OECD wants growth rather than austerity

THE Organisation for Economic Co-operation and Development has urged Europe to shift its economic tack by adopting a growth compact , including interest rate cuts, infrastructure investment, and ultimately, the issuance of eurobonds.

In its half-yearly Economic Outlook, released overnight, the OECD cautiously throws its weight behind the snowballing demands for the European Union to reweight its economic policies to give more priority to growth rather than austerity and low inflation.

Its economic forecasts are heavily qualified, as they rest on the assumption that policy actions will be sufficient to prevent destabilising euro developments, that there will be no major disturbances affecting oil prices, and that disruptive US fiscal consolidation will be avoided .

If those assumptions are right, the OECD estimates GDP growth in 2012 will be 3.1 per cent in Australia, 2.4 per cent in the US, 2 per cent in Japan, 1.6 per cent in the rich world as a whole and -0.1 per cent in the eurozone, ranging from 1.2 per cent in Germany to -5.3 per cent in Greece.

The OECD does not challenge the EU s fiscal compact, which requires EU members to slash their bloated budget deficits to below 3 per cent of GDP by next year, other than to urge that if growth slumps, countries should abandon the targets rather than try to meet them at all costs.

But while noting that prospects for the global economy are somewhat brighter than six months ago , when markets were paralysed with fear of government debt defaults and bank failures, it warns that the risks facing the world are extensive, and primarily on the downside .

The OECD warns that the eurozone crisis is the biggest risk to the global economy and urges the EU to try radical new measures to restore confidence and growth.

In particular, it urges new issues of jointly guaranteed government bonds to refinance Europe s troubled banks, and allow them to write off bad loans. It suggests this could be a step towards the future issuance of eurobonds, which would allow Greece, Ireland, Spain, Italy and other troubled countries to borrow from global markets without prohibitive costs.

France s new President, Francois Hollande, will propose eurobonds tonight at an informal summit of EU leaders called to debate Europe s recession and the crisis of confidence surrounding its banks and government debt.

German Chancellor Angela Merkel firmly opposes any move to centralise debt issuance. Germany s 10-year bond yields have fallen to record lows, just below 1.5 per cent, with widening spreads to other EU members. Yields for French bonds are almost 3 per cent, Italy and Spain close to 6 per cent, and Greece in the 20s. For Germany, a move to eurobonds could be expensive.

An economic think tank based in Paris and financed by its 35 rich and middle-income member governments, including Australia, the OECD is a fringe player in the policy contest now being fought out all over Europe, from national leaders at summit meetings to the voters at the polling booths.

But its endorsement counts for something when new economic policies are in the wind.

Its new report does that, in suggesting that the EU s proposed growth compact includes increased mutualisation of risk by:

Issuing jointly guaranteed government bonds to help recapitalise Europe s banks and encourage them to write off bad loans.

Increasing the resources of the European Investment Bank so it can step up financing new projects in transport, energy and communications infrastructure.

Growth-friendly structural reforms, agreed jointly by a range of countries, to liberalise labour markets and product markets, particularly opening new opportunities for service industries.

An easing of monetary policy by the European Central Bank, in view of the minimal risk of an inflation breakout.

The risk of disruptive policy changes has probably increased, the OECD observes. Against the backdrop of fiscal consolidation, increased inequality, and high and rising unemployment, a sense may be spreading that the burden of the crisis has not been shared fairly.

This risks giving rise to policy upheavals with adverse long-term, and possibly near-term, effects on growth prospects.

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Memo Australians: The IMF dos not agree with you

THE International Monetary Fund has set Australia a challenge. If it is right, in 2012 we will experience the third-fastest economic growth of the 34 rich countries.

This will be at the same time as a fiscal tightening 2? times more severe than in Europe, and a sharp fall in our export prices. If we achieve that, it will be heroic, not to say improbable.

Essentially, the IMF has backed Treasury's forecasts - Australia has a history of getting upset if it doesn't - but the absence of any commentary on Australia in the 400 pages of reports released this week is hardly a ringing endorsement.

It predicts that Australia will grow by 3 per cent this year, and 3.5 per cent next year and thereafter. Inflation will stay within the Reserve Bank's target band.

Prices for coal and iron ore, our two biggest exports, will plunge 25 per cent over 2012 and 2013, sending our current account deficit back up again.

The IMF does not say Australia "will outperform every other major advanced economy in the world", as Julia Gillard and Wayne Swan wrongly claimed yesterday.

The IMF does not endorse Australia's bipartisan policy of pushing the budget into surplus in 2012-13, regardless of the effect of growth.

It implies the opposite: its board of directors and its chief economist, Olivier Blanchard, urge low-debt countries (such as Australia) to "reconsider the pace of consolidation" and rely on "automatic stabilisers" growth-lifting revenues and cutting welfare bills to "reduce deficits over time".

Two key points. The IMF's forecasts are just forecasts. Two years ago, it forecast Australia to grow 3.5 per cent in 2011. A year ago, it cut that to 3 per cent.

The real outcome, as Tony Abbott notes, was growth of just 2 per cent. Its forecasts rarely differ significantly from Treasury's: it doesn't work that way.

What matters in the IMF's World Economic Outlook is not what it says about Australia but what it says about the world. And that is very true this time.

For the world economy, it is hopeful, but not confident. It forecasts growth to be a subdued 3.5 per cent this year, rising to 4 per cent in 2013. But Blanchard depicts the global scene as "uneasy calm: one has the feeling that at any moment things could get very bad again".

The IMF sees three main risks. The biggest is Europe's fragile repair job last December. While the progress is encouraging, it says, the problems remain unsolved, and excessive fiscal tightening risks another collapse, potentially breaking the eurozone apart. If that happens, it warns, the financial cataclysm could make 2008 look good.

Second, an attack on Iran might blow global oil prices sky-high, taking the "fragile" recovery with them.

And third, to fix their balance sheets, Europe's stressed banks might impose a credit crunch that would send a shockwave around the world even here.

Blanchard says the top priority is "to durably increase growth and decrease unemployment" in advanced economies.

"We think that wherever it is possible, automatic stabilisers should be left to play," he said. "This is a remark about Spain, and other countries as well."

Are you listening, Treasurer? Prime Minister? Opposition Leader?

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A budget surplus Swan won't wear

THE OECD has told Wayne Swan how to get his budget back into surplus. Indeed, it has told him how he could run a $100 billion surplus if he wants one. But there's a catch most of its suggestions would be political dynamite.

They include scrapping tax breaks for superannuation and for owner-occupied housing. An emissions trading scheme with a target of a 20 per cent cut from 1990 levels and no compensation. A GST imposed on food, healthcare and financial services.

But in a new report to its 35 member countries, Fiscal Consolidation: how much, how fast, and by what means?, the IMF does not call on Mr Swan to do any of this in 2012-13. It says fiscal tightening must take account of economic growth in "a consolidation strategy that could be implemented flexibly, capable of adjusting the speed and intensity as new information becomes available".

International Monetary Fund chief Christine Lagarde gave the same advice overnight in a speech in Washington, urging countries that "have the flexibility to reconsider the pace of deficit reduction this year, to limit the harm to growth.

"We need more confidence and demand," Ms Lagarde said. "The immediate focus of policies must therefore be to support growth where it is still weak.

"Let me be clear: in many countries, especially in the advanced economies, fiscal adjustment is essential. But the pace of adjustment matters."

The OECD report finds Australia has the lowest government debt of any of the 28 rich countries studied. Gross debt is a bit over 20 per cent of GDP here, compared with almost 100 per cent in the United States and more than 200 per cent in Japan.

The main thrust of the OECD report is to warn countries to adopt medium to long-term plans to get their debt back below 50 per cent of GDP, to give them the flexibility to handle crises at the same time as dealing with the costs of ageing populations.

Even Australia, it warns, will need to tighten its budget to cope with the healthcare, aged care and pension costs as its population ages. An IMF report earlier this week reported that the life expectancy of 60-year-olds in Australia is increasing at the rate of nine years every half-century.

The IMF suggests six reforms it estimates could improve federal and state budget bottom lines by 8.9 per cent of GDP, or roughly $138 billion a year. But few appear politically feasible. They include:

Cut the greenhouse gas emissions target to 20 per cent below 1990 levels, driving up emissions permit prices, with no compensation (saving: $65 billion a year).

Scrap tax breaks for superannuation and owner-occupied housing ($42 billion).

Extend the GST to food, healthcare and financial services ($9 billion).

Tighten eligibility for family benefits ($8 billion), and find savings in healthcare ($8 billion) and schools ($6 billion).

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WTO tips growth to struggle

IN ANOTHER sign that the world is in for a rough year, the World Trade Organisation estimates that exports globally will grow just 3.7 per cent in 2012 barely a third of their long-term average growth rate.

WTO director-general Pascal Lamy said the WTO has also cut its preliminary estimate of export growth in 2011 from 5.8 per cent to 5 per cent, and expressed concern at "a steady trickle of restrictive trade measures" being adopted.

"The world economy and trade remain fragile. The downside risks remain high," Mr Lamy said. "We are not yet out of the woods."

China's growth slowdown follows a similar development in India, now Australia's fourth-biggest export market. Official estimates put India's growth in the year to March at 6.9 per cent, the lowest in three years.

New figures show India's industrial production grew just 4.1 per cent in the year to February, amid weakening export demand and rising interest rates. As in China, India's central bank is expected to cut interest rates to revive growth.

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We keep living longer than we think we will - IMF

LIFE expectancy of 60-year-olds in Australia is increasing at the rate of nine years every half-century, threatening to overwhelm the sustainability of pension schemes and retirement funds, the International Monetary Fund has warned.

The IMF is urging governments to lift the pension age in line with rising longevity and allow retirement funds to reduce retirees' benefits to match the income available.

In an early chapter from its latest Global Financial Stability report, to be released next week, the IMF points out that in just 20 years, life expectancy in the West, including Australia, has risen by three years more than was forecast at the time.

While this "has obvious benefits", the IMF says, it also has less obvious costs and they could be massive.

"Unexpected longevity, while clearly beneficial for individuals and society as a whole, is a financial risk for governments and defined-benefit pension providers, who will have to pay out more in social security benefits and pensions than expected," it warns.

"It may also be a financial risk to individuals, who could run out of retirement resources themselves.

"If individuals [by 2050] live three years longer than expected in line with underestimations in the past the already large costs of ageing could increase by another 50 per cent, representing an additional cost of 50 per cent of GDP in advanced economies."

In Australia, that could mean that by 2050, an average 60-year-old could expect to live into his or her 90s. Back in 1970, men that age were expected to live only to 75.

The cost of public services rises sharply with age. People over 65 occupy half the beds in public hospitals, although they form just an eighth of the population. People aged 75 to 84 visit the doctor three times more than those aged 45 to 54, and run up five times more pharmaceutical bills.

The older people are, the more likely they are to be on the pension and ultimately, in a nursing home.

Official forecasts keep underestimating actual growth in life expectancy because they assume the rapid growth in longevity will level off. But the IMF points out that in fact it never has. Medical advances such as treatments for AIDS and some cancers keep raising life expectancy, even for 80-year-olds.

With the number of retirees now growing rapidly, further rapid growth in longevity could overwhelm public and private retirement funds.

Looking at US pension funds, the IMF found that if life expectancy rises an extra three years, it would increase their liabilities by 9 per cent without a matching rise in assets, capsizing their balance sheets.

It urges governments to:

. Lift the pension age to match lifespans, putting a cap on time people spend in retirement. Australia plans to increase the pension age, but only from 65 to 67, and only after 2017.

. Give pension and retirement income funds the ability to reduce defined benefits if longevity rises faster than expected. Germany, Japan and other Western countries have already reformed their pension schemes this way.

. Introduce mechanisms to allow retirement funds to transfer their "longevity risk" to other financial institutions, as a kind of insurance.

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Commodities outlook bleak - IMF

THE International Monetary Fund has forecast a significant fall in commodity prices over 2012-13, with a risk that an unstable global economy could drag them down even further.

Releasing two chapters from next week's World Economic Outlook, which will publish its new forecasts for global economic growth, the IMF warns that in the near term, and perhaps the long term, commodity prices are likely to slump rather than to hold to present levels.

It also dismisses the case for sovereign wealth funds to invest revenues from commodity exports, saying the money would deliver a bigger return if it were invested in physical and social infrastructure to lift future productivity.

"The weak global economic outlook suggests that commodity prices are unlikely to increase at the pace of the past decade," the IMF says. "In fact, under the baseline World Economic Outlook projections, commodity prices are forecast to decline somewhat during 2012-13. Sizeable downside risks to global growth also pose risks of further downward adjustment in commodity prices."

The IMF's January update cut its forecast of global growth in 2012 from 4 per cent to 3.3 per cent, and in 2013 from 4.5 per cent to 3.9 per cent. Its latest comments suggest next week's revised forecasts will be similar.

They come as China yesterday reported a return to trade surplus in March, largely because its annual import growth fell to just 5.3 per cent. Imports of iron ore, for which Australia is its largest supplier, fell 9.1 per cent from a year ago.

The Bureau of Statistics reported last week that Australia's earnings from mineral exports had fallen by 17.5 per cent in the past six months, from $17.3 billion in August to $14.3 billion in February.

The Reserve Bank's commodity price index also peaked in August, and was down by almost 10 per cent in March.

Unlike Australia's Treasury and the Reserve Bank, the IMF is not convinced that commodity prices will stay high. It warns that long-term prices are "even more unpredictable", and their future direction has "unusually high uncertainty". It urges governments to take "a cautious approach ... building buffers to address cyclical volatility".

Governments earning revenue windfalls from commodity exports, it says, should adopt counter-cyclical policies: stash away windfalls and increase taxes in boom years to keep the economy on an even keel, then spend the windfalls and cut taxes when the boom goes bust.

It is unimpressed by the case for sovereign wealth funds, particularly those (such as China's) that invest in foreign government bonds offering low returns. It urges governments instead to direct the revenues from commodity booms into investment at home to lift productivity.

"Changes in public investment expenditures give the strongest output effect, by raising private sector productivity (for instance, via improvements in education, health and infrastructure), and subsequently by increasing private capital, labour and corporate incomes and consumption," it says.

Another essay from the Outlook, on household debt, says that when highly-geared housing booms go bust, falling house prices explain only about 25 per cent of the consequent slump in consumer spending.

The bigger impact, the IMF says, comes from going from a period of rapidly growing household debt to one of stable or declining leverage. That is why housing busts after years of rising debt are the most severe.

Its insight helps explain why the growth in consumer spending in Australia has slowed far more than was expected.

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Memo Treasurer: We're not the toast of the G20

Treasurer Wayne Swan is out thumping his chest about Europe. First, he warns us that if we don't have a budget surplus in 2012-13, we could end up like Europe. Second, he tells us that Australia is a standout in the world economy, the envy of the world.

On Sunday, the Treas ascribed Spain's 23.6 per cent unemployment rate to lax fiscal discipline before the global financial crisis. Then yesterday, he confided that at the coming G20 meeting in Washington, ''there's not too many finance ministers ? who wouldn't trade places with Australia in a heartbeat''.

We keep hearing this, but is it true? Was Spain's collapse due to lax fiscal policy? Is Australia the country everyone else wants to be?

Take fiscal policy first. This is Swan last Sunday in his weekly economic note: ''If the events in Europe over the past 18 months teach us anything, it's the importance of budget discipline. Many governments ignored the necessary economic reforms over a long period, allowing their spending to blow out and their budgets to become unsustainable. We see the consequences of this today in the region's sovereign debt crisis.

''The failure to maintain fiscal discipline has undermined confidence and economic growth across Europe. This has led to lengthening jobless queues and unemployment rates that are two, three and even four times our own. In Spain, for instance, the jobless rate is nearly 23 per cent. Australia's continued strict budget discipline is our best defence against this uncertain global outlook.''

But hang on, Treas: did no one tell you that before the global financial crisis Spain was running even bigger budget surpluses than Peter Costello: 2 per cent of GDP in 2006, 1.9 per cent in 2007? Or that from 1996, Spanish governments of both sides more than halved its net debt: GDP ratio, from 60 per cent of GDP to 26.5 per cent?

Spain's crash was not due to a lack of budget discipline. It was brought on mostly by the collapse of a huge real estate boom, which has now turned into a savage bust.

That combined with all the factors that have sent Europe into recession: the big losses of European banks lending into US sub-prime housing and other risky markets; the contagion effects from Greece; and the vicious circle of falling asset prices, falling spending, falling employment and falling incomes and revenue, which is now becoming a vortex dragging it down towards a long depression.

Housing prices have slumped 22 per cent from their peak and are forecast to fall by 12 to 14 per cent more this year. Standard & Poor's forecasts that by Christmas, 25 per cent of Spanish home owners will have negative equity, owing more than their property is worth.

What's the lesson? Avoid booms. They tend to bust in damaging ways. But in Australia, officials are cheering on a mining investment boom, which one day will also bust, spreading its fallout all over our economy.

Spain's new conservative government plans to emulate Swan. On Tuesday it presented a budget that aims to cut the deficit next year from 8.5 per cent of GDP to 5.3 per cent.

Bloomberg reports that ministries' spending will be reduced by 17 per cent on average, with the foreign ministry cut by 54 per cent. Income tax and property tax rates have been hiked. But we saw in the 1930s that fiscal austerity in these conditions simply deepens the downturn.

Yes, there was fiscal indiscipline in Europe before the global financial crisis, but mostly by neglect. Greece was a Third World example of fraud, recklessness and incompetence, but it was unique.

IMF data shows that in 2007, of governments in 18 rich European countries, five (all in Scandinavia) were net lenders. Four, including Spain and Ireland, had brought their debt:GDP ratio to relatively low levels, between 10 and 26 per cent. (Ireland, too, was the victim of a property boom going bust.)

Eight others, ranging from Britain (38 per cent) to Italy (87 per cent), were guilty of fiscal complacency. Some stayed in deficit throughout the good years. Germany and France repeatedly breached the EU's Maastricht budgetary rules, which they themselves had written. Portugal, another crisis state, was among the offenders. And lastly, Greece was in a class of its own.

And how does Australia compare? The IMF figures show that, far from being a world leader in fiscal discipline, in 2007 our surplus ranked only 16th of the 34 rich countries as a share of GDP. Last year, we ranked 18th. That's no standout effort.

On the economic front, we are doing better than most European countries, worse than most Asian ones. Last year, our growth rate of 2.1 per cent put us just equal 13th of the 34 rich countries.

Around the G20 table, Swan will find that 13 of his 19 counterparts can boast higher growth than him. They include South Korea (3.6), Germany (3.0) and Canada (2.5), as well as all 10 developing countries.

Australia ranks better on unemployment, but even there, our 5.2 per cent rate is just the ninth best of the 34 rich countries.

Surely we lead in something? Yes: the OECD estimates our growth in unit labour costs last year was the highest in the Western world, at 5.9 per cent.

Maybe the Treasurer can wear that gold medal in Washington.

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COLUMN: Surplus to requirements

PAUL Romer, one of the founders of what economists called new growth theory, used to pose a question which has deep implications, going well beyond economics.

Suppose all the world's stock of structures and equipment remained, Romer mused, but our knowledge of how to create them was wiped out. Then imagine a scenario B, in which all our structures and equipment were wiped out, yet our knowledge of how to build them remained. In the long term, which scenario would leave us better off?

The answer, clearly, is the second. It is the power of knowledge, of human intelligence, our ability to think, learn and create, that is the most valuable asset of any society. Far from knowledge being a limited store, as Western thinkers once assumed, Romer argued that it is virtually unlimited. What leads to growth is the ability to imagine, to think through conflicting propositions, to invent a better solution to problems than the one we inherited.

If only humans always did so. But in the real world, the innovative idea is so often dismissed as heresy. People don't think through conflicting propositions, but rely on prejudice or loyalty to a simple idea. To embrace a better understanding of complex events means discarding an old one. And often those old ideas are convenient ones for us to believe. Often they are in our financial or political interests or come from deep ideological convictions. Mere objective reasoning can find it impossible to break through.

Australia offers plenty of examples in which prejudices block our ears to better ways of doing things. But the riots in Athens over the past week, and the long standoff over how to reduce Greece's public debt, are a dramatic illustration - on an issue with huge implications for the world, and us - of how hard leaders and the public find it to accept ideas and solutions which clash with long-held, convenient prejudices.

Yesterday, Greek MPs voted 199-74 to endorse the latest austerity package negotiated last week by the leaders of the two main parties, slashing the minimum wage to ?560 (roughly $A700) a month, and making deep cuts to pensions and government spending across the board. It is forecast to cost 150,000 jobs over the next three years. That's what they were rioting about.

But the MPs' vote was just another reprieve. Even if the next Greek government implements the package in full, which many doubt, it would deepen the crisis, not solve it. The package dictated by the European Union won't work, for reasons that have been made clear repeatedly, but not accepted. The crisis will return; the worst of it could still be ahead.

On both sides, comfy old prejudices are keeping minds closed to challenging ideas, innovative thinking, and better solutions.

The rioters illustrate why the rest of Europe doesn't trust Greece any more. They symbolise the refusal of Greeks to take collective responsibility for the crisis into which Greece has thrown the Continent, and which might take a decade to resolve. Year after year, the Greek government, on a huge scale, spent money it did not have, employed people it did not need, bought votes with lavish pensions, allowed its people to dodge paying taxes, and then lied to the EU and the world about its financial position.

Even before the crisis, after a decade of boom for the Greek economy, Greece was secretly running the biggest deficit in the advanced world, equivalent to roughly $80 billion a year in Australia. If that's how you run the business in good times, then the bad times are going to be awful. And so they were. No bank would lend to Greece any more; only aid from the IMF and the EU has saved it from bankruptcy. But in the end, bankruptcy might be inevitable.

The EU has lent on the banks to write off half their debts to Greece; but led by the German government, it wants to enforce deep austerity in Greece to start paying back the other half. Unemployment in Greece is already almost 20 per cent, and would get much worse if these budget cuts are implemented; yet the Greek government would then be running a surplus on its primary balance - that is, excluding its debt payments.

I have deep admiration for Germany's economic achievements, which are little understood by politicians or economists here. But it is an illusion to think that countries can cut their way out of trouble as deep as this, unless they can devalue their currency to make them more competitive. Greece can't do that, because it's locked into the euro. Even in Britain, outside the euro zone, the Cameron government's deep spending cuts have pushed the country back into recession - and Britain started from a far better position than Greece.

Is there a better solution? Yes, and IMF managing director Christine Lagarde outlined it last month in a speech in Berlin. Her speech was all nuance, but to paraphrase: timing matters. Yes, getting budget deficits under control is critical, but so is avoiding a deep, self-perpetuating slump. Don't cut current budgets so deeply that you drive the country into recession. Rather, protect your sources of growth, and push through big, long-term reforms that will make your budgets sustainable into the future.

Her message should reverberate here in Australia. It is not getting the budget back into surplus in 2012-13 that matters; events in Europe could make that impossible. As Treasury has shown, the long-term threat to the budget is from an ageing society. We should bite the bullet on this: phase out incentives to early retirement now, and start lifting the pension age, before the baby boomers retire. Timing matters.

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Column: A generous serve of point-scoring

AS WE climbed the steps into Rod Laver Arena on Sunday night, Hanrahan had never been happier - not because we were on our way to see Novak Djokovic and Rafael Nadal play off in the Australian Open final, but because there had never been so much bad economic news for him to bang on about.

Dr Pangloss had booked a corporate box for the Economists Club, using the money we made when he sold the club's beach house a few years back. I couldn't see why he didn't just book the club on an overseas holiday like everyone else now the dollar is so high, but perhaps Martin Ferguson leant on the Doc to get him to spend the money at home.

Still, it looked like being a memorable night between two evenly matched opponents. That was certainly how Hanrahan saw it - as soon as Dr Pangloss appeared, he let fly.

''OK, Doc, this is your moment of humility. This is the time you have got to admit for once that, in your eternal optimism, you got it wrong.

''Remember the budget last May? You were forecasting that the Australian economy would grow 4 per cent in 2011-12. You were predicting that we would add another 200,000 jobs, and the world economy would hum along. The Reserve Bank believed it so much that it was about to raise interest rates.

''Yet, instead, here we are on the brink of another global recession, with no cavalry left to ride to the rescue. On one hand, we've got Europe sinking into a deepening crisis that seems to have no way out. On the other, the US has become ungovernable, with even bigger budget deficits than Europe.

''Now even China is slowing; this time it won't rescue us. And the Australian economy is taking a belting from the high dollar, and growth has slowed to a standstill apart from the mining sector ?''

The good doctor looked puzzled. ''How many hands have you got, Hanrahan?'' he quipped. ''I count four, so far. This should be an excellent night: the best of all possible tennis players, in the best of all possible tennis venues, right in the heart of the best of all possible economies. I'm going for Djokovic. How about you?''

''I'm with the International Monetary Fund,'' declared Hanrahan. ''It's now warning that the world could face a repeat of the 1930s Depression unless Germany drops its demands for even harsher budget cuts by its neighbours. The IMF wants to allow Europe to grow its way out of trouble, but the German public and politicians don't understand that's the choice they face.

''And if the world economy goes down, we know what will happen to Australia. The markets for our coal and iron ore will shrink, prices will fall, and the high dollar and high interest rates have flattened everything else. Where will your 'best of all possible economies' be then?''

There was a roar from the crowd, but they were merely applauding a Nadal backhand. Pangloss smiled: ''Australia will be outperforming the major economies, as it has for the last four years. Yes, growth will not be quite what we hoped for in May. Our mid-year forecast trimmed that to 3.25 per cent, with our global forecast roughly similar to what is now the IMF's central forecast.

''And its central forecast is that the world economy will continue growing at around 3.5 per cent a year for the next two years. It's not forecasting a global recession ?''

''Because the IMF never forecasts a recession,'' Hanrahan butted in. ''Even in 2008 it didn't, yet its words showed that it expected one. And last week in Berlin its managing director, Christine Lagarde, sent a similar message.''

''? and for Australia,'' the Doc went on, ''the IMF predicts that next year we will grow faster than any of the major advanced economies: 3 per cent, against an average of just 1.2 per cent in the advanced economies. That's normal growth; even you can't interpret that as a recession. We are not at risk. Yes, growth in jobs has slowed ?''

''No, it's stopped!'' Hanrahan interrupted. ''The Bureau of Statistics trend estimates show full-time jobs have been going backwards since May, and part-time jobs since October.

''The forward indicators, job advertisements and job vacancies, are falling too.''

''? but those figures do bounce around,'' Pangloss continued, ''and a separate bureau measure finds total hours worked are growing steadily. The government is rightly giving priority to reducing the deficit so we can have the budget back in surplus by 2012-13. We will get there faster than any of the major economies, and our net debt by 2016 will be only a tenth of the average of the G7 countries. Great shot!''

It turned out the Doc was applauding Djokovic rather than Wayne Swan, but it was enough to make Gradgrind jump in. ''Doc, two months ago you forecast a massive $37 billion deficit for 2011-12, followed by three years of surpluses so skinny that any slowdown would knock them down. And if you don't make more spending cuts, that's exactly what will happen!''

Hanrahan turned on him: ''So you want us to make the same mistake as the Germans, and cut ourselves into a recession? I'm for growth. We should stop worrying about the debt and the deficit.

''Rudd's great achievement as PM was to use government spending to create a firewall against the global recession. Gillard or whoever replaces her should be ready to do that again, and scrap the surplus pledge and all those stupid fiscal rules like limiting spending growth to 2 per cent ?''

Dr Pangloss let out a strangled scream. The next thing, a bunch of security guys climbed in and hauled him away: apparently they thought he was some clown imitating Sharapova. Pity, he missed a really good match.

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Resources boom presents real challenge for government

THE OECD's question for Australia is simple: how do you manage a resources boom to maximise the gains and minimise its negative impacts on inflation, the budget, and other industries?

Its own answers are mostly good ones, even if they seem to have been written by Treasury, like a ventriloquist using the OECD as its dummy.

First, ensure taxpayers get the benefit of the boom by putting a comprehensive tax on mining profits, and not the three-legged dog Julia Gillard gave us. The mining tax should be redrawn to cover all minerals, all mining firms, and raised higher rate so taxpayers do not end up paying the miners.

Second, the government should not spend the money on routine services, but save it, or spend it only on infrastructure.

Third, keep open the doors to skilled migrants, to avoid labour shortages pushing wage rises out of control, and forcing the Reserve Bank to drive up interest rates.

Fourth, lift spending on infrastructure and regulate it better. Invest more in public transport, and make trucks pay the full cost of the wear and tear they impose on our roads. Slow the rollout of the NBN, to encourage competition between internet technologies.

Fifth, start a new wave of reform, mainly through comprehensive tax reform, but also by removing government support for the car industry. (Like Treasury, the OECD simply ignores the real-world impact of closing down our biggest manufacturing industry).

And last, set up a serious anti-poverty program, to bring more people into the workforce by tackling the underlying causes of their disadvantage: poor health, poor education, homelessness, welfare traps and dole benefits below the poverty line.

This is a real challenge for a government that has messed up the few bold decisions it has taken, and for an opposition that likes reforms only if they're popular. But if Treasury is right, this is the environment we are facing, so challenges can't be avoided.

It's a pity the OECD relied so heavily on Treasury's advice, and hence proposes to shut down the car industry. That would intensify the damage the resources boom will do to the south-east, where most Australians live. Learn to think outside the square, guys.

But the rest of its report raises many ideas our politicians should be thinking and talking about. Not that they will. Treasurer Wayne Swan yesterday ignored the 98 per cent of the report focused on reforms to highlight the few bits that let him pat himself on the back. How ungainly. How out of touch.

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IMF warns of global currency war risk

THE head of the International Monetary Fund has warned of the risks of a global currency war, as tensions over China's undervalued currency threaten to dominate this weekend's annual meeting of world finance ministers in Washington.

As Japan's central bank began intervening in currency markets to put a lid on the rising yen, the IMF again appealed to China and other emerging economies to allow the markets to set their exchange rates, rather than holding them down to gain a competitive edge.

The appeal came in the IMF's new World Economic Outlook, released overnight, which offers barely changed forecasts for growth in 2011: 4.2 per cent for the world, and 3.5 per cent for Australia.

IMF head Dominique Strauss-Kahn told The Financial Times that Japan's currency intervention made sense if its goal was "to avoid disruptive volatility", but not if it wished to influence the yen long-term.

With an understatement worthy of Casablanca, Mr Strauss-Kahn told the FT that "there is clearly the idea beginning to circulate that currencies can be used as a policy weapon.

"Translated into action, such an idea would represent a very serious risk to the world economy," he warned. "Any such approach would have a negative and very damaging longer-run impact."

China is widely seen as keeping its currency undervalued to make its exports more competitive, and hence attract more foreign investment. In the US, Congress is stepping up pressure on the Obama administration to formally declare China a currency manipulator, and take action against it.

In recent weeks, central banks in Japan, Korea and Taiwan have intervened on currency markets to stop their currencies rising. Brazil has doubled its tax on short-term capital inflows to 4 per cent. But Australia's Reserve Bank has allowed its dollar to keep rising. Last night it was trading at US97.20, up 1.5? in a day.

Markets expect it to overtake the US dollar in coming weeks for the first time since it was floated in 1983.

The IMF's latest 90-page set of forecasts virtually ignore Australia, other than to warn that it faces a "low-risk" threat of a housing crash.

For Australia, the main change is that the IMF has lifted its 2011 inflation forecast to 3 per cent but cut its forecast of the current account deficit. It predicts unemployment will be steady at 5.1 per cent.

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Flaw found in joint plans to cut deficits

IN A finding with dismal implications for the world economy, the International Monetary Fund has found that the new wave of simultaneous deficit reductions in key Western economies is likely to be far more painful than their governments assume.

A major new IMF study tackles the hottest topic in global economics whether it is more important for the United States, Britain and other countries with high unemployment and high deficits to spend up to stimulate jobs, or cut spending to bring their budgets back under control.

The IMF research, published as an early chapter from next week's World Economic Outlook, concludes that cutting spending is the right path in the long term. But it warns that the costs will be far higher and longer lasting than some have estimated.

It tears apart two influential studies by American-Italian economists Alberto Alesina and Silvia Ardagna, which found that fiscal consolidation rarely does much short-term damage to the economy, and can even bring immediate gains. The Cameron government in Britain, and others, have cited this research to justify heavy spending cuts.

But the IMF study apart from accusing Alesina and Ardagna of choosing their examples selectively found this was true only when isolated countries carried out fiscal consolidation, when interest rates were free to fall, and a slump in domestic demand was offset by rising exports.

None of those conditions was true now, the IMF warned. It endorsed arguments by columnists Paul Krugman of The New York Times and Martin Wolf of the Financial Times that Western countries cannot collectively export their way out of a domestic slump, since most of their exports go to each other.

When isolated countries cut spending sharply, as Australia did in the late 1980s, the study found, a budget cut of 1 percentage point of GDP created a similar cut in domestic demand. But an expansion of net exports halved the GDP cost, while interest rate cuts cushioned demand.

By contrast, the costs to GDP are doubled when the rest of the world is also cutting spending, and doubled again when interest rates are already too low to allow further cuts.

Over the long term, however, the study found that fiscal consolidation more than pays for itself, by increasing investor confidence, allowing lower interest rates, and allowing governments room to cut income tax.

It found that spending cuts deliver more long-term gain than tax rises, mostly because central banks are more likely to cut interest rates to offset the impact.

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Make banks pay for risk: IMF

BIG banks with a serious mismatch between their asset and liability maturities could be forced to pay a surcharge or take out insurance against the risks they pose to the financial system, the International Monetary Fund has suggested.

In a review of the October 2008 liquidity crisis that forced governments to guarantee trillions of dollars of bank debts not least in Australia the IMF calls for wide-ranging reforms to reduce systemic liquidity risks in future.

The proposals were revealed overnight in a chapter released early from its Global Financial Stability report, to be published next week at the annual meetings of the IMF and the World Bank in Washington.

The IMF singles out the Australian banks as examples of financial institutions that lent long term but borrowed heavily short term and then were stranded in October 2008 when lenders would not roll over their debts.

At the onset of the crisis, it says, 32.2 per cent of Australian banks' funding came from short-term borrowings, on domestic and global markets. While the banks used the period of the government guarantee to diversify their funding sources and lengthen their maturity structure, at the end of 2009, 25.6 per cent of their funding was still short term.

"Any robust systemic liquidity framework would need to encourage appropriate pricing of liquidity risk in good times to limit its negative impact in times of market stress, and minimise the moral hazard problems", the IMF argues.

"Market participants should be paying the full price of their idiosyncratic liquidity risk".

It urges consideration of an insurance fee or surcharge where the mismatch between asset and liability maturities exceeds a set safety limit.

The IMF also proposes bigger buffers against risk, tighter matches between maturities on each side of balance sheets, more rigorous valuation of collateral and due diligence into the credit risks posed by counterparties, and more use of central counterparties for clearing.

In a second chapter from the report, the IMF also takes on the three global credit ratings agencies Fitch, Moody's and Standard & Poor's calling on them to issue estimates of the probability of default and expected losses by borrowers.

Amid widespread concern, particularly in Europe, over the ratings agencies' failure to warn of the crisis, and of the contagion effects of their downgrades of one country on others, the IMF finds the agencies have done better than their enemies suggest but worse than their own guidelines suggest.

On one hand, it reports, all sovereigns that have defaulted since 1975 were rated below investment grade a year earlier.

On the other hand, the record shows almost one in 1000 corporate bonds given AAA ratings by Moody's has defaulted, roughly 30 times its own estimate of default probabilities.

The IMF urges government investment agencies and central banks to eliminate regulations that "hard-wire" their investment portfolios to ratings changes, warning that these tend to amplify the "cliff effects" of a change on the borrower's access to credit.

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Tread warily on rates: IMF

AS HOME owners brace for an expected rate rise next week, the International Monetary Fund has challenged the Reserve Bank's forecasts that the economy faces a boom ahead, and implied that it should wait and see before acting.

In its latest report on Australia, released at midnight, the IMF also endorses the government's timetable for reducing the deficit now under fire from leading economists and Treasury itself.

The IMF does not directly criticise the RBA. But in pointed comments, it suggests the economy's future is more clouded and uncertain than the Reserve implies. It forecasts that Australia's growth next year will be between 3 per cent and 3.5 per cent, not the 3.75 per cent forecast by the RBA.

Moreover, the IMF says, the risks from the global economy "are tilted to the downside", so there is more chance that Australia will end up below its forecast than above it.

"It was appropriate for the RBA to start withdrawing stimulus in late 2009," it says. "However, capital market turbulence generated by European sovereign debt concerns has increased uncertainty about prospects for a world recovery next year.

"With lending rates in Australia close to their recent historical averages, and economic activity responding quickly to cash rate adjustments, the RBA has scope to wait for the outlook to become clearer."

Following a series of bullish speeches by RBA chief Glenn Stevens and other senior officials, the markets now expect the Reserve's board to raise rates again on Tuesday its seventh rate rise in a year.

Private bank economists are also tipping an eighth rate rise before Christmas, as the central bank tries to offset inflationary pressures from a boom in mining investment in WA by slowing the rest of the economy.

The IMF warns Treasury and the government that "the growing dependence on mining may amplify the business cycle", with bigger booms but also bigger busts when commodity prices fall. It advises them to be ready to move in either direction.

The IMF also backs the mining tax in principle, but says the original version of the tax was better than the watered-down version. In particular, it urges the government to extend the tax to all minerals, not just iron ore and coal.

Macquarie Bank economists, meanwhile, criticised calls for faster spending cuts, pointing out that existing deficit reduction plans, if delivered, would see the fastest cut in the deficit since records began.

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IMF to stress test 25 nations

THE world's 25 biggest financial systems, including Australia's, will be stress-tested by the International Monetary Fund every five years, in a key reform to try to head off another global financial crisis.

In a compromise announced on Monday, the US and other big economies finally agreed to a five-yearly exam after blocking the IMF's plan to conduct stress tests every three years.

The refusal of the Bush administration to allow the IMF to independently stress test the US financial system was a key reason why its collapse caused vast losses worldwide.

The Howard government, by contrast, invited the IMF to join the Australian Prudential Regulation Authority to stress test its banks in 2005-06. The financial system came through the financial crisis intact.

A spokesman for Treasurer Wayne Swan yesterday welcomed the deal, which could see the IMF back in Australia next year. "Our banks are well capitalised and well managed after years of strong supervision by our world-class regulators," he said.

APRA ran its own stress test on the banks last year. Chairman John Laker says that even with a 25 per cent fall in housing prices and a recession worse than 1990-91, all institutions would survive.

The IMF's stress testing to be conducted with the World Bank in developing countries will also test the regulators' own policy framework, and their capacity to manage and resolve a crisis.

An IMF report yesterday urged Britain to accelerate reform of its financial sector while praising the stringent spending cuts imposed by the new Cameron government. In its annual report on Britain, the IMF board said its economy was on the mend. And it said the benefits of bringing the deficit under control outweighed the costs.

The Asian Development Bank has lifted its growth estimate for developing Asia to 8.2 per cent this year, but forecasts it will slow to 7.3 per cent next year as stimulus measures are withdrawn.

Growth next year is forecast to be 9.1 per cent in China, 8.7 per cent in India, 6.3 per cent in Indonesia and between 4 and 5 per cent in South Korea, Taiwan, Hong Kong and Singapore.

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Tackle the debt - IMF tells US

THE International Monetary Fund has called on the US to take "decisive policy action" to bring its government debt under control, warning that it is on track to be almost 100 per cent of GDP by 2020.

In its annual report on the US, released last night, the IMF said the Obama administration and Congress needed to go further to tackle the budget deficit which IMF staff estimate will be between 5 and 8 per cent every year over the next decade.

The IMF's board of directors made it clear that both tax rises a taboo for Republicans and spending cuts would be needed to bring the US budget back anywhere near balance, let alone into surplus.

"A larger than budgeted adjustment would be required to stabilise debt to GDP under the staff's economic assumption, requiring revenue and expenditure measures," it said.

It urged reform of entitlements, such as farm subsidies, pensions and benefits. It also urged the US to aim to cut its debt-to-GDP ratio over the longer term. The US has run just one budget surplus in the past 50 years.

A separate report by IMF staff estimates the deficit this year will be 11 per cent of GDP (compared with 3 to 4 per cent in Australia). That is forecast to halve by 2012, but then rise as the ageing population and soaring health and debt costs inflate spending.

The report tips the 10-year bond rate to average 3.6 per cent this year, but then jump to 5.9 per cent by 2012, and to 6.5 per cent thereafter.

The staff estimate that gross government debt will be larger than the US GDP by 2012.

"The mission saw a key macro-economic challenge as ensuring that public debt is put and is seen to be put on a sustainable path, without jeopardising the recovery," the staff report said.

"Under current policies, federal debt held by the public could rise from 64 per cent to 95 per cent of GDP by 2020."

It suggests most of this will need to be bought by domestic investors, with foreign investors likely to unwind their holdings.

"Over the medium term, higher real interest rates will be needed to encourage the implied portfolio shifts," the report said.

The report lays bare clear disagreements between the IMF team and the US authorities over prospects for the US economy, and hence for returning the budget to some form of sustainability.

In Melbourne yesterday, Harvard historian Niall Ferguson warned that competition between a rising China and a fiscally weakened US could lead to conflict.

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Catch and skill our own

ONE of the fears you hear in the debate over asylum seekers is that Australia is being flooded by refugees. Well, fear not. Australia is being flooded by new arrivals but they're not refugees.

The people flooding into Australia are primarily foreign workers, being recruited here to fill skills shortages. Why? Because it's cheaper to bring in foreign workers who already have skills than to train our own.

Last year 508,000 people arrived to live in Australia as permanent residents, temporary workers or students. Just over 13,000 of them were refugees, or about one in 40. Even if all the asylum seekers arriving by boat were counted, the 2726 of them would make up about one in 200 of the arrivals.

There is a bigger issue here. In my view, it's also a simpler issue than what to do about asylum seekers (which, frankly, I think is one of the most difficult policy issues I've ever come across, with every option breaking one or other principle of good government).

That issue is Australia's policy of relying on importing foreign workers to provide us with the skills we need, rather than doing all it can to ensure that Australians are trained in the skills we need.

It has a parallel with our reliance on foreign capital. Australia is one of the richest countries in the Western world, yet one of the poorest savers. Despite our wealth, every year we are in the bottom half of the OECD in savings rates. That's why our net foreign debt is now $654 billion, and doubling every eight years. As the International Monetary Fund and many others have pointed out, our reliance on foreign borrowing is a risk to our economic future. But our reliance on foreign skilled workers is a risk to something even more important: our social fabric, and our sense of national unity.

For while Australia is importing hundreds of thousands of workers every year, Governments, both Liberal and Labor, have remained silent on the insidious slow growth of men dropping out of the workforce in the prime of their lives.

In the 1960s, the last decade in which we had full employment which, while some economists seem to have forgotten, means that more or less everyone who wants to work can find a job only 2 per cent of men aged between 25 and 54 were outside the workforce. Roughly speaking, 96 per cent of prime age men had a job, 2 per cent were unemployed, and 2 per cent were either unemployable or doing something else.

But in the 1960s, jobs were simple and wages were low. Married women were mostly tied to the home, so men faced less competition for jobs. Heroin was rare, expectations of life were simpler, and fewer people needed psychologists.

Fast forward to 2009. Bureau of Statistics figures show that last year almost 10 per cent of men in the prime of their working lives aged 25 to 54 were not even looking for work. Only 4 per cent were unemployed, but 14 per cent of those of prime age were not working.

Among women the same age, twice as many were not working: 28 per cent of all women aged 25 to 54. But no one asks the questions that would tell us how many of them were not working because they preferred to be full-time mothers, and how many had dropped out for reasons similar to the men. It seems safe to assume that the problem of people outside the workforce is as widespread among women as among men.

You think these are global problems? Yes, but a report released by the OECD last week suggests Australia has been handling them worse than other Western countries.

The OECD's Employment Outlook reports that in 2009, 21 per cent of Australians in that prime working age group were unemployed or outside the labour force. Of the 27 OECD countries the IMF terms "advanced" that is, part of the rich world Australia ranked 20th on that key indicator. Switzerland was top, with only 13 per cent of its prime working age people not in jobs.

Broadly speaking, over the past 10 years, employment rates have risen for older workers, but fallen for men of prime working age. But do you ever hear any minister talk about it? The Treasury? The Reserve Bank? The Productivity Commission? Why is no one in government asking why so many people in the prime of their working life are dropping out of the workforce and what we should do about it?

But that's not the only weakness in Australia's labour market. The OECD says that while Australia's unemployment rate last year was the eighth lowest among its 30 members (not the lowest, as ministers sometimes claim), "overall slack in the labour market is actually higher than the OECD average".

The reason is not only the millions of people not in the workforce, but also the more than 800,000 people the bureau classifies as underemployed part-time workers who want more work, usually full-time work.

"Even before the current downturn, Australia had amongst the highest rates of involuntary part-time employment in the OECD", the report points out. "More than 60 per cent of involuntary part-time workers have no post-school qualifications, and one-third of them are aged under 25."

These are young people falling through the cracks, without the skills to hold down a good job, and many may lack the desire or self-discipline to get them. These are the kids most at risk of joining those who have dropped out of the workforce.

Shouldn't this be the kind of issue our political leaders talk to us about? Shouldn't this be an issue they tackle?

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THE OECD has questioned whether Australia's labour market is in as good a shape as we think, saying a lack of choice and financial incentive is forcing many Australians to make do with part-time jobs.

THE OECD has questioned whether Australia's labour market is in as good a shape as we think, saying a lack of choice and financial incentive is forcing many Australians to make do with part-time jobs.

In its annual Employment Outlook, the Paris-based Organisation for Economic Co-operation and Development says Australia's relatively low unemployment rates the eighth lowest in the OECD last year coexist with poor performance in other areas.

In unusually sharp comments, the OECD highlights a series of flaws in Australia's labour market. It says:

Australia has "a large pool of under-employed workers", who want to work full-time but can find only part-time jobs.

The clawback of means-tested benefits as incomes rise has the perverse effect of locking people into part-time work with part-timers losing up to 70 or more in every extra dollar they earn to the government.

Australia's overall employment rates are worse than the unemployment figures suggest, because 25 per cent of those with jobs are working part-time, and 21 per cent of people of prime working age (25 to 54) have no job at all.

The OECD figures show that Australia's employment rate the percentage of the population with a job ranks only 20th of the 27 rich OECD countries for prime-age workers.

In 2009, 14 per cent of Australian men aged 25 to 54 had no job, and 28 per cent of women.

By contrast, Australia had the fifth-highest employment rate for younger workers, and was a rapidly improving ninth-best for older ones.

But the OECD's main focus is on Australia's very high rate of part-time employment, the third highest in the OECD.

"Despite having a lower than average unemployment rate, overall slack in the labour market is actually higher than the OECD average," the report says. "This includes a large pool of underemployed workers . . . as well as many people who have given up looking for work."

Fifty years ago, only 2 per cent of Australian men aged 25 to 54 had given up looking for work. But last year almost 10 per cent of men in the prime of their working lives had dropped out of the workforce.

"More broadly, part-time workers in Australia often have poor financial incentives to move into full-time work," the OECD says, because all benefits in the welfare system are means-tested, and are clawed back as incomes rise.

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Australia lagging on helping unemployed back to work

AUSTRALIA spends less than almost any other rich country to help its unemployed people get back to work, OECD figures reveal.

The OECD's yearly employment report shows the government's spending on programs to help the unemployed into jobs in 2008-09 was equal fourth-lowest of the 26 rich countries surveyed. The report shows that, in this area, the change of government has meant no change in policy despite Labor's rhetoric on the importance of giving young Australians the skills employers need.

In 2006-07 and 2007-08, despite intense skills shortages, the Howard government spent just 0.14 per cent of Australia's gross domestic product on training, wage subsidies and other support to make the unemployed employable. In 2008-09, despite rapidly rising unemployment, the Labor government spent exactly the same. Of the 26 rich countries surveyed, only the Czech Republic, Japan and Slovenia spent less.

The figures came as a survey of employers found one in three says their business is already suffering from shortages of skilled workers, and almost half predict that by 2015 skills shortages will limit their activity.

Bureau of Statistics figures show that even among men of prime working age 25 to 54-year-olds almost 10 per cent have now dropped out of the workforce, one of the largest dropout rates in the Western world.

The OECD report shows while Australia's spending on the Job Network was roughly the same as other countries spent on their job agencies, other OECD countries on average spent three times as much as Australia did on support programs.

Other OECD countries on average spent 0.14 per cent of their GDP on training alone. Australia spent just 0.01 per cent, and that has not changed since Labor took office.

Denmark, widely admired for its "flexicurity" programs a tough-love agenda which means people losing jobs get retraining instead of redundancy payouts spent 0.98 per cent of its GDP in wage subsidies, retraining and incentives for employers to take on the jobless. That was seven times Australia's spending level.

Labor has significantly increased the number of places available for skills training, although the true number has been disguised by taking money from old programs for new ones. But little of this has been targeted on the unemployed.

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Inflation, rates feeling the heat as jobs balloon

THE job figures continue to amaze. The International Monetary Fund has bumped up its estimate of global growth in 2010 mostly in our key export markets.

Commodity prices are somewhere in the stratosphere, lifting our export earnings. And one survey suggests inflation is now well above the Reserve Bank's target zone.

Could all this lead the Reserve to raise interest rates yet again in August right in the middle of an election campaign?

Until yesterday, the markets were split between those expecting the Reserve to leave rates on hold until 2012, and some punting on a rate cut ahead.

They were focused on the main event in the world economy right now: fears cash-strapped, highly indebted governments may default on their debts.

But the Reserve is focused on what it sees as the main event in the Australian economy: tens of billions of extra dollars flowing in from soaring minerals prices potentially pushing up prices here.

After yesterday's job figures, and the IMF's optimistic new forecasts for global growth, the markets turned around. Most still expect rates to stay on hold, but a minority now tip the Reserve to raise rates a seventh time in August.

An election campaign wouldn't stop it: it made that very clear when it raised rates during the 2007 campaign, embarrassing John Howard. This time it could square up by embarrassing Julia Gillard.

Treasurer Wayne Swan has told the Reserve its job is to keep underlying inflation between 2-3 per cent. It was 3 per cent in March, and Westpac's chief economist, Bill Evans, thinks that if it goes any higher in the June figures due this month, interest rates too will go higher.

Yesterday's job data didn't help, surprising even the optimists. On the volatile seasonally adjusted figures, employment grew by almost 46,000 in June, with almost 200,000 jobs added this year.

Seasonally adjusted unemployment fell to 5.1 per cent, the lowest rate since before the 2009 bushfires.

Even the steadier trend figures show jobs up by more than 300,000 in the past year. And most of them are full-time jobs. Workers who had their hours cut in the crisis are going back to normal.

But are jobs back to normal?

The Bureau of Statistics estimates that in net terms, of the 306,000 jobs created in the past year, only 56,500 went to the unemployed.

The rest went to people formerly outside the workforce migrants, temporary foreign workers, students and others who had been on the sidelines of the job market.

There are still 315,000 more of us unemployed or underemployed mostly wanting full-time jobs but stuck in part-time ones than there were before the crisis. The bureau estimates that 12 per cent of workers are unemployed or underemployed.

Only in Victoria and Queensland are full-time jobs back to their pre-crisis levels. Even Western Australia has fewer full-time jobs now than in 2008. Things are warming up, but hardly hot.

The IMF's forecasts look reassuring. Despite the debt crisis and governments tightening their belts, the IMF has lifted its estimate of global growth this year from 4.2 to 4.6 per cent. It has left its 2011 forecast unchanged at 4.3 per cent. And most of this year's extra growth is in Australia's main export markets.

For Australia, the IMF's forecasts are unchanged at 3 per cent this year and 3.5 per cent in 2011. But it now predicts growth to be 10.5 per cent this year in China (our No. 1 market), 2.4 per cent in Japan (2), 9.4 per cent in India (3), 5.7 per cent in Korea (4), 3.3 per cent in the US (5), 3 per cent in New Zealand (6), 7.7 per cent in Taiwan (7) and an amazing 9.9 per cent in Singapore (8). Wow!

But there's a serious downside. First, that growth is already behind us. The IMF says the global economy grew by 5 per cent in the first quarter of 2010, but will be slower in the second half. And it has sliced next year's growth forecasts for Europe and China alike.

Second, it sees a real risk ahead: unless European governments can persuade markets that they are a safe credit risk, global growth next year could shrink to 2.7 per cent. Europe would sink into a double-dip recession and the US would stagnate.

There is good reason for the Reserve to be wary of getting out even further in front of a world at risk of going backwards. The markets yesterday rated the odds of an August rate rise at just 20 per cent. But the inflation figures could change that.

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