RBA ponders the efficacy of monetary policy as IMF warns of synchronised global downturn


    The unemployment rate ticked down to 5.2 per cent in September, prompting markets to lower the odds of a November rate cut. Minutes from the RBA’s October Board meeting show the central bank weighing up the pros and cons of further monetary easing. The IMF has downgraded the outlook for the world economy. This week’s readings cover housing and the economy, congestion charging, demographic trends and the economics version of the Nobel Prize.

    The unemployment rate fell to 5.2 per cent (seasonally adjusted) in September from 5.3 per cent in August. Employment was up by 14,700. Financial markets responded by nudging down the odds of a November rate cut.

    RBA minutes from the 1 October Board meeting show that now the cash rate is below one per cent, the central bank is thinking hard about the continued efficacy of monetary policy.

    The IMF cut its estimate for world GDP growth to just three per cent for this year, slashed its projection for 2019 world trade growth to a meagre 1.1 per cent, and said that it only expected the Australian economy to grow by 1.7 per cent this year and 2.3 per cent in 2020.

    What I’ve been following in Australia . . .

    What happened:

    According to the ABS, Australia’s unemployment rate fell to 5.2 per cent in September (seasonally adjusted) from 5.3 per cent in August. (On a trend basis, the rate was unchanged at 5.3 per cent.) The underemployment rate also eased, falling from 8.5 per cent in August to 8.3 per cent in September.

    unemployment and underemployment

    Employment increased by 14,700 people in September, with full-time employment rising by 26,200 which was more than enough to offset a decline in part-time employment of 11,400. Over the past year, the average monthly rate of increase in employment has been around 26,000, with full-time employment growing at around 16,000 compared to 10,000 for part-time employment.

    change in employment

    The participation rate fell slightly in September, dropping to 66.1 per cent from August’s record high of 66.2 per cent.

    participants rate employment

    By state, the largest increases in employment came in Queensland (up 25,300 people) and Victoria (up 8,600 people) while the largest decrease was in New South Wales (down 23,000 people). The unemployment rate increased by 0.2 percentage points in New South Wales (to 4.5 per cent), and by 0.1 percentage points in Queensland (6.5 per cent). Unemployment fell in South Australia (down one percentage point to 6.3 per cent), Victoria (down 0.2 percentage points to 4.7 per cent) and Tasmania (down 0.2 percentage points to 6.2 per cent). There was no change in the rate in Western Australia.

    Why it matters:

    At 5.2 per cent, the unemployment rate remains significantly above the RBA’s estimate of a ‘full employment’ rate of around 4.5 per cent, the attainment of which the central bank has repeatedly emphasised in its recent communications about the future direction of monetary policy.

    Markets, however, had expected the unemployment rate to stay unchanged at 5.3 per cent in September, with any outcome worse than that viewed as increasing the chances of the RBA delivering another cut to the cash rate at next month’s meeting. So, when the actual outcome beat those expectations (albeit assisted by a fall in the participation rate), the immediate impact was to trigger a small increase in the value of the dollar as the odds of a November rate cut fell.

    At the time of writing, markets were pricing the probability of a rate cut next month at just below 40 per cent, with that probability jumping to more than 60 per cent for the December meeting.

    What happened:

    The RBA published the minutes from the 1 October Board meeting, at which the central bank cut the cash rate by 25bp, bringing it to a new record low of 0.75 per cent.

    RBA cash rate

    As had been flagged in the statement accompanying October’s rate cut, the minutes point to three factors behind the decision to once again loosen monetary policy: (1) risks to the outlook for global growth remained tilted to the downside as heightened policy uncertainty dragged down international trade and business investment; (2) global interest rates had continued to fall (both the US Fed and the ECB had cut policy rates over the previous month) and yet more global monetary policy easing was expected to follow; and (3) ‘Members noted that the Bank's most recent forecasts suggested that the unemployment and inflation outcomes over the following couple of years were likely to be short of the Bank's goals. The most recent run of data had not materially altered this assessment and, on balance, had been on the softer side.’ And remember, those RBA forecasts already assumed that the bank would follow market expectations and cut the cash rate to 0.5 per cent by the first half of next year, and therefore that even this level of the cash rate would not suffice to achieve the central bank’s targets.

    The minutes – and the statement – also repeated the message that it would be ‘reasonable to expect that an extended period of low interest rates would be required’ and that the Board remained ‘prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.’

    Why it matters:

    October’s rate cut had been expected by financial markets after the August labour market report had shown the unemployment rate edging up to 5.3 per cent – its highest level since August 2018 – and the underemployment rate increasing to 8.6 per cent. Even so, as the cash rate has continued to track closer to zero, there has been a growing debate as to whether monetary policy easing is still effective in terms of delivering stimulus to the economy and even whether it risked being counterproductive, either by undermining expectations or by inflating asset prices.

    In particular,[1] there is a case to be made that lower rates so far do not appear to have done much to support either business or consumer sentiment. For example, although the NAB Business Survey for September showed business conditions climbing by one point to plus two index points , this still saw the index rack up its sixth consecutive below-average monthly reading. At the same time, the business confidence index fell by one point to sit at zero in September, the threshold between improving and declining confidence, and again well below its long-run average of plus six index points.

    NAB business conditions and confidence

    Similarly, October’s Westpac-Melbourne Institute Index of Consumer Sentiment (pdf) fell by 5.5 per cent to 92.8, marking the lowest level of the index since July 2015. The index has now been in negative territory (indicating that pessimists outnumber optimists) for three of the past four months. And as the commentary accompanying the release notes, the index has now fallen by 8.4 per cent since the RBA started cutting rates in June. There therefore seems to be little evidence that lower policy rates are boosting consumer sentiment, with households’ assessments of their own finances and the health of the economy both dropping sharply.

    westpac melbourne institute graph

    August’s retail sales numbers had also been consistent with the message of a still-cautious consumer sector. According to the ABS, retail turnover was up 0.4 per cent (seasonally adjusted) over the month, following a flat outcome in July. That was weaker than market expectations of a 0.5 per cent print and suggested that the anticipated boost to spending from tax rebates and lower rates had yet to fully materialise in the numbers, with the first two months of Q3 now indicating another relatively soft quarter for consumption growth.

    retail trade nominal

    But if lower rates have yet to gain much traction in terms of business and consumer, the same is not true of the Sydney and Melbourne housing markets. The CoreLogic dwelling value index for the combined capitals rose by 1.1 per cent over the month in September, with prices in Sydney and Melbourne both increasing by 1.7 per cent and the national index rising by 0.9 per cent.

    corelogic hedonic home value index

    Both cities have seen a marked rise in home values over the past two months, with Sydney up a cumulative 3.3 per cent and Melbourne up 3.2 per cent. That still leaves housing values 11.9 per cent below their July 2017 peak in Sydney and 7.9 per cent below Melbourne’s November 2017 peak.

    Brisbane (up 0.1 per cent) and Canberra (up one per cent) were the only other capital cities to record monthly price increases, with values flat in Adelaide and down in Perth, Hobart and Darwin.

    That shift in (part of) the housing market is also starting to appear in the lending numbers. ABS data released last week showed lending to households for dwellings excluding refinancing in August was up 2.9 per cent (seasonally adjusted) over the month, albeit still down five per cent over the year. That was the third consecutive monthly increase, with lending for owner occupier dwellings excluding refinancing up 1.9 per cent over the month and lending for investment dwellings excluding refinancing jumped by 5.7 per cent. Again, both values were still down relative to August 2018 (by 1.7 per cent and 13 per cent, respectively), but the numbers do suggest a turnaround in sentiment.

    lending to households for dwellings

    In this context, it’s interesting to note that the minutes from the October meeting do show RBA Board Members discussing four of the key arguments that have been advanced to make the case against further monetary easing:

    1. The argument that ‘monetary policy was already expansionary and that the lower exchange rate was also supporting growth’ and that these factors combined with the recent dose of tax relief might be enough to boost growth, removing the need for further rate cuts. But according to the minutes, members also recognised ‘that it was possible that the effects may be smaller than expected and the global risks were to the downside.’

    2. The argument for keeping some monetary stimulus ‘in reserve’ in the case of future negative shocks. But members felt ‘that argument requires changes in interest rates to be the key driver of demand, rather than the level of interest rates, which experience has shown to be the more important determinant. Members concluded that the Board could reduce the likelihood of a negative shock leading to outcomes that materially undershot the Bank's goals by strengthening the starting point for the economy.’

    3. The argument that monetary stimulus might be losing its effectiveness. The minutes record that members ‘recognised that some transmission channels, such as a pick-up in borrowing or the effect on the home-building sector, may not be operating in the same way as in the past, and that the negative effect of low interest rates on the income and confidence of savers might be more significant’. Here, members also felt that the exchange rate channel was ‘still considered likely to work effectively’ and that the positive effect of lower rates on household cash flows via lower scheduled debt repayments was likely to outweigh any negative impact from lower returns to household savings, given that ‘household interest payments exceed receipts by more than two to one.’

    4. The argument that low interest rates could trigger potentially destabilising increases in housing and other asset prices. In this case, members felt that higher asset prices alone were ‘unlikely to present a risk to macroeconomic and financial stability’ and that warning signals would also need to include ‘materially faster credit growth, weak lending standards and rising leverage’. Still, ‘members assessed that close monitoring of this risk was warranted.’

    Of course, after considering those various arguments for leaving the cash rate unchanged, ‘Members concluded that these various factors did not outweigh the case for a further easing of monetary policy at the present meeting.’ And as noted above, the minutes also left the door open for further easing. Still, the minutes do confirm that as the space for additional conventional monetary policy easing diminishes, the RBA is also acutely aware of the debate over its continued efficacy.

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

    What happened:

    The IMF has updated its forecasts for the world economy. The Fund now sees global growth this year at just three per cent, its weakest since 2009 and the GFC, and envisions only a modest increase to a 3.4 per cent growth rate in 2020.[2] Those numbers represent downgrades of 0.2 and 0.1 percentage points relative to the IMF’s July projections.

    real GDP australia

    Growth in advanced economies is now expected to run at 1.7 per cent this year and next, while growth in emerging market and developing economies is forecast to be a weak 3.9 per cent this year and a more robust 4.6 per cent in 2020.

    Projections for growth in the volume of world trade in goods and services have been downgraded to a meagre 1.1 per cent in 2019 and 3.2 per cent in 2020. That 2019 number implies that trade will be growing more slowly than global output this year: in other words, that on this metric at least, the world economy will be ‘deglobalising’.

    trade volumes

    The IMF has also cut its forecasts for Australian growth. It now thinks that the economy will grow by just 1.7 per cent this year and by a still relatively lacklustre 2.3 per cent in 2020. Those numbers are pretty close to the OECD’s September projections we discussed last month, which put Australian growth at 1.7 per cent this year and two per cent next year.

    Why it matters:

    The IMF reckons that the global economy is now suffering from a synchronised slowdown, with a broad-based loss of economic momentum. There are a range of culprits including US-China trade tensions and global trade policy uncertainty more generally, the risks and uncertainties surrounding Brexit, a downturn in the global auto sector, slower growth in China in response to efforts to rebalance growth and strengthen financial regulations, the waning of the boost to US growth from the Trump tax cuts, weakness in domestic demand in India, and severe economic dislocations in a range of emerging economies including Argentina, Iran and Venezuela. None of which is news.

    More troublingly, while the IMF does think that things will get better in 2020, it also warns that the forecast pick up in activity is precarious. About half of the projected improvement in global growth next year assumes that stressed emerging markets will either recover or endure shallower recessions than they are currently suffering, but those forecasts are subject to significant risks, especially given that the anticipated backdrop to this recovery is a series of forecast slowdowns in major economies: the Fund thinks that growth next year will fall in the United States (easing from 2.4 per cent this year to 2.1 per cent in 2020), Japan (down from 0.9 per cent to 0.5 per cent) and China (down from 6.1 per cent to 5.8 per cent). It does, however, think that conditions will improve in the UK and the Eurozone. At the same time, risks of further trade and geopolitical disruptions also continue to hang over the outlook, compounded by the presence of some financial vulnerabilities accumulated during the period of very low interest rates, and exacerbated by the strictly limited space now available for monetary policy action and the reluctance or inability of many governments to adopt expansionary fiscal policies.

    What I’ve been reading: articles and essays

    While the Weekly was on holiday, the RBA released the latest Financial Stability Review. The bottom line was that the central bank judged the Australian financial system to be ‘generally resilient’ although it also highlighted some ‘notable financial risks’ including the possibility of external shocks and international financial market dislocations; the potential hit to consumption and therefore overall economic growth and the financial system that could arise from a combination of high household debt and any future rise in job insecurity; dangers associated with housing markets (both from a rising incidence of negative equity in the short term – although the RBA notes that this is mostly a regional problem, with the incidence of negative equity low for the economy overall – and in the longer term from a future resurgence in house prices); and non-financial risks to banks including challenges arising ‘from their many legacy systems and the ever-present threat of cyber-attacks.’

    The RBA’s Guy Debelle spoke on housing and the economy, with a focus on the construction and price cycles. According to Debelle, although residential construction activity has fallen by nine per cent since September 2018, ‘much of the downturn in construction activity is still ahead’. The RBA is forecasting a further seven per cent decline in dwelling investment over the next year, with ‘some risk the decline could be even larger’. It reckons that will directly subtract around a percentage point from GDP growth in terms of direct effects (dwelling investment is around six per cent of GDP) although the total drag on activity is likely to be even larger, thanks to spillover effects across the rest of the economy. For example, although residential construction accounted for only two per cent of employment in 2016/17, total employment related to residential construction was closer to six per cent once construction services, manufacturing and other sectors are included. But the central bank also thinks that 2020 should be the low year for the sector, with continued population growth underpinning future demand. Meanwhile, the housing price cycle has turned in the opposite direction to the construction cycle, at least in Sydney and Melbourne.

    Related, ANZ bluenotes on rising confidence in the Australian housing market.

    The Grattan Institute makes the case for Australian cities introducing congestion charging and argues that it’s not as regressive a policy as is often claimed.

    The text above noted that the IMF thinks we’re in a synchronised slowdown. Economists at Brookings instead diagnose the current situation as one of synchronised stagnation, ‘characterised by weak growth in some major economies and essentially no growth or even mild contraction in others.’

    Back on 1 October, the WTO lowered its trade forecast for the world economy. The WTO now thanks that world merchandise trade volumes will grow by just 1.2 per cent in 2019, down from its April forecast of 2.6 per cent growth. Expected growth for 2020 has also been downgraded slightly, trimmed from April’s forecast of three per cent to a new projection of 2.7 per cent.

    The RBA’s Philip Lowe and Jacqueline Loh from the Monetary Authority of Singapore review the lessons from a decade of monetary policy innovation, drawing on two major reports from the BIS, one on the effectiveness of unconventional monetary policy tools, the other on the relationship between large central bank balance sheets and market functioning. They conclude that both sets of policy initiatives delivered, albeit with varying degrees of effectiveness and some lingering side-effects.

    Two from VoxEu: David Bloom describes population ageing as the dominant global demographic trend of the current century, noting that never before have such large numbers of people reached the older age group (it took the world over 99 per cent of human history to reach a total population of one billion, and we now expect to add one billion older individuals in the next 35 years). And Costa-i-Font and Batinti examine the impact of recessions on the size of the middle class, arguing that unexpected shocks to employment, such as those associated with the GFC, can trigger a ‘middle class squeeze.’

    The Peterson Institute’s latest take on global economic prospects (video version only at the moment, but there are pdfs of the three presentations available to read).

    The FT’s Martin Wolf reckons that the global economy is suffering from a surfeit of ‘stupid stuff’, in which category he includes the US-China trade and technology conflicts, Brexit, the Japan-South Korea standoff, and ‘austerity-as-secular-religion’ attitudes.

    Greg Ip, in the WSJ, explores how the US economy has become more vulnerable to global economic developments. Historically, a small trade share and financial markets dominated by domestic developments tended to insulate the United States from global shocks, but the growing relative economic weight of the rest of the world economy (primarily China), a rise in the share of trade in US output and foreign sales in US company profits, and increasingly integrated capital markets mean that its old immunity is not what it was.

    The New Yorker asks, Is Amazon unstoppable?

    From Bloomberg, Noah Smith describes the research that won Banerjee, Duflo and Kremer economics’ version of the Nobel Prize[3] while Mihir Sharma draws an interesting contrast between their work and that of 2015 winner Angus Deaton. See also this piece in the Economist.

    Econtalk’s Russ Roberts in conversation with Andrew McAfee, discussing the impact of ‘dematerialisation’.

    1. Note first that this does not address the counterfactual as to whether sentiment might have been even weaker in the absence of those rate cuts and second that the RBA reckons that it will take between one and two years for changes in the cash rate to have their maximum impact on economic activity and inflation. 

    2. That’s based on world GDP measured at purchasing power parity exchange rates, which give a higher weighting to (faster-growing) emerging markets. Using market exchange rates, the Fund thinks that growth in 2019 and 2020 will be 2.5 per cent and 2.7 per cent, respectively. 

    3. Yes, I know, technically not a Nobel prize. 

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