Minutes from the RBA’s July meeting confirmed the centrality of the labour market to the future trajectory of the cash rate. The unemployment rate remained unchanged at 5.2 per cent in June but the underemployment rate fell.

    China’s annual GDP growth slowed to 6.2 per cent in Q2:2019, its lowest rate in almost three decades. This week’s readings include the Treasury on the Australian labour market, the Department of Industry on innovation, the OECD on structural reform, the IMF on external imbalances, and pieces on the drivers of populism and the case for a universal basic income.

    The RBA minutes for the July meeting confirmed that the RBA remains focussed on the labour market in setting monetary policy.

    Australia’s unemployment rate in June remained unchanged at 5.2 per cent. But the underemployment rate fell to 8.2 per cent from 8.6 per cent in May.

    China’s annual rate of GDP growth fell to 6.2 per cent in the second quarter, its slowest pace since the current quarterly series began, prompting expectations of further policy stimulus from Beijing.

    What I’ve been following in Australia . . .

    What happened:

    The minutes of the 2 July RBA meeting (which saw the central bank cut the cash rate to a new record low of one per cent) were published. According to the summary, ‘Members judged that a further reduction in the level of interest rates would support the necessary growth in employment and incomes, and promote stronger overall economic conditions, which would in turn support a gradual increase in underlying inflation. Members also judged that the extent of spare capacity in the economy, and the likely pace at which it would be absorbed, meant that a decline in interest rates was unlikely to encourage an unwelcome material pick-up in borrowing by households . . . This decision, together with the reduction in the cash rate decided at the previous meeting, would assist in reducing spare capacity in the economy and making faster progress in reducing the unemployment rate. Lower interest rates would provide more Australians with jobs and assist with achieving more assured progress towards the inflation target.’

    Why it matters:

    The discussion in Darwin covered some familiar territory, with a continued focus on the labour market and the RBA’s judgment that there has been a fall in the non-accelerating inflation rate of unemployment (NAIRU), such that ‘members agreed that the Australian economy could sustain a lower rate of unemployment, while achieving inflation consistent with the target.’ With the new estimate of the NAIRU at around 4.5 per cent and the actual unemployment rate unchanged at 5.2 per cent in June (see below), policy still has some work to do1. The RBA will ‘continue to monitor developments in the labour market closely and adjust monetary policy if needed to support sustainable growth in the economy and the achievement of the inflation target over time.’

    Australia: Shift in implied RBA Cash rate 190719

    For now, the consensus interpretation of all this seems to be that the central bank is predisposed to wait a few months to gauge how the economy is travelling post-election, post-rate cuts and post-tax cuts, but that another 25bp cut to the cash rate remains more likely than not before year-end.

    What happened:

    According to the ABS, Australia’s unemployment rate was unchanged at 5.2 per cent (seasonally adjusted) in June, in line with market expectations.

    Australia: Unemployment and Underemployment 190719

    The underemployment rate fell from 8.6 per cent in May to 8.2 per cent in June, taking the combined underutilisation rate down from 13.7 per cent to 13.4 per cent.

    Australia: Change in employment 190719

    The number of employed persons rose by just 500 in June, well-below market expectations which had looked for a gain of 9,000. Full-time employment did increase by 21,100 but that was largely offset by a fall in part-time employment of 20,600. Over the year to June, full-time employment has increased by 246,500 persons and part-time employment has risen by 49,800 persons. The participation rate remained unchanged at 66 per cent.

    Across the states, there were large decreases in employment in New South Wales (down 17,400 persons), Queensland (down 8,200), South Australia (down 4,700) and Victoria (down 4,100). The only increase in employment was in Western Australia (up an impressive 13,800 persons). Western Australia was likewise the only state to see a fall in the seasonally adjusted unemployment rate (down to 5.8 per cent from 6.2 per cent in May) while across the other states the rate was either unchanged (New South Wales) or higher. In terms of levels, unemployment remains either close to or above six per cent in Tasmania, Queensland, South Australia and Western Australia compared to unemployment rates of less than five per cent in New South Wales and Victoria.

    Why it matters:

    As already noted, the RBA is keeping a close watch on the labour market after revising down its assessment of Australia’s NAIRU or natural rate of unemployment to around 4.5 per cent. Driving the headline rate down towards this target is the RBA’s main stated reason for the back to back cuts to the cash rate in June and July, and in this context with June’s unemployment rate staying steady at 5.2 per cent there remains scope for policy to do more (keeping in mind that the full impact of the two rate cuts will not be felt for some time yet). Granted, June’s falls in the underemployment and underutilisation rates do indicate a modest improvement in the amount of overall slack in the labour market. But with the underutilisation rate above 13 per cent, there is still some distance to travel until labour market conditions would become consistent with the RBA’s objective of higher wage growth and hence an inflation rate closer to its target range.

    Employment growth in June was soft relative to expectations with a marked drop in part-time employment that reversed the large increase seen in May. It’s possible that some of this swing across the two months was election related.

    Taken overall, June’s labour market results are broadly consistent with market expectations of further policy action from the RBA but also with the view that the central bank may take some time before delivering its next rate cut.

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

    What happened:

    The annual rate of GDP growth in China fell to 6.2 per cent in the second quarter of this year. Although that result was in line with market expectations it also marked the slowest rate of growth since China’s National Bureau of Statistics (NBS) started publishing the current quarterly GDP series back in 1992.

    China: Quarterly GDP Growth 190719

    Monthly data released this week painted a somewhat rosier picture of economic activity, suggesting that the second quarter may have ended on a stronger note. Retail sales rose by 9.8 per cent in June over previous year, beating consensus expectations for an 8.5 per cent print. Growth in fixed asset investment rose to 5.8 per cent in the same month which was also ahead of the market consensus (5.6 per cent). And industrial production rose to 6.3 per cent in June, up from five per cent in May and once again beating market expectations (for a 5.2 per cent rise).

    China: Monthly activity indicators 190719

    Data released at the end of last week showed that total social financing (TSF) expanded by 2.26 trillion yuan in June, up from 1.4 trillion in May, and up 10.9 per cent over the year. That credit growth comfortably beat market expectations for a 1.9 trillion increase yuan increase over the month. Key drivers of the rise in credit included a marked increase in the net issuance of local government special bonds (to fund infrastructure spending) and a pickup in the rate of issue of corporate bonds.

    China: Total Social Financing 190719

    Why it matters:

    Along with the United States, China is a key driver of global economic conditions, and is particularly important in terms of global trade and commodity prices. And, of course, China is Australia’s largest trading partner.

    The Chinese economy is in the midst of a structural slowdown (reflecting a combination of demographic headwinds, economic rebalancing and changed global conditions) and the quarterly GDP numbers are broadly consistent with that trend and with an official target for a GDP growth rate of between six and 6.5 per cent for this year. Complicating the achievement of this target is that the economy is also negotiating an on-again, off-again trade war with the United States which has been taking a toll on business confidence, manufacturing output and exports. At the same time, policymakers are also engaged in a long-running balancing act between managing financial vulnerability and putting a floor underneath economic growth. When the economy shifted down onto a lower growth trajectory in the aftermath of the global financial crisis, Beijing turned to a major injection of stimulus to support activity. While that succeeded in boosting the economy it also helped spur a very rapid increase in credit to the non-financial as a share of GDP as businesses, households and local governments started to pile on the debt.

    China: Credit to non-financial sector 190719

    The stimulative impact of this credit growth on output appears to have faded over time: in other words, it has required an increasing volume of credit to deliver the same increase in GDP. Moreover, experience with other emerging economies suggests that there is a high risk that credit booms of this order of magnitude tend to end either in a marked slowdown in the pace of growth or in some form of financial crisis, or both. China has some buffers in place (a strong external position, high savings rate, low external debt) which mean that the economy may well be more resilient than the typical emerging market, but Beijing remains acutely aware of the risks and these kinds of concerns prompted a move to tighten the policy stance back in 2016. Those policy efforts to slow credit growth – and to focus more on the quality of output growth than its overall pace – were largely sustained through until last year. But the price of that shift in the policy stance came in the form of a softer growth profile. Meanwhile, the total level of debt in the economy has continued to grow: according to a recent estimate from the Institute of International Finance, China’s total debt stock now exceeds 300 per cent of GDP and is equivalent to about 15 per cent of all global debt.

    For now, the priority for Beijing appears to have tilted towards growth and in this context, the monthly data for June will have provided a degree of comfort, with outcomes that beat expectations and suggest that stimulus measures may be achieving some traction and helping stabilise activity. That said, the durability of at least some components of the June bounce is not clear at this point. For example, the jump in retail sales numbers was driven mostly by auto sales, which in turn look to have been boosted by one-off factors, primarily a policy change relating to emissions standards which meant that in many provinces June was the final month that cars that did not meet the new standards could be sold, with these models attracting large discounts from dealers. For the longer-term, the balancing act between too much debt or too little growth looks set to continue with the weak Q2 GDP reading and the risk of more trade war-related stress to come suggesting that additional stimulus measures are likely to be applied to the economy over the second half of this year.

    What I’ve been reading: articles and essays

    Treasury’s Meghan Quinn gave a speech on what’s driving low wage growth in Australia. She argues that much of the post-GFC decline in nominal wages growth reflects ‘standard macroeconomic mechanisms’ including lower inflation and inflation expectations, slower productivity growth, high participation rates and spare capacity in the labour market, plus the unwinding of the commodity boom. To this extent, she suggests, the ‘puzzle’ of low wage growth is a relatively small one. To help explain the modest part of the wage story not accounted for by macro factors, Quinn draws on recent Treasury work looking at microdata (firm-level data) to suggest that there’s been a weakening in the relationship between firm productivity and real wage growth, possibly reflecting a decline in labour market fluidity and market dynamism.

    The OECD’s Going for growth 2019 report argues that ten years after the GFC, global growth remains fragile and the prospects for strong and sustained medium-term improvements in living standards are still weaker than pre-crisis, reflecting unfavourable demographics and a decade of low investment and productivity growth. The OECD’s solution is structural reform and it suggests that the reform priorities for Australia should include: improving conditions for businesses and strengthening competition (adopting international product standards, reducing the scope of professional and occupational licensing, boosting university-business linkages to strengthen the innovation environment); improving performance and equity in education (better oversight in the vocational education and training (VET) sector, improved access to early-childhood education); improving the efficiency of the tax system (raise the rate of the GST and widen the base, cut direct taxes particularly on big firms, and remove inefficient state-level fees and charges); advancing climate change mitigation policies (an emissions reduction goal for the power sector supported by a market-based mechanism); and improving opportunities and outcomes for indigenous communities (give indigenous communities a greater role in policy design and implementation).

    The Department of Industry has published its new Australian Innovation System (AIS) Monitor. It reports: an increase in the share of Australian firms that are ‘innovation active’ (49.8 per cent in 2018); a mixed picture on entrepreneurship, with evidence of a decline in dynamism between 2002 and 2015 set against more recent positive indicators on the number of people of starting a business and perceptions of business opportunity; a decline in overall expenditure on research and development (R&D) driven by sharp falls in business R&D spending in mining and manufacturing; and a rising Australian share in the world’s top scientific publications.

    The capability review of the Australian Prudential Regulation Authority (APRA) has been released. The report judges that APRA has a strong record by international standards in that, since its inception in 1998, ‘there have been very few failures of significant financial institutions and no systemic financial crisis in Australia’ but it also finds that ‘APRA’s internal culture and regulatory approach need to change’. In particular, while noting that ‘in matters of traditional financial risk APRA is an impressive and forceful regulator’ the review goes on to stress that ‘APRA’s tolerance for operating beyond quantifiable financial risks has been low’ and that the regulator ‘appears to have developed a culture that is unwilling to challenge itself, slow to respond and tentative in addressing issues that do not entail traditional financial risks.’ The review finds that APRA should retain its current focus on maintaining financial safety and stability but that it should also ‘focus more intensely on governance, culture and accountability (GCA) in the financial sector’ and accept that ‘GCA risks have a major bearing on financial risk’.

    The Economist magazine’s briefing on the world economy ponders the unusual length of the current global economic expansion: the US economy has now surpassed the 1990s economic expansion which previously held the US record for longevity, while the Euro area has managed 24 consecutive quarters of GDP growth. As the Economist puts it, ‘none of the things which usually bring expansions to an end – busts in industry and investment, mistakes by central banks and financial crises – has yet shown up’. Although global manufacturing has been faltering, services have held up well in economies where the latter is now increasingly more important than the former; a higher share of investment is now accounted for by (relatively more stable) spending on intellectual property (IP) than more volatile spending on plant and property; and central banks have become less worried about inflation and hence less inclined to pre-emptively tighten policy. That leaves the risk of a financial crisis and here, although there are some clear and present dangers (such as high corporate debt), the Economist reckons none of them are imminent.

    As the greenback nears a multi-decade high on a trade-weighted basis, markets - and President Trump – have been getting excited about the possibility of foreign exchange intervention to drive down the US dollar. The FT provides an overview of how the US might intervene and the challenges it would face in the absence of coordinated support from other economies.

    Dani Rodrik on what’s driving populism, economics or culture?

    The FT wonders does investing in emerging markets still make sense? In a world economy where globalisation is under threat, China is slowing and global financial conditions are shifting, past bets on rapid convergence by poorer economies no longer look as attractive as they used to.

    John Lanchester makes the case for a Universal Basic Income.

    The IMF has launched a new series called Fintech Notes. The first analyses the rise of digital money.

    Also from the Fund: the 2019 External Sector Report is now available. It reckons that 35 – 45 per cent of overall current account surpluses or deficits were ‘excessive’ in 2018, with too-high surpluses in the euro area (driven by Germany and the Netherlands), Korea and Singapore and too-high deficits in the UK, US, Argentina and Indonesia. China’s external position last year was judged to be in line with fundamentals. Likewise, the IMF’s overall assessment for Australia is that our external position in 2018 was ‘broadly in line with the level implied by medium-term fundamentals.’ The Fund also reckons that Australia’s real effective exchange rate was overvalued in the range of 0 to 12 per cent. According to Gita Gopinath, the IMF’s chief economist, trade wars have yet to make a significant impact on the pattern of global current account imbalances, as trade has been diverted to other markets. Instead, their influence has been felt more on global investment and growth.

    Economists at the Federal Reserve Bank of San Francisco ask why is inflation low globally, even though unemployment rates in advanced economies are near historical lows? They argue that the trend predates the global financial crisis and reflects global factors including the way that trade and globalisation helped reduce the costs of production and investments and placed downward pressure on prices around the world.

    Tyler Cowen in conversation with Neal Stephenson. (I’m a fan of Stephenson’s earlier science fiction novels and his Baroque Cycle books are among my favourite historical novels.)

    As the name implies, the NAIRU is the level of unemployment that is consistent with no acceleration in the rate of inflation. Readers will remember that the conventional measure of spare capacity in the labour market is the gap between the actual unemployment rate and the NAIRU. The latter is also often referred to as the natural rate of unemployment. Both terms are commonly used interchangeably, although some purists would insist on the importance of small differences: specifically, that the natural rate is the unemployment rate that is observed once short-run cyclical factors have played out (that is, it applies to the long run) while the NAIRU is the unemployment rate consistent with steady inflation in the short to medium term (say over the next 12 months).

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