vy RESERVE BANK OF AUSTRALIA

Speech
Economic Conditions in Post-Pandemic Australia
with a Regional Lens

Michele Bullock !*!

Governor

Rotary Club of Armidale Annual Lecture
Armidale - 8 August 2024

Thank you to Rotary Club of Armidale for hosting me today. And a worthy cause raising funds for the
University of New England SMART Region Incubator. It is particularly good to be standing here in
Armidale where I grew up and went to university. I see many familiar faces in the crowd, including
school and university friends, and parents of friends. My school maths teacher. And last but not least
my parents who have come back to Armidale to hear me speak today. I am really thrilled by the

turnout here.

I will do two things in my speech today. First, I will briefly set out the Reserve Bank Board's
framework for setting monetary policy and then give some context for the Board's decision on
Tuesday to hold the cash rate steady. I will then talk about economic conditions in regional Australia
since the pandemic and offer some reflections on challenges and opportunities facing these parts of

the country.

How the RBA sets monetary policy

The mandate of the Reserve Bank Board is to contribute to the economic prosperity and welfare of
the Australian people by delivering price stability and full employment. In practice, this means setting
monetary policy to keep inflation between 2 and 3 per cent and employment at the maximum level
that is consistent with maintaining low and stable inflation. We achieve this by setting the interest

rate on overnight loans between banks ('the cash rate'). The cash rate influences other interest rates

in the economy, affecting the behaviour of borrowers and lenders, economic activity and ultimately

the rate of inflation.

That sounds straightforward. But it is quite complex. It involves the Board assessing current
economic conditions, forecasting how the economy is likely to evolve over the coming year or so,
considering the risks and trade-offs and then deciding what level of interest rates is required to
deliver an inflation rate of between 2 and 3 per cent, while at the same time keeping the
unemployment rate as low as possible. The experience since the pandemic has demonstrated just

how complex this can be.

Since the pandemic, there has been a worldwide surge in inflation (Graph 1). Initially it was driven by
disruptions to supply chains. Resurgent demand coincided with difficulties getting goods produced
and distributed around the world, which led to large price rises. Then, when Russia invaded Ukraine,
there was a second shock as energy prices rose dramatically. As with other countries, Australia felt
the impacts of these shocks. We saw inflation rise sharply, peaking at 7.8 per cent at the end of

2022. We hadn't seen inflation this high in more than 30 years.

Graph 1
CPI Inflation

Year-ended with contributions

%

- Total ® Rents %
!) Services* Mi Selected goods**
Wi Utilities I -jOther***

2019 2020 2021 2022 2023 2024

Includes market services and administered items; excludes utilities,
rents and holiday travel & accommodation.

Includes groceries, alcohol & tobacco, consumer durables and
new dwellings.

*** Primarily holiday travel & accommodation and fuel.
Sources: ABS; RBA.

2K

But higher inflation wasn't all due to supply shocks. There was also a surge in demand as countries
came out of the pandemic and people were keen to spend on goods and activities that were
restricted during lockdowns. So central banks around the world increased interest rates sharply - first
to remove the stimulus from very low interest rates and then to move them into restrictive territory

where they would start to restrain demand.

Australia too has seen a sharp rise in interest rates. The cash rate has risen from 0.1 per cent in April
2022 to 4.35 per cent today. The most obvious area where this has had an impact is on the interest
rates paid by households with mortgages. It has increased their payments, which in turn has reduced
the amount of spare cash they have to spend on other goods and services. In this way, it has
lowered demand. But it has also led to an increase in interest rates on deposits, which has been
beneficial for those who have savings. These cash flow effects, though, are just one way in which
monetary policy works through the economy. Higher interest rates also reduce incentives to borrow,

lower the demand by firms to invest, support the exchange rate, and by themselves weigh on asset

prices and hence wealth. All these effects lead to lower growth of demand in the economy, thereby

helping to bring it back into better balance with supply.

Which brings me to Tuesday's Board decision. The most recent inflation reading shows that while
inflation is lower than it was a year ago, it is still too high. Inflation in many goods prices has
declined but inflation in services prices is high and proving very sticky. And the reason for this is that
demand for goods and services in the economy is still higher than the ability of the economy to
supply those goods and services. A key point to make here is that demand recovered very strongly
after the pandemic, to quite a high level. So even though demand growth has been fairly weak
recently, this slowing has not been enough to restore balance in the economy. The Board has been
trying to bring inflation down by slowing the growth of demand to bring it back into line with supply.
And it has been trying to do this while preserving as many of the gains in the labour market as

possible. We've described this as the 'narrow path'.

At its meeting on Tuesday, the Board noted two things. First, that although growth in the economy
has been weak, estimates suggest that the gap between aggregate demand and aggregate supply in
the economy is larger than previously thought and this is resulting in persistent inflation. It also
noted that the growth of demand looks like it will pick up over the next year, although there is
considerable uncertainty around the outlook. The effect of this is that the Board's expectations for
when inflation will come back to target have been pushed out. We don't expect to be back in the 2-3
per cent target range until the end of 2025 - over a year away. This is why the Board explicitly
considered whether another interest rate rise was required to ensure inflation continues to decline in
a reasonable timeframe. On balance, the Board decided to keep interest rates on hold, judging that
such an outcome would still meet the Board's mandate to balance its inflation and employment
objectives. But the Board remains vigilant with respect to upside risks on inflation and will not
hesitate to raise rates if it needs to. I know this is not what people want to hear. But the alternative

of persistently high inflation is worse. It hurts everyone.

Let me now move on to the second part of my remarks - the regional lens.

The importance of our regions

The RBA sets monetary policy for the Australian economy as a whole. Through the pandemic,
economic conditions were relatively similar around Australia. However, the rate of growth in domestic

activity often varies noticeably from one state and territory to another (Graph 2).

Graph 2
State and National Domestic Demand Growth*

Year-ended
%
30
Range of states
and territories
20

National
10

-10

putt Lritittio9
1999 2004 2009 2014 2019 2024

National line shows domestic final demand growth; range shows
minimum and maximum state final demand growth of states and
territories.

Sources: ABS; RBA.

*

While the RBA needs to set monetary policy based on aggregate conditions, we are aware that the
aggregate is just the sum of its parts. So, to fully understand the overall picture, we need to
understand what is going on around the country. We are also conscious that the effect of monetary

policy decisions is not felt evenly across all groups.

The RBA has long had a dedicated team of people to gather and analyse information on economic
conditions in different regions and industries. 't! The team has staff permanently located in five
Australian states, who meet regularly with businesses, industry organisations, government agencies
and community groups. In the past financial year, the team hosted around 950 meetings. We
systematically factor this information into our forecasts and it feeds into the Board's decisions on

monetary policy.

The team regularly speaks with contacts in regional areas and travels to different parts of the country
to do this in person; in fact, some of my colleagues have been visiting Armidale and Tamworth this
week. We do this because we understand the important role of regional areas in the Australian

economy. Regional Australia is estimated to account for around one-third of the population and one-

third of all economic output. !21 Moreover, the contribution of regional areas to certain types of
economic activity is substantial. For example, regional areas play a crucial role in Australia's mining
and agricultural production and exports, with 50 per cent of mining workers and 80 per cent of

agricultural workers living in the regions.

Economic conditions in regional areas coming out of
the pandemic

Given the importance of regional Australia, today I want to touch on how economic conditions in the
regions have evolved since the pandemic compared with those in the capital cities. I also want to

cover some medium-term challenges and opportunities for our regions.

First, however, a couple of disclaimers. In this speech, I draw a distinction between regional areas
that are located relatively close to capital cities and those further out. This is because conditions in
'commutable' regions are quite different from more remote ones. I also want to acknowledge up front
that while I have grouped regions into very broad categories, we know there is significant variation

within these groups.

A standout difference in the experience of regions since the pandemic has been population growth
(Graph 3). Migration from overseas all but stopped for a time during the pandemic, which led to a
sharp decline in population growth in capital cities, followed by an even sharper pick-up as
restrictions eased. By contrast, the regional population continued to grow at roughly the same rate as
it had before the pandemic, with consistently stronger growth in 'commutable' regions than those
located further from capital cities. As many of you would know, net migration to regional areas has
been high since the pandemic as remote and hybrid working has become more common and many

workers have opted for a lifestyle change.

Graph 3

Population Growth
Financial year

% %
Capital cities
2 2
Commutable*
1 1
Other regional

0 0

-1 I I I I ! I I I I I I I 1 I I I I ! I I I I JL

02/03 06/07 10/11 14/15 18/19 22/23

Commutable defined as regional areas less than 150 km from
capital city GPO.

Sources: ABS; RBA.

*

Changes in population dynamics can have an important impact on housing markets. Population
growth is a key determinant of housing demand. But it can also influence housing supply over the
medium term (e.g. if it changes the size of the construction workforce). Increases in housing prices
and rents were much larger in regional areas than in the cities during the pandemic, though this has
slowed somewhat over the past couple of years (Graph 4). Overall, the cumulative increase in
housing prices since the beginning of the pandemic has been higher on average in our regions than
in our cities, while the cumulative increases in advertised rents have on average been broadly similar.
In Armidale, average housing prices have risen by almost 40 per cent since the beginning of the

pandemic, while average advertised rents are up by almost 25 per cent.

Graph 4

Housing Costs
January 2020 = 100

index Advertised rents Housing prices index
140 140
Other regional
120 120
100 100
Commutable* Capital cities
80 80
60 I ! I I ! ! I I l ! ! I I ! ! I I l ! I 60

2016 2020 2024 2016 2020 2024

Commutable defined as regional areas less than 150 km from
capital city GPO.

Sources: CoreLogic; RBA.

*

In a recent speech, my colleague Sarah Hunter discussed how housing supply has not yet responded
materially to strong housing prices and rents growth. !?! Approvals for new housing are below their
average levels from the five years or so prior to the pandemic in many regions (Graph 5). This is
quite a common story, although there are some areas where approvals are close to, or above pre-
pandemic levels, including here in Armidale. More generally, though, we know that the strain on
household finances from high housing costs is being felt acutely in our regional areas as well as our

cities and could continue for some time if construction activity remains low.

Graph 5
Residential Building Approvals

Three-month moving sum, seasonally adjusted

'000

Capital cities

Other regional Commutable*

2004 2008 2012 2016 2020 2024

Commutable defined as regional areas less than 150 km from
capital city GPO.

Sources: ABS; RBA.

*

Looking at labour markets, unemployment rates did not rise as much in regional areas as in capital
cities during the pandemic, consistent with their shorter lockdowns and lower shares of workers
employed in the services sector. After the pandemic, unemployment rates dropped significantly to
very low levels across the country; this was particularly true in 'commutable' regional areas, possibly
due to an increase in remote and hybrid workers around that time. Since then, regional labour
markets have been tighter than those in capital cities. The New England North West region is no
exception, with an unemployment rate that has averaged just 22 per cent since the beginning of
2023, compared with an average of around 6 per cent over the past 20 years. While still at low
levels, there has been a more noticeable increase in the average capital city unemployment rate

compared with average regional unemployment rates to date (Graph 6).

Graph 6

Unemployment Rate* 0}
%

Other regional

Capital cities

Commutable**

2008 2012 2016 2020 2024

13-term Henderson trend; seasonally adjusted.

Commutable defined as regional areas less than 150 km from
capital city GPO.

Sources: ABS; RBA.

*

eK

Some challenges and opportunities for our regions

In addition to the shorter term forces that have been at play as the effects of the pandemic have
worn off, there are also some important longer term structural factors that affect industries in
different ways and in turn the regions in which they operate. The energy transition is one of these

factors that presents both challenges and opportunities for our regions. I will return to this later.

First, though, I want to discuss the changes taking place in the agricultural sector, given its

importance to regional areas and the wellbeing of all Australians.

As I'm sure you are aware, this sector has been undergoing structural change in recent decades.
Innovation in agriculture has boosted productivity significantly, but it has also led to a decline in jobs
in this sector. The people and businesses in regional areas have had to adapt to this change, which is
always challenging. Investment in agricultural innovation is continuing, including in digital
technologies, though technology also has its challenges in regional areas due to difficulties with

access.

On top of this structural change, conditions in the agricultural sector also tend to be more volatile
than other industries, largely due to its dependence on weather. The past few years have been
relatively favourable for agriculture in many regions - particularly in crop-producing areas - with high
global prices and record high production volumes following above-average rainfall (Graph 7). Over
the past year, prices have come down a little and production is forecast to have declined somewhat,
but both prices and production are expected to remain at high levels in coming years, which would
be good news if it eventuates. But of course, the future is uncertain. Increasing volatility in our
weather patterns and rising temperatures over time pose challenges for farmers and will be

disruptive for all communities.

Graph 7
Total Farm Output Volumes*
$b $b
Forecast
80 80
60 60
40 40
20 20

0 0
95/96 00/01 05/06 10/11 15/16 20/21 25/26

* Farm production volumes referenced to 2023/24 gross value of

production.
Sources: ABARES; RBA.

Looking ahead, the changes that are made to mitigate the risks posed by climate change will lead to
even more structural changes in our economy, including in our regions. The shift towards renewable
energy sources and commitments to reduce carbon emissions mean the share of coal-driven
electricity could halve over the next 10 or so years. !*] At the same time, demand for electricity is
expected to grow significantly over coming decades alongside economic growth and the
electrification of transport and industrial activities. Taken together, this suggests the need for greater

investment in new energy generation capacity, storage and transmission.

Regional Australia will play a critical role in this transition, with the majority of utility-scale solar and
wind capacity for electricity generation over coming years expected to be installed in 'Renewable
Energy Zones' (REZs). These zones may be responsible for around half of National Energy Market
generation over coming decades (Graph 8). It is likely that Renewable Energy Zones will be primarily

located in regional areas.

Graph 8

Electricity Generation Scenario*

TWh %
Renewable Energy Zones'

share of generation**
(RHS)

300 60
200 40
Total National Electricity
Market generation
(LHS)
100 20

0
24/25 29/30 34/35 39/40 44/45 49/50

*

Graph shows the 2024 Integrated System Plan, Step Change scenario
- optimal development path - CDP14, National Electricity Market,

as-generated generation; a range of other outcomes are possible.

** - Projected Renewable Energy Zones' collective share of total terawatt

hours (TWh).
Sources: AEMO; RBA.

This will present many challenges, but installing this capacity, and the infrastructure to support it, will
ultimately increase investment in regional communities. This investment should bring with it
significant economic benefits, including jobs and new income streams for landholders hosting this
infrastructure. Of course, these types of changes affect communities in a range of ways and different
communities will follow different paths. But there are certainly opportunities here, and some good

reasons for optimism about the future of many of our regions.

Conclusion

The RBA sets monetary policy for the Australian economy as a whole and we have only one tool -
the interest rate - to achieve our objectives. We are aware, however, that conditions vary across the
country. Regional Australia contributes greatly to the Australian economy and so understanding the
economic challenges and trends in the regions is essential to the work we do at the RBA. I hope
today I have provided some insight into how we are considering the regions in our analysis of the

economy.

Thank you for your attention and I am happy to take your questions.

Endnotes

[*] Thank you to Michelle Wright, Fiona Price and Kate McLoughlin for excellent assistance with this speech.

[1] For more information of the Regional and Industry Analysis team, see Dwyer J, K McLoughlin and A Walker (2022),
'The Reserve Bank's Liaison Program Turns 21', RBA Bulletin, September 2022.

[2] Regional Australia is defined as 'Rest of State' spatial regions under the Australian Statistical Geography Standard
(ASGS). For information on economic output estimates by region, see Department of Infrastructure, Transport,
Regional Development, Communications and the Arts (2024), 'Experimental Gross Regional Product Estimates',

Australian Government.

[3] Hunter S (2024), 'Housing Market Cycles and Fundamentals', Speech at the REIA Centennial Congress, Hobart,
16 May.

[4] Australian Energy Market Operator (2024), '2024 Integrated System Plan'.

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