The impact of public sentiment on the economy
Late last week, Prime Minister Malcolm Turnbull took one of his regular turns on Melbourne radio station 3AW. Presenter Neil Mitchell opened on the economy.
“Prime Minister, arguably we’re headed for a housing catastrophe,” Mitchell began. “Tens of thousands of people could lose their houses if this happens. People are struggling to pay mortgages. The Reserve Bank has indicated interest rates could more than double to 3.5 per cent over a period of time. People could be forced out of their houses … Do you agree there’s a potential disaster?”
He was referring to the minutes of the most recent Reserve Bank board meeting on July 4. As usual, they had been made public a fortnight later – two days before Mitchell’s interview with Turnbull.
“Neil, I think that’s a bit strong,” Turnbull responded. “What the Reserve Bank has indicated is that in the future rates are more likely to go up than down.”
But he went on to warn borrowers to heed the bank board’s message.
“They’re not saying that they’re going to go to that tomorrow, but I think they’re sending a signal – which is probably prudent – which is to say: ‘Ladies and gentlemen, just be aware rates are more likely to go up than go down,’ ” Turnbull said. “… So in other words, don’t get overcommitted.”
As Mitchell insisted it was too late for that, Turnbull retorted:
“It’s not rocket science. You’ve got to be careful about not getting overcommitted and don’t assume that asset prices are always going to go in one direction. So prudence in managing your financial affairs is always important.”
But, he added: “We don’t want to be creating a sense of excessive anxiety.”
Turnbull’s debt warning was in many respects a statement of the obvious.
Nevertheless, over at the independent Reserve Bank, you could almost hear the groan.
For two days, the bank’s officials had watched the Australian dollar head in what they consider to be the wrong direction – up – off the back of those same minutes, which had unintentionally fuelled expectations of a rate rise even before the extra on-air help.
Twenty-four hours later, last Friday, deputy RBA governor Guy Debelle used a scheduled speech to try to calm things down.
“Just as the policy rate in Australia did not need to decline to the very low levels seen in other parts of the world, the fact that other central banks increase their policy rates does not automatically mean that the policy rate here needs to increase,” he said.
He was asked what role he thought government played in building confidence in the economy and summoning the positive “animal spirits” that would give it a boost.
The way he said nothing was telling.
“Being from the central bank, I’m going to happily stay right away from that question,” Debelle responded, to laughter. “That can only go not well.”
With official interest rates still historically low and international currency traders watching for worldwide hints of recovery from a long period of stagnation, public messaging is acting as a material alternative to the usual fiscal and monetary levers – impacting both positively and negatively, deliberately and by accident.
Twice now, the Reserve Bank governor, Philip Lowe, and his colleagues have clarified the bank’s own recent public remarks after what they argue was misinterpretation by commentators and currency markets.
In his speech at Adelaide University last Friday, Guy Debelle explained why the Reserve Bank board had discussed what’s known as the “neutral” interest rate, as recorded in the minutes. Some had interpreted that as meaning the official cash rate was about to rise.
The neutral rate is the level of official interest rates at which, accounting for other influences, the setting has a neutral impact – neither working to expand the economy nor contract it.
The neutral level then forms the benchmark for positioning the official rate – below the neutral rate to speed the economy up, or above, to slow it down.
At the meeting, the board heard the bank had determined the neutral real interest rate – the nominal rate adjusted for medium-term inflation – was probably now about 1 per cent, which is about 1.5 percentage points lower than it was a decade ago.
It said this equated to a nominal cash rate of about 3.5 per cent, from whence Neil Mitchell drew his ammunition.
The current nominal cash rate is 1.5 per cent and the board ultimately decided to leave it there for the time being.
But when the minutes were published last Tuesday, the reference to the neutral rate was seen to signal a coming rise, meaning the economy was taking off. The dollar rose sharply as a result.
The traders were also looking to recent activity in other economies – the United States, Britain and especially equally commodities-dependent Canada, where rates had risen – and watching for the next country to move. To the exasperation of RBA officials, they decided Australia was it.
It’s hardly the first time public comments have moved the markets.
In 1986, then treasurer Paul Keating’s now-famous throwaway line – also delivered on commercial radio – about Australia risking becoming a “banana republic” sent a shudder through the financial sector.
The following year, he delivered an unwitting boost when he responded to a journalist’s question about the overnight sharemarket crash on Wall Street. Keating confessed years later he hadn’t listened to morning radio and hadn’t heard about the crash so he just said nonchalantly: “Oh, we’ll get through it.”
“And it turns out,” he observed retrospectively, “we did.”
Since the global financial crisis of 2008, the markets’ hypersensitivity to officials’ public comments has risen again, especially when they involve the chairwoman of the board of governors of the US Federal Reserve, Janet Yellen.
As one Australian official observed this week: “The markets now look at the poor governor, and every time she changes an adjective, they react.”
And when they react, it affects Australia’s economy, too.
The Australian dollar plunged on publication of domestic monthly inflation figures at 11.30am on Wednesday, which came in at 1.9 per cent annually – lower than expected and lower than the RBA’s target range of 2 to 3 per cent.
But it surged early on Thursday, relative to the US greenback, after the US Federal Reserve kept American interest rates on hold and offered a positive but subdued assessment of the US economy.
This time it was the American dollar falling that left Australia stronger in comparison.
The RBA’s wariness is because it doesn’t want the currency up near – or over – the 80 US-cent mark it reached early on Thursday.
A high dollar hurts Australia’s exporters and contributes to low inflation and low growth, hence the RBA talking
In his speech, Guy Debelle addressed the jumpy response to the board minutes directly.
“No significance should be read into the fact the neutral rate was discussed at this particular meeting,” he said.
“Most meetings, the board allocates some time to discussing a policy-relevant issue in more detail and on this occasion it was the neutral rate.”
He said the topic had been assigned six months earlier for the July meeting.
Philip Lowe has introduced these regular big-picture board discussions since taking over as governor last year.
Independent economist Saul Eslake says they reflect Lowe’s strong focus on long-term financial stability.
“I think the Reserve Bank would like to be in a position where they are among the last central banks in the world to raise interest rates because they want to keep the currency down,” Eslake says. “… I’m sure they would have been surprised at the market’s reaction last week.”
He suggests the bank may need to examine how it communicates.
“When your audience doesn’t understand you, you shouldn’t necessarily blame it on the audience,” Eslake told The Saturday Paper. “Maybe the board should think about the way it records the minutes.”
Lowe echoed his deputy’s clarification in his own speech at a lunch in Sydney on Wednesday.
And he added another clarification, relating to comments he made in June on Australia’s sluggish wages growth.
“Some commentators saw this as the Reserve Bank governor making a rather unusual call to arms, a call for workers to demand larger wage increases from their employers,” Lowe said on Wednesday. “My intention was less dramatic. It was simply to make the point that a gradual pick-up in aggregate wages growth would be a positive development.”
What he had said during a panel discussion at the Australian National University’s Crawford School of Public Policy was that he hoped Australia’s tight labour market would re-energise workers “to get more of the labour share”.
“At some point, one imagines that’s going to lead to workers being prepared to ask for larger wage rises,” Lowe said at the time. “If that were to happen, it would be a good thing.”
Caveats notwithstanding, Lowe repeated the argument on Wednesday: that workers were reluctant to ask for a raise because they feared losing their jobs to either robots or cheaper foreign workers.
“I talk to people in Sydney and in Melbourne in professional business services and some of them worry about people in Chengdu in Sichuan province of China or in Bangalore potentially acting as a competitor,” Lowe said.
He said nervousness was affecting the economy. When wages don’t keep up with price rises, consumers are reluctant to consume.
“If workers are getting no real wage growth year after year after year, that’s insidious,” he said. “It reduces support for sensible economic policy. So I think a lift in wage growth would be useful from a longer-term perspective and it would help get inflation back to target and I think people would feel a bit better as well.”
As the bank’s clarifications prove, there is sometimes a difference between what’s meant and what’s heard, as there is between theoretical economics and real-world sentiment.
In the modern trigger-happy economy, the RBA, governments and business have to expect a degree of reading between the lines.
Some say it’s actually important, because the raw data doesn’t always reflect how people feel.
The head of research at Essential Media, Rebecca Huntley, believes too many chief executives aren’t grasping the sense of insecurity created through the global financial crisis and subsequently never really shaken off.
“There’s this persistent sense of walking on eggshells,” she says. “People feel like they’re working more for the same money … There’s a bit of a lack of understanding about just how pissed off people are.”
Huntley says business should be passing on the benefits of the recovery.
“The worker that you’re not rewarding is also the consumer who’s not spending,” she says.
She says chief executives often rely too heavily on statistics, rather than sentiment that better reflects the combined impact of job insecurity – including underemployment – household debt and stagnant wages.
Huntley says many Australians may wonder why the Reserve Bank governor isn’t directing his pay rise remarks to the employers.
“My instinct, based on research, is that they would say to the Reserve Bank governor: ‘It’s all very well to be telling us to be confident and to ask for a raise. You’ve got a direct link to business. Why aren’t you asking them?’”
In the political domain, the opposition is seizing on this kind of sentiment, framing economic debate around fairness and inequality – social issues that tend to favour Labor, rather than pure economics, which generally favours the Coalition.
Treasurer Scott Morrison rejects any suggestion inequality is growing, quoting the most commonly used index globally for measuring it.
“That figure shows that it hasn’t gotten worse – inequality – it’s actually gotten better,” Morrison told ABC Radio National on Tuesday.
But the next day, Philip Lowe had a different view. “It’s risen,” he said when asked about inequality. “It rose quite a lot in the ’80s and ’90s and it’s risen a little bit just recently.”
Lowe said it was more pronounced around assets than income because of big gains in the price of assets – such as housing – which tended to be owned by the wealthy and that slow growth in wages, especially at the bottom.
The treasurer is confining his criticisms to Labor, telling businesses his opponents didn’t understand them.
“They think if you’re trying to make a buck, that you’re doing something wrong, that you’re doing something sneaky, that you’re trying to do someone over,” Morrison said on Thursday. “… They think … therefore you should be punished for it and the score has to be evened up through the tax system. We don’t share that view and I don’t think Australians buy it either.”
But Rebecca Huntley told The Saturday Paper her research showed many Australians had become deeply resentful of big, profitable businesses getting richer as ordinary people struggled. She said the response to the government imposing a special levy on five big banks this year was, effectively, a satisfied “good”.
Philip Lowe acknowledges the impact of public sentiment on the economy. “If people feel like their wages aren’t growing anymore, they don’t want to spend,” he said. “They get grumpy. They’re kind of unhappy.”
Unhappy borrowers make unhappy voters. Confusing, worrying messages from the top can make it all the worse.
This article was first published in the print edition of The Saturday Paper on Jul 29, 2017 as "Loose lips shift rates ". Subscribe here.