RBA worried about output growth assumption: HSBC's Paul Bloxham
Even the RBA is worried about it. In a key speech, delivered this week, RBA Governor, Glenn Stevens, noted that 'perhaps trend output growth is lower than the 3% or 3.25% we have assumed for many years'.
Our own estimates suggest it could be closer to 2.50-2.75%. In particular, productivity growth has slowed as the resources boom gave policymakers less impetus for reform. If the 'new normal' is, indeed, as low as we estimate, Australia will have lost over two years of possible growth by 2030. Policymakers should focus on tax and regulatory reform as well as investment in infrastructure if Australia is to be able to grow at its previous trend rates.
Implications
This story is not new. Our estimates from early 2014 suggested that Australia's potential growth rate could by then have already fallen to 'around 2.8%' (see Downunder digest: Australia's lowered potential, 22 January 2014). We recently re-ran our models and, if anything, the numbers look a little worse. In our recent report we showed that Australia's new potential growth rate could be 2.50-2.75%.
The key contributor to lower potential growth is a slowdown in productivity growth. Part of this has reflected the direct effect of the mining boom. When mining investment was ramping up, lots of labour and capital were used, but there was little measured output. Now that export volumes are ramping up, mining sector productivity is rising. But overall productivity is still sluggish, suggesting there are other (maybe deeper) factors at work.
A key problem is that the resources boom itself discouraged policymakers from reform. Blessed with income growth from rising commodity prices, policymakers saw fewer reasons to focus on reform. We have long described this as the 'curse' of the resources boom.
For the RBA lower potential growth has a number of implications. First, part of the RBA's role is to ensure monetary policy will contribute to 'the economic prosperity and welfare of the people of Australia'. If trend growth is slower than it used to be, there is less economy to share around. If potential is now 2.50-2.75%, not 3.00-3.25%, by our estimates the economy would be 7.5% smaller than it could be by 2030. That's a loss of over two years of growth. Unfortunately, there is little the central bank can do about this. Monetary policy can manage the cycle and affect demand, but has little effect on the supply potential of the economy.
Second, if potential is now 2.50-2.75%, the Q1 GDP growth rate of 2.3% y-o-y, is not far from trend. This helps to explain why the unemployment rate is already steadying. It also helps explain why underlying inflation is just below the middle of the target band, at 2.3% y-o-y, rather than further below it. If GDP were actually growing a percentage point slower than its trend, it would be surprising that underlying inflation was only 0.2ppts below the mid-point of the target band.
Third, if potential is lower, then the RBA may have less room to move. In this world, only a modest pick-up in growth could be expected to put upward pressure on inflation.
Overall, it would somewhat disappointing if Australia's potential growth rate has fallen permanently, particularly if lack of reform is the cause. We remain of the view that Australia has significant opportunities to grow its economy, as it is still tied to the fastest growing region in the world, Asia. The challenge is to embrace these opportunities. Policymakers should focus on tax and regulatory reform as well as investment in infrastructure if Australia is to be able to grow at close to its previous trend rates.
