It's been tough for those writing the IMF's World Economic Outlook in recent years. 'Is the Tide Rising?', the report asked in 2014, only to conclude later that same year that 'Legacies, Clouds and Uncertainties' still surrounded the global outlook.
The next year there were 'Cross Currents', and then 'Uneven Growth'. In 2016 the team declared that things had been 'Too Slow for Too Long'. It wasn't till April of this year that the global economy was thought to be 'Gaining Momentum', a trend cheered on mid-year with a 'Firming Recovery'. When it releases its next set of forecasts, timed to coincide with the IMF and World Bank meetings in Washington next week, the IMF may well conclude that the world economy is picking up – an announcement pre-empted in OECD forecasts two weeks ago.
Despite the mood swings among forecasters over the last three or four years, the actual pace of global growth has barely changed. World growth in 2014 was 3.5%. The following year on IMF numbers it was 3.4%, then 3.2%. In its June forecast the IMF expected global growth this year would be 3.5% again. The 'Firming Recovery', it turns out, means moving from 3.2% growth to 3.5% growth – recoveries used to have more bounce. While forecaster moods have been volatile, growth overall has been pretty consistent – and pretty good.
The US expansion is a case in point. It is surely among the least-noticed economic phenomenon of our time. Just short of 100 months since it began in June 2009, the current US economic expansion is already the third-longest since World War II. If all goes well it will be the second-longest expansion by this time next year, and the longest by this time the year after that.
Often deprecated as feeble, the average rate of growth has been pretty much the same as the US expansion from 2001 to 2007. And while output growth has been much the same, jobs growth has been much stronger. The last expansion added eight million jobs from the low point – this one has so far added 16 million. At 4.4%, the unemployment rate in the US is a tad above the low after the record-long expansion of the 1990s, and otherwise the lowest in half a century. It is true that business investment hasn't been brisk, but at 12.6% of GDP it is about the average of the last several decades.
The US stock market has not just recovered from the 2008 crash – it is now four times higher than it was when this long US upswing commenced.
Nor is this quiet expansion showing signs of age. As RBA Assistant Governor Luci Ellis reminded us recently, long expansions are no more likely to end than short ones.
It's only now that we're beginning to accept as reality a global expansion that has been continuing for several years. The Euro bloc economies and Japan emerged from recession three years ago. China's output growth has slowed from the peak, but at 6.9% for the year to June it remains very strong.
Thus we have entered what RBA Governor Phil Lowe recently called a 'new chapter' in the global economy, one marked by last month's decision by the US Federal Reserve to cautiously begin shrinking the huge holdings of US government bonds it accumulated to keep the lid on long-term interest rates.
New chapter or a continuation of what is now a familiar story, it seems to me that fixed interest markets are still well behind, or simply unbelieving. In Australia, for example, the 10-year bond rate is 2.6%. This is 1.1% above the cash rate of 1.5%, compared to a long-term average premium of the 10-year bond rate to cash of 0.8%. So there is perhaps some allowance for a rise in the cash rate over the ten years of the bond, but not much.
There is plenty of room for disagreement on how quickly the RBA might get to its announced new neutral or normal rate of 3.5%, but not much dispute that 3.5% or something not far from it will be the new normal. On present trends the RBA might be there in as short a time as two and half years or as long as, say, five years. Whether it is quick or slow, bonds are not priced for it.
If and when the RBA reaches the new normal rate, the 10-year bond rate should be around 4.3%. In principle it should already be heading up there, but it is not. Though it has gone up and down, the bond rate today is where it was a couple of years ago. That suggests to me that markets don't really believe the upswing story, even now.
As RBA Governor Phil Lowe warned last week, those who 'continue to expect a continuation of low rates of inflation and low inflation, despite quite low unemployment rates in a number of countries' might be in for a 'difficult adjustment'.
Markets in Australia and in other advanced economies are perhaps looking at inflation, and rightly reckoning that it might be quite a while before wages and consumer prices growth picks up. Maybe so, but if output growth is satisfactory the RBA may well begin to tighten – even if inflation is below the target. One reason is that very low interest rates at a time of firm economic expansion invite trouble. As Ellis said in a speech two weeks ago, we may see productivity picking up in the advanced economies. In that case we may have higher output growth without an acceleration of inflation. She added that if 'inflation stays low despite reasonable growth in a range of economies, policymakers will face a challenge'. This because policy 'still needs to remain appropriately expansionary while avoiding a further build-up of leverage and financial risk'.
To my mind, Ellis is alluding to the possibility that if growth is OK, rates may need to be increased even if inflation is below target. There is otherwise too great a risk that the price of assets like houses and shares may get too far out of whack with what prove to be sustainable levels.
Speaking shortly after Ellis, Lowe affirmed his expectation that GDP growth will be 3% over the next couple of years, and also affirmed that 3% is a bit higher than the sustainable or potential growth rate as now calculated by the RBA. Why would the RBA long maintain a cash rate at 1.5% (or for that matter 2.5%) with the danger of prolonged asset bubbles that setting presents, if the economy is going as fast as it can sustainably go? Lowe, after all, was one of the earliest central bankers to point out that asset prices could become perilously high even if general inflation was low, and policymakers needed to take that into account in setting interest rates.
It is true that Australia has higher household debt than it did, and this will make the RBA a little cautious in raising rates. Households overwhelmingly borrow on floating rates that move fairly promptly with the cash rate. Interest rate changes accordingly have more impact than in, say, the US.
Households are doing okay
All that said, I am not sure the household debt issue is quite as limiting as the RBA now suggests. Since the 2008 financial crisis in the US and Europe, leverage and debt have increased relatively slowly in advanced economies, including Australia. Over the last seven years, total credit outstanding in the Australian economy (including securitisations) has increased by 39%. In the seven years to the end of 2008 it grew by 140%, or three and half times the recent rate.
This is true even of housing debt in Australia. From 2001 to 2004 housing debt increased from 72% of household disposable income to over 100%. In the last four years it has increased from 120% of household disposable income to 135% – less than half the increase, as a share of disposable income, than the increase at the beginning of the century. Total housing debt increased 35% in the five years to July 2017, little more than a quarter of the rate of increase in the five years to January 2005.
The build-up of household debt in Australia is interesting and important, but often misinterpreted to suggest Australian households collectively are in a fragile position. They are not. Collectively, households in Australia have never been better off. Household net wealth in nominal terms is more than seven times greater than it was when the long Australian economic expansion started in 1991.
About two thirds of that wealth is in land and buildings, but even putting that aside households are in a very strong position. Total household liabilities – home loans, car loans, credit card debt and so forth – stand at around $2.4 trillion. It is an enormous sum but more than offset by household deposits at banks ($1 trillion), shares ($824 billion), various other financial assets ($645 billion), and $2.3 trillion in superannuation and pension assets.
Even excluding all of super and pension assets and the value of land and homes, the total owner-occupied and investor housing debt of households (around $1.6 trillion) is easily exceeded by the value of household bank deposits, shares, and other financial assets.
There should be nothing amazing in this. Households lend money to banks, and the banks then lend to other households to buy homes. That is the basic pattern. Through banks, households lend money to other households. This is why the total of household deposits at banks is usually nearly equal to bank lending for owner-occupied housing, and is today. Banks have outstanding loans to households of around $1 trillion for owner-occupied housing. Households have around $1 trillion in deposits with banks.
There might be a macroeconomic issue were household borrowing to increase consumption, an issue raised in IMF research released this week. But in Australia this is not the case. The growth of consumption spending over the last eight years has been well below its growth in the previous 12 years. As a share of GDP, household consumption is at the lower end of its long-term range. Overall, households are now saving around one seventh of their disposable income – not quite as high a share as immediately after the financial crisis, but well over the average of the last quarter century of economic expansion.
The economic issue or the financial fragility issue is how the financial assets and liabilities are distributed across households. We know from earlier RBA research that around one third of households rent, one third own their homes outright, and one third are buying homes and have a mortgage. This is the third that is vulnerable to higher interest rates, though most of that third have had a mortgage for long enough for repayments to decline as a share of their income. We have also learned the hardly surprising information that big mortgages are almost always held by households with big incomes.
There is certainly a risk that younger households have borrowed more than they will be able to service if rates are markedly higher. This is why APRA has imposed the rule that new borrowers must be able to service the loan if rates are 200 basis points higher, or 7% – whichever is more demanding. No doubt lenders fudge the rules where they can, but overall there should be considerable resilience to the 200 basis point increase in mortgage interest implied in a new normal cash rate of 3.5%. If the cash rate did increase to 3.5%, it would still be the lowest nominal cash rate in recent history, other than the last five years and the brief emergency setting after the 2008 financial crisis.
