Reserve Bank makes note

From a very recent speech by Glenn Stevens, Governor RBA..

Where to from here?

At moments like this, it is hazardous to make predictions. However, it seems to me that the key elements of dealing with the root issues in the crisis are starting to come into place. Policy-makers in the major countries do ‘get it’. The plans are not precisely uniform across countries – that is never achievable anyway – but we can, I think, see the shape of a broad common outline. It addresses the issues of liquidity, capital and confidence. There is much more work to be done yet on the design details, and one area in which further international co‑operation would be helpful is in the area of making these various guarantee arrangements broadly consistent. But the world is, it seems to me, getting on to a better path. As a result, the likelihood of a global catastrophe has in fact declined over the past couple of weeks.

The question of the appropriate macroeconomic policy settings to help economies through this period will also be receiving attention around the world. In those countries where previous settings have been prudent, and where inflation prospects permit, policies can be eased to counteract some of the contractionary forces set in train by the deterioration in global growth prospects resulting from the credit turmoil. Central banks in major countries, recognising weaker demand and the likelihood of easing pressures on prices, reduced interest rates in October.

In Australia, the Reserve Bank made a substantial cut to the cash rate at its October meeting, bringing forward reductions that might ordinarily have taken place over several months. CPI inflation is likely to remain high in the period immediately ahead, and yesterday’s PPI data illustrate the concerns that the Bank has long expressed about inflation. But looking forward to next year, forces seem now to be building that will start to dampen pressures on prices – even though we won’t have evidence for that for a good six months. The Board sought, as always, to respond to the medium-term outlook for prices, not just the current data.

The Australian Government has made a significant change to the fiscal stance which will flow through the demand side of the economy during the summer. The decline in the Australian dollar by about 20 per cent against a trade‑weighted basket also amounts to a significant change for the trade-exposed sectors of the economy, though at the cost of some temporarily higher price rises. These changes will act to lessen the extent of the likely slowdown in Australia’s economy, even as global forces work the other way.

The Reserve Bank will publish its next update on the economic outlook on 10 November, so I will not say any more about that today. I shall finish with the question of what trends will be of importance beyond that horizon.

As I have said before, the emergence of China is not complete and has many years to run. Right now, China’s economy is slowing. This is a reminder that China’s economy has cycles, like economies everywhere. But even if it slows a lot, it will pick up again in due course and will probably grow pretty strongly, on average, over many years.

In countries like Australia, perhaps the long period of household debt build‑up is now giving way to a period in which balance sheets will see some consolidation. If so, household credit growth will not be as fast as it was for the past decade and a half. Perhaps we will need also to get better at turning borrowing for housing into more dwellings rather than just higher house prices.

Perhaps the finance sector globally will return to fulfilling something more like its historical role of being ‘the handmaiden of industry’, with a bit less in the way of exotic innovation of its own. In such a world, a renewed focus on the processes in the real economy which generate growth in productivity could also be apt. In the case of Australia at least, it is now hard to avoid the conclusion that underlying growth in productivity has slowed over the past five years, compared with what was seen through most of the 1990s and the early part of this decade. Of course, these things are notoriously hard to measure and there will be various opinions about the extent of the slowing, why it occurred and what might be done about it. Nonetheless, once the immediate crisis has passed, that might be a conversation worth having.