The IMF's policy prescriptions are wrong for Australia

While Australia's policymakers fret over changes in the rate of inflation, there's a deeper problem that will trouble the economy.

Policy prescriptions advocated at the recent G20 finance ministers’ meeting in Cairns risk dragging Australia into a world of fantasy, far removed from the genuine challenges that confront the nation.

In particular, the IMF’s view that “advanced economies should continue accommodative monetary policies, given still large output gaps and very low inflation” simply holds no relevance for our country.

Australia has a much different set of metrics, alien to many advanced economies like Europe and Japan, for instance.

Specifically, the most recent set of national accounts show that real national income is rising at a solid pace -- 3.5 per cent year-on-year -- a rate that is above trend (3 per cent). More to the point, annual inflation on both headline and core measures is at the top of the band (around 3 per cent). Jobs growth over the course of 2014 has been solid.

These are enviable figures, for the most part, and ones that are clearly inconsistent with a target cash rate that is at record lows. That major trading partner growth is above trend adds to the disparity; a world concocted by global policymakers in opposition to the one we actually confront.

In a similar vein, the Treasurer’s acceptance of macroprudential controls is woefully misguided.

RBA governor Glenn Stevens rightly labelled them as a fad. Framed on the assumption of economic weakness, macroprudential controls have no place in Australia. The IMF encouraged their use where the “risk of premature monetary policy tightening [was] not warranted by the cyclical position”.

With the growth, jobs and inflation outcomes that Australia enjoys, that case cannot be made. House prices are surging because construction is less than what population growth demands and because lending rates are at their lowest in a generation, not because of high loan-to-value ratios or lax lending standards more generally.

This is the real world. The intelligent way to deal with a problem is at its source.

Hockey simply cannot afford to busy himself with the pointless policy prescriptions that flow from the G20, if just for the simple reason that they distract from the real problems at hand.

While the nation’s policymakers remain transfixed by changes in the relative price of traded goods -- convinced that it is the rate of inflation that drives employment and growth -- real-world dynamics show that the nation is ill-prepared for even a modest lift in demand. 

This is because non-mining business investment is at its weakest in decades (as a share of nominal GDP) and in real terms, it has declined over the last few years, down about 10 per cent from its 2011 high.

Persistent underinvestment that coexists alongside an already tight labour market and robust economic growth suggests that the economy will come up against capacity constraints much more quickly as the economy accelerates further. If that is the case, then there is a strong likelihood inflation would lift sharply -- something that is guaranteed if the currency’s  slump is sustained. This is a major problem given that inflation has been the root cause of every recession Australia has had in modern times.   

It’s with that in mind that survey measures of capacity utilisation are most likely overestimating the amount of spare capacity actually available. 

Remember that these survey measures are based on expectations of ‘weak demand’ despite an economy that is, alongside its major trading partners, already growing above trend.

Hockey must embrace the real world -- not this fantasy painted by the IMF and others at the G20 -- if there is to be any hope of steering the economy successfully. It is the decisions that he and Cabinet make today that will determine whether the country remains on a sustainable long-term growth path.  So far, it’s not looking good. 

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