The RBA Governor today delivered his twice year testimony to the Australian Parliament. The central bank appears to have waved the white flag on Australia's growth prospects, with the Governor hinting that it had revised down the economy's potential growth rate. Mr Glenn Stevens cited that the economy had expanded by around 2.5% in the past year and that 'real GDP is expanding at pace a bit lower than what we used to think of as normal'. This might explain why the RBA has been a reluctant rate cutter at a time when animal spirits in the corporate sector have been dormant.
A good deal of the testimony was devoted to the puzzle of reconciling strong labour market conditions in the past year and the associated reduction in the unemployment rate to below 6% with record low wages growth and weak growth in GDP. Mr Stevens suggested that benign wages growth is encouraging firms to lift hiring. This may well be the case, but I suspect that an expansion in the supply of labour has probably played an important role.
Mr Stevens is right to highlight the persistent weakness in unit labour costs is contributing to stronger growth in employment. Productivity adjusted wages or wages per unit of aggregate output have not risen for four years (see chart). In the past three decades, there have only been two other episodes where unit labour costs have been stable: the recession of the early 1990s and the latter part of the same decade. It is noteworthy that these periods were associated with tight money.
A salute to corporate Australia's resilience
The Governor has previously bemoaned what he considers to be the absence of entrepreneurial risk taking, but corporate Australia's belt tightening, restructuring and trend towards corporate clarity have helped to boost efficiency, restrain growth in unit labour costs and ultimately facilitated a strong employment recovery in the past year. This behaviour represents a rational response to what has been one of the largest negative terms of trade shock in Australia's history; the ratio of the prices the country receives for its exports relative to the prices it pays for its imports has declined by one third in less five years. Yet, corporate profitability has been remarkably resilient, falling by less than 10% over this period (see chart).
RBA Governor leaves the door further ajar for more monetary stimulus
The Governor re-iterated the central bank's easing bias, drawing attention to the fact path the inflation outlook does not pose an obstacle to further monetary stimulus if deemed necessary to support demand. In contrast to the Governor's last testimony in September, Mr Stevens did not cite concerns that very low interest rates could foster a worrying debt build-up, nor did he refer to the macro-prudential measures implemented by APRA to maintain sound lending standards. This suggest that central bank has left the door further ajar for more monetary stimulus.