RBA Deputy Governor Philip Lowe today described the structural change that is currently occurring in the Australian economy as a result of the commodities boom and a few other factors, including long-term demographic and income shifts (that favour growth in services over growth in goods) and shorter-term consumption changes due to the rise of the internet and greater spending caution.
Dr Lowe made four comments regarding the implications of these structural shifts for monetary policy:
- First, structural change makes assessing the balance between supply and demand in the economy more difficult.
- Second, the main role for monetary policy is to keep inflation low and stable. There is already enough uncertainty about the economy, and businesses do not need their decision making to be further complicated by adding uncertainty about the general level of prices to the list.
- Third, flexibility in the economy is important to facilitate structural change.
Any significant impediments to the movement of labour and capital between industries and regions will likely “increase the short-run trade-off between inflation and unemployment”. (Note, on this important point, we discussed the likelihood of higher ‘structural’ unemployment in our Australian Economics Weekly, 7 October 2011.) Monetary policy cannot influence the degree of flexibility in the economy.
- Fourth, a high currency, as with the relatively high interest rates by the standards of other developed economies at present, is broadly consistent with the large shift in world relative prices due to the emergence of Asia as an economic force. The high AUD is helping with the task of keeping inflation under control.
However, Dr Lowe also acknowledged that portfolio flows are affecting the currency at present, and “we need to be alert to the possibility that portfolio flows could push up the exchange rate too far”.
He said that the labour market is an important indicator of whether the currency is too high.
“If the unemployment rate were to rise persistently, it might suggest that the contractionary effect of the high exchange rate was more than offsetting the expansionary effect of the investment boom and the terms of trade. If this were to turn out to be the case, monetary policy would have the flexibility to respond provided the inflation outlook remained benign.”
According to ANZ Bank, the key implication is that, in gauging the net impact of the terms of trade boom on the Australian economy and how monetary policy should react, the labour market remains a key barometer.
The unemployment rate and the ANZ job ads series remain key data to watch. That having been said, in the near term, the RBA appears to remain comfortably on hold.