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Is Australia's economic strength a thing of the past?

We hear from the government that the Aussie economy is doing well at the moment, with GDP growth close to 3.5 per cent, the unemployment rate ticking lower and the budget on track to return to surplus.

Others point to the fact that wages growth continues to hover near record lows, household wealth is on the cusp of sharp decline as house prices weaken and the only reason the budget is getting close to a surplus is sheer dumb luck from an unexpected lift in the price of iron ore and coal.

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And does the budget balance matter when the unemployment rate is still 5.3 per cent and a further 1.1 million people are underemployed?

It also begs a question, what sort of economic conditions would we need to see to have everyone agree the economy is actually ‘doing well’.

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The starting point must be linked to the labour market.

Having the economy strong enough to ensure that everyone who wants a job has a job is important. This should be accompanied by moderate growth in real wages, that is, having the rate of annual wage increases about 1 per cent faster than the rate of inflation which lifts living standards of the workforce.

In economist-speak, in Australia this translates to the unemployment rate tracking around 4.5 per cent. At this sort of rate, firms will need to edge their pay levels higher, workers will be able to demand a moderate rise in wages and the economy will be growing around 3.25 to 3.5 per cent.

All this is possible with the inflation rate tracking comfortably within the Reserve Bank’s target of 2 to 3 per cent.

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For the budget, the consequences are frankly neither here nor there.

Unfortunately, in recent years the budget balance – whether it is in surplus or deficit – has been seen as a sign of economic strength on sound economic management.

Instead of this misguided approach to budget management, the budget bottom line should swing from surplus to deficit and back again according to the strength of the economy.

When the economy is under downward pressure, it is good policy management to run a budget deficit. This way, the government is ensuring more money is staying in the economy which helps to support activity and employment.

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When the economy is strong, the budget should be in surplus as the government allows some of the heat to come put of the economy by allowing revenue to flow into the Treasury.

Which brings us to the economy now.

It is fair to say that judgements of Australia’s economic health boils down to a number of key assumptions:

• How strong is the global economy and where will it be in 2019?

• How sharp will the fall in house prices be and what will that mean for consumer wealth, sentiment and banks?

It seems clear that the global economy is continuing to grow, but it is likely to cool somewhat in 2019 as the impact of generally tighter monetary policy and the impact on trade from the Trump tariffs start to bite. Which is not a bad outlook, but there is unlikely to be the upside impetus that have been evident in the last year or so.

In terms of house prices, there are grounds for concern.

We know from the Corelogic data that prices have fallen for 12 straight months and that this is undermining wealth and confidence.

What’s more interesting is the fact that house prices are almost certain to fall further as the recent out of cycle interest rate increases and tightening in lending are still to bite.

Either way, house price falls will likely undermine growth into 2019.

Which brings us back to the start – how good is the economy right now?

Things are reasonable, without being strong. Inflation and wages growth is too low, despite the edging up in the rate of GDP growth.

If the consensus is right and the global economy comes off the boil in 2019 and the falls in house prices damage consumer spending, the current hard data is, unfortunately, set to deteriorate. It is still more likely that the unemployment rate will hit 6 per cent before it breaks below 5 per cent.