We asked 13 economists how to fix things. All back the RBA governor over the treasurer


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

Thirteen leading economists have declared their hands in the stand off between the government and the Governor of the Reserve Bank over the best way to boost the economy.

All 13 back Reserve Bank Governor Philip Lowe.

They say that, by itself, the Reserve Bank cannot be expected to do everything extra that will be needed to boost the economy.

All think that extra stimulus will be needed, and all think it’ll have to come from Treasurer Josh Frydenberg, as well as the bank.

All but two say the treasurer should be prepared to sacrifice his goal of an immediate budget surplus in order to provide it.

The 13 are members of the 20-person economic forecasting panel assembled by The Conversation at the start of this year.

All but one have been surprised by the extent of the economic slowdown.




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The 13 represent ten universities in five states.

Among them are macroeconomists, economic modellers, former Treasury, IMF, OECD and Reserve Bank officials and a former government minister.

The Bank needs help

At issue is the government’s contention, spelled out by Frydenberg’s treasury secretary Steven Kennedy in evidence to the Senate last month, that there is usually little role for government spending and tax (“fiscal”) measures in stimulating the economy in the event of a downturn.

Absent a crisis, economic weakness was “best responded to by monetary policy”.

Monetary policy – the adjustment of interest rates by the Reserve Bank – is nearing the end of its effectiveness in its present form. The bank has already cut its cash rate to close to zero (0.75%) and will consider another cut on Tuesday.

It is preparing to consider so-called “unconventional” measures, including buying bonds in order to force longer-term interest rates down toward zero.




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Governor Lowe has made the case for “fiscal support, including through spending on infrastructure” saying there are limits to what monetary policy can achieve.

The 13 economists unanimously back the Governor.

Seven of the 13 say what is needed most is fiscal stimulus (including extra government spending on infrastructure), three say both fiscal and monetary measures are needed, and three want government “structural reform”, including measures to help the economy deal with climate change and remove red tape.

None say the Reserve Bank should be left to fight the downturn by itself without further help from the government.

There is plenty of room for fiscal stimulus, particularly infrastructure spending – Mark Crosby, Monash University

I agree with the emerging consensus that monetary policy is no longer effective when interest rates are so low – Ross Guest, Griffith University

It is time for coordinated monetary and fiscal policies to boost domestic demand – Guay Lim, Melbourne Institute

The surplus can wait

Eleven of the 13 believe the government should abandon its determination to deliver a budget surplus in 2019-20.

Renee Fry-McKibbin. Ease surplus at all costs.
ANU

Economic modeller Renee Fry-McKibbin says the government should “ease its position of a surplus at all costs”.

Former Commonwealth Treasury and ANZ economist Warren Hogan says achieving a surplus in the current environment would have “zero value”.

Former OECD director Adrian Blundell-Wignall says that rather than aiming for an overall budget surplus, the government should aim instead for an “net operating balance”, a proposal that was put forward by Scott Morrison as treasurer in 2017.

The approach would move worthwhile infrastructure spending and borrowing onto a separate balance sheet that would not need to balance.

Political debate would focus instead on whether the annual operating budget was balanced or in deficit.

Former treasury and IMF economist Tony Makin is one of only two economists surveyed who backs the government’s continued pursuit of a surplus, saying annual interest payments on government debt have reached A$14 billion, “four times the foreign aid budget and almost twice as much as federal spending on higher education”.

Tony Makin. Surplus needed for budget repair.
Griffith University

Further deterioration of the balance via “facile fiscal stimulus” would risk Australia’s creditworthiness.

However Makin doesn’t think the government should leave everything to the Reserve Bank.

He has put forward a program of extra spending on infrastructure projects that meet rigorous criteria, along with company tax cuts or investment allowances paid for by government spending cuts.

Former trade minister Craig Emerson also wants an investment allowance, suggesting businesses should be able to immediately deduct 20% of eligible spending.

It’s an idea put forward by Labor during the 2019 election campaign. Treasurer Josh Frydenberg has indicated something like it is being considered for the 2020 budget.

Emerson says it should be possible to deliver both the investment allowance and a budget surplus.

Quantitative easing would be a worry

Five of the 13 economists are concerned about the Reserve Bank adopting so-called “unconvential” measures such as buying government and private sector bonds in order to push long-term interest rates down toward zero, a practice known as quantitative easing.

Jeffrey Sheen and Renee Fry-McKibbin say it should be kept in reserve for emergencies.

Adrian Blundell-Wignall and Mark Crosby say it hasn’t worked in the countries that have tried it.

A quantitative easing avalanche policy by the European central bank larger than the entire UK economy has left inflation below target and growth fading. Quantitative easing destroys the interbank market, under-prices risk, and encourages leverage and asset speculation – Adrian Blundell-Wignall

Steve Keen says in both Europe and the United States quantitative easing enriched banks and drove up asset prices but did little to boost consumer spending, “because the rich don’t consume much of the wealth”.

The treasurer should step up

Taken together, the responses of the 13 economists suggest it is ultimately the government’s responsibility to ensure the economy doesn’t weaken any further, and that it would be especially unwise to palm it off on to the Reserve Bank at a time when the bank’s cash rate is close to zero and the effectiveness of the unconventional measures it might adopt is in doubt.

Measures the government could adopt include increasing the rate of the Newstart unemployment benefit, boosting funding for schools and skills training, borrowing for well-chosen infrastructure projects with a social rate of return greater than the cost of borrowing, further tax cuts that double as tax reform (including further tax breaks for business investment) and spending more on programs aimed at avoiding the worst of climate change and adapting to it.

The economists are backing the governor in his plea for help. They think he needs it.


The 13 economists surveyed




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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.

0.75% is a record low, but don’t think for a second the Reserve Bank has finished cutting the cash rate


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

Anyone who thought that with the Reserve Bank’s cash rate now close to zero, its run of interest rate cuts was over, needs only to read the last sentence of Governor Philip Lowe’s announcement after Tuesday’s cut:

The Board will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.

For the longest time, the run of cuts was over.

Lowe’s immediate predecessor, Glenn Stevens, cut the cash rate to a record low of 1.5% in August 2016 as something of a “parting gift”, allowing Lowe to take over and keep it steady, unchanged for a record 34 months.

For most of those three years he made it clear the rate was unlikely to fall further. Six times he said the next move in rates was likely to be up, “rather than down”, pointing to rate increases overseas and progress on jobs and returning Australia’s unusually low inflation rate to his target band.

By February this year he was backtracking. Although it wasn’t apparent in the published figures, the unemployment rate was about to begin climbing. Wage growth had been far weaker than forecast, inflation showed no sign of returning to the centre of his target band, and forecasts for global growth were falling.


Reserve Bank cash rate


Source: RBA

More importantly, consumer spending, which accounts for six in every ten dollars spent in Australia, was extraordinarily weak, growing at less than half the usual rate, as households “responded to this extended period of weaker income growth by progressively downgrading their spending plans”.

The probabilities of next move being up and down had become “more evenly balanced”.




Read more:
RBA update: Governor Lowe points to even lower rates


Two weeks after the May election he cut the cash rate, then cut it again, taking it to a new record low of 1%, anticipated by only two of the 19 economists surveyed by The Conversation just six months earlier.

The extra cut announced on Tuesday is because the last two didn’t do enough.

House prices have begun to move up (as would be expected with lower rates) but borrowing is growing only slowly, and home building is weak. The Australian dollar is low (in part because of the lower rates), which should help make Australian businesses competitive, but they are not keen to borrow.

Since the last Reserve Bank board meeting we have learned that economic growth is shockingly low, just 1.4% over the past year, the weakest since the global financial crisis. Household spending is barely keeping pace with population growth.

Lowe would like to believe the economy has reached “a gentle turning point”. He told a community dinner in Melbourne on Tuesday night the board thinks it might have.

There are a number of factors that are supporting this outlook. These include the low level of interest rates, the recent tax cuts, ongoing spending on infrastructure, signs of stabilisation in some established housing markets, and a brighter outlook for the resources sector.

But they will need help. The bank believes the economy is capable of producing an unemployment rate of 4.5%. Instead it has been climbing, to 5.3%.

How the cuts will help

The cash rate is determined by the rate the Reserve Bank pays banks who deposit with it overnight. It drives almost every other rate, including the rates banks pay retail depositors, which help determine their cost of lending.

They don’t have to cut their mortgage and business rates in line with cuts in the Reserve Bank cash rate, but they usually do.

The big banks played a game of chicken yesterday, each waiting for the other to move. The Commonwealth Bank moved first, offering just 0.13 of the 0.25 points, followed by the National Australia Bank, which offered 0.15 points.

The real action is in the discounted rates that target borrowers for whom they matter. Before Tuesday they averaged 3.46%. Some were much lower. HSBC Australia wanted just 3.17%. If it passes on Tuesday’s cut in full it will charge only 2.92%, offering the first Australian mortgage rate in history beginning with the number “2”.

There’s every reason to believe the cuts will help. Even if Australians don’t borrow more to buy houses, they will be able to use the historically cheap credit embodied in their house loans to buy other things, such as solar panels whose payoff period will have shortened dramatically.

Since June many mortgage-holders will have saved A$150 on monthly payments.

Sure, confidence and decent wage growth would help, but given how indebted many Australians are, low mortgage rates will do quite a bit on their own.

Why they’ll continue

Governor Lowe made it clear on Tuesday that they will have to stay low for “an extended period”. A signed agreement with the treasurer requires him to keep them low until unemployment falls and inflation and economic growth return to return to normal levels.

He would like the government to help by boosting spending. He often mentions spending on infrastructure. But his employment contract requires him to use the cards he has been dealt. If the economy is weak, he is required to boost it using the instruments he has.




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


That’s why he says he is prepared “to ease monetary policy further”.

If needed, he’ll do it as soon as next month, cutting the cash rate to 0.5%. If more is needed beyond that, he will get ready to use so-called unconventional measures of the kind being used overseas, buying government and corporate bonds in order to force even more money into Australian’s hands.

There’s no reason to believe that the tools he has won’t work, and every reason to believe he’ll keep using them.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.

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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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.




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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.

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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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.




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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.

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



Road tested. Quantitative easing worked in the US, and can work even better here.
Shutterstock

Stephen Kirchner, University of Sydney

With its official cash rate now expected to fall below 1% to a new extraordinarily low close to zero, all sorts of people are saying that the Reserve Bank is in danger of “running out of ammunition.” Ammunition might be needed if, as during the last financial crisis, it needs to cut rates by several percentage points.

This view assumes that when the cash rate hits zero there is nothing more the Reserve Bank can do.

The view is not only wrong, it is also dangerous, because if taken seriously it would mean that all of the next rounds of stimulus would have to be come from fiscal (spending and tax) policy, even though fiscal policy is probably ineffective long-term, its effects being neutralised by a floating exchange rate.

The experience of the United States shows that Australia’s Reserve Bank could quite easily take measures that would have the same effect as cutting its cash rate a further 2.5 percentage points – that is: 2.5 percentage points below zero.


Reserve Bank cash rate since 1990


Reserve Bank of Australia

In a report released on Tuesday by the University of Sydney’s United States Studies Centre, I document the successes and failures of the US approach to so-called “quantitative easing” (QE) between 2009 and 2014.

It demonstrates that it is always possible to change the instrument of monetary policy from changes in the official interest rate to changes in other interest rates by buying and holding other financial instruments such as long-term government and corporate bonds.

Australia can learn form US mistakes.
University of Sydney United States Studies Centre

The more aggressively the Reserve Bank buys those bonds from private sector owners, the lower the long-term interest rates that are needed to place bonds and the more former owners whose hands are filled with cash that they have to make use of.

In the US the Federal Reserve also used “forward guidance” about the likely future path of the US Federal funds rate to convince markets the rate would be kept low for an extended period.

It is unclear which mechanism was the most powerful, or whether the Fed even needed to buy bonds in order to make forward guidance work. However in a stressed economic environment, it is worth trying both.




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


As it comes to be believed that interest rates will stay low for an extended period, the exchange rate will fall, making it easier for Australian corporates to borrow from overseas and to export and compete with imports.

The consensus of the academic literature is that QE cut long-term interest rates by around one percentage point and had economic effects equivalent to cutting the US Federal fund rate by a further 2.5 percentage points after it approached zero.

QE need not have limits…

Based on US estimates, Australia’s Reserve Bank would need to purchase assets equal to around 1.5% of Australia’s Gross Domestic Product to achieve the equivalent of a 0.25 percentage point reduction in the official cash rate. That’s around A$30 billion.

With over A$780 billion in long-term government (Commonwealth and state) securities on issue, there’s enough to accommodate a very large program of Reserve Bank buying, and the bank could also follow the example of the Fed and expand the scope of purchases to include non-government securities, including residential mortgage-backed securities.

It could also learn from US mistakes. The Fed was slow to cut its official interest rate to near zero and slow to embark on QE in the wake of the 2008 financial crisis. Its first attempt was limited in size and duration. Its success in using QE to stimulate the economy should be viewed as the lower bound of what’s possible.

…even if it becomes less effective as it grows

It often suggested (although it is by no means certain) that monetary policy becomes less effective when interest rates get very low, but this isn’t necessarily an argument to use monetary policy less. It could just as easily be an argument to use it more.

Because there is no in-principle limit to how much QE a central bank can do, it is always possible to do more and succeed in lifting inflation rate and spending.

Fiscal policy may well be even less effective. To the extent that it succeeds, it is likely to push up the Australian dollar, making Australian businesses less competitive.

US economist Scott Sumner believes the extra bang for the buck from government spending or tax cuts (known as the multiplier) is close to zero.

Reserve Bank Governor Philip Lowe this month appealed for help from the government itself, asking in particular for extra spending on infrastructure and measures to raise productivity growth.




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He is correct in identifying the contribution other policies can make to driving economic growth. No one seriously thinks Reserve Bank monetary policy can or should substitute for productivity growth.

But it is a good, perhaps a very good, substitute for government spending that does not contribute to productivity growth.

Three myths about quantitative easing

In the paper I address several myths about QE. One is that it is “printing money”. It no more prints money than does conventional monetary policy. It pushes money into private sector hands by adjusting interest rates, albeit a different set of rates.

Another myth is that it promotes inequality by helping the rich to get richer.

It is a widely believed myth. Former Coalition treasurer Joe Hockey told the British Institute of Economic Affairs in 2014 that:

Loose monetary policy actually helps the rich to get richer. Why? Because we’ve seen rising asset values. Wealthier people hold the assets.

But it widens inequality no more than conventional monetary policy, and may not widen it at all if it is successful in maintaining sustainable economic growth.

A third myth is that it leads to excessive inflation or socialism.

In the US it has in fact been associated with some of the lowest inflation since the second world war. These days central banks are more likely to err on the side of creating too little inflation than too much.

Some have argued that QE in the US is to blame for the rise of left-wing populists
like Alexandria Ocasio-Cortez and “millennial socialism”. But it is probably truer to say that their grievances grew out of too tight rather than too lose monetary policy.

QE has been road tested. We’ve little to fear from it, just as we have had little to fear from conventional monetary policy.The Conversation

Stephen Kirchner, Program Director, Trade and Investment, United States Studies Centre, University of Sydney

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.




Read more:
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.




Read more:
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.




Read more:
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: inflation misses again, so where does the RBA go next?


Richard Holden, UNSW

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


The disturbing trend of persistently low inflation continues, as Wednesday’s data release shows.

Headline inflation was 2.1% for the last 12 months. But the more relevant “underlying” rate came in at 1.9%. This is even below the 2.0% the RBA forecast in May.

Given that the RBA’s target band for inflation is 2-3%, and that inflation has barely touched the bottom of that band over a protracted period, there are implications for monetary policy.

But, before we get to that, the obvious question to ask is: why is inflation so low?




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Vital Signs: booming jobs numbers, but dig deeper and it’s not all rosy


One strand of thinking involves the “Philips Curve”. This basically says that low unemployment pushes up wages growth and hence inflation.

We could get into a long discussion of whether the current 5.4% unemployment rate is “low”. And whether the effective rate really is 5.4% given anecdotal evidence about “underemployment”, the impact of recent decisions on penalty rates and minimum wage rises, and the robot revolution as a backdrop to the whole labour market.

But we don’t need to go there. There is barely any evidence of the Philips Curve in the data over the past quarter century, so let’s just reject that theory and move on.

Plausible factors keeping a lid on inflation

  1. Technology. The information technology and internet revolution has made lots of things much cheaper. Take music. Gone are the days of paying A$20-plus for a CD with maybe 16 songs on it. Streaming services like Apple Music and Spotify give access to literally millions of songs for a small monthly fee.

  2. China. The rise of Chinese manufacturing has led to everything from kids’ toys to cell phones being produced vastly more cheaply than if those things were manufactured with higher-cost labour.

  3. Globalisation and trade. The world has become radically more connected, and so have company supply chains. This not only allows access to lower-cost manufacturing but also leads to better specialisation through the principle of comparative advantage. This means that high-labour-cost countries like Australia can specialise in other components of goods and services, get better at producing those components, and reduce overall costs further.

  4. Wages. Wage growth has been subdued for a long time now. Since labour costs are an important component of many goods and services, this has served to tame inflation. One potential reason for low wage growth is that automation sits as a background threat to human labour. If labour costs get too high then processes get automated, which serves to keep wages in check.

  5. Leverage and consumer spending. A final factor is that given how heavily indebted Australian households are –largely through mortgage debt – they simply don’t have a lot of discretionary income. This limits consumer spending and makes price rises in the retail sector less likely.

These factors don’t look likely to change any time soon – with the possible exception of trade due to the Trump trade war. But even if that escalates dramatically it will shrink economic activity, further depressing prices.




Read more:
Explainer: why some economists think the RBA should drop its inflation target


So we have long-run, persistently low inflation. Is that a problem?

The major concern is that it could turn into deflation, although that doesn’t look terribly likely right now.

If, however, there was another significant economic downturn then deflation is a very real prospect. That would raise the spectre of Japan’s experience of the 1990s where deflation caused people to hoard money, severely contracting economic activity.

But for now the real impact of low inflation is on the RBA.

Faced with inflation below its target band for an extended period, the standard response would be to cut interest rates. The RBA is clearly worried about doing this.

One reason is housing prices – the RBA is worried about further fuelling the bubble.

With housing prices easing, this may become less of a concern, although household debt levels remain extremely high. Not encouraging households to become further indebted seems like a reasonable concern.

A second reason the RBA may be nervous about cutting rates is that it doesn’t have very far to go with the cash rate at 1.50%. If there is another major economic downturn then the RBA wants to have some firepower left to respond.

If short-term rates were already near zero then the only tools available to the central bank would be non-standard measures such as quantitative easing. That would be uncharted territory for the RBA, which seems reticent to explore that territory.

So, as with economic growth and wage rises, the RBA response seems to involve crossing as many fingers and toes as possible and to publicly proclaim that things are looking good, but may take a while.

The ConversationWe will get a better look into how that strategy is going when wage price index figures are released mid-August.

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

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