Tuesday, 27 December 2011

"Trend Economic Growth" - Definitions and Facts

It is difficult to confidently say exactly what the trend rate of economic growth is in Australia given the forever changing patterns in productivity, swings in the terms of trade, fluctuations in wealth and leverage, among many, many things. Suffice to say, most well-informed economists including in Treasury and the RBA suggest that the trend rate of GDP growth in Australia is about 3.0% - perhaps a touch higher.

Whatever the exact number for the trend growth rate of GDP, there is a very simple way of checking whether the economy is growing above, at, or below trend. The simple check that even Economics 101 students can look at is to see what is happening to the unemployment rate and inflation.

When the economy is growing “at trend”, the unemployment rate and inflation are stable. This is by definition. Looked at another way, if the unemployment rate is falling and inflation if rising, the economy by definition is growing above trend. Similarly, when the unemployment rate is rise and inflation is falling, the economy must be growing at a below trend pace.

No one would disagree with that.

So where are we in Australia?

In early 2011, the unemployment rate was 4.9%. The latest figures for November 2011 have the unemployment rate at 5.3%. That is a rise of almost half a percentage point in a little over 6 months. Unemployment is rising, albeit at a moderate pace.

Let’s turn to inflation.

In the September quarter 2008, annual underlying inflation was 5.0%. By the September quarter 2009, it was 3.4%. By the September quarter 2010, it was 2.7%. In the latest data, for the September quarter 2011, annual underlying inflation is 2.4%.

Inflation is falling and falling sharply.

So there we have it. Unemployment going up and inflation going down. The economy is growing at a below trend pace.

Oh – I almost forgot. It might even pay to look at the GDP data to assess the discussion over trend growth! They show that GDP grew by 2.5% in the year to the September quarter 2011, a figure obviously distorted (pushed lower) by lost production from the weather events early in 2011. It is interesting to note that annual GDP growth in Australia has not gone above 3.0% for the last 3 and a half years and over that 3 and a half year period, annual GDP growth has averaged 2.0% - a figure fitting perfectly with Treasury and RBA assessments of trend growth and the other data showing the rising in unemployment and drop in inflation.

Let’s face it, the economy is growing below trend. It’s why the RBA has started an aggressive interest rate cutting cycle.

Buffoons blustering about the economy growing at trend, and there being no domestic case to cut interest rates, remain hopelessly ill-informed. As always, it is best to look at facts and hard data in forming views about key issues in analysing the economy and the policy pressures.

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