Speech
The Economic Outlook and Monetary Policy
[*]
Philip Lowe Governor
Address to the Economic Society of Australia Brisbane - 21 May 2019
Thank you for the invitation to speak to the Economic Society of Australia. It is very good to be back
here in Brisbane today.
I would like to begin by providing an update on recent developments in the global and Australian
economies. I will then discuss how our thinking on the appropriate stance of monetary policy has
evolved over recent times.
The Global Picture
Up until around the middle of last year, the global economy was growing quite briskly (Graph 1).
Then, over the second half of the year, growth slowed and this lower pace continued into 2019.
There are a few factors that help explain this slowing in the global economy.
The first is a slowdown in the Chinese economy. The Chinese authorities have for some time been
seeking to address the build-up of risks in the financial system. As part of their efforts on this front
they have sought to rein in shadow banking. The effect of this has been felt across their economy
and, given the size of the Chinese economy, the impact has also been felt around the world.
A second factor is a marked slowdown in international trade. Over the past year, global trade has not
grown at all (Graph 2). This is unusual as, historically, global trade has tended to increase at least as
fast as GDP. This recent weakness partly reflects the slowing in the Chinese economy, but the
increases in US and Chinese tariffs are also a factor. Not surprisingly, it has flowed through into
weaker conditions in the manufacturing sector around the world and there has been a disruption to
some supply chains. Business investment, too, has been affected, with firms delaying investment
decisions. In the face of increased uncertainty about future trade policy, many businesses have
preferred to wait for a clearer picture. A cyclical downturn in the global electronics industry has also
weighed on exports and investment, particularly in some east Asian economies.
A third factor contributing to the slowdown in global growth has been a series of country-specific
factors, including natural disasters in Japan, a new vehicle emissions testing regime in Germany and
some extreme weather events.
So, these are some of the key factors that have been at work.
Looking forward, the global picture looks a little brighter and it is reasonable to expect that growth
will strengthen a little later in the year.
The Chinese authorities have responded to the slowing in their economy with measures to support
economic activity. Globally, financial conditions are very accommodative and major central banks
have signalled an easier monetary policy stance than was earlier expected. It is also reasonable to
expect that the drag on growth from some of the country-specific factors that I mentioned will pass
in time. Consumption growth in many economies also remains robust, supported by strong
employment growth and rising wages. And notably, the weakness in the manufacturing sector has
not spilled over in a material way to the services sector. All this means that the global economy
appears quite resilient at the moment.
The big uncertainty remains trade policy. A resolution of the current disputes would help boost trade
flows and reduce some of the uncertainties facing businesses. In that case, we could expect a
pickup in investment too. On the other hand, a failure to resolve the disputes represents a major
downside risk to the global economy. So there is a lot riding on this issue.
One other feature of the global economy that I would like to draw your attention to is the
coexistence of low unemployment and low inflation. Unemployment rates in many of the major
economies are the lowest they have been in many decades. At the same time, inflation remains low.
While wages growth has picked up, inflation rates are mostly below 2 per cent and below the central
banks' targets (Graph 3).
Graph 3
This experience is the opposite to that of the 1970s and early 1980s. During that period, many
countries experienced what became known as stagflation: the coexistence of high unemployment
and high inflation. Today, the picture is very different: we have low unemployment and low inflation.
This is obviously a much better configuration.
Understanding why this has happened is a priority for us, as we too in Australia are experiencing
something similar. We are still searching for the full answers, but the fact that the experience is
common across so many countries suggests that there are some global factors at work. In my view,
these are partly linked to changes in technology and to globalisation. Both of these affect
perceptions of competition and they both are a source of uncertainty about the future. In turn, they
are affecting pricing decisions across the world.
We can't be sure how long these effects will last and whether the coexistence of low inflation and
low unemployment is temporary, or whether it is a new normal. Whether or not it is permanent, the
coexistence of low inflation and low unemployment does appear to be highly persistent. This
persistence has led to a reassessment in a number of countries of the unemployment rate that is
sustainable without inflation becoming a concern. This is an important issue and one I will return to
in the context of Australian monetary policy.
The Australian Economy
I would first like to provide an update on the Australian economy.
Just as the global economy slowed over the second half of 2018, so too did the Australian economy
- we went from growing at an above-average pace in the first half of 2018 to a below-average pace
in the second half (Graph 4).
Graph 4
As has been the case globally, we had our own country-specific factors that have temporarily
weighed on economic growth, including the drought and some disruptions to resource production
and exports.
More fundamentally, though, the main reason for the shift in momentum in the Australian economy
is a slowdown in household consumption growth. Over the second half of 2018, household
consumption increased by just 3⁄4 per cent, which is an unusually soft outcome.
The decline in housing prices is a factor here, but the more important factor is the long period of
weak growth in household income (Graph 5). Over the past three years, household disposable
income has increased at an average rate of just 23⁄4 per cent. This compares with an average of
6 per cent over the preceding decade. As this period of weak income growth has persisted, it has
become harder for households to dismiss it as just a temporary development - as something that will
pass quickly. The lower rate of income growth has also made it harder for households to pay down
debt. The end result has been that many people have decided to adjust their spending plans. There
was further evidence of this adjustment in the retail trade data for the March quarter.
Graph 5
We are not expecting a quick turnaround in growth in consumer spending, but we are expecting a
gradual improvement. This is largely on the basis of an expected pick-up in growth in household
income, and a stabilisation of the housing market over the period ahead. We are expecting
household disposable income to grow at an average rate of 4 per cent over the next couple of years,
which is noticeably higher than the average of recent times. Stronger growth in income will help, but
the more important factor is some tax relief.
Over the past year, tax paid by households increased at a much faster rate than did income; almost
10 per cent, compared with 31⁄4 per cent - that is a big difference and it is unusual. We are not
expecting it to continue for a couple of reasons. First, the tax offsets for low- and middle-income
earners announced in the recent budget will boost disposable income. And second, it is likely that we
will return to a more normal relationship between growth in incomes and tax paid.
Our expectation is that the stronger growth in disposable income will flow through into household
spending, although this will take some time.
Looking beyond household spending, the outlook for the Australian economy is being supported by a
number of other developments.
The first is the ongoing investment in infrastructure. This investment is important. It is not only
supporting demand in the economy at a time when this is needed, but it is also adding to the supply
capacity of the economy and directly improving people's lives, including through a reduction in
transport congestion.
There is also strong growth in demand for a range of services, partly as a result of ongoing strong
population growth.
Another factor supporting growth is the recent lift in the terms of trade, which have continued to
surprise on the upside, boosting our national income.
The outlook for investment in the resources sector has also improved, due to both higher levels of
sustaining capital investment and the commencement of some new projects. After five years of
declining mining investment as LNG projects were completed, we are expecting an increase over the
coming year (Graph 6). Non-mining business investment is also on an upward trend as firms invest
in additional capacity. By contrast, investment in residential construction is likely to be a drag on the
economy for the next few years. After six years of strong growth, residential construction is now
declining and this is likely to continue for a while yet.
In comparison with the GDP data, the labour market data over the past year have painted a stronger
picture of the economy and have mostly surprised on the upside. More people have joined the labour
market and job creation has been strong, with employment increasing by 21⁄2 per cent over the year,
compared with growth in the working-age population of 13⁄4 per cent. The unemployment rate has
also declined over the past year (Graph 7).
Recently, though, some labour market indicators have softened a little: the unemployment rate
ticked up to 5.2 per cent in April; the underemployment rate has also moved a little higher as there
are more part-time workers who are seeking additional hours; job advertisements have declined; and
hiring intentions have come off their earlier highs. At the same time, the vacancy rate remains high,
monthly employment growth remains firm and hiring intentions remain above average. Taking these
various indicators together, the labour market continues to be resilient, although our expectation is
that employment growth will slow to be broadly in line with growth in the working-age population.
The other element of the labour market that I would like to comment on is wages. As the labour
market has strengthened over the past year, wages growth in the private sector has picked up. By
contrast, wages growth in the public sector has been steady at around 21⁄2 per cent (Graph 8).
Overall, though, wages growth remains lower than the rate that would appear consistent with
inflation being comfortably within the target range. Even in New South Wales and Victoria - where
the unemployment rates have averaged around 41⁄2 per cent over recent times - wages growth has
been running at just 21⁄2 per cent. It would appear that some of the global factors that I mentioned
earlier are working here as well.
Putting these various elements together, our central scenario - as outlined in our recent Statement
on Monetary Policy - is for the Australian economy to grow by 23⁄4 per cent over both 2019 and 2020
(Graph 9). As always, though, there is a range of uncertainty around this forecast. But the central
outlook is for growth at around our estimate of potential growth in the Australian economy. Given
this, over these two years the unemployment rate is forecast to be around 5 per cent. In 2021, the
central forecast is for slightly better outcomes, partly due to a pick-up in the resources sector.
It is worth pointing out that when preparing these forecasts, we used our normal technical
assumption that interest rates would move broadly in line with market pricing. At the time the
forecasts were prepared, market pricing implied that the cash rate was expected to decline to
1 per cent over the next year. If, instead, we had used an assumption of unchanged interest rates,
the growth forecast would have been lower and the forecast for unemployment would have been
higher.
Turning now to inflation, the outcome for the March quarter was noticeably lower than we had
expected. In year-ended terms, headline inflation was 1.3 per cent and in underlying terms it was
around 11⁄2 per cent (Graph 10). Looking through the details of the CPI, there appear to be only
limited inflation pressures across much of the economy. The low rates of wages growth are
contributing to relatively low rates of inflation in the services sector. Rent inflation is also the lowest
it has been in decades. And various government initiatives to ease cost-of-living pressures are
contributing to lower increases in many administered prices. Together, these factors have led to a
low rate of inflation for non-traded goods and services (Graph 11).

The picture for traded goods and services inflation is a little different. Recently, there have been
increases in some food prices as a result of the drought and floods. The earlier small depreciation of
the exchange rate has also been passed through into the prices for some consumer durables. These
developments mean that tradables prices as a group are no longer declining. Even so, inflation
remains low for most traded goods and services.
Looking forward, the central forecast is for underlying inflation of around 13⁄4 per cent this year,
2 per cent next year and a little higher the following year. In headline terms, inflation is expected to
be noticeably higher in the June quarter, due to the recent increase in petrol prices. For 2019 as a
whole, headline CPI inflation is expected to be around 2 per cent and the same the following year.
This means that inflation is expected to remain around the bottom of the medium-term target range
over the forecast period.
Monetary Policy
I would like to turn now to monetary policy and how our thinking and communication have evolved
over recent times.
You might recall that through 2018 we had three main messages: (1) we were making progress
towards our inflation and unemployment goals; (2) given that this progress was expected to
continue, it was more likely that the next move in interest rates would be up, rather than down; and
(3) given the progress towards our goals was expected to be only gradual, any move in interest rates
was some time off.
Earlier this year, our assessment of the balance of probabilities around the likely direction of the next
move in interest rates shifted a little. At the Reserve Bank Board meeting in February, we assessed
that the probabilities of an interest rate increase and a decrease had become more evenly balanced
than they were through 2018.
This shift reflected two developments.
The first was the slowing in the Australian economy over the second half of 2018 that I just spoke
about. And the second was the lower-than-expected inflation outcome for the December quarter.
The main countervailing consideration was the labour market, which painted a stronger picture of
the economy than the other indicators. In the face of these conflicting signals, we judged that the
best approach was to hold interest rates steady while we obtained a clearer picture of the direction
of the economy.
It was relatively clear, though, that if the GDP data were giving the better signal - and the labour
market eventually softened - lower interest rates would likely be appropriate. This was especially so
in light of the ongoing low rate of inflation. This assessment was reflected in the minutes of the
Board's April meeting, where we discussed a scenario in which there was a lack of progress on
inflation and the unemployment rate trended higher.
Following our April meeting, we received another reading on inflation, which confirmed that price
pressures were subdued across the economy. Over the past year - and particularly in the past two
quarters - inflation has come in lower than we expected and our inflation forecasts have been
revised down. This is evident in Graph 12, which shows the forecasts a year ago, the actual
outcomes and our current forecasts. In contrast to the subdued inflation outcomes, employment
growth has been stronger than we expected a year ago. This can be seen in the right-hand panel. In
most cases, when employment growth is stronger than expected, we expect to see an upside, not a
downside, surprise on inflation. So, from this perspective, the recent experience is a little unusual.
Graph 12
As the Board has sought to understand this experience and studied similar experiences overseas, we
have been asking ourselves: what rate of unemployment is achievable in Australia without
generating inflation concerns?
Over recent years, the answer to this question was thought to be around 5 per cent - in other
words, it was thought that an unemployment rate below 5 per cent was likely to put pressure on the
supply capacity of the economy and, in turn, raise possible inflation concerns.
But from today's perspective, I think we can do better than this. My judgement of the accumulating
evidence is that the Australian economy can support an unemployment rate of below 5 per cent
without raising inflation concerns. This would be consistent with the experience overseas, with many
other advanced economies sustaining lower rates of unemployment than previously thought possible
without leading to a noticeable uplift in inflation.
If this judgement is correct, the question is: how does our society achieve and sustain a lower rate
of unemployment? It is possible that the current policy settings are sufficient to deliver lower
unemployment. The labour market has surprised on the upside over recent times, and it could do so
again. While we can't rule out this possibility, the recent flow of data makes it seem less likely.
In the event that the unemployment rate does not move lower with current policy settings, there are
a number of options. These include: further monetary easing; additional fiscal support, including
through spending on infrastructure; and structural policies that support firms expanding, investing
and employing people. Relying on just one type of policy has limitations, so each of these is worth
thinking about.
The Reserve Bank Board recognises that monetary policy has a role to play here. Earlier today, we
released the minutes of the Board's meeting two weeks ago. At that meeting, we discussed a
scenario in which there was no further improvement in the labour market and the unemployment
rate remained around the 5 per cent mark. In this scenario, we judged that inflation was likely to
remain low relative to the target and that a decrease in the cash rate would likely be appropriate. A
lower cash rate would support employment growth and bring forward the time when inflation is
consistent with the target. Given this assessment, at our meeting in two weeks' time, we will
consider the case for lower interest rates.
Thank you for listening. I look forward to answering your questions.
Endnote
[*] I would like to thank Andrea Brischetto for assistance in the preparation of this talk.
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