Fed Eyes Australia in Search for Holy Grail of Economic Growth

(Bloomberg) -- Federal Reserve officials are looking to Australia’s record run of economic growth for hope that a U.S. recession may not be inevitable.

But have policy makers Down Under really mastered the business cycle? While their economy has entered its 27th year of expansion, it’s been assisted by a commodities boom, the world’s biggest immigration program, a run up in household debt and a particularly stringent definition of what actually constitutes a recession.

Fluke or not, it’s alluring to a Fed that’s hiking interest rates in an economy approaching its own record expansion -- a mix that normally suggests a downturn is in the offing.

“Australia shows there is no cosmological constant that says expansions must cease after a certain number of years,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York. “While the U.S. may not have the same shock absorbers as Australia, with enough finesse and some luck there is no necessity the U.S. will have a recession in the next few years.”

Ostensibly, the world’s most powerful nation should have the edge over a small open economy at the mercy of global forces. But the opposite can often prove true: Australia’s currency tumbles in turbulent times and boosts the economy’s resilience by aiding exports, whereas the U.S. dollar usually soars as investors flee to it for safety.

That’s been happening this year, with the Australian dollar down more than 10 percent from its January high as the central bank keeps interest rates at a record low while the Fed tightens. Having avoided a slump for a generation, most Australians haven’t had to tighten their belts since the early 1990s, meaning household debt levels are now among the world’s highest.

So when the next global downturn hits, Australia will be more vulnerable.

“What usually happens in the good times is debt levels rise and rise,” said Joachim Fels, global economic adviser at Pacific Investment Management Co. “So there will be a need for more deleveraging. It doesn’t necessarily mean the next recession, if it happens in Australia, is deeper -- but it might be longer.”

The Reserve Bank of Australia doesn’t yet see an end to the economy’s dream run, with revised forecasts Friday projecting annual GDP growth of above 3 percent through 2020.

St. Louis Federal Reserve President James Bullard in August cited the Australian experience to argue that "the idea that you’re inevitably going to have a recession just because you’ve had an expansion for a while is not really right.” His optimism echoed Bill Dudley, former president of the Federal Reserve Bank of New York, who earlier this year said the U.S. economy is in a good place and could remain there for 15 or 20 years -- like Australia.

“What’s become clear -- even with the global financial crisis -- is recessions are less frequent,” said James Morley, professor of economics at the University of Sydney and a former research fellow at the St. Louis Fed. He estimates there were twice as many downturns in the 35 years post-World War II than in the past 35.

Morley cites structural changes as a key factor, with economies no longer so reliant on manufacturing and tied to inventory cycles. The increased domination of service industries in the developed world brings fewer slumps, he says.

For the U.S., a soft landing would be something unusual. As JPMorgan points out, downturns there usually start from the Fed slamming the brakes on an overheating economy. With the central bank currently hiking interest rates as the Trump administration’s fiscal stimulus juices growth, more voices in the U.S. and abroad are warning of recession.

What set Australia apart from the U.S. and other developed economies in the last global recession was its response. The government deployed rapid and vast fiscal stimulus to the equivalent of 1.6 percent of GDP -- which included mailing checks directly to households -- compared with the U.S. spending about 1.25 percent, according to the Australian Treasury.

Growth Drivers

The rapid industrialization of China and its hunger for commodities has boosted Australian growth since the early 2000s, as has immigration. Australia admits more migrants than any other major western nation and the annual intake has almost doubled since the turn of the century.

With population growth adding at least 1.5 percentage points to GDP growth each year and another 1 percentage point coming from commodity shipments, a 2.5 percent expansion is pretty much baked in to the economy.

The definition of recession is also a factor in perpetuating Australia’s growth streak on paper. The U.S.’s National Bureau of Economic Research defines it as a significant decline in economic activity lasting from a few months to more than a year. The technical definition in Australia is two straight quarters of contraction.

Australia “actually had two downturns when the rest of the world had two recessions, they are just not called recessions,” said Pimco’s Fels. “I don’t think the Fed would be particularly happy with a situation where the unemployment rate raises significantly. I think in the U.S. we would call that a recession.”

To contact the reporter on this story: Michael Heath in Sydney at mheath1@bloomberg.net

To contact the editors responsible for this story: Nasreen Seria at nseria@bloomberg.net, ;Malcolm Scott at mscott23@bloomberg.net, Chris Bourke

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