Glenn Stevens: The glass half full
Address by Mr Glenn Stevens, Governor of the Reserve Bank of Australia, to the American
Chamber of Commerce (SA) AMCHAM Internode Business Lunch, Adelaide, 8 June 2012.
* * *
It is very good to be back in Adelaide. Thank you for the invitation.
As we meet here, economic discussion in Australia has reached a rather curious position.
Consider the background. Australia avoided a deep downturn in 2009, when most countries
did not. A large number of businesses and jobs were saved by that outcome - though we will
never know how many.
Almost as a matter of arithmetic, the ensuing upswing was always going to be of the
moderate variety. Rapid cyclical growth usually comes after a serious slump (and when it
doesn't, it comes just before one). After small downturns, less spectacular growth is the
usual experience. So it has proved on this occasion.
Even so, three and a half years after the depths of the crisis in late 2008, this unspectacular
growth has nonetheless seen real GDP per capita well and truly pass its previous peak. This
is something yet to be achieved in any of the other nations shown here (Graph 1).
Graph 1
According to data published this week by the Australian Statistician, real GDP rose by over
4 per cent over the past year. This outcome includes the recovery from the effects of flooding
a year ago, so the underlying pace of growth is probably not quite that fast, but it is quite
respectable - something close to trend. Unemployment is about 5 per cent. Core inflation is
a bit above 2 per cent. The financial system is sound. Our government is one among only a
small number rated AAA, with manageable debt. We have received a truly enormous boost
in national income courtesy of the high terms of trade. This, in turn, has engendered one of
the biggest resource investment upswings in our history, which will see business capital
spending rise by another 2 percentage points of GDP over 2012/13, to reach a 50-year high.
To be sure, we face considerable structural adjustment issues arising from the mining
expansion, and from other changes in the world economy. These are not easy to deal with
(though they are not insurmountable). And we live in a global environment of major
uncertainty, largely because of the problems of the euro zone. Nonetheless, an objective
observer coming from outside would, I think it must be said, feel that Australia's glass is at
least half full.
Yet the nature of public discussion is unrelentingly gloomy, and this has intensified over the
past six months. Even before the recent turn of events in Europe and their effects on global
markets, we were grimly determined to see our glass as half empty. Numerous foreign
visitors to the Reserve Bank have remarked on the surprising extent of this pessimism. Each
time I travel abroad I am struck by the difference between the perceptions held by foreigners
about Australia and what I read in the newspapers at home.
I harbour no illusion that this can suddenly be lifted by anything I say today. But it is,
hopefully, worthwhile to offer a few facts, and some perspective and analysis of the situation.
The multi-speed economy
Much of our public discussion proceeds under the rubric of the so-called "two-speed
economy". It's become very much the description of the moment, and not only in Australia.
One picks up the same theme in many other countries. Indeed it is a description of the global
economy. Growth in the advanced industrial countries continues to be sluggish, and in some
cases output is going backwards. Within Europe, Germany has been doing well, while other
nations face huge economic challenges. Meanwhile growth in the "emerging world" has been
pretty robust apart from the effects of natural disasters. So in popular terms, we might say
that there are varying lanes on the global growth highway: fast, slow, very slow. There are a
few economies in the breakdown lane.
Turning to Australia, we have long had a multi-speed economy. For example, it has been a
very long-running trend that population growth tends to be faster in Western Australia and
Queensland than in Tasmania or South Australia. Typically, certain industries such as
housing construction show the expected differences due to population growth.
Moreover while we debate the rise of mining and the much heralded "decline of
manufacturing", we might note that it has been a very long running trend that output and
employment in manufacturing has grown more slowly than in the economy as a whole, and
that output of various kinds of service provision has grown faster. That has been happening
for at least five decades, and in most countries in the developed world. In the case of
Australia's manufacturing sector, this decline reverses an earlier rise. In fact, the respective
shares of mining and manufacturing in Australia's GDP at present are about where they were
in 1900.
It is obvious at present that the mining expansion is quite concentrated both in its industrial
and geographical dimensions, and economic indicators do reflect that. But the mining sector
is not the only sector growing. If the recent data are taken at face value, the non-mining
economy has grown at about 2 per cent over the past year. Mining employment is indeed
growing quickly - interestingly enough according to the available data, the increase in mining
employment exceeded the fall in manufacturing employment over the past year. But the
largest increase of all was in the sector called "health care and social assistance", in which
employment rose by about the size of the combined fall in manufacturing and retailing
employment over the same period. And while there are clearly differing drivers by industry
and by region, there are mechanisms that even out at least some of these differences.
Spillovers do occur both in the private sector and via the tax and expenditure system.1
Remarkably, in the face of the understandable concern about job losses in particular regions
and industries, the dispersion of unemployment rates by statistical region is no larger today
than has usually been the case over the past 20 years. Hence while there are clearly multiple
speeds, the total speed seems to have been one of reasonable growth and low
unemployment.
The behaviour of households
But there is another aspect of the "multi-speed" experience, which I suspect explains a good
deal of the dissatisfaction we see, and it has to do with the behaviour of the household
sector. Some parts of the economy that depend on household spending are still experiencing
relatively weak conditions, compared with what they have been used to. But this isn't
because the mining boom spillovers have failed to arrive. It is, instead, the result of other
changes that actually have nothing to do with the mining boom per se, but a lot to do with
events that occurred largely before the mining boom really began.
The story is summed up in the two charts shown below. The first shows household
consumption spending and income, both measured in per capita terms, and adjusting for
inflation (Graph 2).2 In brief, household spending grew faster than income for a lengthy
period up to about 2005. The arithmetically equivalent statement is that the rate of saving
from current income declined, by about 5 percentage points over that period.
Graph 2
It was no coincidence that households felt they were getting wealthier. Gross assets held by
households more than doubled between 1995 and 2007. The value of real assets
- principally dwellings - rose by more than 6 per cent per annum in real, per capita terms
over the period (Graph 3).
Graph 3
Only a small part of this was explained by an increase in per capita expenditure on dwellings.
The bulk of it came from rising prices. Moreover, a good deal of borrowing was done to hold
these assets and household leverage increased. The ratio of aggregate household debt to
gross assets rose, peaking at about 20 per cent. There was definitely a large rise in
measured net worth, but relative to aggregate annual income, gross debt rose from
70 per cent in 1995, to about 150 per cent in 2007. Correspondingly, by 2007 the share of
current income devoted to servicing that debt had risen from 7 per cent to 12 per cent,
despite interest rates in 2007 being below those in 1995.
It is still not generally appreciated how striking these trends were. I cannot say that it is
unprecedented for spending to grow consistently faster than income, because it had already
been doing that for the 20 years prior to 1995. That is, the saving rate had been on a
long-term downward trend since the mid-1970s. But it is very unusual in history for people to
save as little from current income as they were doing by the mid-2000s. And it is very
unusual, historically, for real assets per person to rise at 6 per cent or more per annum. It is
also very unusual for households actually to withdraw equity from their houses, to use for
other purposes, but for a few years in the mid-2000s that seemed to have been occurring.
Of course, Australia was not alone in seeing trends like this. There were qualitatively similar
trends in several other countries, particularly English-speaking countries that experienced
financial innovation. The international backdrop to this period was the so-called "great
moderation", in which there was a decline in macroeconomic variability. There were still
business cycles but downturns were much less severe than in the 1970s or 1980s, inflation
was low and not very variable, which meant that nominal interest rates also were generally
low and not very variable, and compensation for risk became very modest.3
This "moderation" came to an end with the crisis beginning in 2007. And with a few years of
perspective, it is increasingly clear that Australian households began to change their
behaviour at that time, or even a little before. The rate of saving from current income stopped
falling probably around 2003 or 2004, and began to increase (we now know), slowly at first
as the income gains from the first phase of the resources boom started in about 2005 or
2006, and then more quickly in 2008 and 2009.
Real consumption spending per head initially remained pretty strong in this period, reaching
a peak in 2008. It then declined for a year or so, before resuming growth in the second half of
2009. That growth has, however, been much slower than had been observed previously. In
the nearly three years from mid-2009 through to the March quarter 2012, real consumption
per head rose at an annual pace of about 11⁄2 per cent.
This is more than a full percentage point lower than the growth rate from 1995 to 2005. But
this sort of growth is in fact quite comparable with the kind of growth seen in the couple of
decades leading up to 1995. It is line with the quite respectable growth in income. But the
gap between the current level of consumption and where it would have been had the
previous trend continued is quite significant. If we then consider the growth of foreign online
sales and so on, and the fact that consumers seem more inclined to consume services
- experiences, as opposed to goods - we can see this is a significant change for the retail
sector.
No doubt reinforcing this trend towards more circumspect, but more typical, behaviour is that
the earlier strong upward trend in real assets per head has abated over recent years. In fact,
real household assets per head today are about the same as they were five years ago, with a
dip during the crisis, a subsequent partial recovery and then a slow drift down over the past
couple of years. Both dwelling prices and share prices - the two really big components of
wealth - have followed that pattern.
At some point, wealth will begin to increase again. After all, people are saving a reasonable
amount from current income and placing the proceeds into various assets (especially, of late,
deposits in financial institutions). That is, they are building wealth the old fashioned way.
Ultimately these flows will be reflected in higher holdings of real and financial assets, at least
once debt levels are regarded as comfortable. Asset valuation changes can of course
dominate saving flows in shifting wealth over short periods and they are inherently
unpredictable. So no one can predict the course of these measures of wealth over any
particular short period. But wealth will surely resume an upward track, sooner or later.4
When it does, however, it is unlikely to be at 6 or 7 per cent per year in real, per capita terms.
I would guess that over the long term, something more like 3 per cent would be nearer the
mark.
I think this is a profoundly important point and worth emphasising. The decade or more up to
about 2007 was unusual. It would be quite surprising, really, if the same trends - persistent
strong increases in asset values, very strong growth in per capita consumption, increasing
leverage, little or no saving from current income - were to re-emerge any time soon. That is,
the gap between consumption today and the old trend level on the chart is not going to close.
I noted to another audience about three years ago that the prominence of household demand
in driving growth in the 1990s and 2000s was unlikely to be repeated.5 If there were business
strategies that assumed a resumption of the earlier trend, they will surely be disappointed in
time, if they have not been already.
There were several parts of the economy that benefited from that earlier period, and that are
finding the going much tougher now. Retailing was obviously one, but so was banking. Banks
and other financial institutions enjoyed rapid balance sheet and profit expansion as they lent
to households and some businesses. But they can see that period has now finished.
Businesses that serviced rapid turnover in the dwelling stock (such as real estate agents,
mortgage brokers) are seeing those revenue streams considerably reduced, and are having
to adjust their strategies and capacity to suit changed conditions. For example, the rate of
dwelling turnover is about one-third less than it was on average over the previous decade,
and about half its peak levels. This is affecting state government stamp duty collections as
well as the real estate sector.
We can also see some echoes of these changing trends in household demand in business
investment spending.
Graph 4
This chart shows business investment, split into mining and non-mining, and measured in
real, per capita terms, so as to be consistent with the earlier charts (Graph 4). Investment
has been on a stronger upward trend since the mid-1990s than it had been for a number of
years before that. In particular, business investment in real per capita terms has grown, on
average, by over 6 per cent per annum since 1995, more than double the average pace over
the preceding 35 years. Moreover a lot of this was in the non-mining sector, and it began
before the present run up in mining investment really got going. Some of this growth reflected
the same "consumer facing" growth sectors mentioned above. Of the four sectors that had
the fastest growing investment spending over that period, three were finance, one called
"rental hiring and real estate services", and retail trade. Some of these sectors are slowing
their investment rates now.
Meanwhile, mining investment has recently been rising at an extraordinary pace. In 2005,
mining investment was near its long-run average of around 2 per cent of GDP. By mid-2014
we expect it to reach at least 9 per cent of GDP. If that occurs, mining investment will be
about as large as business investment in the rest of the private economy combined. As a
result of that, total business investment will reach new highs this year, and next. Hence there
is a very large build-up in the nation's capital stock occurring. If it is well managed and
soundly based, that ought to allow the possibility of further growth in output and incomes.
The investment phase of the mining boom will start to tail off in a couple of years' time, after
which the shipments of natural resources should step up significantly.
We might expect by then as well that some other areas of investment spending that are weak
at present will be picking up. More generally, I suspect we will discuss the nature of
investment quite a bit in coming years as we grapple with structural change in the economy
and powerful shifts in the population's needs (think of investment in the aged-care sector, for
example, or public infrastructure needs). We will also be looking for productivity pay-offs from
the various investments.
But the key message for today is that the multi-speed economy is not just about the mining
sector squeezing other sectors by drawing away labour and capital and pushing up the
exchange rate. It is doing that, but slower growth in sectors that had earlier done well from
unusually strong gains in household spending would have been occurring anyway, even if
the mining boom had never come along. It is these changes in behaviour by households, in
asset markets and in credit demand, that I think lie behind much of the disquiet
- dissatisfaction even - that so many seem to have been expressing. But this would, as I
say, have occurred with or without the mining boom. In fact, without the mining boom and its
spillovers, we would have been feeling the effects of those adjustments rather more acutely
than we do now. The period of household gearing up could have ended in a much less
benign way.
Implications for policy
What are the implications of these trends for economic policy, and particularly monetary
policy? Does it have a role in helping the adjustment?
One thing we should not do, in my judgement, is to try to engineer a return to the boom.
Many people say that we need more "confidence" in the economy among both households
and businesses. We do, but it has to be the right sort of confidence. The kind of confidence
based on nothing more than expectations of ever-increasing housing prices, with the
associated willingness to continue increasing leverage, on the assumption that this is a sure
way to wealth, would not be the right kind. Unfortunately, we have been rather too prone to
that misplaced optimism on occasion. You don't have to be a believer in bubbles to think that
a return to sizeable price increases and higher household gearing from still reasonably high
current levels would be a risky approach. It would surely be a false basis for confidence. The
intended effect of recent policy actions is certainly not to pump up speculative demand for
assets.6 As it happens, our judgement is that the risk of re-igniting a boom in borrowing and
prices is not very high, and this was a key consideration in decisions to lower interest rates
over the past eight months.
Hence, I do not think we should set monetary policy to foster a renewed gearing up by
households. We can help, at the margin, the process of borrowers getting their balance
sheets into better shape. To the extent that softer demand conditions have resulted from
households or some businesses restraining spending in an effort to get debt down, and this
leads to lower inflation, our inflation targeting framework tells us to ease monetary policy.
That is what we have been doing. The reduction in interest rates over the past eight months
or so - 125 basis points on the cash rate and something less than that, but still quite a
significant fall, in the structure of intermediaries' lending rates - will speed up, at the margin,
the process of deleveraging for those who need or want to undertake it.
In saying that, of course, we cannot neglect the interests of those who live off the return from
their savings and who rightly expect us to preserve the real value of those savings. Popular
discussion of interest rates routinely ignores this element, focusing almost exclusively on the
minority of the population - just over one-third - who occupy a dwelling they have
mortgaged. The central bank has to adopt a broader focus. And to repeat, it is not our
intention either to engineer a return to a housing price boom, or to overturn the current
prudent habits of households. All that said, returns available to savers in deposits (with a little
shopping around) remain well ahead of inflation, and have very low risk.
So monetary policy has been cognisant of the changed habits of households and the process
of balance sheet strengthening, and has been set accordingly. As such, it has been
responding, to the extent it prudently can, to one element of the multi-speed economy - the
one where it is most relevant.
What monetary policy cannot do is make the broader pressures for structural adjustment go
away. Not only are the consumption boom and the household borrowing boom not coming
back, but the industry and geographical shifts in the drivers of growth cannot be much
affected by monetary policy. To a large extent, they reflect changes in the world economy,
which monetary policy cannot influence. Even if, as a society, we wanted to resist the
implications of those changes other tools would be needed.
In fact Australia does better to accommodate these changes, and to think about what other
policies might make adjustment less difficult and quicker for those adversely affected. It is in
this area, in fact, that we need more confidence: confidence in our capacity to respond to
changed circumstances, to respond to new opportunities, and to produce goods and services
which meet market demands. It is also to be hoped that some of the recent positive data
outcomes will give pause to reflect that, actually, things have so far turned out not too badly.
Conclusion
We face a remarkable period in history. The centre of gravity of the world economy seems to
be shifting eastwards - towards us - perhaps even faster than some of the optimists had
expected. Granted, that is partly because the relative importance of Europe seems to be
shrinking, perceptibly, under the weight of its internal problems. But even if the Europeans
manage the immediate problems well, there is no mistaking the long run trend.
That this comes just as a very unusual period for household behaviour in Western advanced
countries (including Australia) has ended, has been a remarkably fortuitous combination for
Australia. Certainly it means we have the challenge of adjusting our behaviour and our
expectations to new drivers for growth and new imperatives for responsiveness, but we do so
with growing incomes, low unemployment and exposure to Asia. That is infinitely preferable
to the sorts of adjustments that seem to be the lot of so many others at present.
The Australian community has understood that we can't base growth persistently on falling
saving and rising debt and that is forcing changes to business models. But it has to be said
that the return of a certain degree of thrift actually strengthens our medium-term position. If
we can marry that to a focus on incrementally improving the way we do things - lifting
productivity - there is actually a lot to look forward to. For Australians, the glass is well and
truly half full.