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2019 TOPIC PAPERS

NO. 1

TITLE Inflation

PAGE 3

2

External Stability

5

3

Unemployment

7

4

Labour Markets

9

5

Financial Markets

11

6

Economic Growth

13

7

Ecologically Sustainable Development

15

8

Globalisation

17

9

Income Distribution

19

10

Developing Economies

21

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Topic one: Inflation

Inflation (%pa)

5% 4%

Inflation below target range

3%

A period of relatively soft demand in the domestic economy since the Global Financial Crisis is likely to be one factor that has contributed to inflation being somewhat subdued over recent years. Typically, in periods of soft demand, there will be less upward pressure on inflation as weak demand makes it more difficult for producers to raise prices. There has been some volatility in the actual official or “headline rate” of inflation over recent years. Lower petrol prices contributed to the CPI falling to historic lows throughout 2015 and 2016. However, the OPEC cartel had some success at managing oil supply levels and prices firmed, rising to a cyclical peak near the end of 2018, before declining sharply again. Growth Rate % CPI

March 2019 Quarter

Year to March 2019

Year to Mar 2018

0.0%

1.3%

1.9%

2% 1%

Headline CPI Underlying Inflation

Source: Australian Bureau of Statistics 6401

Policy response to inflation Largely in response to concerns over the likelihood of increased inflation in the future, the Reserve Bank embarked on a program of gradually raising interest rates following a period of loose policy in the aftermath of the Global Financial Crisis (GFC). This saw the overnight cash interest rate jump from 3.0% in October 2009 to 4.75% in November 2010. Policy was then loosened again a year later, with the cash rate dropping to 1.5% following 12 reductions between November 2011 and August 2016. After remaining at 1.5% for nearly 3 years, the cash rate was reduced to 1.25% in June 2019. This is the lowest overnight cash interest rate level since published records are available in the 1950s.The Reserve Bank is able to implement such expansionary monetary policy because of the lack of any significant inflationary pressure. The outlook for inflation Both “cost push” and “demand pull” inflationary forces within the Australian economy have been weak for an extended period. This is despite the past presence of a mining boom and very buoyant conditions in the residential housing construction industry over recent years.

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Mar-19

Mar-18

Mar-17

Mar-16

Mar-15

Mar-14

Mar-13

Mar-12

Mar-11

Mar-10

Mar-09

Mar-08

Mar-07

Mar-06

Mar-05

0%

Mar-04

Over the past decade, inflationary pressures within the Australian economy have been modest, with the rate of inflation being held within the Reserve Bank’s 2% to 3% target band for much of this period. However, over the past three years, inflation has slipped below this target range and is currently just 1.3%. Measures of underlying inflation, which remove some of the more volatile or outlier movements from the inflation calculation, are very close to the current standard CPI measure, with the underlying measures showing an average inflation rate for the year to March 2019 of 1.4%.

On balance, therefore, there does not appear to be any significant upward pressure on inflation currently, with wages and the demand for labour and goods and services generally subdued. Although the Reserve Bank does have some willingness to let inflation move outside the target range, they remain committed to targeting inflation. This is evidenced by the following extract from the June 2019 Reserve Bank Board Minutes: “Members recognised that Australia's flexible inflation targeting framework did not require inflation to be within the target range at all times, which allows the Board to set monetary policy so as best to achieve the Bank's broad objectives. However, they also agreed that the inflation target plays an important role as a strong medium-term anchor for inflation expectations, to help deliver low and stable inflation, which in turn supports sustainable growth in employment and incomes.”

Longer-term comparisons The “low” inflation now prevailing is in significant contrast to that which characterised the 1970s and 1980s. As shown on the chart below, inflation is now more comparable to the prolonged period in the 1950s and 1960s when price growth was maintained at very low levels.

16% 12% 8% 4%

2016

2012

2008

2004

2000

1996

1992

1988

1984

1980

1976

1972

1968

1964

0%

1960

In addition to the low level of cost related drivers of inflation, there doesn’t appear to be significant demand pressures currently in the Australian economy. Over the year to March, real private household consumption grew by 1.8%. This is below the 2.9% growth rate recorded one year ago, and represents very modest demand in comparison to the 3.3% annual growth average recorded over the past two decades.

CPI - Annual Growth Rates

20%

1956

Wages growth has been particularly benign in recent years. Over the year to March 2019, the Wage Price Index suggests wages growth has been only 2.3%; which is close to the historic low and less than 1% above the underlying rate of inflation.

Source: Australian Bureau of Statistics 6401.

The shift to low inflation over the past 20 years has largely been a global phenomenon but there are also some Australian specific factors that have assisted in the avoidance of high inflation. Provided below are some reasons why Australia has been able to maintain low inflation rates over the past 20 years: Cheap imports - The growth in the manufacturing base of China, which is a low cost producer, has led to a lowering in the growth of import prices. Reform in wage determination - There is now a closer link between the granting of wage increases and productivity improvement. As such, wage growth is less likely to directly lead to pressure on prices. Inflation targeting – Monetary policy settings in recent times have been determined largely by the need to influence the rate of inflation. Inflation targeting has demonstrated a commitment to achieving low inflation and has resulted in the lowering of inflation expectations. Microeconomic reform- Reforms have driven costs down. Tariffs on imports have been cut and some non-competitive industries have been opened to competition e.g. telecommunications.

International comparison Despite the maintenance of loose monetary policy, inflation in most overseas developed economies has remained low, although some key overseas economies now have inflation rates higher than those existing in in Australia.

Economy Inflation Rate

Aust.

U.S.

Japan

Europe

U.K.

1.3%

1.8%

0.7%

1.9%

2.1%

Source: OECD, ABS. Latest period.

Topic two: External stability As Australia has continued to experience positive economic growth, and has benefited from the previous mining boom, there has been improvement across measures of external stability. A summary of recent trends in these measures is provided below. 1. Current Account deficit Whilst Australia’s Current Account has consistently been in deficit, the size of the deficit has fluctuated significantly with economic cycles. Typically, the deficit has expanded during times of strong economic growth. This is because in times of growth, high overall spending causes import levels to increase by more than exports. The reverse is true when growth is weak. Over the past decade, however, dramatic movements in commodity prices have tended to outweigh domestic influences on the trade accounts. Growing global demand for items that Australia exports has seen export receipts increase strongly. Initially, rising commodity prices pushed export receipts higher. In more recent years, an increased volume of mining output has coincided with strong prices to support export receipts.

The largest contributor to Australia’s Current Account deficit is the high negative balance on the Income Account. Interest payments on foreign debt make up a significant proportion of the income deficit. Other categories of income payments include profits payable to overseas shareholders of companies trading in Australia, wages to overseas residents and rentals to overseas landowners in Australia. The deficit on the incomes account has increased recently – this may partially reflect the high profitability of Australian mining companies leading to additional dividend payments to overseas shareholders. Current Account Items $B Exports Imports Balance of Trade Services Balance Balance of Trade in Goods & Services Net Incom e Current Account Balance

Year to March 2019 $ 358 $ (321) $ 37 $ (5) $ 33 $ (64) $ (31)

Year to March 2018 $ 306 $ (294) $ 12 $ (4) $ 7 $ (57) $ (50)

Source: Australian Bureau of Statistics 5302. Seasonally Adjusted.

Unlike the Net Incomes account, the Balance of Trade has fluctuated between surplus and deficit in recent years. Exports have increased over recent years due to strong volumes from past investment in mining infrastructure. As a result, the surplus on the Balance of Trade has widened.

Current Account Balance (% of GDP per Quarter) Dec-17

Dec-15

Dec-13

Dec-11

Dec-09

Dec-07

-2%

Dec-05

-1%

Dec-03

0%

-3% -4%

Australia has previously run large deficits on the Services Account. However, growth in income from industries such as tourism and education to overseas students, has helped keep the Services Account to a small deficit in recent years.

-5% -6%

2. Foreign debt

-7%

As Australia maintains a deficit on the Current Account, there has been an ongoing need to borrow funds to finance the gap between what is earned and spent between Australia and overseas. Australia has experienced significant growth in foreign debt over the past 3 decades. In June 1980, the net external debt of Australia was only $6.9 billion or 5.8% of GDP. Following a

-8%

Source: Australian Bureau of Statistics 5302

Australia’s Current Account deficit has narrowed significantly over the past 3 years and is now at a very low level when compared with historical averages. In March 2019 the quarterly deficit was just 0.6% of Gross Domestic Product (GDP).

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period of high trade deficits, foreign debt levels increased markedly over the 1980s before stabilising in the mid 1990s. Debt then accelerated again over much of the past decade, before stabilising over the past three years due to the lowering of the size of the Current Account Deficit.

External stability outlook

Since the 1990s, Australia’s external stability has not been a matter of significant concern. In contrast to many other developed nations, the economy has experienced consistent growth, Government debt has been relatively low and the currency relatively strong. However, discussed below are some factors that could potentially cause future disruption to external stability.

In March 2019, the value of the net foreign debt was equivalent to 57.3% of annual GDP. This represents a pull-back from the cyclical high of 61.7% reached in June 2016.

(i) The vicious trade deficit – debt circle Even if Australia experiences ongoing surplus in its Balance of Trade, the high foreign debt means any further significant improvement in the Current Account deficit will be difficult. This is because the high debt creates interest servicing costs which drive the net income outflow on the Current Account. A “vicious circle” can therefore be created whereby high debt leads to higher interest payments, which leads to a higher Current Account deficit, requiring more debt. A rise in interest rates, or a fall in the value of the $A, could exacerbate this vicious circle.

Net External Debt (% of GDP) 65% 60% 55% 50% 45% 40% 35%

Foreign Liabilities Net Foreign Debt Net Foreign Equity Owing Total Net Foreign Liabilities

$ Billion in March 2019 $1,099 -$ 133 $ 966

Source: Australian Bureau of Statistics 5302

% of Total 114% -14% 100%

Over recent years Australia’s Terms of Trade has been at relatively high levels. None-the-less, the Australian economy is vulnerable to downward shifts in the Terms of Trade, with commodity prices historically quite volatile. The chart below highlights the cyclical nature of the Terms of Trade. Australia's Terms of Trade Index (2016/17 = 100) 150 130 110 90 70

Mar-18

Mar-16

Mar-14

Mar-12

Mar-10

Mar-08

50

Mar-06

However, not all the finance coming into Australia is in the form of borrowing. Finance can also be in the form of equity investments (which tend to be purchases of Australian property or shares by overseas entities). Unlike borrowings, equity investments do not add to debt. Currently, all of Australia’s net foreign liabilities are in the form of debt rather than equity. Australia currently has more equity investments overseas (e.g. overseas shareholdings owned by Australians) than it has equity liabilities (e.g. shares of Australian companies owned by foreigners). This is shown on the table below as a net negative foreign liability equivalent to $133 billion. This is a significant change on the historical position. In the mid 1990s, net equity liabilities represented around 30% of total net foreign liabilities.

(ii) A correction in the terms of trade

Mar-04

Source: Australian Bureau of Statistics 5302

Jun-19

Jun-17

Jun-15

Jun-13

Jun-11

Jun-09

Jun-07

Jun-05

30%

Source: Australian Bureau of Statistics 5206

(iii) Weak non-mineral exports

A relative decline in non-mining related exports has made Australia’s external position more vulnerable to a downturn in the mining sector. Between the year to March 1999 and 2019, rural items have dropped from representing 25% of goods exported to 14%. Over the same period, manufacturing exports have fallen from being 29% of the total to 14%.

Topic three: Unemployment Australia’s prolonged period of uninterrupted economic growth has kept unemployment at low to moderate levels for the majority of the past two decades. However, although having fallen over the past 4 years, unemployment is still only slightly below the average of the past decade.

Unemployment & Age 16% 15-24 15-24

12%

8% 25 & Over 25 & Over

4%

0% 2009

Unemployment Rate %

2019

7

Source: Australian Bureau of Statistics 6202. Month of May.

Unemployment and location

6

5

Jan-19

Jan-18

Jan-17

Jan-16

Jan-15

Jan-14

Jan-13

Jan-12

Jan-11

Jan-10

Jan-09

Jan-08

Jan-07

Jan-06

4

Source: Australian Bureau of Statistics 6202

After reaching a low of 4.0% in February 2008, Australia’s unemployment rate gradually increased following the GFC, reaching 5.9% in mid 2009. The unemployment rate then declined back to 4.9% in December 2010 before rising again to over 6% in 2015. A decline over the past 4 years sees the current rate of unemployment at 5.2%. The table below shows that over the past decade there has been a solid rise in the number of workers employed, with a smaller rise in the number of unemployed workers. Month - May (000s) Workers Employed Workers Unemployed Unemployment Rate

2019 12,868 705 5.2%

2018 12,508 712 5.4%

2009 10,733 665 5.8%

Source: Australian Bureau of Statistics 6202

Unemployment and age Unemployment remains considerably higher for younger members of the workforce than for the general population. Of those in the workforce and aged between 15 and 24, some 11.9% were unemployed during May 2019. Although this rate of unemployment is below a cyclical peak of 14.4% in late 2014, it is significantly higher than the pre GFC level of approximately 9%.

As the table below shows, unemployment is at similar levels across most of the states of Australia, with the two territories and NSW enjoying the lowest rate and Tasmania having the highest. Unemployment by state NSW 4.4% SA 5.8% VIC 4.7% TAS 6.6% QLD 6.0% ACT 3.9% NT WA 6.2% 4.5% Source: ABS 6202. Trend Series for May 2019.

Generally, unemployment is lower in the capital cities than in regional areas. The increased metropolitan employment opportunities have been one factor driving a long-term population shift to Australian cities. The mining boom did lead to a surge in employment in many of the non-metropolitan regions in Western Australia and Queensland. However, this trend has reversed over recent years. Long term unemployment Long term unemployment, covering those out of work for more than one year, is less responsive to shorter term fluctuations in economic cycles. Trends in long term unemployment tend to lag movements in total unemployment. The longterm unemployment ratio (i.e. long term unemployed as a percentage of all unemployed) has fallen slightly over the year to May 2019, from 25.2% to 24.2%. This rate is well above the cyclical low of 12.2% recorded in April 2009.

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A reduction in hours worked per employee can reflect a rise in “underemployment.” It may also reflect longer term structural (rather than cyclical) changes, with a shift from full-time to part-time employment. As indicated on the above chart, hours worked per employee has been on a declining longer-term trend.

Underemployment Excluded from the unemployment numbers are those workers who work part-time hours but have a desire to work more hours than is offered by their employer. These workers are referred to as being “underemployed”. In May 2019, the percentage of the workforce reported as underemployed was 8.6%. This rate has marginally increased over the pa...