There’s still plenty of soul searching going on amongst economists and economic commentators today about last week’s strong Australian macro economic data. Ross Gittins spends some time agonising over economic strength before suggesting we all throw in the towel. Given Gittins’ wholeheartedly abandoned his line that we were in a boom after the previous quarter’s weak national accounts, his confusion with this new figure is understandable. David Uren also canvasses a whose who of Australian economists who divulge a bunch of shortcomings in the current data, which is right. Many of our data sources do not capture the dimensions of the current transition in the Australian economy.
As for me, I am not backing away from my contention that Australia faces a long period of sub-trend growth because we’ve had one breakout quarter. As I’ve said many times, forecasting quarterly GDP is a fool’s errand. The two strong dimensions of GDP in the first quarter were consumption growth and private investment. The latter is driven by a handful of very large projects and will be volatile. On the former, it makes pretty good sense that the March quarter showed decent consumption growth. We’d just had two interest rate cuts. Freeing some demand was the point and did show up in improved retail sales. But that is temporary. As I argued last week, and the Reserve Bank Governor affirmed in his seminal speech Friday, the transition underway in the Australian economy necessarily includes the decline of several sectors that were formerly the centre of Australian growth: consumption, housing and retail:
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.
In short, those cherry-picking data to argue that household demand is sustainably strong are indulging in what economists call “partial analysis” and really have no idea what is going on. As I wrote before the Guv’s excellent speech:
Many point to national accounts statistics that show household consumption is still strong (in services they argue) but that is clearly beside the point. It is inarguable that retail and housing are under pressure because aggregate household demand is unable to support the supply available in consumer facing industries. As such, the RBA is now in the business of managing a number of declines in previously growing and large employing sectors. Rate cuts are about supporting demand to prevent them slumping too quickly.
The RBA has now declared that that support will be measured against the needs of saving and, in effect, the repair of houshold balance sheets, that is, deleveraging.
So, what are the conclusions we can draw now? On the current quarter’s GDP, there are several things we already know. Consumption growth will very likely be much lower. The trade balance will probably add to growth given the April turnaround in the bulk contracts and lower imports. Private investment may drop or surge. The GDP deflator (which added 1% to first quarter growth via deflation) is unlikely to provide a second boost of such magnitude but could still help given the obvious lack of inflation in the economy. The balance is anybody’s guess and, to be honest, who cares.
The larger point is this: The Great Disleveraging goes on. It is supported by mining and explicitly now by the central bank, as Stevens said:
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.
And that is the realty of growth you need to embrace if you wish make money in Australia’s new normal. Growth will be volatile, with bursts and cycles within a larger trend of weaker growth than the period that preceded it. A fact for which we should be very grateful. We are not different but we are lucky.
