And it is also a budget taking place against a backdrop of rising cost of living pressures that are simultaneously driving up households’ inflation expectations and undermining their confidence. My detailed budget preview is available here and there’s a shorter, summary version below. And a reminder that you can register for next week’s budget webinar here.
On the data front this week, weekly consumer confidence slumped to its lowest level since early September 2020 while household inflation expectations surged to six per cent. The Flash Australia Composite PMI rose to a 10-month high in March, signalling stronger private sector activity as the economy continues to recover from January’s Omicron-driven ‘pause’. But worsening supply constraints saw the same survey report record rates of input cost and output price inflation. And sticking with the theme of rising price pressures, Bloomberg’s March survey of economists reported that the median forecast for average inflation this year has now risen to 3.9 per cent, up from 3.3 per cent last month and 2.5 per cent at the end of last year.
This week, we also take a look at the OECD’s initial assessment of the economic implications of the conflict in Ukraine.
The regular collection of links includes Deloitte Access Economics’ Budget preview, the need to curtail government pork-barrelling on transport spending, a French perspective on three major challenges for the world economy, some contrasting takes on the economics of climate change, the ‘weirdness’ of asset manager capitalism, Adam Posen on what Russia’s war in Ukraine means for the future of the world economy, a Q&A on Russian sanctions, and Daniel Yergin on the war, energy markets and geopolitics.
There will be no weekly note next week. Instead, we’ll have our usual budget night ‘quick take’ on the key points from Budget 2022-23 to be followed by the budget webinar later in the week. The weekly note will return the following week.
Previewing next week’s budget
Budget 2022-23 will be handed down next week, on 29 March 2022. Budget night will see the Treasurer juggling completing priorities.
On the one hand, there is a compelling case to be made that the Government should use this budget to commence the second phase of its pandemic-inspired fiscal strategy. Phase one was all about using fiscal policy to produce a strong recovery and drive down the unemployment rate. Once those objectives had been met, Canberra had pledged that phase two would concentrate on growing the economy and stabilising / reducing the burden of government debt. With economic growth up and the unemployment rate now down to four per cent and likely to fall further, the Government’s own strategy says that this is the time to begin that second phase.
Helpfully, the path to debt stabilisation and budget repair is likely to be given a decent lift by improvements in some key economic conditions. In particular, a healthier labour market will be good news for the budget bottom line: Lower-than-expected unemployment means lower expenditures while a combination of increased employment and higher wages are delivering higher tax receipts. Budget revenues will also receive a sizeable boost from higher-than-forecast commodity prices. Food, energy and metals prices were already rising as markets struggled to digest the series of shocks generated by the pandemic. Now, the war in Ukraine has generated a further round of upward pressure on commodity prices that has taken several key prices far above the projections in last year’s Mid-year Economic and Fiscal Outlook (MYEFO). This will increase Australia’s export prices, lift our terms of trade, inflate nominal incomes, and translate into a bigger tax take for Canberra. In fact, monthly fiscal data already showed the budget tracking ahead of the profile set out in the December 2021 MYEFO: As of January 2022, the underlying cash deficit for the year-to-date was just $52.2 billion compared to a MYEFO-predicted deficit of $65.4 billion: a $13.2 billion improvement. The full-year deficit should likewise be considerably smaller than the MYEFO target for 2021-22 of a $99.2 billion (4.5 per cent of GDP) shortfall. That in turn implies smaller financing needs and therefore lower levels of public debt in the years ahead – in the line with phase two of the fiscal strategy.
On the other hand, this is also an election year budget, and moreover an election year budget that is taking place against a backdrop of both significant global economic uncertainty and rising cost of living pressures that are taking a toll on household confidence. All of which will push the government towards taking a cautious and gradual approach to the start of any fiscal ‘phase two’ and to combine it with some pre-election goodies including support for stretched household incomes.
The Treasurer effectively confirmed some version of this balancing act approach in his pre-Budget speech on 18 March 2022 on the fiscal dividend of a stronger economy. He acknowledged that it was ‘time to move to the next phase of our fiscal strategy…[with]…a focus on stabilising and then reducing debt as a share of the economy.’ He also flagged that Budget 2022-23 was set to ‘show a substantial improvement to the budget bottom line,’ and that as a result, gross debt as a share of GDP would now ‘peak lower and earlier than forecast at MYEFO’ and then decline over the medium term. But the Treasurer also went on to emphasise that the lessons from past, successful debt consolidation exercises in Australia were that they were ‘almost always achieved gradually,’ and that a ‘gradual and measured pace of consolidation ensures that the economy can continue to adjust and grow, even as fiscal policy normalises.’ Consistent with that historical overview, he ruled out any sudden swing to austerity, saying that any ‘sharp and sudden tightening in the fiscal settings would likely be counter‑productive, undermining the economic recovery and ultimately hurting the Budget.’ And we already know from several media reports that the Government will seek to help out households (voters) on the cost of living front.
On balance, then, do expect the numbers for debt and deficits to look considerably better than those presented both in the December 2021 MYEFO and originally in Budget 2021-22. But don’t expect a dramatic shift in the overall fiscal stance.
For more detail, see this separate budget preview.
Inflation expectations keep climbing as confidence falls again
The latest ANZ-Roy Morgan consumer confidence reading showed the index slumping 4.8 per cent last week, with sentiment dropping across all states and territories. The weekly measure of consumer confidence is now at its lowest level since early September 2020.
Four of the five subindices dropped over the week to 20 March, with ‘future economic conditions’ the only exception. The ‘current financial conditions’ subindex is now at its lowest since July 2020, ‘future financial conditions’ is at its lowest since April 2020 and ‘current economic conditions’ at its lowest since October 2020. ‘Current economic conditions’ have fallen for five consecutive weeks.
Meanwhile, weekly inflation expectations rose again, jumping 0.4 ppts to six per cent.
As noted last week, higher inflation expectations and lower confidence are both likely a product of the rising cost of living in general and the surge in petrol prices triggered by the war in Ukraine in particular.
The OECD on the economic implications of the war in Ukraine
This week saw the OECD publish its interim economic outlook, which focused on the economic and social impacts and policy implications of the war in Ukraine. According to the OECD, ‘the most important consequence of the war in Ukraine is the lives lost and the humanitarian crisis associated with the huge numbers of besieged and displaced people. There are also, however, numerous significant economic implications.’
Some key points from the report:
- The direct role of Russia and Ukraine in the global economy is relatively small. Together, they account for only about two per cent of global GDP and a similar share of global trade. Financial linkages with other countries are generally modest, with stocks of foreign direct investment in Russia, and by Russia in other economies, accounting for between 1-1.5 per cent of the global total. Consolidated cross-border bank claims by BIS reporting banks on residents of Russia and Ukraine represented less than 0.5 per cent of the global total.
- However, Russia and Ukraine’s influence on the global economy is considerably larger than would be implied by these direct linkages. That’s because they are large producers and exporters of key food items, minerals and energy. Together they account for about 30 per cent of global exports of wheat, 20 per cent of exports of corn, mineral fertilisers and natural gas, and 11 per cent of global oil exports.
- A complete halt to combined wheat exports would create serious food shortages in many emerging and developing economies, while the disruption to fertiliser production means those disruptions could be extended via the impact on next year’s agricultural production.
- For some countries, this effect is magnified because of their relative dependence on supply from these particular markets. For example, in many economies in the Middle East, wheat imports from Russia and Ukraine represent around 75 per cent of total wheat imports
- Supply chains around the world are dependent on exports of metals from Russia and Ukraine. Russia is a key supplier of palladium, used in catalytic converters for cars, and nickel, used in steel production and the manufacture of batteries. Russia and Ukraine are also sources of inert gases such as argon and neon, used in the production of semiconductors, and large producers of titanium sponge, used in aircraft.
- The conflict and sanctions on Russia are also creating significant disruptions via financial linkages. For example, delays and difficulties in making international payments are disrupting international trade and threatening debt repayments. And increased risk aversion and uncertainty has led to tighter global financial conditions in general.
- Commercial air travel and freight are being rerouted or halted, leading to increased business costs.
- OECD simulations suggest that, if they were sustained, the moves in commodity prices and financial markets seen in the first two weeks since the outbreak of war could reduce global GDP growth by over one percentage point in the first year, with a deep recession in Russia (a fall in output of more than 10 per cent), and push up global consumer price inflation by approximately 2.5 percentage points. The estimated hit to economic activity in Europe – which is more dependent on Russian energy and more exposed to trade, financial and business linkages – is relatively larger than the rest of the world.
- The war is complicating matters for fiscal and monetary policy. The OECD’s simulations suggest that higher inflation will see monetary policy tighten, with policy rates increased by a bit more than one percentage point on average in the major advanced economies and 1.5 percentage points in the major emerging markets. On the fiscal front, the OECD estimates that a well-targeted rise in government spending of 0.5 per cent of GDP for one year across the OECD could offset around half of the estimated decline in output from the conflict without adding significantly to inflation.
- The humanitarian cost of the war ‘is high and growing’ and includes the fastest refugee flow seen in Europe since the end of the Second World War. The latter will require substantial spending on social and housing assistance, food, medical assistance, childcare and schooling.
- In the medium term, greater investment in clean energy and energy efficiency and higher defence spending are likely to be high on the policy agenda.
What else happened on the Australian data front this week?
Flash Composite, Services and Manufacturing PMIs for March
The S&P Global Flash Australia Composite PMI (pdf) rose to 57.1 in March this year, hitting a 10-month high. Private sector output and demand both rose, as did employment, as the economy continues its bounce back from the impact of the Omicron variant at the turn of the year. Business activity rose across manufacturing and services following the easing of COVID-19 restrictions and the survey reported the first expansion of services export orders in nine months as travel restrictions were loosened.
However, the survey results also reported mounting price pressures this month, with both input cost and output price inflation hitting record rates. Respondents cited higher costs across a range of inputs including fuel, wages and raw materials prices, and reported disruption from both flooding in Australia and the war in Ukraine as well as from ongoing global supply chain constraints. As a result, while overall sentiment in the private sector remained positive, concerns over rising costs saw the level of business confidence fall to its lowest since April 2020.
The S&P Global Flash Australia Services PMI rose to 57.9 in March from 57.4 in February, marking a second consecutive month of expanding activity after the index had dropped into negative territory in January. The S&P Global Flash Australia Manufacturing PMI edged up to 57.3 this month from 57 last month. That’s the 22nd consecutive month of expanding activity in the sector, with the survey reporting that a lessening of COVID-19 disruption had led to an increase in demand.
Bloomberg’s March 2022 roundup of Australian economic forecasts
Bloomberg’s regular monthly survey (this one covering 40 economists surveyed between 19 and 22 March 2022) shows the median forecast for average CPI inflation this year has climbed to 3.9 per cent from 3.3 per cent in February’s survey. The consensus forecast for inflation for this year has risen sharply over the past few months, increasing from just 2.5 per cent last December to 2.7 per cent in January, and now to close to four per cent. Next year, the median forecast sees inflation slowing to an average rate of 2.8 per cent – again above February’s median forecast of a 2.5 per cent rate.
Consensus opinion has also shifted on growth prospects. The median forecast for GDP growth this year is now 4.4 per cent, up from 4.1 per cent in the February 2022 survey, although expected GDP growth next year was unchanged from the previous survey at 2.9 per cent. And the median forecast for the average unemployment rate this year was also unchanged at 3.9 per cent, although it is now expected to edge down to 3.8 per cent in 2023.
ABS experimental data on household spending
According to the new ABS experimental indicator of household spending based on card and bank transactions data, household spending rose 4.3 per cent over the year in January 2022 (current prices, calendar adjusted terms). Annual spending rose in seven of the nine spending categories, with the biggest increases for recreation and culture (up 11.3 per cent), food (up 9.7 per cent) and clothing and footwear (up 9.6 per cent). However, when compared to pre-pandemic January 2020 estimates, total household spending is still down 0.6 per cent, with transport (down 25.7 per cent) and hotels, cafes and restaurants (down 11.7 per cent) still well below pre-pandemic levels.
Other things to note . . .
- Deloitte Access Economics’ Budget monitor previews next week’s budget.
- The limits of fiscal financing in Australia.
- Peter Martin says the RBA will be cautious on rates.
- Last Friday, the ABS released the latest experimental quarterly tourism labour statistics, covering the December quarter 2021. The numbers showed that there were 628,900 tourism jobs by the final quarter of last year, up by 75,100 (13.6 per cent) from the September quarter. Tourism jobs accounted for 4.3 per cent of all filled jobs in the economy. Relative to the pre-pandemic (December 2019 quarter) situation, there are 120, 500 fewer tourism jobs in the Australian economy, a drop of 16.1 per cent. At the same time, the total of all jobs in the economy has risen by 290,400 or two per cent.
- A new report from Grattan on the need to curtail federal government pork-barrelling in transport projects. According to the Institute, at the last federal election only one of the Coalition’s 71 transport promises valued at $100m or more had a business case approved by Infrastructure Australia while for Labor it was just two projects out of 61.
- The ACCC on securing domestic gas supply for commercial and industrial users.
- Blanchard and Tirole examine three major future economic challenges for the world economy: climate change, inequality and demographic change.
- Geoff Mann with a critical review of William Nordhaus’s work on the economics of climate change. Note that there are also critics of this kind of approach from within the economics profession: last year, for example, I linked to Noah Smith’s piece arguing that climate economics has failed us. On the other hand, it’s also worth noting that even the criticised-as-too-modest proposals put forward by the likes of Nordhaus have (so far) proved too much for politicians and voters to swallow.
- For an alternative take from another economist, the Econtalk podcast interviews Robert Pindyck on averting and adapting to climate change.
- Some more economics scepticism: the Boston Review has a long essay on bad economics which focuses on a critique of microeconomics. Some of this is old hat, but there are couple of new angles here, too.
- MIT Technology Review lists ten breakthrough technologies for 2022, from the end of passwords to a long-lasting grid battery, from a malaria vaccine to COVID variant tracking and a pill for the pandemic, to practical fusion reactors and a carbon removal factory.
- Adam Posen asks if this is the end of globalisation?
- From the NY Mag, the weirdness of asset manager capitalism.
- Greg Ip’s Saturday Essay in the WSJ argues that in an economic Cold War pitting the West against China and Russia, the former holds most of the cards, in large part because of the West’s comparative advantage in knowledge. Less clear, he says, is whether the West knows how to play them effectively.
- Some questions and answers regarding Russian sanctions.
- Foreign policy magazine quizzed IMF Managing Director Kristalina Georgieva and First Deputy Managing Director (and previously Chief Economist) Gita Gopinath on the global economic outlook (video).
- The Ezra Klein podcast talks to Daniel Yergin on war in Ukraine, global energy markets and geopolitics.