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Economy - things might not turn out as badly as expected

By Garry Shilson-Josling, AAP Economist
29 May 2009 4:03 PM

SYDNEY, May 29 AAP - Maybe things won't turn out so badly.

With the global economy in recession and Australia waiting for news on Wednesday that gross domestic product fell for the second consecutive quarter, it is hard to imagine the slump might not be as steep or as prolonged as it is widely predicted to be.

And perhaps a gloomy outlook for Australia is justified.

After all, recessions sparked by financial system crises, as this one has been, tend to be more severe than others, as both the Reserve Bank of Australia (RBA) and the International Monetary Fund have been at pains to point out recently.

Key indicators certainly suggest there is worse to come before Australia turns the corner.

Just this week the Australian Bureau of Statistics (ABS) released its survey of business capital spending plans for the remainder of 2008/09 and 2009/10.

The survey results meshed well with the official forecast in the federal budget handed down earlier this month - that business investment in structures and equipment in 2009/10 will post its biggest fall in half a century of quarterly national accounts data.

And most available figures appear to support the official outlook that the economy will grow so slowly that unemployment will not start falling before the second half of 2011.

But all is not doom and gloom.

The resilience of retail spending, with an above-trend rise in the March quarter, confirms the economy is not in free fall.

So too does the data from the RBA on Friday showing credit growth is at least marginally positive.

It has been kept above water by growth in credit to home-buyers, who drive housing construction which is in turn a key cyclical sector of the economy.

And the speed of the adjustment in the business sector is promising.

The biggest falls for over 20 years in capital spending and inventory levels were recorded in the December quarter.

There will probably be more to come.

But the faster the fall, the sooner the bottom is reached and the sooner the recovery can begin in earnest.

And when growth does resume, it will be pushed along by a fiscal and monetary stimulus that is unprecedented in both its size and timing.

In the recession of the early 1990s, for example, when the economy had already emerged from its slowdown and starting growing again the RBA still had 6.5 percentage points of interest rate cuts to go.

On the fiscal policy side, the major impulse from more stimulatory policy will come significantly earlier this time, and in greater volume, than it in either the early 1990s recession or the slump prior to it in 1982/83.

The story has been matched by similar policy easings in the industrialised economies and, just as importantly these days, in China.

These fuses lit under the global economy could turn out to be damp squibs, of course.

No-one can be sure.

Economic forecasting is based on precedent - and too much of the current crisis is unprecedented for predictions to be made with any plausible pretence of confidence.

But at times like this it is a good idea to bear in mind the psychological hurdle towering before any forecaster - from the individual investors to corporate bosses and boffins in the bureaucracy.

It is simply easier - much, much easier - to imagine the economy will stay on its current path than to envisage a major change in direction, even though history tells us that recessions typically end little more than a year after they begin.

It is the sentiment that causes investors to assume last year's returns, no matter how atypical, will be repeated this year, and for economists to consistently fail to identify turning points as the economy flips between boom and bust.

The dysfunction in the world's credit markets may yet be persistent enough to make the recession even deeper and longer, and the subsequent recovery even more tepid, than most forecasters expect.

But by the same token it is too early to conclude that things might not turn out anywhere near as badly as appears so likely right now, amid the wreckage left in the wake of the global credit crisis.