Australian Government, 2009‑10 Budget
Budget

Statement 2: Economic Outlook

The outlook for the domestic economy

Demand and output

The magnitude of the global recession and the speed with which it has hit means that a recession in Australia has become inevitable. Strong and rapid policy action by the Australian Government and the Reserve Bank of Australia is helping to reduce the impact of the global recession on the domestic economy but cannot completely offset its effects. Real GDP is forecast to contract by ½ of a per cent in 2009‑10. This is a much milder contraction than expected in other advanced economies, where output as a whole is expected to fall by 3¾ per cent in 2009. The downturn in the domestic economy is expected to be led by a contraction in business investment and exports.

With private demand contracting, the public sector is providing support through a combination of measures directed towards private consumption, and dwelling and business investment. Government stimulus packages are expected to lead to the largest rise in public investment on record in 2009‑10, making a significant contribution to growth. In the absence of government action, the contraction in domestic activity would be much deeper (Chart 5). In total, the Government's stimulus is expected to raise the level of GDP by 2¾ per cent in 2009‑10 and 1½ per cent in 2010‑11. The stimulus is expected to support up to 210,000 jobs and reduce the peak in the unemployment rate by 1½ percentage points from what it would otherwise have been.

Chart 5: Real GDP growth pre‑ and post‑stimulus

Chart 5: Real GDP growth pre- and post-stimulus

Note: Stimulus includes the Economic Security Strategy; November COAG reforms; Regional and Local Community Infrastructure Program; December Nation Building Package; Nation Building and Jobs Plan; National Broadband Network; and the net effect of 2009‑10 Budget measures.

Source: ABS cat. no. 5206.0 and Treasury.

The 2009‑10 Budget includes an additional forecast year which shows the likely recovery path of the economy as it emerges from recession (Box 4). The economy is expected to enter a gradual recovery in early 2010 as global conditions stabilise. The recovery in 2010‑11 is expected to be led by solid growth in dwelling investment and strengthening export growth as global demand gradually recovers (Chart 6). At 2¼ per cent, growth in 2010‑11 is nevertheless expected to remain below trend, with household consumption remaining subdued and business investment recovering only gradually, given excess capacity. While public final demand will remain at a high level, its growth will slow as a consequence of the temporary nature of the stimulus.

Chart 6: Contributions to GDP growth(a)

Chart 6: Contributions to GDP growth(a)

  1. Adjusted for second‑hand asset sales from the public sector to the private sector.

Source: ABS cat. no. 5206.0 and Treasury.

Household consumption

After slowing sharply in 2008‑09, household consumption is expected to contract by ¼ of a per cent in 2009‑10. This is a mild fall given the substantial headwinds being faced by the household sector, and significantly less than that being experienced by most other advanced economies. While the household sector has been buffeted by a series of negative shocks stemming from the global recession, government stimulus packages are providing considerable support to household consumption. In the absence of this action, the contraction would be much more severe.

Households have benefited from a period of strong capital gains over recent years, driven in part by the mining boom, providing a substantial boost to household wealth and consumption. Sharp falls in global share markets, coupled with recent moderate falls in domestic house prices, have substantially eroded these gains. Household net financial wealth has fallen by a third over 2008 and, despite recent gains, share markets are still around 45 per cent lower than the peak in late 2007.

Ongoing uncertainty about the effect of the global recession, together with the prospect of rising unemployment, continues to affect consumer confidence. Households are paying down debt and rebuilding their savings. A stronger household financial position will help bolster confidence and lead to a more rapid recovery in household consumption.

A large amount of policy stimulus is helping to support household consumption. The Economic Security Strategy and the Nation Building and Jobs Plan will collectively add $19.7 billion to household incomes, and the pension increase announced in the 2009‑10 Budget will also add significantly to household incomes and help support consumption. These stimulus payments are expected to support a higher level of consumption over the forecast period, with the bulk of this support coming in 2009, when the economy is at its weakest (Chart 7). This stimulus is estimated to add 1¼ per cent to the level of household consumption in 2008‑09 and 2009‑10. In the absence of this stimulus, household consumption would have contracted sharply, as it has in other countries. Mortgage interest rates have also been cut to their lowest level in more than 40 years, substantially raising household disposable income.

There is already evidence that the payments made under the Economic Security Strategy have provided a significant boost to household consumption. The level of retail trade in March 2009 was 4.5 per cent higher than prior to these payments, and retail sector employment rose in February 2009, for the first time in over a year (Box 5).

Chart 7: Stimulus effect on household consumption

Chart 7: Stimulus effect on household consumption

Source: ABS cat. no. 5206.0 and Treasury.

Box 4: Updated methodology for forward estimates

The fiscal aggregates in the budget are underpinned by a set of forward estimates consisting of short‑term economic forecasts and projections based on medium‑term assumptions. These estimates provide the base from which to frame the budget and develop sound, forward‑looking economic policy.

Since the mid‑1990s, the budget has been based on forecasts for the current and budget year and an assumption that the economy grows at its long‑run trend rate over the three‑year projection period. This approach was suitable during a period of stable growth when the economy did not deviate far from trend, but is not appropriate in the current circumstances.

The magnitude of the global recession means that the Australian economy is expected to be operating below trend in 2008‑09 and over the next two years, pushing the unemployment rate well above its longer‑term sustainable rate (or NAIRU). Maintaining the previous approach would unrealistically lock into the projections a level of GDP significantly below potential, and does not provide a credible view of the likely growth path of the economy as it emerges from recession. As a result, this approach would provide a misleading picture of revenue and expenditure estimates.

In order to better inform Australians about the likely growth path of the economy, two substantive changes have been made to the forward estimates methodology in this Budget.

The forecast period has been extended by one year to 2010‑11, when the economy is expected to grow below trend. Further, GDP is assumed to grow above (rather than at) trend in the projection years. Both of these changes are broadly based on the historical experience of the economy as it emerged from the 1980s and 1990s recessions.

Extending the forecasts to 2010‑11 better reflects the expected growth path of the economy, notwithstanding the difficulties involved in forecasting that far in the future.

Given the nature and severity of the global recession, the current downturn in the Australian economy is therefore expected to extend to three years of below‑trend growth, compared with one year for the 1980s recession and two years for the 1990s recession (Chart A).

This period of below‑trend growth will result in substantial spare capacity becoming available, and the economy is assumed to grow above trend in the projection period as this spare capacity is brought into use. Strong business investment in the period leading up to the recession has resulted in a substantial build‑up in capacity, particularly in mining production and transport infrastructure. This will enable resource exports to respond quickly as global demand recovers, supporting GDP growth.

Real GDP is assumed to grow by 4½ per cent per annum in the projection period, above the medium‑term trend rate of 3 per cent.

Growth over the first three years of the forecast recovery averages 3¾ per cent. This compares with an average of 4.8 per cent after the 1980s recession and 4 per cent after the 1990s recession (Chart A).

This period of above‑trend growth has the effect of bringing down the unemployment rate by 1 percentage point in each year of the projections, reaching 6½ per cent by the end of the forward estimates. Again, after peaking in the 1980s and 1990s recessions, the unemployment rate declined by around 2 percentage points over the following two years.

This approach is also in line with that taken in budgets in the early 1990s, when above‑trend rates of growth were assumed as the economy recovered from recession.

This approach is also similar to what is being done in other OECD countries, including the United States, the United Kingdom, New Zealand and Sweden.

Chart A: Real GDP

Chart A: Real GDP

Source: ABS cat. no. 5206.0 and Treasury.

Household consumption growth is forecast to strengthen to a still below‑trend 1¾ per cent in 2010‑11. With large falls in household wealth and slower income growth, coupled with still rising unemployment, household consumption is likely to be subdued for some time to come. As households rebuild their balance sheets, this will facilitate a recovery in household consumption. The household saving ratio is expected to average 6¾ per cent in 2008‑09 and remain at a high level over the forecast period (Chart 8).

Chart 8: Household saving ratio

Chart 8: Household saving ratio

Source: ABS cat. no. 5206.0 and Treasury.

Dwelling investment

The near‑term outlook for dwelling investment continues to be dominated by low levels of household confidence and persistent funding difficulties for medium‑density dwellings. As a result, dwelling investment is expected to remain flat in 2009‑10 before staging a solid recovery in 2010‑11 with growth of 11½ per cent (Chart 9).

Building approvals were persistently weak over the second half of 2008, with large falls in approvals for both houses and medium‑density dwellings. Total approvals remain more than 15 per cent lower than a year ago. Given the normal lags between approvals and building commencements, this means that overall activity in the sector is likely to be subdued until late 2009. New dwelling investment is expected to contract over 2009 but this will be partly offset by support coming from alterations and additions activity flowing from the Government's Energy Efficient Homes program.

Following this near‑term weakness, activity in the sector is expected to be supported by firm population growth, the effects of the substantial easing in monetary policy and continued solid rental yields helping to encourage investors back into the market. The Government's First Home Owners Boost has contributed to a significant increase in demand by first home buyers, and thereby supported dwelling prices and auction clearance rates at the lower end of the housing market. Loans to first home buyers have risen sharply to the highest level as a proportion of the market since 1991. This demand is expected to continue to flow through to increased investment in new dwellings, and the extension of the First Home Owners Boost is expected to support activity over the year.

Box 5: The success of stimulus to date

The Government's Economic Security Strategy (ESS) provided more than $8 billion in targeted stimulus payments to households in December 2008, and additional assistance to first home buyers. This stimulus was designed to support domestic demand and employment in the Australian economy. Further stimulus has been made under the Nation Building and Jobs Plan, and while there are early signs this is having an impact on activity, the full impact is yet to be felt.

Whilst it is not possible to measure precisely the actual impact of the ESS, a range of economic data suggest that the package has supported retail spending, employment and consumer confidence, and has stimulated activity in the housing sector.

Retail trade turnover was showing significant weakness prior to the ESS, having grown at an average monthly rate of 0.2 per cent in the previous year. Following the stimulus package, retail trade grew by 3.8 per cent in the month of December 2008, the largest rise in over eight years and the fourth highest in the 27‑year history of the series. This positive outcome was followed by a rise in retail trade employment over the three months to February, the first rise since November 2007 (Chart A).

March 2009 data show that retail trade remains 4.5 per cent above its pre‑stimulus level of November 2008, with Treasury's Business Liaison Program indicating that the stimulus had a substantial impact on retail trade during the post‑Christmas sales period. This compares to falls in retail turnover in other parts of the world. In countries such as the United States, Japan, Canada and Germany, retail turnover is around 2 to 3 per cent lower.

Chart A: Retail sales and
retail employment (qoq)

Chart A: Retail sales and retail employment (qoq)

Note: Retail sales is a chain volume measure. Employment data are mid‑month of quarter.

Source: ABS cat. no. 8501.0 and 6291.0.55.003.

As well as retail sales, consumer confidence has held up better than in many other countries, where confidence fell to record lows in the March quarter 2009 (Chart B). In Australia, consumer confidence has held up since the stimulus, and was 13 per cent higher in April 2009 than its October 2008 level, as measured by the Westpac — Melbourne Institute Index of Consumer Sentiment.

Consumer confidence across the OECD is at around the lowest level in the 31‑year history of the series. In the first few months of 2009, consumer confidence fell to 42‑year lows in the US and 35‑year lows in the UK, and to the lowest level since records began in 1985 in the euro area.

Chart B: Consumer confidence — Australia and international

Chart B: Consumer confidence — Australia and international

Note: Selected advanced economies is a GDP PPP weighted average of US, UK, Japan and euro area.

Source: Westpac — Melbourne Institute, OECD, IMF and Treasury.

The First Home Owners Boost has spurred activity in the housing sector since it was introduced in October 2008. Since then, housing finance for owner‑occupiers has grown strongly, with the number of loans to owner‑occupiers rising for the fifth consecutive month in February 2009, after falling in each of the eight months prior to the introduction of the policy.

Activity has been buoyed by an increase in first home buyers. In February 2009, the number of loans to first home buyers was the highest since the series began in 1991, while finance for new dwellings — a key indicator of residential construction activity — has also grown strongly in recent months (Chart C).

Chart C: Housing finance

Chart C: Housing finance

First home buyers data are original. New dwellings data are seasonally adjusted.

Source: ABS cat. no. 5609.0.

Chart 9: Growth in dwelling investment

Chart 9: Growth in dwelling investment

Source: ABS cat. no. 5206.0 and Treasury.

Business investment

The value of business investment had risen to a four‑decade high as a share of GDP by the end of 2008, driven by rapid growth over the previous few years associated with the mining boom. Since then, the collapse in global and domestic demand, and lower commodity prices and profits stemming from the global recession, have reduced the impetus for business investment.

Business investment is expected to fall swiftly to pre‑commodity boom levels as a share of GDP (Chart 10). Reflecting the deteriorating outlook, business sentiment has weakened further in recent months and business surveys consistently show sharply weaker investment intentions. Total new business investment is expected to fall by 18½ per cent in 2009‑10, before stabilising in 2010‑11 with growth of 3½ per cent. The Government is providing investment incentives through the Small Business and General Business Tax Break, and the Australian Business Investment Partnership will also help to support investment by providing liquidity support to the commercial property sector.

Investment in new machinery and equipment is forecast to contract by 16½ per cent in 2009‑10 as firms cut back on discretionary spending in the face of lower global and domestic demand and a weaker profits outlook. A modest recovery is expected in 2010‑11, with growth of 4 per cent, in line with the gradual strengthening in global and domestic demand. Recent data from the Australian Bureau of Statistics Survey of Private New Capital Expenditure and Expected Expenditure (CAPEX) indicate particular weakness in investment intentions for 2009‑10 in the manufacturing, construction and property and business services sectors.

Total new non‑dwelling construction is forecast to fall by 26 per cent in 2009‑10, led by a fall of almost 40 per cent in non‑residential building construction, in line with the substantial fall in building approvals for this sector.

Engineering construction is also expected to contract in 2009‑10, albeit not as severely as non‑residential construction. Weaker global and domestic demand, and a substantial decline in commodity prices, has eroded much of the momentum of engineering construction investment, and some projects have been postponed or cancelled in light of softer demand and funding constraints. Engineering construction is expected to lead the business investment recovery in 2010‑11, with a number of high value resource projects scheduled to commence work in that year. There are considerable risks around the engineering investment outlook given the possibility of delays or cancellations in light of reduced demand and significantly lower commodity prices.

Chart 10: New business investment as a share of nominal GDP

Chart 10: New business investment as a share of nominal GDP

Note: Adjusted for second‑hand asset sales from the public sector to the private sector.

Source: ABS cat. no. 5206.0 and Treasury.

Public final demand

As private demand slows in the face of the global recession, public demand is helping to fill the gap and moderate the severity of the downturn. Public final demand is expected to grow by 7¾ per cent in 2009‑10, remaining at a high level through 2010‑11 (Chart 11).

Chart 11: Public final demand as a share of nominal GDP

Chart 11: Public final demand as a share of nominal GDP

Source: ABS cat. no. 5206.0 and Treasury.

Strong growth in public final expenditure over the forecast period is driven by public investment flowing from the Government's economic stimulus packages (Chart 12). This includes the infrastructure funding announced in the 2009‑10 Budget, the February 2009 Nation Building and Jobs Plan and other financial packages including the November 2008 Council of Australian Governments reforms and the December 2008 Nation Building package. This is on top of already high levels of state and local investment. These funding packages represent a significant boost to total public investment and are expected to see public investment rise by 25 per cent in 2009‑10, the largest annual increase on record. The increase in government investment will help to cushion the effects of the global recession, support jobs and bolster Australia's long‑term productive capacity.

The successful implementation of these spending programs in a timely manner is critical to the economic outlook. Public final demand is one of the few sectors expected to make a positive contribution to economic growth in 2009‑10. The Commonwealth and State and local governments have put in place extensive arrangements to ensure that the programs are delivered on schedule. To manage risks and avoid slippage in implementation, a Commonwealth Coordinator‑General has been appointed to oversee and coordinate the delivery of the Nation Building and Jobs Plan, and national coordinators have been appointed for each program area. This management structure is mirrored in each of the States and Territories.

Public final demand will remain at a high level in 2010‑11, although its growth will slow as a consequence of the temporary nature of the stimulus.

Chart 12: Public final demand pre‑ and post‑stimulus

Chart 12: Public final demand pre- and post-stimulus

Source: ABS cat. no. 5206.0 and Treasury.

Exports and imports

In line with the collapse in world trade resulting from the global recession, Australia's exports are expected to fall significantly in 2009‑10. The sharp deterioration in the growth prospects of our major trading partners is expected to result in a loss of $50 billion in export income in that year. Exports of elaborately transformed manufactures, non‑rural commodities and services are expected to decline rapidly, with some support coming from a continued recovery in rural exports. As global demand gradually strengthens, non‑rural commodity exports are expected to lead the recovery in 2010‑11. Overall exports are forecast to fall by 4 per cent in 2009‑10, before rising by 4½ per cent in 2010‑11.

While the collapse in world trade will lead to a decline in Australia's exports, the relatively low intensity of manufacturing in Australia's exports means that this decline will be less severe than in other advanced economies (Chart 13).

Rural exports are expected to increase solidly in 2008‑09 and continue this recovery in 2009‑10 with growth of 5½ per cent. Farm production in 2008‑09 rose solidly owing to favourable seasonal conditions, which will flow through to increased rural exports. Farm production is expected to return to around pre‑drought levels in 2009‑10 and remain there over 2010‑11 in line with an assumed return to average seasonal conditions.

Non‑rural commodity exports are forecast to decline by 5 per cent in 2009‑10. The global recession has resulted in a sudden and dramatic collapse in global demand for steel and raw materials. Industrial production has plummeted. Weaker demand has been reflected in lower commodity prices, with prices for key bulk commodities falling sharply from the historical highs in 2008‑09. Global demand is expected to strengthen in 2010‑11 underpinning a solid increase in exports of non‑rural commodities of 7 per cent. Strong investment over the past few years in mining production and transport infrastructure has resulted in significantly increased capacity, which will enable resource exports to respond quickly as global demand recovers.

Chart 13: Growth in international and Australian export volumes

Chart 13: Growth in international and Australian export volumes

Source: ABS cat. no. 5302.0, IMF and Treasury.

Exports of elaborately transformed manufactures and services have borne the brunt of the downturn in demand from the global recession, which has outweighed any boost from the lower exchange rate. Exports of elaborately transformed manufactures are forecast to contract by 7½ per cent in 2009‑10, driven particularly by the collapse in demand for motor vehicles that has seen sales plummet worldwide. Exports of services are forecast to fall by 4½ per cent as global demand for tourism, transportation and communications services also contracts.

Import volumes are forecast to contract by 6½ per cent in 2009‑10, driven by the weaker outlook for domestic demand and the depreciation of the Australian dollar increasing prices of imported goods. The fall in imports is expected to be broad‑based, but is led by a sharp fall in capital goods, reflecting the contraction in business investment which has a high imported component. Imports are forecast to rise solidly in 2010‑11 as the recovery in the domestic economy flows through to a pick up in demand (Chart 14).

Chart 14: Growth in import volumes

Chart 14: Growth in import volumes

Source: ABS cat. no. 5302.0 and Treasury.

Terms of trade

The large price rises over several years for Australia's key bulk commodities saw Australia's terms of trade reach a six‑decade high in the September quarter 2008. Since then, the collapse in global demand stemming from the global recession, and the dramatic slowdown in growth in China, has seen prices fall sharply. This is expected to result in a decline in the terms of trade of 13¼ per cent in 2009‑10, a slightly larger fall than forecast at UEFO. Even after this fall, the terms of trade would remain around 45 per cent higher than the average in the decade prior to the commodity boom, although downside risks remain. Just as the rising terms of trade drove increases in nominal GDP, national income and business investment in recent years, the unwinding of the mining boom is expected to result in falling nominal GDP in 2009‑10 (Box 6). Further falls in the terms of trade would lead to more significant declines in nominal GDP, flowing through to national income.

Global commodity prices remain subdued, with spot prices for iron ore and coal well below 2008‑09 contract prices (Chart 15). Consistent with the terms of trade forecast at the Mid‑Year Economic and Fiscal Outlook and UEFO, benchmark thermal coal contract prices in $US have fallen by 44 per cent, while metallurgical coal contract prices have settled around 60 per cent lower. While benchmark iron ore contract prices are yet to be agreed, large falls in iron ore export prices are anticipated. Prices are likely to remain weaker than in recent years until global growth, and particularly demand from China, starts to recover.

Box 6: Unwinding of the mining boom

After rising rapidly over the past six years to a six‑decade high, Australia's terms of trade are being hit hard by the global recession. Growth in China has slowed sharply, and commodity prices have fallen. Just as nominal GDP and national income rose with the strong gains in the terms of trade in recent years, nominal GDP and profits are expected to fall in 2009‑10, partially reflecting the winding back of the terms of trade.

Industrial production across both developed and developing countries has slowed, particularly in our key markets of China, Japan and Korea, and this has seen demand for bulk commodities slow significantly, resulting in sharply lower prices.

Benchmark thermal coal contract prices in $US have fallen by 44 per cent, while metallurgical coal contract prices have settled around 60 per cent lower. While benchmark iron ore contract prices are yet to be agreed, large falls in iron ore export prices are anticipated.

Rapid growth in the terms of trade since 2003‑04 has provided a significant boost to nominal incomes in recent years, but the forecast fall in 2009‑10 means the terms of trade are now expected to detract from nominal incomes growth.

Quantifying this impact on nominal GDP depends on how the economy would have evolved in the absence of the terms of trade effects. The simplest approach is to recalculate nominal GDP holding the terms of trade constant at the 2003‑04 level. This captures the direct effect of higher export prices on nominal GDP.

Over the five years to 2008‑09, the cumulative increase in nominal GDP is around $260 billion (Chart A).

Chart A: Nominal GDP

Chart A: Nominal GDP

Source: ABS cat. no. 5206.0 and Treasury.

The forecast fall in the terms of trade in 2009‑10 will unwind some of these gains. The 13¼ per cent fall in the terms of trade is expected to wipe off roughly 3 percentage points from nominal GDP growth in 2009‑10, or around $35 billion.

Even after the sharp fall expected in 2009‑10, the terms of trade would remain around 45 per cent higher than the average in the decade prior to the commodity boom.

Chart 15: Bulk commodity prices

Thermal coal (Newcastle)

Chart 15: Bulk commodity prices - Thermal coal (Newcastle)

Iron ore

Chart 15: Bulk commodity prices - Iron ore

Note: Iron ore spot price is cost and freight for India/China imports.

Source: Bloomberg, Global Coal and ABARE.

Current account balance

The current account deficit narrowed to a seven‑year low of 2.2 per cent of GDP at the end of 2008, driven by a trade surplus. The current account deficit is forecast to widen over 2009‑10 and 2010‑11, as the trade account moves back into deficit with commodity prices falling. The net income deficit is expected to remain relatively stable. The current account deficit is expected to average 5¼ per cent of GDP in 2009‑10 and 5¾ per cent of GDP in 2010‑11.

Labour market, wages and consumer prices

Labour market

The sharp slowdown in economic activity stemming from the global recession is expected to weigh heavily on demand for labour over the forecast period. Employment is forecast to contract through to mid‑2010, falling by 1½ per cent through to the June quarter in that year, resulting in a rise in the unemployment rate to 8¼ per cent by that quarter, and a peak of 8½ per cent in the following year. The global recession has resulted in job losses in most countries, and many advanced economies are expected to record double‑digit rates of unemployment.

Employment growth is expected to return gradually as the economic recovery begins, reaching ½ of a per cent through to the June quarter 2011. However, this gradual recovery in employment growth is not expected to be sufficient to absorb new entrants to the labour force and significantly reduce unemployment (Chart 16). As a result, while employment is expected to be increasing at this stage of the cycle, the unemployment rate is forecast to remain high (Box 7).

Chart 16: Employment growth, labour force growth and
change in unemployment rate

Chart 16: Employment growth, labour force growth and change in unemployment rate

Source: ABS cat. no. 6202.0 and Treasury.

The Government's stimulus packages will provide considerable support to economic activity, significantly raising the level of GDP from what would have been the case in the absence of this action. This in turn will support labour demand over the forecast period. The stimulus measures are estimated to reduce the forecast peak unemployment rate by 1½ percentage points. In the absence of policy action, the forecast unemployment rate would have reached 10 per cent (Chart 17).

Chart 17: Unemployment rate pre‑ and post‑stimulus

Chart 17: Unemployment rate pre- and post-stimulus

Source: ABS cat. no. 6202.0 and Treasury.

Wages

In line with the easing in labour market conditions, wages growth is expected to slow gradually. Growth in the Wage Price Index is forecast to moderate from 4¼ per cent through the year to the June quarter 2009 to 3¼ per cent through the year to the June quarters of both 2010 and 2011.

The moderation in wages growth is expected to be broad‑based across the States and Territories. Wages growth has been strongest in those States most affected by the mining boom, with Queensland and Western Australia recording rates of growth well above the national average in recent years (Chart 18). Wage pressures in these States are expected to ease significantly across the forecast period, consistent with a significant easing in mining production and related investment activity as global and domestic demand slows.

Chart 18: Growth in the Wage Price Index

Chart 18: Growth in the Wage Price Index

Source: ABS cat. no. 6345.0.

Box 7: The outlook for employment

Although the economy is forecast to begin to recover in 2010, the unemployment rate is not expected to peak until late 2010. This lagged response is consistent with historical experience. Econometric modelling suggests that movements in GDP affect employment growth between one and five quarters later, with the largest effects occurring after two quarters. The delay in part reflects employers' caution about taking on more staff until they see a sustained recovery in demand for their products.

A sustained period of above‑trend GDP growth is typically required for the unemployment rate to fall, as was seen during the recovery from the 1990s recession. While the economy expanded through 1992, it was not until growth consistently exceeded trend growth that the unemployment rate began to decline (Chart A).

Chart A: GDP growth and changes in the unemployment rate in the 1990s recession

Chart A: GDP growth and changes in the unemployment rate in the 1990s recession

Source: ABS cat. no. 5206.0 and 6202.0.

While the unemployment rate fell relatively rapidly in the initial stages of past recoveries, attaining the pre‑downturn low typically took much longer. This may partly reflect limits on how fast the economy can grow.

Although GDP can grow faster in the initial stage of a recovery when spare capacity is plentiful, growth subsequently tends to moderate as this spare capacity is employed. Moreover, the average duration of unemployment tends to increase during a downturn and continues to rise even after the unemployment rate begins to fall (Chart B).

Chart B: The unemployment rate and average duration of unemployment (trend)

Chart B: The unemployment rate and average duration of unemployment (trend)

Note: Average duration of unemployment since last full‑time job.

Source: ABS cat. no. 6202.0, 6291.0.55.001 and Treasury.

Consumer prices

Inflationary pressures have moderated significantly over the past year as the deepening global recession has lowered previous demand pressures. Growth in the Consumer Price Index (CPI) has fallen rapidly from a recent peak of 5.0 per cent to 2.5 per cent through the year to the March quarter 2009. Underlying inflation, which is less directly affected by falling oil prices and other one‑off factors, has also eased from a peak of 4.7 per cent to 4.2 per cent through the year.

Price pressures are expected to ease further over the forecast period as the effects of the global recession continue to impact on the domestic economy. While underlying inflation is expected to remain elevated over the next few quarters, both headline and underlying inflation are expected to fall to 1¾ per cent through the year to the June quarter 2010 and 1½ per cent through the year to the June quarter 2011 (Chart 19).

These continued falls reflect the substantial spare capacity that is likely to exist in the global and domestic economies. Strong growth in nominal unit labour costs has contributed to upward pressure on prices over the past four years. These pressures are expected to moderate significantly over the forecast period as wages growth slows in line with easing labour market pressures.

Chart 19: Headline and underlying inflation

Chart 19: Headline and underlying inflation

  1. The underlying inflation measure is the average of the RBA trimmed mean and weighted median.
  2. Adjusted for the effects of The New Tax System.

Source: ABS cat. no. 6401.0, Reserve Bank of Australia and Treasury.

Incomes

The commodity boom has supported large rises in the terms of trade and driven strong increases in real GDP as business investment and household consumption grew rapidly. This has led to rapid rates of growth in nominal GDP over recent years. The collapse in global demand, and the resulting sharp falls in commodity prices, has unwound much of this stimulus, and nominal GDP is expected to undergo a significant contraction in 2009‑10, falling by 1½ per cent. Real GDP is expected to contract by ½ of a per cent, while prices, as measured by the non‑farm GDP deflator, are forecast to fall by 1 per cent, reflecting the large fall in the terms of trade. Growth in nominal GDP in 2010‑11 is forecast to strengthen to 3¾ per cent, remaining below trend in line with continued below‑trend growth in both prices and the real economy (Chart 20).

The slowdown in nominal GDP growth is expected to be broadly distributed throughout the economy, with slower growth in compensation of employees, company gross operating surplus and gross mixed income. Compensation of employees reflects the total salary and wages paid to all employees. After rapid rates of growth in recent years driven by strong rises in both employment and wages, it is forecast to slow to 1½ per cent in 2009‑10 as employment contracts and wages growth slows. Growth is expected to strengthen in 2010‑11 as employment gradually recovers.

Chart 20: Decomposition of nominal GDP growth

Chart 20: Decomposition of nominal GDP growth

Note: The small discrepancy between nominal GDP and the sum of its components is due to interactions which cannot be attributed to individual components.

Source: ABS cat. no. 5206.0 and Treasury.

Gross operating surplus is a broad measure of profits, and has been boosted in recent years by strong mining profits stemming from high non‑rural commodity prices. Corporate profits are expected to fall by 11¼ per cent in 2009‑10 as prices unwind and economic activity slows.

Gross mixed income, which includes profits of farm and unincorporated enterprises, is also expected to contract in 2009‑10, albeit at a more moderate pace. This is driven by an expected fall in rural commodity prices, as well as reduced construction activity from the slowdown in dwelling and business investment.

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