CANBERRA: Australia’s monetary policy is being challenged by an apparent lack of spare capacity in the economy, Reserve Bank deputy governor Andrew Hauser says, a week after policy makers signalled an extended interest rate pause.
Recent data showed unexpectedly stubborn inflation and inching-up unemployment underscored the need for investments and higher productivity, Hauser said yesterday in the text of a speech that was heavy on horse racing analogies following last week’s Melbourne Cup.
“The bigger picture challenge for the economy over the medium term, if we are to return to the sort of growth rates we have been used to, is how to create more supply capacity,” he said.
“If we fail to do so, we may find ourselves boxed in on the rail. If we succeed, we could be off to the races.”
The comments come as the Reserve Bank of Australia (RBA) left interest rates unchanged at 3.6% earlier this month, following three cuts this year, and signalled a higher bar to further easing due to a combination of lingering inflation pressures and a steady job market.
Money market pricing implies a strong chance of one more rate reduction next year.
Australian policymakers have been boxed in by a sharp acceleration in underlying inflation to 3% last quarter – half a percentage point above the RBA’s August forecast – and unemployment unexpectedly rising to 4.5% in September.
As a result, they have adopted a neutral policy stance. By contrast, the US Federal Reserve lowered borrowing costs for a second consecutive meeting last month.
Policy makers are grappling with the consequences of a combination of rapid demand growth in 2021-22, the RBA’s deliberately cautious strategy of raising rates slowly and by less than global counterparts, and weak growth in supply capacity.
In comments during a question-and-and-answer session, Hauser said while credit growth has picked up in recent months, measures of leverage in the household and to an extent business sector aren’t really “screaming out” so it’s a balanced picture in the economy.
The central bank’s estimate for potential growth fell to 1.5% per annum in the five years to 2025 from 2.5% a year in the decade before the pandemic, he said.
Policy makers expect it to pick up to around 2% in each of the next two years.
That, together with the absence of spare capacity and sticky inflation, poses challenges for policy making, Hauser said. He set out three scenarios that may play out for the economy:
Hauser described some components of the recent inflation spike as “temporary” and insisted that Australia is unlikely to face stagflation – a period of rising unemployment and persistent inflation.
“It’s a central bank’s nightmare,” Hauser said when asked if the RBA would look through inflation and start supporting growth if a stagflation scenario were to unfold.
“My first response is that it’s not our central projection.”
He said it’s a “difficult question” to answer as “it’s not a situation that we particularly want to be in and it’s not a situation we think we are likely to be in at the moment. — Bloomberg
