RBA update: Governor Lowe points to even lower rates


Peter Martin., Crawford School of Public Policy, Australian National University

Reserve Bank Governor Philip Lowe has said two things about unemployment in the past few weeks. Together, they lead to an inescapable conclusion.

The first was in a speech in May, expanded on in a speech in June. At both times the published unemployment rate was 5.2%.

Lowe said in May that while the Reserve Bank had long thought an unemployment rate of 5% was the best that could be achieved without generating worrying inflation, that view has now changed:

From today’s perspective, I think we can do better than this. My judgement of the accumulating evidence is that the Australian economy can support an unemployment rate of below 5% without raising inflation concerns.

It was good news. And then it got better.

In June he put a number on how low the unemployment rate could go before inflation became a concern:

While it is not possible to pin the number down exactly, the evidence is consistent with an estimate below 5%, perhaps around 4.5%. Given that the current unemployment rate is 5.2%, this suggests that there is still spare capacity in our labour market.

The Reserve Bank should be able to cut interest rates until unemployment fell below 5% and approached 4.5% without worrying about inflation, Lowe argued.

And in May, in a report back from a board meeting, he made it clear that’s what he would do:

At that meeting, we discussed a scenario in which there was no further improvement in the labour market and the unemployment rate remained around the 5% mark. In this scenario, we judged that inflation was likely to remain low relative to the target and that a decrease in the cash rate would likely be appropriate.

It would likely be appropriate to cut interest rates and keep cutting until the unemployment rate was driven below 5%, continuing to cut until it approached 4.5%.

Today, appearing before the House of Representatives economics committee in Canberra with the unemployment rate still stuck at 5.2% despite two consecutive rate cuts, he delivered what on the face of it was bad news.

He said the bank’s central forecast was that the unemployment rate would stay above 5% again until 2021. That’s right, 2021.

But taking the two statements together, it is reasonable to conclude that the Reserve Bank will keep cutting rates until unemployment does fall below 5%. In other words, it will keep cutting rates until 2021.

Lowe ain’t done cutting…

Indeed, the Reserve Bank’s quarterly forecasts update, released as Lowe spoke, countenances that happening. As foreshadowed by the governor, it forecasts that the unemployment rate won’t fall back to 5% until June 2021.

And it contains several other unwelcome forecasts: economic growth of just 2.5% this year, down from a previously forecast 2.75%, and very weak inflation this year of just 1.75%, down from a previously forecast 2%.



RBA Statement on Monetary Policy, August 9, 2019

But here’s the thing. All of those forecasts were compiled, as is the Reserve Bank’s custom, by taking into account not only the two interest rate cuts that have already happened (and have taken the bank’s cash rate down to an all-time low of 1%), but also two more yet to be delivered.

It is explained in the footnote:

Technical assumptions set on 7 August include the cash rate moving in line with market pricing.

The “market pricing” is the consensus of the bets placed on the futures market for what the Reserve Bank is going to do to its cash rate.

The consensus is for another cut of 0.25% in October and then another cut of 0.25% in February, taking the cash rate down to yet another all-time low of just 0.5%.



ASX target rate tracker

The Reserve Bank is normally at pains to point out that this is a mere technical assumption, not a guarantee of how it will move rates. But the awful truth is that its forecasts imply that unless it cut rates two more times in coming months, unemployment won’t fall to 5% by 2021, and inflation will be even weaker than the incredibly weak 1.75% it is forecasting.

…and he might not stop at zero

Two more cuts in its cash rate will take it to 0.5%, close to zero.

Lowe revealed that the Reserve Bank is investigating so-called “unconventional” monetary policy or quantitative easing that would have the same effect as taking the cash rate below zero.

“It is prudent for us to have done the work in advance to see what we would do – it’s really contingency planning,” he said.

Rates might go to zero, or below, worldwide because right now there is a worldwide glut of savings, and not enough investment.

The reality we face is that, if a lot of people want to save and not many people want to use those savings to build new capital, savers are going to get low returns. We can move our interest rates around this new structurally lower level,but we can’t escape the fact that global interest rates are low.

The Reserve Bank’s best case is that its Australian forecasts are wrong – that unemployment actually falls and that inflation, wage growth and economic growth climb.

There’s a respectable view within the bank that this might happen. Its forecasts take into account a range of positive influences, including lower interest rates, the recent tax cuts, the depreciation of the Australian dollar, a brighter outlook for investment in the resources sector, some stabilisation in the housing market, and ongoing high levels of investment in infrastructure.




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Below zero is ‘reverse’. How the Reserve Bank would make quantitative easing work


But they are the result of a mechanical model that takes them into account individually. The governor’s hope is that, taken together, they will achieve more than is forecast.

He would like governments themselves to push things along, starting with the wages they pay their own employees, and he is becoming ever more bold about saying so:

Most public sectors have wage caps of 2.5%, some have 1.5%, I think in Western Australia it’s probably even lower. I can understand why governments are doing that. On the other hand, the wage caps in the public sector are cementing low wage norms across the country. Over time, I hope the whole system, including the public sector, could see wages rising at three point something.

He is as good as powerless to stop what he regards as a worldwide investment strike caused by the trade and technology disputes between the United States and China.

These disputes pose a significant risk to the global economy. Not only are they disrupting trade flows, but they are also generating considerable uncertainty for many businesses around the world. Worryingly, this uncertainty is leading to investment plans being postponed or reconsidered.

Lowe doesn’t believe further interest rate cuts would to do much to encourage businesses to invest, or to encourage home buyers to borrow.

But he is certain they will help in other ways.

They will lower the exchange rate, making Australian goods and services more competitive, and that they will free up the cash of Australians who already have home loans, what he calls the “cash flow” channel:

There is no evidence that has become less effective. It is certainly true that in the current environment, at least in my view, monetary policy is less effective than it used to be. In today’s environment people don’t run off to the bank to borrow more when interest rates fall; they are more likely to pay back their mortgage more quickly. So that dynamic is different than it used to be.

When he last appeared before the parliamentary committee in February he said the probabilities of rates going up and rates going down were evenly balanced. He didn’t say that today.




Read more:
Buckle up. 2019-20 survey finds the economy weak and heading down, and that’s ahead of surprises


The Conversation


Peter Martin., Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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Back-to-back Reserve Bank cuts take interest rates to new low of 1%


Michelle Grattan, University of Canberra and Peter Martin, Crawford School of Public Policy, Australian National University

The Reserve Bank has cut the official interest rate by another 0.25 percentage points to a new low of 1%, reflecting continuing concern over the slow economy.

Reserve Bank Governor Philip Lowe said the latest cut, which came a month after the RBA made a similar cut of 0.25 percentage points, would help “make further inroads” into the economy’s spare capacity, assist in reducing unemployment, and achieve more progress towards the inflation target. The last back-to-back reduction was in 2012.

Treasurer Josh Frydenberg said the government “expects all banks to pass on the benefits of sustained reductions in funding costs.” ANZ Bank immediately announced it would pass on the full cut. On June 4 it passed on just 0.18 points of the 0.25 point cut.

The Commonwealth and National Australia banks will pass on 0.19 of the 0.25 points. Westpac will pass on 0.20 points for owner-occupiers and 0.30 points for investors with interest only loans.


Reserve Bank cash rate since 1990


Reserve Bank of Australia

The Reserve Bank made it clear it could cut further if necessary.

The wording of Lowe’s statement makes clear that he will continue to cut rates until the unemployment rate falls, probably to around 4.5%, which the bank has identified as a target consistent with its inflation target.

Sub-5% unemployment the new RBA target

Over the past six months, the unemployment rate has climbed from 5% to 5.2%, instead of falling as the bank believes it should.

Lowe’s statement says the Australian economy “can sustain lower rates of unemployment and underemployment”. It says its inflation target of 2-3% is not at risk. It expects underlying inflation to climb from its present 1.4% to around 2% in 2020 and then a little higher after that.

After the announcement, JP Morgan predicted another two cuts, taking the cash rate from 1% to 0.5% by mid next year. It said the risks to this view were that the bank “gets there earlier, not later”.

The cut in the cash rate will bring many mortgage rates down to less than 4% for the first time in records that date back to 1959.




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The latest Reserve Bank decision comes as the Coalition government gathers the Senate numbers to pass its income tax package this week. The first tranche will provide an early stimulus to the economy.

Frydenberg said the government’s economic plan, “including significant tax cuts of which the legislation will be introduced into the parliament today, will boost household consumption and overall economic activity”.

While the Reserve Bank described the outlook for both the global and domestic economies as “reasonable”, it pointed to uncertainties in each.

The central scenario for the Australian economy remains reasonable, with growth around trend expected. The main domestic uncertainty continues to be the outlook for consumption, although a pick-up in household disposable income is expected to support spending.

Lowe pointed out that while there had been a pick up in private sector wages growth, “overall wages growth remains low”.

Labor puts the case for bringing tax cuts forward

Shadow Treasurer Jim Chalmers said “two rate cuts in two months are a damning indictment of the Liberals’ economic mismanagement”.

Rates are now a third of their level during the global financial crisis of the late 2000s, he said.

Chalmers said the decision to cut rates boosted the case for Labor’s proposed amendments to the tax package. These amendments would embrace the first stage of the tax plan, bring forward some of stage two and drop the third stage.

But the government is insisting the package must go through without change, and is negotiating with the crossbench to bypass Labor if necessary.




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Stages 1 and 2 of the tax cuts should pass. But Stage 3 would return us to the 1950s


In his speech opening the parliament on Tuesday, Governor-General David Hurley said the government believed “a strong economy is the foundation of the compact between Australians and their government”.

“A strong economy makes us more resilient when economic shocks and global headwinds confront our country,” he said, in an address that is written by the government.

My government understands that you can’t take economic growth for granted and it requires continual work – in improving confidence, competitiveness and productivity.

The speech outlined the government’s program but did not contain anything new.

In the first meeting of the Coalition parties in the new parliament, Prime Minister Scott Morrison said he wanted the government to be known for its humility and urged his troops to be humble.

He declared this as “the year of the surplus” – a reference to the budget’s promise of a return to surplus this financial year.




Read more:
Buckle up. 2019-20 survey finds the economy weak and heading down, and that’s ahead of surprises


The Conversation


Michelle Grattan, Professorial Fellow, University of Canberra and Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

The Reserve Bank will cut rates again and again, until we lift spending and push up prices


Peter Martin, Crawford School of Public Policy, Australian National University

The Reserve Bank cut interest rates on Tuesday because we aren’t spending or pushing up prices at anything like the rate it would like. And things are even worse than it might have realised.

As the board met in Martin Place in Sydney, in Canberra at 11.30 am the Bureau of Statistics released details of retail spending in April, one month beyond the March quarter figures the bank was using to make its decision.

They show the dollars spent in shops fell in April, slipping 0.1%, notwithstanding weakly growing prices and a more strongly growing population.

The March quarter figures the board was looking at were adjusted for prices. They show that the volume of goods and services bought, but not the amount paid for them, fell in seasonally adjusted terms during the March quarter.

Adjusted for population, the volume bought would have fallen further.

We’ll know more on Wednesday

The Bureau of Statistics will release population-adjusted figures as part of the national accounts on Wednesday.

The figures for the September quarter show that income and spending per person barely grew. The figures for the December quarter show income and spending per person fell.

A second fall in the March quarter will mean two in a row – what some people call a per capita recession.



Australian National Accounts

Even unadjusted for population, economic growth is dismal.

During the September and December quarters the economy grew just 0.3% and 0.2% – an annualised rate of just 1%.

That’s well short of the 2.75% the treasury believes we are capable of, and the lower than normal 2.25% it has forecast for the year to June.



Australian National Accounts

We’ve been doing it by ourselves. As Reserve Bank Governor Philip Lowe said in announcing the rates decision on Tuesday:

The main domestic uncertainty continues to be the outlook for household consumption, which is being affected by a protracted period of low income growth and declining housing prices.

The bank wants both inflation and employment higher, and it wants us to spend more in order to do it. Lower rates should help, although not for everybody.

Lowe acknowledged this in a speech to a Sydney business audience on Tuesday night, but he said households paid two dollars in interest for every one dollar of interest they received. So while rate cuts hurt savers, they benefit borrowers by more, and over time should benefit all households by boosting the economy. They also drive the dollar lower, making Australian businesses more competitive.

Tuesday’s cut should free up an extra A$60 a month for a typical mortgage holder. Another one will free up a total of A$120.

It’s not much, and there’s doubt about whether it will do much, but interest rates are about the only tool the Reserve Bank has.

It is required by its agreement with the government to aim for an inflation rate of between 2% and 3%, “on average, over time”.

Treasurer and Reserve Bank Governor, Statement on the Conduct of Monetary Policy, September 19, 2016.
Reserve Bank of Australia

Uncomfortably for Governor Lowe, underlying inflation (abstracting from unusual moves which are quickly reversed) has been below 2% ever since he was appointed governor in late 2016.

Explaining his push for higher inflation to a business audience in Sydney on Tuesday night he said that while adherence to the target was intended to be flexible, that flexibility was “not boundless”.

If inflation stays too low for too long, it is possible that inflation
expectations move lower – that Australians come to expect sub-2% inflation
on an ongoing basis. If this were to happen, it would be harder to achieve the
medium term inflation goal. So we need to guard against this possibility.

He is also required to aim for full employment.

He told the business audience that while for some years the bank and others had thought full employment meant an unemployment rate of 5%, the absence of inflation at 5% and the persistence of underemployment (where people wanted more hours) meant it could and should go lower.

Our judgement now is that we can do better than this – that we can sustain an
unemployment rate of 4 point something.

Lower interest rates should help by making it easier for businesses to borrow to expand, and giving consumers something in their pockets to buy from them.

If you don’t succeed…

If that doesn’t happen, the bank will cut again.

Tuesday’s statement as good as said so:

The board will continue to monitor developments in the labour market closely and adjust monetary policy to support sustainable growth in the economy and the achievement of the inflation target over time.

Tuesday’s cut and the next will take the bank into uncharted waters, where its so-called cash rate – what it pays to banks to deposit money with it overnight – is close to zero.

As far as can be discerned it has never been that low in the 100+ years the Reserve Bank has been in operation, originally as the Commonwealth Bank of Australia.


Reserve Bank cash rate since 1990


Reserve Bank of Australia

Should inflation still not pick up and employment still not fall as far as it believes it could, it will have to effectively cut its cash rate below zero, forcing cash into the hands of banks by aggressively buying government bonds, giving them little choice but to lend it to households and businesses, in a process known as quantitative easing. It has been done in the United States, Europe, the United Kingdom and Japan, and is by now anything but unconventional.

Governor Lowe would prefer the government to pull its weight by cutting tax and boosting spending, especially on infrastructure, and by policies that make Australia more productive.

He said so on Tuesday night

the best approach to delivering lower unemployment and a stronger economy is through structural policies that support firms expanding, investing, innovating and employing people. As we ease monetary policy, it is in the country’s interest that other policy options are considered too.

Treasurer Josh Frydenberg gets it.

He pointed out on Tuesday that the yet-to-be-approved tax offsets in the budget will give Australians on up to A$126,000 a cash bonus of up to A$1,080 when they submit this year’s tax return, far more than the rate cut.

His biggest concern, and the biggest concern of the governor, might be that they don’t spend it. Another concern would be that the banks don’t pass the rate cut on.

The ANZ has said it will only cut mortgage rates by 0.18 points instead of the full 0.25, a decision Frydenberg said “let down” customers. Westpac has cut by only 0.20 points. The National Australia and Commonwealth banks have passed on the cut in full.

On Tuesday night in Sydney Governor Lowe addressed the question of whether the banks should have passed on the full cut head on:

My usual practice in answering this question has been to explain that there are a
range of other factors that influence mortgage pricing, and then say “it all depends”.

Today, though, I would like to break with my usual practice and provide a clearer
answer. And that is: Yes. There has been a substantial reduction in the cost of banks raising funds in wholesale markets. Average rates on retail deposits have also come down.

This means that the lower cash rate should be fully passed through into standard variable mortgage rates. Full pass-through would also mean that the economy receives the full benefit of today’s policy decision.

The Governor is concerned that, for their own reasons, lenders such as ANZ and Westpac are forcing him to cut rates lower than he should and making an already difficult job harder.

If he has to cut further he will, but with the cash rate at just 1.25%, he would dearly love not to have to.


Reserve Bank of Australia



Read more:
Cutting interest rates is just the start. It’s about to become much, much easier to borrow


The Conversation


Peter Martin, Visiting Fellow, Crawford School of Public Policy, Australian National University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Vital signs. Zero inflation means the Reserve Bank should cut rates as soon as it can, on Tuesday week



File 20190425 121224 z24k1w.jpg?ixlib=rb 1.1
The last time inflation was zero the Reserve Bank cut rates twice. It’ll get the chance on May 7.
Shutterstock

Richard Holden, UNSW

What do US pizza executive Herman Cain, US conservative commentator Stephen Moore, US Chief Justice Earl Warren, and Australia’s Reserve Bank governor Philip Lowe have in common?

More than you might think.

The immediate issue for Lowe is Wednesday’s inflation figures released by the Bureau of Statistics. Inflation for the first quarter of 2019 came in at 0.0%. Zero. Nada.

Taken together, the sum of consumer prices moved not at all between the last quarter of 2019 and the first quarter of 2019. The annual increase (all of it in the last three quarters of last year) was 1.3%.

However you cut the numbers, inflation is now incredibly low. The Reserve Bank’s measures of so-called underlying inflation (that mute the effects of sharp movements in things such as the prices of fruit and vegetables) are at the same level they were in 2016 when the Reserve Bank cut rates twice – in May and then August.

The Reserve Bank must cut

It has to do it again. The market expects it and is pricing in a cut.

Trading on the Australian Securities Exchange implies that 67% of those wagering real money expect the Reserve Bank to cut its cash rate from its present record low of 1.5% to another uncharted low of 1.25% when it next meets to consider rates on Tuesday May 7, a fortnight before the election.

A day earlier, before the release of Wednesday’s shockingly low inflation figure, only 13% expected a cut on Tuesday week.


ASX Target Rate Tracker

Three days after the Reserve Bank meeting, and just one week before the election, Lowe is due to release his quarterly report on the state of the economy and his stance on interest rates. He’ll find it easier to write if he justifies a cut.

Not only is inflation far lower than he is his aiming for, but economic growth has plummeted to levels that imply annual growth of closer to 1% than the present 2.3%
or his forecast of 3% by December. Strong house price growth, that would have once been a reason for caution about cutting rates, is no longer a consideration.

A broad cross-section of market economists expect a cut on Tuesday week.

Westpac’s Bill Evans has long predicted 50 basis points of cuts this year, and on Wednesday ANZ economists Hayden Dimes and David Plank said

The downward surprise to core inflation in the first quarter leaves the RBA with little choice but to cut the cash rate by 25 points at its May meeting, with another basis points likely to follow in August

The Reserve Bank’s inflation target of 2-3% has become a joke. Inflation has rarely even entered that range the entire time Lowe has been governor.

Lowe keeps hoping for lower unemployment to spark wages growth, but despite unemployment being consistently at or near its long term low of 5%, nothing much has happened, for almost a decade.

Most observers think that unemployment would need to be much lower – closer to 4% than 5% – for wages to take off.

Politics makes it urgent

Then factor in the election. Labor is odds-on to win. If it does, then there is a chance of fairly radical industrial relations reform. Think about the wish list of Australian Council of Trade Unions Secretary Sally McManus. That seems unlikely to me because of Labor’s extremely sensible economic team, but it’s possible.

Whether it happens or not, until the industrial relations landscape becomes clear businesses are unlikely to do a lot of hiring. Why hire a bunch of folks if you don’t know what you might have to end up paying them or how easy it will be to let them go or change what they do?

That uncertainty is likely to put more downward pressure on wages than whatever upward pressure comes from Labor heavying the Fair Work Commission into reversing its recent penalty-rates decision.

The Bank is losing credibility

All this suggests that the Reserve Bank has waited far too long for wages to tick up of their own accord.

We’ve had recent lessons from the US about the importance of credibility in central banking.

Donald Trump’s nomination of pizza executive Herman Cain to the board of the US Federal Reserve has been withdrawn after sexual harassment allegations, his nomination of Stephen Moore is in doubt after a series of derogatory public remarks he made about women.

They have political problems. Their nominations are in trouble because they are, to put it bluntly, grossly unqualified to govern the Federal Reserve.

The Reserve Bank’s problem is obviously different. It enjoys an impeccable reputation. But repeatedly seeming to ignore inflation numbers (and its own targets for inflation) is putting that reputation at risk.

Having resolve is important. The Reserve Bank isn’t supposed to just do exactly what the market expects or wants it to do.

But getting way out of whack with informed public sentiment without offering good reasons for doing so is very dangerous.

US Chief Justice Earl Warren – the great liberal reformer who desegregated education, ensured the right to a lawyer in criminal cases, and established the principle of one person one vote – was famously mindful of the Court not getting too far ahead of public opinion.

In Brown v Board of Education, which ruled racially segregated education unlawful, Warren worked hard to ensure a unanimous opinion of the Court. That opinion required desegregation “with all deliberate speed” – a phrase that was justly criticised as allowing desegregation to proceed far too slowly, but ensured that the court wasn’t too far out ahead of the Southern states and allowed them to adapt rather than defy it.

The Reserve Bank’s problem is not getting too far ahead of public opinion, it is lagging too far behind.

The consequences can be similar, though. If the public and the markets lose faith in the Bank as an institution – if it seems radically out of touch – then it will lose its ability to persuade and it will risk forced change from the outside.

Forced change is a possibility. Each new government strikes a new agreement with the Reserve Bank governor setting out what it expects of him.

The present one specifies “inflation between 2% and 3%, on average, over time”. If it can be seen that the governor has paid scant regard to the agreement, the new one might make the target more binding, or replace it with a different target.

Treasurer and Reserve Bank Governor, Statement on the Conduct of Monetary Policy, September 19, 2016.
Reserve Bank of Australia

It’s time to stop waiting

Governor Lowe waiting for wages to tick up without any underlying factor to cause it to happen is like Waiting for Godot. And it’s getting absurd.

He needs a better narrative than “something will turn up”, and he needs to cut rates. Not with all deliberate speed, but fast.The Conversation

Richard Holden, Professor of Economics, UNSW

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Vital Signs. If needed, this man can and will cut rates during the election campaign


Richard Holden, UNSW

It was a great story.

Philip Lowe had taken over as Reserve Bank governor after 25 years of uninterrupted economic growth. The Australian economy was transitioning nicely away from the country’s biggest-ever mining boom. Interest rates had been cut to historic lows in the wake of the 2008 financial crisis and had bottomed out. Inflation and wages growth were about to pick up. Unemployment was falling. And the new governor would preside over a return to “new normal”, with gradual rate rises up to a cash rate of 3.5-4.0%.

Then a funny thing happened on the way to the fairytale ending.

In a remarkable speech at the National Press Club on Wednesday, Lowe essentially admitted that the bank might well need to take extra remedial action to get the economy moving again.

Gone was the mantra that “the next movement in interest rate will likely be up”. Rather, Lowe said:

…here are scenarios where the next move in the cash rate is up, and other scenarios where it is down. Over the past year, the next-move-is-up scenarios were more likely than the next-move-is-down scenarios. Today, the probabilities appear to be more evenly balanced.

Translation: “I don’t want to freak you out, but we’re probably going to have to cut rates. And do it sooner rather than later.”

Consider the two main things driving the Reserve Bank’s decision.

Inflation is stubbornly low. As I pointed out last week, the bank has long had an inflation target of 2-3%, but it keeps undershooting it, and not just missing the centre, but missing the lower bound. In two and a half years with Lowe as governor, inflation has averaged just 1.87% – and has never been inside the target band. The latest figure is 1.8%.



Related to that, wages growth is anaemic. For five years it has barely kept up with inflation.

This is broadly true in advanced economies around the world (although our wages are doing worse than those in the United States) and suggests the unemployment rate will need to be pushed down further than in the past in order to reignite wages pressure and hence inflation. That suggests we’ll need even lower interest rates than we’ve got in order to provide what the boffins call monetary stimulus.



And the Reserve Bank’s cash rate — the rate that most other rates are set in reference to — is already the lowest on record, at just 1.5%.

Meanwhile, the housing market has taken a big hit, which isn’t over. Nationwide, the market is down 6.1% from its October 2017 peak. In Sydney and Melbourne, the falls are double that.

They are the mainly the result of a credit crunch that flowed from the Australian Prudential Regulation Authority’s decision to wake from its multi-year slumber and tighten lending rules at about the same time the banks responded to the royal commission by impersonating frightened turtles.

Sinking property prices sink spending

Sliding property prices shrink household spending, which makes up roughly 60% of economic activity.

On Tuesday, in the statement it released after its first board meeting for the year, the bank obliquely signalled that it had cut its GDP growth forecasts, mentioning forecasts of 3% this year and less in 2020 instead of the 3.5% this year and less in 2020 it had mentioned after its December meeting.

Add in the global headwinds from the US-China trade tensions and the fallout from the bungled Brexit, and it’s hard to find much that’s encouraging about the Australian economy in the year ahead.

Lowe didn’t want to state explicitly that he might have to cut rates between now and the election (and if necessary during the campaign itself), but he didn’t need to. He has been as clear as governors get.

Rates could be cut on budget day

A decent bet is the bank will cut 25 points on the first Tuesday in May, after the release of the updated (and possibly weak) inflation data on April 24.

Another possible date is the first Tuesday in April, April 2, after the March release of the December quarter economic growth figures, especially if economic growth turns negative. Coincidentally, April 2 is the day the government has set aside for the early budget, so it can hold the election in May.

If it does there will be some who will try to spin it as good news. In 2007 John Howard campaigned under the slogan that rates would be “lower under the Coalition”.

Don’t think it couldn’t happen

His treasurer Peter Costello was under the impression the bank wouldn’t dare move rate during the campaign, unwisely telling broadcaster Jon Faine it would keep them put.

“He looked me in the eye. He put his thumb down as he sat there…and he said, ‘There will not be a rate rise in November. Take it from me’,” Faine said.

Having marked out the territory, there is no doubt the bank will use it if needed. To do otherwise would be to invite questions about whether it had favoured one party or the other by holding off.

The hard truth is that we live in a secular-stagnation world, with too much saving chasing too few profitable investment opportunities.

Rates no longer need to be particularly high

That means that interest rates don’t need to be anything like as high as they once did to attract enough money to fund good ideas. And even if the ideas are good, it is likely they won’t need as much money as they did. Whereas once it took tens of billions of dollars to create a globally significant company (like BHP or US Steel) all it takes now is maybe $2,000 and a laptop, as with Facebook and Google.

A massive mining boom caused by the transition of China to a market economy and then a huge property bubble masked the new reality here for while.

Now it is here for all to see, the Reserve Bank governor included.




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No surplus, no share market growth, no lift in wage growth. Economic survey points to bleaker times post-election


The Conversation


Richard Holden, Professor of Economics, UNSW

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Vital Signs. Yet another year of steady rates. What’s the point of the RBA inflation target?



File 20190131 112389 1ubj9ef.jpg?ixlib=rb 1.1
Economists expect the cash rate to remain steady for yet another year even though inflation is on the floor.
Shutterstock

Richard Holden, UNSW

The Reserve Bank kicks off its first meeting for the year next Tuesday facing the same dilemma it did throughout last year.

It hasn’t got easier.

The bank has a very public, fairly clear objective: to keep inflation between 2% and 3%. But it keeps missing it. Over and over and over again, and on the downside.

As the following chart shows, inflation has been below the bank’s target band for nearly all of the past four years.



During his decade in office, the previous governor Glenn Stephens achieved an average inflation rate of 2.46% – almost bang in the centre of the target band.

During his subsequent two and half years in the job, Philip Lowe has averaged just 1.87%. At no point during Lowe’s term of office has the average fallen within the target band. The rate for December, released on Wednesday, was 1.8%.

Next Wednesday Lowe will make an unusual address to the National Press Club, during which he will outline his thoughts about the year ahead.

It is a year which The Conversation’s forecasting panel predicted will be free of interest rate adjustments, making it a record 40 months without a rate move – Lowe’s entire term in office.



The RBA has more than one target

Although the inflation target is an important part of the Reserve Bank’s mandate, it is also asked to focus on other things. Among them are GDP growth, employment, and (probably less explicitly) the Australian dollar and house prices.

And therein lies the problem. Unless the rate moves needed to meet all those objectives point in the same direction, the bank needs to make trade-offs, or sideline one or more of its objectives.

A classic principle of economics is that a policy-maker needs one instrument (or policy tool) for each objective. It is called the Tinbergen Rule, after the 1969 Nobel Laureate.

The bank has four or five objectives, but really only one tool – the cash rate, stuck at 1.5% since Lowe took the job.

Throw in the ability to partially shape market expectations through speeches by Lowe and Deputy Governor Guy Debelle (so-called “open mouth” operations), and maybe it has two.

Since Lowe took office, the casualty of this imbalance between instruments and objectives has been the inflation target. And it’s unlikely to change for some time.

So why is inflation so low?

Australia is not alone. Advanced economies around the world have had several years of low wages growth, low productivity growth, and low inflation. Populations are ageing, less keen on spending, and have a glut of excess savings.

Add to this the fact that technology and international trade have made a whole range of goods probably permanently cheaper and it’s hard to find inflationary pressure.




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Vital Signs: inflation misses again, so where does the RBA go next?


Potentially making things worse in Australia is the decline in house prices in Sydney and Melbourne eating into consumer confidence and with it, spending. With well over half of the economy coming from private spending, already soft consumer spending could be hit further.

So far, RBA Governor Philip Lowe has been doing an admirable impression of Mr Micawber, in the Charles Dickens novel David Copperfield. When it comes to inflation, he is hoping “something will turn up”. But it hasn’t, even with historically low levels of unemployment.

Worse still, it doesn’t even seem to really be ticking up in the United States, despite the lowest year-end unemployment rate since 1969.

And why does it target inflation?

The bank targets inflation in order to maintain credibility.

The high levels of inflation in the 1970s and ‘80s – despite quite high levels of unemployment – led to the realisation that expectations had a lot to do with it.

Put simply, if people believe prices are going to rise sharply they will demand steep wage rises, which will cause prices to rise sharply. It becomes a “wage-price spiral”.

Macroeconomists and central bankers realised that a credible commitment to keep inflation low would remove the need for the large wage rises, cutting off the spiral before it got going.

The bank describes the rationale for its inflation target this way:

The Governor and the Treasurer have agreed that the appropriate target for monetary policy in Australia is to achieve an inflation rate of 2–3%, on average, over time. This is a rate of inflation sufficiently low that it does not materially distort economic decisions in the community. Seeking to achieve this rate, on average, provides discipline for monetary policy decision-making, and serves as an anchor for private-sector inflation expectations.

That’s been the logic for the past 25 years. We have certainly done away with inflationary spirals. We are in the age of secular stagnation, with an excess of savings chasing too little spending. A world where, since the turn of this century, robust growth has only really been possible when accompanied with financial bubbles–first in dot-coms, then in housing.

So what’s a central banker to do?

There is an active debate among central bankers and leading macroeconomists about whether to abandon the inflation targeting framework.

Luminaries like former US Treasury Secretary Larry Summers argue that inflation targets are, to borrow from Hamlet, “more honour’d in the breach than the observance”.

Right now Lowe faces a real dilemma. If he doesn’t cut rates, the inflation target will become more and more of a joke. It will add to pressure on him to articulate a new monetary policy framework for a new secular-stagnation era.

If he does, he risks re-inflating the housing bubble, boosting already sky-high household debt, and giving himself even less wiggle room if a recession hits.

On Tuesday he’ll leave the cash rate at 1.50%. And on the first Tuesday of the next month, and the the next, and the one after that…

But I think he’ll begin serious internal discussions about a new monetary policy framework, and the mechanics of getting into (and out of) a massive bond-buying program (otherwise known as quantitative easing or printing money) if needed to ward off the next recession should the cash rate remain or get so low he can’t cut it further.

He might have already started. He might drop further hints on Wednesday.




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No surplus, no share market growth, no lift in wage growth. Economic survey points to bleaker times post-election


The Conversation


Richard Holden, Professor of Economics, UNSW

This article is republished from The Conversation under a Creative Commons license. Read the original article.

Vital Signs: weak inflation means interest rates aren’t rising anytime soon


Richard Holden, UNSW

Vital Signs is a weekly economic wrap from UNSW economics professor and Harvard PhD Richard Holden (@profholden). Vital Signs aims to contextualise weekly economic events and cut through the noise of the data affecting global economies.

This week: changes to how inflation is calculated, stagnant housing credit, and the US Federal Reserve keeps interest rates on hold


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It’s not often there are news stories anticipating Australian Bureau of Statistics data a week before it comes out. But Wednesday’s Consumer Price Index was an exception. The data showed a 0.6% rise in the Consumer Price Index for the December quarter, bringing the annual rate up to 1.9% (from 1.8% in the 12 months to September).

This is still below the Reserve Bank of Australia’s target range of 2-3%, but it’s edging closer. Kind of. It was still below what was forecasted.

One reason why market participants follow the Consumer Price Index so closely is the impact it has on the RBA in setting the official cash rate. For the RBA to start raising interest rates would require it to be pretty confident that the disinflationary pressures in the Australian economy have abated.

That still seems unclear, which is why it is a near certainty they will leave the cash rate unchanged at the next board meeting on Tuesday.

Two changes to how the Consumer Price Index is calculated were also introduced. Firstly, the weights that different categories of expenditure receive were tweaked, as they are periodically. This is to make sure that the goods in the “basket” reflect what households are actually spending their money on.

In the new calculation, items like childcare (now 1.35%) and education (now 4.27%) get a larger weighting.

A less routine and more interesting change was to use scanner data from retailers at point-of-sale in calculating the Consumer Price Index. This was spearheaded by the work of my UNSW School of Economics colleague Professor Kevin Fox, who was quoted by the ABS:

I strongly support the ABS decision to implement new CPI methods for the treatment of transactions data… These new methods will enhance the accuracy of the Australian CPI, provide additional analytics and better inform policy formulation.

Scanner data has been used in the Australian CPI since 2014, and makes up about one quarter of the expenditure basket. There were some issues, however, in how that data was incorporated. Roughly speaking (for technical details see the ABS report), the changes involve using all the products available (rather than a sample) and weighting products by their economic importance. A bonus for the cash-strapped ABS is that, as they put it

The use of multilateral methods will require fewer resources in the medium term.

Using more data, and using it better is definitely a good idea. And in the long run it will give us more informative, and reliable inflation figures.




Read more:
Vital Signs: five economic red flags to watch for in 2018


Reserve Bank of Australia data released Wednesday showed fairly steady credit growth compared to previous months. Housing credit grew at 6.3% for the year to December, as in 2016. Of course, one doesn’t want this to be too high given concerns about property bubbles, not too low given the importance of the housing market to the broader economy.

Meanwhile, in the US, this week marked the final board meeting of outgoing Federal Reserve Chair Janet Yellen. As expected, they left official interest rates unchanged at 1.25-1.50%, issuing this statement.

The Fed continues to be heavily focused on inflation, much like the RBA. The Federal Open Market Committee statement made that point, stating:

Inflation on a 12‑month basis is expected to move up this year and to stabilise around the Committee’s 2% objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

This is best read as a sign that another rate rise at the March meeting is likely, unless material new information arrives in the interim.

The ConversationOne of the significant economic stories of 2018 seems likely to be the divergence between US and Australian interest rates, what it means for the Australian dollar, and what it means for capital flows to Australia. At the moment, it seems the Fed will steadily raise US interest rates this year, while the RBA will be stuck with hard choices and may be reticent to begin a tightening cycle.

Richard Holden, Professor of Economics and PLuS Alliance Fellow, UNSW

This article was originally published on The Conversation. Read the original article.