overblown analysis masks reality

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    Russell Report: Overblown analysis masks reality
    25/10/04 By: Clyde Russell

    It is an unfortunate tendency that those with the loudest voices, or the most dramatic positions, often gather more attention than the more sober-minded. This has certainly been the case in reporting of the economy, where too much attention is given to either the doom and gloom brigade or those who believe we are currently in an everlasting golden age.

    Too often the media, and this newspaper is not excluded, given prominence to views that are quite frankly unrealistic.

    A recent example of this is the report from economic forecaster BIS Shrapnel that predicted interest rates would rise a massive three percentage points in the next three years, leading to a huge bust in the economy.

    Even though my colleague and I tried to highlight that the BIS view was in stark contrast to the prevailing market opinion when writing the report, the overall impression left was one that interest rates are set to soar and provoke a major recession.

    That was indeed an accurate reflection of the BIS report, but, and I can say this in a column, I think the BIS report is plain wrong.

    The situation they describe, namely a huge boom in business investment leading to worsening skills shortages and thus higher wage claims is very unlikely to materialise.

    Quite frankly, how any economist can predict that the cash rate will rise from its current 5.25% to above 8% is beyond me.

    Simply put, the economy would fall over long before the Reserve Bank finds it necessary to increase the cash rate by 70%.

    Imagine what would happen to consumer confidence and spending if the average repayment on a mortgage nearly doubled. It would collapse.

    This would be accompanied by falling sales and profits for companies, which in turn would lead to job losses and a whole host of other problems, which in the end would be more likely to lead to interest rate cuts rather than hikes.

    I think we can safely dismiss the BIS report as extremely unlikely. However, this doesn’t mean that the purveyors of tales of economic woe will simply go away.

    In recent days I have read numerous articles, some from well respected researchers, talking about a new oil-led world recession.

    No one can argue against the fact that higher oil prices, especially if sustained, will cut world economic growth. What is in dispute is just how big the hit will be.

    Those predicting dire consequences tend to downplay or ignore a few things.

    Firstly, oil prices are nowhere near as high in real terms as they were in previous oil shocks, even though in nominal terms they are at record highs.

    Secondly, the world as a whole is less dependent on oil now that in the past, in other words we now produce more goods and services per barrel of oil than at any other time in the past. This means oil isn’t as important as it once was to the health of the global economy.

    And the third factor that is different this time around is that the price rise is mainly led by increasing demand, whereas previous oil shocks were caused by producers restricting supply. This is important because demand-led price rises show that world growth is strong, and thus better placed to handle higher prices.

    Another key factor is that there is a certain risk premium currently built into the oil price, given conflict in the Middle East, uncertainty over the future of Russia’s largest oil producer Yukos, disturbances in Nigeria and ongoing political upheaval in Venezuela.

    While it is possible that these problems will last for some time, the sensible thinking is that eventually some, if not all, of these risk factors will dissipate and oil prices will fall back to somewhere in the high US$30 barrel region.

    So what does all this mean for Australia?

    Well much to the disappointment of the doomsayers, it probably means not that much.

    The official Federal Treasury forecast is for gross domestic product to grow 3.5% in 2004-05 and for the three fiscal years thereafter.

    The higher oil prices may cause that figure to dip toward 3.0%, but equally well, there are several factors, such as increased demand for exports, that could see growth tilt toward 4.0%.

    And, put simply, growth in a region between 3.0% and 4.0% means we continue pretty much as we have been for the past couple of years.

    Consumers stay fairly confident, unemployment remains below 6.0, company profits remains solid, the budget remains in surplus despite profligate politicians and interest rates stay around their current level, with any adjustment likely to be minor.

    This doesn’t mean there are no challenges left in the Australian economy, far from it. There are heaps of things to be done, such as overhauling the tax and welfare system, increasing productivity, reforming the complex and unnecessarily huge Federal, State and Local bureaucracies and doing more than just talking about the ageing population.

    What I am trying to say is that the most likely path for the economy over the next year is one of moderate to good growth.

    This doesn’t make for dramatic headlines or for publicity for any extreme views, but it should come as a relief to many who worry we are constantly on the edge of some dreadful economic precipice.

    Clyde Russell is economics editor of the West Australian some dreadful economic precipice.



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