Glenn Stevens: Economic policy after the booms
Address by Mr Glenn Stevens, Governor of the Reserve Bank of Australia, to the Anika
Foundation Luncheon, supported by Australian Business Economists and Macquarie Bank,
Sydney, 30 July 2013.
* * *
Thank you for coming out to support the Anika Foundation1 once again. This annual occasion
is one of our key fundraising events and your generosity is greatly appreciated. Today would
not be possible without the support of The Australian Business Economists and the
Macquarie Securities Group, and so on behalf of the Board of the Anika Foundation, I thank
them for their continuing contribution to combating adolescent depression and suicide.
Introduction
We have for the past five years or so lived in "interesting times". The shocks to which the
economy has been subject have had larger magnitudes than had been the case during "the
great moderation". The world economy, our terms of trade and the international availability of
credit have been a good deal more variable since 2007. For example, the variability of world
GDP has roughly doubled - compared with that in the decade or so prior to 2007 - while the
volatility of Australia's terms of trade has, on some metrics, quadrupled. In response, our
interest rates and exchange rate have also been more variable.
There hasn't been much additional variation, though, in the real economy or the rate of
unemployment. Depending on your preferred measure, the variability of real GDP has either
increased a little, or declined slightly; a similar story holds for the unemployment rate. There
was a pronounced cycle in inflation, peaking in 2008, but since then inflation has been much
better behaved. This suggests that the various policy responses and the economy's own
adjustment capacity have generally been working as they should towards stabilising overall
outcomes, in the face of the much bigger external shocks we have faced.
That said, achieving the sort of growth we aspire to has become more difficult. Average
output growth has been lower over the past five years in Australia, as it has in all other
advanced economies. Moreover, the challenges ahead are substantial and will require the
appropriate responses. In shaping those responses, we need to be sure to draw the right
conclusions and lessons from the experiences of recent years. In that vein, as I offer some
remarks about the period ahead, I will also draw on those conclusions from recent history
that seem pertinent. In so doing I shall be reiterating some themes I have touched on before,
including at earlier lunches in this series.
The resources boom
It is now well understood that the "mining boom" is shifting gear, and that we are entering a
new phase.
The story of the boom has always had three phases.2 In the first phase, commodity prices
rose to very high levels. As a result, Australia's terms of trade rose to levels not seen in a
very long time. These prices had a hiatus in 2009 with the global downturn but resumed their
upward trend quite quickly.
In historical context, the high prices have been quite persistent.3 This led to the second
phase, in which resource producers ramped up their investment to take advantage of
demand for raw materials, in particular iron ore and natural gas, and to a lesser extent coal.
Resource sector investment rose from an average of about 2 per cent of GDP, where it had
spent most of the previous 50 years, to peak at about 8 per cent. That big rise is now over,
and a fall is in prospect, with uncertain timing. It could be quite a big fall in due course.
The third phase is now under way, in which we will see investment spending fall back, but a
lift in volumes shipped of the various commodities. The latter has already started - for iron
ore, volumes are rising at about 15 per cent per year - but shipments will probably increase
further yet for some time and then stay high. Shipments of natural gas will not start
increasing strongly until 2015, and will probably have several years of very strong growth,
and then remain high for a few decades.
In that third phase, real GDP will get a lift. National income measured in current dollars will
also get a lift from the higher volumes, but that is likely to be offset in part, at least, by lower
prices. The lift in real GDP coming from this rise in exports will be driven more by higher
output per person; in fact, the level of employment needed to extract and ship the materials
will be less than the level needed to build the capacity to do so.
Let's be clear that Australians will continue to benefit from the higher level of resources
output for a very long time. There has been a large lift in the global demand for natural
resources that our country happens to have in abundance. Most people agree that the rate of
growth of that demand will be lower in future than it has been in recent years; some say
much lower. But the lift in the level of demand we have already seen is permanent enough,
and large enough, to have a quite persistent effect on our economy. Australian production is
meeting much of the additional global demand for iron ore and, prospectively, natural gas.
This will be at prices that, although lower than prices observed today, are likely to be higher
than the average seen for many years up to the middle of the past decade. Even allowing for
the high degree of foreign ownership in the resources sector, flows of income accruing to
Australians, through a few different channels, will be high over a long period.
The end of the second phase, the investment phase, of the boom is nonetheless quite a
challenging time. The investment spending by the resources sector will no longer be adding
to growth in demand in Australia. In due course it will, instead, be subtracting from it. To be
sure, a significant part of that investment spend has been supplied by imports, and to that
extent its decline will affect imports rather than domestic production. But even allowing for
that, there has still been substantial demand for Australian product and labour from the
resources sector, which appears likely to abate over the years ahead.
Since we wish to see aggregate demand in the economy sufficient to utilise the productive
resources of labour and capital that we have, this means that we would like to see a
"rotation" to other sorts of demand as the resources sector demand slows. The "post boom"
growth story of the economy would desirably involve stronger expansion in some other
sectors, including those that have seen weaker than normal conditions in the past couple of
years.
It is reasonable to expect that there will be some pick-up in these other areas, for reasons I
have outlined elsewhere.4 In brief, business capital spending outside the resources sector
has been subdued; housing investment likewise has been on the low side. There is ample
scope for both to rise. This is by no means a certainty though and while there are signs of an
increase in dwelling investment getting under way, a stronger trend in non-resources
business investment looks like it is a while off yet.
For a benign outcome to occur, a few things need to be in place. Reasonable global growth
outcomes obviously would be a major help. At this stage global growth is sub-par, though not
disastrous, with most forecasters saying next year will be better. Most of them quickly add a
long list of things that could go wrong. There is nothing we can do about that.
The second condition, which we can do something about, is that macroeconomic policy
settings need to be appropriate. Fiscal policy is in consolidation mode, and that seems
broadly appropriate. Monetary policy is, by historical metrics at least, very accommodative.
The exchange rate has also declined since its recent highs, and doubts about whether it will
play its normal role as a shock absorber have lessened of late.
A third condition is that Australian businesses need to be internationally competitive. The
exchange rate is helping here but productivity and cost performance will also be key. On
these fronts, I think firms have stepped up their efforts considerably.
This combination is a necessary, though not in itself sufficient, set of conditions for the sort of
demand rotation likely to be necessary.
The fourth ingredient is "confidence". It is somewhat concerning that the business
community's confidence has been quite subdued in recent times. To the extent that
substantial structural change has been occurring, and there is inevitable uncertainty over the
international outlook, it is quite understandable that some business segments have found the
going hard and don't feel very confident. Moreover, the phase shift of the mining boom itself
is dampening confidence in some areas.
That said, it would be good if there was a bit more confidence in the business community
about the future. Unfortunately, it is not a straightforward thing to turn sentiment around.
There's no such thing as the "confidence policy lever". Rather, we have to rely on:
 clarity of policy frameworks and objectives;

consistent application of policies towards well-understood goals; and,

attention to avoiding things that can dampen confidence unnecessarily.
All the more reason, then, to make sure that the accretion of regulatory actions being
undertaken does not inadvertently make it harder for businesses to plan with confidence, to
achieve better cost and productivity performance, or to take a chance on a new product, a
new investment or a new worker.
In the case of households, according to surveys sentiment is neither particularly weak nor
particularly strong at present. It is reasonable to expect that households will play a role in
driving demand over the years ahead - and in due course that will help to lift business
confidence. But in thinking about that role we need to understand the ways in which
household behaviour has changed.
The credit boom
The title of this talk, "Economic Policy after the Booms", uses the plural quite deliberately.
There were two "booms". Before the mining boom, or at least before its full flowering from
about the middle of last decade, there was an earlier boom. It was global, but Australians
took part in it. I am referring of course to a boom in credit, which saw a very significant
increase in borrowing by households in particular, and a rise in asset values, especially
dwellings. This was associated with a lengthy period of unusually strong growth in
consumption.
This boom did not end in Australia as painfully as it did in some other places, but end it did.
Consider two charts I showed at the Anika Foundation lunch two years ago in July 2011.
These have been updated, and use revised data.5
Graph 1
Graph 2
5
The level of household financial assets from June 2002 has been revised almost 15 per cent higher on
average, predominantly reflecting upward revisions to estimates of households' holdings of unlisted equity. As
a result, the debt-to-assets ratio has been revised lower by 0.8 percentage points on average. Trend growth in
household assets was also revised slightly lower. In contrast, growth in household disposable income was
revised slightly higher, leading to a small upward revision in the saving ratio in the 2000s.
It is even clearer now than it was two years ago that the behaviour of households has
changed in a very important way. Real consumption per person had risen faster than real
income per person for 30 years, from the mid 1970s until about 2005. (Only the last third of
that period is shown here.) That changed some years ago now, and after a noticeable fall in
consumption in late 2008 and early 2009, spending and income have grown roughly on
parallel tracks. Since 2009, trend growth in per capita consumption has been about 1.4 per
cent per annum, half what it had been from 1995 to 2005.
One contributing factor is seen in the second of the two charts, where it's clear why people's
sense of wealth has not been rising at anything like the pace that it had been up until the
financial crisis. Financial assets have begun to grow again, since the share market has risen
over the past year and households have also accumulated other financial assets such as
deposits. But the value of non-financial assets in particular - mainly dwellings - is lower
today in real per person terms than it was five years ago. Total assets per person have risen
at a pace of 21⁄2 per cent in real terms since the middle of 2009, which is much slower than in
the preceding decade, and even a bit slower than in the period 1975-1994.
The slowdown in asset values has been associated with a lift in saving and a slower path for
consumption, which has had important implications for the economy. The table below
suggests that slower consumption growth is prominent in explaining the slower pace of
overall demand growth and output since the middle of 2007.
Table 1: Contributions to Australian GDP Growth*
Per cent per annum
1995-mid 2007 mid 2007-2013
Domestic Final Demand 4.1 2.9
Consumption 2.3 1.4
Business Investment 1.1 1.1
Mining 0.3 1.0
Other Industries 0.9 0.1
Dwelling Investment 0.2 0.0
Public Demand 0.9 0.6
Gross National Expenditure 4.0 2.8
Net exports -0.2 -0.2
GDP 3.7 2.5
(*) Components are not additive given nature of the chain-volume series.
Sources: ABS; RBA
One's assessment of prospects for consumption will be driven mainly by one's assessment
of the outlook for income, but will also be affected by expectations about asset values and in
particular one's view on whether housing prices are overvalued. Those who think they are
will be drawn to the conclusion that a number of additional years of flat or declining real per
capita asset values lie ahead, for non-financial assets at least; those who are not so worried
about housing prices may expect that stronger growth, in real per capita terms, might occur.
Either way, however, it would seem unlikely that we could bank on a resumption of sustained
growth in assets, in real per person terms, of 7 per cent per year over the next few years. It
follows that the saving rate is unlikely, any time soon, to decline back to where it was in
2005. Average saving rates well above that earlier level seem more likely for some time,
even though there will presumably be cyclical ups and downs. While current saving rates
have been described as "high", a look at longer-run history suggests that "normal" would be a
better description.
Implications that might flow from these observations would include the following.
First, some strengthening in consumption from recent rather subdued growth rates is a
reasonable expectation, but we should not expect a return to the sorts of growth seen in the
1995-2007 period. Nor, surely, should we try to engineer one, at least on the back of
borrowing. Households continue to service their borrowings well - the household arrears rate
is low and has fallen slightly over the past year - but we would be risking future problems
were we to see a big run-up in debt from here. This does not preclude prudent levels of
borrowing by new entrants to the housing market, or by investors, nor does it preclude gains
to consumers as costs are squeezed out of the system. It doesn't mean that consumers
won't respond with their customary alacrity to new products offered at attractive prices. Trend
changes in habits - more consumption of services and "experiences", more online shopping
and so on - will presumably continue. Moreover, factors that lift disposable incomes - such
as higher real earnings on the back of productivity improvements, or sustainable reductions
in taxes - could be expected to lift consumption on a sustainable basis. But we are unlikely
to see a return to the earlier boom conditions.
Second, all other things equal, interest rates are likely to be lower in such a world than they
were in a world in which households were extending their finances. This is a global
phenomenon, but it holds in Australia too. A higher desired rate of saving ex ante means that
the return to saving will, other things equal, be at a lower level as the market clears. Those
who have long been savers no doubt feel aggrieved that the returns they have earlier
enjoyed cannot be found as easily now. That is in large part because other savers have
joined them and the market prices reflect that. Having said that, it is still possible to earn a
gross interest rate on a bank deposit that is a bit above the inflation rate.
Third, a desire to hold savings in a less risky form means that the yield give-up to hold a
safer asset is larger. The way this is usually expressed is that lower risk appetite, or perhaps
more accurate assessment of risk that was there all along, means risk spreads are higher.
Spreads are well down on their peaks reached at the height of risk aversion a few years ago,
but do seem to have settled at a higher level than in the mid 2000s.
Absolute borrowing costs for most borrowers are very low despite higher spreads, because
the return on one of the least risky assets - the cash rate - is the lowest for 50 years or
more. The market yields on government securities, the lowest risk assets of all, have likewise
been very low. In other words, with many investors wanting safety, the price of safety has
risen. It has to rise by enough to prompt at least some people to start to shift their portfolios
in the direction of taking some more risk - by holding equities, physical assets and so on,
though obviously we don't want too much risk-taking. One of the things we have been
watching for as we have been reducing interest rates has been an indication of savers
shifting portfolios towards some of the slightly more risky asset classes, as that is one of the
expected and intended effects of monetary policy easing. There are clearly signs of policy
working in this respect, though not, to date, by so much that we see a serious impediment to
further easing, were that to be appropriate from an overall macroeconomic point of view.
Policy after the booms
In the third phase of the "mining boom" and post the credit boom, our economic challenges
are changing in nature. In the next few years our task will involve supporting, so far as it is in
our power, a change in the sources of demand that affect the economy. As resources sector
investment declines, other sources of demand need to strengthen, but in a way that is
sustainable. The fact that consumption is likely to provide only a modest impetus to any
acceleration in domestic demand suggests that other areas will be important. As I noted
earlier, at least some of the conditions are in place for stronger trends in dwelling investment
and, in time, non-resources business capital expenditure. And exports of resources will
continue to pick up strongly.
But successful "rotation" of demand will probably also involve more net foreign demand for
other Australian output of various kinds. Given that, the recent decline in the exchange rate
seems to make sense from a macroeconomic perspective. It would not be a major surprise if
a further decline occurred over time, though of course events elsewhere in the world will also
have a bearing on that particular price.
The conduct of monetary policy must, and does, take account of the various features of the
environment we face. Calibrations drawn from an earlier part of history can't be assumed to
have the same reliability. Elements of the monetary policy transmission process are probably
working somewhat differently than on other occasions. To take one example, the fact that
policies in major economies have been at very unusual, or extreme, settings for some time is
a complication because of the potential effects on the exchange rate - though, as noted, the
exchange rate appears to have been behaving more normally of late.
The fact that the rest of the world has had such low interest rates, that the desire for safe
assets has been so strong, that the spreads between the cash rate and the rates that matter
most for the economy have widened, and that people have sought to get to a position of
lower leverage - all these have been important in explaining why the cash rate has been so
low compared with what we had been used to until the mid 2000s. That this has occurred
while we have had the peak of the resources investment boom is all the more remarkable.
This has been guided by the flexible inflation targeting framework we have had in place for
20 years now. This framework has prompted appropriate and timely action when needed. It
has seen a substantial easing in monetary policy since late 2011. We have been saying
recently that the inflation outlook may afford some scope to ease policy further if needed to
support demand. The recent inflation data do not appear to have shifted that assessment.
More generally, the credible and sensible approach to policies is:

to keep our eyes on the main objectives;

to preserve sound frameworks;

to act consistently with these frameworks and in ways that support confidence; and,

to keep looking for ways to enhance the flexibility the economy itself has
demonstrated in adjusting to the shocks of recent years.
Failure to do this would be costly. But the rewards from consistent application of good
policies are known, from our own experience, to be big, even if not immediate. Remembering
that is the challenge we face.
Thank you once again for coming along today.