Yahoo Finance When the smoke clears, the Australian economy will be looking strong
For even the best economists, reading the economy can be a tricky business, especially when there are large and observable events that we know will have a material impact on growth, employment and inflation.
The trick is to not only estimate which direction the so-called shock will be – will it cause GDP growth to be stronger or weaker and over what time frame – but then working out how big the impact will be.
This is the case right now with the bushfires which will impact on the economy over the next year or two.
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There seems little doubt the near term impact will be negative, but longer term, when we look to the middle of 2020 and into 2021, it could actual provide a boost to GDP growth and all that goes with that.
What has been overlooked is the underlying health of the economy prior to the fires – it was verging on strong.
Economic hiccups are expected
A classic case of a ‘shock’ to the economy was the global financial crisis a little over a decade ago.
Every economist knew the fall out would be a huge negative for the Australian economy. The known unknowns were how much the impact would be; how long would it last; and how effective the policy stimulus would be as the government and the RBA threw the policy kitchen sink at the unfolding problems.
Treasury took the rare step of forecasting a recession which, somewhat ironically, never arrived. This was not because the global fallout from the GFC was any less than initial expected – it was, in fact, far worse.
The error in judging the extent of the shock by Treasury was due in large part to the policy effectiveness which saw a raft of fiscal and monetary policy stimulus measures which were staggeringly effective in supporting the economy.
Experts got the GFC wrong
In the case of the Australian economy, every forecaster got the impact of the GFC wrong.
Most famously, Professor Steve Keen said in 2019 Australia will experience a "depression that will last for 10 years if we are lucky" and that house prices will fall 40 per cent with the unemployment rate rising to “10 to 15 per cent and could go to 20 per cent”.
Fast forward to today and there is no doubt the bushfires and smoke will impact the economy.
It would be silly to suggest the economic effects are anything akin to the GFC. The negative impact will be short term and will probably have passed through the data in an economic sense by the June quarter 2020.
When the smoke clears
From the second half of 2020, the net effect on GDP from the fires will be positive as the rebuilding of dwellings, commercial real estate, infrastructure and the replacement of durable items (furniture, white goods, cars, and the like) feed into additional spending.
After a lull, tourists are certain to visit their favourite destinations, even those impacted so badly by the fires.
In the next few months, there are likely to be a raft of poor economic indicators published, like the recent consumer sentiment results which showed a sharp dip in January.
What has been overlooked is the underlying health of the economy prior to the fires – it was verging on strong.
The illion survey of business conditions was at a record high. At the same time, house price growth was strong with national wide house prices up a strong 9 per cent from the mid 2019 low, with prices just a few per cent below the 2017 peak.
It is well understood that the wealth effect to consumers from higher house prices will be strong. It will also play into the health of bank balance sheets as rising house prices all but eliminate any possibility of troublesome bad debts and loan arrears.
After a decade of decline, business investment is poised to ratchet higher. Mining investment will be strong and some firms will need to re-equip after the investment drought which accompanied the election of the Coalition in 2013.
Even retail spending, new dwelling approvals, employment and the unemployment rate were a touch better (from a low base) at the end of 2019.
As noted, the aggregate magnitude of these positive indicators is unclear and they will no doubt have been impacted, at least in the short term, by the fall out from the fires and smoke.
And there are still fires burning.
‘Watch and Act’
For policy makers, some policy easing is appropriate given the still significant slack in the economy and more evidence of inflation below the RBA target.
But forecasting for the remainder of 2020 will be subject to greater than usual uncertainty and revision, even though 2021 looks a lock for a return to 3 per cent and more GDP growth.
And the good thing about economic policy, especially official rate set by the RBA, is that they can easily change direction if the economy ‘surprises’ them.
The RBA may well judge the underlying health of the economy to be improving and that after the blip in conditions from the bush fires pass, growth will be back at trend or more around the middle of the year.
But then again, the impact of the fires on the economy may be well away from current estimates.
Policy is likely to be more reactive over the next few months as the economic effects of the fires are seen.
There is still a strong likelihood that the underlying momentum n the economy is to the high side and that after the fires, the economy will register some decent growth.
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