Price Wars: Carbon versus Petrol


It has been well documented that the carbon price will add around 0.7% to the rate of inflation as measured by the consumer price index, with the main addition to household costs being through a 10% rise in electricity prices.  These price effects, while relatively small, will be a dominant issue in the political and policy discussion on the price on carbon.

A big positive unfolding for the Government just as the carbon price comes into force is a large drop in petrol prices.

Recent trends in global oil markets has seen petrol prices fall sharply, by an average of around 13% since a peak was reached at the end of April.  While global oil prices have picked up a touch in the past week, petrol prices will hover about 10% below the April peak for the next few weeks at least.

In terms of the timing and the order of magnitude, the petrol price fall is manna from heaven for the Government.

It is not widely known or commonly understood just how little of the household budget is spent on electricity.  The perception is that electricity makes up a large share of the household budget.  According to the weights used by the Australian Bureau of Statistics in calculating the CPI, electricity accounts for just 2.2% of the household budget.  As an aside and by way of comparison, 4.8% of the household budget is spent on alcohol.

Petrol, on the other hand, accounts for 3.6% of the household budget based on the weights in the CPI, making petrol price falls significantly more important to cost of living than the rise in electricity.   The average household is saving roughly 60% more via lower petrol prices than they will be paying via higher electricity prices.

In other words, the recent 10% fall in petrol prices, if sustained, will directly cut around 0.4 percentage points from the CPI.  Indirectly, the effect will be a little larger as transport and other costs influenced by petrol prices either fall or are kept in check.

These facts show that the overall cost of living impact from the implementation of the carbon prices will fortuitously be more or less completely offset by the recent fall in petrol prices.   If account is then taken of the household compensation by way of income tax cuts and pension increases, the cash position of the household sector will materially improve as the carbon price comes in and as petrol prices edge lower.

From a cost of living or well-being perspective, it should also be noted that the levy on middle to high income earners to pay for part of the repair bill for the Queensland floods ended on 30 June 2012.   The ending of this levy will provide yet a further boost in take home pay, which in turn will further add to the disposable income of the household sector.

The story of the improving finances of the household sector does not end there. Mortgage interest rates have fallen by around one percentage point since November 2011 which for highly indebted consumers, presents a significant boost to cash flows.

The petrol price may not stay low for long.  Its price is a function of the global economic activity and the level of the Australian dollar.  For now, it appears that global economic activity will remain subdued at least until the end of 2012.  At the same time, the Australian dollar appears to be very resilient, buoyed by the triple-A rating that attracts safe haven capital inflows, and relatively high interest rates, a point compounded in international markets where other safe haven countries have interest rates near zero.

These factors suggest that global oil prices and hence petrol prices in Australia are likely to remain well contained, at least for the next few months.  The government would be wise to make these points when talking about cost of living issues as the carbon price starts to push a few other prices a little bit higher.

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Get set for an August interest rate cut


The first two days of the week have provided a snap shot of what can only be seen as a resumption of soft economic data in Australia.

The number of job advertisements, as measured by ANZ, fell 1.2% in June to register the third straight month of decline.  Eye-balling the correlation between job ads and employment – with a 3 month lag – it looks like we are poised to see a period of falling employment over the next couple of months.  It also suggests the unemployment rate could tick towards 5.5% from the current 5.1% level.

The NAB business survey out today was similarly uninspiring.  While “business conditions” rose 3 points, they still registered minus 1 point to stay in the sluggish zone.  Business confidence dropped 1 point to minus 3.

These two indicators are soft enough to suggest the economy may well need a bit more policy stimulus in the not too distant future.  With the Budget tightening now in full swing, the world still as weak as water and the Australian dollar remaining over-valued, the onus remains on the RBA to be move policy to an easier setting.

A rate cut in August is odds on.  Or at least is should.  If the jobs report later this weak catches up with the ANZ job ads series and shows a drop in employment and a rise in the unemployment rate and the June quarter inflation data near the end of July confirm inflation at a fresh 13 year low, the RBA will be keen to edge official rates lower as it works to reinflate the economy.

The betting market has for August a 25 basis point rate cut at $2.80 with no change at $1.45.  From this distance to the next RBA meeting, my view is that those odds should be reversed – a rate cut is much more likely than no change.

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The SIze of Government in Australia


Reproduced from the Australian FInancial Review:

That’s the “big” myth blown 

The conventional wisdom on the side of politics that is big spending and big taxing has been dramatically turned on its head with the 2012-13 budget.

The facts in the budget papers show undeniably that the Labor side of politics is able to deliver smaller government through low spending and taxing as a share of the economy. The Coalition parties, conversely, err on the side of higher spending with the budget surplus objectives inevitably met by high tax receipts.

The facts show that the fifth Labor budget in this political cycle has in place a quite massive 4.3 per cent cut in real government spending in 2012-13, the largest single-year cut yet recorded.

In nominal terms, government spending falls in 2012-13 for the first time. Adding context to this extraordinary spending restraint indicates that in the three years since 2009-10 there has been a cumulative total of zero growth in real government spending, restraint only exceeded in the three Labor budgets from 1986-87.

Not once did the Howard or Fraser governments in about 20 years in office achieve a single year where government spending was cut in real terms, while Labor governments have been able to cut real spending in five years since the mid-1980s. Viewed another way, the 2012-13 budget will see the ratio of government spending to gross domestic product fall to 23.5 per cent. This is 0.7 per cent of GDP lower that the average of the 12 Howard government budgets. In today’s dollars, that is around $10 billion less spending. What is equally striking, in the four years to 2015-16, this ratio will remain at or below 23.7 per cent, a four-year run of low spending not seen in more than three decades.

In terms of taxation receipts, the return to trend economic growth will see the tax-to-GDP ratio rise to 22.1 per cent in 2012-13. In the prior three years, the tax-to-GDP ratio averaged 20.4 per cent to be at levels last seen during a Labor government in the early 1990s and not delivered by a Coalition government since Billy McMahon was prime minister in the early 1970s. Not once did the Howard government have the tax-to-GDP ratio below 22.2 per cent and its average tax take was 23.4 per cent.

For the current Labor government, the tax-to-GDP ratio will, in each of the eight years out to and including the forward estimates, be below the average tax take of the previous Coalition government. If the 2012-13 tax take was equal to the average of the Howard government, Labor would be collecting around $20 billion in extra revenue and delivering a budget surplus close to 1.5 per cent of GDP.

Rounding out the myth-busting fiscal performance of the Labor government is the turnaround in the budget bottom line of 3.1 per cent of GDP in 2012-13. This is more than double the next-biggest single-year contraction in fiscal settings and reflects both cuts in spending and some pick-up in revenue as the economy returns to trend growth. It is beyond argument Labor governments function with a lower tax take than Coalition governments and at the same time have a propensity to rein in spending when the economy is growing.

None of the above facts deals with the philosophical issue of whether “big” government is more desirable than “small” government. That is for others to debate and most times it depends on the state of the business cycle.

Suffice to say, the updated facts on government spending and taxing in the budget papers confirm that Labor delivers smaller government than the Coalition. This is important to recognise because it repudiates the mantra from various opposition spokespeople about this government being “addicted to tax” or not delivering “genuine savings” in terms of cuts in government spending. Nothing could be further from the truth.


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The solid data keeps rolling on


In the past month or so, the news in the run of Australian data has been universally above expectations.  GDP, jobs, retail spending, building approvals, credit, exports and house prices are all on the up… well, for the recent data at least.

Admittedly, many on the economic indicators are coming from a poor starting point – recall the 4.3% GDP result followed 4 straight years where growth had been 3% or less and building approvals had been dismally weak for years before yesterday’s 27% spike.  But there is no doubt the economy has held up better than most thought.

The reasons are not clear.  A mix of influences including prior monetary policy easing, what was a flat to slightly weaker Australian dollar, some spending of the carbon price compensation or even the satisfaction of some pent up demand could all have some impact.

Whatever the reason, the positive tone to the economic news will dissuade the RBA from cutting interest rates too aggressively at least in the short term.

That said, the inflation outlook remains skewed to the downside and the RBA is likely to over-achieve on its inflation target for the next year or so.  That is, inflation is likely to chug along well below 2% for some time (abstracting from the carbon price effect).  This means that further interest rate cuts remain squarely on the table, although I now think that the RBA will cut only 25 basis points in August (after a low June quarter CPI) but it is still be on a path to a 2.5% cash rate but not until the first part of 2013.

In addition to low inflation, the world economy remains extremely fragile, the main budget tightening is still being felt and the Australian dollar rise of recent weeks could, if sustained, come back to constrain activity.  These dynamics will encourage more rate cuts in the months ahead.

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Price signals: A carbon copy of the GST


One of the important if not critical reasons for the implementation of the goods and services tax in 2000 was to change the behavior of consumers and the household sector.

Unashamedly, the broadening of the tax base with the GST had an express purpose:  to discourage consumption and to raise household savings.  The overall price structure of the economy was raised by around 2.75% as the tax came in and given the usual lags and nuances around various business cycles over the past decade or so, the GST has demonstrably achieved at least that part of its objective.  Household consumption as a share of GDP is lower now than in the pre-GST days and household savings are higher.

Like the GST, the price on carbon is designed to change behavior although in a more complex way.  Demand and therefore consumption of goods and services with high carbon inputs are expected to fall.  The producers of those high intensity carbon goods and services have a massive incentive to change the was they do business – using less carbon in the production chain will save them money and boost profits.

In recent days, there has been a flood of ideas in the papers, on line, TV and radio about how we consumers can change our behavior to save money.  People want to save money on their soon-to-be-higher electricity bills by turning off lights, use more energy efficient appliances, tweaking the heater down a degree or whatever will consumer less electricity.

Hooray!  The price signals are working.

What will take longer, no doubt, is for the big polluters to change the way they do business so that they can get a competitive advance and hence higher profits before their competitors do.  They are changing already so that in years to come, they can avoid or at least minimise the cost of whatever amount of carbon they add to the atmosphere.

It will be an interesting few years to see how this supply side of the carbon price unfolds.

The bottom line of all this is that price signals work.  If price goes up, demand goes down and people also substitute.  If the cost of doing business goes up, firms change their behaviour to maintain profits and get a competitive edge.  The carbon tax or price is a text book implementation of this very basic principle.

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