What RBA Governor Stevens thinks is going on

In a speech this week titled “The Lucky Country” the RBA Governor Glenn Stevens focused on Australia’s relatively favourable economic performance.

He used his speech to answer a number of questions posed in the general economic debate about Australia’s economic performance.

  • Did luck have a significant role or was it due to the implementation of sensible policies?
  • What are the risks of things going awry e.g. China’s economy weakening dramatically and/or domestic house prices here collapsing?
  • Can we avoid the consequences of a severe global downturn, like a banking crisis or an inability to fund the current account deficit?

The Governor then detailed Australia’s relatively favourable macro-economic performance over the past seven years against the major economies in terms of real GDP growth, GDP per capita growth and unemployment rates.

The escape from the GFC related problems seen in other economies from 2008 onwards can be explained by a number of influences.

The first was that Australia’s banking system was in comparatively good shape prior to 2008 and the resulting credit quality issues were manageable. The banks were able to access capital from the markets when required and paid the Federal Government for its assistance. Unlike in the US, the EU and the UK the Federal Government did not need to buy the banks.

Second, there was large scope for decisive and targeted Federal and State Government fiscal expansion here because of relatively low public sector debt. China’s rapid return to strong growth provided the third reason, lifting resource prices and demand levels throughout Asia.

The Australian dollar’s fall to the USD0.60 area was the fourth reason, providing an extraordinary lift in export receipts. The floating AUD was opposed by many in 1983 but it turned out to be the correct

policy move. It allowed control over domestic inflation and interest rates, with the AUD becoming the shock absorber for shifting world economic conditions.

There was some luck involved.

The Governor admitted there was an element of luck in the way Australia avoided the worst outcomes post the GFC.

Resource endowment and proximity to Asia is part of the luck story. But we still have implemented the policies to take advantage of it. The banking system here is well regulated and managed which is not down to luck. Fiscal easing on a major scale is possible if “disciplined” fiscal policy and debt levels are the normal practice.

So, while there was some luck, there should also be recognition of the “factors that didn’t happen by accident”.

What RBA Governor Stevens thinks is going on

What could go wrong?

Addressing the things that could go wrong, the Governor began with China’s growth outlook. He indicated that China’s growth had slowed over the past year, an outcome deliberately arranged by policy makers to address inflation and produce more sustainable growth.

The most likely outcome, he thought, was that China’s GDP outcomes would be in the 7% to 8%pa range and industrial production growth near 10%pa. Recent easing of policy looks to be indicating that the authorities believe that inflation pressures have eased.

The Governor compared the dwelling prices experience in Australia with other economies over the past seven years.

From their peaks, US prices are down 30% and the UK by 20% compared to the 5 to 10% fall in Australia. Are local dwelling prices overvalued? On some measures, like dwelling prices to income they may be. But the ratios have been high for a considerable time without shifting.

Something that tends to undermine the case that an imminent adjustment is nigh. But when a number of countries are examined, Australia’s prices to income ratio is not unusually high and is in the “middle of the pack”.

He indicated that recently repayments, as a share of income, on a new loan are the lowest for a decade.

On funding exposures, the Governor noted that Australia’s banks have shifted to being largely funded by local deposits, reducing foreign exposures. While the current account deficit is being funded by foreign buying of Government securities.

He also indicated that China’s, and most likely Australia’s, response to weaker world growth would be more stimulus.

His conclusion was that while Australia was well-placed, the economic environment would remain challenging.

Source: Commonwealth Bank Economic Update


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