Why raising the minimum wage isn’t the best way to reduce inequality

From The Conversation.

Walmart is giving more than one million of its employees a raise later this month as part of a plan that will lift all but its newest hires to at least US$10 an hour.

The move, first announced last year, follows an aggressive campaign to get the largest private employer in the U.S. to lift worker wages and coincides with a nationwide push to raise federal and state minimum wages and a prolonged period of little growth in pay.

While Walmart’s decision is at least in part a result of that pressure, it’s still the action of a private company to revamp its own wage policies, as opposed to the result of a government forcing it to lift worker pay. Proponents of requiring just that argue raising the minimum helps reduce inequality. Critics contend it can actually worsen it by driving up unemployment and weakening economy-wide labor market flexibility by raising the costs firms face.

So what does the economic research say about the impact of minimum wages on income inequality and is there a better way to reduce it?

Minimum wage fallacies

Many of the articles in the mainstream press promoting minimum wages are incompatible with basic economic principles.

The first fallacy is that changes in the minimum wage do not affect the behavioral response among firms and individuals. The second fallacy is that higher wages will force companies to innovate in order to reduce costs. Both these arguments overlook some very basic, but informative, economic principles.

The first overlooks the fact that wages are designed to compensate workers for productivity. When wages are distorted, they affect the profit-maximizing decisions that businesses make. The textbook prediction, which is generally supported in the data, is that higher minimum wages reduce employment since companies restrict the number of workers they will hire. These adverse effects are especially likely given the pace of technological change and automation.

The second overlooks the fact that there are effective and ineffective ways to stimulate innovation among businesses. The idea that making hiring more costly will spur innovation is tantamount to requiring companies to reduce the size of their physical presence so they become more productive. While these types of distortions may prompt a small fraction of companies to innovate, misallocation more generally is a major factor behind cross-country differences in productivity.

Protests like these may have helped persuade Walmart to raise wages. Reuters

Minimum wage and inequality

Nonetheless, economists themselves have debated how minimum wages affect employer decisions for many years.

In 1994, economists David Card and Alan Krueger were the first to provide some evidence that such effects may be small. But more recently, a consensus has generally emerged that changes to minimum wages have strong effects on jobs growth.

How minimum wages affect inequality, however, remains controversial. Detecting it with standard statistical methods is very challenging because their full effects are constantly changing and require data on both individuals and companies.

Back in 1999, Princeton economist David Lee used the Consumer Population Survey (CPS) from 1979 to 1989 to argue that the declining purchasing power of the minimum wage largely explains why inequality surged in the 1980s.

Other new research, however, has put that conclusion in doubt. Perhaps the most conclusive reassessment comes from economists David Autor, Alan Manning and Christopher Smith earlier this year. Using many more years of microdata from the CPS, as well as a different statistical approach, they found that the minimum wage explains at most 30 percent to 40 percent of the rise in wage inequality among the lowest earners.

Since economists had thought that changes in the minimum wage could explain as much as 90 percent of the shift in inequality, these new estimates are important.

How wages affect worker behavior

While the extent is still uncertain, it’s clear that the minimum wage and other wage-setting forces such as tax rates and union bargaining power do in fact affect inequality and the labor market.

My own ongoing research, which focuses on the link between such wage-setting mechanisms and company behavior, suggests labor-market distortions like raising the minimum wage can have other negative effects on workers, businesses and inequality beyond the overall impact on employment.

The first adverse effect concerns how much people work. If, for example, worker wages rise due to a government mandate, the employer may reduce the number of hours staff work, leading to lower paychecks even after the raise. That’s part of the reason why we’ve seen companies like McDonald’s increasingly try to automate tasks that were once held by people.

In addition, my research suggests one of the major ways people acquire new skills is by spending more time at work. Thus policies that lead to fewer hours could lower employees’ ability to improve their long-run earnings potential.

The second is an indirect effect on the way businesses invest in workers and design compensation and organizational policies. When companies are forced to pay higher wages, they may offset the cost by reducing how much they invest in workers. There is evidence that minimum wage laws have this effect.

This can result in weaker compensation contracts (e.g., purely salary-based), which provide employees with fewer incentives to accumulate skills. As a result, workers paid fixed wages suffer greater long-run earnings volatility than those receiving performance-based pay.

Put simply, if a recession comes and an individual loses his or her job, having more skills makes it easier to find a new position and return to the previous income level.

Minimal impact on inequality

Even setting aside all the plausible economic arguments against the minimum wage, under the best case scenario, what does it really achieve?

If the average full-time employee works 1,700 hours per year, then moving from $7.25 an hour to $9 an hour produces only about $2,975 in additional annual earnings. While some may argue that something is better than nothing, this would be at best a marginal solution to inequality.

Taking a look at the most recent 2015 Current Population Survey data and restrict the sample to full-time earners with over $10,000 earnings per year, Americans at the 90th income percentile (they earn more than 90 percent of their compatriots, or $80,000 a year) make 5.6 times as much, on average, as those at the 10th percentile ($14,200). Increasing the minimum wage to $9 an hour would put the ratio around 4.65.

In other words, even in the best of worlds – where the minimum wage has no unintended side effects – it appears to only marginally reduce inequality.

Alternatives to raising the minimum wage

Where does this leave us in trying to reduce inequality?

First, companies are welcome to raise wages at any time they want. And letting them do so may be more effective at reducing inequality than when they’re forced to because it avoids the adverse consequences such as reducing hours.

Businesses are well aware of their marginal costs and benefits – how much it costs to produce an additional unit of output versus the incremental gain. When governments set uniform wage regulations, they require all companies – each with their own and distinct marginal costs and benefits – to abide by the same rules. In contrast, when companies decide to change their own pay practices – as Walmart is doing – they do so in a more efficient way.

Second, as Stanford economist John Cochrane has remarked, instead of addressing the short-term problem of low wages, governments and companies can address the more structural problem: a lack of skills.

Companies and local governments can provide training programs and support for additional education, such as through community colleges, in order to equip workers with additional skills that translate into meaningful value for their companies. Investing in worker skills can lead to increased employee productivity and creativity, which in turn translates into sustained higher wages. And these benefits have broad spillover effects throughout the labor market and make sustainable gains in narrowing the gap between the richest and the poorest.

While the economic effects of minimum wage laws are very complex and a subject of scrutiny within the economics community, there are much better ways to deal with systematic challenges in the labor market. Getting more people to work, reducing the barriers for businesses to hire and encouraging the accumulation of new skills are all strategies for promoting sustainable long-term growth in wages.

Author: Christos Makridis, Ph.D. Candidate in Macroeconomics and Public Finance, Stanford University

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.

Retail Trade Flat In December – ABS

The latest Australian Bureau of Statistics (ABS) Retail Trade figures show that Australian retail turnover was relatively unchanged (0.0 per cent) in December 2015, following a rise of 0.4 per cent in November 2015, seasonally adjusted.

In seasonally adjusted terms there were rises in food retailing (0.8 per cent), clothing, footwear and personal accessory retailing (1.1 per cent) and department stores (0.1 per cent). Household goods retailing (-1.0 per cent), other retailing (-0.9 per cent) and cafes, restaurants and takeaway food services (-0.5 per cent) fell in December 2015.

The fall in household goods retailing was the largest of any industry in December. This fall follows large rises in recent months which have contributed significantly to stronger rises in total retail turnover. Despite the fall in December this industry maintains the strongest growth rate of any industry compared to this time last year, rising 6.3 per cent compared to December 2014.

In seasonally adjusted terms, there were rises in the Australian Capital Territory (2.4 per cent), Queensland (0.2 per cent), New South Wales (0.1 per cent), South Australia (0.2 per cent) and the Northern Territory (0.3 per cent). There were falls in Western Australia (-0.6 per cent), Victoria (-0.1 per cent) and Tasmania (-0.6 per cent).

The trend estimate for Australian retail turnover rose 0.3 per cent in December 2015, following a 0.3 per cent rise in November 2015. Compared to December 2014 the trend estimate rose 4.0 per cent.

Online retail turnover contributed 3.0 per cent to total retail turnover in original terms.

In seasonally adjusted volume terms, turnover rose 0.6 per cent in the December quarter 2015, following a rise of 0.5 per cent in the September quarter 2015. The largest contributor to the rise was Household goods retailing which rose 2.5 per cent in seasonally adjusted volume terms in December quarter 2015.

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.

Dwelling Approvals Fall For The Eighth Month Straight

Australian Bureau of Statistics (ABS) Building Approvals show that the number of dwellings approved fell 0.1 per cent in December 2015, in trend terms, and has fallen for eight consecutive months. Building-Approvals-To-Dec-2015
Dwelling approvals decreased in December in the Australian Capital Territory (21.9 per cent), Western Australia (3.1 per cent), Tasmania (0.8 per cent), New South Wales (0.4 per cent) and South Australia (0.4 per cent) but increased in the Northern Territory (1.8 per cent), Victoria (1.6 per cent) and Queensland (1.1 per cent) in trend terms.

In trend terms, approvals for private sector dwellings excluding houses fell 0.1 per cent in December. In contrast, approvals for private sector houses rose 0.1 per cent. Private sector house approvals rose in Queensland (0.8 per cent), Victoria (0.7 per cent) and South Australia (0.5 per cent) but fell in Western Australia (1.8 per cent) and New South Wales (0.2 per cent) in trend terms.

The seasonally adjusted estimate for dwelling approvals rose 9.2 per cent in December following a 12.4 per cent fall in November. The rise in December was driven by dwellings excluding houses (13.5 per cent). The largest state contribution to the rise in total dwellings in December came from Victoria (37.4 per cent).

The value of total building approved rose 0.2 per cent in December, in trend terms, after falling for four consecutive months. The value of residential building rose 0.1 per cent while non-residential building rose 0.4 per cent.


Four key economic trends shaping society

From The Conversation.

The year is off to a turbulent start; both in the UK, and around the world. January saw oil prices plummeting, while Chinese growth slowed, spooking investors (but surprising none). But amid the turmoil and confusion of global stock markets, there are a few economic trends which look set to hold sway throughout 2016.

Here’s a wrap up of some of the key developments which will shape our society in the months to come.

Employment for women

Many developed economies are experiencing a rise in total employment. And in most cases, it comes down to one critical factor: the growing number of women joining the work force. This represents one of the biggest social changes of modern times. For example, in the UK, the employment rate for women is the highest since records began, at 68.8% – in part due to the ongoing equalisation of men and women’s retirement ages.

Of course, there are still huge discrepancies between the economic rights and opportunities available for women across the globe. But ultimately, nations where women do not work lose out. Research shows that women’s skills in the labour force add much value to a national economy. Granted, this is partly related to the low pay and promotion inequality facing women, and more progress is needed to address these issues.

Women at work. from www.shutterstock.com

Expect to see women’s employment continuing to rise, and to be associated with economic growth and wider social benefits, despite global economic challenges. In 2016, countries and organisations that give positive employment opportunities to women will have greater chances of doing better, even in tough times.

The debt trap

While women’s employment may inspire hope in today’s challenging economic environment, credit and debt trends offer less reassurance. After the financial crisis, governments and central banks busted a gut to pump money into the banks and get them lending. But there is currently a feeling of déjà vu – as though the world could very easily experience another credit crisis in 2016. There are two clear signs: one in the UK, and one abroad.

Carney’s conundrum. Pool/Reuters

The first one is that premier league central banker Mark Carney – who transferred from Canada to the Bank of England as the ultimate master of inflation – now has a curious problem. He cannot find any inflation to master.

A little inflation is good for the economy, a bit like one glass of wine a week for health. The UK economy currently gets nowhere near its target of 2%. Inflation would decrease the value of current debts, making them less of a burden. In a world without much inflation, it is hard to get wages up. The worse case scenario is that debt costs increase, as prices and wages stagnate.

Elsewhere, the small interest rate rise in the US has made credit more expensive for many. Businesses in rapidly developing countries, which borrowed when the dollar was cheap, look vulnerable. For countries tied into dollar-based lending, there’s cause to fear the appreciation of the dollar against their local currency.

Expect debt statistics to go on spooking commentators throughout 2016. Look for a different policy approach that tries to kick start credit via governments and central banks. New strategies will be needed to get money to the parts of the economy that can enhance productivity and pay real, long-term rewards, such as renewable energy. Better this, than for credit to inflate existing assets such as current housing stock, or company merges and acquisitions.

A transport boom

Speaking of productive growth – transportation has been a key growth area in the world economy, and looks set to continue on this path.

In the UK, the railways have been a growth area for two decades, with more investment planned, albeit not without political pitfalls. And China has seen extraordinary growth in high speed rail development and use.

Meanwhile, air transportation grew globally in 2015 and “hub” countries such as the UK and Gulf States benefit from this. Low oil prices make flights cheaper and encourage growth. Air transportation in the UK is ripe for expansion, but is linked to a difficult political decision over London’s runways.

Business is booming. from www.shutterstock.com

Global car sales continue to rise at a time when oil is cheap. And while the number of electric cars grew more rapidly in 2015, they still represent a small proportion of the total.

This productive growth in transportation has to be debated alongside the need for the uptake of greener technology. Many governments know the ultimate prize will be getting ahead with the production of electric cars and the infrastructure they require, in order to reduce pollution and improve health.

For example, the UK government just financed four UK cities to provide better charging and parking facilities for electric vehicles. In London, the mayoral candidate, Zac Goldsmith, has clearly linked electric cars with a sustainable environment and proposes financial incentives to encourage their use. Tesla in the US has invested huge amounts gambling that the electric car will become more popular. Fortune favours the brave.

Expect to see continuing growth in rail and air travel. Meanwhile, the countries and companies that invest to get ahead with electric cars and other green transport options are likely to see the biggest long term returns. Oil will not stay at $30 a barrel forever.

Young people in poverty

Another key trend is the increase in the poverty experienced by young adults. A growing number of students in the UK are exiting with greater long term debt, while Australia is implementing measures to ensure student loans are paid. In the US, student debt now stands at $1.3 trillion.

Where’s my piece of the pie? www.shutterstock.com

As well as debt, housing will be a major issue for this group. The price of property is increasing in major cities such as Sydney, Vancouver, London and New York: these markets require high deposits, and rents are rising. In the UK, this is making the generation gap worse, when it comes to wealth: those aged 50 and over own most of the UK’s asset wealth, including housing.

And in this age of austerity, these factors will work against governments seeking to reduce the welfare bill. Recent data shows that, in UK cities, growing numbers of low paid jobs have led to rising claims for welfare such as housing benefits, defeating the government’s aims to reduce spending.

These major challenges for young people prevail across most developed countries. Expect young adults to be increasingly dependent on wealth transfers from their parents to clear university debt and secure housing, while those without such support face increasing disadvantages. Only major changes in policy can prevent further inequality for this generation.

Politicians are prioritising the needs of the growing older population who are living longer. But the young are paying the price in lost opportunities and look vulnerable to further economic and social change.

Author: Philip Haynes, Professor of Public Policy, University of Brighton

Japan Goes For Negative Interest Rates

In a surprise decision, the Bank of Japan (BoJ) has announced a policy of negative interest rates in an attempt to boost the country’s flagging economy.

“At the Monetary Policy Meeting held today, the Policy Board of the Bank of Japan decided to introduce “Quantitative and Qualitative Monetary Easing (QQE) with a Negative Interest Rate” in order to achieve the price stability target of 2 percent at the earliest possible time. Going forward, the Bank will pursue monetary easing by making full use of possible measures in terms of three dimensions; quantity, quality, and interest rate”.

In a 5-4 vote, the Bank of Japan’s board imposed a 0.1% fee on deposits left with the Bank of Japan, effectively a negative interest rate, from the reserve maintenance period, which commences from February16, 2016.

The authorities hope negative interest rates will encourage commercial banks to lend more to promote investment and growth, and drive inflation higher. Latest data showed that Japan’s inflation rate came in at 0.5% in 2015, well below the BoJ’s 2.0% target.

This experiment takes Japan into new and uncharted territory.

“Japan’s economy has continued to recover moderately, with a virtuous cycle from income to spending operating in both the household and corporate sectors, and the underlying trend in inflation has been rising steadily. Recently, however, global financial markets have been volatile against the backdrop of the further decline in crude oil prices and uncertainty such as over future developments in emerging and commodity-exporting economies, particularly the Chinese economy. For these reasons, there is an increasing risk that an improvement in the business confidence of Japanese firms and conversion of the deflationary mindset might be delayed and that the underlying trend in inflation might be negatively affected”.

The Bank will adopt a three-tier system in which the outstanding balance of each financial institution’s current account at the Bank will be divided into three tiers, to each of which a positive interest rate, a zero interest rate or a negative interest rate will be applied, respectively.

1. The Three-Tier System
(1) Basic Balance: a positive interest rate of 0.1 percent will be applied With regard to the outstanding balance of current account at the Bank that each financial institution accumulated under QQE, the Bank will continue to apply the same interest rate as before. The average outstanding balance of current account, which each financial institution held during benchmark reserve maintenance periods from January 2015 to December 2015, corresponds to the existing balance and will be regarded as the basic balance to which a positive interest rate of 0.1 percent will be applied.
(2) Macro Add-on Balance: a zero interest rate will be applied A zero interest rate will be applied to the sum of the following amounts outstanding.
a) The amount outstanding of the required reserves held by financial institutions subject to the Reserve Requirement System
b) The amount outstanding of the Bank’s provision of credit through the Loan Support Program and the Funds-Supplying Operation to Support Financial Institutions in Disaster Areas affected by the Great East Japan Earthquake for financial institutions that are using these programs c) The balance calculated as a certain ratio of the amount outstanding of its basic balance in (1) (macro add-on). The calculation will be made at an appropriate timing, taking account of the fact that the outstanding balances of current accounts at the Bank will increase on an aggregate basis as the asset purchases progress under “QQE with a Negative Interest Rate.”
(3) Policy-Rate Balance: a negative interest rate of minus 0.1 percent will be applied A negative interest rate of minus 0.1 percent will be applied to the outstanding balance of each financial institution’s current account at the Bank in excess of the amounts outstanding of (1) and (2) combined.

Also, the Bank decided, by an 8-1 majority vote, to set the following guideline for money market operations for the intermeeting period. The Bank of Japan will conduct money market operations so that the monetary base will increase at an annual pace of about 80 trillion yen.

“a) The Bank will purchase Japanese government bonds (JGBs) so that their amount outstanding will increase at an annual pace of about 80 trillion yen.3 With a view to encouraging a decline in interest rates across the entire yield curve, the Bank will conduct purchases in a flexible manner in accordance with financial market conditions. The average remaining maturity of the Bank’s JGB purchases will be about 7-12 years.
b) The Bank will purchase exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) so that their amounts outstanding will increase at annual paces of about 3 trillion yen4 and about 90 billion yen, respectively.
c) As for CP and corporate bonds, the Bank will maintain their amounts  outstanding at about 2.2 trillion yen and about 3.2 trillion yen, respectively”.



Banks’ Mortgage Rate Rise hits Affordability – HIA

November’s increase in the major banks’ variable mortgage interest rate was a setback for housing
affordability, according to the latest Affordability Report from the Housing Industry Association.

HIA-Affordability-DecAffordability deteriorated by some 6.4 per cent during the December 2015 quarter. Canberra saw the most unfavourable change in affordability (-11.4 per cent), with affordability worsening by 10.5 per cent in Melbourne and by 3.3 per cent in Sydney. Darwin was the only one of the eight capital cities to see improved affordability during the quarter. Just two of the seven regional markets covered by the report saw more favourable affordability during the December 2015 quarter.

“The unilateral increase in the major banks’ variable mortgage rates which came despite the absence of
any change in the official cash rate has delivered a significant blow to housing affordability,” noted HIA
Senior Economist, Shane Garrett.

“Combined with double-digit dwelling price growth in cities like Sydney and Melbourne, the shock jump
in interest rates has pushed home affordability to its least favourable position in over three years,”
Shane Garrett pointed out.

“The affordability challenge has been compounded by the slow pace of earnings growth which means
that the buying power of households has not kept pace with dwelling prices.”

“The increase in mortgage interest rates during November was an unpleasant surprise for homeowners, and housing affordability will be damaged even further if this tactic is repeated,” warned Shane Garrett.

“Governments must play their part too. Stamp duty is a huge source of woe for those trying to come up
with the funds for a home. HIA research has shown how the typical stamp duty bill of around $20,000
eventually costs homebuyers about $50,000 over the course of the mortgage due to higher LMI
premiums and mortgage interest costs. It’s time for this inefficient tax to be addressed,” concluded
Shane Garrett.

The Budget Conundrum

John Fraser’s speech yesterday as Secretary to the Treasury, is significant because it does highlight some of the key issues driving future economic outcomes, and even our credit rating.

“The clear message is that we cannot rely on any cyclical bounce to reduce outlays as a percentage of GDP or, for that matter, the deficit. We are not in a crisis. But the Budget is rightly a focus of attention”.

“We have a structural budget problem that arose before the global financial crisis. A very substantial amount of the revenue windfall was used to lock-in long-term spending commitments”.

“Much of the deterioration in the budget position has been the result of revenue collections falling short of forecasts as we experience the flipside of the mining investment boom”.

“As a result, at 25.9 per cent of GDP, spending in 2015 16 is forecast to be close to the post-GFC peak, and could have been higher were it not for the measures taken by the Government in MYEFO”.”The Commonwealth’s interest bill has reached over a billion dollars a month. This is projected to more than double within the decade, unless action is taken to improve our budgetary position”.

“The Commonwealth achieving surpluses means that the States can run small overall deficits that they can use to finance productive infrastructure investment. This was a key conclusion of the 1993 National Savings Report commissioned by the then Treasurer, John Dawkins. In my view, this is still a sound framework for thinking about fiscal policy today. The rising structural deficits and debt give rise to intergenerational issues”.

“Around two-thirds of Commonwealth public debt is held by non-resident investors. This share has risen since 2009 and remains historically high. This, if anything, leaves Australia’s fiscal position a little more exposed to shocks in global capital markets”.

“It’s important that Australia maintain its top credit ratings, which helps to contain the costs associated with servicing public debt. Australia is one of only ten countries with a triple A credit rating from all three of the major rating agencies, reflecting our reputation for fiscal prudence”.

“But there have also been a number of policy decisions over recent years that have pushed the ratio higher: including increasing base pensions and supplementary payments, increased Defence operations and border protection spending, expenditure related to the carbon compensation package and the outcomes of negotiations around the repeal of the Minerals Resource Rent Tax. And the Government continues to face spending pressures”.

“There are many worthwhile spending programs and, every year, there are more good ideas than government resources to support them. There is also often, a mismatch between what the community expects the government to support and what they are prepared to pay for either in tax or in user charges. In framing budgets, we are really asking ourselves now and in the longer term what sort of society we want to have”.

“The ageing of Australia’s population will weigh heavily on Australia’s potential growth rate and long-term fiscal position. Demographic and broader medium-term pressures will place greater demands on government finances, making deficit and debt reduction more difficult”.

“Structural reform is critical and this includes reforming competition policy and implementing the Harper Review recomendations”.

“Improving productivity is a far more sustainable way to boost economic growth than relying unduly on an exchange rate depreciation”.

“These growth-enhancing policies also very much include tax reform. Tax is not just about raising revenue, it is also about helping to shape the economy so that we attract and deploy resources in a manner to promote long term growth. The arguments for a tax mix switch rest heavily on encouraging more jobs through a higher growth path. Tax reform is a complex issue and is very much the focus of the Government at the current time”.

NZ Reserve Bank Holds Rate

The NZ Reserve Bank today left the Official Cash Rate unchanged at 2.5 percent. The statement by Reserve Bank Governor Graeme Wheeler highlights the risks in the outlook.

Uncertainty about the strength of the global economy has increased due to weaker growth in the developing world and concerns about China and other emerging markets. Prices for a range of commodities, particularly oil, remain weak. Financial market volatility has increased, and global inflation remains low.

The domestic economy softened during the first half of 2015 driven by the lower terms of trade. However, growth is expected to increase in 2016 as a result of continued strong net immigration, tourism, a solid pipeline of construction activity, and the lift in business and consumer confidence.

In recent weeks there has been some easing in financial conditions, as the New Zealand dollar exchange rate and market interest rates have declined. A further depreciation in the exchange rate is appropriate given the ongoing weakness in export prices.

House price inflation in Auckland remains a financial stability risk. There are signs that the rate of increase may be moderating, but it is too early to tell. House price pressures have been building in some other regions.

There are many risks around the outlook. These relate to the prospects for global growth, particularly around China, global financial market conditions, dairy prices, net immigration, and pressures in the housing market.

Headline CPI inflation remains low, mainly due to falling fuel prices. However, annual core inflation, which excludes temporary price movements, is consistent with the target range at 1.6 percent. Inflation expectations remain stable.

Headline inflation is expected to increase over 2016, but take longer to reach the target range than previously expected. Monetary policy will continue to be accommodative. Some further policy easing may be required over the coming year to ensure that future average inflation settles near the middle of the target range. We will continue to watch closely the emerging flow of economic data.