The Australian Contagion

The past week saw global markets move in response to the announced hike of interest rates by the Reserve Bank of Australia. It was taken as a sign of global recovery, Australia being the first of the G20 (Group of 20) countries to come out of its downturn. The Australian dollar approached levels not seen in over a year (chart below produced from Yahoo!7Finance).

PM Kevin Rudd was criticised by the "doyen of Labor economic advisers" Ross Garnaut for his social democrat inspired stimulus package in response to the global financial crisis.

The secretary of the treasury, Ken Henry quickly defended the government response by highlighting the counterfactual scenario of an additional 100,000 unemployed and more prolonged downturn without the spending.

The latest unemployment figures seemed to support this with an unexpected drop in the unemployment rate and a rise in the number of hours worked. This was in stark contrast to the unexpected increase in the number of workers unemployed in the previous month in the United States. The Dow Jones industrial average took it all in stride ending up at new highs for the year.

Latest polling figures show the Labor government having a seemingly supreme advantage over the Liberal opposition, a result that has fuelled speculation over the fate of its leader Malcolm Turnbull.

Turnbull having staked his leadership on climate change policy was castigated by former Treasurer Peter Costello as he announced his early retirement from Parliament.

With the current government riding high on a wave of both local and international respect, the early election scenario now seems a distant possibility as Treasurer Wayne Swan predicted a better than expected result for the budget prior to the release of the Mid-Year Economic and Fiscal Outlook.

Having coupled itself to the Chinese and emerging Asian economies which have exhibited resilience against the global financial crisis and having relatively little exposure to the sub prime markets, Australia finds itself in the best of all possible worlds with the growing demand for its mineral exports triggering a huge investment project off the Western Australian coast.

The challenge for the government now would be to manage both in the near and medium term the steady unwinding of government stimulus. The first part was accomplished with the phasing out of the top-up stimulus to the housing market announced last year. The withdrawal of bank guarantees is being thoroughly studied but is proving difficult. Winding back of monetary stimulus has already begun in earnest.

With monetary and political business cycles not in sync, expect monetary and fiscal policy to be in continued conflict for the next twelve months or until the next election, whichever comes sooner.