Speech
From Recovery to Expansion
[*]
Philip Lowe
Governor
Keynote Address at the Australian Farm Institute Conference
Toowoomba - 17 June 2021
Thank you for the invitation to join the Australian Farm Institute's conference. It is a great pleasure
for me to visit Toowoomba and to learn more about the issues facing the farm sector and regional
Australia.
As we all know, the past year has been an extremely challenging one in the life of our nation. But as
a country we pulled together, and we have been up to the task. The results are evident in our health
and economic outcomes, which are better than elsewhere in the world. It is important that we don't
lose sight of this.
This morning, I would like to talk about how the economy is now transitioning from recovery mode
to expansion mode, and highlight some of the issues that this raises, including for regional Australia.
I will then conclude with some comments about the outlook for monetary policy.
Back in March last year, the national economic strategy quickly turned to building a bridge to the day
when the virus was contained. The idea was to use this bridge to help people and businesses get
across to the other side. The hope was that by doing this, we could avoid much of the costly damage
that would be caused by mass unemployment and widespread business failures. This was the right
strategy, and it was supported by governments across Australia, the RBA and Australia's financial
institutions. The results speak for themselves.
Today, the level of employment in Australia is above its pre-pandemic level. Australia and New
Zealand are the only advanced economies where this is the case (Graph 1). In the United States,
employment is still nearly 5 per cent below the pre-pandemic level and in Spain it is 3 per cent
below.
Graph 1
Change in Employment
Since December 2019
% %
0 0
-2 -2
-4 -4
-6 -6
Italy
Spain
Korea
Japan
States
France
Canada
Zealand Sweden
Australia
Kingdom
Germany
Switzerland
Netherlands
South
New
United
United
Sources: RBA; Refinitiv
The GDP data also paint a positive picture of the recovery, which has been V-shaped (Graph 2). The
level of output in Australia is now above its pre-pandemic level; not many other countries are in this
same position. The bounce-back has been quicker and stronger than was widely expected; back in
August we did not expect the previous level of output to be regained before the first half of 2022,
yet here we are already.
Graph 2
GDP Growth
% %
Year-ended
4 4
2 2
0 0
Quarterly
-2 -2
-4 -4
-6 -6
-8 -8
2005 2009 2013 2017 2021
Source: ABS
There has also been a sharp V-shaped recovery in farm output (Graph 3). After the devastating
drought, farm output is up 40 per cent since the middle of last year, and now stands at a record
high. Rural exports are also at a record high. This recovery in the farm sector is positive news not
only for those in the industry and the communities that support it, but it is also making a welcome
contribution to the recovery in the national economy.
Graph 3
Farm GDP
Chain volume, quarterly, 2018/19 prices
$b $b
11 11
10 10
9 9
8 8
7 7
6 6
5 5
2001 2005 2009 2013 2017 2021
Source: ABS
As positive as these outcomes are, it is important not to lose sight of the fact that we are still in the
recovery phase. Our international borders are still largely closed, outbreaks of the virus are still
leading to periodic lockdowns, and many firms are still adjusting to changes in how people spend
their money and where they work. It is also worth recalling that the economic recovery is being
underpinned by unprecedented fiscal and monetary policy measures that will not last forever. So we
still have a way to go before the recovery is complete.
It is time, though, to be thinking about how we transition from recovery mode to expansion mode
and consider the issues that will affect that transition. I would like to touch on 3 of these issues this
morning, including:
how household spending evolves in light of the substantial changes in household balance
sheets
the tightening of the labour market and its implications for wages and prices
the need for further productivity growth.
Household balance sheets
One of the stand-out features of the past year has been the large increase in household saving. Last
June, the saving rate spiked to 22 per cent, the highest level on record (Graph 4). This increase in
saving reflected the combination of: the boost to incomes from government support; the limited
opportunities to spend; and households feeling uncertain about the future. While the saving rate has
since declined as restrictions have been eased, it remains high by historical standards. The fact that
households have saved more means that, in aggregate, household balance sheets are in better
shape than they were previously.
Graph 4
Household Net Saving Rate
Quarterly
% %
20 20
15 15
10 10
5 5
0 0
-5 -5
1996 2001 2006 2011 2016 2021
Sources: ABS; RBA
Household balance sheets have also been affected by the recent rise in housing prices. This rise has
been a nationwide development, but was first seen in parts of regional Australia, with price gains in
many areas outstripping those in the capital cities. (Graph 5). Global factors, including low interest
rates, have played a role here. But there has also been strong demand for properties in regional
Australia due to people moving out of the capital cities and fewer people leaving regional areas
during the pandemic. The effects of this are evident not just in prices but in rental markets too, with
rents rising quickly in many regional centres (Graph 6).
Graph 5
Housing Prices
March 2020 = 100, seasonally adjusted
index index
100 100
Regional*
Capital cities*
80 80
60 60
40 40
2005 2009 2013 2017 2021
*
Capital cities index captures the 8 capital cities; the regional index
captures the rest of Australia
Sources: CoreLogic; RBA
Graph 6
Advertised Rents
March 2020 = 100, seasonally adjusted
index index
New South Wales Queensland
Capital city
100 100
Regional
75 75
50 50
2009 2015 2021 2009 2015 2021
Sources: CoreLogic; RBA
How households respond to these changes in their balance sheets will help shape the next stage of
the recovery. If households were to run down their additional savings quickly or if higher housing
prices spurred more spending than usual, a stronger economic path than the one we have envisaged
could eventuate. On the other hand, it is possible that households sit on these extra savings for a
long time and restrain their spending because of uncertainty about the future. If so, this would slow
the recovery. So this is an issue we are watching carefully.
It is also worth noting that the rise in housing prices is encouraging more housing construction. The
challenge here is to make sure that planning processes are sufficiently flexible to allow the supply
side of the market to respond to the extra demand; regional centres should be better placed on this
front than capital cities, although this is not always the case. A related challenge is to find the
workers to build the new housing in regional Australia - an issue to which I will return shortly.
The other aspect of the housing market that we are paying close attention to is the increase in
household borrowing. The RBA does not, and should not, target housing prices. We do though have
a strong interest in trends in household borrowing, especially given the already high level of
household debt in Australia. It is important that lending standards remain sound in an environment
of low interest rates and rising housing prices. At its meeting last week, the Council of Financial
Regulators also discussed the risks that could arise if growth in household borrowing substantially
outpaced growth in household income. This is not the case at the moment, but the Council did
discuss possible policy responses to a scenario in which rapid growth in household debt posed
heightened risks to the future stability of the economy.
The labour market
I would now like to turn to the second issue and that is the labour market.
The recovery here has been much stronger than was anticipated. The result is that the national
unemployment rate fell to 5.5 per cent in April, which is just a little higher than before the pandemic.
Job vacancies and job ads are at high levels and hiring intentions are very strong. Given this, we are
expecting the unemployment rate to trend lower over the months ahead, with our central scenario
being that unemployment declines to around 41⁄2 per cent by the end of 2022.
The improvement in the labour market is especially evident in many regional communities (Graph 7).
For the first time in many decades unemployment in regional Australia is noticeably lower than it is in
the capital cities. There is still a lot of variation across regions, but the average unemployment rate
for regional Australia as a whole is at its lowest level in more than a decade.
Graph 7
Unemployment Rate*
% %
8 8
Regional areas
6 6
Capital cities
4 4
2 2
2001 2006 2011 2016 2021
*
Seasonally adjusted by the RBA
Sources: ABS; RBA
The labour market is uneven, though. Many people are still struggling to find work, while, at the
same time, some firms are reporting that they are finding it difficult to find workers. Many of these
reports come from businesses in regional Australia, including those in the agricultural, hospitality,
mining and construction sectors. And in nationwide business surveys, many firms are now saying
that finding suitable labour is a major constraint on output (Graph 8).
Graph 8
Constraints on Output
Share of firms reporting significant or minor constraint
% %
Sales & orders
80 80
Suitable labour
60 60
40 40
20 20
Availability of materials
0 0
1991 1997 2003 2009 2015 2021
Sources: NAB; RBA
Notwithstanding these signs of a tightening labour market, wages growth and inflation remain
subdued and there have not been upside surprises. The Wage Price Index increased by just
11⁄2 per cent over the past year, with wages growth slow in the private and public sectors (Graph 9).
And it is noteworthy that even in those pockets where firms are finding it hardest to hire workers,
wage increases are mostly modest. There are some exceptions to this, but they are fairly isolated.
Graph 9
Wage Price Index Growth*
% %
Year-ended
4 4
3 3
2 2
Quarterly
1 1
0 0
2001 2006 2011 2016 2021
*
Total hourly rates of pay excluding bonuses and commissions
Source: ABS
This experience speaks to a broader dynamic in the economy that has been evident for some time
and is contributing to the subdued wage and price outcomes.
Most businesses feel they are operating in a very competitive marketplace and that they have little
ability to raise prices. As a result, there is understandably a laser-like focus on costs: if profits can't
be increased by expanding or by raising prices, then it has to be achieved by lowering costs. This has
become the predominant mindset of many businesses. This mindset can be helpful in making
businesses more efficient, but it also has the effect of making wages and prices less responsive to
economic conditions.
This mindset became entrenched during the resources boom when the exchange rate appreciated
very significantly. When one Australian dollar was worth more than one US dollar, many Australian
businesses felt that their Australian dollar cost structure was simply too high. You might recall that
through this period many businesses were saying that Australian costs, including labour costs, were
leaving them uncompetitive. This experience has left a lasting imprint on many businesses and it has
reinforced the narrative about the importance of cost control.
Against this background, the economy is now recovering from the pandemic and some firms are
finding themselves facing labour shortages. At least some of these business face a choice: do they
increase wages in an effort to attract new employees and put up their prices or do they pursue
another strategy?
Many firms are choosing this second option, relying on non-wage strategies to retain and attract
staff. Some are also adopting a 'wait and ration' approach: wait until labour market conditions ease,
perhaps when the borders reopen, and until then, ration output. For some, this is a better option
than paying higher wages and driving up their own cost base. This is especially so if: increases in the
cost base are difficult to reverse later on; there is a reluctance to increase prices; and the business
expects labour market conditions to ease before too long. By waiting and rationing, firms can avoid
entrenching a higher cost structure in response to a problem that might be only temporary.
The underlying point here is that there are a range of factors that are contributing to limited upward
pressure on wages, even in tight labour markets. I have previously talked about the effects of
globalisation, technology and industrial relations arrangements. While there is always a degree of
uncertainty about the future, we are not expecting the influence of these various factors to wane
quickly. Some are structural in nature and others will not be overcome until a tight national labour
market is sustained for some time. As I will discuss shortly, our monetary policy strategy is designed
to achieve this. It is also noteworthy that fiscal policy is also seeking to achieve lower unemployment
in Australia.
Productivity growth
I would now like to turn to a third issue that will shape the expansion: that is productivity growth.
Earlier, I spoke about how the economic strategy during the early days of the pandemic was to build
a bridge to the other side. On the fiscal front, that bridge was built by governments borrowing
against future national income to support households and businesses in the here and now. This was
the right thing to do. It was affordable and the higher level of public debt that has resulted from this
is manageable.
The stronger our future national income is, the more this strategy makes sense. It is for this reason
that I have raised the issue of productivity growth. The best response to higher debt levels is
stronger growth in future national income, underpinned by a more productive economy.
Over the past year, Australia's national income has once again been boosted by the higher prices for
our exports. Australia's terms of trade are now approaching the once-in-a-century peak reached
during the resources boom a decade ago (Graph 10). There has been a lot of focus on the price of
iron ore, but the prices of many agricultural commodities have also increased substantially
(Graph 11). Since the start of 2019, wheat prices have increased by 15 per cent, beef prices are up
by 20 per cent and lamb prices are up by 25 per cent. The prices of canola, sugar and cotton have
also increased sharply over the past year.
Graph 10
Australia's Terms of Trade*
2018/19 = 100
index index
120 120
100 100
80 80
60 60
40 40
1901 1941 1981 2021
*
Annual data from 1870 to 1959; quarterly data from September 1959
Sources: ABS; Gillitzer and Kearns (2005); RBA
Graph 11
Rural Commodity Prices
January 2016 = 100, SDR
index index
Total Beef
125 125
100 100
index index
Lamb Wheat
150 150
100 100
50 50
2018 2021 2018 2021
Sources: Bloomberg; Landmark; MLA; RBA
These higher commodity prices are welcome news and they are helping the national recovery. But,
ultimately, it is a more productive economy that will form the basis of sustainable increases in future
national income. As has been well documented, labour productivity growth in Australia had slowed
prior to the pandemic (Graph 12). The reasons for this are complex and they are not fully
understood, but it is likely that this slowing is related to the subdued levels of investment over recent
times.
Graph 12
Labour Productivity*
March 1993 = 100, log scale, quarterly
index index
1993-2002 2003-2014 2015-2021
150 150
0.6%
1.2%
125 125
2.4%
100 100
75 75
1996 2001 2006 2011 2016 2021
*
GDP per hour worked; black lines denote linear trend; labels show
average annual growth
Sources: ABS; RBA
From this perspective, it was pleasing to see a pick-up in business investment in the recent national
accounts. Machinery & equipment investment increased by 10 per cent in the March quarter and was
particularly strong in the manufacturing, construction, retail and farm sectors, as firms responded to
the government incentives. The farm sector had been at the forefront of this pick-up in investment,
with tractor sales surging over the past year (Graph 13).
Graph 13
Tractor Sales
Seasonally adjusted, quarterly
'000 '000
4.0 4.0
3.5 3.5
3.0 3.0
2.5 2.5
2.0 2.0
2009 2013 2017 2021
Sources: Agriview; RBA
This pick-up in business investment is welcome, but we have a fair way to go to reverse the decline
in investment over the past decade. If we are to build the capital stock that is needed for a more
productive economy and a durable expansion, a further lift in business investment is required.
This should be possible, as there are investment needs and opportunities in many areas of our
country. The government has rightly identified the digital economy as one of these areas. The farm
sector knows this, with some exciting opportunities in the area of agtech. Ongoing investment in
infrastructure and human capital is also needed. Further investment is also required in the energy
sector, where technology is evolving quickly, as are the attitudes of investors. The changes in the
global energy system are opening up new sources of comparative advantage for Australia. We will
need more investment to capitalise on this advantage, with much of this investment being in regional
Australia. How well we do this will have a bearing on our future national income and the shape of
the ongoing expansion.
Monetary policy
I would now like to turn to monetary policy, which has played an important role in building the
bridge that I spoke about earlier. The RBA's actions have led to the lowest funding costs on record, a
banking system that is flush with liquidity and very low bond yields. The actions have also meant
that the exchange rate is lower than would otherwise have been the case and household and
business balance sheets are stronger. This has been our contribution to the recovery in jobs and
economic activity.
At the Reserve Bank Board's next meeting we have 2 important decisions to make. The first is
whether or not to extend the yield target from the April 2024 bond to the next bond, which matures
in November 2024. And the second is whether, and in what form, to extend the bond purchase
program once the current program is completed in September.
The 3-year yield target was introduced in March 2020 during an exceptional period. Our judgement
is that it has been a successful monetary policy response, which has helped keep funding costs low
and reinforced our forward guidance about the cash rate.
At the time the target was introduced, the 3-year government bond had a maturity date in early
2023. At that time, the Board recognised that the pandemic would require an extended period of
very accommodative monetary policy. Reflecting this, the Board's view was that the probability was
extremely low that the conditions for an increase in the cash rate would be met within 3 years.
Adopting a 3-year yield target reinforced that message.
Now, with the passage of time, the 3-year government bond has a maturity date of April 2024 and,
in a few months' time, the maturity date will move to November 2024. In considering whether or not
to extend the target to the November 2024 bond, the central issue is again the probability of the
cash rate increasing over a 3-year window. In this context, the Board has reviewed a range of
possible scenarios. In some of these, the conditions for an increase in the cash rate could be met
during 2024, while in others these conditions are not met. The Board will review these scenarios
again at its next meeting.
The bond purchase program has also been an important part of the RBA's monetary policy response.
It has lowered bond yields and funding costs across the economy and contributed to a lower
exchange rate. With the current 6-month bond purchase program to be completed in September, the
Board has been working through a range of options for what comes next. These options include:
i. ceasing purchasing bonds in September;
ii. repeating the current $100 billion purchase program over a similar time frame;
iii. scaling back the amount purchased or spreading the purchases out over a longer period;
or
iv. moving to an approach where the pace of the bond purchases is reviewed more
frequently, based on the flow of data and the economic outlook.
We have made no decisions yet, other than to rule out the first option - the cessation of bond
purchases in September. The RBA's bond purchase program is one of the factors underpinning the
accommodative conditions necessary for our economic recovery. It is premature to be considering
ceasing bond purchases.
The key consideration in our decision here is how the RBA can best support the ongoing recovery of
the economy. The Board wants to see the recent recovery transition into strong and durable
economic growth, with low unemployment and faster growth in wages than we have seen recently.
Over time, this will help achieve the inflation target.
As part of the Board's overall strategy, it will not increase the cash rate until inflation is sustainably
within the 2-3 per cent target range. Year-ended CPI inflation will temporarily spike in the June
quarter to around 31⁄2 per cent due to the unwinding of some pandemic-related price reductions.
There have also been price increases for some items due to pandemic-related interruptions to
supply. But beyond this, inflation pressures remain subdued and are likely to remain so. For inflation
to be sustainably in the 2-3 per cent range, wage increases will need to be materially higher than
they have been recently. Partly for the reasons I talked about earlier, this still seems some way off.
Thank you for listening. I look forward to your questions.
Endnote
[*] I would like to thank Penny Smith for assistance in preparing this talk.