Saturday, December 01, 2007

Happy birthday prosperity, thank you PJK

My colleague Shane Wright of the West Australian remembers:

“This is the recession we had to have.” — Treasurer Paul Keating, November 29, 1990.

It is 17 years today since Paul Keating uttered some of the most infamous, misunderstood and deliberately misconstrued words in Australian politics.

After the release of that year’s September quarter GDP figures, Mr Keating stunned Australians — and plenty of ALP backbenchers — with his declaration that it was a recession the nation needed.

A recession is technically defined as two consecutive quarters of negative growth. The 1990 recession Mr Keating referred to is generally regarded as Australia’s last recession. However, it actually reached well into the middle of 1991, with negative quarters of growth in March and June of that year.

What is most striking about Mr Keating’s utterances is not that what he said was devoid of any empathy for the thousands of business owners and workers who would soon be tossed on the unemployed scrap heap. It is what that recession marked and what’s happened since...

A quick scan of Australian Bureau of Statistics figures shows that since that June 1991 negative quarter (when the economy contracted 0.2 per cent) there has only been two three-month periods since when the economy has shrunk — September 1993 (a drop of 0.1 per cent) and December 2000 (a drop of 0.8 per cent).

The reason for all these statistics is to give the context of the current period through which we are all living. Economists call it the Great Moderation. It may not sound as imposing as the Great Depression, or as solid as the Great Wall, but in terms of greatness, well, it’s hard to go past.

The Great Moderation refers to the way the global economy, particularly in the developed world, has lost much of its volatility. Let’s put it this way. There hasn’t been a technical recession since Mr Keating’s comments. That’s a record stretch of almost 17 years.

Between 1959 and 1990, however, there were six recessionary periods or one nearly every five years.

And it’s not just Australia that has enjoyed the fruits of the Great Moderation. Great Britain is enjoying the same period of uninterrupted growth, as is much of the OECD.

The US, and some other nations, did dip into recession in the 2000-01 period, but it was neither as deep nor destructive as past financial downfalls.

Now there has been plenty of discussion in economic circles about why the globe is going through perhaps its greatest period of economic stability, and growth, in recorded history.

American economist Peter Summers, in a paper for the Kansas City Federal Reserve, has highlighted three factors as reasons for this global phenomenon. He found monetary policy, the control of inflation and better handling of inventories by the business community, and the interaction of them, were likely to be root causes.

In this context, he’s talking about the decision to take monetary policy control out of the hands of politicians and handing it to central banks (such as the Reserve Bank of Australia), giving those banks an inflation target (normally somewhere between one and three per cent) and the fact businesses now have a much better idea of what they need to produce rather than leaving great piles of goods in warehouses.

Professor Summers found the amount of economic volatility in the G-7 group of nations and Australia had effectively halved. In Australia’s case, he put the date of this abrupt ending in volatility as the third quarter of 1984.

HSBC Australia chief economist John Edwards became an adviser to Paul Keating just ahead of those famous 1990 words.

He says the Great Moderation in the Australian context can be largely attributed to four factors: the advent of enterprise bargaining, the cutting of tariffs, the rise of China (and East Asia) and financial deregulation.

And surprisingly, he puts enterprise bargaining at the top of the reasons of Australia’s economic success.

“The introduction of enterprise bargaining is the point where the market decided wages, where productivity was put into the system and we forever ended the notion of relative wage justification delivered by a centralised industrial relations commission,” he said.

Dr Edwards also puts a lot of importance on the rise of China, and the increased competition faced by Australian businesses by opening up the economy through tariff cuts and financial deregulation.

He said China, and other East Asian nations, had helped deliver low inflation globally while becoming the world’s manufacturing base (and also providing a huge revenue injection of commodity nations such as Australia).

Some experts believe the 1990 recession also marked the death of inflation in this country. With the Reserve Bank developing an inflation target after the recession, it had the starting platform from which it has since fashioned monetary policy where official interest rates with a six in front of them are considered high.

But Dr Edwards said the path to low inflation was set before the recession.

“It was coming down in the mid-1980s,” he said. “A recession of the sort that we had, it did bring inflation down but there are better ways to do it.”

So why is the Great Moderation so important?

I’ll let current US Federal Reserve boss Ben Bernanke explain with these comments he made in 2004.

“Reduced macroeconomic volatility has numerous benefits,” he said. “Lower volatility of inflation improves market functioning, makes economic planning easier and reduces the resources devoted to hedging inflation risks. Lower volatility of output tends to imply more stable employment and a reduction in the extent of economic uncertainty confronting households and firms.”

Hopefully, it means that a future Australian treasurer won’t have to make the same type of comment Paul Keating did on that day 17 years ago.