Three reasons why this recovery is fragile
Australia’s position is similar, but not as extreme. Without an extension of this extraordinary level of stimulus, the recovery may not continue. Forward growth estimates below the trend reflect the loaded structure upstream of the stimulus.
The case for a return to stronger growth assumes that global consumers are spending their $ 3 trillion ($ 4 trillion) on excess savings. It is not guaranteed. Savings are concentrated in high-income households with a lower marginal propensity to consume. For low-income households, concerns about job security, income prospects, confidence in the future and the sustainability of wealth will determine how these sums are spent.
Australia has benefited from high iron ore prices and volumes driven by China. At current prices (which are about four times assumed Treasury levels), revenues have almost doubled from pre-COVID-19 levels. This more than made up for the losses caused by the decline in immigration and the decline in the value of international student exports and tourism.
It boosted national income and contributed significantly to improving federal and state public finances. Given the stark political differences with our major trading partner, it would be unwise to assume that this premium can continue, especially when iron ore supplies from Brazil and other producers resume.
Tax side effects
Third, the potential side effects of expansionary fiscal and monetary policies are already evident. As recently announced by the US Federal Reserve, official global interest rates may rise earlier than expected. Long-term government bond rates have already risen sharply from their 2020 lows.
One of the reasons is tax incontinence. With budget deficits expected to persist around the world for many years, the supply of public debt could become increasingly problematic. When central banks cut back on purchases, which have absorbed all or a significant portion of issuance, further upward pressure on rates is possible.
Real inflation and inflation expectations have risen, in part due to the base effects of the abnormal conditions in 2020.
However, real price pressures are evident; for example, rising food and oil prices, supply chain bottlenecks, especially in semiconductors, and rising shipping costs. Longer-term factors, such as the impact of declining short-term and long-term worker mobility on labor costs, will be particularly important for Australia.
Higher rates can undermine asset prices which are based on the TINA argument (there is no alternative). He will draw attention to the levels of public and private debt, in particular the increase in real estate debt due to high house prices.
While still historically low, a rate hike would affect the housing market and investment. Central banks have sought to raise inflation to help reduce debt in real terms.
But a significant rise in rates will make high borrowing difficult to manage and increase the possibility of financial instability and economic downturn.
By choosing to ignore these risks for a truly self-sustaining recovery, policymakers and investors are resembling the old Asian folk tale of the monkey trying to catch the moon’s reflection in the water.