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RBA’s Latest Statement Raises Two Interesting Questions

The latest Statement of Monetary Policy, released today, continues to tell the now well rehearsed story. Resources down, China under pressure, local growth slowish, and transitioning from mining, sort of working, whilst home lending continues to grow at above 7% annually. But they kick around two interesting issues. First, why is the unemployment rate so good when growth is sluggish, and second why is the household savings ratio lower now?

Looking at employment first:

…strong employment growth has also been supported by a protracted period of low wage growth which, along with the exchange rate depreciation, may have encouraged firms to employ more people than otherwise. At the same time, growth in the supply of labour has increased through a rise in the participation rate, notwithstanding lower population growth. The unemployment rate declined to around 5¾ per cent in late 2015, having been within a range between 6 and 6¼ per cent since mid 2014. Nevertheless, there is evidence of spare capacity in the labour market, as the unemployment rate is still above recent lows, the participation rate remains below its previous peak and wage growth continues to be low.

Also, the low growth of wages is likely to have encouraged businesses to employ more people than otherwise. Measures of job vacancies and advertisements point to further growth in employment over the coming months. In response to this flow of data, the forecast for the unemployment rate has been revised lower. The fact that the improvement in labour market conditions has occurred against the backdrop of below-average GDP growth raises some uncertainty about the economic outlook. It is possible that the strength in the labour market data contains information about the economy not apparent in the national accounts data, or that the strong growth in employment of late will be followed by a period of weaker employment growth. Alternatively, the strength in labour market conditions relative to output growth may reflect a rebalancing of the pattern of growth towards labour intensive sectors and away from capital intensive sectors.

DFA is of the view that the growth in lower-paid non-wealth producing jobs at the expense of productive jobs is the key – more are now working in the healthcare and services sector (in response to growing demand thanks to demographic shifts), but it just moves the dollar around the system, and does not create new dollars. There is difference between being busy, and being productively (economically speaking) busy.

Turning to the savings ratio:

… after falling for more than two decades, the aggregate household saving ratio in Australia increased sharply in the latter half of the 2000s. While it has since remained close to 10 per cent – which implies that, collectively, households have been saving about 10 per cent of their incomes – the saving ratio has declined modestly over the past three years or so.

5tr-hhinconJan2016Understanding developments in the saving ratio is important because changes in household saving behaviour can have implications for the outlook for aggregate consumption. Trends in the household saving ratio in Australia over recent years are likely to reflect a range of factors, including the effect of the boom in commodity prices and mining investment on household incomes, behavioural changes stemming from the global financial crisis, and the current low level of interest rates. Longer-term factors such as financial deregulation and population ageing have also played a role. Households’ expectations about future income growth and asset valuations, and the uncertainty around those expectations, are also relevant to their saving decisions. Many households accumulate precautionary savings to insure against an unanticipated loss of future income or unexpected expenditure (such as on a medical procedure). At the macroeconomic level, precautionary saving is likely to be particularly important if households are very risk averse or constrained in their ability to borrow to fund consumption when their incomes are temporarily low. For example, the financial crisis is likely to have made households more uncertain about their future employment or income growth and/or led them to reassess their tolerance for risk, which would have encouraged them to increase their rate of saving. Surveys at that time showed an increase in the share of households nominating bank deposits or paying down debt as the ‘wisest place for saving’, although this may have also reflected lower expected rates of return on other financial assets following the financial crisis.

The level of interest rates can also influence the saving ratio. On the one hand, the current low level of interest rates reduces both the return to saving and the cost of borrowing, which encourages households to bring forward consumption; this might explain some of the recent decline in the aggregate household saving ratio. Low interest rates also support the value of household assets, which increases the amount of collateral households can borrow against, and potentially reduces the incentives for households to save. On the other hand, the household sector in aggregate holds more debt than interest-earning assets, so cyclically low interest rates provide a temporary boost to disposable income through a reduction in net interest payments, some of which may be saved. Households also need to save more to achieve a given target level of savings when interest rates are low.

Structural changes to the Australian financial system have been important longer-term drivers of changes in household saving behaviour. Financial deregulation in the 1980s and a structural shift to low inflation and low interest rates in the 1990s allowed households that were previously credit constrained to accumulate higher levels of debt for a given level of income. This rise in indebtedness was accompanied by strong growth in housing prices and a reduction in the household saving ratio to unusually low levels. In this way households were able to support consumption via the withdrawal of housing equity.  Innovation in financial products – such as credit cards and home-equity loans – also gave households much better access to finance. The adjustment to these structural changes in the financial system appears to have largely run its course by the mid 2000s.

The ageing of the population is another longer-term influence on the saving ratio. If shares of younger and older households in the population were constant over time, the different saving behaviours of these households would not affect the aggregate saving ratio. However, Australia’s baby-boomer generation is a larger share of the population now and has been entering the retirement phase since around 2010. Because households save less in their later years, this is expected to have a gradual but long-lasting downward influence on the aggregate household saving ratio. However, a potentially offsetting influence is rising longevity, which may lead households to save more during their working years to finance a longer period of retirement.

Pop-By-AGe-BandsThe amount that each of these drivers have contributed to recent trends in the aggregate household saving ratio is unclear. It is also uncertain how they will evolve over the next few years, although the Bank’s central forecast embodies a further modest decline in the saving ratio, that reflects, in part, the unwinding of the impact on saving from the earlier boom in commodity prices and mining investment.

Using data from the DFA household surveys, we note three factors in play. First, household confidence levels still below long term trends, so we would expect households to continue to save, if they can, against perceived future risks. Second, older households hold the bulk of the savings, and they are indeed growing as a proportion of the total, so again we would expect to see a rise, not a fall in the ratio. But, the third factor, is in our view, the most significant.  That is that many are relying on income from savings, and as deposit interest rates have fallen (and alternative investment options become more risky), some have switched savings into investment property and others are having to eat into capital to survive.  The RBA’s policy settings of low interest rates, and high house prices are being reflected back in lower savings ratios.

Living Costs Growth Highest For Self-Funded Retirees

The ABS published their data on living costs by household type today, to December 2015. It is worth reading the ABS information about these indices:

The Analytical Living Cost Indexes (ALCIs) have been compiled and published by the ABS since June 2000 and were developed in recognition of the widespread interest in the extent to which the impact of price change varies across different groups of households in the Australian population.

ALCIs are prepared for four types of Australian households:

  • employee households (i.e. those households whose principal source of income is from wages and salaries);
  • age pensioner households (i.e. those households whose principal source of income is the age pension or veterans affairs pension);
  • other government transfer recipient households (i.e. those households whose principal source of income is a government pension or benefit other than the age pension or veterans affairs pension); and
  • self-funded retiree households (i.e. those households whose principal source of income is superannuation or property income and where the Household Expenditure Survey (HES) defined reference person is ‘retired’ (not in the labour force and over 55 years of age)).

A living cost index reflects changes over time in the purchasing power of the after-tax incomes of households. It measures the impact of changes in prices on the out-of-pocket expenses incurred by households to gain access to a fixed basket of consumer goods and services. The Australian Consumer Price Index (CPI), on the other hand, is designed to measure price inflation for the household sector as a whole and is not the conceptually ideal measure for assessing the changes in the purchasing power of the disposable incomes of households.

Looking at the data, we see that whilst the living costs have fallen through 2015, they are now on the rise, and self-funded retirees have the higher cost growth rate.


There are subtle differences in spending patterns and household mix which contribute to the differences. For example, self-funded retirees spend less on housing, but more on health care and recreation activities.

Table 1 from the ABS,  illustrates significant differences in expenditures, both in total and at the individual commodity group level across the household types. Although differences in incomes are likely to be a major reason for this, other factors such as the demographic make-up of the households and dwelling tenure would also play a part. For example, age pensioner households have on average the lowest number of persons per household and self-funded retiree households have a higher than average rate of outright home ownership.

Table 1: Estimated average weekly expenditure during 2009-10, Household type by Commodity group(a)(b)

Age pensioner
Other government transfer recipient
Self-funded retiree
Commodity group

Food and non-alcoholic beverages
Alcohol and tobacco
Clothing and footwear
Furnishings, household equipment and services
Recreation and culture
Insurance and financial services(d)
All groups
1 557.77
1 022.72
1 371.30

(a) Based on 2009-10 Household Expenditure Survey (HES) at June quarter 2011 prices.
(b) Figures may not add up due to rounding.
(c) House purchases are included in the CPI but excluded from the population subgroup indexes.
(d) Includes interest charges and general insurance. Interest charges are excluded from the CPI and general insurance is calculated on a different basis.

Household Debt Higher Than Ever

The latest RBA chart pack, to December 2015 was released today. Households remain under financial pressure, as shown by the updated data relating to household debt as a percentage of household disposable income continues to move higher, and well above 175% . Whilst interest rates are low, so interest paid is on average a little above 8%, this masks significant differences across household segments, and highlights the risks to households if interest rates were to rise.

6tl-hhfin Dec 2015

We also see that income growth is as at the low-end of trend in the past 20 years, and the savings ratio continues to fall. Consequently consumption is on the low-side.

5tr-hhinconNot a pretty picture.

Australian Household Debt Reaches Record Highs at $245,000

Average Australian household debt is four times what it was in 1988, rising from $60,000 to $245,000 after inflation, according to the latest AMP.NATSEM Income and Wealth report – Buy now, pay later: Household debt in Australia.

AMP-DebtThe ratio of household debt to disposable income has almost tripled, from 64 per cent to 185 per cent during the same time. Declining interest rates, low unemployment and a strong economy have driven Australians to take on more debt and at the same time cushioned the impact of repayments.

But if interest rates were to rise by 2.5 percentage points, interest payments for Australia’s most indebted households with mortgages would rise to at least 58 per cent of household income, up from the current 42 per cent. These households would need to find an extra $16,615 a year just to cover interest payments, which would increase from $43,926 to $60,541 a year. For households with mortgages and typical levels of debt, a 2.5 percentage point increase would mean debt repayments would rise from 16 per cent to 23 per cent of income, taking annual interest payments from $15,464 to $21,687, or an extra $6,223 per year.AMP-Debt-2

Other findings from the report include:
• Typical households headed by 30 to 50 year olds have been hit the hardest with their debt to income increasing from 149 per cent to 209 per cent during the past 10 years.
• For people aged over 65, mortgages make up almost a third of their household debt – up significantly from 20 per cent 10 years ago.
• For low-income households, debt is 43 per cent of their disposable income, almost doubling since 2004.
• The top 10 per cent most leveraged Australian households now have an average debt to disposable income ratio of 600 per cent.

Household debt in Australia has increased considerably
• In 1988, the average household could have paid off all its debt with the after-tax income it earned in eight months – it would now take almost two years.
• Australian household debt has grown at 5.3 per cent above inflation each year, outstripping income growth of 1.3 per cent.
• Australia’s most leveraged households have six times as much debt as their annual disposable income.

Australians are taking more debt into retirement
• Of the top 10 per cent most indebted households, it’s the over 65 year old households that have increased their level of debt the most – their repayments to income have almost doubled from 9 to 17 per cent.

First home buyers are taking on considerably more debt
• Rising house prices have seen first home buyers doing it tough with their debt levels at 3.6 times their annual disposable income, up from 3.1 since 2004.
• Typical first homebuyers would feel the greatest impact from rising interest rates – a 2.5 percentage point rise in rates would increase interest repayments as a percentage of disposable income from 21.2 per cent to 30.2 per cent or an extra $8,047 a year.

Lower income families have also taken on a lot more debt
• Among the top 10 per cent of indebted households, low-income households are in the most vulnerable position with their interest payments increasing from 40.8 per cent to 59.9 per cent of disposable income during the past 10 years.

The debt picture is precarious for the most leveraged households
• Australia’s debt boom has impacted all households, but it is the most indebted who have ramped up their leverage the most – for households with the top 10 per cent of debt levels, debt to income has increased from 4.4 to six times income, compared to the typical household which increased from 0.7 to 0.88 times income.

Australian households are among the most indebted in the world
• Australian households have the fifth highest debt levels in the world, with more average household debt than comparable economies like Canada.

Mortgage debt is highest for households headed by a 30-50 year old and over 65s have the most investor debt
• Home mortgages make up almost 63 per cent of debt for households headed by a person aged 30 to 50.
• Investor debt is highest for over 65 year old households at almost 60 per cent of their total debt.

Ninety per cent of Australian household debt is being used to buy a home or to build wealth through investing
• 56 per cent on mortgage and 36 per cent on investing (e.g. rental properties or shares).

Many Australian households experience financial stress
• A quarter of Australians currently experience financial stress from things like paying bills, raising emergency money or having to ask friends for financial assistance.
• Low income families experience six times the rate of financial stress than higher income families.

Single parents face significant financial stress
• Nearly two in three single parents are facing at least one financial stress, compared to just 13 per cent of couples who have children.
• Single parents are 10 times more likely to be experiencing at least three forms of financial stress compared to couples with children.

Regions with the highest typical repayment to income are in the outer suburbs of Sydney, Perth and Melbourne
• For households with the top 10 per cent of debt, it’s the inner city suburbs of Sydney, Perth and Melbourne with the highest repayment to income.

Tasmania and NSW households have the greatest share of mortgage debt
• As a share of debt, mortgage debt is highest in Tasmania, with almost 66 per cent of household debt tied to mortgages and New South Wales has the second highest level of mortgages at just over 58 per cent of total debt.
• The combined territories (Australian Capital Territory and Northern Territory) have the lowest share of mortgage debt at almost 50 per cent.
• Investor debt is highest in Australia’s territories, at 44 per cent, followed by Queensland and Western Australia at around 38 per cent each.

Of the most leveraged households (those with the top 10 per cent of debt) debt is 5.4 times household income in New South Wales, but Western Australia leads the way with debt levels at 6.1 times household income
• Highly leveraged households in the combined territories carry debt levels 5.7 times annual income and for Queensland households debt comes in at 5.5 times income.

Regions with the highest typical debt repayment burden are found in the outer ring suburbs of major capital cities
• Looking at households with typical repayments in each region, households in northern Perth are the most burdened with interest repayments at $15,100 per year or 14 per cent of disposable income. A 2.5 percentage point increase would push up repayments by $6,400 a year.

AMP publishes these reports to help the community make informed financial and lifestyle decisions and to contribute to important social and economic policy debate.

‘Catch up’ super contributions: a tax break for rich (old men)

From The Conversation.

It’s no secret that our superannuation system is unfair. Over half the value of the tax breaks goes to the top 20% of income earners, people who already have enough resources to fund their own retirement.

As shown in our new report for Grattan Institute, Super tax targeting, the system provides overly generous opportunities to contribute to super. These opportunities are usually defended on the grounds that people with broken work histories, especially women returning to work, can “catch up” before retirement. Super lobby groups make a lot of noise about middle-income people scrambling to build a decent nest egg for retirement, and our super system bends over backwards to help them.

But it’s hard to find many middle-income earners in real life who make large voluntary contributions to super. Instead the system mainly creates large tax-planning opportunities for many more people who already have enough resources to fund their own retirement. The plight of catch-up contributors is the tail that wags the super dog.

Author provided

Superannuation tax breaks allow people to pay less tax on their super savings than is paid on other forms of income. Annual caps on super contributions act as a brake on the system’s generosity, and its cost. If set at the right levels, these caps prevent high-income earners from abusing generous super tax breaks to lower their tax bills.

Yet Australia permits larger voluntary contributions to superannuation than many other countries. The flat 15% tax rate is applied to contributions made from pre-tax income – delivering enormous tax breaks to high-income earners on high marginal rates of income tax. Even where superannuation contributions are made from post-tax income, savers then benefit from generous tax breaks on super fund earnings, only taxed at 15%, or zero in retirement.

Catch-up contributors are a myth

All the evidence shows that very few middle-income earners, and even fewer women, make large catch-up contributions to their super funds. Only 12% of taxpayers, or about 1.6 million people, make large pre-tax contributions of more than $10,000 a year, and that includes compulsory super paid by their employer. Just 164,000 women earning less than $77,000 make such large pre-tax contributions. However 935,000 men earning more than $77,000 do so. These high-income savers get a tax break on the way in, and then pay little or no tax on their super earnings.

Author provided

Why do so few middle-income earners make large catch-up contributions? Put simply, they can’t afford to. In 2012-13, the median taxable income in Australia was $41,561. Gross incomes (before any deductions) are not much higher. More saving boosts incomes in retirement, but it reduces living standards today. This fundamental trade-off is rarely discussed in the superannuation debate.

Benefits flow to high-income earners

Not surprisingly it is mainly high-income earners who have the disposable income to put more than $10,000 a year into their super. They get large tax breaks, even though they are likely to retire with enough assets to be ineligible for an Age Pension.

The cap on post-tax contributions is even more generous. It allows people to contribute up to $180,000 per year. People under age 65 can also bring forward an extra two years’ contributions, so they can put in up to $540,000 during a single year, and that’s on top of up to $35,000 in contributions from pre-tax income.

These post-tax contributions total $33 billion a year – about three times the size of voluntary pre-tax contributions. Many post-tax super contributions appear to represent tax-planning rather than any genuine increase in retirement savings. Of all post-tax contributions, around half are made by just 200,000 people who already have at least $500,000 in their superannuation. Only 1.2% of taxpayers have total super account balances of more than $1 million, yet this tiny cohort accounts for 26% of all post-tax contributions. By contrast, the 70% of taxpayers with super balances of less than $100,000 make just 9 per cent of total post-tax contributions.

Author provided

Lifetime caps would likely make things worse, unless set at very low levels. To maximise their superannuation tax breaks, taxpayers who have not used up their lifetime pre-tax cap could sacrifice the entirety of their earnings into super. Such tax planning is likely given how super tax breaks are used already.

Counting the cost

Whatever the benefits of superannuation tax breaks, they must be balanced against the costs. Superannuation tax breaks cost a lot – over $25 billion in foregone revenue, or well over 10% of income tax collections – and the cost is growing fast. Lower-income earners and younger people have to pay more in other taxes – both now and in the future – to pay for the tax-free status of so many retirees.

The way forward

Caps on super contributions need to strike a better balance between allowing those with broken work histories to contribute towards a reasonable superannuation balance, and restricting the opportunities for tax minimisation by those unlikely to qualify for an Age Pension. That means being realistic about the level of catch-up contributions that are likely from those who are genuinely making up for broken work histories.

Grattan Institute’s new report, Super tax targeting, recommends three reforms to better align tax breaks with the goals of superannuation.

One, annual contributions from pre-tax income should be limited to $11,000 a year. This change would improve budget balances by $3.9 billion a year. There would be little increase in future Age Pension payments since the reductions in tax breaks would mainly affect those unlikely to receive an Age Pension anyway.

Two, lifetime contributions from post-tax income should be limited to $250,000. It won’t save the budget much in the short term, but in the longer term it will plug a large hole in the income tax system.

Three, earnings in retirement – currently untaxed – should be taxed at 15%, the same as superannuation earnings before retirement. A 15% tax on all super earnings would improve budget balances by $2.7 billion a year today, and much more in future.

Previous repeated changes to superannuation have been too timid. Decisive reforms must target super tax breaks at those who need them most, and limit the benefits for those who don’t need them. Until then the system will keep chasing its own tail.

Authors: John Daley, Chief Executive Officer , Grattan Institute; Brendan Coate, Senior Associate, Grattan Institute.


No Sovereign Credit Impact From Australia PM Change – Fitch

The change in Australia’s premiership following a Liberal party leadership vote held on Monday will not have an immediate credit impact for the sovereign, says Fitch Ratings. Frequent changes in leadership, with four prime ministers governing the country over the past five years, have made little difference in core economic policies so far. There is no sign that this latest transition will lead to deterioration in policymaking effectiveness.

Notably, there is cross-party consensus at the federal level in favour of fiscal consolidation – there is much less appetite in Australia relative to some other high-grade peers for abandoning efforts to reduce deficits. Recent leadership changes, including the vote against incumbent Tony Abbott on Monday, have been driven more by personality and social or constitutional issues as opposed to differences over economic policy.

Political volatility will, in general, only have a credit impact if it were to result in tangible economic policy changes, loss of foreign investor confidence, reduction in policymaking capacity and/or if it impaired the authorities’ ability to respond to a crisis. But in Australia’s case, there has been little to no signs that the recent frequent changes in power have had any such effects.

Beyond the leadership issues, Australia shares some of the long-term challenges of other high-grade sovereigns, including an ageing population and the need to foster productivity growth. The Australian economy is also facing immediate challenges linked to its reliance on commodity exports, particularly to China. High personal indebtedness – over 150% of disposable income – also means households are more vulnerable to higher interest rates and any substantive worsening in the job market. Incoming Prime Minister Malcolm Turnbull has placed some weight on the need to address long-term economic challenges in his public statements, although it remains to be seen whether this will lead to concrete policy changes.

Any further deterioration in Australia’s macroeconomic position may require more politically difficult policy decisions to keep fiscal consolidation on track. As such, continued political volatility, while not a significant issue thus far, could yet impair authorities’ ability to implement policies should economic conditions deteriorate further.

Turnbull, the minister for communications, defeated Abbott as leader of the Liberal party in a 54 to 44 vote by Liberal MPs on 14 September. Turnbull was sworn in as Australia’s 29th prime minister on 15 September.

Data indicates the recession is effectively here; it’s what policy makers do next that counts

From The Conversation.

The latest economic figures released by the Australian Bureau of Statistics (ABS) have fuelled the debate on the future of the Australian economy and prompted many to ask: “Will Australia go into a recession?”

This question is legitimate, but off the mark. In fact, the data tells us that we should not be worried about going into recession.

What we should worry about instead is how to get out of the recession. Because, like it or not, the recession is already here and the sooner we acknowledge the problem, the sooner we can start the recovery.

So, what does the data say?

According to ABS, trend Gross Domestic Product (GDP) growth in Australia in the second quarter of 2015 was 0.5%. This was only marginally below the rate observed in the first quarter of the year (0.6%). The implied annual growth rate of GDP is therefore around 2%.

While considerably below the long-term average of 3.25% a year, trend growth is still positive, which means that Australia is not technically in a recession.

Economists technically define a recession as a period of at least two consecutive quarters of negative GDP growth. This occurs rarely in an advanced economy like Australia.

The last time Australia was technically in recession was 24 years ago, when trend growth turned negative in the third quarter of 1990 and did not go back to positive until quarter four of 1991.

Before then, trend growth was negative for five quarters between 1982 and 1983, for two quarters in the middle of 1974, and for four quarters between 1960 and 1961.

However, while not being technically in a recession, Australia today shows most of the symptoms of recession.

Reload: what does the data say?

First of all, trend GDP is by construction smoothed. However, recessions (and expansions) are cyclical phenomena that are better represented by seasonally adjusted GDP.

In the second quarter of 2015, seasonally adjusted GDP in Australia grew by a mere 0.2%, sharply down from the first quarter when it grew by 0.9%. That is, seasonally adjusted data suggests that the country is much closer to the beginning of a technical recession.

Second, seasonally adjusted Gross Domestic Income (GDI) showed negative growth of -0.4%. This is particularly worrying because GDI is statistically more reliable than GDP as a predictor of the cyclical fluctuations of the economy.

Third, and probably even more importantly, indicators of an individual’s welfare are taking a turn for the worse. The second quarter of the year saw a negative growth in GDP per capita (-0.2%) and net national disposable income per capita (-1.2%).

These negative income dynamics add to persistently weak labour market performance.

The ABS labour force survey shows that in July 2015, seasonally adjusted unemployment reached 795,500 units. This is the highest level since November 1994 and approximately 125,000 units higher than at the peak of the global financial crisis (June 2009). The corresponding unemployment rate was 6.3%.

In the same month of July 2015, youth unemployment increased to 13.8%. This was the first monthly increase since the beginning of the year.

Perhaps this is not technically a recession, but certainly it looks, smells, and feels a lot like one.

Intervention needed

The government, however, seems to be in denial.

Finance Minister Mathias Cormann is reportedly “very optimistic about the outlook moving forward”. Treasurer Joe Hockey recently said that “the Australian economy is showing a deep resilience that people in Canada and elsewhere would die for.”

Unfortunately, the fact that Canada is in a technical recession and other resource intensive countries are suffering from falls in commodity prices does not make the situation of Australia any better.

Conversely, the business sector seems to have understood the reality of the situation. This is evident, for instance, in the declining levels of business confidence and conditions reported by the NAB Monthly Business Survey of July 2015.

The good thing about recessions is that, generally, they end. The bad thing, instead, is that their effects are felt proportionally more by households at the bottom end of income distribution.

Another bad thing is that the consequences of a recession (in terms of unemployment, reduced welfare for instance) tend to outlive the recession itself.

For all these reasons, some form of intervention would be desirable; but how?

In Australia’s case, the empirical evidence clearly indicates that fiscal stimulus works: for each dollar spent by the government, GDP increases by more than one dollar.

In fact, already now, what has prevented the country from recording negative GDP growth is good old Keynesian spending.

Government final consumption grew by 2.2% in the second quarter of the year and 4% since the beginning of the year. Public gross fixed capital formation increased by 4% in the second quarter.

Without this extra public spending Australia would have probably experienced its first quarter of negative growth.

Certainly, Australia also has structural problems that condition its longer-term performance and that a fiscal stimulus will not solve.

But the stimulus will improve the short-term outlook, restore confidence, and create favourable socioeconomic conditions to undertake structural reforms.

To get there, however, an initial step is required: the government must get past its denial of the problem. Let’s hope that this happens sooner rather than later.

Author: Fabrizio Carmignani, Professor, Griffith Business School at Griffith University

Middle Income Households Income Is Getting Squeezed

Data from the ABS looking at income and wealth, shows that the average income of high income households rose by 7 per cent between 2011-12 and 2013-14, to $2,037 per week, whist low income households have experienced an increase of around 3 per cent in average weekly household income compared with middle income households which have changed little since 2011-12.

The average income of all Australian households has risen to $998 per week in 2013–14, while average wealth remained relatively stable at $809,900. Similarly, change in average wealth was uneven across different types of households. For example, the average wealth of renting households was approximately $183,000 in 2013-14. Rising house prices contributed to an increase in the average wealth for home owners with a mortgage ($857,900) and without a mortgage (almost $1.4 million).

Most Australian households continue to have debts in 2013-14, with over 70 per cent of households servicing some form of debt, such as mortgages, car loans, student loans or credit cards. For example, the average credit card debt for all households was $2,700.

One quarter of households with debt had a total debt of three or more times their annualised disposable income. Mortgage debt was much higher

These households are considered to be at higher risk of experiencing economic hardship if they were to experience a financial shock, such as a sudden reduction in their income or if interest rates were to rise, increasing their mortgage or loan repayments.

The survey findings also allow comparisons of income and wealth across different types of households.

In 2013–14, couple families with dependent children had an average household income of $1,011 per week, which was similar to the average for all households at $998 per week.

By comparison, after adjusting for household characteristics, one parent families with dependent children had an average household income of $687 per week.

Australia’s economy is slowing: what you need to know

From The Conversation.

Australia’s economy grew by just 0.2% in the June quarter, below expectations of 0.4%, largely as a result of reduced mining and construction activity and a decline in exports of 3% during the quarter.

Nominal Gross Domestic Product grew by 1.8% during the year, which the Australian Bureau of Statistics said was “the weakest growth in nominal GDP since 1961-62”. Despite this, Australia has now recorded 24 straight years of growth.

The news has some analysts and economists spooked, and politicians blaming each other for the slowdown.

Treasurer Joe Hockey said:

At a time when other commodity based economies like Canada and Brazil are in recession, the Australian economy is continuing to grow at a rate that meets and sometimes beats our most recent budget forecasts.

He also said it was “factually wrong” to say it was the weakest growth since 1961.

The fact is that the economic growth we had in the last quarter was in line with expectations. Of course it bounces around from quarter to quarter, but it was in line with our overarching expectation to have two and a half per cent growth in the last financial year.

Shadow Treasurer Chris Bowen said:

Growth has flat-lined since the Abbott government’s first damaging budget last year and cost of living pressures are continuing to increase. This is the biggest quarterly decline in living standards since the global financial crisis.

This is a very weak set of figures and for the government to cast around for international comparisons to try and make it sound better is a pretty pathetic excuse.

The Treasurer says Australia is still doing better than Canada, Brazil, the US and New Zealand. How should people view these numbers in a global context? To what extent is the slowing rate of growth due to global economic headwinds, and to what extent is it due to domestic factors?

Griffith Business School Professor Fabrizio Carmignani answers:

In the past, the Australian economy has proved to be quite resilient to global economic shocks. Today we are facing what could be potentially a perfect storm.

For one thing, international commodities prices are very volatile and have resulted in a sharp contraction of Australian’s terms of trade. For another, China is going through a complicated economic phase and it is not, at this moment, the same solid anchor for the Australian economy as it might have been previously. So, it is not surprising to see that on a seasonally adjusted basis, quarterly growth in Australia has been oscillating between 0.2% and 0.3% for the last five quarters.

We owe it to some good old Keynesian stimulus on the demand side (read: government consumption and to a lesser extent public gross fixed capital formation) if we are not entering a technical recession.

The comparison with Canada, on surface, is favourable to Australia. Canada has officially entered a recession after recording two consecutive quarters of negative GDP growth in the first half of 2015. This is essentially due to low oil prices. However, according to media reports, Canada is still committed to achieving a target of annual growth of 2.5% this year, which is exactly what the Treasurer has stated for Australia. So, it seems to me that the difference between Australia and Canada here is thinner that what might appear at first sight. A fraction of a percentage point below or above the zero growth line is not really indicative of substantially different structural positions.

Both Australia and Canada are facing similar challenges in terms of diversification. The current “crisis” to me shows that these challenges are still far from being fully addressed in both countries.

Australia has had 24 years of consistent growth. How much of this can we attribute to the mining boom? And given the cyclical nature of the economy, can we expect a downturn?

Griffith University Professor Tony Makin answers:

Australia has performed relatively well compared to other OECD economies over recent decades, though did actually experience a recession during the GFC according to income and production measures of GDP.

Taking population growth into account, Australia’s economic performance since the global financial crisis has been worse than the raw GDP numbers show. On a per capita basis, national income has grown on average below one per cent per annum, less than half the almost two and a half per cent per head per annum average rate in the decade before the GFC.

The extraordinary boost to the terms of trade from the world commodity price hike, especially between 2005 and 2011, substantially raised Australia’s international purchasing power. However, GDP growth during the mining boom was actually less than during the economic reform era from the mid-1980s through to the end of the 1990s when commodity prices were fairly flat.

The main culprit for Australia’s sub-normal economic growth in recent years has not been falling commodity prices, which have undoubtedly played a role, but Australia’s underlying competitiveness problem, combined with a productivity slowdown that began from the turn of the century.

While the recent depreciation of the dollar will go some way to restoring Australia’s competitiveness and help stave off recession, genuine productivity-enhancing reform focusing on the economy’s supply side remains as important as ever for returning GDP and income per head growth to long-term average rates.

One journalist at Wednesday’s press conference said the new data showed “the weakest growth since 1961”, but the Treasurer said that was factually wrong. Who is right?

UNSW Australia Professor Richard Holden answers:

The statement that it is the slowest growth since 1961 seems, to me, to be false. We have had recessions in the 1990s and 1980s, which is two successive quarters of negative growth. And yesterday we had positive growth, so it was a slowdown but not the worst we have seen since 1961. I think the journalist’s statement doesn’t seem correct to me, on the face of it. I think the Treasurer is right.

It is possible the journalist was referring to the Australian Bureau of Statistics comment yesterday that:

GDP growth for 2014-15 was 2.4%. Nominal GDP growth was 1.8% for the 2014-15 financial year. This is the weakest growth in nominal GDP since 1961-62.

Nominal growth and growth are not quite the same thing. Nominal growth means GDP growth that is not adjusted for inflation.

But yes, yesterday’s numbers are still below projected growth. It is below market expectations. I think the Treasurer saying we have projected 2.5% annual growth this year and this is basically on target is a bit disingenuous. This is slow growth, it’s actually very troubling.

I understand the Treasurer can’t talk down the economy so his comments are understandable and he is in a difficult position. But the low rate of growth is genuine cause for concern.

I have written before about the concept of secular stagnation, which is the idea that growth of advanced economies looks like it has slowed down dramatically. The figures yesterday are further evidence of that theory.

Victoria University Senior Research Fellow Janine Dixon answers:

While it is factually correct that real GDP – the volume of production in the economy – has grown, the low growth in nominal GDP points to an underlying weakness in the economy. This is our exposure to the very large fall in commodity prices. When we translate real GDP into real income, we take into account that fact that the prices of the things we produce for export have fallen relative to the prices of the things we consume, some of which are imported. This has been a very important determinant of real incomes in the last few years.

Real net national disposable income is a better measure of our living standards than GDP. As well as adjusting for prices, we take into account the fact that some of the income generated domestically actually accrues to the rest of the world if the factors of production are foreign owned. We also deduct the value of capital that is “used up” or depreciated during the year.

Real net national disposable income per person has now fallen for 14 quarters in a row. This represents the most sustained fall in standards of living in the last 50 years.

What’s especially interesting about this period is that falling incomes have not been associated with falling output or particularly high unemployment. In the 1990-91 recession (the one we had to have) or the early 1980’s, incomes fell, but the solution to the problem was fairly clear. More than 10% of the workforce was unemployed. Fixing unemployment would boost production, incomes and living standards.

This time around, incomes are falling because commodity prices are falling. Commodity prices, set on world markets, are largely out of our hands. The labour market is much more flexible these days, and unemployment is 6%, not 10%. We are left with just one way to turn things around. In the words of Nobel laureate Paul Krugman, “Productivity isn’t everything, but in the long run it is almost everything”.

Is GDP really in line with expectations, both of the government and the market?

Griffith University Professor Ross Guest answers:

These GDP expectations are continuously being revised down as new information comes to hand.

The projected growth is lower than nearly everybody expected and everybody is having to revise downward their expectation.

What will the slowing annual growth mean for the federal budget, which had forecast growth for 2015-16 of 2.75%?

Ross Guest answers:

If growth were to remain at its current level of 2%, the budget deficit would be A$15 billion larger, in ball park terms, than the government projected. To put that in perspective, the total amount we spend on unemployment benefits is A$10 billion.

Australia living standards and the Australian government budget are being hit by a perfect storm of lower commodity prices and lower productivity growth.

Victoria University Senior Research Fellow Janine Dixon answers:

The GDP growth forecast for 2015-16 is fairly subdued at 2.75% and the budget not overly ambitious – a deficit of 2% of GDP. The trouble lies in 2016/17 and beyond, when annual GDP growth is forecast to be above 3%.

Over the next five years a couple of downside risks exist that will make it unlikely that GDP will grow this strongly, and consequently the budget’s return to surplus will be more difficult to achieve.

If the terms of trade fall further than allowed for in the budget forecasts, and if productivity growth remains weak, as it has been in recent years, real national income could be 3% lower than forecast by 2020. Roughly, this means the tax base for the government will be 3% smaller than expected. Rather than having a balanced budget by 2020, we would still be running a deficit, of around 0.75% of GDP or $12 billion in today’s terms.

The Long-Term Evolution of House Prices: An International Perspective

Excellent speech from Lawrence Schembri, Deputy Governor, Canadian Association for Business Economics on house price trends. The speech, which is worth reading, contains a number of insightful charts. Australian data is included. He looks at both supply and demand issues, and touches on macroprudential.  You can watch the entire speech.

I have highlighted some of the main points:

First, Chart 1 shows indexes of real house prices since 1975 for two sets of advanced economies. Chart 1a shows Canada and a set of comparable small, open economies (Australia, New Zealand, Norway and Sweden) with similar macro policy frameworks and similar experiences during and after the global financial crisis. In particular, they did not have sizable post-crisis corrections in house prices. For comparison purposes, Chart 1b shows a second set of advanced economies that did experience significant and persistent post-crisis declines in house prices.

Real-House-PricesSince 1995, house prices in Canada and the set of comparable countries have increased faster than nominal personal disposable income (Chart 2a). During this period, all of these countries experienced solid income growth, with the strongest growth in Norway and Sweden (Chart 2b).

Price-to-IncomeDuring the global financial crisis, these countries also experienced house price corrections. This caused the ratios of house prices to income to decline temporarily, after which they continued climbing.

One of the factors that has affected population growth rates is migration. Net migration was highest in Australia and Canada over the entire sample. In addition, net migration increased importantly in all five countries in the second half of the sample period (Chart 3b)

population-GrowthIn Australia, Canada and New Zealand, the rate of population growth of the approximate house-owning cohort of those aged 25 to 75 declined in the second part of the sample period. This likely reflects the aging of their populations as the postwar baby boom generation moved from youth into middle age (Chart 4). Nonetheless, the growth rate of this cohort still remains well above 1 per cent for these three countries.

CohortsChart 9 provides some suggestive evidence on the impact of land-use regulations on median price-to-income ratios. Many of the cities with higher ratios also have obvious geographical constraints—Hong Kong and Vancouver are good examples—so the two sources of supply restrictions likely interact to put upward pressure on prices.SupplyWhen we look at the post-crisis experiences of the countries in our comparison group, they have similar levels of household leverage, measured by household debt as a ratio of GDP (Chart 12). Household leverage has risen along with house prices, as households have taken advantage of low post-crisis interest rates. The one exception is New Zealand, where a modest degree of household deleveraging seems to have occurred. For Canada, the ratio of household debt to GDP has risen since 1975, although the growth of this ratio has notably declined since 2010. For Sweden and Norway, the ratio also grew at a modest pace in the post-crisis period. Note Australia has the highest ratios.

LeverageCharts 13a and b draw on recent work by the IMF, which shows that macroprudential policies in the form of maximum loan-to-value (LTV) or debt-to-income (DTI) ratios have tightened across a broad range of countries over the past 10 years. The IMF’s research, as well as that of other economists, has found evidence suggesting that the tightening has helped to: reduce the procyclicality of household credit and bank leverage; moderate credit growth;
improve the creditworthiness of borrowers; and lower the rate of house price growth.

The most effective macroprudential policies to date appear to have been the imposition of maximum LTV and DTI constraints. Increased capital weights on bank holdings of mortgages have also had an impact. While long-term evidence on these instruments is not yet available, permanent measures that address structural regulatory weaknesses and that are relatively straightforward to implement and supervise will likely be the most effective over time.

MacroprudentialInteresting to note that in Canada, they have had four successive rounds of macroprudential tightening, primarily in terms of the rules for insured mortgages. The maximum amortization period for insured loans has been shortened from 40 years to 25. LTV ratios have been lowered to 95 per cent for new mortgages, and 80 per cent for refinancing and investor properties. These latter two changes effectively eliminate new insurance for refinancing and investor properties. Qualification criteria such as limits on the total debt-service ratio and the gross debt-service ratio, as well as requirements for qualifying interest rates, have also been tightened.


Let me conclude with a few key points from the mountain of facts, graphs and analysis that I have reviewed with you today. As I mentioned at the outset, the purpose of my presentation is to help provide more context for an informed discussion about housing and house prices given their importance to the Canadian economy and the financial system.

First, real house prices have been rising relative to income in Canada and other comparable countries for about 20 years. There are many possible explanations, mostly from the demand side, but also from the supply side.

Second, in terms of demand, demographic forces, notably migration and urbanization, have played a role in the evolution of house prices, as have improving credit conditions through lower global real long-term interest rates and financial liberalization and innovation. There are, of course, other demand factors that warrant more data and analysis, including the impacts of foreign investment and possible preference shifts.

Third, in terms of supply, the constraints imposed by geography and regulation have decreased housing supply elasticity, especially in urban areas. This reduced supply elasticity has interacted with demand shifts toward more urbanization to push up house prices in major cities.

Fourth, the credible and effective macro and financial policy frameworks in place in Canada and the other countries considered here have contributed to a high degree of macroeconomic and financial stability. Consequently, in the face of a protracted global recovery, their countercyclical policies successfully underpinned domestic demand in the post-crisis period. The resulting strength in the housing market has increased household imbalances, but the risks stemming from these vulnerabilities have been well managed by complementary macroprudential policies.

The experience in these countries therefore suggests that macroprudential policies that address structural weaknesses in the regulatory framework are best suited for mitigating such financial vulnerabilities. They reduce tail risks to financial stability and enhance the overall resilience of the financial system.