Monday, June 11

Understanding our price-deflationary boom

One headline message from the Q1 National Accounts was that prices across the economy fell by one per cent. This deflation meant that an anaemic nominal quarterly growth in our economy of 0.3 per cent for the quarter translated into a real economic growth of 1.3 per cent. To use an Americanism, because of this price-deflation, our economy grew at 5.2 per cent annualised: thunderous growth in anyone’s books. Real growth was much better than the well below trend 1.2 per cent annualised nominal growth.

Not withstanding Ross Gittin’s exhortations in today’s Fairfax press, I remain a little sceptical of the real growth figures. My scepticism has two fronts. First, I think the outcome is an anomalous statistical artefact. I have real doubts about whether it is real, real growth. Second, I wonder about the sustainability of a price-deflationary boom. For how long can prices fall while the real economy continues to go gangbusters?

Table 5 of the national accounts includes the implicit price deflators (IPD) for each term in the expenditure equation for GDP:
GDP(E) = Private Consumption + Investment + Government + (Exports – Imports)
Let’s have a look at these deflators. In the next chart, FCE stands for 'Final Consumption Expenditure', which are the private and government consumption terms in the GDP expenditure equation. GFCF stands for 'Gross Fixed Capital Formation', which are the investment terms in the GDP expenditure equation.

The above graph shows that the big deflationary item was exports. The other significant deflationary items were ownership transfer costs and imports. In terms of their impact on GDP, the next chart (which retains the deflationary order of the previous chart) shows that exports and imports are the big value contributor to GDP. 

Having come this far, you will not be surprised to see that exports were the biggest contribution to the difference in outcomes between the growth in nominal and real terms, which I mentioned in the opening paragraph above. (Imports would work in reverse given their role in the GDP equation above). By and large, the deflationary items above contributed more to real GDP growth; whereas the inflationary items worked to reduce real GDP growth.

So we get to the heart of the anomaly: largely because we exported a touch less in volume terms (in Q1 2012 compared with Q4 2011) but at significantly reduced prices, this contributed significantly to an outcome where real GDP grew significantly while nominal GDP stagnated.

And we get to my sustainability question: how long can export prices fall before growth stalls?

Postscript: Just to be clear, I am not a recessionista. I don't think the Australian economy is in decline. I just have doubts about the scale of real GDP growth figures, given the nominal GDP growth figures. My suspicion is that real growth is less than this initial print. Given the broader macroeconomic restructuring and deleveraging, my medium-term prognosis remains sub-trend growth.

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