In the years after the GFC and as the mining boom peaked, then-treasurer Wayne Swan was fond of referring to the “patchwork” nature of the Australian economy.
There were also frequent references back then to the “two-speed economy” as activity in WA and Queensland accelerated, creating swathes of jobs and triggering surges in wages and property prices. The RBA kept interest rates relatively high, compared to what was happening in many advanced countries in the post-GFC environment, to make way for the boom. It effectively stood on the throats of the economies in NSW and Victoria as they struggled with much higher levels of unemployment and softer activity.
In reality, economies are always “patchwork” as people move to where the work is and competing regions see surges in activity while others stall. This exposes the limits of centralised monetary policy, and there’s no finer example of this right now in the world than in Europe, where the Frankfurt-based ECB sets interest rates for economies at hugely varying points in the cycle, ranging from the steadily recovering France and Germany to the basket-cases of Greece and Italy.
The divergences aren’t as spectacular in Australia, where overall the economy is growing reasonably well. But the growth is again uneven as the economy adjusts to falling Chinese demand and the lower Australian dollar. Economic activity in NSW and Victoria is now surging, helped by rapid growth in construction, health and education, tourism, and professional services like the finance sector. In other parts of the country – WA in particular – jobs are being lost and growth is stalling, while official interest rates are set centrally by the RBA.
Economics advisory firm SGS has looked in detail at the performance of Australian cities and regions and released an estimate of where interest rates would be if they were set by hypothetical regional central banks taking into account the requirements of the local economy.
Terry Rawnsley, Principal at SGS, explained the current challenge: “The RBA has to manage a booming economies in Sydney and Melbourne while the rest of the country is struggling to grow in the face of a range of headwinds”.
In a scenario that might horrify some home owners in Sydney, SGS says a hypothetical RBA of Sydney would have had rates at 3.5% through 2014-15 – 150 basis points above the current RBA cash rate and something that would likely see average mortgage rates in Australia’s largest city at around 6% or more.
Perth would have seen interest rates cut to 1.25% in in 2014-15 and a Reserve Bank of Brisbane would have cut rates to 1.0%.
Macquarie Research referenced the SGS report in a note to clients, noting that “Australia’s regional GDP outcomes reveal an economy with its ‘Head in the oven, feet in a bucket of ice, but on average just fine’.”
Macquarie produced this chart based on the SGS research which showed what interest rates would be for Australia’s various regions:
A cash rate at 1% for much of the country!
These differences are driven by the huge variations in the economic growth rates of various regions, shown in the next chart.
The NT, for example, grew at a blistering 10.5% last year, but it doesn’t make much of a difference to the overall picture because it is a relatively tiny part of over GDP, at just 1.4%.
And Perth growth has tanked while regional WA has held up strong. Mines which were conceived, approved and built during the boom are now online and working, but the spillover effect of all of the planning and exploration in Perth has vanished.
Sydney, as you can see, grew at just 3% but even that level of growth would be enough to warrant significantly higher interest rates than current settings.
This highlights many things, but let’s pick out a couple.
It obviously highlights the complex web of competing economic priorities the RBA needs to balance when setting interest rates. However, in an election year, it also by implication highlights the problems with uniform national policies for an economy where there are different geographical needs, especially when it comes to broad-based policy areas such as income tax and, to some extent, the negative gearing debate currently in play.
It also partially explains the heat in the property markets of the major cities. To help along the weaker parts of the economy the RBA has been dropping rates but they are now lower than they would ideally be if there was a local “central bank” for Sydney and Melbourne. This naturally adds more fizz to housing prices; higher interest rates would tamp down demand.