Warwick McKibbin on trying to model economic certainty in uncertain times

Global markets have remained on edge after Donald Trump’s “Liberation Day” tariffs caused panic worldwide. Now, more than ever, markets and economists are looking for trying to read the implications.

Joining us from Washington DC is Warwick McKibbin, an internationally renowned economic modeller from the Australian National University whose services are now in high demand. McKibbin is also a former member of the Reserve Bank board.

With much earlier talk about whether Australia can do a deal with Trump on tariffs, McKibbon argues:

The best way to deal with the president is to ignore him. And I think that’s to take him off the front page of Australia’s newspapers for example. I think what we should be doing is accelerating a process that was already underway. And that was to open up our trade with other partners around the world, Korea, Southeast Asia, Europe, in particular.

There’s a lot of trading opportunities. Our products – fortunately for us – the ones we sell to the US, we can sell somewhere else. We know that that’s a flexibility we have.

McKibbin says it’s “unlikely” Trump’s trade wars will cause a recession in Australia, but:

the problem we do have is that we haven’t dealt with the key problems that Australia faces, which is low productivity. We have a productivity problem which means [you’re] more likely to have a recession if you’re not growing. The second thing is we haven’t been given enough fiscal space. That is, running budget surpluses when we have full employment. But we’ve been running budget deficits, so our debt-to-GDP ratio has gone up, which means we have got less capacity to respond. But we also have a flexible exchange rate, which is good news. That helped us during the Asian financial crisis and the global financial crisis. We have the central bank, the Reserve Bank of Australia, [which] has plenty of capacity to cut interest rates if required.

Our modelling suggests that under the scenario of no change in the severe tariffs that the US put on in the beginning of April, you would probably cut interest rates in Australia by 50 basis points over the year as a result of the tariffs alone.

McKibbin says Australia’s interest rates are “probably a little bit too low”:

I think at the moment where we stand is without this shock Australia’s rates are probably a little bit too low, but probably close to being neutral. This shock will give you an extra 25 to 50 basis points capacity, if you need it. We’re still at full employment, and the bank worries about inflation relative to the target and still above the target if you adjust for the cyclical elements and about employment or output relative to potential which we’re very close to potential, so really there wasn’t a big case for a big interest rate cut.

On the Australian election, McKibbin outlines the need for reforms, which are not being much talked about in this campaign:

We know what the fundamental problems are in Australia. We need serious reform. We need to deal with the tax system not functioning properly. We have a cost of living crisis – our reaction is to pump more money into the housing market, to drive up demand relative to supply. We’re also hitting our own exports of higher education.

And so we’re actually responding completely the opposite way. And both parties are arguing for cutting foreign student numbers. That is a key export of the Australian economy.

The problem with the housing market is lack of supply. You don’t fix the lack of supply by attacking foreign students who are a very, very small part of the demand coming from immigration. And actually those students, they come and they go mostly.