RDP 2011-07: Australia's Prosperous 2000s: Housing and the Mining Boom 2. Overview of the Decade

Despite the perception of being an old economy, Australia was experiencing above-average growth at the turn of the century, with strong domestic demand and stimulus provided by a strong international economy and a low exchange rate (Figure 1). The announced introduction of the Goods and Services Tax (GST) on 1 July 2000 resulted in a substantial bring-forward in housing investment which saw a slowing in the second half of the year. Just as the economy was recovering, the international economy was slowing, with the United States and a few other developed economies entering a shallow recession (see Bayoumi and Bui (2011) for a summary of the North Atlantic economies over the decade). It had often been said that when the United States sneezes, Australia catches a cold. But on this occasion, the Australian economy did not follow the United States into recession. There are a number of reasons for this. The first is that, thanks to fortuitous timing, the Australian economy was bouncing back from the slowing in the second half of 2000 associated with the introduction of the GST. Second, in a signal of the changing economic landscape, Australia's major trading partner growth remained positive thanks to strong growth in Asia and despite output in the G7 declining in three consecutive quarters. Third, the bursting of the tech bubble did not lead to large negative wealth effects in Australia as the absence of large tech firms meant that the domestic equity market continued to rise through to 2002 as global markets declined. Finally, reinforcing these effects, household spending remained strong as house prices and household wealth continued to rise. As the Australian economy outperformed other developed economies in the early part of the decade, the Australian dollar rebounded from its all-time low in 2001 to around the average of the floating era by 2003.

Consumer spending in Australia continued to grow at a brisk rate following the global downturn, fuelled by rising incomes and wealth. The robust growth in domestic demand was to a large extent self-reinforcing, as strong employment growth and rising wages drove income growth, which in turn contributed to rapid house price growth. The increasing value of housing assets, and solid stock market returns, meant that household wealth grew at an above-average rate. Consequently, households felt more confident and were willing to take on more debt and reduce their saving. The impact on household balance sheets of rapid house price growth and the associated increase in debt was substantial, as discussed further in Section 4. Concern that speculative elements were building given the rapid price growth and expansion of credit, and the possibility of the erosion of lending standards, led to a number of policy initiatives, as outlined in Section 5 (see also Bloxham, Kent and Robson (2010)). While domestic demand was strong, export growth was weaker than might have been expected given above-average growth in Australia's major trading partners, and consequently the trade deficit and current account deficit remained wide.

In late 2003 the seemingly inexorable rise in house prices finally abated with national dwelling prices flat in nominal terms over the following couple of years; prices fell in Sydney, with small price rises in most other cities. Nevertheless, households remained optimistic, with consumption broadly growing in line with incomes and the net household saving ratio remaining around zero. Gradually, though, business investment came to play a more important role as a driver of growth in the middle part of the decade. Initially the strength in investment was in the non-mining economy, but with the sharp increase in commodity prices from 2005, mining investment increased dramatically (as discussed by Connolly and Orsmond (2011)). With this shift from consumption to investment, domestic demand continued to be the main source of growth for the Australian economy as export growth remained below expectations. Resource volumes were unable to respond immediately to the stronger global demand, and the further appreciation of the Australian dollar associated with the rise in commodity prices weighed on other exports and stimulated import demand.

Through this sustained expansion in the middle of the decade, excess capacity was gradually absorbed with the unemployment rate declining by 3 percentage points from late 2001 and survey measures of capacity utilisation reaching record highs. With inflationary pressures building, monetary policy was gradually tightened over a long six-year phase. The cash rate reached 7.25 per cent in early 2008, its highest level in over a decade.

The domestic economy was slowing over the first half of 2008, prior to the extreme financial shock in September in the aftermath of the bankruptcy of Lehman Brothers. The resulting collapse in sentiment and the marked deterioration in the global economic outlook precipitated a sharp fall in commodity prices and the Australian dollar and a prompt fiscal and monetary stimulus in Australia. By May 2009, the RBA's commodity price index in SDRs had fallen by over 30 per cent from its October 2008 level, while the Australian dollar depreciated by around 30 per cent over the six months from its July 2008 peak. The first stage of a large discretionary fiscal stimulus – which totalled around 6 per cent of GDP over several packages – was implemented within three months of the collapse of Lehman Brothers. Monetary policy was also eased rapidly, with the cash rate cut by 100 basis points at the scheduled Reserve Bank board meeting just three weeks after the collapse of Lehman Brothers, and by a total of 375 basis points within five months of the Lehman Brothers collapse. The downturn in Australia turned out to be milder than expected, thanks to the rapid policy response, the sharp depreciation of the Australian dollar and the strong demand for bulk commodities from China, which resulted in part from infrastructure construction associated with China's own large fiscal stimulus. As a result of China's demand, Australian export volumes continued to grow through late 2008 and early 2009, a remarkable performance given global trade volumes fell by around 20 per cent.^[3] Despite the deep recessions in developed economies, key emerging economies continued to grow and demand for Australian export commodities rebounded quickly with SDR prices exceeding their previous peak a little over 18 months after their precipitous decline.

The Australian dollar quickly appreciated along with rising commodity prices. Apart from the large, but short-lived, fall during the financial crisis, the currency trended higher over the 2000s with the trade-weighted exchange rate appreciating more than 40 per cent in nominal terms from its trough in 2001 to the end of the decade, and almost 60 per cent on a real basis (Figure 2). By the end of the decade, the real effective exchange rate was at its highest level since 1977.

A recurring theme in the second half of the decade was that the economy was operating at multiple speeds, with rapid growth in mining and related sectors, and below-trend growth in a number of other sectors and in the south-eastern states.

This often led to the claim that monetary policy settings were inappropriately tight for the non-mining parts of the economy. This mirrored the argument earlier in the decade that the setting of monetary policy was overly tight because of the housing boom in the south-eastern states. While there were differences in regional and sectoral economic performance, on the whole there was substantial spillover from the mining sector to other parts of the economy through demand for goods and services by the mining sector, taxes and income flows to other sectors through dividend payments, as discussed in Connolly and Orsmond (2011) and Stevens (2010a, 2011).

2.1 The 2000s in Historical Context

On many levels the 2000s were a successful decade for Australia. As discussed above, Australia experienced relatively mild downturns in the face of two international recessions, and in between these experienced a strong expansion. Annual employment growth averaged 2.2 per cent over the decade, substantially faster than in the 1990s and recovering to rates recorded in the 1960s and 1980s (Table 1). In both downturns experienced in Australia, the increase in the unemployment rate was much smaller than in the 1980s and 1990s recessions, and subsequently fell more quickly. Consequently, the average unemployment rate over the decade was significantly lower than in the 1980s and 1990s and, in addition, there was a substantial increase in the participation rate. Indeed, the low unemployment rate in the second half of the decade – which troughed at 4 per cent, a rate not seen since the mid 1970s – prompted significant consideration as to what rate represented full employment (see Borland (2011)).

The introduction of the GST at the start of the decade added a little over 3 percentage points to the headline inflation rate. As this was a temporary impact, the Reserve Bank said at the time it would not react to this spike in inflation. Abstracting from this, annual inflation over the decade averaged 2.8 per cent, consistent with the inflation target that inflation should average ‘two-point-something’, although slightly higher than the 1990s inflation-targeting period.^[4]

For much of the 2000s, growth in export volumes was surprisingly weak given generally strong external conditions, the low value of the exchange rate over the first part of the decade and the strong commodity demand over the latter part of the decade. Conversely, the growth in consumption and investment resulted in strong import growth. Consequently, the average trade deficit, at 1.3 per cent of GDP, was larger than in the 1990s, but still smaller than in the 1980s. Toward the end of the decade the trade position moved to surplus, as a result of the increased value of resource exports. The average current account deficit in the 2000s was larger than in previous decades at 4.6 per cent of GDP, reflecting the trade deficit as well as increased net foreign liabilities and strong returns on Australian assets. Equivalently, the large current account deficit in Australia can be seen as the outcome of the high investment rate. This was Australia's largest decade average current account deficit in the period since Federation. Yet the 1980s debate about the perils of current account deficits summarised in Tease (1990) did not resurface, with a general view that the current account deficit in Australia did not represent an imbalance, but rather the outcome of savings and investment decisions of individuals and firms in the absence of major distortions, as discussed in Debelle (2011).

One area in which Australia's performance over the 2000s was less impressive is the growth of output per capita. While average real GDP growth, at 3 per cent, was roughly ½ percentage point less than in the 1980s and 1990s, growth in real GDP per capita was ¾ percentage point less than in the 1990s reflecting the stronger population growth in the 2000s (Figure 3). Further, much of this growth in per capita GDP reflected greater use of factors of production: labour utilisation increased with the decline in the unemployment rate and the increase in the participation rate, while the pick-up in investment resulted in faster growth in the capital stock (Figure 4). The relatively weak growth in output given the stronger growth in labour and capital reflects the marked slowing in multifactor productivity growth in the 2000s. In contrast, productivity growth, and so growth of GDP per capita, had accelerated in the 1990s following significant economic reforms.

While growth in productivity and GDP per capita were weak in the 2000s, this was offset by the large increase in the terms of trade, which resulted in faster real income growth. Real gross domestic income (GDI) per capita grew at an average annual rate of 2.3 per cent, the fastest rate since the 1960s, and well above the 1.5 per cent average growth in per capita real GDP. Since this margin between GDP and GDI growth reflected the increase in the terms of trade from higher commodity prices, and the mining sector has significant foreign ownership, some of this income growth will have accrued to foreigners (see Connolly and Orsmond (2011)).

Footnotes

See Kearns (2011) for a discussion of the roles of policy and external demand in the performance of the Australian economy in 2008–2009 in the context of a comparison with Canada. [3]

The target of inflation averaging between 2 and 3 per cent over the cycle is sometimes misinterpreted to imply inflation should average this midpoint of 2.5 per cent. For an early expression of the target equating to inflation averaging ‘two-point-something’, see Debelle and Stevens (1995). [4]