malcolm edey : general economic and financial environment in australia panel session speaking notes by mr malcolm edey, assistant governor ( financial system ) of the reserve bank of australia, to the property council of australia, darwin, 25 july 2011. * * * i ’ ve been asked to speak today about the general economic and financial environment in australia. i ’ ll leave it to the other panellists to talk more specifically about the property sector. as you know, the australian economy came through the recent financial crisis in better shape than most – certainly in the developed world. in fact, what is often referred to as a global crisis was mainly a crisis of the united states and europe. those were the economies that experienced the most serious distress in their financial sectors, and they were also the ones that required significant public - sector capital support for their banks. they also experienced severe recessions, from which they are still recovering. the australian economy avoided recession, and the banking sector remained in relatively good condition throughout the recent period, though of course it was not immune from the international distress. the overall dimensions can be summed up in a few facts and figures : at the height of the downturn, the us economy contracted by about 4 per cent over a year ; the euro area by 5 per cent, and the uk by 6 per cent. for all these economies, it was their most severe recession in the post - war period. in contrast, growth of the australian economy remained positive. it dipped to an annual figure of around 1 per cent during much of 2009, before picking up to a pace that was around trend in 2010. ( i note in passing that the most recent growth outcomes are affected by the temporary effects of flooding and cyclone at the beginning of this year. ) unemployment in australia rose only moderately during the global downturn, and has since fallen. and australian banks, in aggregate, remained profitable, although they did experience a decline in loan quality. loan losses have generally now peaked, and banks have strengthened their capital and liquidity positions since the crisis. when i ’ m asked to explain australia ’ s good performance in this period, i usually attribute it to a mixture of good luck and good management. australia was fortunate to have been at a relatively strong point in the business cycle when the crisis hit ; and, in the recovery phase, as is often remarked upon, we have benefited from being well connected to the fast - growing economies in the asian region. but i think there were also some important

due to a combination of debt repayment and credit that has been written off by lenders. after falling off a cliff during the first half of 2009, global trade has rebounded. both u. s. exports and u. s. manufacturing output have expanded rapidly over the past six months ( chart 17 ). although these are encouraging developments, i believe that the recovery is likely to be quite muted compared with past recoveries. this comes back to the framework discussed earlier. for faster growth, we need ex ante investment to rise relative to saving and ex ante spending to rise relative to the current trend of income. but it is difficult to see where this impulse will come from in the near term. the early stages of past recoveries have been led by consumer spending, particularly for durable goods and residential investment. for example, in the first year of recovery following the deep recessions of 1973 – 1975 and 1981 – 1982, real consumer spending increased an average of 6. 5 percent and residential investment rose an average of 38 percent. it is unlikely that we will experience this type of strength this time. households have suffered unusually large shocks to both income and wealth and many remain highly leveraged ( chart 18 ). although the household debt to net worth ratio has declined considerably from its peak, it is still around 26 percent, well above the already elevated average of the past decade ( chart 19 ). moreover, even if consumers wanted to borrow, credit availability is still constrained and underwriting standards remain relatively tight. real consumer spending increased at a 2. 25 percent annual rate over the second half of 2009 and looks to be growing at about that rate in the first quarter of 2010. given that the personal saving rate is still relatively low, it will be hard for consumer spending to grow more quickly without large increases in real labor income. but big increases in real labor income won ’ t be possible without a much stronger recovery in output. and a much stronger recovery in output is unlikely without stronger consumption. residential investment did increase over the second half of 2009, boosted by relatively low mortgage interest rates, lower home prices and the first - time home buyer tax credit. but recent data on the housing sector indicates that the recovery has stalled ( chart 20 ). as with consumption, we are unlikely to see the typical surge of housing starts and residential investment that was a key feature of most past recoveries. there is already an unusually large volume of vacant homes for rent and for sale ( chart 21 ). more