Garnaut's view on crisis and Aussie economy

Comments on Paul Kelly “Painful adjustment for spendthrifts”, 21/10/2009, http://www.theaustralian.news.com.au/story/0,25197,26237570-12250,00.html

Garnaut is an experienced and knowledgeable economist and policy adviser, so his views on the economy must be listened to carefully by the government and policy advisers including bureaucrats.

Garnaut is most likely right that Australia needs to adjust to its living standards in the wake of the crisis.

His point on what the Rudd government can deliver is probably correct, given that the budget deficits and rising community expectations.

His view on the tendance of government to increase interventions in the economy to the detriments of the economy following the crisis is correct. The Rudd government is a good example.

However, such adjustment does not necessarily mean lowering the standards immediately and drastically. Adjustment can be undertaken over a period of time and over that period of time the living standards may not grow as much as their trend growths, as opposed to an absolute fall.

The second point that we may need some caution in interpreting Garnaut's view is about the current account deficit. He may be half correct but is unlikely to be completely correct. A country with significant immigration may sustain current account deficit over a very long period without serious problems to its economy.

Further, even current account deficit adjustment can take a very long time without serious problems. As long as intertemperary budget constraint can be satisfied, there is no need to require the constant current account balance.

The last point is that while Australians' living standards may need an adjustment, it will be far smaller than the adjustment in the US, due to vastly different pre-crisis conditions between the two countries, as well as the quite differential impact on China and Asian economies on the two countries.

On this point, the much better pre-crisis condition of the Australian economy and government balance sheet were important factors and that should be attributed to the Howard/Costello government.

The deterioration in the terms of trade effect may not be as big as was originally thought, and there may be some significant recover in the terms of trade in Australia’s favour.