The Australian economy in 2020 (maybe)

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What should we expect from the Australian economy in 2020?

Forecasting the future is a tough game, but economist Stephen Koukoulas has given it a go. In an article for Yahoo Finance, Koukoulas has taken a look ahead into the future for the Australian economy. I’ve focused on four of his predictions and you can read his full article for more.

Australia’s Economic Growth

In 2019, Australia’s annual growth in gross domestic product (GDP) was relatively weak. GDP averaged around 1.7 per cent in annual terms. Compare that with the government’s goal for economic growth of around 3-4 per cent in annual terms.

In his article, Koukoulas presents an optimistic case for Australia’s GDP. He suggests it could reach 2.5 per cent by mid-2020 and perhaps as high as 3 per cent by the end of this year.

His relative optimism is based on three factors:

  • A rise in public sector spending, particularly in infrastructure (this represents government spending, or G, in the aggregate demand equation)

  • Increased business investment, potentially helped by record low interest rates in Australia

  • Increased consumption, boosted by a recovery in consumer confidence and the wealth effect (where rising asset prices, house prices in Australia’s case, encourage consumers to boost spending).

Australia’s Unemployment

In 2019, Australia’s labour market was relatively weak and unemployment did not budge far from the 5 to 5.2 per cent range. Koukoulas believes UE could rise even further to around 5.5 per cent in 2020.

But! If the predictions around higher economic growth come true, unemployment will likely fall. Koukoulas states that if GDP growth hits 3 per cent, then we will see noticeable falls in unemployment and underemployment.

Why is this the case? Well, if economic growth rises, this means there is greater production of goods and services in the Australian economy. To achieve this, local firms will need additional factors of production (or resources) — particularly labour. They will demand more labour, which will push down UE. (This is known as derived demand, where the demand for labour is derived from the demand for goods and services).

Inflation in Australia

The Reserve Bank of Australia’s goal is to keep inflation between 2 to 3 per cent over the course of the business cycle. This is known as the target band. For the duration of 2019, Australia’s inflation rate was below the target band.

Koukoulas says if the economic growth mentioned above takes place, inflation will likely rise to 2 per cent or to sit inside the target band. This demonstrates the link between economic growth and inflation: as economic growth rises, the demand for goods and services will also rise, leading to higher prices and inflation.

The Australian Dollar

In late 2019, the $A traded around the US$0.66-US$0.68 mark. However, Koukoulas believes the $A could be trading as high as US$0.77 in 2020.

He presents two potential reasons for this appreciation:

  • Improving global economic growth will lead to higher demand for Australia’s commodity exports. This will increase demand for the $A as buyers need local currency to purchase Australian exports.

  • Improving domestic conditions could lead to greater investment in the Australian economy. To participate in this, foreign investors will need $A, which will also cause the currency to appreciate.

One point I would add here is that a stronger $A will make exports more expensive and less internationally competitive. This could result in Australia actually selling fewer exports, which may have negative consequences for the trade balance and the Balance of Payments.

We’ll be watching this year to see how these forecasts unfold.