Working Papers

Another Great Post-Budget Address from Treasury Secretary Henry

Treasury Secretary Ken Henry’s annual post-Budget address to ABE is invariably one of the most interesting contributions to public debate about economic policy.  This year’s address is particularly pleasing for the fact that it echoes this blog’s criticisms of the popular hysteria about the current account deficit.  As Henry makes clear, the deterioration in Australia’s current account is a reflection of the fact that we are getting richer via the terms of trade:

The sustained gap between growth in ex post (realised) real domestic demand and real output over the past three years does not provide unambiguous evidence of ex ante (planned) demand for domestic product running ahead of increasingly constrained supply. Instead, it can, at least partly, be explained by strong substitution of relatively cheap imports for domestic product.

One should therefore think very carefully before accepting a conclusion that macroeconomic policy should be tightened to slow domestic final demand growth to meet the rate of GDP growth. To do so would amount to targeting the net export contribution to GDP – which would be a curious, but inappropriate, role for macroeconomic policy.

Needless to say, I am not convinced that there is a case for allowing the tax to GDP ratio to rise to off-set the income boost from higher export prices. I don’t think it obvious at all.

And don’t miss the none too subtle dismissal of Ross Gittins in footnote number 2! 

Tomorrow’s headlines will be full of hysterical beat-ups about differences between Treasury and the RBA over policy, which is unfortunate, because it only distracts attention from the substantive issues being raised by Henry.

posted on 17 May 2005 by skirchner in Economics

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not being an economist, i only vaguely followed the quotes, so i checked out the full paper. this part made it perfectly clear:

“To illustrate, suppose we were to observe that the quantity of lamb actually being sold in Australia is lower this year than last. Would this be because the demand curve has shifted to the left or because the supply curve has shifted to the left? The observation is consistent with both of these explanations. But, clearly, if you are somebody who has a concern for lamb prices it is very important to know which of the two explanations is the more likely.”

well done to henry for explaining this concept clearly enough for a layman to understand.

this paragraph is also nice, for explaining the specific instance:

“But consider this alternative explanation. The real exchange rate also rises strongly in response to higher export prices, with two important consequences: first, the size of the nominal income boost is reduced; and second, imports become cheaper relative to domestic product. Yes, the higher income, and higher real wealth, due to higher export prices means an increase in the demand for domestic product. But there is a strong substitution effect working in the opposite direction: the lower relative price of imports encourages demand substitution away from domestic product. Imports increase strongly not because they are being sucked in to fill an excess demand gap for domestic product, but rather because, in responding to changes in relative prices, demand is being taken away from domestic product.”

thanks for the link

Posted by .(JavaScript must be enabled to view this email address)  on  05/17  at  10:33 PM

I thought imports were part of domestic demand.

How can net exports be? Surely if you reduced domestic demand net exports would increase as exports are unaffected but imports would drop.

Do I have to get a refund on my university education?

Posted by .(JavaScript must be enabled to view this email address)  on  05/19  at  02:58 PM

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