Glenn Stevens: Issues in economic policy
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, 22 July 2015.
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I thank Elliott James for research assistance.
Thank you for coming out once again to support the Anika Foundation.1 As a result of your
generosity in past years, the Foundation is continuing to expand its activities, as you have
heard from earlier presentations.
The very efficient logistics for today were again provided by The Australian Business
Economists. I also thank Macquarie Group for its financial support of today's event.
I will organise today's remarks under four headings:
• Negotiating turbulence
• Accepting adjustment
• Maintaining stability
• Securing prosperity.
Negotiating turbulence
Until recently, we were living, at a global level, through a period of remarkably low volatility
and skinny pricing for risk. There was bound to be some set of events with the potential to
change that.
Once again, some of them have been in Europe. After some months, difficult discussions
between the Greek Government and its European partners reached an impasse and Greece
was, as a result, unable to make a scheduled repayment to the IMF. The ensuing few weeks,
during which the Greek authorities had no choice but to curtail access to the banking system,
have been extremely difficult and surely quite damaging for the Greek economy.
There has been progress towards a solution in recent days, though a huge amount of work
remains ahead to put the Greek economy, and the whole European project, onto a stable
footing.
To date, though, the financial spillovers from the Greek situation have not been large.
Spreads to German sovereign yields observed for debt issued by the governments of Spain,
Portugal and Italy remain quite contained. At this stage, we do not see a market response
that signals serious doubts about the ability of those countries to remain in the euro area.
There could be little doubt about the willingness of their European partners and European
institutions to support these countries in the event that market conditions took a serious turn
for the worse - as they might have done, and still might, had/if "Grexit" occurred. The likely
direct economic spillovers to the rest of Europe also seem fairly contained, since Greece is
quite a small economy.
Of course, things remain fluid. An unexpected turn of events - of which there have been
many over time - could change the assessment above. Broader financial and economic
impacts might be longer in coming and harder to predict. There are also important geo-
strategic elements to the situation, which is one reason why nations outside Europe are
taking such an interest. For our part, all we can do is watch and see what eventuates.
Meanwhile, and of arguably greater relevance in our part of the world, China's economy and
financial system are going through a period of adjustment and uncertainty.
Recently there have been some quite spectacular developments in the equity market. A rapid
run-up in share prices - which more than doubled in the space of a year, far beyond any
plausible prospective improvement in company earnings - turned to a slump in mid June to
early July. Share prices remain well above their level of a year ago, but the speculative
nature of the run-up, and the part played by an increase in leverage, has understandably
made everyone a little nervous. The Chinese authorities have acted forcefully with some very
wide-ranging interventions to stabilise the situation.
The effect this will have on the Chinese economy is not clear, but may prove to be relatively
small. Share prices have stabilised in recent days and authorities have been making financial
conditions more accommodative. Households' direct exposure to equity prices is relatively
small, notwithstanding their large share of turnover. In addition, the rise in share prices was
probably too short-lived for there to have been much in the way of positive wealth effects on
spending. Other leveraged entities, such as banks and brokers, have shown little obvious
sign of stress resulting from the developments in equity markets.
It seems, on the basis of information available at present, that developments in the Chinese
property markets and the broader financial sector are likely to be more important for the
outlook. The economy had been showing signs of slowing, of course, in the first part of this
year. But policies have been responding to this, and some of the recent economic data
suggest they have been having a positive effect.
Lastly on the international front, the likelihood still seems to be that US interest rates will
begin to rise before the end of this year. This change, when it comes, will have been very
well telegraphed. That being said, long-term yields in the United States and elsewhere are
still very low, and risk premia compressed, albeit not so much as they were. Some
turbulence may well occur as a result not of the first increase in US rates, but of investors
trying to assess how soon subsequent increases might occur. But sooner or later we have to
see a start to the process of adjusting these financial prices and I would expect Australian
financial markets to be able to take all that in their stride.
Accepting adjustment
The Australian economy has been growing, but at a pace a bit below what we have
traditionally thought of as average, as it adjusts to some pretty large changes in
circumstances.
The story of the phases of the "mining boom" is well known. Commodity prices rose
massively and have since declined (though some prices remain pretty high compared with
longer-run history). Investment spending followed suit - first it rose by about 5 to
6 percentage points of GDP, and now it is on its way back down. Finally, shipments of
resources picked up, as the new capacity created by the investment became available. As an
aside, unlike the situation posited some years ago in the United States, and notwithstanding
the growth of services, the physical weight of Australia's GDP has probably increased over
the past decade. For iron ore and coal, annual tonnages being shipped from Australian
mines have increased by more than half a billion tonnes since 2004.
Growth in domestic demand, in contrast, is fairly subdued. Over the latest year for which we
have data (to March 2015), final domestic spending rose by a bit under 1 per cent, as the fall
in resources sector capital spending accelerated. Capital spending by other businesses has
been weak too, while public demand was roughly unchanged over that year.
The weakness in those areas is juxtaposed, as you know, with changing household
behaviour. After a lengthy period during which consumer spending growth ran ahead of
income growth, and leverage (measured as the ratio of debt to income) almost trebled,
households changed course some time ago. To be sure, the rate of saving from current
income has declined a little over the past couple of years, which is what is expected at a time
of very low interest rates and positive wealth effects resulting from rising asset values. But it
remains significantly higher than it was a decade ago. The types of saving rates we see now
are more likely to be "normal" than those of a decade ago.
Moreover, while some households (such as first home buyers or, perhaps increasingly the
same thing, first home investors) are taking on more leverage, many others are reducing it.
They are taking advantage of lower borrowing costs to repay mortgage debt ahead of the
schedule in their debt contracts. Despite the lowest interest rates that any current borrower
has ever seen, the pace of lending to households remains moderate.
This is not a credit crunch - lenders are willing to lend and competition to do so is strong.
Indeed, the prudential supervisor has been minded recently to issue some timely warnings
about the need to maintain sound lending standards. Rather, the story is that households are
being more prudent about debt and are holding more liquid assets. One measure of this is
the size of "offset account" balances - bank deposits held to offset mortgage debt. These
now amount to about $90 billion. When the housing credit data are adjusted for the increase
in offset account balances, the rate of growth over the past year is put at about 6 per cent, as
opposed to over 7 per cent as published.
This may mean that the effect of easy monetary policy is to be somewhat lessened, at least
for a time. Taking a medium-term perspective, though, the general strengthening of the
balance sheet among many formerly more-indebted households has to be seen as a good
thing.
In the interim, the somewhat more restrained attitude to debt and spending by households,
combined with a similar attitude by the government sector, has meant that there has not
been quite enough domestic demand to achieve full employment, in the face of the fall in
business investment. That is why we have felt that, on balance, a somewhat lower exchange
rate was likely to be a part of the necessary adjustment. That adjustment seems to be
occurring, with relatively little disruption, and is having an expansionary effect. Growth in
services trade for example is picking up. The "net export contribution" of services trade over
the past year, of around 1⁄2 percentage point of GDP, is about the same as the contribution
from iron ore exports over that period.
It is worth noting that business conditions as measured in surveys have tended to improve
overall, outside the mining sector, over the past year or so. At the same time, the state of the
labour market, while still somewhat subdued, appears to be better than we had expected
three or six months ago. Employment growth has picked up noticeably, and hours worked
have also increased. The rate of unemployment is unchanged from a year ago, whereas we
had been thinking it might be a little higher than this by now, since growth in real GDP has
been, according to the available statistics, below trend.
Candidate explanations for this better-than-expected set of labour market outcomes include
the following:
• Perhaps there is statistical noise in the labour force data or maybe future
observations or revisions will paint a different picture. It is worth noting here that
recent information on Australian population growth suggests that the absolute
growth of employment will be revised down somewhat, though this should not
significantly affect labour market ratios like the unemployment rate or the
employment-to-population ratio.
• Perhaps output growth has been higher than the GDP data suggest, in which case
upward revisions to those data would probably occur over time.
• Perhaps below-trend output growth and trend employment growth can be reconciled
in the form of the slower-than-expected growth of wages.
• Perhaps trend output growth is lower than the 3 per cent or 31⁄4 per cent we have
assumed for many years. That is, perhaps the growth we have seen is in fact closer
to trend growth than we thought.
Some or all of the above possibilities may be at work. Time will tell which ones, but a few
observations may be worthwhile at this point.
First, the economy is making the adjustments required, even if it is a bit slower than we
would ideally have liked.
Second, if the slow growth of wages has in fact been a significant saver of jobs, that would
appear to indicate a degree of labour market flexibility in operation.
Third, to the extent that the data are hinting that our assumptions about trend growth may
need to be revisited, that will be worth some discussion. It need not be the case that per
capita growth would be any lower, if the lower growth simply reflects slower population
growth. So there may be few implications for living standards as measured by income per
head. But if there are assumptions about absolute growth rates embedded in business or
fiscal strategies, or retirement income plans, they would need to be re-examined.
I suspect this will turn out to be an important discussion: what is Australia's potential
economic growth rate, per head, and why? And what do we want it to be? And, of course,
what do we need to do to achieve our desired outcome? I return to that theme - securing
prosperity - shortly.
But first, a few words about stability.
Maintaining stability
One of the features of much regular discussion of macroeconomic policy, and monetary
policy in particular, is that people tend to adopt a rather short time-frame. Everyone watches
high-frequency data and adjusts expectations about what policy should or will do accordingly.
Policymakers are expected to respond to events and to deviations of economic performance
from what had been anticipated. The number of surveys and obscure indicators seen as
conveying information has continued to grow, as has the number of commentators to talk
about them.
To some extent this is perhaps a natural outworking of richer, more complex societies
possessing more information and analytical resources, the 24/7 operation of financial
markets and a competitive media searching for content. And to a point, it is perfectly
reasonable to expect policy to be adjusted in response to relevant information about how
things in the economy are tracking relative to policy objectives.
The risk, however, is that this process can lead to a mindset in which policymakers end up
responding to quite short-term phenomena, using instruments that take quite some time to
have their full effect, including effects that might actually turn out to be adverse. This is
relevant to our situation. A period of somewhat disappointing, even if hardly disastrous,
economic growth outcomes, and inflation that has been well contained, has seen interest
rates decline to very low levels. The question of whether they might be reduced further
remains, as I have said before, on the table.
But in answering that question, it is not quite good enough simply to say that evidence of
continuing softness should necessarily result in further cuts in rates, without considering the
longer-term risks involved. Monetary policy works partly by prompting risk-taking behaviour.
In some ways that is good: in some respects, there has not been enough risk-taking
behaviour. But the risk-taking behaviour most responsive to monetary policy is of the
financial type. To a point, that is probably a pre-requisite for the "real economy" risk-taking
that we most want. But beyond a certain point, it can be dangerous.
Deciding when such a point has been reached is, unavoidably, a highly judgemental process.
And that is after the event, let alone beforehand. My judgement would be that policy settings
that fostered a return to the sort of upward trend in household leverage we saw up to 2006
would have a high likelihood, some time down the track, of being judged to have gone too
far. That is not the case at present, given the current rates of credit growth and so on. But the
point is simply that in meeting the challenge of securing growth in the near term, the stability
of future economic performance can't be dismissed as a consideration. A balance has to be
found. I note that the Board's post-meeting statements routinely refer to seeking a stance of
policy that will "most effectively foster sustainable growth and inflation consistent with the
target" (emphasis added). The adjective "sustainable" is used deliberately and financial
sustainability is very definitely one of the things we have in mind.
Securing prosperity
The transition in growth is not perfectly smooth, but our economy has, in my judgement,
coped remarkably well through a lengthy period of very large shocks in a difficult world.
Despite the doom and gloom and fulminations over the airwaves, in newspapers and in
cyberspace, business confidence has risen in recent months. One day last week as I was
preparing these remarks, newspapers carried stories that personal insolvencies are the
lowest for more than a decade. On the same day we could read that income inequality in
Australia, as measured in the most detailed survey available, has not, in fact, increased,
contrary to the impression so often given. Perhaps we might be allowed to conclude that we
have been meeting some of our challenges, thus far, with outcomes that, while not perfect,
are not too bad.
So there are reasons to feel more confidence in our future than we often seem to. The
question to be asking is how we build on the broadly successful record we have in order to
secure prosperity in the future.
In this context, it is likely that questions about potential growth, in per head terms, will
become even more prominent. This is partly because of the well-known implications of the
lower terms of trade for income per head (i.e. it grows more slowly than output per head). It is
partly about demographics, also a well-known issue. Ageing will lower the proportion of
people working and hence, other things equal, output and income per head in the country.
We all know these things at an intellectual level. But unless we think our wants, including for
publicly provided services, will grow more slowly, which I doubt, the very practical imperative
will increasingly be to secure sources of growth. And it is increasingly clear to people that the
kind of sustained growth in mind here won't be the result of the manipulation of interest rates
or year-to-year government fiscal settings. Demand management policies play an important
role, but they have their limitations.
Raising the economy's potential isn't just some esoteric concern for economists, or at least it
shouldn't be. Our collective ability to deliver social policy outcomes, to enjoy the benefits of a
"good society", or at a more basic level to provide public services and even to defend
ourselves, ultimately rests on a productive economy. Many problems, including distributional
ones, are easier to deal with if per capita incomes are rising steadily, less so if they are
stagnant.
Let's be clear that this is not "growth at any price". Wealthy countries tend to have cleaner
air, cleaner water, better health and education systems, and more demanding standards for
environmental protection, employee safety and leave entitlements. They can afford to devote
resources to such things because their business sector is so productive. They tend also to
have higher wages - not because they decree wages shall be high but because
welleducated, skilled workforces working with a lot of capital and modern technology are more
productive. The poorest peoples usually have far less in the way of such things. If we care
about wellbeing in the broadest sense, we should care about things that affect potential
output per head.
Our citizens certainly care about the results. They don't frame the question as being about
per capita real GDP or productivity per hour and they care about more than just "narrow"
outcomes for economic statistics. Many would be concerned to reduce our environmental
footprint. They would not wish to sacrifice civilising aspects of our society and culture,
including many that result from government intervention. But nor will they accept a future in
which they are marginalised in the global village because of unwillingness to adapt or to
invest, or because of a failure to foster a growth economy.
There is a lot of talk at present about "reform". I would suggest that the case for "reform"
needs to be presented as a positive narrative for economic growth. We all know that
competitive markets, investment in education, skills and infrastructure, and adaptability, are
key parts of that growth narrative.
These reforms matter because of the gains to incomes resulting from better allocative
efficiency. But they also, ideally, would support entrepreneurship and innovation -
"risktaking" by another name and of the kind we want. Measuring "entrepreneurship" is not
straightforward and various studies have somewhat differing results. At the risk of
oversimplifying, one might say that Australians hold our own in the entrepreneurship stakes,
but since we don't generally score at the top in such surveys, there must be scope to
improve. That too can be part of the growth narrative - the narrative of how we build on the
success enjoyed to date and secure an even more prosperous future.
Conclusion
Thank you again for your attention, and for your support of the Anika Foundation. I hope to
see you again in another year for a new round of challenges.