Monday, August 10, 2020

'Extreme uncertainty' causes RBA's bright-side mask to slip

I can’t be sure, but the econocrats seem to have become uncertain about what they’re uncertain about. The one thing about which they’re not uncertain is how uncertain they are. And, of course, they’re no longer pretending to be certain it’ll all be fine.

Central bank governors take a professional pride in concealing whatever doubts and fears they have. Which is as it should be. Treasurers, on the other hand, have become so ruled by their young spin doctors they’re perpetually in bulldust-your-way-through mode.

Economists (and media economic commentators) always exude confidence about their knowledge of what lies ahead because they know that’s what the customer’s paying for. They’re like doctors who dispense pills not because they’ll work but because they’re what will make the patient feel good. At least until they’re out of the surgery.

Psychologists tell us the human animal is eternally seeking “the illusion of control”. We want to know what the future holds so we can – we fondly hope – control how it affects us. People ask me questions about the financial future. I explain why it’s not possible to know. They say: “Yes, I know that, Ross, but whaddya reckon?”

The new forecasts the Reserve Bank issued on Friday were significantly different to those it issued three months ago. Worse, they laughed at Treasury’s forecasts in the economic update just two weeks earlier.

The general story is that, thanks to the setback in Victoria, the upturn in the economy’s production (real gross domestic product) will now come later than expected, and be weaker. When Reserve governor Dr Philip Lowe says the recovery is “likely to be both uneven and bumpy” you can be confident he’s not exaggerating. “Uneven” means stronger in some states than others. “Bumpy” means not every post will be a winner.

Reading between the lines, the lockdown's full contractionary effect on GDP was expected to come in the June quarter (for which we’ll see the figures in three weeks’ time), with the recovery starting in the present September quarter.

The first quarter after the contraction should always be pretty strong (and, this time, particularly because the end of the lockdown meant people could get out, visit shops and restaurants and pubs), even if subsequent quarters aren’t as strong.

This time last week, the smart money was expecting the recovery in the September quarter to be followed by a contraction in the December quarter, as demand was hit by the wind back in the JobKeeper wage subsidy and the JobSeeker supplement.

Now, the September quarter recovery in the other states is likely to be overwhelmed by the effects of Victoria’s move to a harder lockdown. This, in turn, probably means there's less likely to be a further contraction in the December quarter – just continuing weakness. We do know that, in response to Victoria’s problems, Scott Morrison has modified JobKeeper at a cost of more than $15 billion.

Friday’s statement on monetary policy acknowledged “extreme uncertainty” about the course of the pandemic and, hence, its economic effects. In response to this uncertainty, the Reserve has moved from a single set of forecasts to three scenarios: baseline, upside and downside.

As explained by the Reserve’s assistant governor (economic), Dr Luci Ellis, in a webcast for the Australian Business Economists, the baseline scenario assumes that the rate of infection subsides, the tightening of restrictions in Victoria succeeds, there are no new lockdowns elsewhere, and restrictions are eased progressively over the rest of the year.

The upside scenario assumes the pace of decline in the number of cases is a bit faster than in the baseline, so the restrictions are eased a bit faster – like recent experience in the smaller states. People take more comfort from this and so confidence recovers faster than in the baseline.

Households are thus willing to spend more of the savings they accumulated during the first half of this year, compared with what’s assumed in the baseline scenario.

The downside scenario assumes that infection rates continue to escalate around the world this year and next. Australia faces a series of outbreaks and periods of stage three and four restrictions in some states. The result is further near-term weakness in economic activity. Confidence is damaged and so the recovery is much slower as well.

The other main point of variation between the three scenarios is how long Australia’s international borders remain closed. Three months ago, the Reserve was assuming travel restrictions would be lifted by the end of this year. In the new baseline and upside scenarios, it’s assumed that the borders reopen mid next year. In the downside scenario, it’s assumed continuing spread of the virus overseas causes our borders to be closed for the whole of next year.

There is, of course, another major source of uncertainly that the econocrats are too polite to mention: whether Morrison retains his pragmatic approach and keeps the government-spending tap open to fill whatever gaps emerge during the slow and troubled recovery, or succumbs to his ideological instincts and eschews further spending. My scenario: he’ll do more, but not enough.