Business confidence fell in June, reversing its previous jump in May. Business conditions did improve over the month but remain well below their long-term average. RBA rate cuts and government tax refunds were not enough to prevent consumer sentiment slumping to a two-year low in July.

Australia’s Council of Financial Regulators noted that, although housing loan arrears have been rising, to date risks to lenders from falls in house prices have been limited by low unemployment, low interest rates and improvements in living standards.

Lending to households for dwellings fell in May and in annual terms dropped by its most in about a decade.

Financial markets interpreted US Fed Chair Jerome Powell’s testimony to Congress as signalling that the Fed is set to cut rates at its 30-31 July FOMC meeting. US stock markets celebrated.

What I’ve been following in Australia . . .

What happened:

According to the NAB monthly business survey, Business confidence dropped by five points in June, with confidence declining across all industries other than retail (which saw a modest increase).

NAB Business Conditions and Confidence

On a more positive note, business conditions rose two points in June, lifted by gains in the employment and trading sub-indices. June’s survey saw the employment index well above its long-run average but the trading and profitability indices below theirs. Overall, however, the business conditions index remains well below its long-run average level. By sector, conditions are strongest in mining, followed by the services sector and construction. The retail sector continues to be the weakest, followed by manufacturing, transport and utilities and wholesale.

Why it matters:

Back in May, the business confidence index had enjoyed a big, seven-point post-election increase. That was the largest monthly jump in the index recorded since 2013, although the accompanying analysis from NAB at the time cautioned that other forward-looking indicators suggested that the bounce was ‘likely to be short-lived’. That prediction looks to have been on the money: June’s decline in business confidence has unwound most of May’s increase, suggesting the lift from the election result and the RBA’s rate cut has already faded.

Conditions in the retail sector remain particularly weak, with levels of business conditions last seen in the depths of the GFC, as household spending remains constrained. On the other hand, business conditions improved markedly in the construction sector (up to an eight-month high), implying that here at least the RBA’s action to ease policy may have gained some early traction.

What happened:

The Westpac-Melbourne Institute Index of Consumer Sentiment fell (pdf) 4.1 per cent in July to 96.5 from 100.7 in June, taking the index down to a two-year low and moving it back into the territory where pessimists outnumber optimists for the first time since March.

Westpac-Melbourne Institute Consumer Sentiment Index

The main drivers of this month’s decline were sharp drops in views about economic conditions over the next 12 months and five years, and in expectations about family finances over the next 12 months. Views on family finances vs a year ago and time to buy a major household item were both up over the month (but down over the year). Confidence in the labour market also deteriorated in July, with an increase in the share of respondents expecting a rise in unemployment in the year ahead. The one bright spot was housing market sentiment, where the ‘time to buy a dwelling’ index delivered the first above trend reading in more than four years.

Why it matters:

In the commentary accompanying the release, Westpac noted that the fall in sentiment in July was ‘troubling’, coming as it did against the backdrop of a second 25bp rate cut from the RBA and the passage of the government’s tax package1. So although the announcement effect of easier monetary policy does seem to have been positive for the housing market, that hasn’t been the case for consumer sentiment more broadly, where rate cuts seem to have been treated more as a signal about the weakness of the economic outlook than as offering reassurance that a potential cure for that weakness was now being applied. June’s survey showed a similar response to the RBA’s first rate cut. 

What happened:

Australia’s Council of Financial Regulators published its July 2019 quarterly statement. Among the factors included in the regulators’ discussions were:

  • The housing market. The Council noted signs of stabilisation in the Sydney and Melbourne housing markets alongside continued soft conditions in other capital cities. Despite some sizeable price adjustments, they judged that risks to lenders from falls in house prices to date have been limited by the strength of the labour market, low interest rates and improvements in living standards. All that said, housing arrears have continued to edge higher.
  • Credit growth. According to the Council, housing credit growth has stabilised at a relatively low level, with lending to investors remaining weak. Demand for housing credit has been subdued and supply has also seen some tightening. Business credit growth has weakened recently, with lending to small businesses declining over the past year.
  • Policy changes. The Australian Prudential Regulatory Authority (APRA) noted changes in its guidance on the minimum interest rate used in serviceability assessments for residential mortgage lending, announced on 5 July. The changes are in line with APRA’s earlier proposals outlined in the Weekly back in May and mean that banks no longer need to assess home loan applications using a minimum interest rate of at least seven per cent. Instead, they can set their own minimum interest rate floor and use an interest rate buffer of at least 2.5 per cent over the loan’s interest rate.

This week also saw APRA announce lower capital targets for Australian banks. Last November, the regulator had proposed that the four major banks be required to increase their total capital by four to five percentage points of risk weighted assets (RWA) over four years. Instead, it will now require them to lift total capital by three percentage points of RWA by 1 January 2024, based on concerns about a lack of market capacity to absorb the original proposed increase and the potential impact on bank funding costs. Meanwhile, the long-term aim of an additional four to five percentage point increase will remain while over the next four years APRA considers alternative approaches to raising the additional one to two percentage points. Separately, APRA has said that it will apply additional capital requirements to three of the major banks (ANZ, NAB and Westpac) to reflect higher operational risk identified in their risk governance self-assessments. This follows a decision in May last year to apply a capital add-on to CBA.

Why it matters:

The Council’s assessment of the housing market and credit conditions are in line with the data reported here over the past couple of months and contain no surprises. In terms of rising arrears, back in June the RBA’s Jonathan Kearns had noted that housing arrears as a share of bank housing loans had risen to around the level reached in 2010, the highest share for many years, albeit still well below the level reached in the early 1990s recession. However, he also pointed out that at around one per cent, the level of arrears was still relatively low both in absolute terms and compared to international experience.

APRA’s decision to change its loan affordability test is expected to boost the borrowing capacity of households and hence provide more support for the housing market. As such, it could work to offset some of the tightening in credit availability that has occurred over the past couple of years, albeit at the potential cost of adding yet more debt to households’ already heavily burdened balance sheets.

What happened:

Lending to households fell 1.3 per cent (seasonally adjusted) over the month in May, following a 0.6 per cent rise in April.

Lending to households for dwellings excluding refinancing was down 2.4 per cent over the month and 20.9 per cent over the year, reflecting monthly drops in lending to households for owner occupier dwellings (down 2.7 per cent) and investment dwellings (down 1.7 per cent), leaving both series deep in negative territory in annual terms.

Lending to households dwellings

Lending to households for personal finance excluding refinancing was likewise down 0.7 per cent over the month and down more than 16 per cent from May 2018.

In contrast, lending to businesses jumped by 12.1 per cent in May over April and was up more than 34 per cent over the year.

Why it matters:

The near 21 per cent annual drop in housing finance commitments in May was the biggest fall in ten years. However, the May result predates the two rate cuts by the RBA and a post-election rebound in housing market sentiment which together have seen some signs of price stabilisation in the Sydney and Melbourne markets.

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

What happened:

In testimony to Congress, Chair of the US Federal Reserve Jerome Powell fuelled market convictions that the Fed will cut rates later this month.

Powell said that the Fed’s ‘baseline outlook is for economic growth to remain solid, labour markets to remain strong and inflation to move back up over time to the Committee’s two per cent objective.’ But he then went on to flag an increase in uncertainties surrounding the outlook, noting that ‘economic momentum appears to have slowed in some major foreign countries’, that several ‘policy issues have yet to be resolved, including trade developments, the federal debt ceiling, and Brexit’ and that ‘there is a risk that weak inflation will be even more persistent than we currently anticipate.’ Referring to the June meeting of the Federal Open Market Committee (FOMC), Powell went on to note that ‘Many FOMC participants saw that the case for a somewhat more accommodative monetary policy had strengthened. Since then, based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the US economic outlook. Inflation pressures remain muted.’

The minutes of the June meeting have also been published, recording that ‘Participants generally agreed that downside risks to the outlook for economic activity had risen materially since their May meeting, particularly those associated with ongoing trade negotiations and slowing economic growth abroad.’ The minutes go on to report that ‘Although nearly all members agreed to maintain the target range for the federal funds rate at 2.25 to 2.5 per cent at this meeting, they generally agreed that risks and uncertainties surrounding the economic outlook had intensified and many judged that additional policy accommodation would be warranted if they continued to weigh on the economic outlook.’

The growing conviction that a Fed rate cut is on its way prompted a positive response by US stock markets, with the S&P 500 index (briefly) pushing through the 3,000 level for the first time.

Why it matters:

Investors and financial markets (and not forgetting some aggressive tweeting from President Trump) have been engaged in a kind of debate with the Fed over the need for rate cuts. On the case for patience, the Fed has been able to point to generally good economic outcomes including a record-long economic expansion, a strong Q1 GDP reading, and an unemployment rate that had fallen to a fifty-year low of 3.6 per cent in April and May of this year. Set against that have been fears about trade wars, signs of fragility in the global economy more generally, and subdued inflation.

Last week’s labour market report appeared to add more weight to the case for patience, with non-farm payrolls jumping by 224,000 in June, comfortably beating consensus forecasts of a 160,000 gain and representing a marked bounce from May’s weak 72,000 print. Granted, the unemployment rate did tick up a bit to 3.7 per cent in June, but that mainly seems to reflect more Americans joining the labour force. The strength of that result looks to have been enough to head off market expectations of a 50bp cut when the FOMC meets on 30-31 July, but left forecasts of a 25bp reduction intact.

The latest round of Fed communications seems to have locked in that expectation. One argument is that the Fed is taking out some insurance in case the more pessimistic outcomes start to materialise. According to the latest minutes, for example, ‘Several participants noted that a near-term cut in the target range for the federal funds rate could help cushion the effects of possible future adverse shocks to the economy and, hence, was appropriate policy from a risk-management perspective.’ Interestingly, the Fed Chair also appears to have discounted the latest trade truce between Washington and Beijing.

In this context, it’s also worth mentioning that the New York Fed’s measure of the probability of a recession in 12 months’ time rose above 32 per cent in June. That’s the highest level since 2009 and the measure has breached the 30 per cent threshold before every US recession since 1960.

NY Fed recession probability model

Note that the model is based on the difference between the 10-year and 3-month Treasury rate, and as discussed in previous editions of the Weekly, there are reasons to be cautious about the current information content of this signal, despite its past successes as a recession indicator.

What I’ve been reading: articles and essays

An FT Editorial argues that recent decisions to loosen mortgage lending standards and scale back planned increases in bank capital requirements pose longer-term risks for the Australian economy, and that a better approach to slowing growth rests on tax cuts and increased public spending.

The RBA has released two new research discussion papers:

  • A paper investigating the costs and benefits of ‘leaning against the wind’ (setting interest rates higher than purely macroeconomic conditions would warrant in order to address concerns about financial stability). The paper estimates that for Australia the costs of such a policy in terms of higher unemployment could be three to eight times larger than any benefit in terms of a lower probability of financial crisis, although the authors are also careful to note that there may be additional, hard-to-quantify benefits from such a policy, including the impact of low interest rates on households’ level of indebtedness and the associated negative economic effects.
  • A paper looking at the effect of owner-occupier mortgage debt on consumer spending. Starting from the observation that the household debt-to-income ratio has risen to record levels in Australia while household spending has been relatively weak, the authors find evidence of a ‘debt overhang’ effect, whereby households cut back on their spending when they have higher levels of mortgage debt. They estimate that a 10 per cent increase in debt could reduce household expenditure by 0.3 per cent. Moreover, they find evidence of this overhang effect for both gross and net housing wealth – in other words, households reduce their spending even when the increase in the gross value of their debt is matched by an offsetting increase in the value of their assets (that is, net wealth remains unchanged). They also report that while indebted households reduce their spending by more than other households during adverse shocks, such as falling house prices, the negative effect of debt on spending also persists in more ‘normal’ times. The authors point out that since their results suggest that an increase in aggregate owner-occupier debt can constrain overall spending, they can also help explain the ‘puzzle’ of unusually weak household spending in Australia.

Treasury’s Meghan Quinn gave a speech on the role of economics in public policy.

Duncan Bentley on the Australian tax system in a digital age, and the need to protect taxpayer rights in the context of digital disruption.

Hugh White talks about how to defend Australia (this one is a podcast). White also sets outs his arguments here, and a there’s a critique here. Note that White reckons this kind of approach would require a defence budget of about 3.5 per cent of GDP (or four per cent with nuclear weapons) while critics suggest that his proposals would require a more radical restructuring of the Australian economy. Currently we are on track to raise the defence budget to two per cent of GDP by next financial year.

The NSW Innovation and Productivity Council (IPC) has released a report on business size, productivity and innovation. Large businesses (those with 200 or more full time equivalent employees or FTE employees) account for just 0.6 per cent of all employing businesses2 but earn 72 cents in every dollar of total employing business turnover, account for 58 per cent of exports and 52 per cent of jobs. At the other end of the size distribution micro businesses (1 – 4 FTE employees) account for 77 per cent of all employing businesses, just four per cent of turnover, six per cent of exports and 15 per cent of jobs. About 70 per cent of large businesses are involved in innovation activity compared to 36 per cent of micro businesses. About 57 per cent of other small businesses (5 – 19 FTE employees) and 61 per cent of medium-sized businesses (20 - 199 FTE employees) are involved in innovation activity.

Habib and Venditti review the global capital flows cycle and its drivers and argue that global risk is a key force, where financial shocks are slightly more important than US monetary policy in influencing that factor.

Barry Eichengreen thinks about what might bring the US record economic expansion to an end. An adverse geopolitical shock or a wage breakout and a Fed policy reaction are his two leading candidates.

The Bank of England’s Bank Underground blog investigates the long-run effects of uncertainty shocks, pointing to persistent negative effects on GDP, consumption, R&D investment and productivity growth.

Gavyn Davies warns that the UK economy is in danger of recession partly because Brexit-driven uncertainty has undermined investment spending, although he also notes that the UK labour market has remained buoyant.

James Kynge on the Communist party put. He argues that the kind of bounce markets saw in 2008 and 2014 is unlikely to be repeated, despite the hopes of some investors.

A new paper (pdf) from Acemoglu, Naidu, Restrepo and Robinson presents evidence that democracy has a positive effect on GDP per capita: their estimates imply that a country that transitions from nondemocracy to democracy achieves about 20 per cent higher GDP per capita in the next 25 years relative to a country that remains a non-democracy. Marginal Revolution’s Alex Tabarrok has some interesting thoughts on their results.

The Canadian model of pension provision faces challenges, which have in turn triggered a rise in leverage.

The Atlantic looks at a post-crisis Greece and the legacy effects across Europe.

The OECD-FAO agricultural outlook 2019-2028 reckons that real food prices will decline over the coming decade, helping consumers but putting farm incomes under pressure. Per capita food consumption of staple products (cereals, roots & tubers and pulses) has now levelled off globally, with future demand driven largely by population growth. Demand for higher value agricultural commodities (sugar, vegetable oils, meat, dairy) will grow faster, driven by a combination of rising per capita consumption and population growth. On the supply side, the Outlook expects continued productivity growth to see agricultural production increase by around 14 per cent over the coming decade while land use will be flat. Productivity growth will be powered by greater investment and technological catch up in emerging and developing economies and will allow growth in food production to outpace growth in demand.

1 While the bulk of the survey was completed prior to the tax package passing on 4 July, Westpac notes that this outcome had been widely predicted by media coverage earlier in the week.

2 In NSW there are also 904,000 non-employing businesses including sole proprietors, partnership and trusts. That compares to 271, 277 employing businesses.

The Economic Weekly (28 June 2019)

While we were away, the RBA signalled that there is more monetary easing to come here in Australia, with markets expecting a rate cut next week, while the US Fed left rates unchanged at its 19-20 June meeting but has since indicated that it too could deliver rate cuts before year-end. Markets, businesses and governments will all be watching this week’s G20 summit in Osaka in the hope that Washington and Beijing declare a ceasefire in their trade war, which has been taking a heavy toll on global confidence at a time of weak international trade flows. This week’s readings include the latest RBA Bulletin and pieces on Australian QE, oil price risks, currency wars, cryptocurrencies, and the decline of the specialist.

The publication on 18 June of RBA minutes from the 4 June board meeting and Governor Lowe’s speech on the labour market delivered on 20 June both reinforced market expectations of additional rate cuts from the central bank. At the time of writing, markets were putting the probability of a cut at next week’s 2 July meeting as higher than 70 per cent, although this was down from a more than 80 per cent probability a few days earlier.

The US Federal Reserve left rates unchanged after the 19-20 June FOMC meeting but has since been signalling a shift to a more dovish policy stance. President Trump remains unimpressed with his choice of Fed chair.

At this week’s meeting of the G20 in Osaka, attention will be focused on whether Washington and Beijing can find enough room for compromise to allow for a ceasefire, if not a peace agreement, in the current trade war. Meanwhile, the WTO has warned of rising G20 protectionism.

What I’ve been following in Australia . . .

What happened:

On 18 June the minutes of the 4 June 2019 monetary policy meeting of the RBA board were published. On 20 June RBA Governor Philip Lowe gave a speech on The labour market and spare capacity.

Why it matters:

The minutes for the 4 June meeting were always going to be interesting, given that they would shed further light on the first rate cut of Governor Lowe’s tenure and the first policy change since August 2016. Unsurprisingly, they confirmed the continued centrality of the labour market in the central bank’s thinking, noting that ‘it was apparent that the labour market still had significant spare capacity’, with the current unemployment rate (at 5.2 per cent) above the RBA’s estimate of the ‘full employment’ unemployment rate of around 4.5 per cent. That in turn allowed RBA Board members to recognise ‘the accumulation of evidence that there was now more capacity for the labour market to absorb additional labour demand before inflation concerns would emerge.’ As a result, they judged that a ‘lower level of the cash rate would assist in reducing spare capacity in the labour market, providing more Australians with jobs and greater confidence that inflation will return to be comfortably within the medium-term target range in the period ahead.’

So far, so expected. But critically, the minutes then went on to note that, ‘Given the amount of spare capacity in the labour market and the economy more broadly, members agreed that it was more likely than not that a further easing in monetary policy would be appropriate in the period ahead.’ In other words, RBA board members flagged the case for more rate cuts.

That message about the likelihood of further monetary policy easing was given a further boost by Governor Lowe’s speech in Adelaide on 20 June. As well as emphasising – once again – the RBA’s focus on the labour market, the governor also argued that it ‘would, however, be unrealistic to expect that lowering interest rates by ¼ of a percentage point will materially shift the path we look to be on. The most recent data – including the GDP and labour market data – do not suggest we are making any inroads into the economy's spare capacity. Given this, the possibility of lower interest rates remains on the table. It is not unrealistic to expect a further reduction in the cash rate as the Board seeks to wind back spare capacity in the economy and deliver inflation outcomes in line with the medium-term target.’ So, the cash rate will be heading to (at least) one per cent.

Markets and economists reacted to this messaging by bringing forward their expectations for the next RBA rate cut from the August meeting to 2 July. At the time of writing, markets were putting the probability of a rate cut next week at more than 70 per cent (down from more than 80 per cent last week). And according to a Reuters poll of 40 economists, nearly 70 per cent expect a rate cut on Tuesday.


Australia: Shift in implied policy rates


Moreover, implied rates plus an increasing volume of market commentary both indicate that this won’t be the end of the current easing cycle. According to that same Reuters poll, for example, 20 out of 38 economists think that the cash rate will be at 0.75 per cent by year end and three think it will fall to 0.5 per cent (the remaining 15 see the RBA staying put at one per cent).

Note that a cash rate of one per cent or below would not only leave the RBA running very low on conventional monetary policy ammunition but would do so at a time when the economy was still growing, albeit slowly, and when the central bank continued to believe (according to the latest minutes, anyway) that the outlook for the Australian economy remained ‘reasonable’.

So, what would happen if, with the cash rate already at – say – 0.75 per cent, we were then hit by an adverse external shock, such as a severe worsening in the US-China trade wars, or the current US-Iran confrontation turning hot? One possibility is that fiscal policy would then be called on to do more of the lifting: Canberra is already committed to delivering tax cuts in the second half of this year, and the current fiscal position would allow scope for more stimulus, albeit at the cost of putting next year’s projected slim budget surplus at further risk. Another possibility is that the RBA would consider non-conventional monetary policy options, which could include – but not necessarily be limited to – forward guidance or an Australian version of Quantitative Easing (see this week’s reading list for more on this discussion).

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

What happened:

The US Federal Reserve left rates unchanged after the 19 -20 June meeting of the Federal Open Market Committee (FOMC) but indicated that it continued to shift towards a more dovish policy stance. Subsequent statements by Fed Chair Jerome Powell and other officials further reinforced market views that the Fed will deliver rate cuts this year.

Why it matters:

Financial markets have spent much of the past six months betting that – having retreated from last year’s commitment to further rate hikes during 2019 – the Fed will be forced to ease policy this year. And with the Fed having a dramatic influence on global monetary conditions, the trajectory of Fed policy is a key factor driving global markets. The latter include the Australian dollar: the market assumption of a shift in the Fed stance, and hence in the profile of expected US interest rates and the US dollar, is likely one key factor (along with high commodity prices) behind the way that the Australian dollar has reversed some of its earlier slide towards US$0.68 and headed back towards US$0.70, despite all the talk of rate cuts here. That is unhelpful for the RBA: remember, when it cut the cash rate at the start of this month, Governor Lowe argued that the main impact was likely to come through two channels, one of which was ‘a lower value of the exchange rate’1.

Australia: Australian dollar -US dollar daily exchange rate

So, the Fed again held fire in June (the vote in favour of the status quo was 9 – 1 with St Louis Fed president James Bullard the lone dissenter), with the FOMC noting that it ‘continues to view sustained expansion of economic activity, strong labour market conditions, and inflation near the Committee's symmetric 2 percent objective as the most likely outcomes.’ But Fed watchers seized on the subsequent qualification that ‘uncertainties about this outlook have increased. In light of these uncertainties and muted inflation pressures, the Committee will closely monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion’ as indicating a greater change of Fed action, relative to previous language to the effect that the Fed would be ‘patient’ in setting monetary policy.

Subsequent commentary from Fed officials has reinforced that interpretation: last Friday saw Bullard and Minneapolis Fed president Neel Kashkari both make the case for lower rates, while in a speech on 25 June, Fed chair Jerome Powell again warned that risks to global growth had increased, due to ‘greater uncertainty’ over trade policy and the consequent hit to business confidence and investment intentions, and pointed to ‘incoming data raising renewed concerns about the strength of the global economy.’

The Fed’s evolving monetary policy stance comes against a backdrop of continued criticism from President Trump. On Monday this week he tweeted that the Fed ‘doesn’t know what it is doing’ and followed that up on Wednesday, when he said that Powell was ‘doing a bad job’ and that Fed policy was ‘insane’.

What happened:

This week sees the start of the G20 leaders’ summit in Osaka2. The official meeting is scheduled to run over 28 and 29 June, but the main focus is likely to be on a ‘sidelines’ meeting between Presidents Donald Trump and Xi Jinping, expected to take place on Saturday, to discuss the two countries’ ongoing trade and technology disputes.

Why it matters:

At last year’s G20 meeting in Buenos Aires, Trump and Xi used a similar meeting to agree a pause on tariffs and restart trade talks between the United States and China. Observers are hoping that the two leaders can repeat the trick and stave off a potential costly escalation in the bilateral trade conflict.

Their meeting takes place in the context of weak global trade and rising protectionism. According to data released this Tuesday, world trade volumes fell 0.7 per cent in April, continuing a run of subdued outcomes for global trade flows.

World: Trade volumes

This week also saw the WTO warn that trade restrictions among G20 members are at historically high levels. The last two G20 monitoring reports produced by the organisation show a dramatic

World: Coverage of Import-restrictive trade measures

At almost US$336 billion, the trade coverage of the new import-restrictive measures over the report’s review period was the second highest on record, exceeded only by the US$481 billion cited in the WTO’s November 2018 report.

What I’ve been reading: articles and essays

The June 2019 edition of the RBA Bulletin has been published. As always, there’s a large amount of content here with topics ranging from cryptocurrencies to the Chinese local government bond market and Australian bank fees. Articles that caught my attention included Hambur and Jenner on the low level of non-mining investment (they reject compositional effects as a key driver of low investment rates and instead point to a combination of (1) lower output growth due to lower productivity growth, and (2) lower rates of depreciation due to a shift in the capital stock towards longer lived assets such as office towers, roads and railways, although they also can’t rule out cyclical factors such as a rise in risk aversion or an increase in risk premia); Cassidy, Rankin, Read and Siebold on explaining low inflation rates (they find that key factors include the level of spare capacity in the economy and the associated weakness in wage growth, plus several sectoral developments such as slower growth in some administered prices, low rent increases and intense competition in the retail sector); and Guttman, Hickie, Rickards and Roberts on spillovers to Australia from the Chinese economy (trade linkages and the impact on global commodity prices are identified as likely to be the most important channels through which a Chinese economic shock would impact Australia, with a slowdown in Chinese growth of around five per cent estimated to result in a decline in Australian GDP of up to 2.5 per cent, depending on the nature of the scenario).

Bloomberg Economics on how Australia is debating Quantitative Easing (QE). Related, Stephen Kirchner offers a guide to lessons from the US experience with QE for Australian policymakers.

The Productivity Commission has produced a performance dashboard to track progress towards the Council of Australian Government’s (COAG’s) key commitments.

The ABC’s Stephen Letts asks why the oil price has been relatively immune to the current rise in risk in the Middle East. He has a two-part answer. First, the oil market to date has been more worried about a slowing global economy driving down demand and prices. Second, the rise of the United States as the world’s largest oil producer has brought with it the ability of US shale producers to operate as swing suppliers. That said, if the current faceoff between Washington and Tehran were to seriously jeopardise the 30 per cent of seaborne oil that passes through the Strait of Hormuz, the oil price would rapidly lose its previous immunity to geopolitics. On the other hand, see this FT piece from a couple of weeks ago on how a backdown by Tehran could destabilise the new normal in oil prices.

The Economist’s Buttonwood column reckons that the world is primed for currency wars.

A selection of opinions on Facebook’s cryptocurrency plans from Martin Wolf, Barry Eichengreen, James Hamilton, and Antonio Fatas.

Jared Bernstein makes three observations on US monetary policy.

Paul Krugman offers some notes on what he calls ‘excessive wealth disorder’ and the political and policy consequences of high inequality.

Economists from the OECD investigate the impact of online platforms on the productivity of services firms.

The Atlantic considers the decline of the specialist.

A Guardian profile of Edward Luttwak, often credited with the development of geo-economics, or what Luttwak described as ‘the logic of conflict in the grammar of commerce’.

1 The second was a boost to the disposable income of the household sector.

2 The G20 comprises 19 countries (Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Korea, South Africa, Russia, Saudi Arabia, Turkey, United Kingdom, United States) and the EU and collectively accounts for more than 80 per cent of global GDP.


The Economic Weekly (14 June 2019)

After the previous bumper issue, a somewhat shorter Weekly this time. Please note that due to travel commitments, there will be no publication next week (21 June).

Business confidence jumped in May post-election, but business conditions have slumped, with the retail sector reporting recession-level readings.

Consumer confidence fell in June, with the RBA’s cash cut seemingly failing to support sentiment and perhaps even serving to weaken it.

Australia’s unemployment rate was unchanged at 5.2 per cent in May, but the number of employed persons rose by more than 42,000 as the participation rate hit a new record high.

Mexico managed to avoid a threatened imposition of US tariffs after reaching a deal with Washington to curb illegal migration. President Trump’s focus has meanwhile moved on to Germany and Nord Stream 2.

According to UNCTAD’s latest World Investment Report, global FDI flows fell by 13 per cent to US$1.3 trillion in 2018, their lowest level since the global financial crisis. More evidence of ‘slowbalisation’?

What I’ve been following in Australia . . .

What happened:

The NAB monthly business survey for May showed business conditions continuing to soften, with reported weakness particularly pronounced in the wholesale and retail sectors.

NAB Business Conditions and Confidence

In marked contrast, the business confidence index enjoyed a big, seven-point post-election increase. That was the largest monthly jump in the index recorded since 2013, although the accompanying analysis from NAB cautioned that other forward-looking indicators suggested that the bounce was ‘likely to be short-lived’.

Why it matters:

While the election outcome has given business confidence a boost, current conditions continue to weaken. In particular, according to NAB, the recent deterioration in results for the retail sector has now seen conditions fall to levels not seen since the GFC. As well as indicating a retail sector in recession, this is also consistent with the ongoing story of an Australian consumer that remains reluctant to spend given slow income growth, falling house prices and high debt levels.

What happened:

The Westpac-Melbourne Institute Index of Consumer Sentiment (pdf) fell 0.6 per cent to 100.7 in June from 101.3 in May.

Consumer Sentiment Index

Why it matters:

Soft consumer sentiment is consistent with last week’s retail trade release and the retail outcomes reported in the NAB monthly survey (above).

Interestingly, survey responses reportedly showed a marked drop-off after the RBA rate cut, with responses collected before the decision having a combined index read of 106.8 compared to an index read of 95.5 for those collected after the June meeting. The daily results also showed a fall after the release of the weak first quarter GDP result. It’s therefore possible that June’s rate cut (plus the soft growth number that followed it) might have done more to alarm households regarding the health of economy than it did to reassure them with the prospect of lower interest payments.

Also noteworthy was a big bounce in expectations for house prices, which posed a dramatic gain in June, as the index rose to its highest level since August 2018. Other indicators of housing-related sentiment also showed a positive, if rather more muted, response to the rate cut, with a modest improvement in the ‘time to buy a dwelling’ index.

What happened:

According to the ABS, Australia’s unemployment rate was unchanged at 5.2 per cent in May (seasonally adjusted). The trend unemployment rate was likewise unchanged at 5.1 per cent.

Unemployment rate

Underemployment rose from 8.5 per cent in April to 8.6 per cent in May, leaving the underutilisation rate at 13.7 per cent (seasonally adjusted).

Unemployment and underemployment

The number of employed persons increased by 42,300 persons in May, with an increase of 2,400 in full-time employment and an increase of 39,800 part-time. That was a much stronger rise than the consensus forecast, which had called for an overall increase of just 16,000.

Change in employment

Over the past year, full-time employment has now increased by more than 266,000 while part-time employment has grown by almost 94,000 over the same period.

The participation rate has now risen to 66 per cent, a new high.

Employment and population ratio

Why it matters:

Despite the weak GDP growth performance reported for the first quarter, the Australian economy continues to generate jobs at a decent rate. The average monthly rate of employment has been running at more than 27,000 persons over the past 12 months, delivering sizeable gains in both full-time and part-time employment, and employment growth is currently at close to an annual rate of three per cent. That in turn has encouraged more Australians to enter the labour force, pushing up the participation rate to a new record high.

Even so, that’s still not been enough to drive down the unemployment rate, which remains stuck at a little above five per cent, and the underemployment rate. With the RBA now estimating that the non-accelerating inflation rate of unemployment or NAIRU is closer to 4.5 per cent than five per cent (see for example speech by Luci Ellis discussed in the readings section below), this month’s labour market report indicates that there is still space capacity in the Australian labour market, and as such is consistent with further policy easing from the central bank: in other words, markets will continue to bet on another RBA rate cut1.

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

What happened:

Officials from Mexico and the United States reached an agreement to curb immigration flows from Mexico, with the tariffs that had been scheduled to be imposed on Mexico this Monday now ‘indefinitely suspended.’ The deal says that the success of the agreement will be reviewed within 90 days, and Washington has indicated that if Mexico does not make sufficient progress relative to US expectations, the tariffs could still be imposed.

As Mexico moved out of the crosshairs, President Trump switched his focus to Germany, saying that he was considering imposing sanctions over Nord Stream 2 (a 1,225 km pipeline project led by Russia’s Gazprom to ship gas from Russia to Germany). Washington under both President Obama and President Trump has opposed the project.

Why it matters:

The good news is that the deal with Mexico helps defuse one potentially destabilising confrontation in the ongoing ‘trade wars.’

The not-so-good news is that some of the more troubling lessons to be taken from the eight-day standoff between the two-sides include the increasing willingness of the Trump administration to deploy tariffs to attain foreign or security policy goals in a very blunt way; the scant cover provided for Mexico by the recently negotiated USMCA trade agreement (Trump’s planned replacement for NAFTA); and the fact that the tariff threat does not appear to have been fully removed.

US trade policy

More generally, the Mexican story is another example of the high level of uncertainty currently characterising the implementation of US trade policy.

What happened:

UNCTAD released its latest World Investment Report. It shows global flows of foreign direct investment (FDI) in 2018 fell by 13 per cent to US$1.3 trillion, down from a revised US$1.5 trillion in 2017.

FDI inflows

Looking ahead, UNCTAD forecasts a modest 10 per cent recovery in FDI flows in 2019, which would take them back up to almost US$1.5 trillion. That would still leave FDI flows below their ten-year average, however.

Why it matters:

This was the third consecutive annual fall in global FDI flows. However, a significant share of the drop reflected the impact of US tax reforms introduced at the end of 2017, which saw large repatriations of accumulated foreign earnings by US multinationals in the first half of 2018. The tax shifts may also have contributed to a rise in cross-border mergers and acquisitions (M&As) in the second half of last year. Still, UNCTAD reckons that even disregarding the fluctuations caused by the tax reform and the increase in cross-border M&As, the underlying FDI trend was negative. In fact, average annual growth in the underlying trend, which had been running at ten per cent until a decade ago, has now fallen to less than one per cent.

UNCTAD explains that decline in terms of three key drivers: Policy factors (an international shift from FDI policies that had been biased towards liberalisation efforts towards a greater focus on restrictions on foreign ownership based on national security or strategic technology considerations); Economic factors (the global rate of return on inward FDI is estimated to have fallen from eight per cent in 2010 to 6.8 per cent in 2018); and Business factors (the adoption of digital technologies in global supply chains is leading to a shift towards intangible investment and ‘asset-light’ forms of international production, producing a rise in the importance of trade in services and international payments for royalties and licensing fees relative to the roles played by goods trade and FDI).

UNCTAD’s reported decline in trend FDI is also broadly consistent with the proposition that the previous era of ‘hyperglobalisation’ may have been replaced by something that looks more like ‘slobalisation’.

What I’ve been reading: articles and essays

The RBA’s Luci Ellis urges us to watch the invisibles. Starting with the concept of the expectations augmented Phillips Curve – which looks at the relationship between the difference between actual and expected inflation and the difference between the actual unemployment rate and the ‘non-accelerating rate of unemployment (NAIRU), Ellis notes that in economics we are often confronted with the idea of setting policy based on variables that we can’t directly see or measure (expected inflation and the NAIRU in this example), but which are still of great importance. Ellis goes on to note that the NAIRU is ‘the perfect example of this’ since the RBA’s estimate of it is an important input into assessments of the state of the economy and the appropriate stance of monetary policy. In this context, Ellis notes that the RBA has now lowered its estimate of the NAIRU from around five per cent to 4.5 per cent. That change in thinking was one of the factors behind the RBA’s recent decision to cut the cash rate.

More from the RBA: Christopher Kent provides a short overview of the evolution of Australia-China bilateral financial ties, including a rise in the use of the renminbi by Australian businesses.

A low US inflation reading this week provided more ammunition for markets’ bet on future Fed rate cuts. Tim Duy (writing before the inflation data was released) argues that the recent run of US data is indeed clearing the way for a Fed rate cut, although he also reckons that July is more likely than June.

The FT on why ‘cracking seven’ (pushing down past Rmb7 per US dollar) is a big deal for China’s currency market.

Also from the FT, Martin Wolf on who should succeed Mario Draghi as president of the European Central Bank.

Barry Eichengreen mounts a political economy defence of quantitative easing (QE). While some critics have charged that QE has opened the door to political interference in central bank operations, Eichengreen argues that absent QE the likely scenario would have involved deflation, a more severe post-crisis recession, and as a result, an even more aggressive assault on central bank independence.

Noah Smith on surveillance capitalism. This caught my eye in part because he opens by citing a great book that I read an awfully long time, ago, David Brin’s Transparent Society.

Remembering Martin Feldstein, a one of ‘the most respected and influential US economists of his generation’.

Menzie Chinn on how models are showing rising probabilities of a US recession. Related, Antonio Fatas on the reliability of some statistical recession indicators. The IMF’s Finance & Development magazine has a special issue looking at the IMF at 75, including a visit from JM Keynes.

1 The basic idea is that the NAIRU helps assess the degree of labour market slack, which can be measured as the difference between the actual unemployment rate and the NAIRU, sometimes known as the ‘unemployment gap’. If the actual rate of unemployment is below the NAIRU, the assumption is that labour market conditions will be tight, creating upward pressure on wages and (therefore) prices. If actual unemployment is above the NAIRU, on the other hand, then labour market slack is assumed to place downward pressure on wages and inflation. For more on estimating the NAIRU, see here.

The Economic Weekly (7 June 2019)

This has been a big week for the Australian economy, delivering the first RBA rate cut in almost three years and the weakest annual GDP outcome since 2009. With the global trading environment also deteriorating and the Productivity Commission providing a reminder of the trend decline in Australia’s productivity performance, the economic outlook is looking increasingly challenging, although our external performance remains a relative bright spot.

The RBA cut the cash rate by 25 basis points on 4 June, taking it to a new record low of 1.25 per cent. Markets expect at least one – and possibly more – rate cuts to follow.

In a speech delivered shortly after the rate cut, the RBA Governor validated those expectations, stating that ‘it is not unreasonable to expect a lower cash rate.’

GDP growth in the first quarter of this year rose by 0.4 per cent in quarterly terms but slowed to just 1.8 per cent over the year, producing the weakest year-on-year result since 2009.

House prices dropped again in May, although the pace of the downturn continues to moderate.

Retail sales fell in April, disappointing market expectations and confirming the ongoing squeeze on both consumer spending and the retail sector.

Strong growth in export earnings helped Australia’s current account deficit shrink to just $2.9 billion in the first quarter of the year, or only 0.6 per cent of GDP.

A $4.9 billion trade surplus in April showed that strong external performance continuing into the second quarter of the year.

The Productivity Commission’s latest annual review of Australia’s performance highlights a trend of weakening productivity growth since 2012-13, with labour productivity growth running well below its long-run average.

The outlook for global trade took another hit after President Trump threatened to impose tariffs on imports from Mexico. According to the New York Times, Washington has also considered imposing tariffs on imports of Australian aluminium, but ultimately rejected the idea. China added some more fuel of its own to the bonfire of the global trading system.

Jerome Powell, chair of the US Federal Reserve, said in a speech that the Fed stands ready to act to sustain the current economic expansion in the face of trade wars, giving markets more confidence in their bet on Fed rate cuts this year.

The World Bank became the latest international body to cut its growth forecasts for this year, despite detecting some signs of stabilisation in the world economy. The IMF’s surveillance note for the upcoming G-20 meeting in Japan also highlights ‘tentative signs of stabilisation in global growth’ but again sets that against a familiar set of downside risks.

What I’ve been following in Australia . . .

What happened:

The RBA cut the cash rate by 25 basis points (bp) to 1.25 per cent on 4 June, a new record low. According to the central bank, the decision was taken ‘to support employment growth and provide greater confidence that inflation will be consistent with the medium-term target.’ The accompanying Statement argues that the cut to the cash rate ‘will help make further inroads into the spare capacity in the economy. It will assist with faster progress in reducing unemployment and achieve more assured progress towards the inflation target.’

RBA cash rate

Why it matters:

The last time the RBA changed the cash rate was on 3 August 2016, when it delivered a 25bp cut. It then left rates unchanged for an unprecedented 30 consecutive meetings. That makes this month’s cut the first cash rate change of Governor Lowe’s tenure (he commenced as Governor in September 2016).

Technically, the RBA started its current – elongated – policy easing cycle in November 2011, when it cut the cash rate from 4.75 per cent to 4.5 per cent. This latest cut therefore means that the policy rate has now been lowered by a cumulative 350bp, although it has taken the RBA more than 90 months to get here.

June’s cut was widely expected: financial market pricing in the run-up to this week’s meeting put the chance of a rate cut as a virtual certainty, while a Bloomberg survey of economists had 36 out of 38 respondents predicting that the central bank would ease policy. All of which meant that a decision to leave rates unchanged for a 31st consecutive meeting would have been a big – and potentially credibility-sapping – surprise.

As well as validating market expectations, the RBA’s decision reflects the economic context, where key domestic factors include low inflation, soft growth, the risk of a weakening labour market and a household sector under considerable pressure:

  • Headline inflation fell to just 1.3 per cent in the March quarter of this year, well below the bottom of the RBA’s target band. The central bank has been struggling to get inflation high enough to hit its inflation target since the end of 2014 and throughout Governor Lowe’s term.
  • Annual GDP growth had slowed to 2.3 per cent by the final quarter of 2018, below estimated potential growth of 2.75 per cent. First quarter 2019 growth figures were only released the day after the RBA meeting (see below), but market expectations ahead of the release had been for growth of just 1.8 per cent – so almost a full percentage point below potential.
  • Until recently, the labour market has been one of the bright spots of the Australian economy, adding jobs at rate fast enough to keep the unemployment rate pegged at around five per cent. But April’s report showed the unemployment rate ticking up to 5.2 per cent, raising some questions over that labour market resilience.
  • An uncomfortable combination of sluggish wage growth, falling house prices and high levels of household debt is squeezing the financial position of households, and hence overall consumption spending.

In addition, the global backdrop has been complicated by a deterioration in the trade environment as trade policy uncertainty continues to rise.

In this context, financial markets don’t believe that the RBA is done with rate cuts, with market pricing suggesting that the cash rate will be down to one per cent within the next three months and will then stay there – or even move lower – over the next three years. Indeed, the first forecasts of a cash rate as low as 0.5 per cent next year have now appeared.

The RBA will be hoping that this rate cut and perhaps one or two more, plus tax refunds and an easier stance from regulators (see the piece on APRA in the Weekly a couple of weeks back) will be enough to obviate the need for even more radical monetary policy options. But the economic outlook remains hostage not only to Australia’s heavily indebted household sector, but also to an increasingly unpredictable global economic environment.

Finally, it’s worth noting that the last time the RBA delivered a rate hike was 3 November 2010. If current market pricing turns out to be right, much more than a decade will have passed before we see another rate rise from the RBA.

For more on the RBA’s views, see the following item on Governor Lowe’s 4 June speech.

What happened:

RBA Governor Philip Lowe gave a speech later on same day that he delivered the first cash rate cut in nearly three years, using the opportunity to set out the central bank’s thinking behind the move.

Governor Lowe argued that the decision to lower the cash rate was ‘taken to support employment growth and to provide greater confidence that inflation will be consistent with the medium-term target.’ He also stressed that in his view ‘the decision is not in response to a deterioration in our economic outlook since the previous update was published in early May. The economic outlook remains reasonable, with the main downside risk being the international trade disputes, which have intensified recently.’ The immediate triggers for action were subdued inflationary pressures and the presence of significant spare capacity in the labour market.

The speech also tackled the possibility of more rate cuts, with Governor Lowe commenting that ‘it is not unreasonable to expect a lower cash rate’ and noting that the current set of RBA forecasts already bake in market expectations of a cash rate of around one per cent by the end of the year. He also (again) flagged the case for fiscal support, including infrastructure spending, and for structural reforms to help reduce unemployment.

Finally, he made a point of arguing that all the latest reduction in the cash rate should be passed on in the form of lower variable mortgage rates, arguing that changes in monetary policy plus declines in market-based spreads had delivered ‘a substantial reduction’ in wholesale funding costs for banks at the same time as rates had also fallen on retail deposits.

Why it matters:

Despite the presence of some caveats (the governor did flag ‘a range of other possible scenarios’), the speech was nevertheless quite clear in indicating that the 4 June rate cut would not be the last one, and that markets are right to expect a further policy response in the absence of any future marked improvement in the economy. The RBA was also transparent in its call for Canberra to do more to support the economy, both through infrastructure spending and structural reform. It was similarly – and unusually – candid in its call for the banking sector to pass on the rate cut in full to its customers.

There was also an interesting discussion on the RBA’s approach to its inflation target, with Lowe noting that the flexibility of the current regime meant that the RBA has ‘never sought to have inflation always between two and three per cent’, but also conceding that this flexibility ‘is not boundless’ and that if inflation were to stay ‘too low for too long’, this could undermine inflationary expectations.

Finally, Lowe also touched on household debt. Here the governor sounded more sanguine about the risks, arguing that ‘this concern has receded recently’. It’s certainty true that, as the speech emphasises, lending practices have been tightened and lenders have become more risk averse, meaning that further large increases in debt now seems unlikely. It’s also the case that the prospect of a shock to servicing costs due to rising rates now appears to be further away than ever. All that is true enough. Still, the current level of the household debt burden remains extremely high, and as such continues to represent a significant source of risk.

What happened:

Australian real GDP in the first quarter of this year rose by 0.4 per cent over the previous quarter (seasonally adjusted), beating the December quarter’s lacklustre 0.2 per cent outcome but coming in a bit below market expectations of a 0.5 per cent result. In year on year terms, growth slipped to 1.8 per cent, its weakest outcome since the September quarter of 2009.

Real GDP

GDP per capita fell (well, marginally – it was almost flat) for a third consecutive quarter, extending the so-called per capita recession.

By expenditure component, key positive contributions to quarterly growth in the March quarter came from public demand (mainly government consumption including spending on disability and health services) which added 0.2 percentage points and net exports, which made similar sized contribution. Household consumption and private business investment each added a further 0.1 percentage point, while dwelling investment subtracted from overall growth.

Contribution to real GDP growth

The nominal side of the economy – which determines the health of the fiscal accounts – continues to be stronger than the real side: the terms of trade (that is, the ratio of export to import prices) were higher over the quarter and that saw nominal GDP grow at 1.4 per cent in quarterly terms and climb by 4.9 per cent over the year.

Nominal GDP

Labour productivity growth (both in terms of GDP per hour worked and gross value added (GVA) per hour worked in the market sector) fell, continuing the weak run of productivity outcomes.

Labour productivity growth

Why it matters:

The first quarter GDP numbers provided confirmation of what we already knew: the weakness that marked the Australian economy during the second half of last year continued into the first quarter of this one. Headline growth is now running well below not only our pre-GFC average growth rate, but also the more subdued post-GFC average. It’s also about a percentage point below official estimates of Australia’s growth rate.

Real GDP growth

The immediate drivers of that weakness continue to be the adjustment in the housing sector and a weak performance by the consumer. Dwelling investment fell 2.5 per cent over the quarter – the second consecutive quarterly drop – and was down more than four per cent over the year.

Private investment in dwellings

Household consumption expenditure was up by a modest 0.3 per cent over the quarter and grew by just 1.8 per cent over the year as households cut back on discretionary spending.

Real household consumption

Households increased their savings rate this quarter in a sign that the negative wealth effect from falling house prices may be prompting a rise in precautionary savings.

Household saving ratio

Taken overall, the GDP result provides further support for the case for more RBA rate cuts. At the same time, an ongoing disappointing productivity performance continues to raise questions about the medium-term outlook for the economy (see also the story on the Productivity Commission’s latest update, below).

What happened:

According to CoreLogic, national house prices fell 0.4 per cent in May over the previous month.

CoreLogic Hedonic home value index

National values are now down 7.3 per cent over the past year and 8.2 per cent from their peak, while values in Sydney are down 10.7 per cent over the year and 14.9 per cent off their peak. The corresponding falls for Melbourne are 9.9 per cent and 11.1 per cent, respectively. While those are substantial falls, both Perth (down 19.2 per cent from the peak) and Darwin (down 29.5 per cent) have experienced much larger declines over their own housing market cycles.

Why it matters:

Australia’s housing market ‘remains in a geographically broad-based downturn’, with monthly price declines in May in every capital except Adelaide. The positive news here is that May’s fall in national dwelling values was the smallest monthly decline since May 2018, with price falls in Sydney and Melbourne – which until now had been falling at the fastest rates across the capital cities – having slowed as both cities reported the slowest pace of monthly decline since March 2018.

What happened:

Australian retail turnover in April fell by 0.1 per cent over the previous month (seasonally adjusted) and was up 2.8 per cent over the year. Markets had been expecting a 0.2 per cent monthly increase.

Retail trade

Retail trade fell in New South Wales, Victoria, the Northern Territory and the ACT over the month but was modestly higher across the other states. Why it matters:

April’s reading was disappointingly weak, indicating that both the retail sector, and the consumer more generally, remained under pressure into the second quarter of this year.

What happened:

Australia’s current account deficit fell to just $2.9 billion (seasonally adjusted) in the first quarter of 2019, reflecting a record goods and services surplus of $13.6 billion.

Current account balance

Goods export values in particular were boosted by high prices for metals and minerals over the first quarter, including iron ore, as well as by high prices for non-monetary gold.

Why it matters:

Measured as a share of GDP, this was the smallest current account deficit recorded this century (in fact, the smallest since 1979) and represents a continued decline in Australia’s reliance on external funding. This strong external performance continues to provide support for the Australian dollar, working to offset the downward pressure coming from lower current and expected future interest rates while net exports remains a positive source of growth momentum.

What happened:

Australia recorded a $4.9 billion trade surplus (seasonally adjusted) in April, almost unchanged from the March outcome.

Trade balance

Why it matters:

Hot on the heels of the Q1:2019 current account result, April’s trade reading confirms the continued strong performance on the external account, as high commodity prices contributed to a sizeable increase in the value of exports of metal ores and minerals despite a fall in the value of coal exports.

What happened:

The Productivity Commission published its latest analysis of Australia’s productivity performance. Growth in labour and multifactor productivity for the market sector was just 0.4 per cent and 0.5 per cent respectively in 2017-18, continuing a trend of weakening productivity growth since 2012-131,2. , Labour productivity growth is now running well below the market sector’s long-run annual trend growth rate of 2.2 per cent and labour productivity growth has also been weak at the economy-wide level (see also the section on Q1:2019 GDP above).

Why it matters:

The Commission reports that an important part of the current weakness in Australian labour productivity growth is due to a marked slowdown in investment in capital. Indeed, the slowdown has been so significant that the ratio of capital to labour has fallen – a process of ‘capital shallowing’ in contrast to the more positive process of capital deepening. As the Commission emphasises, that’s concerning since investment typically embodies new technologies, which complement people’s skill development and innovation. This relationship is particularly strong for investment in research and development (R&D), where the Commission points out that capital stocks are now falling.

In contrast to subdued investment, growth in labour inputs was relatively strong over 2017-18, reflecting a combination of strong population growth, a rise in the labour force participation rate and a fall in the unemployment rate.

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

What happened:

Mexican officials have been in Washington this week for talks aimed at heading off another escalation in the global trade wars. At the end of last week, US President Trump had announced that he would impose tariffs on imports from Mexico unless it took actions to alleviate what he describes as a ‘migration crisis.’ Trump’s plan suggested that Mexican goods would initially be subject to a five per cent levy beginning on 10 June, followed by staggered monthly increases taking them up to a 25 per cent rate by October if Mexico did not meet US expectations. In a press conference held during his visit to the UK, President Trump said that he thought the tariffs would take effect next week although back in Washington some US officials have sounded more optimistic about the possibility of an agreement to forestall such a move.

According to the New York Times, the Trump administration has also considered imposing tariffs on imports of Australian aluminium (and possibly on other products) after the former surged in value. The same story cited ‘fierce opposition’ from military officials and the State department as helping defeat the proposal, at least for now. Meanwhile, in yet another blow struck in the US-China trade conflict, Beijing has announced that it plans to establish a ‘non-reliable entity list’ targeting foreign companies that harm the rights and interests of Chinese groups. While details were scant at the time of writing, press reports had suggested that companies on the list could find their operations in China limited by restrictions on sales, investments, business permits and visits by employees. Beijing has also warned its nationals about the difficulties it says now face Chinese students seeking to study in the United States.

Why it matters:

If Washington does decide to impose tariffs on Mexico, that will have a significant impact on an economy where growth is already struggling (Mexican GDP contracted in the first quarter of this year) and which is heavily reliant on trade with its northern neighbour: exports of goods and services were worth almost 38 per cent of Mexican GDP in 2017 and about 80 per cent of those exports go to the United States. There would also be (further) damage to the global value chains that span the North American economy and a hit to US consumers, particularly through the price of autos, plus the potential fallout from any subsequent Mexican retaliation.

Auto imports by source market

More generally, the targeting of Mexico is another blow to confidence in the global trading system, which is already suffering thanks to the US-China and US-EU trade clashes. It therefore risks further damaging business investment plans and hence undermining both short- and medium-term global growth prospects.

Finally, and as noted before, even prior to this latest announcement, US tariff rates are now on track to be significantly higher than those prevailing in most advanced economies and are starting to rival the levels of protection imposed by emerging markets.

Average import tariffs

What happened:

In remarks on 4 June, US Federal Reserve Chair Jerome Powell said that the Fed was closely monitoring the implications for the US economic outlook of recent developments involving trade and stood ready to ‘act as appropriate to sustain the expansion’.

Why it matters:

Powell’s speech follows comments from other members of the Fed that also appear to be signalling a greater willingness on the part of the central bank to contemplate a rate cut: for example, James Bullard, President of the Federal Reserve Bank of St Louis said in a recent speech that lower interest rates might be ‘warranted soon’ and that the current policy rate setting was ‘inappropriately high’. Market expectations of (multiple) Fed rate cuts have now soared, with markets pricing the probability of a rate cut as early as the July Federal Open Market Committee (FOMC) meeting as high as 50 per cent at the time of writing.

President Trump has long made it clear that he’d like to see the Fed cut rates this year. His decision to ratchet up the trade war rhetoric is now making it more likely that he’ll get the rate cuts he wants.

What happened:

The World Bank has become the latest international institution to trim its forecast for global growth this year, reckoning that growth in 2019 will now run at 2.6 per cent, down 0.3 percentage points from its January 2019 projections. Growth forecasts for both advanced economies and emerging market and developing economies were downgraded by the same amount while the Bank’s forecast for growth in world trade volumes this year was slashed by a full percentage point to just 2.6 per cent, which would be its weakest result since the global financial crisis. On a more positive note, the Bank thinks that the economic struggles of first half of the year may be followed by a period of economic stabilisation, although it also cautions that risks remain skewed to the downside.

The IMF is pushing a similar message: in its surveillance note for the 8 – 9 June G-20 Finance Ministers and Central Bank governors meetings in Fukuoka, the Fund points to ‘tentative signs of stabilisation in global growth’ alongside persistent – and familiar – downside risks.

Why it matters:

The World Bank reckons that around 80 per cent of advanced economies are expected to register slowing growth this year, with trade, industrial production and investment spending all showing weakness.

Trade and investment volume growth

Still, with both the IMF and the OECD having already downgraded their own forecasts for 2019, the Bank’s latest set of adjustments serve mostly to confirm the story of a weak first half for the current year.

What I’ve been reading: articles and essays

Alexandra Heath, the RBA’s Head of Economic Analysis, looks at Australia’s resource industry. Noting that the sector now accounts for about 20 per cent of business investment and almost 60 per cent of exports, Heath starts off with the (now familiar) RBA forecasts that ‘mining investment is probably around its trough and is likely to pick-up gradually over the next year or so. Resource exports are also expected to contribute to GDP growth before plateauing at a new, higher level.’ But her focus is on the longer-term outlook where she identifies key factors as ongoing industrialisation and urbanisation in large emerging economies, including India; the impact of technological change; and the degree to which governments worldwide seek to implement their commitments to reduce carbon emissions.

The RBA has also published its latest chart pack.

More slides: the Grattan Institute’s policy priorities for the returned government. A fast-approaching jump in demand for tertiary education places, youth underemployment, demographic pressures on private health insurance, the changing skill-mix of Australian migration and rising homelessness all feature.

The Bank of England’s blog reviews the relationship between the yield curve and growth in the US and UK. The authors find that historically, yield curve slopes do contain some predictive power in forecasting the level of economic growth one year ahead, but that since the 1990s this predictive power has tended to decline. Interestingly, they also find that recently there has been a renewed strengthening in the relationship.

An FT Big Read on rare earths and their possible role in the US-China trade wars. China currently accounts for almost 80 per cent of the global mined supply and an even higher share of the manufacturing of rare earth magnets. But the complexity of global supply chains – which mean that the US imports relatively little raw material directly from China – complicate their use as a trade weapon.

Related, Martin Wolf considers ‘the looming 100-year US-China conflict’ whereby ‘across-the-board rivalry with China is coming an organising principle of US economic, foreign and security policies.’

The Economist on clearing houses: ‘Collectively these institutions contain one of the biggest concentrations of financial risk on the planet.’ Designed to address the transparency shortcomings associated with bilateral clearing, central clearing has created new risks, including, the Economist argues, a new collection of institutions that has joined the ranks of the too big to fail.

The economics of Rihanna’s superstardom. Lessons from the music industry - where the top one per cent of performers take in about 60 per cent of all income - on ‘winner take all’ effects and the economics of superstars.

Noah Feldman writes that Google and Facebook shouldn’t worry about a breakup. Yet.

Noted (but not read): a new eBook from Voxeu assessing a decade of financial regulation.

What I’ve been reading: books

Jonathan Coe’s Middle England. The third in Coe’s trilogy that started off with The Rotter’s Club (set in 1970s Birmingham, UK) and continued in The Closed Circle (Britain in the Blair years) finishes the story with a look at Brexit England. An entertaining conclusion to the series, albeit one that at times seems unable to resist pretty much every cliché about the ‘state of the nation’.

1 In this report, the Commission focuses on productivity in the so-called market sector, which comprises 16 industries where prices are set in markets, which makes it relatively straightforward to value outputs. The relevant measure of labour productivity here is gross value added (GVA) per hour worked. An economy-wide perspective on productivity is given by GDP per hour worked which also includes four industries from the non-market sector (public administration and safety, education and training, health care and social assistance, and ownership of dwellings. Dwellings produce accommodation services).

2 Labour productivity measures the increase in output per hour worked. It reflects changes in two components: (1) the quantity of capital inputs used per unit of labour input, captured by the capital to labour ratio and (2) the efficiency with which inputs are used in production, or multifactor productivity (MFP). Capital deepening is the process of increasing the capital to labour ratio while growth in MFP captures all the factors other than inputs of labour and capital that influence the economy’s growth performance.

The Economic Weekly (3 June 2019)

What I’ve been following in Australia . . .

According to the ABS, private new capital expenditure in the March quarter fell by 1.7 per cent over the previous quarter (seasonally adjusted) and was down 1.9 per cent over the year1. The consensus had expected a quarterly increase of 0.4 per cent.

Private Capital Expenditure

The weakness in Q1 investment spending was relatively widespread: mining was down 1.3 per cent over the quarter and 12.9 per cent over the year while manufacturing was down 7.4 per cent in quarterly terms and 8.5 per cent annually. Other industries were also down 1.2 per cent over the quarter but were up 4.3 per cent over the year.

Real capital expenditure by sector

On a more positive note, the sixth estimate for total capital expenditure for 2018-19 was $122.1 billion, up almost four per cent on the same estimate for the previous year. And the second estimate for total capital expenditure for 2019-20 was $99.1 billion, up almost 13 per cent compared to the corresponding estimate for 2018-19, reflecting a large increase in estimated mining expenditure (up 21 per cent).

Real Capital Expenditure estimates

Why it matters:

The capital expenditure numbers for the first quarter were disappointingly weak and consistent with the story of a soft start to this year, showing spending being pulled down by a combination of continued falls in mining investment and a marked drop in manufacturing investment. Still, the outlook for investment looks more positive. In particular, the estimates for 2019-20 suggest that the economy may have finally negotiated its way down the mining investment cliff, with capital expenditure estimates for mining up significantly over the previous year. The removal of that particular headwind should be helpful for the overall growth outlook going forward, especially given the outlook for dwelling investment (see below).

What happened:

Total dwelling units approved in April fell by 4.7 per cent over the month (seasonally adjusted) and were down 24.2 per cent over the year. The consensus forecast had expected no change over the month and a 22 per cent yearly fall.

Building approvals

Private sector housing approvals were down by more than 20 per cent over April 2018 while approvals for private sector dwellings excluding houses were down by almost 29 per cent over the same period.

Why it matters:

On a trend basis, the pace of monthly approvals has fallen from around 20,000 to less than 15,000. Granted that there is still a sizeable construction pipeline to work through – which should continue to support investment in the short-term – the implication is that dwelling investment is then set to decline quite significantly as existing construction projects are completed.

Private investment dwellings

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

What happened:

Yields on global sovereign bonds have been tumbling.

In the United States, the yield on ten-year government debt has fallen back to lows last seen in 2017.

Ten year government bond yield

At the same time, a key segment of the US Treasury yield curve has inverted (again), with the gap between the yield on three-month Treasury bills and ten-year Treasury bonds moving back into negative territory.

Treasury yield spread

As noted before, markets pay a great deal of attention to US yield curve inversions since in the past they have been good predictors of a future (in roughly one year’s time) recession: the spread between the US three-month Treasury bill and the US ten-year Treasury bond has been negative before each of the past seven US recessions, most recently before the 2007-2008 slump. This indicator has delivered only one major false positive (an inversion in late 1966) and one near miss (a very flat curve in late 1998).2

Other markets have seen similar moves, indicating that there is an international aspect to the story. For example, in Germany, the yield on ten-year bunds, which had already fallen below zero, has now moved deeper into negative territory and is approaching its 2016 record low.

Ten year government bond yield

And here in Australia, the yield on the ten-year government bond fell to below 1.49 per cent – a new record low that also took it below the cash rate for the first time since 2015.

Ten year government bond yield and cash rate

Why it matters:

The decline in government bond yields (or equivalently, the rally in bond prices) indicates a rise in bond market pessimism regarding the growth and inflation outlook for the world economy and (hence) expectations of upcoming rate cuts from central banks, including from the RBA but also from the US Federal Reserve – despite the latter’s repeated claim that it plans to be ‘patient.’ These general concerns have been compounded by fears about specific risk developments.

Regarding the latter, signs of an intensification in the ongoing trade dispute between Washington and Beijing have been one important source of recent market nerves. Following the exchange of tariff increases and US action targeting Huawei, the latest twist in the story has seen Chinese newspapers speculate that Beijing could use its dominant position as an exporter of rare earths – China accounts for about 80 per cent of the current global supply of the 17 metals that are key inputs into high technology products from consumer electronics to defence equipment – as a weapon in the trade war, reflecting comments from the National Development and Reform Commission (NDRC). There have also been reports that international institutions have been winding back their holdings of Chinese shares to reduce their exposure to companies vulnerable to US trade policies. In one piece of good news, the United States did choose not to label China as a ‘currency manipulator’ when the US Treasury Department released its semi-annual report on the macroeconomic and foreign exchange policies of major trading partners to Congress at the end of May, thereby avoiding another opportunity to increase bilateral tensions3. Markets are now hoping that the G20 summit in Osaka – due to begin on 28 June – will offer an opportunity for the two sides to bridge their differences.

In addition to these worries about the global trading environment, uncertainty has also been on the rise in Europe. In the UK, Theresa May has joined the growing list of Conservative Prime Ministers to have been brought down by Europe while the meltdown in the European election results that hastened her demise saw voters punish both the major parties, opting instead for parties offering either hard Brexit or Remain in a political earthquake. The current official exit date for the UK is 31 October, and while the present febrile state of British politics means that the end game remains extremely difficult to call, the chances of a potentially disruptive, no-deal Brexit have almost certainly increased. Further complicating the European outlook, the European Commission has asked the Italian government to explain a deterioration in Italy’s public finances in the form of an increase in government debt. Absent a satisfactory explanation, Brussels could launch formal disciplinary steps against Rome, which in theory at least could trigger a fine of 0.2 per cent of GDP. With the European elections having bolstered the relative position of Matteo Salvini and his Eurosceptic Lega party in Italy’s coalition government, confrontation now appears more likely here, too.

What I’ve been reading: articles and essays

Harold James reckons that May’s European Parliament elections turned out to be a Game of Thrones replay – ‘a long and complex story with a surprising and, for many, unsatisfactory outcome.’ James thinks that Europe’s ‘long-standing duopoly of centre-left and centre-right forces is definitely over.’ Gideon Rachman’s piece on a fragmented Europe for the FT reaches a similar judgment. All of which reminds me (a tiny bit, without the parallel universe stuff) of my Easter holiday reading – Fractured Europe, anyone?

At Voxeu, Lukcasz Rachel argues that the rise of leisure-enhancing technological change can help explain both the long-term increase in leisure hours and the decline in productivity experienced across the developed world. One apparent macro puzzle has been the apparent disconnect between rapid innovation on the one hand and disappointing productivity growth on the other. Rachel’s proposed solution to this puzzle is that the rise of the leisure sector has seen increased resources directed to innovation there, reducing the amount of creative time available to drive productivity growth in the business sector. Our current inability to correctly measure the value of leisure services then further exaggerates the measured slowdown in aggregate productivity.

An FT Big Read on Snowy 2.0.

Bloomberg economists have estimated that the global cost of the US-China trade war could hit US$600 billion by 2021, the year of peak impact. That estimate is based on 25 per cent tariff rates being applied to all US-China bilateral trade and a consequent ten per cent drop in equity markets.

Nouriel Roubini assesses the global consequences of what he views as an increasingly likely Sino-American cold war. He worries that a full-scale cold war could trigger either a new stage of de-globalisation, or alternatively split the global economy into two incompatible economic blocs.

Related, the MIT Technology Review on the possible balkanization of tech and the consequent downside for the pace of global innovation.

Bloomberg’s Tom Holland looks at how economics is reinventing itself ten years on from the global financial crisis. Also on economics, Vox’s Dylan Matthews on how Raj Chetty is seeking to change the way Harvard teaches economics by shifting the focus from theory to empirics and building on the so-called ‘credibility revolution.’

Hyun Song Shin, Head of Research at the BIS, examines the current slowdown in international trade and manufacturing compared to the relative resilience of the services sector and overall employment. Shin’s focus is on the connection between global value chains (GVCs) and US dollar trade financing, with the proposition that when global dollar financing conditions tighten (for example, during periods of relative US dollar strength), very long and elaborate GVCs tend to lose their economic viability and give way to strategies of on-shoring /re-shoring or a shift from global to (closer to home) regional strategies. Shin also discusses the possibility of ‘bubbles’ in GVC activity that could parallel bubbles in finance.

The Economist analyses the OECD jobs boom. Rich countries have added 43 million jobs to their economies over the past five years, the unemployment rate has fallen to its lowest level in decades, and labour-force participation rates in many OECD member economies (including Australia) are at record highs. The article reckons that part of the story is cyclical – easy US monetary policy and what will soon be a US record economic expansion, rapid growth in employment intensive services, and lingering investment uncertainties that encourage firms to opt for more labour instead of capital. But it also argues that there are more structural forces at work including demographics (ageing societies tend have lower unemployment rates), technology (supporting better matching between workers and vacancies) and changes to labour market policies (boosting labour market participation via more generous parental leave, improving human capital by investing in education, freeing up labour markets to make wages more flexible, and making unemployment benefits less generous). Related, Michael Spence makes a case for going beyond the unemployment rate as an indicator of labour market performance and social welfare.

Chris Schelling in the Institutional Investor writes that while critics of US capitalism who argue that the current system isn’t working may have a point, they are mis-diagnosing the problem, which is that the United States has far too little capitalism, rather than too much. Rising market concentration, declining competition, more regulation and more barriers to market entry are the real problem, he argues.

Businessweek profiles Gabriel Zucman, an economist who has made a career out of tracking offshore wealth.

1 Note that the data only cover private investment for a subset of industries. They exclude Agriculture, Forestry and Fishing, Public Administration and Super Funds. They also omit Education and Training and Health Care and Social Assistance, although there are now experimental estimates for this second group. These experimental estimates are not included in any of the totals and for now are only available in current price original data.

2 The Weekly of 1 April took a detailed look at the signal of an inverted curve and discussed whether it was still as potent an indicator of an upcoming recession as it used to be, examining the impact of the disappearing term premium (estimated to have fallen to a new record low) and the role of central bank asset purchases.

3 Interestingly, the report added five new markets (Ireland, Italy, Vietnam, Singapore and Malaysia) to its ‘Monitoring List’ of major trading partners that ‘merit close attention’. China, Japan, South Korea and Germany were already on the list while Italy and Switzerland were removed.

The Economic Weekly (27 May 2019)

After the Federal Election delivered a surprise win and a majority government for the Liberal/National Coalition, the focus shifts to how the returned government will respond to a weak economy. You can listen to my ramblings on the post-election economic outlook here.

The RBA has thrown in the towel and shifted to an easing bias. Markets are now confidently expecting to see a cut in the cash rate at the 4 June meeting.

The Australian Prudential Regulation Authority (APRA) has proposed amending its guidance on mortgage lending in a sign that its concerns have shifted from excessive borrowing to a credit squeeze.

The OECD released its May 2019 Economic Outlook. It forecasts ‘sub-par’ growth for this year and warns that any escalation of the current US-China trade tensions could strip more than half a percentage point from global GDP.

What I’ve been following in Australia . . .

What happened:

The reputation of the economics profession took a heavy blow from its general failure to call the global financial crisis. Famously, even the Queen had a dig. But over the past couple of years, opinion pollsters and political soothsayers have been doing their best to offer competition for the title of worst forecasters. Brexit and the US Presidential elections were two high profile efforts and we can now add the 2019 Australian Federal elections to the list. Despite the predictions of the polls1, the pundits and the betting markets, the election returned the Liberal/National coalition to government.


Counting was still underway at the time of writing, but the Australian Electoral Commission (AEC) was predicting a majority coalition government with 78 seats in the House after claiming a bit more than 51 per cent of the national two party preferred vote with a swing of about 0.9 per cent.


The counting process in the Senate is less advanced, but the ABC was predicting 34 seats for the Coalition, 26 seats for Labor, eight for The Greens and five in total for the smaller parties, with three seats still in doubt.2

Why it matters:

With the election over, the focus will now shift to how the re-elected government will tackle the challenges facing the economic outlook. Simplifying things, we can boil that down into near-term and medium-term challenges.

The near-term challenge can be summarised as responding to economic weakness, particularly around household consumption (household consumption accounts for almost 60 per cent of GDP and if that much of the economy is misfiring, it’s difficult to get a strong overall outcome). The housing market correction and weak growth in household disposable incomes had together contributed to a decline in growth that saw quarterly GDP growth slow to an annualised rate of just 0.7 per cent (seasonally adjusted) in the final quarter of 2018.3


Since then, there hasn’t been much sign of any significant improvement in households’ situation: wage growth has been slowly grinding higher but remains quite weak; house prices are still falling, although the pace of decline has moderated; underemployment remains high, and the unemployment rate has edged up over the past two months; and households continue to labour under a troublingly high debt burden. Together, that all adds up to a recipe for slow growth and some significant downside risks.


How might the election outcome change this picture?

First, by removing any specific election-related uncertainty. Conventional wisdom was that the difference between the two sets of policies on offer at this election was larger than usual, so all else equal that might have been expected to lead to a greater degree of uncertainty in the run up to the vote, which in theory can act as a drag on consumption and investment decisions. That said, on the measures we have, uncertainty the month before the election was considerably lower than (for example) the spike around the July 2016 election. In this context, it will be interesting to track post-election measures of business and consumer confidence.


There may also have been specific sectoral uncertainty effects. One possible candidate here is the housing market, where Labor was proposing some quite significant changes in policy settings. Some economic analysis had suggested that these kinds of measures were likely to have only a modest implications for the level house prices. But it’s possible that there could have been an additional impact on expectations not captured by this kind of modelling, especially in the context of an ongoing property market correction. If so, any such effect should now drop out of the house price equation.

Second, the government can now implement its policy agenda as set out in Budget 2019 and over the course of the election campaign. A key element here is the pledge to deliver tax relief to low- and middle-income households through a tax rebate. Once legislated (and it now seems that the process will be delayed), the plan will deliver an injection of about $7.5 billion to the household sector, with around ten million households likely to receive a rebate up to a maximum individual payment of $1,080.

Economists at the Commonwealth Bank have estimated that this stimulus equates roughly to two 25bp rate cuts by the RBA. When it finally does arrive, that financial payout should offer some useful support to households’ disposable incomes and help offset some of the current squeeze. And by targeting the low- and middle-segment of the income distribution, the plan makes it more likely that the money will be spent rather than saved.

Other policy support for the near-term growth outlook will come from the continued roll out of infrastructure spend (on which more below) and measures to assist the SME sector.

The medium-term challenge is to address Australia’s slowing growth and disappointing productivity performance. Prior to the global financial crisis, the Australian economy was averaging an annual growth rate in excess of three per cent. Since the crisis – and like much of the world economy – we appear to have shifted down onto a lower growth trajectory.


There are a range of factors that could potentially explain this downshift, but one important element is that there are signs that our productivity performance is weakening, with recent readings being both disappointingly low and trending lower.


Here, the near-term policy program seems to have rather less to offer, although one potentially important exception to this assessment is the plan to deliver more infrastructure spending. As well as providing a helpful short-term boost to the economy through the construction and delivery phase, investment in infrastructure also has the potential to lift the economy’s underlying growth rate. Current plans call for a total of $100 billion of infrastructure investment over the coming decade. According to Budget 2019, this will be delivered at the same time as a shift to sustained budget surpluses. But with borrowing costs at record lows – at the time of writing the yield on Australian government ten-year debt had fallen to below 1.6 per cent – the case for borrowing to invest, if needed, also looks pretty compelling. The RBA has cited OECD estimates that an increase in public infrastructure investment in Australia is associated with a fiscal multiplier of between 1.1 and 1.3 after two years.4 That payoff can increase over time: for example, in Budget 2018, the government published estimates of a multiplier of four over the 25-year lifetime of an asset.

A note of caution here, though. To maximise the benefits of infrastructure investment it’s important to select the projects that offer the highest potential rate of return. One assessment of the election campaign offerings from both sides raised some questions about the quality of current commitments when benchmarked against Infrastructure Australia’s current priority list.

What happened:

In a speech on 21 May in Brisbane, RBA Governor Philip Lowe indicated that the central bank has shifted to an easing bias. Governor Lowe took his audience through the RBA’s evolving thinking on the relationship between unemployment and inflation, noting that until recently, the RBA thought that an unemployment rate of around five per cent was compatible with low inflation. That has now changed, with Lowe noting that his ‘judgement of the accumulating evidence is that the Australian economy can support an unemployment rate of below five per cent without raising inflation concerns.’ He went on to note that while it was ‘possible that current policy settings are sufficient to deliver lower unemployment’ he also conceded that ‘the recent flow of data makes it seem less likely.’ Having laid out the case for using monetary policy to achieve a better unemployment outcome, the Governor concluded his speech by saying that at the next RBA board meeting ‘we will consider the case for lower interest rates.’

Why it matters:

With growth readings looking soft and first quarter inflation coming in well-below expectations, the RBA had been left with the relatively strong run of labour market data as the main piece of evidence against shifting to an easing bias. Last week’s news that the unemployment rate had started to edge up – hitting 5.2 per cent in April – looks to have removed the last element in what has been a steadily eroding case for leaving rates unchanged.


The aftermath of the Governor’s speech saw markets price a 25 bp rate cut at the upcoming 4 June RBA Board meeting as extremely likely (a more than 90 per cent probability at the time of writing).

They also expect another cut to follow, taking the cash rate down at one per cent within six months.


What happened:

The Australian Prudential Regulation Authority (APRA) has proposed amending its guidance on mortgage lending.

Under the current set up, APRA’s guidance to Australian authorised deposit-taking institutions (ADIs) is that they should assess whether borrowers can afford their repayment obligations using a minimum interest rate of at least seven per cent. Instead, APRA now suggests letting ADIs set their own minimum interest rate floor. APRA has also suggested a change to the way ADIs assess loan serviceability. Currently, ADIs are expected to use the higher of either (i) an interest rate floor of at least seven per cent; or (ii) a two per cent buffer over the relevant loan’s interest rate. APRA proposes to replace this with an interest rate buffer of 2.5 per cent.

Why it matters:

By relaxing the serviceability guidelines, the proposed change would increase the maximum borrowing capacity for borrowers. That would ease credit conditions and so – potentially – provide some support for the housing market.

The guidelines – which were introduced in December 2014 – were a product of APRA’s concerns around the housing market, high levels of household debt, and the potential for low interest rates to encourage yet more ‘excessive’ borrowing that would leave then borrowers vulnerable in the event of any sharp increase in interest rates in the future. And while house prices have since fallen, it’s still the case that interest rates remain low (and may be heading lower) and, rather more importantly, household debt levels remain troublingly high. So, is encouraging more leverage in the household sector really a smart move at this point?

APRA’s rationale for the proposed shift is that not only are interest rates now at record lows, but they are ‘likely to remain at historically low levels for some time’, which means that the gap between the old seven per cent floor and the actual rates paid by mortgage borrowers (and the rates they are likely to pay in the future) may have become ‘unnecessarily’ wide.

More generally, the move reflects how far we’ve moved from an environment where the regulators felt that a key risk was that access to credit had become dangerously easy to one in which access to credit has undergone a significant squeeze.

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

What happened:

The OECD published its May 2019 Economic Outlook. It sees global growth slowing from 3.5 per cent in 2018 to a ‘sub-par’ rate of 3.2 per cent this year. The slowdown is expected to be widespread, with the pace of activity moderating in most economies.


Why it matters:

The OECD’s expectation that 2019 will be a relatively disappointing year for the global economy echoes last month’s IMF assessment. The Outlook warns that even this mediocre performance is hostage to US-China trade tensions, reporting simulations suggesting that renewed tensions could strip more than half a percentage point from world GDP over two to three years. It reckons that the current standoff is already taking a toll on medium-term prospects for the world economy by pushing up uncertainty and (therefore) depressing investment and trade.

Two other items feature prominently on the OECD’s worry list. First, the future of the Chinese economy, which is now an increasingly important drive of global growth: the OECD thinks that a two-percentage point reduction in domestic demand growth in China, if sustained for two years, could reduce global GDP by 1.75 per cent by the second year. Second, the rapid expansion of private sector debt in several major economies has seen the global stock of non-financial corporate bonds almost double in real terms from 2008. At the same time, the quality of that debt has been deteriorating and consequently the OECD worries that a ‘new bout of financial stress could erupt’.

What I’ve been reading: articles and essays

A Financial Times Big Read takes on the Indian elections and the challenge of sustaining high growth rates.

This McKinsey Global Institute Paper looks at the drivers of the declining labour share of income in the United States. While they identify some familiar culprits, they also argue that the most important drivers may not be the usual suspects. In their view, Supercycles and boom and bust (in commodity prices and real estate), and higher depreciation rates, including due to a shift to more intangible capital (which increases the depreciation share of income and therefore reduces the amount available to labour or capital) have been relatively more important than either technology or globalisation in driving the decline.

Chad Brown and Eva Zhang of the Peterson Institute provide a useful update on the evolution of US trade measures applied to China. Smoot-Hawley ahoy?

The Economist’s Free Exchange column on lessons for China from Japan’s past accommodation of US pressure over trade.

Drawing partly on the recent Australian election results, Tyler Cowen argues that the rise of the ‘New Left’ has been exaggerated and that the real political revolution is the success of conservative populism.

Claudia Fontanari, Antonella Palumbo and Chiara Salvatori set out a case for developing new measures of potential output, arguing that the standard approach tends to produce estimates that ‘completely overlook the margins for output expansion.’

Brad Delong thinks we still have about two generations before the rise of the robots represents a major threat to employment, and that we should worry more about the role of technology in spreading disinformation.

1. Sure, I do know about margins of error. On a more serious note, there may be some interesting analogies here to the way in which changes in the way economies work have made both existing economic models less useful in understanding what’s going on while also making existing statistics less accurate in capturing the underlying economic reality.

That has created some significant challenges for economic analysis. It seems that there could be parallel shifts across voters, electorates and measures of voting intentions that are producing similar complications for political analysis.

2. Only 40 of the 76 Senate seats were being decided at this election. So, for example, there were 16 continuing Coalition seats, 13 continuing Labour seats and three continuing Greens seats.

3. One worrying scenario is that this near-term weakness is a symptom of structural changes that mean it will also be a medium-term challenge.

4. That is, a $1 billion increase in public infrastructure investment would increase GDP by around $1.1 billion - $1.3 billion after two years.


The Economic Weekly (week starting 20 May 2019)

All eyes will be on the Federal Election on Saturday 18 May. (The current schedule for the Weekly means that my draft content is finalised on the Thursday so by the time readers see these words, the outcome will be known.) We’ll run a webinar on the post-election outlook for the economy on 22 May. You can register here.

The latest set of RBA forecasts from May’s Statement on Monetary Policy foresee slower growth and lower inflation ahead, even after incorporating market forecasts of two cuts to the cash rate.

Reversing a surprise monthly bounce in February, lending to households for dwellings (excluding financing) fell by more than three per cent in March and was down more than 18 per cent over the year.

According to NAB’s monthly business survey, business conditions declined in April, delivering a negative signal on employment prospects.

The Westpac-Melbourne Institute Index of Consumer Sentiment rose by 0.6 per cent over the month in May.

For a third consecutive quarter, Australia’s wage price index rose at an annual rate of 2.3 per cent in the first quarter of this year, signalling continued moderation in wage growth.

The unemployment rate rose to 5.2 per cent in April, up a revised 5.1 per cent in March.

After the United States imposed new tariffs on Chinese imports, Beijing responded with trade measures of its own. Financial markets were unhappy.

On another front in the geo-economic confrontation, President Trump seems to be paving the way to ban US companies from using telecoms equipment manufactured by Chinese company Huawei.

In somewhat better news for world trade, Washington was reported to have deferred for up to six months a decision to impose tariffs on cars and car parts from the EU and Japan.

Monthly data for April cast some doubts on the current strength of the Chinese economy.

What I’ve been following in Australia . . .

What happened:

The RBA released its May 2019 Statement on Monetary Policy1. The central bank’s latest update offered a relatively subdued assessment of current economic conditions, opening by noting ‘Growth in the Australian economy has slowed and inflation remains low. Subdued growth in household income and the adjustment in the housing market are affecting consumer spending and residential construction.’ Continuing in this vein, the RBA also noted that ‘the March quarter inflation data suggest that domestic price pressures are more subdued than previously thought.’ But consistent with its previous commentary, it also emphasised that ‘the labour market is performing reasonably well.’

Most attention focused on the RBA’s revised forecasts, which delivered a raft of downgrades relative to February’s Statement:

RBA forecasts

The RBA thinks the near-term outlook now looks considerably softer than it did back at the time of February’s Statement. In particular, it has lowered its forecasts for growth in wages and real household disposable income, and as a result expects household consumption growth to be appreciably weaker across both this year and 2020. Dwelling investment too is expected to be a greater headwind this year than was anticipated back in February. As a result, the RBA sees real GDP growth slowing to just 1.75 per cent over the year by June instead of the previous projection of 2.5 per cent growth, and overall growth in 2019 is only expected to average two per cent, down from the previous forecast for 2.75 per cent growth.

Back at the time of the November 2018 Statement, the RBA had been expecting the economy to be expanding at an annual rate of 3.2 per cent by June this year, so over the past six months or so the RBA has downgraded its growth forecast by almost one and half percentage points. That’s a sizeable drop.

The low inflation outcome for the March quarter – where the RBA highlights the contribution of the weak housing market (rents and new dwelling purchases by owner-occupiers are the two largest housing components of the CPI and together account for one-sixth of the total basket) – is also reflected in the new projections. In particular, the RBA now thinks that underlying inflation as measured by the trimmed mean will end the year at below two per cent and will only be a little above two per cent by early 2021. The rise in oil prices over recent months has produced an upward revision to the short-term outlook for headline inflation, but once again the rate is not expected to move much above two per cent.

There are also a couple of areas where outcomes have surprised to the upside. For example, commodity prices have been higher than expected, and as a result the RBA has pushed up its forecast for the terms of trade, where it notes that the increase has been ‘larger and more persistent than had been anticipated and is expected to provide a significant boost to national income over the forecast period.’ Non-mining business investment growth also performed better than the RBA had anticipated last year, while growth in public demand over 2018 was much stronger than forecast (up 6.3 per cent over the year in the final quarter against a February forecast for 4.2 per cent growth). According to May’s Statement, the central bank now expects continued growth in investment over the next couple of years, with a ‘solid pipeline’ of private infrastructure and building work, along with a large pipeline of public infrastructure projects.

Why it matters:

After the RBA left rates unchanged at its meeting on 7 May despite a very low first quarter inflation number, central bank watchers had looked to May’s Statement for an update on how the RBA’s thinking might be changing. In the event, the significant downgrades to the growth and inflation forecasts outlined above confirm that the RBA is in broad agreement with the consensus view that the economy is now appreciably weaker than it was a year ago (even though it’s still more optimistic than the market consensus). And remember, the RBA makes these forecasts conditional on the technical assumption that the cash rate will move in line with market pricing. In other words, this soft outlook for growth and inflation is one that already incorporates a forecast of two 25 basis point cuts over the coming year.

The main narrative of the Statement continues to be largely in line with the RBA’s long-running view assigning a central role to the uncertainties around the outlook for household consumption. Key factors here include households’ views about the likely persistence of low income growth (it continues to hope that tighter labour market conditions – plus some support from tax policy – will allow a modest pick up in growth in real disposable incomes), the impact of housing market developments (the RBA thinks that the deterioration in the housing market will continue to weigh on consumption over coming quarters, while flagging any further sizeable falls in prices will inject additional weakness to the consumption profile), and the high level of household debt. No surprise, then, that the message that ‘the Board will be paying closer attention to developments in the labour market’ gets another run out.

One important adjustment to that now-familiar story, however, is a nod to the possibility that the equilibrium level of unemployment may be lower than the RBA’s previous estimates: ‘the ongoing subdued rate of inflation suggests that a lower rate of unemployment is achievable while also having inflation consistent with the target.’ Reworded slightly, that implies that for the bank to hit its inflation target, unemployment will have to fall below its current rate of five per cent (or if that’s not quite the case, then at least the underemployment – and therefore underutilisation – rate will have to fall).

Finally, it’s worth noting that the RBA’s new forecasts also paint a somewhat weaker picture of the economy than the Treasury forecasts that underpinned April’s budget (and that were reaffirmed in the recent Pre-election Economic and Fiscal Outlook). For example, while Treasury sees household consumption growing at 2.75 per cent over 2019-20, the RBA puts likely growth a bit lower at 2.5 per cent. Among other factors, that reflects a softer outlook for wage growth (Treasury has the wage price index growing at 3.25 per cent by 2020-21 while the RBA forecasts don’t see wage growth getting much above 2.6 per cent across the whole forecast period) and household consumption (which Treasury has growing at three per cent by 2020-21 while the RBA thinks the growth number will continue to have a two in front of it by June 2021).

Real GDP forecast compared

What happened:

The value of lending commitments to households in March fell 3.7 per cent over the month (seasonally adjusted) and dropped 16.2 per cent over the year. Lending to households for dwellings excluding refinancing fell 3.2 per cent over the month and 18.4 per cent over the year.

Lending to households for dwellings

Why it matters:

February had seen a surprise monthly bounce in lending to households for dwellings excluding refinancing, which along with some other recent readings (auction clearance rates, a decline in the pace of monthly price falls) had been seen – albeit rather tentatively – as a potential indicator of some early stabilisation in the housing market. The March numbers, however, show continued large falls in the value of lending for both owner occupiers and investors, suggesting we’re not out of the woods yet.

Lending to households for dwellings

What happened:

According to the NAB monthly business survey, business conditions fell by 4.1 points in April, more than unwinding the increase seen in March. That leaves trend business conditions a little below average but still in positive territory. Notably, all business conditions components saw a decline in April, including a particularly sharp drop in the employment sub-index.

NAB business conditions and confidence

The business confidence index increased by one point in April but remains around neutral (balanced between improving and deteriorating confidence) and below its long-run average.

Why it matters:

With the RBA still signalling the importance of the labour market, the drop in the employment component of the business conditions index was a key takeaway from the April result. According to NAB economists, based on historical relationships the current value of the employment index is consistent with employment growth of around 14,000 per month. If realised, that would be significantly weaker than the average monthly performance over the past quarter, or indeed the past year.

What happened:

The Westpac-Melbourne Institute Index of consumer sentiment (pdf) rose 0.6 per cent to 101.3 in May from 100.7 in April. The index fell by 0.5 per cent relative to May 2017 but has now been above 100 for ten of the last 12 months, indicating that optimists continue to outnumber pessimists, and is close to its long run average (101.5).

Westpac Melbourne institute consumer index

The Unemployment Expectations Index recorded a 5.1 per cent decline in May and is back near recent lows, indicating that fewer consumers now expect unemployment to increase over the year ahead, while the Index of House Price Expectations fell 6.5 per cent, partially reversing a surprisingly strong 11.9 per cent increase in April.

Why it matters:

Given that an uncertain outlook for household consumption has been cited by the RBA as one of the key risks to its growth projections, it’s useful to keep an eye on consumer sentiment. While the headline number remained in positive territory again this month, the component indices painted a bit more of a mixed picture. So, while there were gains in the sub-indices tracking family ‘finances vs a year ago’ and ‘economic outlook, next 12 months’ there were also falls in ‘family finances next 12 months’ and ‘economic outlook, next five years’. The sub-index ‘time to buy a major household item’ was up 0.3 per cent over the month but down 4.5 per cent over the year, consistent with the relatively weak reading on first quarter retail trade volumes reported in the previous Weekly.

What happened:

The seasonally adjusted Wage Price Index (WPI) rose 0.5 per cent in the March quarter and was up 2.3 per cent over the year, according to the ABS. Quarterly growth was just below expectations (which had been for a 0.6 per cent print) while annual growth was in line with the consensus forecast.

Wage Price Index

Private sector growth was up 0.5 per cent over the quarter in seasonally adjusted terms and rose by 2.4 per cent over the year, catching up with the annual rate of growth of public sector wage increases (which was up 0.4 per cent over the month and 2.4 per cent over the year)2.

Why it matters:

With headline wage growth unchanged in annual terms, the story of a slow wage growth economy remains intact, despite what had been strong employment growth and a relatively low level of unemployment over the first quarter of this year.

Private sector wage growth continues to grind its way up from the lows of mid-2017. And as headline inflation dropped to just 1.3 per cent in the first quarter, the March WPI reading implies real wage growth is currently running at around one per cent (or a bit lower if core inflation is used), which is its fastest rate since the June quarter of 2016.

As noted above, the RBA’s (downwardly) revised forecasts now expect annual wage growth to hit 2.4 per cent by June 2019. This quarter’s numbers do suggest that this modest outcome could be within reach, but it’s worth remembering that we’ve now had 2.3 per cent growth for the WPI for three consecutive quarters. We need to go back to the final quarter of 2014 to find the last time the economy recorded a faster rate of wage increase.

What happened:

Australia’s unemployment rate rose to 5.2 per cent in April (on a seasonally adjusted basis), while the March unemployment rate was revised up to 5.1 per cent from five per cent. Markets had been expecting the unemployment rate to stay at five per cent. The underemployment rate also increased in April, rising to 8.5 per cent from 8.2 per cent in March, taking the underutilisation rate up to 13.7 per cent from 13.3 per cent.

Unemployment and underemployment

Across Australia, the unemployment rate was up over the month in New South Wales, Victoria, South Australia, Western Australia and Tasmania, while Queensland saw a decline.

Unemployment rate by senate

Seasonally adjusted employment increased by 28,400 persons in April 2019, comfortably beating market expectations of a 15,000 gain. The number of persons in full-time employment fell by 6,300 but this was more than offset by an increase of 34,700 persons in part-time employment. Over the past year full-time employment has increased by more than 248,000 persons while part-time employment is up by almost 75,000.

Change in employment

Across the States, employment was up in New South Wales by more than 25,000 persons, in Western Australia by more than 6,000 and Queensland by more than 5,000. The only decrease was in Victoria (down 7,600 persons).

Nationwide, the participation rate increased, rising to 65.8 per cent, the (joint) highest level recorded this century.

Why it matters:

Given the centrality of the labour market to the RBA’s thinking, the rise in the unemployment rate in April to its highest level since August last year (along with the upward revision to March) was the big news this month. Granted, in trend terms (which the ABS reckons smooths the more volatile seasonally adjusted elements and therefore provides the ‘best measure of the underlying behaviour of the labour market’) the April reading was unchanged from March at 5.1 per cent. But either way, a look at the recent monthly unemployment results is hard to reconcile with the RBA’s search for an improvement in the labour market, especially once the increase in underemployment is also considered. That certainly seems to have been the market reaction, with the Australian dollar dipping below US$0.69 shortly after the labour market data were released.

Recent trends in unemployment rate

For those looking for better news, the data on jobs growth and the high level of the participation rate both offer a rather more positive perspective on the labour market. But it’s that rise in the unemployment rate that will grab most of the attention.

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

What happened:

After Washington had followed through on its threat to increase tariffs on US$200 billion of Chinese imports on 10 May, Beijing responded on 14 May by announcing that it would raise tariffs on US$60 billion of US imports. Later the same day, the US Trade Representative listed a further US$300 billion of Chinese imports that could be subject to 25 per cent tariffs.

Meanwhile, on another front in the geo-economic contest between the two superpowers, President Trump issued an executive order barring US companies from using telecom kit made by firms deemed to pose a national security risk – which has been widely interpreted as paving the way for an effective ban on dealings with China’s Huawei and possibly other Chinese telecommunications companies such as ZTE.

Why it matters:

The escalation in the tariff war between the United States and China triggered a negative reaction across financial markets as share markets fell in both countries on the news of the tariff increases. There now seems to be a rather fascinating game underway. President Trump appears to judge that China is feeling the economic pain of the trade war more than the United States, and therefore that he can ratchet up the pressure on Beijing by making aggressive moves on tariffs, perhaps even by weaponizing the use of twitter to trigger swings in sentiment about China’s vulnerability to trade wars. It turns out that the difficulty with this approach, however, is that this is very much a two-edged sword since the President also appears to treat a strong US stock market as a kind of vote of confidence in his administration’s handling of the economy. So, when tariff increases send the US market tumbling, his instinct is to respond by curbing the aggressive trade rhetoric and playing up the scope for an agreement. At least until the next time.

Beijing faces its own complications in managing the trade war, including the likelihood that it will run out of US trade to target before Washington faces the same constraint – a consequence of the current bilateral trade imbalance. This has left some analysts wondering whether China will look to other avenues to prosecute any future geo-economic tit-for-tat. Back when observers first started worrying about a possible US-China economic confrontation, a favourite candidate for Chinese action was Beijing’s large holdings of US government debt (anyone remember Larry Summers talking about a ‘balance of financial terror’ in the years before the global financial crisis?) That old theory has been taken out for a spin again over the past few weeks, although most analysts seem sceptical of its potential efficacy as a weapon for China.

As of March, China held about US$1.12 trillion of US government debt, making it the largest foreign holder of US government paper, ahead of Japan (with US$1.08 trillion), although its relative importance has been falling for several years now, with its share of total foreign holdings peaking back in 2011.

China's holdings of US Treasury securities

As noted last week, while the elements of a potential short-term compromise between Washington and Beijing are relatively straightforward to identify (if apparently much harder to negotiate, given 11 rounds of trade talks and counting), the longer-term prognosis remains troubling.

What happened:

Press reports indicated that the US administration was planning to defer a decision on whether to impose tariffs on imports of cars and car parts from the EU and Japan. Previously, President Trump had threatened to impose tariffs of up to 25 per cent on the grounds of national security, but Washington is now said to be considering giving Brussels and Tokyo 180 days to agree to a deal limiting or restricting imports into the United States.

Why it matters:

While the delay had still to be formally announced at the time of writing, it seems that Washington is deciding to focus on one trade war for now, rather than ramping up the conflict on other fronts. Unfortunately, the news is about a delay to the policy rather than a reversal. So, while President Trump may have avoided adding another straw to the camel’s back this week, this is only qualified good news for world trade and globalisation more generally.

What happened:

According to China’s National Bureau of Statistics, nominal retail sales grew at 7.2 per cent over the year to April. That was their slowest rate of increase in nearly 16 years and came in below consensus forecasts for growth closer to nine per cent. Growth in industrial production fell to 5.4 per cent in the same month, down from more than eight per cent in March and below market expectations for a 6.5 per cent print. And cumulative fixed asset investment also experienced a decline in the pace of growth, growing at an annual rate of 6.1 per cent over the first four months of the year compared to a 6.3 per cent result for the first quarter and a consensus forecast of 6.4 per cent.

Monthly activity indicators

Why it matters:

With three key data releases all coming in below expectations, April’s ‘data dump’ suggests that the impact of Beijing’s earlier efforts at stimulating the Chinese economy may have started to wane. And that’s before the impact of the latest round of US tariffs has been felt. That said, some China watchers have cautioned against reading too much into April’s numbers, pointing to several one-off factors that could have distorted the data, including the introduction of VAT cuts in April (which may have encouraged businesses to font-load purchases to March in order to benefit from higher input tax deductions) and longer public holidays from 1 – 4 May (which saw Beijing increase the number of working days in April and which may have seen consumer spending delayed until this month).

What I’ve been reading: articles and essays

ANZ’s bluenotes series on the appearance of green shoots in the Australian housing market. ANZ expects nationwide house prices to fall a further five per cent this year before stabilising in 2020.

According to CommSec’s latest ‘State of the States’ report, Victoria and NSW currently share the title of best performing state economy, with the ACT in joint third spot with Tasmania.

In previous editions of the Weekly I’ve noted the big drop in government bond yields and the rise in the value of debt carrying negative rates. There’s a nice Box in the RBA’s May Statement that reviews some of the reasons as to why long-term bond yields are so low: very low expectations about future central bank policy rates reflecting falls in estimates of the neutral rate; entrenched low inflationary expectations; and unusually low term premia are identified as the leading culprits.

I’ve also referred to the global economic policy uncertainty index a few times here in the Weekly and in some of my presentations. This Voxeu column argues that the sharp increase in policy uncertainty seen over the first quarter could be enough to trim up to half a percentage point from global growth this year. Blanchard and Summers ask whether the future of macroeconomic policy will be characterised by evolution or revolution. They reckon that the current economic conjuncture of low (neutral) interest rates, the re-emergence of fiscal policy as a tool for economic stabilisation, the difficulties central banks now face in hitting their inflation targets, and the financial ramifications of a low interest rate environment will prompt big changes in policy.

Related, Barry Eichengreen on the return of fiscal policy. Eichengreen starts from the apparently irreconcilable worldviews of Thomas Piketty’s r > g and Olivier Blanchard’s r < g before explaining that the two economists are talking about two different interest rates, separated by the risk premium. But his main point is the increasingly common refrain that in the future we will have to rely more on fiscal policy and less on monetary policy to deliver stable growth.

The FT’s Gideon Rachman with an interesting take on what he sees as the mirror-image positions of Beijing and Washington: Beijing seeks to transform the world’s strategic order and wants to retain the current international economic order to help it do so, while Washington wants to preserve the prevailing strategic order and to that end wants to revise the current economic order.

Conventional economic wisdom is that US consumers have borne the brunt of the current trade war, with higher tariffs on Chinese products largely passed through as increases in US prices. One estimate is that tariffs have reduced real incomes by about US$1.4 billion per month, while another study puts the projected decline in US real income at around US$7.8 billion per year. Tyler Cowen has a slightly different view. While he doesn’t dispute the view that tariffs have produced higher prices for US consumers, he thinks that in the longer run China might end up suffering larger costs than the United States via damage to its export and investment competitiveness relative to neighbouring economies.

The Economist on the brains behind Corbynomics. This piece canvasses ‘the assumption that Britain has once again become a political laboratory, as it was in 1979 when Thatcher began to transform the state.’ Since it turns out that a chunk of the funding for some of the left wing think tanks carrying out this work is coming from the Buffett family, the Economist helpfully points out that ‘the seed capital of modern British socialism is being indirectly provided by the godfather of American capitalism.’ Which would seem to make for an interesting start up proposition.

Finally, a list of the top 100 economics blogs of 2019 (found via Marginal Revolution, which is ranked in the number one spot for general economics blogs).

1 Yes, the Statement came out the week before last, but I did promise to cover it this week.

2 Readers may wonder how 2.4 per cent annual growth in both public and private sector wages can produce a 2.3 per cent headline rate. The answer, according to the ABS, is that the published index numbers are all rounded to one decimal place, and the percentage changes (themselves rounded to one decimal place) are calculated from those same rounded numbers. In some cases ‘this can result in the percentage change for the total level of a group of indexes being outside the range of the percentage changes for the component level indexes.’


The Economic Weekly (week starting 13 May 2019)

Despite much speculation to the contrary, the RBA decided to leave the cash rate unchanged after its 7 May meeting.

Australia’s retail trade in March was up 0.3 per cent over the month and 3.5 per cent over the year, but in volume terms growth in the March quarter overall was disappointing.

Australia recorded another big monthly trade surplus in March, contributing to a record result for the first quarter of this year.

The Australian dollar has been testing the US$0.70 ‘floor’ that has applied for the past couple of years.

Washington has threatened to impose additional tariffs on imports from China after complaining that Beijing was retreating from earlier commitments made in US-China trade negotiations.

What I’ve been following in Australia . . .

What happened:

The RBA left the cash rate unchanged at 1.5 per cent for a 30th consecutive meeting.

The central bank also flagged its forecasts for growth and inflation. The RBA now expects the Australian economy to grow by around 2.75 per cent in 2019 and 2020 under its central scenario. Unemployment is projected to remain around five per cent for the next year or so, before ‘declining a little’ to 4.75 per cent in 2021. And underlying inflation is expected to be 1.75 per cent this year, two per cent in 2020 and ‘a little higher’ after that, with headline inflation put at around two per cent this year.

Why it matters:

It’s been a long time since the run-up to an RBA Board meeting generated quite the amount of excitement that the 7 May meeting did. After all, the last time the central bank moved on interest rates was all the way back in August 2016, before the current governor was even appointed (in September that year). But as noted in the previous Weekly, the very low inflation outcome for the first quarter of this year had convinced RBA watchers that May’s meeting was a ‘live’ one.

In the event, the RBA stood still. Doing so was consistent with its view – expressed most recently in the minutes to the April meeting discussed (also discussed in the previous Weekly) – that it would need to see a deterioration in labour market conditions to trigger a rate cut.

What the RBA did do, however, was to move on the preconditions for a rate cut. The latest statement concedes that the ‘inflation data for the March quarter were noticeably lower than expected and suggest subdued inflationary pressures across much of the economy.’ And it then goes on to note that while the Board judged it was appropriate to leave policy unchanged in May, ‘it recognised that there was still spare capacity in the economy and that a further improvement in the labour market was likely to be needed for inflation to be consistent with the target’. That suggests that while labour market developments will continue to be critical in determining the RBA’s next move, the bar for a future rate cut has now been lowered: whereas before the RBA reckoned that a deterioration in the labour market was a precondition for a change in policy, it now appears to be signalling that the absence of a continued improvement in conditions will be a sufficient trigger.

The RBA also outlined its forecasts ahead of the release of the Statement on Monetary Policy on 10 May. Back in February’s Statement, the RBA reckoned that underlying inflation (as measured by the trimmed mean) would end 2019 at two per cent and rise to 2.25 per cent by December 2020. The new numbers seem to imply a weaker trajectory. Moreover, despite highlighting the need for an improvement in the labour market to keep inflation in line with the RBA’s target, the forecasts suggest that unemployment will remain unchanged this year and ease only slightly by 2021. Several commentators have highlighted this apparent inconsistency, and it will be interesting to see whether the upcoming May Statement brings a bit more clarity.1

The RBA’s decision may also prompt another round of discussions as to the appropriateness of the current monetary policy framework. Over the past quarter century or so, it’s fair to say that inflation targeting has served Australia well relative to previous monetary regimes. But the current bout of lowflation – which has left inflation below target for a prolonged period – arguably poses a growing challenge to the regime’s credibility (a problem that is not just restricted to Australia and the RBA, but which also applies to other inflation targeting central banks). One option that has been canvassed is a change to the inflation target itself (it’s possible to find advocates for both higher and lower inflation targets in this debate), while another is a shift to a different regime, such as nominal income targeting. No such change is likely to be imminent, but the longer inflation remains below target, the more pointed such debates are likely to become.

What happened:

Retail trade rose 0.3 per cent in March (seasonally adjusted) and was up 3.5 per cent over the year. That was slightly better than consensus expectations for a 0.2 per cent monthly rise.

Retail trade

Retail trade volumes for the March quarter were down 0.1 per cent, following a flat result in the December quarter, and up only 1.1 per cent over the year.

Retail trade volumes

Why it matters:

While the monthly outcome for March may have been slightly better than consensus expectations, the weak quarterly volume number received the lion’s share of attention, implying as it does another muted contribution from household consumption to the upcoming March quarter GDP. That would follow on from a soft Q4:2018 reading and would therefore be consistent with a continuation of the story of weak growth in disposable income constraining household spending.

What happened:

Australia recorded a $4.9 billion trade surplus in March, following on from a (revised) record $5.1 billion surplus in February. That implies an impressive cumulative total trade surplus of $14.7 billion for the first quarter of this year (or closer to $14.2 billion once quarterly seasonal adjustments have been applied).

Trade balance

Exports fell two per cent over the month (largely driven by a big drop in non-monetary gold but also reflecting a decline in iron ore exports due to weather-related disruption) while imports dropped by one per cent. In annual terms, exports rose by almost 12 per cent relative to March 2018 while import growth was closer to one per cent.

Why it matters:

Australia continues to enjoy a strong international trade performance, with the preliminary estimate of a Q1:2019 trade surplus of more than $14 billion representing a marked increase on what was already a sizeable surplus in the final quarter of last year. That also suggests we should expect a decent contribution from net exports to first quarter GDP growth. While the overall story may be positive, however, the detail around the monthly drop in imports is rather less welcome, with the fall in imports of consumption goods (down more than three per cent over the month and one per cent over the year) providing another indicator of continued weakness in domestic demand.

What happened:

Over the past week or so, the Australian dollar has been pushing below US$0.70, which has served as something of a floor to the exchange rate since January 2016.

AUD - US dollar exchange rate

Why it matters:

There’s a strong case to be made that Australia’s flexible exchange rate has been one of the key contributors to our current run of recession-free growth (now at 110 quarters and counting). By acting as a shock absorber, movements in the dollar have helped offset a series of major economic shocks. During the resources boom, for example, a sustained real exchange rate appreciation helped the economy avoid overheating and a potentially destabilising inflationary outbreak. Then, once commodity prices had started falling, a real depreciation boosted the relative competitiveness of the Australian non-resource export sector and provided a new source of growth.2

Exchange rate and the terms of trade

In many ways, we might expect the current period to be another one of real depreciation (and as the chart above shows, to some extent that has indeed been the case). But it’s also true that the Australian dollar has been subject to several offsetting forces over the past year.

So, on the one hand, a widening interest rate differential with the United States, market expectations of additional RBA cuts to the cash rate (which would make the current rate gap even larger), soft economic growth readings, falling house prices and on again, off again fears about US-China trade wars would all be expected to place the currency under downward pressure.

RBA cash rate vs Funds rate

On the other hand, there are several forces that have been pushing in the opposite direction. High commodity prices and hence relatively robust terms of trade, for example.

The dollar and commodity prices

Likewise, a series of sizeable trade surpluses have contributed to a marked narrowing of the current account deficit and a consequent decline in the need for external financing that should, all else equal, imply a stronger exchange rate.

Current account balance Australia

These two sets of offsetting factors have meant that the slide in the Australian dollar that began around February 2018 lost momentum towards the end of last year. If that earlier downward move were to now resume, that would be helpful for the economy (and the RBA) on two fronts.

First, a lower dollar would offer additional support both to exports and to overall growth. In the past, the RBA has estimated that a ten per cent depreciation in the real exchange rate works to increase export volumes by around three per cent and to decrease import volumes by about four per cent, together implying a cumulative boost to GDP of around 1.5 percentage points over a two year period. Exports of manufactures and services would benefit the most, while resource exports would receive a smaller lift and rural exports would be largely unaffected.

Second, a weaker dollar would also inject some life into tradables inflation by boosting the price of imports and hence help move headline inflation closer to the RBA’s inflation target.

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

What happened:

After a period of optimism about the outcome of US-China trade talks, the mood soured again this week. On 5 May, President Trump tweeted that the United States would not only implement its postponed increase in tariffs from 10 per cent to 25 per cent on US$200 billion of Chinese imports on Friday 10 May, but that he would also consider imposing 25 per cent tariffs on the remaining US$325 billion of Chinese imports. Trump’s intervention was followed the next day by more formal comments from US trade representative Robert Lighthizer and US Treasury secretary Steve Mnuchin confirming that Washington was indeed planning to implement the proposed tariff hike from ten to 25 per cent, with Mr Lighthizer describing China as ‘reneging on prior commitments.’ (See this Reuters piece for details on China’s supposed change in approach, which reportedly included revisions to its position on intellectual property, technology transfers, competition policy, access to financial services, and currency manipulation). For its part, Beijing has threatened to retaliate with ‘necessary countermeasures’ if US tariff increases go ahead.

Why it matters:

Over the past few weeks, markets had become increasingly confident that Beijing and Washington were close to reaching an agreement over their long-running trade dispute. The abrupt shift in tone has undermined that complacency and sent global economy watchers back to worrying about trade wars.

In fact, it’s always been quite hard to see a good outcome to this. First, as noted here before, it’s difficult to see a lasting resolution to what appear to be the fundamental issues between China and the United States. Sure, it should in theory be possible to stitch together a deal whereby China agrees to buy more US goods and services, tightens domestic rules on intellectual property and allows increased investment that would collectively be enough for President Trump to declare a victory. And that’s pretty much what markets have been assuming will happen. But to the extent that what Washington is really targeting is the Chinese growth model itself, along with China’s geo-economic rise more broadly, it’s much harder to envision a permanent solution. In that context, and absent a very big shift in position in one or both capitals, the best that we can hope for is a short-term agreement that delivers what would basically be a temporary ceasefire.

Granted, that would still deliver some short-term upside by reducing the trade policy uncertainty currently roiling financial markets. Yet even that kind of deal would arguably be problematic for the overall health of the global trading system, since it would indicate that two of the world’s major trading powers were now choosing to settle trade issues outside of the multilateral system, even to the extent of creating new (extra-WTO) monitoring and enforcement mechanisms.

Finally, it's worth noting that if the United States did choose to implement both sets of threatened new tariffs, economists at Deutsche Bank have calculated that this would take the average US tariff rate up to 7.5 per cent. That would make the United States an outlier across developed economies in terms of the level of applied trade protection, leaving it with tariff barriers higher than those that now apply in many emerging and developing economies.

What I’ve been reading: articles and essays

From August last year, the RBA’S Guy Debelle describes some of the factors behind low inflation (in fact, the headline rate was – unusually for recent years – just above the bottom of the RBA’s target band at the time of his speech). Rather than looking at macro drivers, Debelle looks at changing price dynamics at a more disaggregated level. He highlights competition in the retail sector, the impact of technological change on the prices of audio, visual and computing equipment (adjusted for quality change), historically low increases in rents, low wage growth and slower growth in some administered prices as key drivers of recent low inflation outcomes.

Also from last year, Warwick McKibbin and Augustus Panton from the ANU’s Centre of Applied Macroeconomic Analysis (CAMA) provide an evaluation of the RBA’s inflation targeting regime, which has served as the framework for Australian monetary policy since around 1993. They conclude that the ‘flexible inflation targeting regime followed by the RBA has clearly outperformed the alternative monetary frameworks . . . that had been implemented in earlier decades’ but argue that a change to a nominal income growth targeting framework may be warranted. In their view, supply shocks in the form of climate policy, climate shocks, technological disruption and structural change in the global economy are likely to become more important in the future, and this shift will increase the case for a change in monetary policy regime.

The FT’s Martin Wolf looks at how our low inflation world was made. He divides the last two decades into two periods: ‘pre-crisis secular stagnation’ characterised by low and falling real interest rates and destabilising property and credit bubbles; and ‘post-crisis secular stagnation’ characterised by near-zero real interest rates, partial deleveraging, weak growth and pervasive populist policies.

A new IMF working paper examines the vulnerability of Asian corporates to any tightening in global financial conditions. The authors find that higher global interest rates and home currency depreciation increase the probability of default, with a 30 per cent currency depreciation associated with a two-notch downgrade in the corporate credit rating.

The Conference Board has released its latest estimates of global productivity growth. It calculates that global growth in output per worker was 1.9 per cent in 2018, compared to two per cent in 2017. That means that the trend decline in global productivity growth – which had slowed from an average annual rate of 2.9 per cent between 2000 and 2007 to 2.3 per cent between 2010 and 2017 – has continued. The Conference Board notes that the ‘long-awaited productivity effects from digital transformation are still too small to see reflected in a lasting improvement at the macroeconomic level.’ The Board also released productivity estimates for 123 countries, including Australia, where growth in GDP per person employed is estimated to have fallen from 1.4 per cent over 2000-07 to 1.1 per cent over 2010-2017 and to 0.8 per cent last year (up from no change in 2017). GDP per hour worked in Australia is estimated to have been about 82 per cent of US levels in 2018, putting us 15th out of the 40 so-called ‘mature economies’ ranked.3 

Harold James on why historians may be more dangerous than economists. After the global financial crisis, ‘the sheer depth of political and economic uncertainty turned historians into pundits whose critiques of conventional social science are overly biased toward random pet narratives.’

Peter Egger and Katharina Erhardt propose that traditional trade models may severely underestimate the impact of recent tariff increases.

Tyler Cowen argues that ‘the basic view that big business is pulling the strings in Washington is one of the major myths of our time.’ Cowen reckons that ‘there is plenty of crony capitalism in the United States today’, but emphasises that across a range of areas what the US government is actually delivering is quite different from what US corporate leaders would prefer to see.

Finally, I haven’t had a chance to dig into any of the contents yet, but the latest edition of the Journal of Economic Perspectives includes a symposia on automation and employment and a series of essays on fiscal policy that are now on my ‘should read’ list.

1 The plan is to look at the May Statement in the next Weekly.

2 Bilateral exchange rates (such as the exchange rate between the Australian and US dollars) are the most commonly quoted exchange rates. The RBA also constructs a trade-weighted index (TWI) which captures the price of the Australian dollar in terms of a weighted average of the currencies of our major trading partners. Real exchange rates account for differences in price movements across countries. The real TWI, for example, is the (nominal) TWI multiplied by the ratio of Australian prices to prices in our trading partners. Real exchange rates are typically seen as a better measure of competitiveness than nominal exchange rates and are driven by the combined impact of changes in nominal exchange rates and changes in relative rates of inflation. In the case of Australia, changes in the nominal rate tend to be a major driver of changes in the real rate. There’s a good RBA explainer available.

3 The Conference Board data on cross-country productivity are based on purchasing power parity (PPP) conversions. That has implications for the estimated level of productivity (for example, it means that the Conference Board’s number for the level of Australian productivity is lower than that implied by ABS statistics. Other methodological differences (e.g. in measuring capital and labour inputs) mean that there are also differences between these growth estimates and those produced by the ABS.


The Economic Weekly (week starting 6 May 2019)

As this is the first Weekly following a short break, it looks back at a few key data releases from the holiday period.

The latest set of RBA minutes reported that members did not see a strong case for a near-term adjustment in monetary policy, viewed inflation as ‘likely to remain low for some time’ and agreed that a trend rise in unemployment would warrant a cut in the cash rate.

Australia’s unemployment rate ticked back up to five per cent in March from 4.9 per cent in February, but employment increased by almost 26,000 persons over the month.

Australia’s consumer price index (CPI) in March was unchanged over the previous quarter and up just 1.3 per cent over the year. The surprisingly weak reading prompted a jump in market (and economist) expectations for a cut to the cash rate on 7 May.

Australian house prices fell again in April, although the pace of decline continues to ease.

First quarter GDP readings from China, the United States and the euro area were all somewhat stronger than had been expected.

The US Federal Reserve left rates unchanged at its May meeting and – despite some public encouragement from President Trump to loosen policy – signalled that no change to its current stance was imminent.

What I’ve been following in Australia . . .

What happened:

The RBA published the minutes for the 2 April monetary policy meeting.

Members saw the ‘central scenario was for further gradual progress to be made on both unemployment and inflation . . . [and] agreed that there was not a strong case for a near-term adjustment in monetary policy.’ In addition, they ‘agreed that inflation was likely to remain low for some time . . . In these circumstances, members agreed that the likelihood of a scenario where the cash rate would need to be increased in the near term was low.’

They also ‘discussed the scenario where inflation did not move any higher and unemployment trended up, noting that a decrease in the cash rate would likely be appropriate in these circumstances.’

Finally, the minutes reported an interesting discussion on funding availability for Australian businesses. For larger enterprises, the conclusion was that conditions were ‘accommodative’, with three-year corporate bond yields at record lows and ‘robust’ bank lending to (large) businesses. At the same time, however, ‘credit conditions for some small businesses were reported to have tightened further.’

Why it matters:

The RBA’s messaging continues to be broadly consistent with its previous commentary, with a bias towards no near-term shift in the policy stance combined with a recognition that any significant deterioration in labour market conditions would nevertheless be likely to warrant a cut in the cash rate. The RBA also signalled that it seems to be reconciled to a sustained period of low inflation, and that this alone is unlikely to be enough to trigger a policy response. That said, the discussion was centred around a situation in which ‘inflation did not move any higher’, which arguably left scope for any shift to an even lower inflation profile to change the picture (on which more below).

The minutes also touched on the debate as to the likely efficacy of any additional cuts to the cash rate given that the latter is already at a record low. Here, the view was cautiously optimistic, as although members accepted ‘that the effect on the economy of lower interest rates could be expected to be smaller than in the past, given the high level of household debt and the adjustment that was occurring in housing markets’, they also judged that ‘a lower level of interest rates could still be expected to support the economy through a depreciation of the exchange rate and by reducing required interest payments on borrowing, freeing up cash for other expenditure.’ Related, members noted that ‘the major banks’ funding costs had declined over the preceding couple of months’, which, all else equal, should increase the scope for banks to pass on a greater share of any cut to the policy rate. That said, it’s also worth remembering that the impact from any rate cut now would also have to push against the current tightening in lending standards.

What happened:

Monthly employment increased by 25,700 persons (seasonally adjusted basis) in March, according to the ABS. Full-time employment increased by 48,300 while part-time employment fell 22,600.

Change in employment

The total gain was significantly greater than consensus expectations for a 15,000 increase in employment. There was also a sizeable upward revision to the February employment numbers, with the estimated increase up to 10,700 from the previous estimate of 4,600.

The unemployment rate rose to five per cent in March, up from 4.9 per cent in February. With the underemployment rate also increasing (to 8.2 per cent from 8.1 per cent), the underutilisation rate climbed to 13.2 per cent.

Unemployment and underemployment

The participation rate increased by 0.1 percentage points to 65.7 per cent and remains close to recent highs, while the employment to population ratio remained unchanged at 62.3 per cent.

Participation rate

Why it matters:

As flagged in the most recent set of RBA minutes, labour market developments are a critical input into the central bank’s thinking on interest rates. In that regard, there was nothing in the March data to advance the case for an imminent rate cut: the unemployment rate continues to hover around the five per cent mark, the economy is still adding jobs at a decent rate, and the participation rate remains high. The main negative signal relates to the high rate of underemployment, which means that the overall underutilisation rate also remains disappointingly high. In turn, that elevated level of labour market slack continues to act as a dampener on wage growth and hence overall inflation.

What happened:

The consumer price index (CPI) recorded no quarterly increase in March (seasonally unadjusted) and was up just 1.3 per cent over the year. Price falls for automotive fuel (down 8.7 per cent due to falls in world oil prices back at the start of this year), domestic holiday, travel and accommodation (down 3.8 per cent) and international holiday, travel and accommodation (down 2.1 per cent) were particularly large over the quarter, offsetting increases in vegetables (up 7.7 per cent), secondary education (up 4.2 per cent), motor vehicles (up 2.4 per cent) and hospital services (up 1.3 per cent).

Consumer prices

Measures of underlying or core inflation were similarly subdued, with the trimmed mean recording a 1.6 per cent increase over the year and the weighted median up 1.2 per cent over the same period1. The average of the two measures was just 1.4 per cent.

Underlying inflation

Why it matters:

March’s inflation print was much weaker than expectations. Consensus forecasts had expected a headline rate of 0.2 per cent over the quarter and 1.5 per cent over the year. Likewise, expectations for core inflation (consensus expected the trimmed mean to be up 1.7 per cent over the year and the weighted median up 1.6 per cent) were also disappointed. With a couple of brief exceptions (in March 2017 and June 2018), the headline inflation has now been stuck below the bottom of the RBA’s target band since December 2014, leaving Australia mired in a period of ‘lowflation.’

The market reaction to all of this has been to bring forward its expectations for a cut in the cash rate. The proposition here is that, although the March labour market results described above may on their own be inconsistent with the RBA’s view that a marked deterioration in unemployment is a necessary precondition for a change in its policy stance, a fall in Australia’s already-subdued inflation profile might be enough to tip the balance. As a result, at the time of writing, market pricing was indicating a decent (roughly 40 per cent) chance of a rate cut at the RBA’s meeting on 7 May.

Policy rates

What happened:

April saw Australian national dwelling values fall by 0.5 per cent over the month and drop by 7.2 per cent over the year. According to CoreLogic, that’s the largest annual fall since February 2009, during the global financial crisis. Nationwide, values are now 7.9 per cent down from their September 2017 peak.

Home value index

Sydney dwelling values were down 10.9 per cent over the year to April, Melbourne values were down ten per cent, Perth down 8.3 per cent, Darwin down 7.1 per cent and Brisbane down 1.9 per cent. Only in Adelaide (+0.3 per cent), Canberra (+2.5 per cent) and Hobart (+3.8 per cent) were values still above their April 2018 levels. On a monthly basis, prices fell across every capital city with the sole exception of Canberra.

Why it matters:

Dwelling values continue to fall, dragging down housing wealth and undermining the health of household balance sheets. Moreover, the geographic scope of that fall appears to be widening. Offsetting that, the pace of decline continues to slow. Since peaking at 1.3 per cent in December last year, the monthly rate of decline in prices across Australia’s capital cities has now eased for four consecutive months.

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

What happened:

First quarter 2019 GDP readings for the ‘big three’ of China, the United States and the euro area all beat expectations.

In the case of China, GDP growth rose at an annual rate of 6.4 per cent in Q1:2019, unchanged from the final quarter of last year and a bit ahead of market expectations for a 6.3 per cent result.

Real GDP growth

Growth in the United States rose by 3.2 per cent (at a seasonally adjusted annualised rate) in the first quarter of this year. That both comfortably beat market expectations for a 2.3 per cent print and represented a substantial increase from the Q4:2018 result of 2.2 per cent.

US Real GDP growth

Finally, real GDP in the euro area in March rose by 0.4 per cent over the previous quarter and was up 1.2 per cent over the year. Again, that beat market expectations of a 0.3 per cent quarterly increase and a 1.1 per cent annual rise.

Euro Real GDP growth

Digging into the aggregate numbers shows that, following two consecutive quarters of negative growth, the Italian economy has moved out of technical recession with GDP up 0.2 per cent over the quarter. France saw real GDP expand 0.3 per cent and Spain by 0.7 per cent over the same period. (German GDP data has not yet been released, but the overall euro area result implies a better outcome than the flat result in Q4 last year which, following on from a contraction in the third quarter, saw Europe’s largest economy narrowly avoid falling into a technical recession.)

Why it matters:

One key theme for the start of this year was that the global economy had entered a soft patch in the second half of 2018 and that this had been sustained into 2019. As noted in previous editions of the Weekly, that in turn has seen a series of international forecasters including the IMF, OECD and the ECB trim their growth forecasts for this year. Given that context, the fact that first quarter GDP outcomes beat expectations across three major economies (albeit with only the US result significantly surprising on the upside) is certainly welcome news. That said, the devil is in the details.

In the case of China, for example, although the first quarter result did surpass market expectations, it still marked the (joint) lowest growth outcome since March 2009, during the depths of the global financial crisis. On the upside, March results for industrial production and retail sales also exceeded expectations alongside GDP growth. But April’s survey results for manufacturing (both the official purchasing managers index and the private Caixin survey) fell back slightly from their previous month’s results, serving to dampen some of the optimism generated by the earlier March readings.

Turning to the United States, there is no doubt that the GDP result was a strong outcome, especially given a backdrop of soft data from the start of the year, a (temporary) inversion of the US treasury yield curve, and the uncertainty caused by ongoing trade disputes with Beijing and Brussels. Even so, some of the details serve to qualify the headline number. A significant part of the strong growth result represented a substantial build-up in inventories, for example, which looks vulnerable to reversal later in the year. At the same time, the US domestic demand story was relatively weak, with soft growth in personal consumption. And markets have also been focussed on another set of weak inflation data (see below).

Meanwhile, other US data continue to paint a similarly mixed picture: for example, according to the Institute for Supply Management (ISM), the US manufacturing sector grew at its slowest pace in more than two years in April. On the other hand, numbers from payroll processor ADP showed US private employers adding 275,000 jobs in the same month, marking the biggest monthly increase since July 2018.

Finally, in the case of the euro area, the decent quarterly GDP result stands in marked contrast to a series of disappointing survey results over past couple of months. Most recently, for example, economic sentiment in April slipped to its lowest level in more than two years while industrial confidence in the same month dropped to a five-year low, suggesting that the euro area economy may not be out of the woods yet.

What happened:

The US Federal Reserve left the target range for the fed funds rate unchanged at 2.25-2.5 per cent after its 1 May meeting. According to the accompanying statement, the Federal Open Market Committee (FOMC) ‘continues to view sustained expansion of economic activity, strong labour market conditions, and inflation near the Committee’s symmetric two per cent objective as the most likely outcomes.’ And once again, the FOMC stressed that it will be ‘patient’ in assessing any future adjustment to policy, with Chairman Jay Powell saying that he saw no immediate need to move rates in either direction.

The FOMC also announced ‘a small technical adjustment’ to the rate of interest paid on required and excess reserve balances.

Why it matters:

While the Fed had been expected to leave rates unchanged this month, financial markets have been betting that the central bank will still be forced to ease policy at some stage this year. Despite the strong Q1 GDP number discussed above, that view was reinforced by another weak inflation reading last month which saw the Fred’s preferred measure of inflation – the core personal consumption expenditures (PCE) price index – rise at just 1.6 per cent over the year in March, down from 1.7 per cent in February. That was the slowest rate of increase since January 2018 and once again left inflation below the Fed’s two per cent target.

US inflation

With President Trump also putting the Fed under an unusual amount of public pressure in recent weeks to cut rates and restart quantitative easing, Fed watchers had been looking for any sign this month that the central bank was starting to move away from its ‘patient’ approach. No such sign was forthcoming, however, with the FOMC statement pointing out that ‘economic activity rose at a solid rate’ since the last meeting. The closest the text came to flagging any change in position was an acknowledgment that ‘overall inflation and inflation for items other than food and energy have declined and are running below two per cent.’ The RBA is not alone in struggling with lowflation.

What I’ve been reading: articles and essays

The Grattan Institute’s Commonwealth Orange Book, which sets out their suggested policy priorities for the winner of the upcoming Federal Election, including a scorecard (pdf) showing how Australia rates against a set of its peers across metrics including energy, health, education, economic development and budget policy. There are too many proposals to summarise here, but as a flavour, the recommendations on tax include: reducing the capital gains tax discount to 25 per cent, limiting negative gearing, increasing the tax on super earnings in the pension phase to 15 per cent, broadening the GST base and/or increasing the rate, introducing investment allowances or accelerated depreciation on new investment to lower effective company tax rates, and encouraging the states to replace stamp duties with general property taxes.

The ABS’s updated historical statistics on Australia’s population. Compared with the situation at Federation in 1901, Australians today are older2 (the median age has increased from 22 to 37 and the share of the population aged 65 or over has risen from four per cent to 15 per cent), more urban (in 1901 just one in three Australians lived in capital cities, now it is two in three), have fewer children (the fertility rate has fallen from an average of 3.1 babies per woman in 1921 to 1.8 babies today), more likely to be female (the ratio of men to women has fallen from 110:100 to 100:98), and can expect to live longer (life expectancy at birth has increased by around 25 years for males and 26 years for females).

An FT Big Read on Why America is learning to love budget deficits. The Congressional Budget Office’s latest outlook sees US deficits averaging around 4.4 per cent of GDP over 2020-29. That’s well above the past 50-year average of 2.9 per cent of GDP and, if realised, would put US public debt on a trajectory that would eventually see it exceed the record levels set in the immediate aftermath of World War Two. The piece argues that ‘the trend towards looser fiscal policy led by the US marks potentially the greatest change in economic policymaking for a generation.’

Related, and also from the FT, Gavyn Davies on What you need to know about modern monetary theory (MMT). There’s been a spate of pieces on MMT recently, many of them involving prominent US economists dismissing the approach. (I also linked to a similar style piece by Adair Turner a couple of issues ago.) Davies is broadly sympathetic to these mainstream critiques, saying that he tends to agree with the description of MMT as ‘a questionable extension, made by fringe economists, of a doctrine that may be partially true, but only in extreme circumstances.’ But he also concedes that some of MMT’s insights can be relevant to modern economies under certain circumstances.

Uri Dadush and Guntram Wolf think about what life after the multilateral trading system might look like. In their view, it will be a world of power, bilateral agreements and (unenforceable) norms dating back to the era when the WTO still mattered. The power in this world will rest with the big three of the US, EU and China, with smaller nations finding themselves pushed into asymmetric bilateral deals with what are likely to become three major trading blocs.

Daron Acemoglu (among other things, co-author of Why Nations Fail, a paean to the importance of economic and political institutions that is worth a look if you haven’t already come across it) argues that the top priority for policymakers should be creating high-wage jobs, and that this should ‘guide policymakers’ approach to everything from technology, regulation and taxes to education and social programs.’

Indermit Gill at the Brookings Institution suggests that ‘the world’s economic geography is changing in disconcerting ways’. He offers three interesting examples: the southward shift of economic power in India; regional dislocation in the US and UK prompting the rise of ‘Anglo-American populism’; and the expansion of China’s external reach.

Finally, I couldn’t find a transcript for this one, but here’s a video of Ken Rogoff’s recent speech to the G30 asking, Is this the beginning of the end of central bank independence? This makes for interesting viewing in the context of the discussion above on Australian and US inflation. Rogoff argues that central banks around the world are now facing a rising challenge to their independence, due to a combination of sometimes sticking to their inflation targets too rigidly, sometimes taking undeserved credit for good outcomes, the current lack of inflation (in this environment it’s quite a bit harder than it used to be to argue that any erosion in independence will jeopardise price stability), and an apparent lack of effective tools for delivering stimulus when interest rates are approaching the zero bound.

What I’ve been reading: books (NB. This was holiday reading so ymmv even more than usual)

Europe at Dawn, the fourth (and I think final?) volume in Dave Hutchinson’s quite excellent Fractured Europe series.

Holy Sister, the concluding volume in Mark Lawrence’s Book of the Ancestor series. Fun beach reading and a satisfying end to an entertaining trilogy.

The Uninhabitable Earth by David Wallace-Wells. Intentionally apocalyptic.

1 The idea here is that the headline CPI is subject to a degree of short-term volatility (fruit and vegetable prices or fuel prices can move substantially in the short-term due to changes in supply conditions [for example, the 400 per cent rise in banana prices that occurred in mid-2006 due to Cyclone Larry]; a change in tax rates can have a large one-off impact; and changes in administered prices and government policies – such as the introduction of the childcare rebate in 2007 – can also influence the headline rate) that can make it hard to interpret the economic content of quarterly movements in measured inflation. Hence the RBA also looks at several measures of underlying inflation which are designed to be less influenced by short-term volatility. These measures include ‘exclusion-based measures’ (such as the CPI excluding volatile items) and ‘statistical measures’ (such as the trimmed mean and weighted median). The former approach excludes the volatile items of fruit, vegetables and fuel; the latter use statistical adjustments. The trimmed mean is the weighted mean of the central 70 per cent of the quarterly price change distribution of all CPI components; that is, the top and bottom 15 per cent of the distribution are trimmed. Hence it excludes extreme movements in any expenditure class. The weighted median is the inflation rate for that expenditure class which is in the middle of the total distribution of price changes; that is, it trims away all but the midpoint of the distribution so that half the component weights are on one side of the median, and half on the other. It can therefore also be thought of as a 50 per cent trimmed mean. See this explanation from the RBA and for a more recent update on the statistical measures, this helpful overview from the ABS.

2 As of 2016.


The Economic Weekly (week ending 12 April 2019)

Since I spent last week on the road in Queensland, this will be a shorter Weekly than usual. And as I’m just about to head off once more – this time for leave – the Weekly will now be on hiatus for a little while before returning in May.

(As a quick aside: many thanks to the AICD members and guests who gave up their time to come and listen to my presentations – and put up with a lot of PPT slides – over the past week, as well as to the AICD team who pulled the trip together. And, of course, thanks to all of you who have been reading my stuff over the past two months as I’ve been settling in to my new role here and to my AICD colleagues who have been turning my scribblings into publishable content.)

What I’ve been following in Australia . . .

What happened:

According to the ABS, lending to households rose 2.6 per cent in February (seasonally adjusted) over the previous month but was down more than 15 per cent over the year. Lending to households for dwellings (excluding refinancing) rose by 2.7 per cent in February in what was the first monthly increase since July last year, although it was still down more than 18 per cent over February 2018. Lending to both owner-occupiers and investors was up over the month.

Lending to households for dwellings

Why it matters:

While lending for housing was still down sharply over the past year, the small upward bounce in the monthly numbers – together with the declining pace in the fall of house prices noted in the previous Weekly – may indicate that the housing market correction is starting to moderate. Still too soon to tell, of course. But just possibly, some straws in the wind?

What happened:

The Westpac-Melbourne Institute Index of Consumer Sentiment (pdf) rose 1.9 per cent to 100.7 in April.

Westpac-Melbourne Consumer Sentiment Index

Why it matters:

April’s survey was conducted over 1 – 5 April and that timing meant that it captured consumer reactions to the Federal Budget. The latter appears to have had a positive impact on confidence: sentiment among those surveyed post-Budget was 7.7 per cent higher than for those surveyed before the budget. According to Westpac, that’s ‘the most positive turnaround since we began tracking pre and post Budget responses in 2011.’

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

What happened:

The IMF released its April 2019 World Economic Outlook (WEO), describing the global economy as at a ‘delicate moment.’

The Fund has trimmed its growth forecast for this year from the 3.5 per cent it had been expecting in January (and the 3.7 per cent forecast last October) to a more modest 3.3 per cent, while leaving the forecast for 2020 unchanged at 3.6 per cent1. Growth in the advanced economies collectively is now expected to run at 1.8 per cent this year (down from a two per cent growth forecast in January) while growth forecasts for emerging and developing economies have been trimmed by 0.1 percentage points in 2019 and 2020. On a more positive note, the Fund thinks that global growth should stabilise over the first half of this year before staging a gradual recovery over the second half of 2019.

Real GDP growth 2000-2024F

For Australia, the IMF now expects our economy to grow by just 2.1 per cent his year before expanding at 2.8 per cent in 2020. That 2019 projection represents a sizable downgrade from the October 2018 WEO, which had expected the Australian economy to grow by 2.8 per cent in 2019.

Elsewhere, notable downgrades for forecast real GDP growth in 2019 across the developed world include Germany (down 0.5 percentage points to 0.8 per cent), Italy (also down 0.5 percentage points to just 0.1 per cent), Canada (down 0.4 percentage points to 1.5 per cent) and the UK (down 0.3 percentage points to 1.2 per cent). The growth forecast for the United States saw a more modest downgrade of 0.2 percentage points to 2.3 per cent growth. In emerging economies, there were sizeable downgrades to growth forecasts for Mexico (down 0.5 percentage points) and Brazil (down 0.4 percentage points).

The Fund also cut its forecast for world trade growth, with trade volumes now expected to grow by 3.3 per cent this year, down 0.6 percentage points from its January forecast.

Why it matters:

IMF forecasts are arguably the closest we come to an ‘official’ view of global economic prospects, and as such are a useful gauge of current conditions. One theme of the Weekly over the past month or so has been the soft start to the year for the global economy, and the downgrades to the Fund’s growth expectations reflect this. While the IMF’s base case is for global growth to improve as 2019 progresses, it is also clear that the Fund reckons that the balance of risks ‘remains skewed to the downside’, highlighting: trade tensions; downside risks in systemic economies; financial vulnerabilities; and medium- and long-term risks including ‘pervasive effects of climate change and a decline in trust with regard to establishment institutions and political parties.’

What happened:

US President Trump warned that he was considering imposing tariffs on US$11 billion of EU products in retaliation for Brussels’ subsidies to Airbus. For its part, Brussels said it was seeking punitive tariffs on US$12 billion of US exports in response to US policy support for Boeing.

Why it matters:

While US-China trade talks tend to get most of the headlines, we’ve noted before in the Weekly that trade tensions between Washington and Brussels are another important feature of the contemporary global trade landscape. The current Airbus-Boeing fracas dates all the way back to disputes in the WTO in 2004, but tensions have been rising more recently after the US administration extended tariffs on steel and aluminium to the EU in June last year, prompting retaliatory measures from Brussels. The US has also threatened to impose tariffs on European automotive imports. One possibility worrying trade analysts is that any resolution of the current dispute between Washington and Beijing could be followed quickly by an intensification of US-EU trade disputes.

What happened:

The US Federal Reserve released the minutes from the March 2019 meeting of the Federal Open Market Committee (FOMC). The report of the discussions noted that ‘With regard to the outlook for monetary policy beyond this meeting, a majority of participants expected that the evolution of the economic outlook and risks to the outlook would likely warrant leaving the target range unchanged for the remainder of the year.’ But there was also something of a warning shot for markets, with the follow up statement that: ‘Several participants noted that their views of the appropriate target range for the federal funds rate could shift in either direction based on incoming data and other developments. Some participants indicated that if the economy evolved as they currently expected, with economic growth above its longer-run trend rate, they would likely judge it appropriate to raise the target range for the federal funds rate modestly later this year.’

Why it matters:

In past issues of the Weekly we’ve discussed the marked swing in the Fed’s stance towards monetary policy since the turn of the year. We’ve also noted that financial markets have been increasingly inclined to anticipate a forthcoming rate cut. While the minutes do little to change the assessment of a Fed that is considerably more cautious in its views of the economy than it was in 2018, they also show that the FOMC is keen to remind markets that they may have been getting slightly ahead of themselves with their expectation of a looming rate cut.

What happened:

The European Central Bank (ECB) promised that it would leave official rates unchanged ‘at least though the end of 2019, and in any case for as long as necessary’. In his press conference, ECB president Mario Draghi gave strong hints that further policy stimulus might be on the way later this year, if the ECB does not see a pick up in euro area activity.

Why it matters:

Europe in general and the euro area in particular has been a prominent contributor to the soft global growth conditions highlighted by the latest IMF forecasts, with sluggish underlying growth exacerbated by what Draghi has previously described as ‘continued weakness and pervasive uncertainty’, with the latter reflecting what might be described as ‘known unknowns’ including Brexit and US trade policy. Mindful of the downside risks, the ECB has previously announced that it would launch new measures (in the form of targeted longer-term refinancing operations, or TLTROs) this September to try and provide additional support to the sagging European economy, and Draghi – who will step down from his current role in October – is keen to emphasise that the central bank remains ready to respond to any further signs of weakness.

What I’ve been reading: articles and essays

RBA Deputy Governor Guy Debelle gave a speech on the state of the economy. Debelle covers some familiar ground, highlighting a couple of key disconnects across the economy. The first of these is the contrast between household consumption growth, which has been much weaker than the RBA had previously anticipated, and the rest of the economy, where things have played out largely as the central bank expected. Debelle reckons that the sharp slowdown in consumption growth in the second half of last year was mainly a product of low growth in household income along with ‘an increasing expectation that it is likely to remain low’. In contrast, the story across the rest of the economy has been more upbeat: non-mining business investment has been ‘growing at a good rate’, the decline in mining investment is ‘about at the end’, and exports have continued to expand. The second disconnect is between ‘surprisingly weak’ growth in real GDP and a ‘surprisingly strong’ labour market, with evidence from business surveys bridging the gap. According to Debelle, the ‘tension highlighted by these different lenses on economic growth is of critical importance.’

The RBA has released its latest Financial Stability Review. The summary judgement is that ‘domestic economic conditions remain broadly supportive of financial stability’ with low unemployment and healthy corporate profits offsetting a (consumption-led) slowdown in growth and weak conditions in the housing market. According to the Review:

  • Measures of financial stress among Australian households are generally low and – despite an increase in housing loans arrears, particularly in Western Australia (but where they are still less than two per cent) – low unemployment and low interest rates mean households ‘remain well placed to service their debt’.
  • While large falls in house prices have left some borrowers facing negative equity, the incidence remains quite low. The RBA estimates that nationally only around 2.75 per cent of securitised loans by value (or just over two per cent of borrowers) are in negative equity, with the highest rates in Western Australia, the Northern Territory and Queensland. Almost 60 per cent of loans in negative equity are in Western Australia or the Northern Territory. Elsewhere, rates of negative equity remain very low. By way of contrast, negative equity peaked at more than 25 per cent of mortgaged properties in the US in 2012 and in Ireland it exceeded 35 per cent. That low Australian result reflects (i) the previous large increase in house prices, (ii) the low share of housing loans with very high loan to valuation ratios; and (iii) the fact that many households are ahead on their loans. Of course, if house prices keep falling, those numbers will keep changing . . .
  • Corporate debt remains moderate compared to income and assets, and businesses too ‘are well placed to meet their debt obligations given the strong profit growth’.
  • The large degree of change required by some financial institutions in response to the Hayne Commission ‘raises the significant challenge of managing the implementation in an effective and timely manner.’
  • Banks ‘now have much higher levels of capital, more liquid assets and more stable funding structures’ than they did around the time of the financial crisis.


The OECD’s new report on the ‘squeezed middle class’. Defined as covering those earning between 75 per cent and 200 per cent of the median national income, the report finds that the middle class has shrunk in most OECD economies, with the share of people in middle income households falling from 64 per cent to 61 per cent between the mid-1980s and the mid-2010s. This group has also ‘grown smaller with each successive generation’: while 70 per cent of the baby boomers were part of the middle class in their twenties, that compares with 60 per cent of millennials. At the same time, in many OECD countries ‘middle incomes have grown less than the average and in some they have not grown at all’. Worth noting: according to the short country summary graphics (pdf), at 58 per cent, the size of the Australian middle class is actually somewhat smaller than the OECD average (61 per cent).

What I’ve been reading: books

Ryan Avent on the Wealth of Nations: Work and its absence in the 21st Century. Avent’s focus is on the implications of the ‘Digital Revolution’ for the future of work. Unlike techno-sceptics such as Robert Gordon, Avent thinks that the Digital Revolution is a big deal2. But unlike some of the techno-optimists, he also worries that the implications for work, for our institutions and for society as a whole could be very negative unless they are well managed, citing current features of the global economic landscape (real wage stagnation, rising income inequality, a falling share of labour in total income, growing political polarisation) as indicators of the potential troubles ahead. Avent’s thesis is that it is scarcity that determines relative economic returns, and that in today’s economy, labour has become abundant thanks to a combination of automation, globalisation, and the extremely high productivity of a subset of the most skilled workers. At the same time, he argues that artificial measures that had been designed to improve the relative bargaining power of workers (for example, controls on migration, unionisation, occupational licensing) have also either been eroded or undermined. As a result, Avent worries about what he describes as an ‘employment trilemma’, whereby there is no easy solution to what is effectively a diagnosis of a global labour glut. According to his trilemma, we can only choose two out of three from jobs that (i) can deliver high productivity and wages, (ii) are resistant to automation and (iii) can employ vast amounts of labour. So, for example, jobs that are well-paid and scalable will tend to be automated away, while jobs that are resistant to automation and can employ large numbers of people will tend to be low productivity, low wage affairs. Avent canvasses a range of potential solutions to the challenges posed by his diagnosis of the threats to work and wages, ranging from institutional changes (higher minimum wages, universal basic income, a revival of unionism) to increased education and increased investment to offsetting demographic shifts (ageing and shrinking working age populations) and the sharing economy. But he doesn’t seem to be particularly convinced by any of them.

1 The IMF’s headline forecasts reflect world output shares based on purchasing power parity (PPP) exchange rates, which give a relatively greater weight to faster-growing emerging and developing economies. At market exchange rates, the Fund thinks that the world economy will grow at 2.7 per cent this year and 2.9 per cent in 2020. Since the bigger growth downgrades this time were for developed economies, the slowdown in this measure of global growth for the current year (0.3 percentage points relative to the January 2019 forecast) is somewhat larger than the slowdown in the headline growth rate reported above.

2 One of Gordon’s famous debating points that seeks to downplay the relative merits of recent innovations vs. previous waves is to ask whether people would be prepared to swap indoor plumbing for their smart phone. Avent’s view is that the trade-off is not at all as clear as Gordon thinks it is. Personally, I’m closer to the Gordon view on this one particular test . . .


Summary (week ending 5 April 2019)

  • Inevitably, for the past week, the focus has been on the budget. Just in case you’ve not already overdosed on the traditional deluge of post-budget coverage, you can find our initial take, written on budget night, here, and you can register to watch a recording of a webinar covering some of the key themes, delivered a few days later, here.
  • The RBA Board met on 2 April.  As expected, there was no change to the cash rate. 
  • Australian house prices fell again in March, and while the pace of decline slowed, the geographic spread of house price declines widened.
  • The NAB monthly business survey showed business conditions rising to above average levels in March.  But on a forward-looking basis, business confidence fell again.
  • Australian retails sales staged a strong comeback in February.
  • February’s trade surplus set a new Australian monthly record.
  • And according to the March 2019 Resources and Energy Quarterly, Australia’s resource and energy exports will reach a record $278 billion in 2018-19.
  • The global composite purchasing managers index (PMI) for March told a similar story to last month’s reading, with ongoing strength in services offsetting continued weakness in manufacturing. Attention focused on China, where the official manufacturing PMI delivered its biggest monthly increase since 2012.  The Caixin China general manufacturing PMI also recorded its first improvement in four months, along with the highest reading since July 2018.


What I’ve been following in Australia . . .

What happened:

The RBA Board met on 2 April.  As widely expected, it decided to leave the cash rate unchanged at 1.5 per cent. 

The accompanying statement gave no indication that the central bank has undergone any major rethink in terms of the future stance of monetary policy, noting only that the ‘low level of interest rates is continuing to support the Australian economy. Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual . . . the Board judged that it was appropriate to hold the stance of policy unchanged at this meeting.’

Why it matters:

No change in policy had been expected for this meeting and no change was what we got.  On the other hand, those hoping for signs of a shift to a more dovish policy stance in the accompanying statement were likely disappointed: arguably, the best they could point to was the rather anodyne closing comment that the board ‘will continue to monitor developments.’

Perhaps of more interest on the monetary policy front was the financial market response to the budget in terms of how it saw the implications for the RBA’s likely policy stance.  One way of interpreting the short-term tax component of this week’s budget measures is to see it as providing fiscal support to households that could potentially substitute for (or at least act as a complement to) easier monetary policy.  Analysis by CBA economists suggests that the personal income tax cuts included in the budget over 2019-20 and 2020-21 would have about the same impact on disposable income as two 25bp rate cuts, for example.  And with monetary ammunition running low, sharing the burden with fiscal policy would certainly make sense.  A look at the level of implied policy rates from a few days before the budget compared to implied levels the day after, however, suggests that the immediate market judgment was that the budget had done little to change expectations of the need for central bank action.


What happened:

Australian house prices across the eight capital cities fell by 0.7 per cent in March over the previous month, according to CoreLogic, and were down 8.2 per cent in annual terms.   The steepest falls in prices came in Sydney (down 0.9 per cent) and Melbourne (down 0.8 per cent) with the only two cities not to see a fall in prices Hobart (up 0.6 per cent) and Canberra (no change).

Sydney dwelling values are now down almost 14 per cent from their peak while Melbourne values are down 10.3 per cent.  In Darwin and Perth, where prices have been falling for longer, dwelling values have fallen by a cumulative 27.5 per cent and 18.1 per cent respectively, since peaking in 2014.


Why it matters:

The March report painted something of a mixed picture of housing market health since, despite another monthly fall, the pace of decline has been easing over recent months, prompting CoreLogic to suggest that the housing downturn is ‘losing steam’.  Set against that, however, price weakness is now spreading geographically.

What happened:

The NAB monthly business survey showed business conditions rising by three points in March, with increases across each of the index components, including the employment index, which is now well above average.  But business confidence fell two points from February.


Why it matters:

The recovery in business conditions following on from last month’s fall was welcome news, and the strength of the employment component was again consistent with the positive aspects of recent labour market outcomes.  But the continued slide in confidence since last month indicates that businesses continue to view the future with some concern.

What happened:

Australian retail sales in February rose by 0.8 per cent over the month (seasonally adjusted) and by 3.2 per cent over the year, according to the ABS.  That was better than consensus forecasts of a 0.3 per cent monthly increase and marked something of a recovery following two weak monthly results (a 0.4 per cent fall in December and a 0.1 per cent rise in January).


Why it matters:

It’s only one month’s number, but after disappointing results in December and January, and with a heightened focus on the conjunction of weak income growth and falling house prices and their combined consequences for consumer spending, the bounce back in February provides grounds for hoping that the adverse wealth effect on household spending is not – yet – biting too deeply.

What happened:

Australia’s trade balance reached a record surplus of $4.8 billion in February.  That comfortably exceeded market expectations for a $3.7 billion result and follows on from a chunky $4.4 billion surplus in January.   Export values were up more than 13 per cent over the year, while growth in imports was closer to four per cent over the same period


Why it matters:

The monthly trade numbers help highlight how much Australia continues to benefit from a strong performance in resource exports, including a dramatic surge in the value of exports of natural gas over the past several years.  The implications of these developments have been apparent in the fiscal position and played an important role in supporting this week’s budget bottom line.  (See also the following section on the March 2019 Resources and Energy Quarterly.


What happened:

The Department of Industry, Innovation and Science published the March 2019 edition of Resources and Energy Quarterly (REQ).  According to the REQ, Australia’s resource and energy export earnings are forecast to reach a record of $278 billion in 2018–19 after the prices of some of our major commodity exports hit seven-year highs.  That represents an upgrade of about $13.9 billion to the estimates in the December 2018 REQ.  Moreover, the new forecast for 2019-20 (which sees the expected value of resource and energy exports drop only slightly next year, to $272 billion) is now an impressive $31 billion higher than the projections in last December’s REQ.


Why it matters:

As already noted in this Weekly, high commodity prices have pushed up resource exports and contributed to a stronger budgetary position.  One key message from the REQ is that a large part of this strength has been driven by supply disruptions (iron ore mine closures in Brazil following the collapse of Vale’s Brumadinho mine tailings dam have had the biggest impact, but there have also been disruptions to global copper and oil producers, as well of course as weather-related disruption here in Australia) that have pushed up US dollar commodity prices.  That, along with weakness in the Australian dollar which boosted local currency returns, helped drive the record result for 2018-19.  As supply problems are overcome, prices will adjust, and export values are forecast to fall back over the next five years, dropping to a still relatively healthy $256.2 billion by 2023-24 (in nominal terms).


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

What happened:

The JP Morgan global composite PMI suggested that the pace of global economic expansion accelerated in March (pdf). As was the case in February, a stronger performance by the services sector was enough to offset continuing subdued conditions in manufacturing, as services activity increased for a second successive month, while the global manufacturing PMI was unchanged from February.


Why it matters:

While the global PMI story triggered only moderate interest, news about developments in China attracted rather more attention.  China’s own official manufacturing PMI rose to 50.5 in March from 49.2 in February.  That was the biggest monthly increase since 2012 and took the index back into expansionary territory.  The measures for new orders and new export orders also staged sharp increases (although note that the latter remained deep in negative territory).

At the same time, the Caixin China general manufacturing PMI also showed the Chinese manufacturing sector finishing the first quarter of this year on a positive note, with operating conditions improving for the first time since last November, and the highest reading since July 2018.

With the Chinese economy having started the year on a relatively rocky footing, the two PMI readings for March provide some early evidence that Beijing’s latest bout of stimulus efforts, including via infrastructure spending, may now be having a positive effect on economic activity.



What I’ve been reading: articles and essays

A smaller offering on the readings section this week (although I suppose I could have included the budget papers to bulk things out a bit).

The Parliamentary Budget Office (PBO) has released a new report on the fiscal impacts of Australia’s ageing population.  The old-age-dependency ratio is the ratio of those people aged 65 and over to the prime working age population (defined as those aged between 15 and 64).  Between 1971 and 2011, this ratio increased from 13 per cent to 21 per cent (that is, by 2011 there were 21 people aged 65 and over for every 100 people of working age).  Since 2011, the rate of increase in the ratio has doubled, and between 2011 and 2031, Australia’s old-age dependency ratio is expected to increase from 21 per cent to 29 per cent, with the next decade representing ‘a unique period of population ageing for Australia’. According to the PBO, that coming decade of demographic change is projected to subtract 0.4 percentage points from annual real growth in budgetary revenues while at the same time adding 0.3 percentage points to annual real growth in spending, resulting in an annual cost to the budget of about $36 billion by 2028-29.  That’s projected to be larger than the cost of any one of Medicare, NDIS, or Commonwealth funding for schools and hospitals in the same year.

Adam Tooze asks, Is this the end of the American century?  Tooze reckons talk of an end to the US world order is – for now – a ‘gross exaggeration.’ The two key pillars of US power – military and financial – are ‘still firmly in place’ and much less has changed than is often claimed, since ‘Republican policy is just Republican policy, American military power is waxing not waning, and the dollar remains at the hub of the global economy.’  The biggest shift is the relationship with China, where he writes, intriguingly, ‘we may find ourselves facing not so much an end of the American-led order, as an inversion of its terms. Where the US previously offered soft-power inducements to offset the threat of communist military power, backed up by hard power as a last resort, in the next phase the US may become the provider of military security against the blandishments offered by China’s growth machine.’  Almost worth reading just for the arresting closing image of President Trump on a golf cart, careening around the flight deck of a nuclear-powered aircraft carrier engaged in ‘dynamic force deployment’ to the South China Sea.  (By the way, if you don’t mind bulky books, Tooze’s Crashed from last year is definitely worth a look, although I preferred The Deluge.)

Adair Turner wonders whether zero interest rates are the new normal, and warns that while in the current environment monetary financing will certainly have its attractions, ‘excessive monetary financing is hugely harmful’ and is far from a costless solution.

Veteran environmentalist and journalist Bill McKibben ponders a future without fossil fuels, proposing that the question ‘At what point does a new technology cause an existing industry to start losing existing value?’ may ‘turn out to be the most important economic and political question of the first half of this century.’ 

The IMF has released the analytical chapters for its April 2019 World Economic Outlook.  Topics covered are the rise of corporate market power, the price of capital goods, and drivers of bilateral trade.  Full disclosure: strictly speaking, these should really be on my ‘yet to read list’, rather than on my ‘currently reading’ one.  But I did have time to read Christine Lagarde’s speech on what she’s describing as a ‘delicate moment for the global economy.’  Key takeaway: while 2017 saw 75 per cent of the global economy enjoy a synchronised upswing, this year the IMF expects 70 per cent of the global economy to undergo a slowdown in growth.

An interesting note from Branko Milanovic contrasting some of the ideas of Francis ‘end of history’ Fukuyama with those of mainstream economics (and Hayek).

The WTO foresees continued headwinds for global trade growth.  It now thinks world trade volumes will only manage to grow at 2.6 per cent this year, down from three per cent last year and much slower than the 4.6 per cent achieved in 2017 (see also the previous Weekly’s piece on slowing momentum in global trade).  Previously, the WTO had been expected trade to grow at 3.9 per cent in 2018 and 3.7 per cent this year.