mixed labour market messages

Podcast

Many of you have asked me if the AICD’s economics podcast The Dismal Science is returning. I am pleased to announce we recorded my first episode last week, covering the US-China trade war and the inflation outlook. It was a lot of fun. We will be putting out episodes every fortnight from here on in. You can subscribe and listen on your pod player of choice at the links below.

Business conditions weakened in July.

Consumer sentiment staged a recovery in August.

The pace of annual wage growth remained unchanged at 2.3 per cent in the second quarter.

Australian employment rose 41,100 in July but a higher participation rate saw the unemployment rate unchanged at 5.2 per cent.

Last week, RBA Governor Lowe told the House Economics Committee that monetary policy was still effective, that they should expect an extended period of low interest rates, and that the central bank stood ready to do more if required.

Economic activity in China softened in July, suggesting ongoing vulnerability to the trade war despite President Trump’s decision this week to step back from some of the proposed tariff increases.

The German economy shrank in the second quarter as trade wars and Brexit fears took a toll.

What I’ve been following in Australia . . .

What happened:

The NAB monthly business survey for July showed business conditions falling two points relative to June, driven by a decline in the employment sub-index.

NAB Business Conditions and Confidence

In contrast, business confidence rose by four index points, bouncing back from last month’s sharp decline. But that still left the reading below average.

Why it matters:

According to NAB, the overall message from July’s survey results was little changed from June’s: with both business conditions and business confidence below their long-run averages, the survey is telling the story of a business sector that has lost significant momentum since early 2018. Forward-looking indicators – such as forward orders which remain negative – also suggest that the RBA’s recent rate cuts are yet to have a significant impact on business expectations.

NAB forward orders

What happened:

Consumer sentiment rose 3.6 per cent in August to reach 100, up from 96.5 per cent in July, according to the Westpac-Melbourne Institute Index of Consumer Sentiment (pdf).

Westpac-Melbourne Institute Consumer Sentiment Index

There were also strong monthly increases in the readings for economic conditions over the next 12 months (up 9.6 per cent over the month) and next five years (up 4.5 per cent), with more modest gains for family finances, although all three series were still down over the year. Both the house price expectations index and the time to buy a dwelling index recorded monthly increases and yearly gains.

Why it matters:

Last month’s reading had been disappointing, with a sharp fall in the index suggesting that the back-to-back rate cuts from the RBA in June and July had not only done nothing to reassure households, but might even have served to unnerve them, perhaps by sending a negative signal about the economic outlook. Seen in that context, the August reading is much more reassuring, suggesting that expectations have switched from the ‘sticker shock’ of lower rates to an appreciation of the benefits they might bring. At the same time, the continued improvement in housing-related sentiment indicators is providing some more evidence in support of the call that housing market conditions have now stabilised.

What happened:

The wage price index (WPI) rose 0.6 per cent over the June 2019 quarter (seasonally adjusted) and was up 2.3 per cent over the year, according to the ABS. That was broadly in line with market expectations, which had expected a 0.5 per cent quarterly increase and a 2.3 per cent annual gain.

Wage price index

Public sector wage growth rose by 0.8 per cent over the month (seasonally adjusted) and 2.6 per cent over the year, while private sector wage growth was more muted, up 0.5 per cent and 2.3 per cent, respectively.

By State, public sector wage growth was strongest in Victoria while private sector wage growth saw the biggest annual rise in Tasmania. Private sector wage growth was weakest in Western Australia. The overall pace of annual wage growth ranged from 2.9 per cent in Victoria to 1.6 per cent in Western Australia.

Wage price index by state

By industry, wage growth ranged from 3.2 cent over the year for the Health care and social assistance sector to 1.7 per cent for Wholesale trade.

Why it matters:

Relatively subdued wage growth has been a contributory factor to both low inflation and slow growth in household consumption. During his grilling by the House Economics Committee last week (see below), RBA Governor Low suggested that he thought wages in Australia in the medium-term should be increasing at a rate of around 3.5 per cent (based on inflation at 2.5 per cent and productivity growth at one per cent), and that at minimum he would like to see wage growth ‘starting with a three’. The June quarter numbers are obviously still some way off that target1.

What happened:

The ABS reported that employment increased by 41,100 persons in July (seasonally adjusted), with full-time employment up 34,500 and part-time employment up 6,700. Over the past year, the economy has added more than 332,000 jobs, with full-time employment up almost 256,000 and part-time up more than 77,000. Part-time employment currently accounts for roughly 31 per cent of total employment.

Change in employment

Despite the strong growth in employment, the unemployment rate remained unchanged at 5.2 per cent on a seasonally adjusted basis and ticked up to 5.3 per cent on a trend basis.

Unemployment rate

The underemployment rate rose to 8.4 per cent (seasonally adjusted) up from 8.2 per cent in June, and the overall underutilisation rate rose by the same amount to 13.6 per cent.

Unemployment and underemployment

The discrepancy between the big jump in employment and the stability in the unemployment rate is explained by the participation rate, which rose to a new record high of 66.1 per cent in July as more Australians entered the workforce. The employment to population ratio also increased, climbing to 62.6 per cent, and is now only a little below the high of 62.9 per cent reached in 2008.

Unemployment rate by state

By State, the largest increases in employment were in Queensland (up 19,900 persons), New South Wales (up 13,000), and Victoria (up 3,600). The largest decrease was in Western Australia (down 4,200). The unemployment rate increased in South Australia (up 0.9 percentage points to 6.9 per cent) and Western Australia (up 0.2 percentage points to 5.9 per cent), while decreases were recorded in Tasmania (down 0.8 percentage points to six per cent), New South Wales (down 0.2 percentage points to 4.4 per cent) and Queensland (down 0.1 percentage points to 6.4 per cent), with Victoria recording no change.

Why it matters:

Even though employment growth in July was a fair bit stronger than market expectations (+41,400 vs +14,000), another increase in the participation rate meant that wasn’t enough to drive down the unemployment rate, which in fact edged up again in trend terms. So, although job growth remains very healthy, the level of labour market spare capacity is still stuck above the RBA’s desired indicator of an unemployment rate closer to 4.5 per cent. The combination of rising labour market participation and continued labour market slack is also consistent with the ongoing absence of any marked acceleration in wage growth, as noted above, and with the latest set of RBA forecasts set out below.

What happened:

Last Friday, RBA Governor Philip Lowe appeared before the House Standing Committee on Economics. In his opening statement the governor discussed some of the factors he thought were contributing to low inflation, including ‘slow growth in wages; the ongoing spare capacity in the economy; various government initiatives to address cost-of-living pressures on households; and the adjustment in the housing market, which has contributed to unusually low increases in rents and declines in the price of building a new home in some cities.’

In terms of the future direction of monetary policy, Lowe repeated his message that we should ‘expect an extended period of low interest rates in Australia’ and went on to sketch out a central scenario under which ‘inflation will be below the target band for some time to come and the unemployment rate will remain above the level we estimate to be consistent with full employment’, concluding that ‘While this remains the case, the possibility of lower interest rates will remain on the table. The Board is prepared to ease monetary policy further if there is additional accumulation of evidence that this is needed to achieve our goals of full employment and inflation consistent with the target. Time will tell.’

Lowe also stressed that low interest rates in Australia are partly a reflection of global developments, noting that ‘it is difficult to escape the fact that if global interest rates are low, they are going to be low here in Australia too. When the global appetite to save is elevated relative to the appetite to invest – as it is now – interest rates in all countries are affected.’

In the discussion (pdf) following his opening testimony, the governor pushed back against the argument that monetary policy is ineffective at low rates while also conceding that cutting rates was less effective than it used to be. According to Lowe, that decline in effectiveness reflects the impact of (1) high debt to income ratios, which mean households are more inclined to use the relief from lower rates to pay down debt than to borrow more, and (2) the fact that, as rates get very low, it becomes increasingly difficult for the banks to pass reductions on in full to their mortgage rates as their deposit rates start to bunch up around zero. But Lowe also stressed that the exchange rate and cash rate channels for monetary policy remained effective, having already noted in his opening statement that ‘In the current environment, easier monetary policy mainly works through two channels. The first is that it affects the exchange rate, which is now at the lowest level it has been for some time. The second is that it boosts aggregate household disposable income. I acknowledge that lower interest rates hurt the finances of the many Australians who rely on interest payments . . . [but] . . . for every dollar the household sector receives in interest income, it pays well over two dollars in interest to the banks and other lenders. This means that lower interest rates put more money into the hands of the household sector, and at some point, this extra money gets spent’.

The session with the Committee also covered the possibility of the RBA adopting unconventional monetary policy measures. Lowe conceded that ‘It's possible that we end up at the zero lower bound. I think it's unlikely, but it is possible.’ He also indicated that the RBA still had ‘scope to lower interest rates at least a couple more times,’ that quantitative easing (QE) would only come into operation with rates very close to zero, that the most likely form of an Australian version of QE would involve ‘the central bank purchasing government securities’, and that the kind of circumstances under which the RBA might consider a QE-style intervention would require very adverse conditions, such as the world’s major central banks all driving rates down to zero or below or ‘if the economy underperforms materially our central scenario, growth is very weak—it stays in the one per cent range for a longer period of time—the unemployment rate starts rising, wages growth doesn't pick up and inflation's falling short’. A helpful checklist, there.

The August 2019 Statement on Monetary Policy (SOMP) which was also released on Friday provided further details on the RBA’s assessment of economic conditions. In his statement to the House Committee, Lowe had said that there were signs that the economy may have reached what he described as a ‘gentle turning point’ and the GDP growth forecasts in the SOMP do assume a gradual pick up in the annual pace of growth, reaching a projected three per cent by June 2021. This cautiously optimistic projection is based on the impact of lower interest rates, the government’s tax changes (including the low- and middle-income tax offset), a weaker Australian dollar, and the recent signs of stabilisation in the housing market. The RBA estimates that the tax offset payments will boost household disposable income by 0.6 or 0.7 per cent, and that households will spend around half of that. The central bank also thinks that a stronger outlook for resource investment and continued infrastructure investment will help. Dwelling investment is expected to be more of a headwind in the near-term, but the stabilisation in the housing market (and assumed further cuts to the cash rate) mean that the trough in dwelling investment is now expected to arrive about half a year earlier than previously forecast.

Selected RBA forecasts August 2019 vs. May 2019 Statement on Monetary Policy

On the other hand, household consumption growth is now expected to be weaker across the whole of the forecast period relative to May’s forecast, unemployment to be higher, and wage growth to be lower. As a result, the RBA is also anticipating a lower profile for both headline and underlying inflation, which it now thinks won’t hit two per cent until June 2021.

Why it matters:

Last Friday’s messaging from the RBA has several key take-aways:

First, that in the near-term the central bank is in wait-and-see mode as it monitors the impact of its June and July rate cuts. Hence last week’s decision to leave the cash rate unchanged.

Second, that the RBA thinks we will all be living in a low interest rate world for quite some time.

Third, that the possibility of further cuts to the cash rate ‘remain on the table’. That message is reinforced by the latest batch of forecasts in August’s SOMP. Remember, these projections are based on the technical assumption that the cash rate will follow the path implied by market pricing. Currently, that means one 25bp cut before year-end and another 25bp cut in the first half of next year, which would take the cash rate down to 0.5 per cent. And even with those additional cuts baked in, the RBA still thinks that the most likely scenario is for inflation to remain below the bottom of its target band until June 2021 and for unemployment to be stuck above its estimate of the non-accelerating inflation rate of unemployment (NAIRU) of 4.5 per cent throughout the forecast period. And since the governor believes that monetary policy is still effective, the implication must be that in the absence of those two rate cuts both inflation and unemployment would be in danger of ending up even further away from where the RBA would like them to be (at least, without any other changes in policy settings elsewhere, such as additional fiscal stimulus).

Finally, the discussion with the Economics Committee also provided some useful insights into the RBA’s thinking on unconventional monetary policy. While Governor Lowe was at pains to stress that he thinks (hopes?) that the need for such policies is unlikely, he also confirmed – as he would be expected to – that the RBA is doing the prudent thing and thinking about how it would implement policies such as QE if it were required to do so.

. . . and what I’ve been following in the global economy

What happened:

President Trump announced that the US would delay implementing some of the new tariffs (about US$156 billion of the US$300 billion originally targeted) that had been scheduled to be imposed on Chinese imports from the start of September. Instead, some consumer goods will now only be subject to the new ten per cent tariff rate from mid-December. According to Trump, the move was to protect US consumers in the run up to Christmas.

Why it matters:

Financial markets reacted positively to the news, treating it as a helpful de-escalation following the previous set of tit-for-tat moves. And there’s been some speculation that this in turn reflects a belated recognition / admission on the part of the president that US consumers are also among the casualties of the trade war, and that this could incur a rising political cost at home. Perhaps all that is true. And with the Chinese economy suffering (see below), a compromise deal should still be attractive for Beijing. But given the recent tortuous record of bilateral negotiations, for now it makes more sense to take this latest announcement as simply further evidence of the continuing high level of trade policy uncertainty and unpredictability afflicting the world economy.

What happened:

A series of indicators suggest that economic activity slowed in China in July.

Unemployment rate by state

The annual rate of growth of Chinese industrial output was just 4.8 per cent in July, the slowest result since February 2002 while growth in retail sales slipped to 7.6 per cent over the year, down from nearly ten per cent in June (although that month’s outcome reflected the distorting effects of new emissions standards on car sales). Growth in year to date fixed asset investment also fell slightly, dropping from 5.8 per cent in June to 5.7 per cent in July.

The rate of urban unemployment also rose to 5.3 per cent in July, up 0.2 percentage points over the month.

Why it matters:

June’s data releases had brought a bounce in activity readings, but that good news has proved to be short-lived, suggesting that the Chinese economy remains vulnerable to both the ongoing trade war with the United States and the more general downshift in global economic activity that conflict is helping to deliver. China-watchers are now looking to see if Beijing will be prompted to deliver additional stimulus to prop up growth.

What happened:

German GDP shrank by 0.1 per cent over the second quarter, pulling annual output growth down to 0.4 per cent, its slowest pace for six years.

Real GDP Germany

Why it matters:

As a traditionally export-reliant economy, Germany is often treated as a useful indicator of how the current bout of trade wars are disrupting growth prospects, and the news was not encouraging. It appears that policy uncertainty related to trade wars and the rising risk of a no-deal Brexit along with auto sector problems saw exports slump in the June quarter, dragging down overall growth. As a result, Germany’s growth performance was actually weaker than that of the Euro area as a whole, which itself only managed a fairly lacklustre 0.2 per cent quarterly expansion and 1.1 per cent annual growth.

Outside the Euro area, the UK economy has also being suffering. Data released last week showed second quarter UK GDP shrank too, with output contracting by 0.2 per cent in the first quarterly fall since 2012 as firms ran down the stocks they had built up ahead of the original 29 March deadline for Brexit (the same effect in reverse had helped push up growth in the first quarter).

What I’ve been reading: articles and essays

RBA Deputy Governor Guy Debelle gave a speech on risks to the outlook for the Australian economy. It’s a familiar list: the trade and technology dispute (which as Debelle points out, in its trade form has been with us for almost two years now); the mixed outlook for domestic consumption; and climate risk. In terms of the trade dispute, Debelle notes that, for Australia, the near-term damage has been offset by resource-intensive Chinese stimulus, leaving us more vulnerable to the medium-term risk of damage to the global trading order. Related, see this AFR piece, which makes the case that the trade war has worked to increase China’s reliance on Australia (although presumably the story with iron ore, at least, is more about supply disruptions in Brazil than Trump’s tariffs).

In another speech from the RBA, Assistant Governor Christopher Kent spoke on the transmission of monetary policy. According to Kent (echoing Governor Lowe’s comments from last week and contra to the fears that at low rates policy loses traction) the normal transmission mechanism in Australia is alive and well: cuts in the cash rate have helped reduce funding costs for banks, businesses and households to historic lows while the past 12 months or so have also seen the Australian dollar decline by about seven per cent in trade-weighted terms, taking it down to its lowest level for several years.

In the AFR, Alan Mitchell argues that fiscal policy should follow monetary policy, and that we should put technocrats in charge of fiscal stimulus.

The Grattan Institute examines when vocational education is a good alternative to university, noting that while the past 20 years has seen a rapid expansion in Australian higher education, vocational education attainment rates have flat-lined. That’s prompted concerns that some students are being encouraged to enrol in higher education and to overlook potentially better-paid vocational education alternatives in fields with good job prospects. Grattan’s Andrew Norton and Ittima Cherastidtham reckon that these fears are only partly justified given that for many students, realistic vocational education alternatives are limited.

The ABC takes a look at the tussle over geographical indications (GI) in the Australia-EU FTA negotiations.

Infrastructure Australia published its Australian Infrastructure Audit 2019, looking at ‘the major challenges and opportunities facing Australia’s infrastructure over the next 15 years and beyond.’ I’ve only had time to dip into the Executive Summary, which suggests that relative to the previous audit, ‘governments and industry have made important progress to promote reform, improve planning and invest in infrastructure gaps. Since 2015 over $123 billion of work has commenced, with a committed forward pipeline of over $200 billion.’ But growing demand due to a rising population (which is expected to exceed 30 million people within 15 years) along with ageing infrastructure assets and a consequent increase in the maintenance backlog mean that ‘a new wave of reform and investment is necessary’.

Greg Ip in the WSJ argues that global downturns can be the product of shattered assumptions about how the world works: past examples include the end of cheap oil in the 1970s, the prospect of sovereign defaults in the early 1980s, and the lesson that US mortgages and global banks weren’t safe in the 2000s. Ip reckons that the new lesson we are in the process of learning involves a rethink of globalisation, the consequences of which are pushing the world closer to a recession. I don’t suppose that it will come as a surprise to readers that this is an argument with which I have a great deal of sympathy.

The IMF summarises China’s economic outlook in six charts. For those after more detail, the Fund has also published the latest Article IV staff report.

Interesting comment from the FT’s Alphaville, wondering whether business flows are the new capital flows (the idea is that modern, asset-light businesses are more able to up sticks in a way that is a reminiscent of ‘hot’ capital flows than are more traditional firms).

Although most important financial concerns are long term in nature, the difficulty of measuring long-term risks means that standard risk management techniques used by industry and regulators focus overwhelmingly on the short term. According to the authors of this VoxEu piece, the resulting dissonance of short and long term risks results in ‘the wasting of resources, procyclicality, poor performance, and insufficient attention towards important long-term risk.’

The Economist’s Free Exchange describes how shrinking chocolate bars and ‘quantum pricing’ pose a challenge to simple textbook models of supply and demand.

Two from Bloomberg Opinion on negative interest rates. Joe Weisenthal argues that it’s not crazy that savers in Europe now pay to store their wealth, even if money storage fees feel very different to paying for the cost of (say) a safety deposit box. And Karl Smith makes the related point that demographic forces mean that borrowers may be doing lenders a favour, and hence deserve to be paid to borrow money. Both writers have good points to make – the Weisenthal piece reminded me of (Kaldor’s?) old story about how goldsmiths, by virtue of possessing strongrooms of their own, could offer storage facilities for others, thereby providing a service which eventually morphed into modern banking. And yet . . . might it instead be the case that US$15 trillion and counting in negative yielding bonds across the globe indicate the mother of all bond bubbles? Negative rates really are weird: hence Paul Samuelson’s remark that at negative (or even zero) real interest rates, almost any investment is profitable: it would pay to level the Rocky Mountains to save even the small amount of fuel involved in climbing steep gradients2.

The FT has two helpful explainers on Argentina: one looking at the prospects for President Macri and one on the market fallout from recent political developments.

1 It’s perhaps worth noting here that, earlier in the same testimony, Lowe had pointed out that one of the reasons – in addition to low wage growth – that overall household income growth was so slow last year was the increase in tax take: while gross household income was up between 3.5 – four per cent, taxes paid by household rose by ten per cent. Lowe said he did not expect a rerun of that relationship this year and pointed to tax refunds as a source of stimulus.

2 Spoilsports have pointed out that Samuelson’s example doesn’t quite work in the presence of market imperfections such as unsecure property rights, finite investment horizons, credit risk, liquidity service yields and so on. But you get the general idea.