2016: A Most Reasonable Year for the Economy

The Australian economy is in reasonable shape as 2016 draws to a close. Real GDP growth is around three per cent, inflation is 1.5 per cent while the unemployment rate is hovering near 5.75 per cent.

To be sure, it would be desirable if growth was a little stronger and unemployment lower, but given the collapse in mining investment, consumer spending being constrained by record low wages growth and the pressure of global disinflation on local producers, 2016 has been a stronger year than almost all forecasters were anticipating at the start of the year.

There are reasons to think that 2017 will also be a reasonably good year for the economy.

Commodity prices are edging up and are higher now than at the start of 2016, and, in some cases, this is by a large amount. This is leading to a lift in national income and nominal GDP growth. The Australian dollar, which has been stuck around US 75 cents for many months now, is providing a competitive boost which will further underpin economic growth. One only has to look at the surge in tourism and education exports to see how the lower Aussie dollar is helping the economy.

Another positive is the record low level of interest rates. This is having the dual effect of freeing up cash flow for households and businesses with debt, while also lowering the hurdle rate for borrowing, spending and investing. This should feed into a more positive outlook for non-mining business investment which is an essential element if economic growth is to remain at three per cent, or more, next year.

Another less obvious positive for the economy is the fact that fiscal policy from the Federal government is broadly neutral. The cuts in government spending are trivial, or have been offset by spending elsewhere in the economy. The government is not even taking baby steps with tax reform, meaning revenue is linked to economic growth and not new policy measures.

At the state government level, infrastructure spending is being ramped up. This appears set to be a solid contributor to GDP growth as transport investment is undertaken, mainly in the big cities. This could be a big plus as 2017 unfolds.

There are some negative influences at play, which will stop the economy being even stronger. Given the looming glut of apartments in many cities, dwelling investment is likely to fall during the course of the year. It could be a sharp fall in new construction if the oversupply of building from the last couple of years takes a long time to clear and foreign investor demand falters.

The house price story is another risk, albeit a moderate one. If house prices, Australia wide, keep rising at a moderate pace or even edge five per cent lower, the economic effect would be miniscule. If prices were to drop 10 per cent or more over the next year, the shock to consumer sentiment, spending and financial stability would be significant and present a large downside risk. But sharp house-price falls seem unlikely given the likely path for population growth and interest rates.

There is also a chance that the government will be spooked by the prospect of a credit rating downgrade and will move to tighten fiscal policy and, in doing so, undermine
growth. Perversely, some of the current momentum in the economy owes much to the draconian measures in the 2014 budget delivered by Joe Hockey being rejected by Parliament or dropped by the government when it realised how misplaced those policies were.

With the Mid Year Economic and Fiscal Outlook less than a month away, Treasurer Scott Morrison needs to tread carefully between a more meaningful path to budget surplus and maintaining economic growth. If there is a push to tighten fiscal policy at a time when the economy is just gaining some momentum, the downside risks will quickly emerge.

If this time next year real GDP growth has averaged a little more than three per cent, if
inflation has edged back to the lower part of the RBA two to three per cent target band, and the unemployment rate has eased to around 5.25 per cent, it will have been a good year for Australia.

The way 2016 is ending, and given global events and domestic policy settings, the odds are strong for such a scenario to unfold.

@TheKouk

Adelaide In-depth

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