Until now, extraordinary policy tools such as central bank purchases of assets (ie, quantitative easing) and negative interest rates have been deployed in economies that have struggled to deliver growth and ignite inflation. Yet, Australia’s economy is slowing, and perhaps worryingly so. After having registered 10 years through December 2018 where annualised quarterly growth averaged 2.6 per cent, the country’s GDP failed to reach that rate during any of 2019’s first three quarters.
Growth prospects are expected to only worsen as the global economy grapples with the effects of the rapidly expanding COVID-19 coronavirus. Facing both supply disruptions and demand destruction, monetary authorities have been forced to act, something illustrated by the recent Reserve Bank of Australia (RBA) 25 basis point (bps) and Federal Reserve (Fed) 50 bps rate cuts. Authorities in both countries cited the “significant effect” that COVID-19 would have on the global economy. Despite the RBA’s target cash rate sitting at a record low of 0.50 per cent, futures markets expect an additional 25 bps cut at the central bank’s April meeting. Should that occur, the RBA would find itself effectively at its lower bound for interest rates, thus leaving only unconventional steps as a policy lever.
Even prior to the coronavirus outbreak, the RBA under governor Philip Lowe was proactive in addressing this slowdown. Late last year he presented his ideas of what form extraordinary policy in Australia may take. While he made clear his preference for purchasing government bonds, many aspects of how such a program would be instituted – and what the economic and market ramifications would be – remain up for debate. Rather than presuming Australian-style accommodative policy would resemble that of other developed markets, one must account for factors in trade and the government’s fiscal position that would likely influence which policy prescription may ultimately be implemented.
While inroads in the US-China trade dispute and last autumn’s stabilisation of global purchasing manager indices seemed to have improved the outlook for global growth, the economic contagion sparked by the coronavirus will likely force authorities to explore policy options sooner rather than later.
Headwinds vonverging
Acutely threatening Australia’s run of uninterrupted economic growth was 2019’s slowdown in global trade. With China in the crosshairs of US tariffs, suppliers of raw materials to the world’s second-largest economy and main manufacturing hub felt the second-derivative effects of the trade dispute. Yet the trade war only intensified the headwinds emanating from China, namely already slowing economic growth and authorities’ attempts to rein in that country’s recent debt binge. The spillover into Australia’s economy has been evidenced in both coal and iron exports to China well off their 2017 highs. With economists forecasting dramatically lower Chinese GDP growth in the first and second quarters of 2020, the Asian giant will continue to cast a long shadow over Australia’s economy.
Other factors negatively impacting Australia’s economic prospects are domestic in nature. Household debt as a percentage of GDP is among the highest in the world, eclipsing the levels found in the US, UK and Canada. Housing debt as a percentage of housing assets has recently climbed, hinting that consumers’ ability for additional borrowing may be limited. Over the past two years, non-mortgage consumer lending has trended downward, perhaps signifying a shift toward deleveraging. And given the interconnectivity of global markets, Australia is not immune to the low-growth, disinflationary forces that have hampered other advanced economies. Foremost among these are poor demographics and the deflationary effects of technology.
Reigniting growth
Faced with this backdrop, the RBA has set about identifying countercyclical tools that could be deployed to combat a further slowdown in the economy. With a decade’s worth of case studies provided by advanced economies that have implemented unconventional policy, the RBA has plenty of options to examine. In seeking the appropriate policy, Australian policymakers need to clearly identify their objectives. At the highest level, it’s to spur economic growth. The manner through which it would seek to accomplish this is most likely credit expansion.
Unlike what was experienced by many advanced economies in the throes of the global financial crisis (GFC) when lenders were afraid to deploy capital, Australia’s current problem is a lack of demand for credit. Illustrating this is the considerable slowdown in borrowing by businesses that has occurred over the past year. To remedy this lack of demand, the RBA must set about creating the conditions in which companies view taking on additional debt as an attractive proposition. Perhaps the most direct way this can be accomplished is by lowering the cost of capital to a degree that new investment becomes more compelling. These projects, in turn, would allow funds to circulate into other businesses and, ultimately, translate into higher wages, thus creating a tailwind for the consumer to contribute to economic growth as well.
Daniel Siluk, portfolio manager at Kapstream Capital
In part two, Mr Siluk will discuss the right policy prescription for QE, the role the territories might play, and the limits of monetary policy.
