The period from 2012 to 2015 was Australia's 'dog days'. Our 'dog days' were when declining commodity prices led to a decline in the terms of trade. This decline in the terms of trade led to low nominal GDP growth. Low nominal GDP growth put tax revenue under great pressure. This meant expenditure needed to be tightly controlled to stop the budget balance blowing out.
Figure 1: Major economic parameters
SOURCE: Budget Paper No 1, Table 2, Page 1-10
In Figure 1 above, we see the outlook for the Australian economy shown on Budget Paper No 1, Table 2, page 1-10. What is interesting here is the bottom line. That bottom line is nominal GDP. In previous commentary, we have noted that nominal GDP growth in our 'dog days' from 2012 to 2015 was really only around 2%. Nominal GDP is how wages are paid which meant that wage growth was pretty miserable. Nominal GDP is also how corporate profits are paid. This also meant that corporate profits were pretty miserable.
Nominal GDP (as shown in Figure 1) increased from around about the 2% figure in the previous three years to 5.9% in 2016-2017. This figure also shows that nominal GDP is expected to rise by 4.25% in 2017-2018. They expect it to increase by 3.75% in 2018-2019 and then 4.75% in 2019-2020. In the two years after that, nominal GDP continues to grow at 4.5%. The recovery in nominal GDP rescues Australia from its 'dog days'. Faster nominal GDP growth rescues us from the misery of that period. It also means that tax revenues are now rising at a pace where governments can fund things like individual tax cuts as long as they keep a steady line on budget expenditure.
We note from the Figure above that the government forecasts consumer price inflation to never rise above 2.5% and unemployment to never fall below 5%. Should that scenario actually occur, the Reserve Bank need not bother going to work again until sometime in late 2022.
Figure 2: Commodity prices and the terms of trade
SOURCE: Budget Paper No 1, Chart 8, Page 2-24
In Figure 2, we see the reason that nominal GDP recovered. The real cause of our 'dog day' period was the decline in commodity prices and the decline in the Australian terms of trade from 2012 until 2015. It is this decline which inflicted low nominal GDP growth on the Australian economy.
Since the beginning of 2016, we have seen a sharp recovery in commodity prices. The RBA index of our export commodity prices has risen more than 20%. The terms of trade has had a similar but slightly smaller recovery. The Australian Treasury thinks that the terms of trade will drift down from now on. We have a whole lot of reasons including the expanding US budget deficit for thinking that Australian export commodity prices are going to be stable or continue to rise.
This article was first published by Morgans.
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