I J Macfarlane: Observations regarding stability in the Australian economy
Talk by Mr I J Macfarlane, Governor of the Reserve Bank of Australia, to Business Council of Australia
Annual Dinner, Melbourne, 8 July 2003.
* * *
I would like to start by thanking the Business Council of Australia for inviting me to its Annual Dinner.
This is the first such occasion I have attended, and I note that the price of my invitation is that I have to
give the after-dinner speech. Given the time of day, you will be pleased to hear that I will confine
myself to a few simple observations, rather than delivering an economic treatise.
Some people may be expecting a commentary on the current outlook for monetary policy, but I am
afraid they will be disappointed. Last week we made a decision on monetary policy at our July Board
Meeting, and it received a lot of press coverage. Not everyone agreed with the decision, but I have to
say that I was quite impressed with the quality of the discussion it generated. I think there is a very
well informed and reasoned appreciation of the conflicting pressures and trade-offs we at the Reserve
Bank face. Given that, I am reluctant to add any more at this stage, because, no matter how carefully
modulated my comments, I would run a great risk of destabilising a basically stable situation.
Instead, I would like to move into my talk by starting with the observation that the Australian economy
has now gained international recognition for its stability, whereas in previous decades it was noted
more for its booms and busts. In the jargon of financial markets, investing in Australia is now a
"stability" or "safe haven" play whereas formerly it was known as a "cyclical" play. The latter term
meant that the Australian economy did better than the world economy when the world economy was
doing well, and worse when it was doing badly.
The change in the world's perception of the Australian economy from one of instability to one of
stability has obvious advantages to us, but it does not eliminate the need for hard policy decisions - it
simply changes the nature of those decisions. But before discussing that, I would like to illustrate some
of the changes in the behaviour of economic variables that have given rise to the changed perception
of the Australian economy.
The first clear sign that the Australian
GDP
Year-ended change, constant prices
economy was showing a new-found
% %
stability was the way in which it handled
the Asian crisis. Although we had a higher
share of our exports going to the
8 8
crisisaffected Asian economies than any other
developed country, we were able to
Australia*
negotiate this difficult period without any
4 4
noticeable economic slowdown. It was not
that our exports were unaffected - total
exports fell by 6 per cent in 1997/98 and
0 0
exports to Asia by 19 per cent - but that NJA
(ex China)
strong domestic demand offset that effect.
-4 -4
-8 -8
1997 1998 1999 2000 2001 2002 2003
* Non-farm GDP
Sources: ABS; CEIC
BIS Review 31/2003 1
GDP
The second episode where Australia's
Year-ended change, constant prices
relative stability showed up was during the
% %
recent recession that occurred among the
major economies in 2001. Over the
6 6
course of that year, the G7 economies
showed zero growth whereas we grew by
Australia*
about 4 per cent. Another interesting
4 4
feature of that period was the divergent
pattern between the Australian and US
economies. It used to be common to
2 2
remark on the close link between growth
in the Australian and US economies, but
that pattern broke down during the recent
0 0
US recession. Note that we did have a
slowdown in the second half of 2000, but
US*
that was a once-off effect caused by a fall
-2 -2
in house-building following the
1997 1998 1999 2000 2001 2002 2003
introduction of the GST. * Non-farm GDP
Sources: ABS; Thomson Financial Datastream
Turning to financial variables, the one we
are most frequently made aware of is
Share Price Indices
equity prices. Again, Australia stands out
January 1997=100
Index Index
for relative stability. If we compare the
Europe
behaviour of the ASX 200 with its
equivalents in the US, UK and Europe, the
contrast is very striking. The boom and
200 200
bust behaviour of the other three indices is
US
hardly apparent at all in our stock prices,
and over the whole six-and-a-half year
period since the start of 1997, our stock
150 150
market has risen as much from end-point
to end-point as any of them.
Australia
Two real economic variables that are
100 100
closely related to my previous graph are
UK
business fixed investment and the profit
share of GDP. For simplicity, I have only
compared the Australian experience to
50 50
1997 1998 1999 2000 2001 2002 2003
that of the US. On business fixed
Sources: Bloomberg; Datastream
investment, again we have experienced
none of the boom and bust that was
Business Fixed Investment
Share of GDP, constant prices
apparent in the US.
% %
In fact, our business fixed investment
US
remained remarkably subdued during the
period of booming stock markets, but has
picked up over the last 18 months or so,
when it has been most useful for us in a
13 13
counter-cyclical sense.
The comparison for profits is very
Real Corporate Profits*
similar. Corporate profits in Australia September 1994 = 100
Index Index
have risen relatively smoothly over
the past decade, while in the US
Australia
they rose until about the end of 140 140
1997, but have fallen thereafter. The
interesting thing to notice about the
120 120
US was that profits were falling
through the boom years on the stock
100 100
market of 1998 and 1999.
I think I have shown enough to get US
80 80
my story across, so I will not labour
the point by showing any more
comparisons. Instead, I will try to
60 60
answer the questions of why our
recent outcomes have been more
40 40
stable than in the past, and why they
1993 1995 1997 1999 2001 2003
have been more stable than most
* Net of depreciation and interest
Sources: ABS; Bureau of Economic Analysis
comparable countries.
The first of these questions is why has the Australian economy recently been more stable than it
formerly was? My answer to this is that it is largely the result of policy reforms, but luck also played a
part, which I will refer to later. On economic policy, I would point to a number of major reforms over the
past 20 years that have been crucial:
The floating of the exchange rate.

 The non-inflationary financing of budget deficits through the tender of government debt.
The move of monetary policy to one based on an independent central bank and

inflationtargeting regime.
The move towards a more disciplined fiscal policy.

 Labour market deregulation. The main change here was to decentralise, i.e. to move away
from a system based on a National Wage Case which awarded every worker a given
percentage rise once a year (or, in earlier times, once a quarter). The labour force looks a lot
different today, with a considerably smaller proportion working for the government, and a
smaller proportion unionised.
The opening up of the economy to international influences, both through the reduction in

tariffs and the abolition of controls on capital movements.
Competition policy applied both to the private sector and the government sector, and

significant privatisation of the latter.
These changes have generally moved the economy away from centralisation to decentralisation and
away from regulation towards deregulation. They have resulted in a myriad of small changes occurring
almost continually, rather than a few large ones. So the economy shows more day-to-day volatility but
is less likely to build up the pressure that results in crises and large disruptive adjustments.
There is another reason why the performance of the Australian economy has become more stable
than formerly which is not the result of deliberate policy decisions. I refer to the changed behaviour of
our terms of trade, a subject I have spoken of on many previous occasions. The terms of trade is the
ratio of the price of our exports to the price of our imports, that is the "buying power" of our exports.
For much of the 20th century our terms of trade trended downwards because the prices of
commodities, which make up much of our exports, failed to keep up with the prices of manufactures,
which make up most of our imports. In my view, this trend started to change about 15 years ago, as
new sources of low-cost manufactures started to come on stream from Asia, particularly from China.
Now it is manufactures prices that act like "commodity" prices, and not just in a trend sense, but
cyclically too. You will note from my next graph that in the recent major-country recession of 2001, our
terms of trade actually improved. Normally, we would have expected them to fall, which would have
magnified the contractionary effect of the global slowdown.
Terms of Trade
The second question is why has the Australian
March 1982 = 100
economy recently shown much more stable Index Index
behaviour than the much larger and more
diversified US economy? This is not what you
105 105
would normally expect of the two economies on
the basis of their size or their history.
I think the major reason for this is that the US
100 100
had an asset price boom and bust - commonly
known as a bubble - and we did not. I have
already shown the rise then fall in equity prices,
95 95
profits and business investment in the US and
the effect this has had on economic activity. The
US economy is suffering from a hangover after
90 90
the binge; we did not have the binge and so
have avoided the hangover.
85 85
I would like to say that it was excellent economic 1982 1985 1988 1991 1994 1997 2000 2003
Source: ABS
policy that prevented us from participating in the
National Budget Balance
binge, but that would be claiming too much.
Per cent of GDP
Noone really understands the relationship between
% %
macro-economic policy and asset price booms
US
and busts well enough to make that claim. The
2 2
unfortunate fact is that it seems to be possible to
experience an asset price boom in an economy
where macro-economic policy settings seem to
0 0
be relatively well disciplined and inflation quite
Australia
restrained.
One thing we do know, however, both from the
-2 -2
US experience and the earlier Japanese
experience, is that once the asset price boom
has turned into a bust, the effect on the
-4 -4
macroeconomic policy settings is profound. Partly this
is because the contracting economy affects the
policy settings, and partly it is because
-6 -6
1997 1998 1999 2000 2001 2002 2003
policymakers are quick to adjust their levers in an
Sources: Commonwealth Treasury; Thomson Financial Datastream
attempt to head off the contraction.
Again, a comparison with the US makes the Official Short-term Interest Rates
point. On fiscal policy, the Australian budgetary % %
position has varied little over recent years, with
6 6
predominantly small surpluses being the order of
Australia
the day. In contrast, the US budgetary position
has moved from a surplus of 2 per cent of GDP in 5 5
2000 to an expected deficit of 4 per cent of GDP
in 2003. The US has used a huge amount of its
4 4
fiscal ammunition, while we have not even started
to do so.
3 3
On monetary policy, the contrast between the two
2 2
countries is equally pronounced. The US put
US
interest rates up slightly more than we did in
1999/2000, but the difference was minor. 1 1
However, since the US recession hit in 2001,
they have reduced their interest rates much more
0 0
1997 1998 1999 2000 2001 2002 2003
than us. From a peak in the second half of 2000,
Sources: Federal Reserve Bank of New York; RBA
they have come down by 51⁄2 percentage points,
while we have come down in net terms by
11⁄2 percentage points. I do not want to give the impression that I think stability of interest rates is a
goal in its own right - only that it reflects the greater stability of the Australian economy.
Again, the contrast in both of the above policy variables between the two countries is as great as the
contrast in the other variables I showed earlier, with Australia again representing stability and the US
instability. Equally importantly, stability was not pushed at the price of lower growth: to the contrary,
the Australian economy has grown faster than the US, not just over the past few years, but over the
past decade. This, of course, has been the main point of my presentation this evening. The other
point, I hope that has come out, is that the really large examples of instability in recent decades have
emanated from a species of financial event - namely, an asset price boom and bust - rather than from
the normal cyclical fluctuations we are all familiar with under the heading of the business cycle.