Speech
The Recovery, Investment and Monetary Policy
[*]
Philip Lowe
Governor
AFR Business Summit
Sydney - 10 March 2021
Thank you for the invitation to participate in this year's AFR Business Summit and it is great to be here
in person. I would like to begin by congratulating the AFR on its 70th anniversary - that is quite an
achievement in an industry with so much change. I look forward to many more years of business and
finance reporting and analysis.
The timing of this year's summit coincides with a lift in sentiment about the global economy. The rapid
development of vaccines and their rollout have improved the global outlook and lessened some of the
downside risks. The plan for further fiscal stimulus in the United States has also improved growth
prospects there. The result has been a reassessment by investors of the outlook for inflation and
interest rates around the world.
Against this backdrop, I would like to begin by reviewing recent economic and financial developments. I
will then turn to the importance of business investment in sustaining a strong economic recovery.
Finally, I will discuss the outlook for monetary policy in Australia.
Recent economic and financial developments
Last week we received further confirmation that the Australian economy is recovering well, and better
than expected. GDP increased by 3.1 per cent in the December quarter, following a similar rise in the
previous quarter (Graph 1). These back-to-back large increases are materially better outcomes than we
expected back in August. They reflect the success that Australia has had on the health front, the very
large fiscal and monetary policy support, and the flexibility of Australians in getting on with their lives
and businesses. As a result, we are now within striking distance of recovering the pre-pandemic level of
output.
Graph 1
GDP Growth
% %
Year-ended
4 4
2 2
0 0
Quarterly
-2 -2
-4 -4
-6 -6
-8 -8
2000 2004 2008 2012 2016 2020
Source: ABS
There has also been positive news on the employment front over recent months. The recovery in
employment has been V-shaped and there has been a welcome decline in the unemployment rate to
6.4 per cent (Graph 2). Job vacancies, job ads and hiring intentions remain strong. This suggests that
the unemployment rate will continue to trend lower, although this trend could be temporarily
interrupted when JobKeeper comes to an end later this month.
Graph 2
Labour Market
% m
Unemployment rate Employment
7 13.0
6 12.5
5 12.0
4 11.5
2017 2021 2017 2021
Sources: ABS; RBA
These better-than-expected outcomes are very welcome news. However, they do not negate the fact
that there is still a long way to go and that the Australian economy is operating well short of full
capacity. There are still many people who want a job and can't find one and many others want to work
more hours. And on the nominal side of the economy, we have not yet experienced the same type of
bounce-back that we have seen in the indicators of economic activity. For both wages and prices, there
is still a long way to go to get back to the outcomes we are seeking. In underlying terms, inflation is
running at 11⁄4 per cent, and we expect it to remain below 2 per cent over at least the next 2 years
(Graph 3).
Graph 3
Trimmed Mean Inflation
Year-ended
% %
4 4
3 3
2 2
1 1
0 0
2008 2012 2016 2020
Sources: ABS; RBA
Turning to other countries now, the recent experience has been mixed. A number are benefiting from a
pick-up in international trade in goods, following the shift during the pandemic to spending on goods,
rather than services. This shift has underpinned stronger conditions in the manufacturing sector,
especially in east Asia, and broad-based increases in commodity prices (Graph 4). In contrast, in some
other countries, virus outbreaks around the turn of the year have interrupted their recoveries.
Graph 4
Commodity Prices
USD, January 2013 = 100
index index
Iron ore Oil
100 100
75 75
50 50
25 25
index index
Copper Aluminium
120 120
100 100
80 80
60 60
40 40
2013 2017 2021 2017 2021
Sources: Bloomberg; RBA
Looking forward, the rollout of vaccines has improved the prospect of a sustained recovery in the global
economy. In the United States another important factor is the further large fiscal stimulus, amounting to
9 per cent of GDP, with this stimulus coming on top of the significant measures announced last year.
The brighter global outlook has been associated with an increase in bond yields (Graph 5). This follows
a period in which 10-year bond yields were at historic lows in many countries, including Australia. These
historic lows reflected a combination of structural and cyclical factors. On the structural side, there has
been, for some time, an elevated desire to save, relative to invest, which has kept real interest rates
low. On the cyclical side, the steep declines in GDP, the uncertainty about the future and an expectation
of a long period of very low inflation have each played a role.
Graph 5
10-year Government Bond Yields
% %
US
2.0 2.0
1.5 1.5
Canada
Australia
1.0 1.0
0.5 0.5
UK
0.0 0.0
S D M J S D M
2019 2020 2021
Sources: Bloomberg; Yieldbroker
Recently, as the outlook improved it is understandable that yields moved off their historic lows, although
explaining the exact timing and trigger for any change is always difficult. Initially, the repricing in the
bond market was associated with additional volatility in financial markets. Subsequently, conditions
settled down more quickly than they did in March/April last year, although further bouts of volatility are
possible.
The move higher in bond yields since November mainly reflects a lift in investors' expectations of future
inflation, although there has also been some bring forward in the expected timing of future policy rate
increases.
The lift in inflation expectations is evident in the graph below (Graph 6). For most of the past year,
expected inflation was well below the rates being targeted by central banks. This has now changed and
expected inflation has moved to be closer to those targets. This suggests that investors have more
confidence that the policy measures are working to stimulate the global economy and that the recovery
will be strong enough to generate inflation close to target. If so, this would be good news. It is also
worth noting that expected inflation rates are not especially high and are still not above central bank
targets.
Graph 6
Inflation Expectations*
% %
UK**
3 3
Australia
2 2
US
1 1
Canada
0 0
S D M J S D M
2019 2020 2021
*
Measured as the difference in yields between nominal and
inflation-linked 10-year government bonds.
**
UK breakeven inflation is structurally higher as it is linked to the UK
Retail Prices Index rather than the Consumer Price Index.
Source: Bloomberg
The other element of the lift in yields is the bringing forward of the timing of the expected increases in
policy interest rates. Current market pricing suggests an expectation that some central banks will
increase policy rates next year and in 2023 (Graph 7). This is a change from the situation a few months
ago, when longer periods of unchanged policy rates were expected. This change has occurred despite
expected inflation remaining below the thresholds set by central banks for higher policy rates.
Graph 7
Policy Rate Expectations
% %
United States United Kingdom
2 2
1 1
0 0
% %
Canada Australia
2 2
1 1
0 0
-1 -1
2021 2024 2021 2024
Sources: Bloomberg; RBA
Reflecting these global developments, we have seen a similar move in market expectations about future
policy rates in Australia. I will return to this issue shortly when I discuss the outlook for monetary policy
here.
Investment
Before doing that, I would like to focus on one piece of the economic recovery in Australia that has been
slow to click into gear: that is, private business investment.
The left-hand side of the next chart shows the RBA's forecast for non-mining business investment
prepared in February last year together with the actual outcomes (Graph 8). The right-hand side shows
the same for consumption.
Graph 8
Investment and Consumption
Chain volume, December quarter 2019 = 100
index index
Non-mining business Consumption
investment
105 105
Feb 2020 forecast
100 100
95 95
90 90
85 85
M J S D M J S D M J S D M J S D M J S D M J S D
2018 2019 2020 2018 2019 2020
Sources: ABS; RBA
The rebound in consumption has been strong, with growth of 12 per cent over the second half of last
year. Investment is a different story. While there was a welcome pick-up in the December quarter,
particularly in machinery and equipment investment, investment is still 7 per cent below the level a year
earlier and over 10 per cent below where we thought it would be at the start of last year.
Nonresidential construction is especially weak, with the forward-looking indicators suggesting that this is
likely to remain so for a while yet.
This weakness in business investment follows a run of years in which non-mining business investment
as a share of nominal GDP was already low by historical standards (Graph 9). Since 2010, this
investment ratio averaged 9 per cent, compared with 12 per cent over the previous 3 decades. This is a
material difference and cumulates to slower growth in Australia's capital stock, with implications for our
longer-term productive capacity.
Graph 9
Private Non-mining Business Investment*
Share of nominal GDP
% %
15 15
10 10
5 5
0 0
1985 1992 1999 2006 2013 2020
*
Net of second-hand asset transfers; RBA estimates
Sources: ABS; RBA
A durable recovery from the pandemic requires a strong and sustained pick-up in business investment.
Not only would this provide a needed boost to aggregate demand over the next couple of years, but it
would also help build the capital stock that is needed to support future production. Stronger investment
would also support a more productive workforce and a lift in both nominal and real wages.
Unfortunately, there is no magic ingredient for boosting business investment. A good starting point,
though, is businesses having confidence that the economy will grow and that there will be demand for
their products and services. Another important ingredient is having stable and predictable regulatory
regimes. Access to finance on reasonable terms is also important. To this list, you could add businesses
that are able to generate great new ideas and that have the risk appetite and the capability to back
these ideas. Having a highly skilled workforce and management are obviously important elements here.
Looking across the economy, there are investment needs and opportunities in areas as diverse as
infrastructure, power generation and distribution, health and social services, food production, advanced
manufacturing and digitalisation and data science. So there is no shortage of areas where additional
investment would help our economy grow.
have recently been examining this using the ABS s BLADE database. One of the exercises that we
have undertaken is to examine the investment and output of firms grouped by size - small, medium and
large. The results of this work are shown in this next graph (Graph 10).
Graph 10
Output and Investment Shares by Firm Size*
Private, non-mining sector, financial years 2002-2017
% %
Output
Investment
40 40
20 20
0 0
Small Medium Large
*
Output is measured by total revenue; small firms are classified here
as those with annual output less than $2 million, medium as annual
output between $2 million and $50 million, and large as annual output
greater than $50 million; firms with annual output less than $10,000
are excluded
Sources: ABS; RBA
Not surprisingly, large firms account for the biggest shares of output (blue bars) and investment (red
bars). But small firms, on average, invest much more relative to their output than do other firms. There
is, of course, a lot of variation among small firms, but many of them invest very intensively. In
aggregate, small firms accounted for 32 per cent of investment in Australia from 2002-17, while
accounting for only 17 per cent of output. This investment drives innovation, generates new ideas,
stimulates competition and supports employment. So one of the important ingredients to the recovery in
business investment in Australia is ensuring a supportive environment for innovative small and
mediumsized businesses.
Monetary policy
I would now like to return to the outlook for monetary policy in Australia.
Over the past year, monetary policy has complemented fiscal policy in cushioning the economic effects
of the pandemic and in building the bridge to the recovery in economic activity and jobs. The RBA's
policy measures have been keeping financing costs very low, contributing to a lower exchange rate than
otherwise, supporting the supply of credit to businesses, and strengthening household and business
balance sheets. In doing so, we have been helping in the national recovery effort.
The Reserve Bank is committed to continuing to provide the necessary assistance and will maintain
stimulatory monetary conditions for as long as is necessary. We want to see a return to full employment
in Australia and inflation sustainably within the 2 to 3 per cent target range. These are our goals and we
are committed to achieving them.
An important element of our policy package is the cash rate target being set at what is the effective
lower bound of 0.1 per cent (Graph 11). The Board will maintain this setting of the cash rate target until
inflation is sustainably within the 2-3 per cent range. It is not enough for inflation to be forecast to be
in this range. Before we adjust the cash rate, we want to see actual inflation outcomes in the target
range and be confident that they will stay there. This is an evolution from the approach earlier in the
inflation-targeting regime, in which forecasts of inflation played a more central role in decision-making
about interest rates. We continue to pay close attention to the forecasts, but we want to see actual
inflation outcomes consistent with the target before moving the cash rate.
Graph 11
Cash Rate
% %
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
2005 2009 2013 2017 2021
Source: RBA
A question that investors have been grappling with recently is when will this condition for a higher cash
rate be met?
As I discussed earlier, over the past couple of weeks market pricing has implied an expectation of
possible increases in the cash rate as early as late next year and then again in 2023. This is not an
expectation that we share.
For inflation to be sustainably within the 2 to 3 per cent range, it is likely that wages growth will need to
be sustainably above 3 per cent. This is assuming that Australia generates ongoing growth in labour
productivity and that the profit share of national income does not continue to trend higher.
Currently, wages growth is running at just 1.4 per cent, the lowest rate on record (Graph 12). Even
before the pandemic, wages were increasing at a rate that was not consistent with the inflation target
being achieved. Then the pandemic resulted in a further step-down. This step-down means that we are
a long way from a world in which wages growth is running at 3 per cent plus.
Graph 12
Wage Price Index Growth*
Year-ended
% %
4 4
3 3
2 2
1 1
0 0
2008 2012 2016 2020
*
Excluding bonuses and commissions
Source: ABS
The evidence from both Australia and overseas strongly suggests that the journey back to sustainably
higher rates of wages growth will take time and will require a tight labour market for an extended
period. Prior to the pandemic, multi-decade lows in unemployment rates were recorded in many
countries, yet even then there was only a modest lift in wages growth and inflation. And here in
Australia, even though unemployment rates in some states fell to levels last recorded in the early 1970s,
wage growth remained subdued.
The commonality of experience across advanced countries suggests that there are some powerful
structural factors at work. These include:
increased competition in goods markets, which makes firms very conscious of cost
increases
the trend towards more services being provided internationally
advances in technology, which have reduced the demand for some types of skills and
increased the demand for others
changes to the global supply of labour and regulation of labour markets.
Together, these factors have altered wage and pricing dynamics in almost all advanced economies and
these changes are likely to persist. This means that, in the absence of another major shock, it is a long
way back to seeing wage increases consistent with the inflation target.
Wages, of course, are only one factor influencing inflation outcomes. We will be reminded of this when
headline CPI inflation increases temporarily to around 3 per cent in the June quarter because of the
reversal of some pandemic-related price reductions. Also, there are always relative price shifts occurring
due to changes in the balance of supply and demand: recent examples include higher prices for
homewares following strong demand during the pandemic and higher prices for meat as farmers rebuild
herds after the drought. We will see more such examples as other sectors adjust to the altered balance
of supply and demand due to the pandemic. In setting monetary policy, the Reserve Bank Board will
look through these transitory fluctuations in inflation.
The point I want to emphasise is that for inflation to be sustainably within the 2-3 per cent target
range, wages growth needs to be materially higher than it is currently.
The evidence strongly suggests that this will not occur quickly and that it will require a tight labour
market to be sustained for some time. Predicting how long it will take is inherently difficult, so there is
room for different views. But our judgement is that we are unlikely to see wages growth consistent with
the inflation target before 2024. This is the basis for our assessment that the cash rate is very likely to
remain at its current level until at least 2024.
I also want to emphasise that the monetary stimulus is not just about achieving an inflation rate of
2 point something. It is just as much about achieving the maximum possible sustainable level of
employment in Australia. Unemployment is a major economic and social problem and the Board places a
high priority on a return to full employment.
There is, inevitably, some uncertainty about exactly what constitutes full employment in our modern
economy. Over the past decade, the estimates of the unemployment rate associated with full
employment have been repeatedly lowered both here and overseas. So there is uncertainty. But based
on this experience, it is certainly possible that Australia can achieve and sustain an unemployment rate
in the low 4s, although only time will tell. As we progress towards full employment, we will be relying on
the wages and prices data to provide a signal as to how close we are. The current signal is that we are
still a long way away from full employment.
Consistent with the judgement that the condition for an increase in the cash rate is unlikely to be met
before 2024, the Bank remains committed to the 3-year yield target. We are not considering removing
the target or changing the target from 10 basis points.
The Board has, though, discussed the question of whether to keep the April 2024 bond as the target
bond, or to move to the next bond - that is the November 2024 bond - later this year. If we were to
keep the April 2024 bond as the target bond, the maturity of the yield target would gradually decline as
time passes until the bond finally matures in April 2024. The Board has not yet made a decision on this
question and will consider it again later in the year when it has more information about the economic
recovery and the labour market.
Later in the year, the Board will also consider the case for further extending the bond purchase
program. We are prepared to undertake further bond purchases if that is required to reach our goals.
Until then, we remain prepared to alter the timing of purchases under the current programs in response
to market conditions. We did this last week when liquidity conditions deteriorated and bid-ask spreads
widened noticeably, and will do so again if necessary.
At its recent meetings, the Board has also discussed developments in the housing market, including the
rising housing prices across most of the country. There are many moving parts at present: record low
interest rates; a shift in preferences towards houses and away from apartments; strong demand for
housing outside our largest cities; large government incentives for first-home buyers and home builders;
and the slowest population growth in a century. Time will tell as to how these various factors ultimately
balance out, but history suggests that shifts in population growth can have large effects on the housing
market.
I would like to reiterate that the RBA does not target housing prices, nor would it make sense to do so.
I recognise that low interest rates are one of the factors contributing to higher housing prices and that
high and rising housing prices raise concerns for many people. There are various tools, other than
higher interest rates, to address these concerns, leaving monetary policy to maintain its strong focus on
the recovery in the economy, jobs and wages.
As part of this focus, we are continuing to pay close attention to lending standards, especially given the
combination of low interest rates and rising housing prices. Looser standards would increase
mediumterm risks and add to the upward pressure on prices, so would be of concern. Reflecting this, the
Council of Financial Regulators has indicated that it would consider possible responses should lending
standards deteriorate and financial risks increase. We are not at this point, but we are watching
carefully.
Conclusion
I will conclude by briefly drawing the 3 themes together - the recovery, investment and the outlook for
monetary policy.
The full recovery of our economy requires a further lift in business investment. Stronger investment will
also boost our productivity and provide a firm basis for stronger growth in nominal and real wages.
Globally, higher levels of investment relative to savings are also one of the keys to a return to more
normal levels of interest rates over the medium term.
The Australian economy is recovering from the pandemic and we expect this recovery to continue. We
are also expecting further progress towards the RBA's goals, although the journey back to full
employment and inflation consistent with the target is likely to be a long one. The RBA will maintain
supportive monetary settings for as long as is required to achieve these goals.
Thank you for listening and I am happy to answer your questions.
Endnotes
[*]
I would like to thank Ellis Connolly for assistance in preparing this talk.
[1]
This analysis uses data sourced from the Australian Bureau of Statistics' BLADE (Business Longitudinal Analysis Data
Environment) database (see BLADE).
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