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Effects of the financial crash on australias economy

The Australian economy has been hit hard by the global recession. However, while experiencing difficult times, the Australian economy is doing better than almost all other advanced economies.

Let me provide one illustration of this relative success. In the March quarter 2009, the Australian economy grew by 0. In contrast, all the G7 economies contracted in the March quarter and as a group by 2.

But on any number of measures, such as unemployment and the stability of the financial system, Australia is doing better than most other advanced economies. I think there are three reasons for this: There are around 11. This can surprise Australians and others. People often think of Australia as a predominantly mining and agricultural economy. Immigration has been and continues to be an important driver of Australian growth.

Robust growth in immigration, especially with its focus on skilled migration, helped Australia adjust to a rapid increase in demand for its mineral resources from 2003 to 2008, which drove commodity prices to record highs. While income growth in Australia was strong before the global financial crisis hit because of the surge in commodity prices and associated mining boom, it was also clear in this period that Australia was running up against capacity constraints.

The labour market was tight, despite the strong growth in immigration, with the unemployment rate hitting a 33-year low of 3. It was against this domestic economic context that the new Australian Labor Government delivered its first Budget in May 2008. However, even in early 2008, the global financial crisis was already on the scene, with possible serious flow-on implications for global growth. Though I should say that while some of us were aware there was the possibility of a significant deterioration in global conditions, there were few people that anticipated the full ramifications of the global crisis that would ensue.

The Global Financial Crisis and Australia As for much of the world, the key turning point for the Australian economy was the change that swept through the global economy in mid-September 2008, with the collapse of Lehman Brothers. Of course, it does not all start and end with the collapse of Lehman Brothers, as there were many signs of financial stress before and many factors that contributed to the crisis [see Gruen 2009 for an analysis of the various factors surrounding the global financial crisis].

In Australia, there was considerable discussion about the prospect of global recession among the Prime Minister, Deputy Prime Minister, the Treasurer and other senior Government ministers and their advisers in July and August of 2008. This, in part, reflected information that the Prime Minister and Treasurer had gleaned first hand from trips to the US and Europe through 2008, as well as signs of increased difficulties within the Australian economy.

In a period when events are moving rapidly, leaders often hear about developments before they have filtered through their bureaucracies. The provision of credit dried up around the world and business confidence plunged. We now know that many businesses responded very quickly to the financial crisis by slashing production and running down inventories.

Consumer effects of the financial crash on australias economy plummeted along with consumption. Throughout the month of September and into October, the financial crisis spread from the US to Europe, and all around the world economies began to contract. The minutes of this RBA Board meeting noted: In the event, the recommendation put to the Board at the meeting was for a reduction of effects of the financial crash on australias economy basis points, to 6.

Australia, China and the Global Financial Crisis

Events were moving quickly. While events were moving rapidly it was thought important that the Treasurer obtain first-hand experience of the crisis in the US while remaining in daily contact with the Prime Minister and his colleagues back in Australia. As the weekend of the 11th and 12th of October approached, it became clear that the Government needed to act proactively to cushion the Australian economy from the emerging global crisis. Because other governments had guaranteed the borrowings of their banks, Australian banks were being put at a competitive disadvantage despite being in better shape than were their international competitors.

These financial stability measures effectively involved the Government taking on risk to ease consumer and business concerns about the financial sector and more broadly economic conditions.

In this highly volatile and risk-averse environment where there was the potential for disorderly and irrational behaviour, it was essential that governments calmed the situation by temporarily taking on private sector risk. The Government and its advisers had been discussing possible fiscal policy responses for some time before the package was announced, and considerable thought had gone into its structure.

The package also followed the key tenets of good-quality discretionary fiscal policy in that it was timely, targeted and temporary.

How Australia escaped the global financial crises of the last 25 years

The housing aspect of the stimulus package — a time-limited grant to first home buyers — took effect immediately. This was not the first time that grants to first home buyers had been used to stimulate the economy. A similar policy had been effective in bringing forward housing construction activity when the economy had slowed in the early 2000s.

Further, the Government was aware of significant pent-up demand for owner-occupied housing after a period of relatively high interest rates and strong migration.

Hence, it knew that if this policy was withdrawn at the right time and in an appropriate way, it could bring forward activity without leading to a substantial collapse in activity when the policy was withdrawn. The consumption aspects of the stimulus package were also designed to be quick acting, with significant cash bonuses paid to pensioners, carers and seniors, and low-income households within weeks of the announcement.

These are household groups that tend to have relatively high propensities to consume out of income. That is, they tend to spend more out of any additional income they receive than do other groups, thus maximising the economy-wide stimulus effects of the package.

This consumption component of the package had the added advantage of providing much-needed cash assistance to the less well off in the community. In October, this first, as it was to become, stimulus package was considered by the Government a prudent response to the dramatic deterioration in global conditions, although the potential need for further stimulus down the track was fully appreciated.

Thus, to prepare for the possibility that the global financial crisis might be deeper and longer lasting than expected, the Government started planning to bring forward the commencement of large-scale infrastructure projects.

There were other important developments in late 2008 worth noting. Through November and December, interest rates were cut aggressively and the global response to the crisis intensified. Prime Minister Kevin Rudd attended the first G-20 Leaders summit on the 15th of November and spoke of the potential for the financial crisis to affect the real economy and most importantly, unemployment.

Not long after the October stimulus package, the Australian Government had begun planning for the possibility that the unemployment rate might rise dramatically should the effects of the financial crash on australias economy slow. In the recessions of the early 1980s and 1990s, the unemployment rate rose quickly.

Australia's response to the global financial crisis

Given that the likelihood of recession was increasing, the Government wanted to be ready to respond with policies to support the work force that went beyond support for aggregate demand. It has worked as an effective automatic stabiliser, curtailing demand in the good times and supporting in bad.

And it has been especially beneficial for the Australian economy because of the relative importance of mineral production. With the potential for commodity mineral prices to rise and fall dramatically, movements in the exchange rate have helped to buffer the effects of these price swings on the broader economy.

The global recession becomes worse than previously thought Through December 2008 and January 2009, it became clear that global conditions were much worse than initially envisaged. By late January, it was also becoming clear that the global economy had experienced a very weak December quarter. As has been noted by the IMF, financial crises and global recessions with high degrees of synchronisation are associated with long and deep recessions and weak recoveries.

In late January, the Strategic Policy Budget Committee ministers finalised a package that work had effectively begun on not long after the delivery of the first package. In constructing this second stimulus package, it was clear that further support for consumption would be required. Despite the considerable planning that had gone into constructing a fast-acting infrastructure program, further consumption measures would still support the economy more quickly than even a fast-acting infrastructure package.

And it was important, given the size of global recession, that the Government provide additional stimulus to keep the economy as strong as possible before the effects of the infrastructure program could make their way through the economy. There is now strong evidence that these aspects of the stimulus package provided substantial support to the economy. In the month of April 2009, Australian retail trade turnover was 4. However, perhaps the strongest evidence of the positive effects of consumption-based stimulus measures is the empirical analysis that has been undertaken in the US.

Often when people see consumption fall or saving rise in a period in effects of the financial crash on australias economy the Government has provided additional income through tax rebates or welfare bonus payments, they are inclined to conclude the stimulus was ineffective.

Analysis that explores a world without stimulus versus one with stimulus, has been undertaken in the United States by Broda and Parker 2008 and Johnson, Parker and Souleles 2006. They use individual-level household data to show that tax rebates or bonus payments are effective in stimulating consumption, especially among low-income groups. The US Congressional Budget Office 2009 has lent its support to this style of careful empirical analysis, regarding it as the most valuable in gauging the effectiveness of consumption measures.

While the consumption aspects of the second major stimulus package were important, because the global recession was expected to be deep and long, infrastructure spending played the central role. You might be tempted to ask why did the Government not just undertake infrastructure spending as part of its second large stimulus package, especially as IMF analysis suggests infrastructure spending is effects of the financial crash on australias economy most effective in stimulating activity, followed by tax rebates or bonuses and followed in turn by tax cuts.

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The infrastructure component of the stimulus package Australian governments have attempted to use infrastructure spending to support the economy in the past.

Unfortunately, the experience has not been wholly successful, with much of the infrastructure spending and activity not getting started until the economy was already recovering. The Government and its advisers had absorbed this lesson and set about designing an infrastructure component of the stimulus package focused on quick-starting mid-scale infrastructure.

The package had the following elements: The largest component of the infrastructure package, the school-based infrastructure spending, has a number of elements that both enable speedy construction and maximise the impact of the stimulus across Australia. These include the immediate availability of school land upon which to construct new buildings, hence no planning delays.

The school buildings that are being constructed by States have standard design features. That is, schools choose from standard designs rather than developing their own designs, to speed up construction. School-based infrastructure spending also has the added advantage of providing stimulus to almost every population area of Australia. This was important because the slowdown in Australia is not expected to have an especially strong geographic focus.

That is, the economic weakness is expected to be geographically broadly spread and therefore it is useful if the stimulus is geographical broadly based. Finally, in addition to the support to local labour markets across the country, school infrastructure projects have a low import content, thus the domestic impact of this stimulus is maximised. Once the package has been fully implemented, over 9,500 schools in Australia will either have a new multi-purpose centre, library or assembly hall or they will have substantially refurbished existing facilities.

Therefore, while the school-based infrastructure was designed with stimulus benefits in mind, it will also provide a positive lasting legacy for the education sector. One of the defining aspects of economic slowdowns and rising unemployment is their harsher impact on the less skilled.

Industry informed Government that typically a one-day training course was required before people could begin working on insulating the ceilings of homes under supervision. This part of the package therefore would not only lower energy-related costs for Australians by providing free insulation for over 2 million homes, it would also provide employment opportunities for predominantly less skilled workers.

To counter this effect, the Government simplified the process for households obtaining a rebate for insulating their ceilings. The household is never out of pocket. The other infrastructure components of the February stimulus package — the investments in social housing and transport infrastructure — were also designed to be quick acting. Jobs program and compact The February stimulus package was designed to add to earlier packages and cushion the Australian economy from the worst of the global downturn.

However, the Government understood that the effects of the global recession on the Australian economy could not be completely resisted. In particular, the unemployment rate, which had already begun to rise, was expected to rise further. The past two recessions in Australia provided a number of important policy lessons, not only for the shape of stimulus packages, but al so the design of policies to support the unemployed. That is, around one-third of the rise in unemployment might be due to a lower level of employment while around two-thirds is due to too few jobs being generated to absorb an ever increasing labour force.

Moreover, many of these new entrants to the labour market tend to be younger people. In the early 80s and 90s recessions, a large proportion of the unemployed were effects of the financial crash on australias economy under 25 years.