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Part IV: Uncertainties
The outlook for inflation in 2000-01 will depend heavily on whether prospective solid productivity growth and moderate wage outcomes are achieved as the unemployment rate falls further, and on whether the economy begins to face significant capacity constraints more generally as it enters a tenth year of economic expansion. There is evidence of some labour market tightness in particular sectors and regions, although there is little clear sign of a general increase in wage pressures. While the structural rate of unemployment in Australia is difficult to estimate with any degree of certainty, it is likely to have fallen during the 1990s as the labour market has responded to a range of reforms.
The risk that wage pressures will begin to build will increase if the unemployment rate falls rapidly or if overall activity is appreciably stronger than forecast. While there is currently little evidence to suggest that wage bargainers are attempting to seek a `second layer' of compensation for price effects associated with indirect tax reform (that is, on top of the substantial income tax cuts and increases in social security payments), ensuring wages outcomes do not build in this `over-compensation' will be important in sustaining low inflation and strong growth (see Statement 3).
The impact of the recent decline in the exchange rate on consumer prices also poses some uncertainty to the outlook for ongoing inflation. While rises in `over-the-docks' import prices had little impact on retail prices of imported items during the East Asian financial crisis, the recovery in the global economy and the reversal of some of the global deflationary forces since then raises the possibility that changes in import prices could be reflected in consumer prices more quickly over the period ahead. The impact of exchange rate movements on final retail prices of imported items also depends, importantly, on how long any particular level of the exchange rate is sustained.
There is also some uncertainty surrounding the profile of activity in the latter part of 1999-2000 and the first half of 2000-01. The introduction of The New Tax System is expected to result in a net bring-forward of household consumption and dwelling investment into 1999-2000 that will more than offset a net deferral of business investment into 2000-01. However, the magnitudes of these bring-forwards and deferrals are uncertain. A stronger than expected net bring-forward of activity prior to the introduction of the GST on 1 July 2000 may see growth in 1999-2000 stronger than forecast, at the expense of weaker growth in 2000-01. It will, however, be difficult to untangle GST induced bring-forwards and deferrals from ongoing demand and output growth, which will make assessing underlying trends in the economy particularly difficult over the next few quarters. The Sydney Olympics will also add some uncertainty to the profile of demand and output in the second half of calendar 2000.
The recent softness in retail sales and measures of consumer confidence also suggest that the expected bring-forward of consumption in the latter months of 1999-2000 could coincide with some moderation in `underlying' growth in household consumption relative to the last couple of years.
The outlook for business investment, particularly non-residential construction, is also uncertain. While the forecasts incorporate significant falls in non-residential construction in both 1999-2000 and 2000-01, some forward indicators of activity in this sector point to much larger falls. On the other hand, the impact of a strengthening world economy on non-residential construction (particularly mining related construction) is difficult to assess and it is possible that activity might recover more quickly than anticipated in 2000-01.
While world growth is expected to strengthen further in 2000, there are uncertainties surrounding the outlook, particularly in 2001. The pattern of growth over the forecast period is projected to alter - with the US easing and Japan and Europe strengthening - and there is some risk that the adjustment could be sharper than expected and have broader effects. This could arise, for example, if inflationary pressures were stronger than anticipated, particularly in the US, and to a lesser extent Europe, necessitating strong macroeconomic policy responses. Alternatively, strong productivity growth could sustain high rates of growth in the US for a longer period.
The recovery in Japan continues to be fragile and significant uncertainty remains around the outlook for 2001. The strength and sustainability of the recoveries in the East Asian economies depends on the timely and effective implementation of structural reforms, particularly in the financial and corporate sectors, as well as the world outlook. While the outlook for Russia and most of the emerging economies of Latin America has improved, vulnerabilities remain and it is important that continued steps are taken to lessen the impacts of such risks, such as by improving budgetary positions and public governance.