Speech
Supporting Growth in the Short Run and the Long
Run
[*]
Luci Ellis
Assistant Governor (Economic)
Plenary Session Address to the Melbourne Institute Outlook
Conference
Melbourne - 11 October 2018
I'd like to thank the organisers of this conference for inviting me to participate in this session. It is
truly an honour to be included in this roster of speakers.
The topic for this session is a broad one: how do we support growth? As the extended form of the
topic indicates, there are many considerations that need to be taken into account. In the time
available I can only do justice to a few of those considerations. In these opening remarks, I'd like to
focus on the issue of the time horizon. The question of how public policy can support growth
depends in part on whether we are talking about the short run or the long run.
In the Short Run
In the short run, supporting growth implies a role for macroeconomic policy, both fiscal and
monetary. Australia has achieved its record of economic expansion in part because macroeconomic
policy has, by design, supported growth when needed. This has helped us avoid the serious
downturns that can do so much damage, even long after they have ended.
In Australia, the role played by macro policy is informed by longstanding frameworks that govern its
conduct. In the case of monetary policy, that framework is the medium-term inflation target that was
adopted a quarter-century ago. This framework inherently points policy in the direction of supporting
growth when that is needed, because demand would otherwise be insufficient. Of course, there are
other considerations, including debt and asset prices as highlighted in the session title. But the
Bank's Financial Stability Review will be released tomorrow, and it will cover those issues in far more
detail than is possible the time available today. The basic message for policy is still to support
demand when it would otherwise be insufficient to absorb spare capacity.
Spare capacity in the economy, as there has been in recent years, tends to put downward pressure
on inflation. To avoid inflation getting too low, monetary policy therefore needs to be set at an
expansionary level, supporting growth so that inflation either does not depart too far from target, or
returns to target in cases where it has already moved. That is how an inflation target works, and it
would do so even if the Reserve Bank's legislated mandate was expressed solely in terms of price
stability. But the mandate in our Act also encompasses full employment and the welfare of the
Australian people. These things are not in conflict with an inflation target. Rather, they inform how
that inflation-targeting regime operates day-to-day. They are relevant to the choices made about
how quickly to return to target.
The role of an inflation-targeting regime for monetary policy in supporting growth can be well
illustrated by events in the Australian economy over the past decade or so. During the build phase of
the mining investment boom, there was a great call on Australia's production capacity to get all the
new mines built. This meant that, unlike many other countries, Australia reached a point of having
little spare capacity quite soon after the Global Financial Crisis peaked. So there was a period where
it was appropriate to set the cash rate a bit higher than the levels reached in the immediate
aftermath of the crisis.
Since the peak of the mining boom, though, it has been appropriate to cushion the drag on growth
as the terms of trade and mining investment declined. That is one of the reasons why monetary
policy has been set to support growth in recent years. We expect mining investment to bottom out in
coming quarters, as the last of the large LNG expansion projects completes. After that, it will
probably increase a little, as resource firms invest to maintain their production capacity at current
levels. The scale of that 'sustaining investment' is nothing like that of the boom of the past decade or
so. But the important point is that mining investment will no longer be dragging on growth.
While there is spare capacity remaining, it is important for policy to support above-trend growth and
work that spare capacity down. This raises the question of what trend might be and how we would
know. Just waiting until you see wages growth or inflation pick up would leave policymakers in the
dark about how quickly they are moving towards their goals, or even if they are doing so at all.
Instead people use a range of different rules of thumb to assess how growth is tracking relative to
trend, or 'potential growth'. Some of these are trickier to use in practice than others. For example,
some estimates hinge on an estimate of feasible productivity growth. But these will be subject to the
risks that historical relationships no longer apply, or that productivity (which is not directly
observable) is just plain mismeasured for a period. A measure of trend constructed in this way is
okay to use as cross-check, but I wouldn't want to rely on that as my only guide.
The labour market is, by contrast, a source of pragmatic and accessible signals of where growth is
relative to trend. If employment is growing faster than the working-age population, and the
unemployment rate is coming down, those are pretty good signs that the economy is running faster
than 'trend'.
It can take a while for spare capacity to be absorbed. Therefore policy settings might need to be
expansionary for a number of years. So it is natural to want to ask whether extended periods of
expansionary monetary policy might lead to unintended consequences. The consequences for asset
prices and financial stability have been dealt with at length elsewhere, including in the Financial
Stability Review as I have already mentioned.
Another aspect of expansionary policy that has raised concerns in some quarters is the distributional
effect. Other central banks have looked into this (for example see, Ampudia et al (2018), Bunn, Pugh
and Yeates (2018) and Colciago, Samarina and de Haan (2018)). That is understandable, because
they had set interest rates at much lower levels than seen in Australia, and in some cases also
expanded their balance sheets with asset purchases.
The findings of that research is that the first-order effect of expansionary monetary policy is to put
more people in jobs who wouldn't have had one otherwise. This tends to benefit households at the
lower end of the income distribution more than those whose incomes are already high. For wealth,
there are a number of effects that offset one another, so the net effect on summary measures of the
wealth distribution tend to be small. While lower interest rates and asset purchases do tend to
support asset prices, and higher equity prices tend to benefit higher-wealth households, higher
housing prices tend to have the largest effect on households in the middle of the wealth distribution.
The effect of asset price increases are also greatest for people with a bit of leverage against their
asset holdings; they tend not to be those with the highest wealth.
In the Long Run
In the short run, then, the answer is clear. It is the job of macro policy to support growth by
encouraging sufficient demand to employ our nation's productive resources. But this leaves open the
bigger question of how we ensure our living standards continue to increase in the longer run. That is
not so much an issue of helping the economy grow faster than trend when there is spare capacity.
Rather it is a separate question of how fast trend can be.
Having low and stable inflation is helpful because it can create a more predictable investment
climate. But beyond that effect, monetary policy doesn't have much effect on the feasible trend rate
of growth. There are many drivers of long-run productivity growth, but monetary policy would be
way down that long list. Its role is more in the short run than the long run.
Of course, there could also be synergies and linkages between the short run and the long run if
there is path dependence. If short-run prosperity helps create the conditions for even more long-run
prosperity, that is even more reason to ensure that policy supports growth. We are seeing an
example of this in Japan at the moment. There, unemployment is so low and the labour market is so
tight, that firms are investing rapidly in labour-saving technology. That will boost productivity in the
longer run.
Contrast that with the productivity malaise that can set in following a period of contraction or
stagnation. People's skills atrophy - or are assumed to - through lack of use. Firms don't invest to
expand production when sales aren't growing. And a kind of 'scarcity mentality' can take hold, where
risks are not taken and opportunities are missed.
Scarcity mentality is all about hunkering down and defending what you have. So it's easy to see how
that could get in the way of the processes needed to support growth in the long run. Firms might
become less willing to innovate and invest, in case the new venture doesn't pan out. People might
become less willing to switch jobs, in case the new role isn't really better than the old one.
If living standards are to rise, it needs to be possible to produce more with the same resources. The
good news is that this means better jobs at better firms. But getting there requires making changes
and taking risks. It also requires firms to become better, more productive firms, so they can offer
those better, higher-paying jobs. And it requires workers to have the confidence to take those jobs,
rather than always stick with what they have. For this reason, it is significant that job turnover is not
particularly high in Australia at present, and that average tenure in a job has been rising.
It's worth considering what a productive firm looks like, because not all firms are the same. Some of
the latest research on growth highlights the role of differences between firms in creating prosperity
(Andrews, Criscuolo and Gal 2015). The evidence both in Australia and abroad is that productivity
varies widely across firms, even within the same narrowly-defined industry. Firms that are highly
productive - so-called 'superstar firms' - tend to grow faster, grow employment faster, and pay
better than firms that are a long way from the frontier of productivity (Autor et al 2017). So the data
do show that better firms do offer better jobs.
But there is a concern here. Because these 'superstar' firms are more productive than average, they
gain market share at the expense of less-productive competitors. The leading firms could start
moving further and further ahead of the pack. The firms that lag behind would then find it harder
and harder to catch up. The result could be that markets become more concentrated. The market
leader begins to reap monopoly profits, which isn't good for consumers and might not be good for
long-run innovation and welfare.
Must laggard firms always lag? Could they instead catch up to today's superstars? It depends what
determines which firms are leaders and which firms lag. Perhaps this dispersion has something to do
with the distribution of management ability. If so, it's not set in concrete, either at the firm level or
more generally. (That said, raising the bar on management skills in an organisation can be difficult
and isn't always successful.)
Another reason for the dispersion in productivity between firms might be that the lagging firms are
not adopting latest technologies in the way that the 'superstars' are. Whether this is a universal
pattern, or something specific to current conditions is not yet known. It is also not yet settled
whether this pattern applies in Australia; the existing research focused on other countries. But if this
'superstar' pattern has instead only arisen recently, it could be something to do with the nature of
current technological developments and their ease of adoption. While some observers have dubbed
the current technological wave a 'fourth industrial revolution', innovations like machine learning and
artificial intelligence seem to have a very different character to previous general-purpose
technologies.
Prior waves of innovation in general-purpose technologies, such as the Industrial Revolution,
electricity and the previous computing revolution, all had a 'democratising' character, in the sense
that the new technology could be operated by less-skilled workers than the technology it replaced.
This wasn't always benign, as the child factory workers who replaced artisan weavers during the
Industrial Revolution could attest. But it did set these technologies up for widespread adoption.
The most recent technological wave seems to have a different character, so it might not be so
pervasive in the end. Using machine learning and other emerging techniques to automate routine
business processes seems to involve specialist skills and, often, PhD-level training in statistics or
computer science. These skills are much rarer and take longer to develop than those required for the
[1]
jobs that are thereby replaced. That doesn't mean it's impossible, but it could take a long time.
If leading-edge technologies are currently unusually costly or difficult to adopt, they become a kind
of barrier to entry protecting the firms that are already using those technologies. In that sense, they
are a particular case of the more general barriers to entry, that advantage incumbent firms and
[2]
industries over challengers. That is a concern, because contestability of markets is another
essential element for long-run growth and prosperity. Laggard firms will never catch up, and will
never become those better firms offering better jobs, if they have no chance of contesting the
market or fully competing within it. And if incumbents never face rivals, they are more likely to
become complacent. Innovation could slow down, and growth in living standards with it.
All of this comes back to the question of where growth comes from, and the answer is it comes from
all of us. Growth is not something that is bestowed upon a nation by external forces. And though
domestic institutions matter, neither is growth in the long run something that governments can
bestow upon society. Instead it's about the myriad of individual decisions within firms and other
organisations to find better ways of doing things. An important question is how we as a society
support and enable those decisions. But more important is whether we actually make them.
Thank you for your time.
Bibliography
Ampudia M, D Georgarakos, J Slacalek, O Tristani, P Vermeulen and G Violante (2018), 'Monetary Policy and Household
Inequality', European Central Bank Working Paper Series No 2170.
Andrews D, C Criscuolo and PN Gal (2015), 'Frontier Firms, technology diffusion and public policy: Micro evidence from
OECD economies', OECD: The Future of Productivity: Main Background Papers.
Autor D, D Dorn, LF Katz, C Patterson and J Van Reenan (2017), 'The Fall of the Labor Share and the Rise of Superstar
Firms', NBER Working Paper 23396.
Bunn P, A Pugh and C Yeates (2018), 'The distributional impact of monetary policy easing in the UK between 2008 and
2014', Bank of England Staff Working Paper No 720.
Colciago A, A Samarina and J de Haan (2018), 'Central bank policies and income and wealth inequality: A survey', DNB
Working Paper No 594.
Endnotes
[1]
A better analogy for the current technological wave, in the sense that it emphasised higher-skilled roles, might be
containerisation in the transport industry. This raised productivity by replacing raw physical labour and drawing on
machine operation and load optimisation skills, but was not the kind of general-purpose technology represented by
steam power, electricity or general computation. My thanks to Merylin Coombs for pointing out this similarity.
[2] This type of barrier to entry is also separate from the network externalities that can be important in technology
industries.
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