Friday 15 Nov 2019 | 23:33 | SYDNEY
What's happening on
  • 15 Nov 2019 12:30

    Ayodhya verdict and unruly consequences

    India’s Supreme Court has delivered a ruling that will embolden the Hindu right and challenge the country’s secularism.

  • 15 Nov 2019 10:00

    Autocrats Anonymous

    A White House confessional reveals Donald Trump incapable of change – a kind of Marvel superhero, but less interesting.

  • 15 Nov 2019 06:00

    Book Review: The original corporate raiders

    Historian William Dalrymple looks at how a small trading company in London became a mighty army and conquered India.

About the project

From 2012 to 2016, the G20 Studies Centre at the Lowy Institute for International Policy produced independent research on global economic governance and the role of the G20, and supported research networks in Australia and overseas. The Australian Government provided funding to establish the Centre.

The archives of the Centre’s quarterly G20 Monitors (as well as other publications from the G20 Studies Centre) are available below. The Monitor brought together opinions from Australia and around the world to discuss developments in the G20 and suggest policy ideas.

The Lowy Institute will continue to comment and publish on economic governance issues.

Experts

Anne Fulwood
Media Director of Ogilvy Public Relations Australia and Australia’s representative at the W20
James Hospedales
Executive Director of the Caribbean Public Health Agency
Sam Bide
Economic and G20 policy adviser at the Department of the Prime Minister and Cabinet
David Gruen
Deputy Secretary, Economic at the Department of the Prime Minister and Cabinet

Latest publications

G20 Monitor: Towards Hangzhou and Hamburg

The 21st edition of the G20 Monitor highlights considerations for the G20 ahead of the 4–5 September 2016 G20 Leaders’ Summit in Hangzhou, China. It also canvasses three topics that are possibly of interest to the 2017 German G20 Presidency: cyber rule-setting, global migration governance, and global health governance.

Photo: Getty Images/VCG/Stringer

Making the most of the G20

In this Lowy Institute Analysis, G20 Studies Centre Research Fellow and Project Director Tristram Sainsbury and Research Associate Hannah Wurf argue that the G20 should be at the centre of Australia’s approach to international economic engagement in the years ahead.

Photo: Getty Images/VCG

G20 Monitor: New considerations for China’s 2016 G20 Presidency

The 20th issue of the G20 Monitor discusses the economic leadership China can display in 2016 by opening its services sector; the successes and structural gaps in the G20 financial regulatory agenda; the merits of G20 target-setting; and how the G20 can respond to the new Green Finance Study Group. 

Photo: Getty Images/China Photos

Yes, monetary policy does still work

Did you know that Australia once had a double dissolution election where the trigger was the conduct of monetary policy? It was our second double dissolution election, in 1951  (we are currently looking at our seventh), and the question at hand was the management of the Commonwealth Bank, which later in the decade had the Reserve Bank cleaved from it in an unrelated reshuffle.

Monetary policy matters. It has mattered for a long time. Tight monetary policy played a central role in the depths of the Great Depression. Even as far back as the early 1700s, monetary decisions caused the industrial sector of France to contract by 30%.

It would be quite a unique historical episode if monetary policy were ineffective. Some claim we are in that world now.

Let me explain why I think they are wrong.

First, let’s distinguish between two different types of economies: those at the zero lower bound for nominal interest rates (or near the lower bound, whatever it is, given some economies have negative rates), and those that are not.

Those not at the zero lower bound can still cut interest rates. I’m not sure why people think that the normal channels will not work properly. You often hear the claim that 'an extra 25 basis points (the amount of a usual interest rate cut) won’t have any effect'. Why would it have any less effect than usual? When I’ve looked at market and interest rate reactions to policy rate surprises lately, I haven’t seen any change in the effects of policy.* I don’t understand what evidence people are looking at when they say interest rate cuts don’t work anymore.

Another refrain I often hear is: 'if companies won’t invest at these low rates, they won’t invest at rates that are even lower'. But it is unlikely that the direct effect of interest rates on business investment has ever been strong. So, again, it does not look like the effects of monetary policy have changed.

Economies stuck at the zero lower bound can implement unconventional monetary policy, such as quantitative easing. Unconventional policy has been effective, as outlined by the Peterson Institute’s Joe Gagnon in a wonderful seven page brief on the topic.  Gagnon surveyed studies that looked at the effects of quantitative easing, and had this to say:

By and large, this research has attracted little attention from the public or even the financial press. Studies overwhelmingly agree that QE does ease financial conditions and there is no reason to doubt that it supports economic growth. QE can be especially powerful during times of financial stress, but it has a significant effect in normal times with no observed diminishing returns. Rarely, if ever, have economists studying a specific question reached such a widely held consensus so quickly. But this consensus has yet to spread more broadly within the economics profession or the wider world.

A stark example of the success of unconventional policy has been Japan…so far. Below is a graph of Japanese inflation and an indication of when quantitative easing began in Japan. We have gone from outright deflation of around 1% a year, to inflation of 1% a year (the spike up and down in 2014-15 is the effect of a tax increase, ignore it).  Some will counter that this is just the effect of a depreciating exchange rate, but wage inflation is up too, and so is the GDP deflator, so it’s not just the result of more expensive imported goods.

So the Japanese experience is encouraging. One problem, though, is that they want to get to 2%, and that line has stopped moving up.  That should call for more stimulus, but the Bank of Japan shied away from that during its last meeting. That left some observers, like Joe Gagnon, perplexed and worried that the BOJ does not have the will to get that line to where it needs to go.

Alright, so if monetary policy still has an effect, and if monetary policy settings are stimulative, why don’t we see more growth? One issue, I think, is that policy is not as stimulatory as it might otherwise be because the 'natural' interest rate has fallen.  The 'natural' interest rate is, basically, the interest rate the economy would face in normal times. The IMF wrote about a falling natural rate in its April 2014 October World Economic Outlook. If the interest rates in normal times are lower than in the past then expansionary monetary policy would also have to be associated with lower interest rates (and more unconventional policy) than in the past.

You could think about it in the following way. Economists often talk about something called the IS curve which, in a very crude way, shows the level of output you get for a given interest rate. What the IMF is saying is that the IS curve has shifted down, shown in the diagram below as a movement from r to r*. So the same level of interest rates do not give you as much output as it did before. That is not the same thing as saying monetary policy is ineffective. The effectiveness of monetary policy is given by the response of output to the interest rate, or the slope of the IS curve. The IMF, and I, think the IS curve has moved down, and there is evidence for that, but there is little evidence that the slope has changed.

In the past, people have thought monetary policy was ineffective. I wrote a piece last year discussing how some thought the high inflation of the 1970s could not be solved with monetary policy . During the Great Depression, Federal Reserve monetary policy was influenced by the flawed 'real bills doctrine', that led policymakers to conclude that monetary policy was easy, and not much could be gained by a loosening of it. Those who doubt the power of monetary policy have typically been wrong. I’m yet to be convinced why this time is different.

*For the wonks, there’s a subtle reason why cuts when interest rates are lower should give you MORE bang for your buck. One of the channels of monetary policy is the wealth channel. When asset prices go up, people feel more wealthy, and they spend more. An interest rate cut of a given size, say 25 basis points, should deliver a larger asset price response when interest rates are lower. Take, for example, the Gordon growth model for pricing a company’s stock. The divisor in that equation is the interest rate (well, cost of capital, but for argument’s sake, say it is the risk free interest rate) minus growth. The lower the interest rate, the larger proportional change you will get in the divisor for a 25 basis point cut, and the larger the stock price response. There’s a number of issues I’ve abstracted from in this example, for example, the interest rate in the model is fixed into the infinite future, but in general they shouldn’t change the conclusion.

Budget 2016: How well does the Australian Treasurer understand our global economic context?

 

 

We face 'extraordinary' times, 'very sensitive' times, international headwinds and fragility. But the overarching message we are meant to take away from this year's Budget with is a positive one.

In his 2016-17 Budget speech, delivered tonight, Australian Treasurer Scott Morrison stated that the Turnbull Government understands the economic challenges Australia faces. And indeed there is a comprehensive range of measures and policy announcements intended to assure us that the government is responding to our challenges and successfully navigating the transition away from the mining boom.

Unfortunately, the Treasurer's words have been undermined somewhat by his extremely light treatment of the global challenges and risks that are materially important to the Budget figures.

The avoidance of international context is particularly worrying on the back of the Treasurer's decisions not to attend the IMF, World Bank and G20 meetings in Lima last October and in Washington last month, as well as other recent international gatherings.

The scant international content in the Treasurer's remarks is particularly striking in light of the 0.25% interest rate cut announced this morning by Reserve Bank of Australia Governor Glenn Stevens. In justifying the interest rate decision, the key factors cited by the Reserve Bank Board were primarily global in nature. Weighing on the Board was a confluence of downgrades in global economic forecasts, uncertainty about the economic outlook, difficult conditions in emerging-market economies, and the divergence in monetary policy settings.

The Treasurer cited precisely none of these factors in his speech.

He had much to work with. Digging into the details of the Budget papers suggests a prudent, middle-of-the-road set of estimates about the global economy, awareness of the risks, and broad alignment with the international economic discourse and the Reserve Bank Board decision.

The US, Japan and Euro area are expected to grow at modest rates or remain subdued out to 2018 the forecast years. As for our emerging-market trading partners, the ongoing Chinese transition means moderating growth and ongoing risk to the global economy, India's title as fastest growing major country in the world will continue to present opportunities, and other East Asian countries are expected to grow slowly relative to history.

The overall picture is one of moderating global growth, reflecting unresolved crisis legacies, low productivity growth and unfavourable demographics.

Table 1: International GDP growth forecasts

Given the Budget papers’ claim that risks to growth are broadening and are evident in both advanced and emerging economies, it is also worth paying attention to the uncertainty around the estimates. For interested wonks, Budget Paper 1, Statement 7 details forecasting performance and scenario analysis and is worth a read. It is technical but rich in detail about the uncertainty of numbers.

I’ve produced, with a couple of tweaks, an Aussie version of the ‘most depressing chart in the world’, an honour bequeathed to a chart from the 2016 Economic Report of the US President which explains the succession of World Real GDP growth forecast downgrades by the IMF.

Australian Major Trading Partner GDP forecast, 2010-2018 

Source: Various Australian Budgets and Mid-Year Economic and Fiscal Outlooks (MYEFOs)

The graph explains how well, or rather how poorly, Australia has forecast the performance of our major trading partners – those of particular importance to domestic economic activity – in recent Budgets. We have gotten into a routine of projecting a rosy recovery, which has failed to materialize by the time forecasts become actual, known figures. 

It is an observation entirely consistent with the experience of other forecasters, such as the IMF, and is unsurprising given the tendency for Australian forecasts of the international economy to benchmark our international projection, for very understandable reasons, against credible global and national forecasts. But it means we inherit their mistakes, and this has meant downgrades so far this decade.

What continued downgrades in the international economy means is a very real thing for the Budget. It is a material contributor to the ‘parameter and other variations’ (changes in Australian economic conditions not associated with policy) that are collectively responsible for around $13.5 billion in net tax receipts downgrades since MYEFO out to 2018-19, a smaller downgrade than in recent budgetary documents. In comparison, though, the net impact of policy decisions on the budget bottom line across the same four years (which admittedly covers a range of actions that impact on the budget bottom line) is just $1.2 billion.

In all, this is very much the Budget of a salesperson, one that allows Morrison to distance himself firmly from his predecessor and the highly optimistic tone on the global economy that was a hallmark of last year’s Budget.

A side effect, though, is that when it comes to the big picture, the impression is that Australia’s Treasurer is completely focused on a fraction of the change that drives our nation’s bottom line.  The action by the Reserve Bank, and what it implies about the trajectory of the Australian economy, is therefore likely to steal some of the headlines away from this unusually early Budget.

China and Australia: How closely linked are our economies really?

Like my colleague Steve Grenville, I was lucky enough to attend the Reserve Bank of Australia (RBA) Conference on China last week.

The RBA managed to assemble a gold-plated line-up for the conference. It was a truly impressive effort.

Several discussions I had focused China’s connections to the Australian economy; this was usually in the context of what a hard landing in China would look like.

It got me thinking about how strong the connection is. It turns out, by some measures, not terribly. First, below is a graph of year ended Australian GDP growth. Can you see the mining boom? It’s quite tough. If you knew nothing of the history of the Australian economy, before being told there had been a massive mining boom, you would be hard pressed to pick it.

To be sure, you could see it in the composition of GDP. But aggregate GDP shows little trace.

More systematically, we could look at the correlation of Chinese and Australian GDP to gauge the influence of China. The graph below shows how this correlation has changed through time, by showing ten-year rolling correlations — that is, each point in the graph shows the correlation between the economies for the previous 10 years.

I’ve shown the correlation between the US and Australian economies as well. Up until the early 2000 recession in the US, the US and Australian economies appeared tightly linked. Now, according to this graph, China has overtaken the US. New era, right?

Not so fast. This increase in the correlation between Australia and China owes much to 2008-09, when the two economies both had a relatively short patch of soft growth, followed by a rebound. If we were to use a shorter window, say seven years instead of ten, then that period drops out from the calculations more quickly. The results are below.

There has essentially been no correlation between Chinese and Australian GDP over the last seven years. That was certainly surprising to me. The primacy of the US economy is restored, although not to the previous highs we saw before the millennium.

What does this mean? It depends upon your interpretation of the 2008-09 period. It was volatile, and volatile periods have a big influence on correlation statistics. So in periods of volatility, would we expect the Australian economy to be more correlated with the Chinese economy, or the US economy? I suspect it would depend upon the nature of the shock underlying the volatility.

Nonetheless, there are linkages between Australia and China that do not necessarily show up in high-frequency GDP movements. In particular, Australia’s fiscal position is heavily influenced by commodity prices, and China's role in commodity markets is clear.

Photo courtesy of Flickr user Paul Englefield

G20 update: Finance ministers disappoint but China's leadership shows promise

G20 discussions were back in international media headlines during the last week, as Shanghai hosted the first major meeting of China's 2016 G20 Presidency.  The concluding statement issued by finance ministers and central bank governors on Saturday was strong on rhetoric, and Chinese leadership has managed to insert a sense of momentum back into G20 discussions. But the meeting will disappoint the many who called for the G20 to be more active in addressing economic vulnerabilities and risks. In particular, on the main substantive issue for the meeting, that of calls for greater fiscal action, a lack of consensus has led to the finance ministers and central bank governors kicking the can down the road.

In the lead up to the meeting, there was plenty of speculation on whether the G20 would discuss exchange rate tensions. Two matters in particular had been prominent: whether the Chinese authorities would devalue their exchange rate in response to recent market pressures, and whether the meeting would lead to a grand Plaza-style accord on exchange rates. But, prior to the G20 meeting, China had largely put issues around the yuan to bed when PBoC governor Zhou articulated, in rich detail, China's approach to exchange rate management, and it appeared a grand bargain on exchange rates was not a realistic proposition. More G20 attention therefore went to warding off the temptation for competitive devaluations, with a reiteration of previous exchange rate commitments and a commitment to consult closely on exchange rates.

There was some positive news in the G20's rhetoric on fiscal and monetary policy settings. This was not a meeting convened under crisis settings, and the G20 recognised as much. However, there are significant challenges facing the global economy. As finance ministers and central bank governors recognised, they aren't achieving growth and employment goals, and, since the Antalya leaders summit, downside risks and vulnerabilities have lifted. Volatile capital flows, commodity prices, geopolitical tensions, Brexit, and refugee issues were all highlighted. Finance minister and central bank governors also reiterated the point they made last September that monetary policy alone cannot lead to balanced growth, and called for faster progress on structural reform, as well as making tax policy and public spending as growth-friendly as possible.

Finance ministers did not see eye to eye on co-ordinated fiscal stimulus. This was not surprising, given the diversity in positions going into the meeting, and the fact there was no crisis to focus minds on consensus The G20 did, however, state that it would use all policy tools  — monetary, fiscal and structural — to achieve its goals of strong, sustainable, and balanced growth. The implied hope is that governments will individually take the initiative to do more so policymakers can be confident they would be able to respond to a global shock.

But with little specific direct action expected to come out of the meeting, it is difficult to escape the the conclusion these impressive-sounding statements ring hollow.  Finance ministers have done little to lift pressure off central banks, and not much to assure financial markets their governments have the political will necessary to advance substantive structural reform, especially given this has proved near impossible in recent years.

The lack of commitment to act is a disappointment for those hoping governments would act more urgently to position fiscal policy more prominently  in the policy mix. The broad chorus advocating for this included the IMF, the OECD, The Economist, members of think tanks  (including me), academia, and financial market analysts.

Ultimately, we are in much the same position as we were before the meeting. We may not be in a crisis, but governments need to do more heavy lifting to boost growth. What is clear from the past week is that a lack of policy urgency on the part of governments is now flying in the face of expert advice. If negative risks are realised and economic conditions deteriorate markedly, the fact that governments did not act when they had opportunity to do so will reflect poorly on those who were around the table last week.

In the lead-up to this meeting, I also suggested it would be important for the G20 itself, which needs to restore a sense of relevancy to discussions. Post event, it's fair to say the meeting in and of itself is not enough to address complaints that today's version of the G20 is no more than talkfest. But, beyond the headlines, there was much to like in the more detailed and procedural parts of the communique and this should be of interest to technocrats and active G20 observers.

The communique flagged potentially substantive advances in a number of G20 finance work streams. Encouragingly, China has made a conscious effort to reign in discussions from Turkey's host year experience, and focus on substantive outcomes in multi-year 'core finance' areas rather than yet another re-branding exercise. It was clear that work would continue in IMF and World Bank governance reform discussions, and in prosecuting the investment agenda. Further, the Chinese G20 presidency will prioritise widespread, consistent, and effective implementation of agreed reforms in financial regulation and international tax.

Among the list of actions to look to in the future are a proposed structural indicator system to secure the delivery of the G20's growth strategies (by April); IMF reviews on the global financial safety net architecture (by April) and on the possible broader use of the SDR (by July);  support for a proposal to develop a tax platform jointly by the IMF, OECD, UN and World Bank Group, and various actions by development banks and the Global Infrastructure Hub  on investment challenges. Perhaps the most surprising development was the G20-acknowledgement of a Chinese decision to set up a tax policy research centre.

China should be reasonably happy with a solid start to its leadership year. Its first meeting was able to signal ambition, and its negotiators worked effectively to push the G20 forwards on 'core finance' areas such as investment, the financial architecture, financial regulation, and tax. But the G20's relevancy depends upon its capacity to respond to both pressing issues of the day as well as longer term challenges of global governance.

With just over six months to go until G20 leaders meet in Hangzhou, the focus now should be on building on the platform created in Shanghai. And when finance ministers and central bank governors pick up their conversation in Washington in just six weeks time, the world will be looking for a stronger statement of political will to address near-term economic challenges.

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