Speech
An Economic Update
[*]
Philip Lowe
Governor
Address to the Armidale Business Chamber
Armidale - 24 September 2019
I would like to thank the Armidale Business Chamber for the invitation to speak this evening. I grew
up in regional New South Wales - in Cootamundra and Wagga Wagga - so it is a treat for me to
have been invited to speak in another great regional city. Thank you.
Tonight, I would like to provide you with an economic update. I will focus first on the global situation
and then talk about the Australian economy. And finally, I will make some remarks about monetary
policy.
The main message on the global economy is that while it is still growing reasonably well, the risks
are increasingly tilted to the downside. The main source of these downside risks are geopolitical
developments in many parts of the world. These developments are creating considerable uncertainty
and this uncertainty is causing businesses to reconsider their spending plans. This is making the
international environment more challenging for us.
On the Australian economy, there are two main messages.
The first is that after having been through a soft patch, a gentle turning point has been reached.
While we are not expecting a return to strong economic growth in the near term, we are expecting
growth to pick up. Against this backdrop, the main source of domestic uncertainty continues to be
the strength of household spending.
The second message is a longer-term one. And that is the fundamental factors underpinning the
longer-term outlook for the Australian economy remain strong. One of the ongoing challenges we
face as a country is to capitalise on those strong fundamentals.
The Global Economy
This first graph shows global economic growth and the International Monetary Fund's (IMF) forecasts
for the next few years (Graph 1). Looking at this graph, one might ask why the concern: global
growth has been stable and reasonable over recent times and the IMF is forecasting this to continue
over the next couple of years. If this forecast were to come to pass, that would make for 12 years of
solid growth.
Graph 1
Looking at labour markets, one might also ask why the concern. Unemployment rates in most
advanced economies are the lowest they have been in many decades, and businesses are finding it
more difficult to fill jobs (Graph 2). These tighter labour markets are finally translating into stronger
wages growth, with wages now increasing at close to the rates seen before the financial crisis in
some countries. With inflation remaining low, this pick-up in wage growth is translating into real
wage increases and strong growth in household spending.
Graph 2
So why the concern?
The answer is the increased downside risks generated by various geopolitical developments. The
most prominent of these are the trade and technology disputes between the United States and
China. Others include: the Brexit issue, developments in the Middle East, the problems in Hong Kong
and the tensions between Japan and South Korea.
The US-China disputes, in particular, are having a disruptive effect on international trade flows. Over
the past year there has been no growth at all in international trade, despite the global economy
growing at a reasonable rate (Graph 3). This weakness on the trade front is flowing through to
factory output, with growth in industrial production slowing considerably.
Graph 3
More broadly, though, the geopolitical concerns are creating considerable uncertainty about the
future. This can be seen in measures of economic policy uncertainty constructed from news stories in
leading media around the world (Graph 4).
Graph 4
In the face of this uncertainty, it is not surprising that many businesses are preferring to wait before
committing to significant investments; they are inclined to sit on their hands for a while and see how
things play out. This is evident in the surveys of business investment intentions, which have fallen
considerably (Graph 5). The effect is also evident in June quarter GDP figures, with GDP declining in
Germany, the United Kingdom and Singapore.
Graph 5
A particular concern is that if this uncertainty continues, businesses might decide not only to defer
investment, but to also defer hiring. Of course, it is also possible that some of these uncertainties will
be resolved. If this were to happen, the global economy could grow quite strongly as firms caught up
on their capital spending in an environment of easy financial conditions.
Notwithstanding this possibility, as the downside risks have come more clearly into focus, there has
been a marked shift in the outlook for monetary policy globally. Almost all major central banks are
expected to ease monetary policy over the year ahead, with the United States Federal Reserve and
the European Central Bank having already moved in this direction (Graph 6). Given that inflation is
low - and forecast to remain low - investors are also expecting central banks to maintain very
accommodative settings of monetary policy for years to come.
Graph 6
This expectation has had a major effect on long-term bond yields around the world. In Europe and
Japan, investors are paying governments to hold their money for them (Graph 7). The Swiss
Government, for example, can borrow for 30 years at a negative interest rate of 0.5 per cent. For the
world as a whole, around a quarter of the total stock of government bonds on issue has negative
yields. And where yields are in positive territory, they are at very low levels and in many cases at the
lowest on record.
Graph 7
All this is making for a challenging international environment.
The Australian Economy
I would now like to move to the Australian economy.
Over recent times, our economy has been going through a soft patch. Over the year to June, GDP
grew by just 1.4 per cent, which is the slowest year-ended growth for some years (Graph 8). We did
not expect this slowdown, so it has come as a bit of a surprise.
Graph 8
It is important, though, that we keep things in perspective. The economic expansion in Australia has
now been running for 28 years. That is quite an achievement. Over such a long expansion, there are
going to be ebbs and flows in growth. There are also going to be periods where growth is stronger
than expected - as it was in the first half of 2018 - and other periods, like now, where growth is
weaker than expected.
With the benefit of hindsight, there are a few factors that help explain the slowing in the Australian
economy over the past year.
One is the international developments that I spoke about earlier. While Australia has been less
directly affected by the US-China trade disputes than have many other countries, there is an indirect
effect through slower global growth and increased global uncertainty.
A second and more important factor is weak consumption growth.
Over the past year, there has been no growth at all in consumption per person, which is an unusual
outcome at a time when employment is growing strongly (Graph 9). An important part of the
explanation here is that household disposable income has been increasing only slowly for an
extended period, reflecting both subdued wage increases and strong growth in taxes paid.
Graph 9
The persistence of slow growth in household income has led many people to reassess how fast their
incomes will increase in the future. As they have done this, they have also reassessed their spending,
particularly on discretionary items, which has been quite weak over recent times (Graph 10). Not
surprisingly, spending on household essentials has been much less affected.
Graph 10
Another part of the explanation for weak growth in household spending is the adjustment in the
housing market. As housing prices have fallen, there has been a marked decline in housing turnover,
with the turnover rate having declined to the lowest level in more than 20 years (Graph 11). With
fewer of us moving homes, spending on new furniture and household appliances has been quite soft.
So too has expenditure on moving costs and real estate fees. More broadly, the correction in the
housing market has also affected the economy through its impact on residential construction activity.
Graph 11
A third factor contributing to the slower growth has been the drought.
Across the Murray-Darling Basin, including here in the Northern Tablelands, farmers have faced
extremely dry conditions. Indeed, as indicated in this graph, in some areas conditions have been the
driest on record (Graph 12). Reflecting this, farm output in Australia has fallen for the past two years
and there has been a sharp drop in farm income as farmers have had to cope with the increased
costs for obtaining feed and water. These difficult conditions have contributed to the weakness in
overall household incomes and consumption, and the effects are particularly felt in regional
communities. The drought has also put upward pressure on food prices over the past year,
particularly for bread, milk and meat. We are all hoping that the drought breaks soon.
Graph 12
© Commonwealth of Australia 2019, Australian Bureau of Meteorology; available at
<http://www.bom.gov.au/climate/drought/> under Creative Commons Attribution 3.0 Australia Licence.
Full terms at <http://creativecommons.org/licenses/by/3.0/au/>.
Even after accounting for these three factors - the slowdown overseas, weak growth in household
disposable incomes and the drought - part of the slowing in the Australian economy remains
unexplained. This is especially so taking into account the labour market data, which continue to paint
a stronger picture of the economy than the GDP data.
Over recent times, employment growth has been stronger than was expected. Over the past year,
the number of people with a job increased by 21⁄2 per cent (Graph 13). Reconciling this with GDP
growth of just 11⁄2 per cent remains a challenge, because, normally, output growth exceeds
employment growth, rather than falls short. We are seeking to understand what is going on here. It
is possible that it is just measurement noise, but we can't yet rule out something more structural.
Graph 13
The other striking feature of the labour market over recent times has been a large increase in labour
supply. In particular, there has been a material lift in the labour force participation by women and by
older Australians (Graph 14). As a result, the increase in labour supply has more than outstripped the
increase in labour demand. Reflecting this and despite the strong employment growth, the
unemployment rate has moved higher since the start of the year to 51⁄4 per cent.
Graph 14
This increase in labour supply is a positive development, but it does mean that it is proving quite
difficult to generate a tight labour market with the flow-on consequence that wage increases remain
subdued. Over the past year, the Wage Price Index increased by just 2.3 per cent (Graph 15). This is
a pick-up from the rates of recent years, but the lift in wages growth looks to have stalled recently.
Another relevant factor here is the ongoing caps on wage increases in the public sector.
Graph 15
Low wages growth is one of the factors contributing to low inflation outcomes. Over the year to
June, inflation was 1.6 per cent, in both headline and underlying terms (Graph 16). Another
contributing factor is the adjustment in the housing market, with rents increasing at the slowest rate
in decades and declines being recorded in the price of building a new home in some cities
(Graph 17). Another factor is various government initiatives to address cost-of-living pressures, with
these initiatives pushing down inflation in administered prices. The price rises for utilities are also
much lower than over recent years. Working in the other direction, the drought and the depreciation
of the exchange rate have been pushing up retail prices over the past year.
Graph 16
Graph 17
Looking forward, there are some signs that, after a soft patch, the economy has reached a gentle
turning point. This is evident in the fact that GDP growth over the first half of this year was stronger
than it was over the second half of last year (Graph 8). We are expecting a further modest pick-up in
the quarters ahead.
This outlook is supported by a number of developments, including lower interest rates, the recent tax
cuts, the depreciation of the Australian dollar, ongoing spending on infrastructure, the stabilisation of
the housing markets in some cities and a brighter outlook for the resources sector. It is reasonable
to expect that, together, these factors will see growth in the Australian economy return to around its
trend rate next year, although there are some obvious risks to this outlook.
One factor that should help is an expected pick-up in household disposable income. Many
households are currently receiving larger tax refunds due to the low and middle income tax offset.
These payments will boost aggregate household income by 0.6 per cent this year. Past experience
suggests that around half of these tax refunds will be spent over coming quarters. Household
disposable income is also being boosted by lower interest rates, although the effect is uneven across
the community, with lower rates reducing the income of those households who rely on interest
income. Household spending should also be supported by an increase in housing turnover. Working
in the other direction, though, is a further contraction in residential construction activity.
Another positive element is likely to come from the resources sector. Mining investment is expected
to increase over the next year, after having declined for six years as the LNG investment boom
wound down (Graph 18). Mining companies are increasing their investment not only to sustain their
current production levels but, in some cases, to expand capacity as well. There has also been a pick-
up in exploration activity. To be clear, we are not predicting a return to boom-time conditions in the
resources sector. But we are predicting better times for the sector ahead.
Graph 18
Business investment elsewhere in the economy is also expected to move higher. Earlier I discussed
how uncertainty globally is affecting the outlook for investment in many countries. Fortunately, we
don't see the same spike in the measure of policy uncertainty in Australia that I showed in the earlier
graph for the world economy. There has, however, been some softening in measures of business
conditions - from well above average to around average.
The investment outlook is being supported by a solid pipeline of infrastructure projects. This ongoing
investment in infrastructure 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 providing better services and reducing transport congestion.
Together, it is reasonable to expect that these various factors will see annual growth pick up from
here. Apart from the international uncertainties, the main source of uncertainty around this outlook
continues to be the strength of household spending. It remains the case that a sustained pick-up in
household spending will require faster growth in household incomes than we have seen over recent
times.
As we grapple with these issues, it is important that we do not lose sight of the fact that the
Australian economy has strong fundamentals.
Australia is fortunate in having enviable endowments of natural resources, both in terms of minerals
and agricultural land. We have a reputation as a highly reliable supplier and a producer of
highquality clean food. We also have close links with the rapidly growing countries of Asia. Three of the
four most populous countries in the world - China, India and Indonesia - are in our neighbourhood.
And our ties with these countries are strengthened by the many people from there who live, work
and study in Australia.
Our demographics are also reasonably favourable. Our population is aging less quickly than that of
many other advanced economies. The population is also growing relatively rapidly for an advanced
economy - 1.7 per cent a year, compared with 0.6 per cent in the United States and declining
populations in some countries in north Asia and Europe. Immigration has been a strong contributor
to this: almost half of us were born overseas or have at least one parent who was born overseas.
While we have struggled to meet the infrastructure needs that come with this growing population, it
does bring a dynamism that is not easily matched in countries with declining populations.
We also have a highly talented, flexible and adaptive workforce. We have strong public institutions, a
well-established macroeconomic framework, and the rule of law is respected. There is also a
demonstrated record of responsible fiscal policy and low public debt. And, finally we benefit from
having both a flexible exchange rate and a flexible labour market. So, our fundamentals are strong.
The challenge we face is to fully capitalise on these fundamentals. If we can do this then I am
confident that we can, once again, experience strong growth in real incomes in Australia.
Monetary Policy
I would like to finish with some remarks about monetary policy.
As you would be aware, the Reserve Bank Board lowered the cash rate in June and July to a new low
of 1 per cent. Financial markets are pricing in further reductions in the cash rate over the next year.
Our decisions - and the expectations of investors about the future - reflect both international and
domestic factors.
On the international front, as I discussed earlier, interest rates around the world are low and they
are moving lower. There are many reasons for this, but the central reason is that the global appetite
to save is elevated relative to the global appetite to use those savings to invest in new productive
capital. When lots of people want to save and there is not much demand for those savings, savers
earn low returns.
We live in an interconnected world, which means that we cannot completely insulate ourselves from
long-lasting shifts in global interest rates. Our floating exchange rate gives us a degree of monetary
independence, but we can't ignore structural shifts in global interest rates. If we did seek to ignore
these shifts, our exchange rate would appreciate, which, in the current environment, would be
unhelpful in terms of achieving both the inflation target and full employment.
As I have spoken about on other occasions, the key to more normal interest rates globally is
addressing the factors that are leading to a depressed appetite to invest relative to the appetite to
save. Whether or not this will happen, time will tell. But as a small open economy, we have to take
the world and global interest rates as we find them.
On the domestic front, there has been an accumulation of evidence over recent times that the
economy can sustain lower rates of unemployment and underemployment than previously thought
likely. The flexibility of labour supply also means that strong rates of employment growth can be
sustained without inflation becoming a problem. These are both positive developments.
Inflation has been below the 2-3 per cent medium-term target range for some time now for the
reasons that I spoke about earlier. Looking ahead, inflation is expected to pick up, but to remain
below the midpoint of the target range for some time to come.
The decisions to ease monetary policy in June and July were taken to help make more assured
progress towards full employment and the inflation target. Further monetary easing may well be
required. While we are at a gentle turning point and expect growth to pick up, the strength and
durability of this pick-up remains to be seen.
Regardless of the short-term outlook for monetary policy, the point about the solution to low global
rates is relevant here in Australia too. We will all be better off if businesses have the confidence to
expand, invest, innovate and hire people. Given Australia's strong fundamentals, this is not out of
our reach, but it does require constant effort.
At our Board meeting next week, we will again take stock of the evidence. It is nevertheless likely
that an extended period of low interest rates will be required in Australia to make progress in
reducing unemployment and achieving more assured progress towards the inflation target. The
Board is prepared to ease monetary policy further if needed to support sustainable growth in the
economy, make further progress towards full employment, and achieve the inflation target over time.
Thank you for listening. I look forward to answering your questions.
Endnotes
[*] I would like to thank Ellis Connolly for assistance in the preparation of this talk.
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