Australia is still in a recession.

The government has claimed that Australia dodged a recession, but they can only claim this by using aggregate data instead of per person data. And the simple truth is that people are only ever one person at a time. If we have $100 to share between five people, and then we must share the $101 between ten people, each of us has become poorer.

Australia has been in a recession for the past year, and tomorrow we will find out whether we are still in recession. The population grows at about 0.4% per quarter, so if the GDP growth rate is below 0.4% then we are still in a recession. My best guess is that we are still in a recession.

I’m not saying this because I’m a doom merchant. Indeed, I have been consistently more up-beat about the Australian economy than most other economists. The natural robustness of a market economy is able to withstand lots of shocks, including international shocks (from the American housing collapse) and political shocks (with Rudd’s stupid economic policies).

One element playing against our economy is trade. Because the government has borrowed so much from international markets (and promised to borrow much more), there had been an upward pressure on our exchange rate. The simple reality, which is not open to dispute, is that an increase in net foreign borrowing (capital account) must be matched by an identical reduction in net exports (current account). Every dollar internationally borrowed for the stimulus package has been taken from an Australian business that exports or competes against imports. The stimulus is a tax on trade-exposed businesses.

This is a bit of a dry argument, and so the opposition is using a high-profile example of imported pink batts. This unfortunately misses the broader point. It doesn’t matter whether the government spending is on domestic or imported products. What matters is how the fiscal policy crowds out trade-exposed businesses.

I am still fairly optimistic about the Australian economy. The government has done some damage, and we’re still in recession, but they won’t stop an eventual recovery.

UPDATE 2/9/09: I was wrong about the growth numbers. I had predicted growth of 0.4% or less, but the national accounts released today confirm that we had GDP growth of 0.6% for the June quarter. The main positives were household consumption (+0.5%) and increased government inventories (+0.5%), partially offset by the change in net exports (-0.3%) and a drop in private non-farm inventories (-0.4%). The good news was that private business investment (the driver of long-term growth) increased, contributing 0.3% to GDP. It looks like we’re out of recession now, hamd’allah.

13 thoughts on “Recessionomics

  1. Can you explain this bit further, i don’t understand why borrowing reduces your exports:

    “The simple reality, which is not open to dispute, is that an increase in net foreign borrowing (capital account) must be matched by an identical reduction in net exports (current account).”


  2. Australian dollars are only spent on Australian things. For us to borrow Australian dollars from a foreigner, that foreigner must first have gotten Australian dollars somehow. Total money inflow must always equal total money outflow.

    That is why the capital account (money flowing for investment) is always inversely equal to the current account (money flowing for goods & services).

    For example, consider if we import $100 worth of goods and export $50 worth of goods. Abstracting from a few other issues which aren’t relevant right now, we will then have a current account deficit (CAD) of $50.

    But how can we afford to buy the extra imports? And what are foreigners doing with pointless Australian dollars which they can’t spend overseas? The answer is that we borrow the $50 back from overseas. That is the capital account surplus (KAS).

    When you change either the CAD or the KAS, then the other one must move by the same amount in the opposite direction. The government just increased the KAS by borrowing more. Therefore, the CAD must increase by the same amount.


    I’ll put it another way. Our exchange rate is determined by the supply of Australian dollars and the demand for Australian dollars.

    We “supply” Australian dollars when we want to exchange it for foreign currency. We want foreign currency to (1) buy imports; or (2) invest overseas. The “demand” for the Australian dollar comes from foreigners who want to (1) buy our exports; or (2) invest in Australia.

    The government is borrowing more from foreigners, which is the same as foreigners investing in Australia. That means the “demand” for the Australian dollar will go up. When the demand goes up, then the price goes up (the dollar appreciates). When the dollar appreciates, that makes our exports more expensive (so foreigners don’t want them as much) and it makes imports cheaper (so people buy more of them). Exports and imports will change until the supply of Australian dollars equals the demand for Australian dollars.

  3. John – following that logic, shouldnt the US with its foreign-funded trillion dollar deficit have strong currency? Or is that being negated by the inflation of the money supply?

  4. Thankyou John, that pretty much explained the guts of it to me. So basically, changes to the exchange rate is the mechanism for what you’re saying.

  5. Chris — yes, the exchange rate is the mechanism.

    Todd — if people want more USD, then their currency will appreciate; if people want fewer USD, then their currency will depreciate.

  6. Sorry John, you’ll have to forgive me, Im not an economist.

    You seem to argue that government borrowing creates currency demand, which drives up the relative price of the currency. That is, our dollar has appreciated over the last nine months or so because government borrowing has created demand for Australian dollars.

    The US government (along with the Japanese and I suspect a raft of others) has much larger foreign borrowing commitments, hence currency demand, but the value of their currency has declined in relative terms.

    The more a government borrows, the more demand for the national currency, the higher the relative value of the currency, right? It doesnt make much sense to me that people would demand US dollars to lend to the government and at the same time shun the US dollar.

    I can see that government borrowing would create some demand for national currency, but this must be relatively minor compared to other economic factors, surely?

  7. The value of a currency is determined by the total demand and total supply.

    Yes, government international borrowing will result in higher demand for their currency. Consequently, the value of their currency will be higher than it otherwise would have been.

    That does not mean that when the government borrows money, their currency must appreciate. It just means that it will be higher than what it otherwise would have been.

    There are many players in the foreign exchange markets, who are buying and selling currency for a range of reasons. The government is just one player in the market. They influence the currency, but they are not the only influence. In economic jargon, we say that government international borrowing would increase the exchange rate, ceteris paribus (which means: holding all else equal). Of course, in reality all other things don’t stay equal… and so the currency jumps up and down.

    How much the government borrowing impacts the exchange rate isn’t important. It is just the mechanism. What is important is that net exports must change by the same amount as net capital flows, by definition. So every dollar borrowing overseas from the government came from trade-exposed businesses in Australia.

    Btw, the level of the government debt isn’t going to change the exchange rate. The current exchange rate already factors in known capital flows. It is the change in the capital flows that will lead to a change in the exchange rate.

  8. Government borrowing need not drive down exports if business and domestic borrowing has declined (or savings increased) in tandem with the rise in government borrowing. I’m sure some would argue that the later theoretically happens in a recession. As such the stimulus may in fact be a tax on the users of capital, who might have otherwise enjoyed marginally lower interest rates, more so than a tax on exporters.

    Of course as usual John chose his words quite carefully and said that trade was merely one element to be considered. So I’m not disagreeing with anything he has written. I certainly agree with his characterisation of the governments policy response as an economic shock.

  9. Terje — government international borrowing.

    Domestic borrowing (and potential crowding out) is a different story. Indeed, to the degree that the government gets their money from the domestic pool of savings it is theoretically possible for fiscal policy to work… so long as they have encouraged an increase in the credit multiplier by the banking sector (that’s a big “if” in the current situation).

    However, at least half (often more) of government borrowing comes from international markets. And it is not even theoretically possible for fiscal policy to work when the money comes from overseas.

  10. Naturally, it was the stimulus wot dun it.

    Actually, the stimulus would have had a small positive effect – but at the cost of a massive reduction in wealth.

    Money well spent? Nope…

  11. Well, I was wrong about the growth number. But it’s interesting to note why I was wrong. On their own, net exports reduced our GDP by 0.3% while household consumption increased our GDP by 0.5%.

    But the unexpected positive number was the increase in government inventories, which contributed 0.5% to GDP growth. This is the equivalent of the ABC book shop buying a bunch more books.

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