Dave has prepared some great notes for our listeners – check out the resources for this topic below.

If you enjoyed this episode, you may also enjoy these:

Ep. 89 – Capital growth – what increases property value?

Ep. 119 – How supply and demand dictates market movements – Part #1 Macro-economic forces

Ep. 158 – How interest rate cycles have impacted the property market since 1990 when the RBA first started targeting the cash rate and some predictions on what will happen this time

Ep. 217 – The Inflation Conundrum: Unravelling its Causes and Consequences

Ep. 219 – The Role of the Reserve Bank of Australia (RBA), Why they Target Interest Rates & Why we Need Inflation, Just not too much!

1. What data does the Reserve Bank monitor when deciding whether rates should be increased?
   1. Household consumption
      1. What are the ways in which household consumption can lead to price changes?
      1. Why are Property Prices on the RBA’s radar when considering household consumption?
      1. RBA’s recent comments on Household Consumption –
   1. Labour markets
      1. What does the RBA pay attention to when looking at labour market data?
      1. What is the significance of wage growth?
      1. Why does the RBA set a higher target for wage growth than for inflation?
      1. How has wage growth been doing in our recent history?
      1. Why is the RBA fearful of wage-price spirals?
      1. How does unit labour costs fit into the picture?
   1. Neutral/Preferred Level of Unemployment and Cash Rate
      1. What impact does the unemployment rate have on inflation?
      1. What is the concept of NAIRU and what does it spell for the future of unemployment?
      1. We’ve also heard about there being a ‘Neutral Cash Rate’, what is this and where is the cash rate right now?
   1. Productivity
      1. What is productivity and where is productivity currently sitting in Australia?
      1. Why is productivity important?
      1. Why do we want high productivity growth?
      1. Why is our low productivity relevant to rate rises and what does low productivity cause?
      1. What could be causing Australia’s productivity problem?
      1. Aus Productivity commission’s recommendations for reform – 17 Mar 2023
      1. RBA comments on Labour Markets/unemployment and productivity
   1. Overseas Economies and Interest Rates:
      1. How can Economic developments in other countries influence inflation in Australia?
      1. RBA comments
2. We’ve talked about rising inflation, interest rates, wage costs, and unemployment. How might these negatively impact the Australian property market with regards to purchasers and renters?
3. Why have property prices been on the rise despite all of the negative factors weighing on the economy?
4. What could cause prices to rise again, even if they start to plateau?

1. What data does the Reserve Bank monitor when deciding whether rates should be increased?

We have broken into 5 areas:

1. Household Consumption
2. The job market
3. Neutral/Preferred Level of Unemployment and Cash Rate
4. Productivity
5. Overseas economies and cash rates

A. Household consumption

I. What are the ways in which household consumption can lead to price changes?

Demand-Pull Inflation that leads to price changes:

1. Household consumption is a major component of aggregate demand in an economy.
2. When households increase their spending on goods and services, it can stimulate overall demand, potentially leading to demand-pull inflation.
3. If the increase in household consumption outpaces the economy’s capacity to produce goods and services, businesses may respond by raising prices to match the higher demand. In other words, if demand outstrips supply.
   1. Demand-pull inflation is currently reducing with increases in interest rates -comments from ABS re March 2023 quarter:
      1. Consumption expenditure by households and government were subdued, with a combined contribution of 0.1 percentage points to GDP.
      1. Household spending rose 0.2%, the weakest quarterly result since the fall recorded during the COVID-19 Delta-variant lockdowns in September 2021.
      1. Growth in essential spending increased (+1.1%), while discretionary spending (-1.0%) fell, as cost of living pressures exhausted residual post-lockdown demand.
   1. In Dec 2021 Quarter – Spending on goods rose 6.3%.
      1. This reflects the pent-up demand for below items as over the lockdown period non-essential retail stores were closed.
         1. Furnishings – CPI up 1.1% over the quarter, 3.6% annually
         1. Recreational goods – CPI up 1.5% over the quarter, 2.1% annually
         1. Clothing and footwear – CPI up 2.6% over the quarter, -0.3% annually
      1. Spending on goods was 8.8% above pre-pandemic levels.
   1. Victoria Home Heating And Cooling Upgrades Program – $1,000 rebate when replacing or installing an energy-efficient reverse-cycle air conditioner. Anecdotally I heard that the price of airconditioners increased by the amount of the rebate, I haven’t been able to verify though

Therefore, higher levels of household consumption can contribute to inflationary pressures.

Price Changes:

1. Household consumption patterns and preferences can directly impact price changes for specific goods and services.
2. If there is increased demand for certain products or sectors, it can lead to price increases due to limited supply or increased production costs.
   1. Gym/exercise equipment during Covid-19 lockdowns during gym closures:
      1. Online retailers inundated with orders, long waits for sold-out stock and prices on the rise as suppliers blame a lower Aus $ and higher transport costs.
         1. JS Fitness Home Gym costs $800 more, now $1399
         1. the ForceUSA My Rack Base Unit has jumped $200 to $699
         1. Assault Fitness Airbike has risen by $500 to $1595
   1. Highest inflation ever seen in Australia was 23.9% in Dec 1951 during the ‘Korean War Boom’ – A large factor was the surging global demand for wool, one of Australia’s key exports, with tripling prices leading to a massive increase in GDP growth, pushing up domestic demand.
3. On the other hand, decreased demand for certain goods or services can put downward pressure on prices.

ii. Why are Property Prices on the RBA’s radar when considering household consumption?

1. Changes in residential property values can affect inflation through the wealth effect.
2. When property values rise, homeowners may experience an increase in their wealth, which can lead to higher consumer spending.
3. Increased consumer spending, in turn, can put upward pressure on prices.

This relationship is known as the wealth effect, where changes in asset values impact consumer behavior and, consequently, inflationary pressures.

iii. RBA’s recent comments on Household Consumption –

1. A significant source of uncertainty continues to be the outlook for household consumption.
2. Household consumption growth is weak, as is dwelling investment.
3. Many households are experiencing a painful squeeze on their finances, while some are benefiting from rising housing prices, substantial savings buffers and higher interest income.
4. The central forecast is for GDP growth of around 1¾ per cent over 2024 and a little above 2 per cent over the following year.

B. Labour markets

i. What does the RBA pay attention to when looking at labour market data?

This includes factoring –

1. Wage growth and unit labour costs – approaching 4 % and 8%
2. Unemployment – 3.5%
3. Productivity – (-4.6%)

ii. What is the significance of wage growth?

Target band for Wage Growth – 3-4%

As the RBA has stated repeatedly, assuming that productivity growth runs at its recent decade average of about 1 per cent a year, annual wages growth of 3-4 per cent is consistent with the central bank’s 2-3 per cent inflation target.

So that is the important nexus or connection between productivity, inflation and wage growth.

Inflation is 2/3%

Productivity is -4.6%

Wages growth can be 3 to 4 % and we increase our standard of living, savings and purchasing power because we are getting 1% better at doing our jobs every year as a nation.

iii. Why does the RBA set a higher target for wage growth than for inflation?

1. Enhancing Living Standards:
   1. Setting a higher wage growth target than the inflation target can be motivated by the objective of improving living standards and purchasing power for workers.
   1. By aiming for wage growth that exceeds inflation, policymakers seek to ensure that workers’ wages increase in real terms, allowing them to afford a higher standard of living and maintain their purchasing power over time.
2. Reducing Income Inequality:
   1. A higher wage growth target can be part of a broader strategy to address income inequality.
   1. By prioritizing wage growth, policymakers aim to narrow the income gap between different segments of society.
   1. This approach recognizes that workers’ wages often form a significant portion of their income, and higher wage growth can lead to a more equitable distribution of income.
3. Stimulating Aggregate Demand:
   1. A higher wage growth target can also serve as a measure to stimulate aggregate demand and support economic growth.
   1. When workers’ wages increase at a faster rate than inflation, it can contribute to higher consumer spending, driving demand for goods and services.
   1. This increased consumer spending can stimulate business activity, job creation, and economic expansion.
4. Improving Labour Market Conditions:
   1. Aiming for higher wage growth can be a strategy to attract and retain skilled workers, improve labour market conditions, and reduce labour market frictions.
   1. By providing workers with higher wages, it incentivizes labour force participation, reduces the risk of labour shortages, and encourages productivity growth.
   1. This, in turn, can contribute to sustainable economic development.

Productivity commission recommendations

1. Feb 2023 – Migration often targets labour shortages, thereby putting downward pressure on wage growth.
   1. Wages are an important mechanism in a well functioning labour market — the adjustment of relative wages encourage workers to shift to jobs and industries where their skills are most valued.
   1. For these reasons, migration settings often hinge on attracting migrants where there are domestic skill shortages and incipient wage pressures that could limit economic growth.
   1. During the mining boom, for instance, migration was crucial in securing the skills needed to take advantage of commercial opportunities, while likely providing at least some downward pressure on the exponential growth in mining related wages.
2. March 2023 – The Australian Government should introduce a pilot of a special permanent visa subclass for occupations in human services sectors largely funded by government (such as aged and disability care), but only if these are facing likely enduring and significant labour shortages that are weakly responsive to wage increases.
   1. The visa subclass should be subject to the current Temporary Skilled Migration Income Threshold, and include a condition that the applicant remain employed in the relevant sector for 4 years.
   1. The pilot should be evaluated for its impacts and need after several years.
   1. It should also be abandoned if the Australian Government develops sustainable alternative funding options for aged care that are sufficient to meet the wage increases required to limit labour shortages.

iv. How has wage growth been doing in our recent history?

Over the last 25 years the average has been 3.07% from 1998 to 2023 (data started being tracked in 1998)

Ave Annual wage growth – decades

• 1990s – 3.1% (started tracking 1998)
• 2000s – 3.7% (reached all time high of 4.30% in 2008)
• 2010s – 2.7%
• 2020s so far – 2.3%
  • March 2023 Quarter – 3.7%

(June quarter released 15^th Aug)

So, we are at a rate of wage growth which is moving towards the all-time high of 4.30% in 2008.

The graph we will place in show notes is suggesting that trajectory still has some way to go.

This will be a concern for the RBA because if it get to far above 4%, especially as inflation is coming down, this will cause inflation to stay higher for longer because our spending power is growing.

This can lead to a wage price spiral which is the next point.

v. Why is the RBA fearful of wage-price spirals?

1. Rising Demand for Higher Wages:
   1. In the initial stage, inflation may start to increase due to various factors such as rising production costs, higher demand, or supply-side shocks such as we have had with the breakdown of supply chains and the energy shock from the Ukraine war.
   1. As inflation rises, workers may perceive a decline in their purchasing power which we have seen happening, and demand higher wages to maintain their standard of living.
   1. Labor unions, collective bargaining agreements, or individual workers negotiate for wage increases in response to the increasing cost of living and we have seen various examples such as recently which will concern the RBA.
      1. 5100 academics and administrative staff at the University of Tasmania an average annual wage increase of 5.6 per cent until 2025
      1. About 8400 hospitality workers at Crown in Melbourne and Perth signed on for a one-year deal with a 5 per cent pay bump
      1. retailer Target inked an agreement covering 8553 employees linked to movements in award wages, which increased by 5.75 per cent on July 1.
      1. 8.6 per cent increase in the minimum wage (and the 5.75 per cent increase in all award wages, affecting more than one in four workers.)
2. Wage Increases Feed into Production Costs:
   1. When wages increase, businesses face higher labor costs which can affect the production costs of goods and services.
   1. Businesses may pass on these increased costs to consumers in the form of higher prices.
   1. As prices rise, workers may perceive a further erosion of their purchasing power, leading to demands for additional wage increases.

This then leads to…

• Price Increases Reinforce Inflation Expectations:
  • As prices continue to rise, consumers and businesses develop expectations of ongoing inflation.
  • These inflation expectations can become embedded in the decision-making process, leading to behavior that supports further price increases.
  • Consumers may anticipate future price hikes and therefore increase their spending, contributing to demand-pull inflation.
  • Businesses, anticipating higher input costs, may proactively raise prices to protect profit margins.

• This becomes a Feedback Loop, of a wage-price spiral and Inflationary Expectations:
  • The wage-price spiral becomes entrenched when there is a feedback loop between wage increases and price increases.
  • Rising wages contribute to higher production costs, which are passed on to consumers as higher prices.
  • In response, workers demand even higher wages to compensate for the rising cost of living, and businesses further increase prices to cover their growing costs.
  • This self-perpetuating cycle reinforces inflationary expectations and sustains higher inflation levels.

vi. How does unit labour costs fit into the picture?

And this leads to higher unemployment because ultimately businesses and governments need to cut costs by letting go of staff.

We received new evidence that Australia is grappling with a nascent wage/price spiral. The official statistician’s data highlighted that the RBA’s preferred measure of wage growth, known as unit labour costs, had expanded by an astonishing 8 per cent over the 12 months to March 2023 based on data released by the RBA on 5 July. This represents the biggest jump since 1990 (absent pandemic-induced distortions). And Lowe warned that “ongoing strong growth in unit labour costs would underpin ongoing high inflation outcomes”.

• The RBA actually however looks more closely at what is known as unit labour costs, which is the RBA’s preferred measure, and it is at its highest since 1990 with an 8% increase over the last 12 months.

This unit labour or wage costs represent nominal wage growth less labour productivity and a key forecast variable that centra banks use to predict future inflation.

At the moment productivity is really low and this is compounding this concern.

Productivity is at its lowest level since 1980’s, at -4.5%

1. US unit labour costs – 5.3% increase p/a
   1. EU unit labour costs – 6.4% p/a

The big driver of this massive labour-cost inflation is the poorest productivity that Australia has experienced since World War II.

C. Neutral/Preferred Level of Unemployment and Cash Rate

i. What impact does the unemployment rate have on inflation?

Definition – Unemployment represents the percentage of the labour force that is actively seeking employment but unable to find jobs.

The relationship between unemployment and inflation – This is often described by the Phillips curve, which suggests an inverse relationship between the two variables.

This is as unemployment gets too low, inflation will start to rise and vice verca as follows –

1. In a strong labour market with low unemployment rates, workers have more bargaining power to demand higher wages. This wage pressure can translate into higher production costs for businesses, potentially leading to higher prices and inflation.

• Conversely, when unemployment is high and there is excess labour supply, workers may face limited job opportunities and reduced bargaining power, making it difficult to negotiate for higher wages. This can help keep inflation in check.

ii. What is the concept of NAIRU and what does it spell for the future of unemployment?

NAIRU “Non-accelerating inflation rate of unemployment” or NAIRU

The Non-Accelerating Inflation Rate of Unemployment (NAIRU) is an economic concept that represents the level of unemployment at which inflation remains stable or does not accelerate.

It is often referred to as the “natural rate of unemployment” or the “full employment unemployment rate.”

In short, it is an economic theory whereby there is a level of unemployment that is neutral to the economy and therefore helps maintain equilibrium for inflation to remain in the 2% to 3% range.

The NAIRU suggests that there is a trade-off between unemployment and inflation. If the actual unemployment rate falls below the NAIRU, it is believed that the labour market becomes tight, and upward pressure on wages and prices increases, leading to inflationary pressures.

Currently the unemployment rate sits at 3.5%, the lowest unemployment rate since the 1970’s

Many suggest that the rate this low is too low, and that it is below the NAIRU and therefore will cause inflation. Hence why Michelle Bullock, the incoming RBA governor said recently on 20^th of June that unemployment needs to get back up to 4.5% and this means roughly 140,000 people will need to lose there jobs.

Kieran Davies – Chief Macro Strategist at Coolabah Capital Investments, responsible for macroeconomic research and investment strategy – in December 2021 did modelling that found that the NAIRU for unemployment was actually 5-5.5 per cent.

With unemployment currently at 3.5%,  he believes that 280,000 jobs need to be lost

In December 2021, the financial market was pricing in a peak RBA rate of slightly less than 2 per cent by 2024. Davies’ modelling concluded that given a neutral cash rate of 3.5 – 4 per cent, the RBA would be compelled to lift its cash rate to between 4.6 per cent and 5.6 per cent. This was much higher than any other mainstream economists’ estimates at the time.

For perspective at that point in time –

• Government cash rate was 0.1%, it is now 4.1%.
  • Annual Inflation was 3.5%,

The RBA’s freedom of information disclosures show updated research the RBA produced from the 1 May 2022 point to the need for it to now get the cash rate to 4.8 per cent to push core inflation back down to 2.5 per cent by June 2025. Reminder, we are currently at 4.1%.

This is important, because it suggests the mindset around the RBA table could be that they expect it needs to get to 4.8% which implies that we need 2 or 3 more rises.

iii. We’ve also heard about there being a ‘Neutral Cash Rate’, what is this and where is the cash rate right now?

This is a corollary to the concept or economic theory that there is an ideal ‘neutral cash rate’ that is neither inflationary or deflationary. The RBA current cash rate is 4.1%.

• RBA in Oct 22 said it was 2.5%
  • Now they believe it is – 3.8%

Unemployment rates and inflation inverse correlation:

1. Pre-Covid – March 2020 – unemployment 5.2% (Annual CPI was 2.2%)
   1. March 2023 – 3.5% (Annual CPI was 7%)
   1. May 2023 – 3.5% (Annual CPI was 5.6% – this is monthly inflation, may not be as accurate as quarterly, not all aspects are tracked monthly)
   1. June 2023 – 3.5% (figures yet to be released for CPI)

D. Productivity

i. What is productivity and where is productivity currently sitting in Australia?

In economics, productivity refers to how much output can be produced with a given set of inputs.

Productivity increases when more output is produced with the same amount of inputs or when the same amount of output is produced with less inputs.

Said in laymens terms, we get more done with less.

Essential one of the things the RBA is trying to do by raising rates is to force Australian’s to complete the same amount of work with less people, thus increase unemployment. That is the difficult truth.

Ultimately, it is the same thing that every individual, organisation and country that is trying to grow their career and income is trying to do.

We currently have the poorest labour productivity that Australia has experienced since World War II.

Productivity growth has slumped to a 60-year low over the past decade and productivity has gone backwards during the pandemic to 2019 levels.

Labour productivity history in financial years- ABS

• 1995-1999 – Ave growth 3%
• 2000-2009 – Ave growth 1.8%
• 2010-2019 – Ave growth 1.7%
• 2020-so far – Ave growth 1.6%
  • 2020-21 fin year: 1.8%
  • 2021-22 fin year: 1.4%
  • 2022-23 fin year: not out yet from ABS – quarterly -4.6%

ii. Why is productivity important?

Over the long term, productivity growth is the key driver of living standards.

Productivity – how efficiently labour produces goods and services – is the secret sauce of prosperity.

Better ways of producing the same output, with fewer inputs accounted for more than 80 per cent of national income growth over the past 30 years, according to the Productivity Commission.

It allows economies to produce and consume more for the same amount of inputs – that is, working smarter rather than harder.

On a micro level this reflected in the incomes we earn, and on a macro level, it is reflected through the relative wealth of the country and therefore the standard of living of people in that country.

When businesses or governments are putting in place new technology, equipment or systems, the goal is to improve the businesses productivity. But often this ‘change’ is seen as negative and pushed back against.

Productivity growth is important for maintaining the economic welfare and prosperity of all Australians.

iii. Why do we want high productivity growth?

1. Higher wages: Productivity growth enables firms to increase wages for workers. Unit labour costs (ULCs), which measure the labour costs associated with producing one unit of output, decrease as labour productivity increases, meaning that firms can offset the effect of wage increases on profits with productivity improvements.
2. Lower prices: Businesses can pass on productivity improvements to consumers through lower prices without reducing profits or wages. This also makes Australian businesses more competitive in global markets.
3. Higher profits: In response to an improvement in productivity, businesses can increase their profits as it now costs less to produce a given level of output. These profits can be distributed to the business owners or shareholders, or reinvested into the firm.
4. Stronger economic growth: Labour and capital inputs tend to be subject to diminishing marginal returns. In other words, holding other inputs constant, the addition of one more unit of labour or capital will lead to a smaller and smaller addition to output. This leaves productivity growth as the main driver of higher living standards in the long run.

iv. Why is our low productivity relevant to rate rises and what does low productivity cause?

Rate rises:

1. Low productivity levels can contribute to inflation by limiting the economy’s capacity to produce goods and services efficiently.
2. When productivity growth is sluggish, it can lead to increased production costs, such as higher labour and resource costs.
3. These increased costs are often passed on to consumers in the form of higher prices.

What does Low productivity cause?

1. Stagnant economic output:

Productivity growth is a key driver of economic output and overall economic growth.

When productivity levels are low, it means that less output is generated per unit of input (such as labor or capital). This can result in slower economic expansion, fewer job opportunities, and limited business profitability.

As a consequence, the overall standard of living may be negatively affected as there are fewer resources available for individuals and the economy as a whole.

• Wage stagnation:

Productivity growth is often linked to wage increases.

When workers become more productive, their contribution to the value of goods and services they produce is higher. This can create room for higher wages as employers benefit from increased output per worker. However, if productivity growth remains low, employers may have less incentive to raise wages, resulting in stagnant or slow wage growth. This can hinder individuals’ ability to improve their standard of living and may lead to financial strain.

• Limited innovation and technological progress: Productivity growth is closely tied to innovation and technological advancements.

When productivity growth is low, it can indicate a lack of innovation and the adoption of new technologies that can drive efficiency and output. Without significant advancements, industries may struggle to produce goods and services more efficiently, reducing the potential for increased standards of living through improved products, reduced costs, and better quality of life.

• Reduced competitiveness: In a global economy, low productivity growth can impact a country’s competitiveness in the international marketplace.

If other countries experience higher productivity growth rates, their goods and services may become more competitive, potentially leading to lower demand for domestically produced goods. This can affect industries and employment opportunities, potentially reducing wages and overall living standards.

• Decreased investment in human capital: Productivity growth often relies on investments in education, skills training, and research and development.

If productivity growth remains low, there may be less incentive for individuals, businesses, and governments to invest in these areas. A lack of investment in human capital can hinder the development of a skilled and innovative workforce, limiting future productivity gains and potential improvements in the standard of living.

If productivity is low relative to wage growth and inflation, standard of living reduces

For example think about how this is happening currently

• Inflation = 7% March 2023 quarter, monthly reading for May 6.4%
• Wage growth = 3.7% March 2023 / Unit labour costs = 8% 27 July 2023 (highest since 1990)
• Productivity = -4.6% (well below the above), which leads to job losses because costs are too high for business reduced standard of living due to higher costs for all goods and services.Reduce income growth over timeLess innovation by business halting economic growthLess competitiveness with other countries hampering all the above

v. What could be causing Australia’s productivity problem?

Australia has dropped from one of the standout global productivity performers in the 1990s to a laggard today due to a range of short and long-term local and international factors.

1. Pandemic interruptions from clogged supply chains, labour shortages and delayed business investment

identified by Lowe may explain the unprecedented -4.5 per cent fall in output per hour worked over the year to March 31.

• The ultra-low unemployment rate of about 3.5 per cent is a likely contributor.

What politicians and central bankers can talk less openly about is that the ultra-low unemployment rate of about 3.5 per cent is a likely contributor.

The tight labour market is sucking in less skilled and less experienced workers. More long-term unemployed and youths getting jobs is a good social outcome. But the downside is they may be producing less output per hour of work than experienced workers.

• Businesses are bloated and have never carried more staff.

Just look at the big banks. The rise of re-regulation has meant they have massively increased the size of their risk, compliance, legal, public affairs, and environmental, social and governance staff.

This is true across many industries. We are therefore producing products with many more hands in the till, which is why output per hour worked – the very definition of labour productivity – has deteriorated so dramatically over a long period of time.

• Internationally, productivity has been deteriorating as economies mature and populations age.

Wealthy economies are shifting away from manufacturing to lower productivity services such as aged care, healthcare, disability care and personal services such as massage and beauty.

• Productivity gains in labour-intensive services are harder to deliver compared to manufacturing, where machines can produce more output as technology advances

Moreover, it is challenging to measure productivity in services – both in terms of quantity of output and the quality. For example, improvements in medical technology to replace a knee won’t necessarily be captured in productivity data, even if an operation gives a higher quality of life for more years.

• Most economists and many business leaders agree a chief cause of poor productivity in Australia is chronically weak business investment.

The climate and energy policy wars of the past 15 years have probably contributed to investment uncertainty for business, while more recently Labor’s energy price caps and gas interventions also have not helped.

Investment in new machines, equipment, tools and technology allows workers to produce goods and services more efficiently. Output per hour rises and the income gains are shared between firms and workers. That’s what happened under the Hawke, Keating and Howard governments in the 1980s and 1990s during the “reform era”.

Worryingly, Australia’s economy and businesses are becoming less dynamic, according to a growing body of research from Treasury, the RBA, OECD, e61 Institute and the Committee for Economic Development of Australia.

Many local businesses have not kept pace with leading firms overseas in adopting emerging technologies. The divergence in technology and innovation between global frontier firms, such as miners like BHP, and laggards has widened – dragging down overall productivity.

The substandard management and technology skills of Australian executives may be contributing to the nation’s waning innovation, the Productivity Commission has warned.

The OECD estimates that the productivity gains from upskilling managers could be three times higher than for upskilling workers.

vi. Aus Productivity commission’s recommendations for reform – 17 Mar 2023

Example of some of the reforms recommended:

1: Improve schools’ capacity to lay the educational foundations for the future workforce

1. Leverage digital technology in schools
2. Make best practice teaching common practice

2: Enable innovative schooling approaches for improved learning outcomes

1. Enable experimentation with alternative approaches to schooling

3: Grow access to tertiary education

1. Grow access to higher education over time
2. Better targeting of investment in higher education
3. Improve price setting in tertiary education
4. Expand loan eligibility to more students

4: Support a culture of lifelong learning for an agile workforce

5: Increase tertiary education teaching quality to underpin a well trained workforce

6: Better and more flexible matching between students and work opportunities

7: A better targeted skilled migration system

1. Abolishing investor visas
2. Implementing wage thresholds for employer sponsored visas
3. Improving Skilled Independent visas
4. Meeting the needs of human services without stifling wage increases
5. Improving temporary migration and pathways to permanent residency
6. Improving job mobility for employer sponsored visas

vii. RBA comments on Labour Markets/unemployment and productivity

1. Firms report that labour shortages have lessened, yet job vacancies and advertisements are still at very high levels.
2. Labour force participation is at a record high and the unemployment rate remains close to a 50-year low.
3. With the economy and employment forecast to grow below trend, the unemployment rate is expected to rise gradually from its current rate of 3½ per cent to around 4½ per cent late next year.
4. Wages growth has picked up in response to the tight labour market and high inflation.
5. At the aggregate level, wages growth is still consistent with the inflation target, provided that productivity growth picks up.
6. The Board remains alert to the risk that expectations of ongoing high inflation will contribute to larger increases in both prices and wages, especially given the limited spare capacity in the economy and the still very low rate of unemployment.
7. Accordingly, it will continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms.

E. Overseas Economies and Interest Rates:

i. How can Economic developments in other countries influence inflation in Australia?

While it’s not a certainty that Australia will always follow suit when the US raises interest rates, there are reasons why Australia may choose to do so. Here are some key factors:

1. Increase cost of goods we Import – For example, if overseas economies are experiencing strong growth or higher inflation, it can impact the prices of imported goods and commodities
   1. If the exporting country is experiencing inflation, production costs of the exported goods/services go up.
   1. These higher prices are then passed on to consumers, resulting in increased prices for Aus
   1. If the cost of imports are rising and contributing to overall inflation in the importing country (Aus), the central bank may decide to increase interest rates to reducing borrowing and spending and ease inflationary pressures arising from increased import costs.
2. Exchange Rates:
   1. Interest rate differentials between countries can influence exchange rates.
   1. If the US raises interest rates while Australia keeps rates unchanged, it can potentially lead to a depreciation of the Australian dollar relative to the US dollar.
   1. This depreciation may impact Australia’s trade competitiveness and inflation dynamics.
   1. To manage exchange rate movements and their potential impact on the economy, the Reserve Bank of Australia (RBA) may adjust interest rates accordingly.

Aud currency falling/overseas currency strengthening increasing the cost of goods we import – Additionally, changes in interest rates in overseas economies can influence exchange rates, which, in turn, can impact import prices and inflation.

• Here is an example of how this impacts Australia – US exchange rate
  • 0.74 USD – 9 October 22 – import $1,000,000 US goods would cost – AUD $1,351,351
  • 0.68 USD – 25 Jul 23 – import $1,000,000 US goods would cost – AUD $1,478,305

• Inflation and Price Stability:
  • The RBA’s primary mandate is to maintain price stability and keep inflation within its target range.
  • If the US raises interest rates in response to inflationary pressures or to control economic growth, the RBA may consider similar actions to ensure price stability and manage inflationary risks in the Australian economy.
  • Aligning interest rate policies can help anchor inflation expectations and maintain stability.
• Economic Interdependence:
  • Australia and the United States have economic ties through trade, investment, and financial markets.
  • Economic developments in the US, such as changes in interest rates, can have spillover effects on Australia.
  • If the US economy experiences significant changes that impact global economic conditions, Australia may adjust its interest rates to manage the domestic implications of those changes.
• Capital Flows:
  • Australia, like many other countries, has an open economy that is closely linked to global financial markets.
  • When the US raises interest rates, it can make US assets more attractive to global investors seeking higher yields.
  • As a result, capital may flow from other countries, including Australia, to the US.
  • To prevent excessive outflows and stabilize their respective markets, central banks may raise interest rates to maintain interest rate differentials or prevent rapid currency depreciation.

ii. RBA comments

1. There are also uncertainties regarding the global economy, which is expected to grow at a below-average rate over the next couple of years.

2. We’ve talked about rising inflation, interest rates, wage costs, and unemployment. How might these negatively impact the Australian property market with regards to purchasers and renters?

1. Decreased Housing Demand: When consumer spending declines, potential homebuyers may postpone or cancel their plans to purchase a property.
   1. Reduced purchasing power and financial uncertainty can lead to a decrease in housing demand.
   1. This can result in fewer buyers in the market, leading to a slowdown in property sales and potentially putting downward pressure on prices.

• More Selling Increasing Supply –

Investors (and holiday home owners) in particular selling to reduce costs

1. Most investors have negative cash flow. This is increased by rising rates and people will attempt to hold their home at all costs which means often the investment property is the first jettisoned.
   1. New listings owned by investors – decade average 25% – currently at 32.7%
      1. 40% in Sydney
      1. 36% in Melbourne
   1. Investors choose to take profits while the market is rebounding – with Sydney displaying an increase of 9% in auction volumes from this time last year.

• Longer Time on the Market: With reduced demand, properties may take longer to sell. Sellers may need to adjust their pricing or offer incentives to attract buyers.
  • Properties staying on the market for an extended period can contribute to a more sluggish and buyer-favorable market environment.

• Lower Property Price growth: Reduced consumer spending can create downward pressure on property prices.
  • When demand weakens, sellers may need to lower their asking prices to attract buyers.
  • This can lead to price reductions and potentially a decline in property values, particularly if the reduction in consumer spending is sustained.

• Decline in Property Investment:
  • Investors may become cautious and delay or reduce their real estate investments, especially if they anticipate a prolonged period of decreased consumer spending.
  • This can result in lower demand from investors, potentially affecting property prices and overall market activity.
  • Increased borrowing costs can reduce the profitability of investment properties, potentially discouraging some investors from entering or expanding their holdings in the market.

• Rental Market Challenges:
  • If people are cutting back on spending and experiencing financial strain, they may be more inclined to downsize their housing or seek more affordable rental options.
  • This increased supply of rental properties, coupled with potentially reduced demand, can lead to increased vacancies and downward pressure on rental prices.

• Financial Stress, Mortgage Defaults and Distressed Sales:
  • High unemployment rates can result in financial stress for homeowners who may struggle to make mortgage payments.
  • This can increase the risk of mortgage defaults and foreclosures.
  • Distressed properties may enter the market as a result, potentially increasing housing supply and putting downward pressure on prices.

• Reduced Housing Affordability:
  • Increased unemployment can contribute to reduced housing affordability.
  • Individuals who lose their jobs or experience income reduction may face challenges in meeting mortgage payments, leading to a decline in the ability to afford homeownership.
  • This can result in a shift towards renting or downsizing, impacting the demand for properties in certain segments of the market.
  • Increasing interest rates raise borrowing costs for homebuyers, making mortgages more expensive.
  • As a result, potential homebuyers may face reduced affordability, particularly for those on the margin of qualifying for a loan.
  • This can dampen demand for homes, leading to a slowdown in property market activity.

3. Why have property prices been on the rise despite all of the negative factors weighing on the economy?

1. Low listing levels
2. Lack of supply of new properties
3. High wage growth
4. Low unemployment
5. Record migration
6. Big savings buffers
7. Equity from recent price growth
8. Record rental growth
   1. Some individuals who lose their jobs may opt for rental housing as a more affordable alternative or as they reassess their housing needs.
   1. This can potentially increase the demand for rental properties, particularly in areas with a high concentration of job losses.
   1. Higher rental demand could put upward pressure on rental prices, especially if the rental supply does not keep pace with the increased demand.
9. Interest rate rises have a lag effect, with many suggesting in can take 1-2 years for the full impact to play out.

4. What could cause prices to rise again, even if they start to plateau?

• Rates stabilise and then fall during 2024
• Wage growth is still rolling through due to multi year deals
• Record migration
• Record rental growth
• Low supply of rentals
• Lack of supply of new properties