Let’s get fiscal with productivity-enhancing measures
There is significant debate about whether the Reserve Bank of Australia ought to cut its cash rate further. But the key problem Australia faces is not that interest rates are too high, it is that productivity growth is too weak.
This is something the central bank can do nothing about.
The solution ought to be fiscal and, with the government coffers cashed up, the upcoming budget should be used to deliver policy that helps to support productivity growth.
The current debate requires an understanding of where the economy is at present. This is no easy task, given considerable divergence across the key economic indicators.
Let's start with the jobs numbers. If these were your only guide, the conclusion would be that the economy was doing well. Jobs growth picked up pace over the past six months, the national unemployment rate is at a seven-year low and, in the two largest states, the unemployment rates are around their lowest levels since the mid-1970s.
In contrast, the recent gross domestic product numbers mostly tell a different story. GDP growth slowed sharply in the second half of 2018, with a key driver being weaker consumer spending.
However, this is not the full story either. Although the headline GDP growth rate slowed, growth in nominal GDP – a key measure of national income – actually picked up pace. Nominal growth was boosted by rising commodity prices, which boosted corporate profits and, in turn, tax revenues.
In short, there has been plenty of income growth but it has not been getting through to households, as wages growth is weak. Sluggish growth in household disposable incomes, combined with the cooling housing market, have been weighing on consumer spending, which was a key reason for the slowdown in headline GDP growth.
Finally, a significant conclusion that can be drawn from these numbers is that productivity growth has been weak. After all, per capita GDP fell in the second half of 2018, as strong jobs growth was only delivering weak output growth.
For policymakers there are three key challenges.
First, getting a clear read of the extent to which growth has slowed, given the tension between the weak headline GDP figures and the strong labour market numbers.
Secondly, understanding why, though national income growth has picked up pace and is strong, not much of it is flowing through to households and what action to take.
Finally, understanding why productivity growth is weak and what to do about it.
The RBA has an option to cut its cash rate further, particularly as inflation is low. Cutting the cash rate would provide some support for household incomes and the housing market.
However, cutting the cash rate also comes with its own problems. With the cash rate already at a historic low, the power of rate cuts to affect the economy is somewhat diminished. This is partly because it is unlikely that rate cuts would be fully passed through to mortgage rates, as the banking sector seeks to protect profit margins.
Cutting the cash rate further would also risk re-inflating the housing market and further increasing household debt, which could be undesirable. Finally, there is little evidence that interest rates are too high, particularly for businesses, given their profitability, increased borrowing, strong hiring and plans to increase their investments.
Nonetheless, if it turns out that the weakness in the GDP figures flows through to a downturn in the labour market, the RBA may be forced to cut, despite the diminished impact lower rates are likely to have.
Another option is fiscal policy. Strong tax revenue growth means that there is scope for larger tax cuts, increased government spending and reform when the government delivers its budget on April 2. Redistributing some of the strong national income growth to the household sector makes some sense, particularly if it comes in the form of tax cuts that help to sharpen incentives to work and invest.
Paul Bloxham, Chief Economist, Australia, New Zealand and Global Commodities
Managing the cycle is usually the preserve of monetary policy, but because interest rates are already at such low levels, fiscal stimulus may be more appropriate.
From an optimal policy perspective, it makes sense for governments to borrow to invest in useful productivity-enhancing infrastructure (both physical and social), rather than the RBA lowering already low rates, and, once again, pump-priming the housing market.
However, it is imperative that budget initiatives focus on lifting productivity. Weak productivity growth is likely to be the key reason that wages growth is low. There is a growing danger that calls for wages to increase – without being linked to productivity – become louder. Higher wages growth without higher productivity growth would damage Australia's competitiveness and eventually drive higher inflation.
In sum, slow productivity growth is finally catching up with the Australian economy and making the policy choices harder. Looser monetary policy is not the solution. A clear focus on productivity-enhancing reform ought to be key to the budget.
Paul Bloxham, Chief Economist, Australia, New Zealand and Global Commodities, HSBC. This opinion article was published in The Australian Financial Review on Thursday, 28 March 2019.