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Lucky to stabilize NGDP, not inflation

Summary:
Australia has long been known as the “lucky country”, and hence many people attribute their current 28-year expansion to dumb luck—perhaps they benefited from trade with China. The NYT has a new piece that suggests the reason for Australia’s success goes well beyond just luck: But China’s gravitational pull can explain only so much. For one thing, other countries nearby have had recessions, some severe, in recent decades. And there are a long list of policy choices that enabled the long Australian boom even as otherwise similar economies sank. One episode is particularly telling. In 1997, an East Asian financial crisis walloped the economies of countries like South Korea, Thailand and Indonesia. These nations were major buyers of Australian exports. The value of

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Australia has long been known as the “lucky country”, and hence many people attribute their current 28-year expansion to dumb luck—perhaps they benefited from trade with China. The NYT has a new piece that suggests the reason for Australia’s success goes well beyond just luck:

But China’s gravitational pull can explain only so much. For one thing, other countries nearby have had recessions, some severe, in recent decades. And there are a long list of policy choices that enabled the long Australian boom even as otherwise similar economies sank.

Lucky to stabilize NGDP, not inflation

One episode is particularly telling. In 1997, an East Asian financial crisis walloped the economies of countries like South Korea, Thailand and Indonesia. These nations were major buyers of Australian exports. The value of the Australian dollar started to fall on global currency markets, putting the expansion at risk only six years in.

On the other side of the Tasman Sea, New Zealand’s central bank responded to the same problem by raising interest rates. After all, a falling New Zealand dollar indicated a lack of confidence in the currency and implied that inflation would soon rise.

At the Reserve Bank of Australia, by contrast, officials concluded that the falling value of the Australian dollar reflected shifting economic fundamentals that were ultimately healthy — part of how the Australian economy could adapt to faltering demand from East Asia.

Rather than raise interest rates to try to prevent a falling currency, they viewed a falling currency as the key to navigating the peril — by making Australian exports more competitive in the United States and Europe, for example. . . .

Sure enough, New Zealand fell into recession in 1997 and 1998, while Australia endured only a period of subpar growth. Good policy, it turns out, has a way of creating good luck. And it wasn’t the only time.

The Kiwi’s were foolish to focus on inflation targeting.

Although the NYT piece is mostly excellent, there are a few weak spots:

The housing market in Australia did not see the severe boom-bust cycle that the United States experienced as part of the global financial crisis, though the market has softened lately.

Technically that’s accurate, but most American readers will get the wrong impression.  Most readers will infer that Australia was smart to avoid the excesses of 2000-06, as experienced in America.  But they did not avoid those excesses; their housing boom was just as big as ours.  They avoided the “boom-bust cycle” by avoiding the bust, not by avoiding the boom.

HT:  Clare Zempel

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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