From the perspective of equity portfolio managers, Evidente has long argued that nominal GDP or income represents a better measure of the state of the economy than real GDP because households earn nominal wages, companies generate nominal profits and governments collect revenue in nominal terms. For economists and central banks, the fixation on real GDP can be misleading. Measures of business and consumer sentiment reflect nominal income more than inflation adjusted GDP.
The National Accounts showed that nominal GDP - the dollar value of the flow of production un-adjusted for inflation - rose by only 0.6% in the September quarter. Without the big assist from the resurgence of commodity prices and the terms of trade in late 2016 and early 2017, growth in nominal GDP has now slowed considerably in the June and September quarters.
The renewed weakness is a return to the tepid income growth characteristic of most of the past six years. Nominal income growth has averaged 80 basis points per quarter since 2011, down from an average of 180 basis points that prevailed in the preceding decade (see chart). This has been the basis of Evidente's view that for much of the post-2011 period, Australia's economy has been stuck in an income recession.
Market monetarists suggest that central banks ought to abandon their inflation targets and instead target either a growth rate of GDP or a nominal level of GDP. The chart below shows that nominal GDP started to fall below the trend line (estimated back to 1993) in around 2011. On this measure alone, money in Australia has been tight for the past five to six years despite the record low cash rate.
The size of the nominal GDP gap has now widened to -15%, the largest negative gap since the financial crisis (see chart). While not shown here, the gap is comparable in size to the United Kingdom, United States and European Union. And yet, the RBA's policy rate remains well above those regions. Now that the RBA has formally added financial stability to one of the goals of monetary policy, it is difficult to envision a cut to the Overnight Cash Rate (OCR), at least while conditions in residential and commercial property markets on Australian eastern border remain robust. The central bank governor acknowledged as much recently, indicating that the next move in the OCR was more likely to be up than down.
Australia's central bank therefore appears to be condemning Australia to a continued slow income growth. Against this backdrop, the broader implications are clear. Slow wages growth is likely to persist, even in the face of further declines in the unemployment rate. Underlying inflation should continue to undershoot the RBA's target. If the RBA is determined not to cut the OCR again out of fear of undermining financial stability, interest rates are likely to remain on hold for at least another two years. Any steepening of the yield curve is likely to be short lived. Its too early to buy domestic cyclicals that are not exposed to the infrastructure boom. Animal spirits in the business sector will remain dormant as top line revenue growth will continue to be subdued, so companies will continue to boost profit margins through restructuring and trimming costs.