Economic historians and academics specialising in finance
and macroeconomics have been and will continue to be the main beneficiaries of
the financial crisis. Academics are
still debating the causes of the Great Depression; one can easily extrapolate
that academics will be publishing journal articles debating the antecedents of
the 2008 Great Recession in 2100 and beyond.
Skeptikoi believes that another phenomenon associated with
the financial crisis has not been as well documented as persistently high
unemployment; the Great Disinflation. Inflation
and inflation expectations have dropped below the central bank target levels in
most developed countries since around 2008.
In the United States, the core CPI (which excludes food and energy) has
followed three distinct phases in the past decade. From 2003 to mid-2008, the core CPI expanded
at annualised rate of 2.3%. This dropped
to 1.1% in the two years to September 2010 and has posted compound annual
growth of 1.9% since then.
Australia’s disinflation also commenced around the time of
the collapse of US investment bank, Lehman Brothers. The trimmed mean CPI – which excludes items
in the CPI basket that experience the most extreme movements – grew at a
compound annual rate of 4.3% from March 2007 to September 2008 before slowing
to 3.2%pa from September 2008 to March 2010.
Since then, the trimmed mean CPI has grown at 2.2%pa. So for three years now, underlying inflation
has remained at the bottom end of the Reserve Bank of Australia’s (RBA) target
range. This should come as little
surprise considering that the RBA’s excessively tight monetary policy coincided
with Australia’s deepest nominal recession in over two decades; nominal GDP
posted average annual growth of 2.5% in the 2013 financial year.
Labour market developments do a pretty good job of explaining
Australia’s disinflation. Nominal unit
labour costs – which are a measure of productivity adjusted wages – are
currently at the same level as they were in September 2011. Excluding the financial crisis, this
represents the longest period of stability since the late 1990s. The unemployment rate of 5.6% remains close
to the financial crisis trough and has climbed by close to 15% in the past two
years, the largest proportionate rise in over a decade, excluding the crisis.
Later this week, the release of Australia’s September
quarter CPI will once again bring into focus the RBA’s policy
deliberations. The consensus forecast
points to a 0.6% rise in underlying inflation.
The deprecation of the Australian dollar represents some upside risk;
the Trade Weighted Index fell by an average of 7% in the September
quarter. But movements in the currency
have become less reliable than labour market developments in explaining inflation
trends in recent years, possibly reflecting the strength of competitive
activity at the retail level.
Some commentators have suggested that the easing cycle is
over and are forecasting that the RBA will raise the overnight cash rate (OCR) as
soon as in the first half of 2014. A
number of recent developments have brought the RBA some time. On the local front, there has been a
post-election bounce in business confidence and auction clearance rates remain
high in Sydney and Melbourne. Meanwhile,
there is growing evidence of a synchronised recovery in world growth; the
chances of a hard landing in China have diminished, renewed vigour in
quantitative easing is having the desired effect in Japan (Abenomics) and the
United Kingdom (Carneynomics), economists are no longer downgrading growth
prospects in Europe, and have recently started to upgrade their forecasts, the
US recovery remains modest but on track, with tail risk of a default on
Treasuries having reduced for now, and the deferral of tapering has stemmed the
flight of capital from emerging markets.
But Skeptikoi believes that the RBA’s easing cycle is not
over. The prospect of a synchronised
recovery in the world economy is a welcome development for a small open economy
like Australia’s, and should help to support commodity prices and the terms of
trade. But the renewed appreciation of
the Australian dollar is already mitigating part of the stimulatory benefits of
improving global conditions. And mining
companies are unlikely to kick-start large capex programs, having sought to
educate the market over the past year of their new 'laser like' cost focus.
Despite the recent significant improvement in business
confidence following the Coalition’s decisive victory at the September
election, the renewed cost discipline that pervades the corporate sector will
keep in check growth in capital investment.
Feedback from the ASX200 companies is that they remain focused on cost
containment, the deferral of growth options where feasible and the return of
capital to shareholders to cater to the market’s insatiable appetite for
income. Consequently, dividend payout
ratios remains close to a record high, no mean feat for a country that already
had among the highest payout ratios in the world due to the low effective tax
rate on dividends. Of course, higher
payout ratios help to reduce the agency costs of free cash flow, an important
development in light of investors’ loss of trust in corporate governance
structures since the financial crisis.
A corporate sector that remains focussed on returning
capital to shareholders and lifting productivity to combat the prospect of
still anaemic revenue growth is good news for earnings growth and investors,
but bad news for the labour market and nominal GDP growth. The RBA reminds us that private
sector savings rates remain at two decade highs, that business and household
sector balance sheets remain in rude health and that both have the capacity to
lift spending and withstand an adverse income shock. The RBA’s key mandate at present should be to
revive the dormant animal spirits that permeate the business and household
sectors by further easing monetary policy.
But their reluctance to do so appears to stem from the misguided notion
that persistently low interest rates would stoke a future property bubble and
undermine financial stability.
