Glenn Stevens: Economic update
Speech by Mr Glenn Stevens, Governor of the Reserve Bank of Australia, at the
Econometric Society Australasian Meeting and the Australian Conference of Economists,
Hobart, 3 July 2014.
* * *
I thank Alexandra Rush for assistance in compiling these remarks and Selwyn Cornish for comments on the
historical material.
Thank you for the invitation to visit Hobart - in winter! - and to take part in this conference.
Economics in Tasmania
This year marks a century of economics at the University of Tasmania, dating from the time
Herbert Heaton took up duties as a lecturer in History and Economics in 1914. Heaton's
pacifist and somewhat left-leaning views apparently caused some controversy, both in
Tasmania and subsequently at the University of Adelaide. He left Australia in 1925 for
Canada, and later had a successful academic career at the University of Minnesota.1
Over the ensuing period, some of the greatest names in Australian economics studied here,
taught here or otherwise carried out some part of their professional duties here. It's quite a
line-up.
There was LF Giblin, born in Tasmania, sportsman, student at Cambridge, some-time
acquaintance of the Bloomsbury Set, Yukon adventurer, enlisted soldier in middle age and
wounded three times in the First World War, Tasmanian Government Statistician, adviser to
government on economic policy in the 1930s depression and board member of the
Commonwealth Bank.
Then there were those called "Giblin's Platoon" in the very nice book of that name by William
Coleman, Selwyn Cornish and Alf Hagger:2
• Sir Douglas Copland, lecturer at University of Tasmania, the first dean of the
University of Tasmania faculty of commerce, Professor at the University of
Melbourne, adviser, contributor to Depression era policies, inaugural Alfred Marshall
lecturer at Cambridge, diplomat and founding Vice Chancellor of the Australian
National University. He was succeeded at the University of Tasmania by James
Bristock Brigden.
• Brigden, like Giblin a soldier, also wounded, post-war lecturer in Economics here at
the University of Tasmania, Director of the Queensland Bureau of Economics and
Statistics, Secretary of a number of government departments during WWII,
influential in the development of tariff and wage policies, and diplomat in
Washington.
• Sir Roland Wilson, born in Tasmania, completed a bachelor of commerce at the
University of Tasmania (taught by Brigden and Copland), where he later lectured in
economics. He was later Commonwealth Statistician, turning down a chair at the
university here to remain in Canberra, took up diplomatic roles in Washington upon
Brigden's retirement, became Chairman of the UN Employment Commission and
was the longest-serving Secretary to the Australian Treasury.3
Coleman et al. chronicle the way the relationships between these four bore fruit. It was a
remarkable period of activity for the fledgling profession in this country, and people who had
been or were associated in some way with the University of Tasmania were in the thick of it.
It might be said that, in many respects, much of the genesis of modern policy economics in
Australia occurred here in Hobart.
Every generation has its own challenges. In the careers of today's generation of economists
we have had, as described by various authors, "the Great Inflation", "the Great Moderation",
"the Great Recession". The ensuing slow recovery in the advanced countries could be
described as "the Great Disappointment", though one commentator has used stronger
language - describing it, rather biblically, as "the Great Tribulation".4
Maybe there is undue devaluation of the adjective "great" in such characterisations. Or
maybe not. The generation of Giblin et al. faced enormous challenges, especially given the
much more limited stock of accumulated knowledge at that time and the scarcity of trained
economists.5 But plenty of writers, including some who have been intimately involved in
policymaking, have seen the recent episode as potentially as catastrophic as the 1930s,
averted only due to interventions framed with the lessons of the 1930s in mind.
But a fuller evaluation of those issues may need to wait for another occasion. Today I
propose something less ambitious. In early May, the Bank published its latest Statement on
Monetary Policy. Since then we have had the Federal and some state budgets, and some
further data as well as a couple of interest rate decisions. Hence, it seems appropriate to
provide a brief update and some comments on a few issues connected with monetary policy.
Economic update
It appears that the economy's pace of growth increased somewhat in the second half of last
year, and that this persisted in the first few months of 2014. Real GDP expanded at an
annualised pace of about 3 per cent in the second half of 2013, up from just under 21⁄2 per
cent in the first half. Business survey readings are broadly consistent with this picture. The
March quarter of 2014 saw a further pick up, to something that was above trend, measured
either in the quarter or over the year.
A key question is the extent to which these recent national accounts data in particular
illustrate the likely ongoing pace of growth. The results owed a lot to a very substantial rise in
resource exports. This in turn reflected new capacity coming on stream and also unusually
benign weather. While further rises in resource export volumes are expected, they are
unlikely to be at the same pace.
Hence, the most recent set of GDP figures, while certainly encouraging, probably overstate
somewhat the true ongoing pace of growth in the economy. The Bank's forecasts from early
May, which we have not materially changed, embody ongoing growth but, in the near term,
probably a little below trend. We will provide an update of forecasts next month.
What are some of the key features of this outlook?
The world economy continues to show moderate growth, probably a little below average but
not by all that much. The advanced countries are seeing somewhat better outcomes than last
year overall, while some emerging market economies slowed somewhat during the first half
of 2014, including China.
Looking at domestic economic policies, the stance of monetary policy is very
accommodative, certainly when measured by the metric of interest rates. The level of rates,
including for borrowers, is at a 50-year low. The cash rate measured in "real" terms is
approximately zero. In either nominal or real terms the cash rate is well below "normal"
levels, and comfortably below even the mooted lower "new normal" levels. Moreover, we still
have "ammunition" on interest rates - we have not got close to the zero lower bound that has
afflicted some other countries.
The low interest rates have been having many of the effects they normally do. Savers have
altered their behaviour to look for returns in slightly more risky assets; asset prices have
risen; demand for credit has strengthened; and interest sensitive areas of spending, like
some areas of consumption and especially dwelling construction, have firmed. The exchange
rate also declined, though not by as much as might have been expected. The full effects of
the very accommodative stance of policy have not been seen at this stage. It will be
supporting demand for some time yet.
The Federal Budget seems unlikely materially to change the near-term outlook. Over the
next couple of years the estimated impact of the budget is not very different from what we
had previously been assuming, and the extent of fiscal contraction, as conventionally
measured, is actually not particularly large when compared with past episodes of fiscal
tightening.
Beyond that period, the measures in the budget will result in a more significant consolidation
than earlier assumed. It was over that more medium-term horizon that the Commonwealth's
finances, left unattended, looked like they were going to start going more seriously off
course. So the timing of the intended consolidation seems broadly sensible.
That having been said, the fact that the real issues with public finances are medium-term
ones is not a reason to put off taking decisions to address them. On the contrary, as
experience in so many other countries demonstrates, by the time these sorts of problems
have gone from being out on the horizon to on our doorstep, they have usually become a lot
more difficult to tackle. Early, measured actions that have effects that build up over time are
a much better approach than the much tougher response that might be required if decisions
were delayed.
There has been discussion about confidence effects of the budget. Some surveys do
suggest some decline in household confidence of late. It is important, though, to ask how
persistent such effects might be. Last year's budget, which contained some tough messages,
also seemed to be associated with a decline in such measures of confidence. They
recovered after a few months. We can only wait to see whether that pattern will be repeated
this year. Measures of business confidence don't show any obvious response to the budget.
While there has been much focus on budget measures, the biggest sources of uncertainty
about the pace of private demand growth remain the speed of the impending large decline in
capital spending by the resources sector, and the timing of the recovery in non-mining capital
spending and non-mining activity more generally.
The biggest and most persistent terms of trade gain in at least a century ushered in a capital
spending response by mining and energy companies that saw the private business
investment share of GDP reach a 50-year high, even though investment outside the mining
sector approached recession-level lows. Now, the terms of trade are falling, and the
investment part of the boom has peaked. Mining investment, as a share of GDP, has
probably already declined by about 1 percentage point, and is expected to fall by another
3 or 4 percentage points over the next few years.
Unlike in all previous such booms, we did not experience serious overheating in the upswing.
What is being attempted now is to negotiate the downswing phase without the slump that
characterised the aftermath of all the other booms.6 The fact that the upswing was managed
without the excesses of the previous episodes is no guarantee of success in the next phase,
but it has to be a good starting point.
We have seen some encouraging early signs of the "rebalancing" taking place. Consumer
demand has been rising moderately, even if recently perhaps a little more slowly than it did
over the summer. Residential construction is moving up strongly, and intentions to invest
outside the resources sector have started to improve, from very subdued levels. The labour
market has also shown some early indications of mild improvement.
But these signs remain early ones. There is quite some way to go yet before the episode is
completed.
Meanwhile, the environment seems likely to be one in which a number of sectors are making
serious efforts to contain costs and lift productivity (Graph 1). That amounts to an outlook for
wages and prices that does not appear to threaten the inflation target, even were we to see a
somewhat lower exchange rate. Perhaps more fundamentally, a better trend for productivity,
if we can sustain it - and especially if it can be further improved - would be a reliable basis
for optimism about the longer-run prospects for the economy and our living standards.
Graph 1
Communication about monetary policy
It is in that context that the Board has left the cash rate unchanged at 2.5 per cent for almost
a year now.
For rates to have been stable for this long isn't unprecedented. But since markets and media
commentators find the idea of masterly inaction neither appealing nor interesting, this has put
more focus on communication.
The Bank's language has evolved, given the passage of time and the flow of new
information. Up to the time of last August's meeting, the post-Board statement for some
months included language about the inflation outlook, as then assessed, providing "scope" to
ease further should that be appropriate to support demand. At the May and August 2013
meetings the Board used some of that scope. Subsequent post-meeting statements did not
include that phrasing. The minutes of those meetings simply recorded the Board's view that
"the Bank should neither close off the possibility of reducing rates further, nor signal an
imminent intention to reduce rates further". That phrasing was retained until the December
minutes.
The data that emerged over the summer saw somewhat firmer growth, a lower exchange
rate and higher inflation than had been embodied in the outlook as at the end of last year.
This led the staff forecasts for both growth and prices to be revised higher for the February
meeting and the subsequent Statement on Monetary Policy. The December quarter CPI in
particular was something of a surprise. We interpreted those data as containing a degree of
noise but could not entirely discount the possibility that they may also contain some signal.
Hence, the inflation forecast was revised up somewhat.
With both growth and inflation forecasts moving higher, it would have been odd to continue
with the earlier language. After all, policy had been eased a great deal, it seemed to be
having many of the expected sorts of effects, inflation wasn't threatening to be too low and, if
anything, was going to be higher than earlier expected, and there was mildly better news on
output. Accordingly, the Bank's communication continued to evolve in light of new
information.
Although this shift in language was quite gradual, the problem we can sometimes have in
such periods is that people may react by thinking that, if the Bank is not thinking about
easing, then it must be thinking about tightening. But we were not contemplating tightening.
In fact, the conclusion we had reached was that we might be on the brink of sitting still for
some time. That is why we adopted language about "stability" in interest rates, the intended
effect of which was to be clear to people that we did not think that higher interest rates were
imminent. That has not stopped people from opining about the timing of possible future
increases - or, indeed, decreases. That's what makes a market - people have differing
views, for various reasons.
Overall, I judge that language to have served its intended purpose. Present market pricing
suggests that market participants expect interest rates to remain low for some time yet. If
anything, pricing in recent days has suggested that, if a move were to occur over the next
several months, markets expect it would be down, not up. Any increase in rates is thought by
market participants, on average, to be unlikely for quite some time.
The evolution of language should be expected to continue, as more time passes and further
information comes to hand. Long before any thought were to be given to an increase in rates,
it would probably be sensible for the Board to cease references to a future "period of stability"
and revert to the more normal formulation that the stable policy settings "remained
appropriate" or something like that. Such an evolution would amount to no more than a
recognition that a "period of stability" had in fact already been occurring and wasn't entirely in
the future, but wouldn't imply any particular change in the Bank's views about the future
course of policy. It should go without saying that those seeking to understand our thinking
should, in any event, look not just at the wording in the post-Board statement, nor just that in
the minutes, but also at the whole analysis of the economy and the outlook in the regular
Statement on Monetary Policy.
The exchange rate
Another issue in communication has been how to describe the exchange rate. For a period
we described it as "uncomfortably high". It subsequently declined, though we suspect that
was due more to a change in mood in global capital markets than to our words per se. We
altered our language to reflect that decline, and then adjusted it again as the currency
re-traced some of that rise.
There seems to have been a very strong focus on whether the adjective "uncomfortable"
would be put into use once more in the post-Board statements. It hasn't been, though I don't
regard that to be as significant as many people seem to think it is. We have tried to avoid
frequent and large language shifts about the exchange rate. It can vary enough from month
to month that we risk chasing our tails if we seek to engage too actively in "jawboning" each
month.
But lest there be any uncertainty about this, let me be clear, again, that the exchange rate
remains high by historical standards. There is little doubt that significant parts of the
tradeexposed sectors still find it quite "uncomfortable": it continues to exert acute pressure for cost
containment, productivity improvement and business model change. When judged against
current and likely future trends in the terms of trade, and Australia's still high costs of
production relative to those elsewhere in the world, most measurements would say it is
overvalued, and not by just a few cents. Of course, we live in unusual times, with interest
rates at the "zero lower bound" in several major jurisdictions. Nonetheless, we think that
investors are under-estimating the likelihood of a significant fall in the Australian dollar at
some point.
Housing prices
Finally on communication and monetary policy generally, there is the question of housing
prices. Few issues seem as capable of sharply dividing opinions as this one. Some use the
"B" word, sometimes followed by calls for interest rates to be higher. Others regard it as
unthinkable that interest rates would ever respond to housing prices. Still others call for
regulatory actions to constrain housing lending, which, by the way, has overall remained
quite moderate so far.
The Bank's views on this have been quite consistent. We have made four points.
First, with dwelling prices having fallen between 2010 and 2012, some recovery was not in
itself particularly cause for concern, certainly not initially. Moreover, if we think there is a
need for higher construction, which we do, an environment of declining prices is probably not
conducive to that outcome. Some pick-up in housing prices as a result of lower interest rates
was to be expected; it shows that monetary policy is working and is part of the normal
transmission process.
Of course, this argument becomes less persuasive if valuations reach new highs and keep
rising. So, second, were there to be a further big run-up in prices, with past increases leading
to overconfident expectations of continuing gains, it would be a different matter. If this were
accompanied by a return to significant increases in household leverage, from already high
levels, that would be a matter for concern. It would be adding risk to the system.
But, third, to date the amount of new borrowing does not appear, overall, to be imprudent.
The rise in the value of loan approvals over the past year of around 20 per cent is certainly
significant. It's important to note, however, that scaled by the amount of credit outstanding,
the rate of this flow over recent months, while clearly well off its 2011 low point, is actually
not that high compared with longer-run history (Graph 2). It's only a little above 2008 lows, in
fact. The growth of credit outstanding for housing is about 6-7 per cent per annum, or slightly
above trend nominal income growth. It's hard to mount the soap box to complain about that
pace.
Graph 2
Nonetheless, fourth, investors should take care in the Sydney market, which is the main area
where a large increase in borrowing has been occurring. The total value of credit approvals
for investor loans in New South Wales as a whole is about 130 per cent higher than in 2008,
and it is in the investor segment where there has been evidence of some increase in lending
with loan-to-value ratios above 80 per cent in the past couple of quarters.
Here we continue to have two messages.
The first is that in forming expectations about future price gains and deciding their financing
structure, people should not assume that prices always rise. They don't; sometimes they fall.
The second is that banks and other lenders need to maintain strong lending standards.
APRA has helpfully been reinforcing this point directly with bank boards, as well as stressing
the importance of having adequate, higher, interest rate buffers in place, given the current
very low level of rates in the market.7 The maintenance of strong standards will be all the
more important given the significant improvement in access to funding via the securitisation
market over the past year and the associated increase in competition to lend.
Some segments of the housing market do appear to have been calming down lately. Prices
have flattened out in several cities and even in Sydney the pace of increase has lessened.
It remains to be seen whether this slower pace of growth in dwelling prices is temporary or
more persistent. It would in my opinion be good, for a range of reasons, if it did persist for a
while. If the next couple of years saw an unremarkable performance on prices, and
construction staying at the higher levels that will clearly be reached over the coming year, it
would be an outcome that would contribute to a balanced growth path for the economy and
to housing more people at manageable cost.
Overall, the Bank has not seen developments in the housing market as warranting higher
interest rates than the ones we have had, in the current circumstances. This isn't because
we think that financial stability considerations should be ignored in the policy decision. On the
contrary, they should be, and have been, given due weight, along with all the other factors
we have to take into account, in deciding the interest rate path we have chosen. We judge
that path to have best balanced, to date, all the various considerations.
Conclusion
I wonder whether Giblin and his "platoon" could have imagined a meeting like this: hundreds
of economists and econometricians converging, from around the country and around the
world, on Hobart for just a few days, travelling not at stately pace in ships and trains, as they
would have, but through the stratosphere at just under the speed of sound. Probably not.
But at least some of the issues about which we talk today would sound familiar to them.
Swings in the terms of trade, the effects of massive international financial events with all their
spillovers, policymakers grappling with events they had not seen before, come to mind. They
would have seen a need, as should we, for the economics profession to make a constructive
contribution to national debate about economic matters.
I hope the discussions today and over the course of the conference will help us all to play our
parts.