Keynes is alive and well and living in Australia. This conclusion (a paraphrase of the famous quote by economist George Stigler about Adam Smith being alive and well and living in Chicago) comes to mind after recent economic news from Down Under.
Australia has just beaten the Netherlands’ record as the country experiencing the longest period of time without a recession (defined as two consecutive quarters of declines in GDP). The Netherlands went without a recession for nearly 26 years (103 quarters) between 1982 and 2008 and Australia has just surpassed that record after reporting GDP growth of 0.3% in the first quarter of 2017. Australia is among the few developed economies that did not experience a significant downturn in economic activity following the global financial crisis of 2008.
Canada belongs to a similar group of countries that had a relatively mild downturn in economic activity after 2008 (three consecutive quarters of declining GDP, from Q4 2008 to Q2 2009, with a total decline of 4.5%, followed by a gradual rebound). But Australia still holds the no-recession record.
So, how did the Aussies do it? Did they benefit from having a lower debt compared to income before or during the crisis? Did they apply strict austerity measures following the crisis as many other countries did (e.g. the UK and Spain)?
You would be correct if you chose none of the above.
As a matter of fact, Australia has always had one of the highest household debt-to-GDP levels among developed economies. In the last three years, Australia’s household debt as a percentage of GDP has grown quickly and reached 123% in 2017. Only Switzerland, a comparatively small and economically specific country, has higher relative household debt (128%). By comparison, Canada’s household debt-to-GDP hovered around 90% in the years following the global financial crisis of 2008 and then grew rapidly in the last two years reaching 101% in 2017.
After learning about Australia’s two records (no recessions and highest debt levels), a question naturally arises: are these records by any chance related? Evidence and logic would suggest that they are as the Australian government openly encouraged more private debt creation after the 2008 crisis by expanding programs such as the First Home Owners Grant and other initiatives intended to bust borrowing and spending. This was based on a typical Keynesian recipe: when an economy is threatened with recession, its government should introduce stimulus by increasing the money supply, encouraging lending and creating additional aggregate demand.
But Keynes’ recipe has at least one important caveat: stimulating the economy by flooding the system with new money put into the hands of the private sector only works if that money is put to productive use and thus creates added value and employment. If, instead, newly-created money is invested in fixed assets such as real estate, the general economy will not benefit while prices of those fixed assets will inevitably become artificially inflated.
Is that what happened in Australia?
Based on The Economist’s Global House Price Index, Australia had the second-most overvalued real estate market of all developed economies in 2017 (its neighbour New Zealand holds first place). Two main reasons seem to be behind this overvaluation, the first being the credit expansion that saved the Australian economy from recession while at the same time contributing to a strong rise in real estate values. According to the International Monetary Fund’s Global Housing Watch, countries that applied credit expansion policies after the 2008 financial crisis experienced only a modest drop in house prices from 2007 to 2012, followed by a quick rebound (e.g. Australia).
The second reason for skyrocketing house prices is foreign buyers. According to The Economist, since late 2014 $1.3 trillion of capital has flowed out of China, some of which has found its way into residential property in many of the world’s most desirable cities. In the United States, Chinese investors purchased some 29,000 homes in the 12 months leading up to March 2016 with a total value of $27 billion, according to the National Association of Realtors. Unfortunately, such statistics do not exist for Canada; however, it is a widely held opinion that foreign buyers were among the reasons for the extraordinary house price growth seen in Vancouver and Toronto in the years leading up to the end of 2016.
In sum: Australia’s recession-free record came largely as a consequence of its government’s credit expansion policies implemented in the aftermath of the global financial crisis. These policies, together with the influx of wealthy foreign buyers, also contributed to house price inflation in Australia. As socially undesirable as this inflation may be, it has not, so far, produced major economic problems or the collapse of real estate values. On balance, thus, credit expansion policies worked well in Australia and they have since been vindicated. Such policies are therefore not necessarily discredited as the gurus of political and economic conservatism would have us believe. In fact, these Keynesian-style policies are very much alive and functioning well in Australia.
If there is a moral of this story relevant for Canada, it is that the present government’s budget deficit policies should not necessarily and upfront be dismissed as dangerous or irresponsible. Well-invested borrowed or newly created money can have many positive effects on the economy as Keynes showed us a long time ago, and as practical experience has confirmed many times, Australia’s present situation being just the most recent. Whether these policies will be successful in the Canadian context remains to be seen, but the reality of (meagre, but positive) GDP growth and the absence of major economic problems, such as a crash in real estate prices, are the reasons for hope.