Whether Australia takes the road to prosperity or stays in the slow lane depends largely on fixing productivity, according to a top Reserve Bank official.
Australia’s economy faces three possible paths forward, RBA deputy governor Andrew Hauser told a room of investors on Monday.
And which route it takes will determine how many more rate cuts mortgage holders can expect.
The central bank’s second-in-command said Australia was undergoing an unusual recovery because the economy seemed to be running hotter and unemployment remaining lower than historical trends suggested would happen after a period of high interest rates.
Because of rapid growth in demand after the COVID-19 pandemic, the Reserve Bank deliberately keeping interest rates low to preserve jobs and weak growth in supply, the economy was already growing about as fast as it could without pushing inflation up.
Australia had been experiencing its “tightest economic backdrop” to a recovery since at least the early 1980s, Mr Hauser said in a speech to the UBS Australasia Conference.
As a result, achieving the RBA’s goal of bringing inflation back to target over the medium term would require interest rates to stay relatively restrictive, he said.
But it remains unclear exactly how that will play out, Mr Hauser said.
One possibility is that inflationary pressures have been overstated. Perhaps the spike in inflation in the September quarter was entirely temporary, the labour market might not be as tight as feared or the global economy would turn south and activity slow.
That would give the central bank a bit more room than thought to cut rates further.
A second possibility is that the economy is “boxed in” by its capacity constraints and there’s little scope to grow without inflation remaining above target.
There’s some evidence to suggest the pick-up in inflation is more permanent – rises in construction costs and market services prices can be sticky, and financial conditions are no longer constraining activity.
Household spending might take off and global financial conditions, fuelled by the AI boom, prove resilient while strong iron ore prices continue to boost Australia’s economy.
“On that view, there may be little scope for demand growth to rise further without adding to inflationary pressures, and hence there may be little room for further policy easing,” Mr Hauser warned.
But if that view proved true, there was also a third track – an “escape route” – that Australia could choose to take.
To get out of its inflationary bind, Australia must find a way to grow the nation’s economic pie by boosting productivity.
Growth in productivity is already expected to bounce back modestly from current lows but the RBA only predicts it will recover to 0.7 per cent, which is lower than its historical average.
To further grow the economy’s productive capacity Australia must revive business investment, which has been flat over the past 18 months, Mr Hauser said.
“The bigger-picture challenge for the economy over the medium term, if we are to return to the sort of growth rates we have been used to, is how to create more supply capacity,” he said.
“If we fail to do so, we may find ourselves boxed in on the rail. If we succeed, we could be off to the races.”
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