic requirements and accounting changes and secondly the rescheduling of construction activity in the economy. Many individuals and businesses brought forward construction activity in late 1999 and early 2000 in the knowledge that the GST was pending. This meant a commensurate downturn in late 2000 and early 2001.
Both the Reserve Bank and Treasurer Peter Costello issued statements saying that Dr Grenville had not blamed the downturn on the GST. They did so after various media outlets had jumped to that conclusion. Mr Costello pointed out that the GST was part of long-term, pro-growth structural changes. The Reserve Bank pointed out that the income tax reductions had over-compensated for the GST and if anything were expansionary rather than contributors to contraction. They are probably both right on this score. However, as the Treasurer himself acknowledges, given that the whole economy except construction grew, the technical contraction can be solely put down to the GST-induced construction downturn. If it continues next quarter, we can state that the GST caused the recession – the technical blip after strong growth – even if in the long-term it will probably contribute to long-term growth. It shows the nonsense of relying too much on GDP and other economic data.
But if interest rate increases and the GST are not to be blamed for the slowdown, what is its cause?
Dr Grenville pointed to the danger of talking ourselves into a recession. This is perhaps the most critical factor. Business and consumer confidence are essential ingredients to a well-functioning economy. Indeed, it is these psychological factors which dog the most erudite economist. The best modelling and data gathering in the world will not withstand irrational mass movements of confidence. As President Franklin Roosevelt said in the midst of the 1930s recession, “The only thing that we have to fear is fear itself.”
That sentiment should also be applied politically. In the lead-up to the election at the end of it this year, the government will be tempted to spend its way out of trouble. Indeed, it has already begun. Hitherto, international markets might have been at less concerned about fiscal loosening given the capacity of the Reserve Bank to tighten interest rates. But if Dr Grenville is correct, it would appear that interest rates are not so powerful as we have imagined.
The question of whether politicians are capable of talking up or down the economy is probably of little moment. Everyone expects a government to say the economy is rosy and for the opposition to say the economy is going sour because of government mismanagement. Government actions are far more important than Opposition words when it comes to business confidence.
We should all be hoping that Dr Grenville is right on one point: that if this is a downturn it will be short lived. Once we get over some one-off effects — like the rush on construction to beat the GST, the Olympics and the pressures of oil prices and a weak dollar — the solid fundamentals in the Australian economy should enable economic growth to resume.
In any event, the well-being of Australians does not depend on the technical definition of recession as two quarters of negative economic growth. If the negative figure is low in each of those quarters it might not matter. Moreover, the technical recession might come at a time when unmeasured, non-economic factors are improving.