Introduction

Lately, there seems to be a heightened level of angst that economic conditions are getting harder and that the two-party political system – and maybe democracy too – is failing voters. There seems to be a hankering for times past that some feel were better. There is no doubt that “cost-of-living” issues have become real in the post-pandemic years. This has been associated with relatively stagnant real household disposable income and poor productivity growth over the last decade. Unfortunately, there are no quick fixes to this. Rather getting productivity up requires hard-nosed economic reforms that may take years to bear fruit. But while the Australian economy does have some real challenges to address, it is worth keeping things in perspective. This note looks at how economic conditions in Australia have changed over the last half century.

Some things are worse today

The table below provides a brief comparison of economic indicators where conditions were better 25 and 50 years ago. These periods were chosen because the 1970s broadly coincided with baby boomers entering the workforce, while Millennials entered in the 2000s and Gen Z in the 2020s.

The bad news is that consumer sentiment seems to be stuck around much lower levels, despite the absence of really high unemployment as seen in the recessions of the 1980s and 1990s. And associated with this over the last 20 years happiness has been trending down. From the next chart it can be seen that the trend in both has been down since around 2015, not just the last few years.

We also paid less tax as a share of our income back then. But housing is the big one – today the ratio of home prices to incomes is way above what it was 25 and 50 years ago, and it takes far longer to save for a deposit. Associated with this has been a down trend in the home ownership rate since it’s mid-1960s peak. And this arguably goes a big way to explain why younger generations may be feeling less happy today as getting a home is seen as too hard.

Of course, in the past things were also less regulated so we may have felt freer, there was a greater sense of community, there was less choice (i.e. four TV channels in the 1960s and 70s versus lots of streaming and TV options now), so less decisions to make, which resulted in less pressure. And there was no social media to bully us, rile us up or create a perpetual sense of FOMO (and in many cases relieve us of our money – though small town gossip was probably worse back then!).

But many economic indicators are far better now

Against this, virtually all other economic indicators are much better today.

In recent decades the economic cycle has been milder with less severe recessions, generally lower unemployment and generally lower inflation. Today we are far better off materially: real household income is double what it was 50 years ago, there is a greater share of the population in employment (~64% versus 60% in the 70s, reflecting more jobs), and the female participation in the workforce has risen (helped by better education, childcare and attitudes).

With this wealth has come more discretionary spending power to devote to things like overseas holidays – 50 years ago, an average Australian had an overseas holiday once every 16 years, now it’s just a bit less than once every two years. And more gadgets like cars – where there is now nearly one for every two people – and household appliances like huge flatscreen TVs. And multiple cafes per suburb with endless choice of coffee and food compared to the burgers and instant coffee of a few generations ago.

But it’s also a far more equitable society. For example, female participation in the workforce has surged from being way below that of men, more girls now go on to a university education than boys and the gender pay gap has fallen sharply (albeit there is still a way to go). It’s hard to look back a generation or two ago and say things were great when opportunities for half the population (i.e. women) were way below those of the other half. At this point we hear the manosphere crowd saying how guys are now discriminated against…and think come on guys “get a grip”! – don’t you realise that manosphere influencers are just telling you what you want to hear so they can get a buck out of you!

And with this surge in income and wealth has come huge medical advances which means we are living longer, active lives. (Of course, this is not to say there are not issues with obesity and too much sugar which may be starting to take a toll in the last few years!)

While we pay more taxes as a share of income, and more is demanded of Government, the social safety net is bigger than ever. It’s seen explosive growth in the provision of spending on welfare, health, aged and disability care – which have each more than doubled as a share of GDP. And Government is mostly doing a good job of protecting us from ourselves and each other, with for instance, a collapse in road death and homicide rates.

Australia is now also a far more diverse country with far more born overseas and less of those that are from a UK/European background. This has led to a richer society (e.g. more restaurants to choose from), a more innovative society and relief from the pressures of an aging population and labour shortages.

Of course, immigration is once again a hot topic – it has been periodically for as long as I can remember – but for most this seems to reflect a concern about poor housing affordability.

And finally, despite all the talk to the contrary, it’s still too high but the suicide rate is around where it was 25 and 50 years ago and is in fact below its level in the pre-WW2 years, the 1960s and the late 1980-90s.

So why do people still feel miserable even with all these economic achievements?

Simply because most people nowadays weren’t around back then! Around 65% of the population was born after 1975, and 78% were either not born or too young in the 1970s to remember it clearly, so much of the hardship discussed in this note sits outside most people’s lived experience. And recency bias means that even for those who were around “back then”, the tougher times they might have had can be hard to recall after three decades of economic growth and virtually no recessions in Australia.

Recency bias and higher baseline expectations also make comparisons with 25 or 50 years ago less meaningful. At the same time, things have indeed gotten a bit worse in the last 5 years.

For example, health outcomes have improved over the long term, helped by medical advances, increased government health spending and better access to health care with e.g. higher bulk billing rates. But bulk billing fell sharply from 2022 until late last year as medical goods and services costs rose, with some surveys suggesting many people delayed medical appointments because of affordability. That marks a clear regression from 2020-2022, when the average bulk billing rate was 89%.

In addition, real wages have gone up significantly over the last 25 and 50 years, but the average wage earner (if they have not upskilled or changed jobs) has seen their pay lag inflation since 2021.

The root core of this is low productivity growth. Coincidentally, the structural decline in happiness in 2015 started around the same time productivity started stagnating.

Concluding comments

None of this analysis is to deny that many are struggling with “cost of living” issues and that there is a wider malaise of dissatisfaction. Government’ need to do more to boost productivity and hence grow living standards and avoid the delusion that the answer is even more government. But we suspect a big part of the problem is poor housing affordability which leads to a growing wealth gap between the haves and the have nots – fix that with a fundamental rebalancing of underlying housing supply and demand, and a lot of the angst will likely fade. This likely involves getting the balance right on immigration but not slashing it such that it just leads to labour shortages and the economy struggling with an aging population.

Finally, we need to recognise that part of the malaise associated with poor happiness and confidence reflects a problem of success. The rise in affluence has led to higher expectations than the economy can at times deliver upon. And social media – itself a product of technological success – may be contributing to the malaise via its focus on grievance and quick hits. Finding better ways to live with this success – and recognise more “things” won’t necessarily make us happier – is probably key.

Dr Shane Oliver – Head of Investment Strategy and Chief Economist, AMP

The RBA hikes to 4.35%

The RBA’s decision to hike rates to 4.35% was no surprise with it being about 75% factored in by the money market and 21 of the 22 economists surveyed by Bloomberg expecting a hike. The decision means that the RBA has now reversed all of the three rate cuts we saw last year, which followed 13 rate hikes in 2022 and 2023. Once passed on to mortgage holders it will leave mortgage rates around levels prevailing in late 2011. For a mortgage holder with an average $660 mortgage this will mean an extra $110 a month in mortgage payments or $1300 a year.

Growth down, inflation up – a whiff of stagflation

The RBA revised down its growth forecasts compared to February reflecting the impact of the War and a higher money market profile for the expected cash rate. While it revised up its unemployment forecast for 2028 it was only marginally to 4.7%. It also revised up its forecasts for trimmed mean inflation for the next year reflecting second round impacts from the War, but then sees it falling in 2027-28 back to target as higher rates and lower growth lead to lower demand and hence lower pricing.

This is a dismal outlook with growth of 1.3-1.4% for two years, a poor inflation/growth trade-off and higher unemployment. It’s a whiff of stagflation. The risk is that unemployment ends up much higher than the RBA’s 4.7% forecast.

Key reasons for the rate hike

In hiking rates again, the RBA noted an expected further boost to inflation from the War including via second round effects, at a time when inflation was already too high and increasing concern that inflation expectations will rise as a result. It is clearly more concerned at this point about inflation (where it is underperforming relative to its objective) than full employment (where it is arguably meeting its objective at least for now).

Governor Bullock’s press conference comments basically reinforced these concerns and left the door open for further interest rate hikes if needed.

The RBA also indicated it will remain “attentive to the data”. If unemployment remains lowish but underlying inflation high, then more rate hikes are likely. But if unemployment starts to rise sharply relative to inflation, then it will put a brake on RBA hikes.

With the RBA hiking and the money market still expecting another 1.5 rate hikes by year end (on top of this one), interest rates in Australia are moving higher relative to other major countries. This reflects other major countries mostly having inflation much closer to target before the War started, whereas Australia already had an inflation.

The oil supply shock makes the RBA’s job difficult

It was hoped at the time of the last RBA meeting in March that we would have more clarity around the Iran War. And a collapse in Australian petrol prices to near pre-War levels helped along by the fuel tax cuts and an easing in the immediate fuel supply fears of a month ago may be providing a sense of complacency. Unfortunately, the outlook for the War is as clear as mud. Trump wants to TACO but Iran remains intent on inflicting economic pain until the US backs down more. The Strait remains closed and Iran is responding militarily to any move by the US to prize it open without at the same time the US lifting its own blockade on Iranian shipping. So, it’s a standoff.

And the longer the Strait remains closed the greater the odds of a severe bout of stagflation – with inflation well above 5% and recession – as the full implications of the implied 10-15% hit to global oil and gas supply will become apparent as oil reserves run down.

This would mean higher oil prices (possibly up to around $US150 a barrel), and for Australia a sharp rebound in petrol prices from the recent lull and fuel rationing which will lead to a bigger boost to inflation initially and hit to economic activity. It’s not our base case – as the pressure on Trump to strike a deal with Iran (no matter how vacuous) is very high given the approaching midterm elections. But the risk rises for each day the Strait remains effectively blocked. This leaves the RBA in a difficult balancing act – should it focus on inflation or worry about the hit to growth and the risk of a much bigger rise in unemployment?

The 1970s suggests keeping inflation down is key

The experience of the 1970s holds key lessons for today. It saw inflation progressively surge into double digits in response to labour and oil shocks, rapidly rising government spending and overly easy monetary policy. Importantly, inflation had already started to rise before the first oil shock in 1973. It contributed to even higher inflation and weak growth and rising unemployment giving rise to the term stagflation. Then like now central banks grappled with whether to target inflation or weak economic activity but initially ran too easy monetary policy which allowed inflation to get out of control with surging inflation expectations which then meant that ultimately to get it under control in the 1980s (and 1990s in Australia) very tight monetary policy and deep recession were required. The key lessons were that: entrenched inflation is bad for the economy as most lose from cost of living pressures; once the inflation genie gets of the bottle it gets harder and harder to get it back in as inflation expectations rise; and that whether its initially due to a hit to supply or strong demand the central bank has to respond by tightening monetary policy and focussing initially on keeping inflation down to avoid a higher cost later.

History doesn’t repeat but it does rhyme and there are several parallels today with the 1970s – bigger government, deglobalisation, decarbonisation and aging populations have already made the economy more inflation prone and with the oil shock we are now seeing the third supply shock this decade (following the pandemic and the Ukraine War). And the Iran War threatens a further rise in underlying inflation with many reports and anecdotes of price rises for everything from airfares to toilets. Underlying inflation may also be boosted if fuel shortages lead to supply side problems. And with Australian inflation already above target and now likely to be more so the greater the risk that this will flow through to higher inflation expectations leading to higher wage demands and business being more inclined to put through bigger price rises. The longer inflation stays above target, and it now looks like doing so for five of the last six years including the present year, the more people will expect it to stay above target and the harder it will be for the RBA to get it back down. Businesses are already reporting a big rise in price pressures. This effectively blew my pre-War optimism on inflation out of the water!

So the RBA is right to be concerned and wants to show that it remains determined to get inflation back to target and to not let it spiral higher as occurred in the 1970s. This is not about thinking that higher rates can get fuel costs back down but rather is about bring demand in the economy back into line with supply and showing that its serious about: preventing a further flow on to underlying inflation; wanting to see inflation go back to target in a reasonable time frame; and trying to keep inflation expectations down.

The risk of course is that higher mortgage rates combined with War drag Australia into recession. Household spending power will be hit by a combination of the three rate hikes (which in total will cost around $300 a month in higher interest payments for those with a mortgage) and a likely rebound in petrol prices with the Strait remaining closed. Households with a mortgage are far more sensitive to changes in their disposable income than older Australians who may benefit from higher rates on their bank deposits. It’s also worth noting that the value of household debt in Australia is almost double the value of household bank deposits so higher rates cost the household sector far more than it benefits it. And fuel rationing possibly in June if the Strait remains closed will have a broader impact on the economy in curtailing some activities. Australia is particularly vulnerable on this front as we import 80-90% of our oil products.

All up and depending on how long the oil disruption lasts, in a worst case scenario the hit to economic activity could knock 1 to 2 percentage points off GDP growth and knock the economy into a recession.

On balance we think that the potential significant hit to economic growth cannot be ignored by the RBA. Although the June RBA meeting will be “live” for another hike our base case for now is that it will leave rates on hold waiting to get a better handle on the hit to the economy from the rate hikes so far and the impact from the oil supply shock. We are pencilling in one last rate hike for August though, but see the RBA cutting rates next year as weaker growth starts to bear down on inflation.

How can the Government take pressure off the RBA?

Further cost of living relief in the Budget should hopefully be limited given the risk of just adding to demand and hence inflation. More fundamentally the Government should focus on reducing capacity pressures in the economy and boosting capacity. The three key things it needs to do this are: to cut government spending back to the normal levels that prevailed pre covid; deregulate the economy to make it easier to start new businesses, employ people and supply more homes; and reform the tax system to in particular lower income tax and encourage business to invest more. Fiddling with negative gearing and capital gains tax – while they have some merits – are more about optics than fundamentals on this front.

Dr Shane Oliver – Head of Investment Strategy and Chief Economist, AMP