With the low Q3 GDP print in hand, and mounting expectations of a low Q4 GDP outcome, UBS's Matt Johnson (who anticipated both before most), and a mysterious unnamed colleague that is being inducted by Matt into the UBS hall of fame, have published an impressive study with, amongst many other things, these findings:
"Australia’s recent experience with demand shocks has demonstrated that changes in final demand are not completely encompassed by changes in real GDP. In several quarters, the terms of trade effect has been more salient than the real GDP effect. This is partly due to the fact that businesses operate (and therefore hire labour) in a profit framework where temporary price changes matter, which is not the case for the measurement of real GDP.
Gov Stevens has also shown some apprehension in trusting GDP statistics released in real-time that conflict with employment indicators8.
The unemployment gap (defined as the difference between unemployment and the NAIRU) is led by changes in commodity prices with a one quarter lag, supporting our view. Despite the mining sector itself accounting for less than 2% of employment, the income and job creation benefits of the boom are spread well beyond the mining sector and States, according to Treasury research9. As a knock-on effect, the RBA’s forecast for inflation follows changes in commodity prices (as measured in $A) quite closely.
The dominance of employment and terms of trade data over real GDP in the RBA’s decision rule was quite clearly observed in 2006, an economic climate that mirrors 2010 conditions. The initial data available in this period indicated weak growth of 0.3% in the June and September quarters, compared to the decade average of 0.9%.
In contrast to the flagging growth story, employment data indicated strong and persistent job creation accompanied by a positive terms of trade shock. In response to this contradictory data, the board weighted their decision rule toward the unemployment story, tightening the cash rate by 75 basis points...
The major divergences between the rule and observed policy are in periods late 2003, early 2006 and mid 2007. The two unexplained hikes in late 2003 were due to the bank “leaning against the wind” in response to the former governor’s concern about a housing price bubble12.
As for 2006 and 2007, the RBA held the cash rate steady despite market expectations of accelerating inflation13, and inflation in these periods turned out higher than the RBA anticipated. We are not surprised to find that the cash rate lagged where it should have been according to the decision rule in both these times, a criticism the bank has since accepted."
