Good COP, bad COP?

The main domestic economic news this week was the publication of the Minutes of the RBA’s November Monetary Policy Meeting. As usual, central bank watchers busied themselves examining the text for clues about the next rate move, like Roman haruspices inspecting sacrificial entrails to divine the future. Digging through the guts of the release suggests there were two – somewhat offsetting – messages to be found.

On the one hand, the Minutes noted it was ‘important to remain forward-looking, thereby avoiding an excessive reliance on backward-looking information that might lead the Board to react too late to a change in economic conditions’. That suggests some easing in the RBA’s prior data-dependency and a recognition that it can make sense to move on rates before unemployment has risen markedly or before inflation is back within the target band. All else equal, this is consistent with an earlier rate move by the RBA.

On the other hand, however, the Minutes noted that if inflation surprised to the downside, Board members would ‘need to observe more than one good quarterly inflation outcome to be confident that such a decline in inflation was sustainable.’ Much market commentary seized on this point because the next two quarterly consumer price inflation (CPI) releases will not arrive until 29 January 2025 (the December quarter 2024 CPI) and 30 April 2025 (the March quarter 2025 CPI). So, requiring at least two quarters of good inflation outcomes as a precondition for a rate cut would imply that the earliest timing would be the 19-20 May 2025 meeting. So much for my February 2025 call.

In fact, that’s not quite what the Minutes said. The caveat applied to a specific scenario where inflation fell more quickly than expected due to factors such as easing rental growth or a more pervasive disinflationary effect from energy rebates. But the Minutes also discussed other scenarios that could justify a rate cut, including a faster than expected loosening in the labour market or persistently weaker than anticipated household consumption. In theory then, it is still possible that some mix of a good December quarter CPI number plus evidence of labour market loosening and/or disappointing consumption readings could yet see a cut in February. But right now, that just doesn’t look to be what the RBA is planning.

The messy geoeconomics and geopolitics of COP29

For the past two weeks, the 29^th Conference of the Parties (COP) to the UN Framework Convention on Climate Change (UNFCCC), or COP29, has been underway in Baku, Azerbaijan. Scheduled to run between 11 and 22 November and taking place against estimates that this year will have brought record global temperatures, rising climate hazards, and record global emissions, the hope was that the summit could deliver progress on three fronts.

• First, the main ambition for COP29 was to reach agreement on a so-called ‘New Collective Quantified Goal’ (NCQG) on Climate Finance. This is intended to update and replace the commitments made under COP15’s Copenhagen Accord, whereby developed countries had committed to mobilise US$100 billion a year in climate finance by 2020. In the event, they missed their deadline, but did eventually manage to deliver an estimated US$115.9 billion in 2022. Now, the developing world is seeking much greater assistance. The combined developing country G77 and China negotiating group has proposed US$1.3 trillion of support, for example. In recognition of the key role of the NCQG, some have dubbed COP29 the ‘Climate Finance COP’.

• Second, progress was anticipated around Article Six of the Paris Agreement, which sets out how countries can pursue voluntary cooperation to reach their climate targets, and in particular around Article 6.4, the Paris Agreement Crediting Mechanism, which sets the framework for a UN high-integrity carbon crediting mechanism.

• Finally, and less formally, there was the chance that COP29 could provide some additional impetus for countries to announce progress on their nationally determined contributions (NDCs). NDCs are country commitments to reduce national emissions and are central to the 2015 Paris Agreement, which tasked each country with setting out their post-2020 climate actions. NDCs are supposed to be submitted every five years, with the next deadline February 2025. According to the UN’s Emissions Gap Report 2024, a failure to increase ambitions relative to existing NDCs would leave the world on course for a temperature increase of between 2.6C and 3.1C over the course of this century, breaching the Paris Agreement’s temperature goal of limiting global warming to well below 2C above pre-industrial levels.

At the time of writing, COP29 had made progress on the second point, with agreement on the standards for how international carbon crediting projects would work, although some critics remained sceptical and considerably more work will be needed before the mechanism can become operational. But talks on finance remain deadlocked, with press reports suggesting a large gap between developing and developed economies. Cash-strapped developed countries have been pushing back against many of the larger ambit claims from developing countries, while also making the case for expanding the set of donor countries to include emerging markets like China and Saudi Arabia.

One feature of the COP process worth noting here is the increasingly messy geoeconomics and geopolitics involved. For the second consecutive year, the host of a COP was a petrostate, which has raised accusations of ‘greenwashing’ in some quarters. Many world leaders decided to skip this year’s summit. The Argentine delegation subsequently withdrew. Then there are the tensions between developed and developing countries, and between the former and some major emerging markets when it comes to burden sharing. Looming over all this is the prospect that a Trump Presidency could take the United States out of the Paris Agreement for a second time, and the potential this could trigger further exits (true, when the United States left in 2020, no other country followed – but times have changed). And then there is the contradictory position of China. Simultaneously the world’s largest annual emitter of greenhouse gases (by far) while also a clean energy superpower and the dominant producer of technology critical for the transition including solar panels (86 per cent of global production in 2023), lithium batteries (74 per cent) and EVs (68 per cent). Beijing is also increasingly the target of protectionist policies in the West that are aimed directly at some of those same green industries. Messy indeed and with both geoeconomic and geopolitical complications likely to increase further over the coming year, prospects for the COP process look challenging. Hope instead may have to rest with the ongoing dramatic pace of technological change in renewables.

We discussed both COP29 and the RBA Minutes (including my steadily waning confidence in my February 2025 rate call) in this week’s episode of the Dismal Science podcast. There is also more detail from those RBA Minutes below, along with a roundup of the rest of the week’s data releases, plus the usual collection of extra reading and listening.

RBA minutes show Board contemplating range of scenarios

The RBA published the Minutes of the 4-5 November 2024 Monetary Policy Meeting of the Reserve Bank Board, at which the Board had decided to leave the cash rate target unchanged at 4.35 per cent for an eighth consecutive meeting. According to the minutes, factors supporting the Board’s view that ‘there was no immediate need to change the cash rate target’ included:

• The Board’s view that economic conditions and the overall outlook were little changed from August 2024, and hence the projections in the November 2024 Statement of Monetary Policy differed little from their August predecessors. Moreover, the risks to those forecasts were still assessed as balanced.

• While lower fuel and electricity prices had pushed down headline inflation, underlying inflation ‘remained too high and…staff forecasts did not see inflation returning sustainably to target until 2026’.

• Monetary policy settings were judged to be restrictive, but the degree of this tightness was seen as uncertain and broader financial conditions were assessed to have eased over the preceding months.

• Staff forecasts remained consistent with the Board’s declared strategy of returning inflation to target within a reasonable time, while also preserving as many of the labour market gains as possible. Those forecasts assumed no change to the cash rate in the near term.

Interestingly, the Minutes did note that the Board was cognisant of the need to remain forward-looking and not be too reliant on data:

‘…members recognised it was important to be ready to adjust the future stance of monetary policy as the economic outlook evolves…They noted too that it is important to remain forward looking, avoiding an excessive reliance on backward-looking information that might lead the Board to react too late to a change in economic conditions.’

This marks an interesting adjustment to the data-dependent mode that has seemed to be prioritised in recent RBA thinking. According to the August 2024 Minutes, for example, the Board had commented that ‘it was appropriate to continue placing somewhat greater-than-usual weight on the flow of data, relative to the forecasts’. This message was not meaningfully adjusted in the September 2024 Minutes which noted only that ‘members reiterated that the data and the evolving assessment of risks would guide their future decisions’.

The minutes reported that members discussed a range of scenarios that could warrant either a future change in the cash rate or a decision to leave it unchanged for a prolonged period.

There could be a case for a rate cut if:

• Consumption turned out to be much weaker than the RBA expected over a sustained period, and if this in turn led to lower inflation.

• Labour market conditions eased more sharply than projected, leading to a more rapid decline in inflation.

• Inflation declined ‘materially more quickly than currently forecast,’ for example if rental markets returned more quickly to balance, or if the electricity rebates had a broader disinflationary effect than expected. Although members would ‘need to observe more than one good quarterly inflation outcome to be confident that such a decline in inflation was sustainable.’ [emphasis added].

There could be a case for a prolonged period of an unchanged cash rate target if:

• The recovery in consumption was faster and stronger than anticipated, placing pressure on underlying inflation.

And there could be a case for a rate hike if:

• It became clear that the economy’s supply capacity was ‘materially more limited’ than the RBA had assumed.

• It became evident that inflation would remain above target for longer than forecast, given that inflation had already been above target for a ‘lengthy period.’

• The Board formed the view that the monetary policy stance was not in fact as restrictive as it had previously judged.

Finally, the Board also discussed risks arising from the international environment, including:

‘…the potential for major changes in US economic policy following the presidential election, the prospect of the size or composition of the stimulus package foreshadowed by Chinese authorities differing from expectations, and the more general risk of unsustainable growth in global government debt’.

But members also agree that ‘it was not yet possible to factor in events such as these, given pertinent details were unknown and still largely unpredictable’.

All of which led to a familiar conclusion:

‘Based on the information available at the time of the meeting, members agreed that it was not possible to rule anything in or out in relation to future changes in the cash rate target.’

What else happened on the Australian data front this week?

According to the ABS, real Gross State Product (GSP) rose in all state and territories in 2023-2024, with the strongest growth in the Northern territory (up 4.6 per cent), followed by the ACT (four per cent), Queensland (2.1 per cent) and Victoria (1.5 per cent). Growth was softer in NSW and South Australia (at 1.2 per cent) and weakest in Western Australia (0.5 per cent). In the same year, overall Australian real GDP growth was 1.4 per cent.

The ABS said that according to its Monthly Employee Earnings Indicator, total wages and salaries paid by employers amounted to $103.7 billion in September 2024 (original, calendar-adjusted basis). That result marked a record monthly high as payments exceeded $100 billion. The September 2024 result was up 3.9 per cent from the previous month and 6.3 per cent higher than the sum paid in September 2023. For the September quarter 2024, wages and salaries paid were up 3.3 per cent over the quarter and 6.4 per cent over the year.

The ANZ-Roy Morgan Consumer Confidence Index was little changed in the week ending 17 November, edging up by just 0.1 point to 86.8 index points. That means the index has remained above the 85 level for a fifth consecutive week for the first time since October 2022. ANZ noted that optimism about the year ahead has now been rising since July, with the ‘short-term economic confidence’ (next 12 months) subindex up 10.7 points since then, while the ‘future financial conditions’ (next 12 months) has risen by 8.2 points over the same period.

Weekly inflation expectations eased from 4.9 per cent to 4.7 per cent. It has now been 14 weeks since the inflation expectations reading had a five in front of it.

Other things to note . . .

• The Productivity Commission’s Chair and Deputy Chair argue that just as the 1990s Hilmer reforms helped lift productivity in the past, so could a new wave of national competition policy (NCP) reforms boost our current productivity performance. They reckon a revitalised NCP could permanently boost Australia’s GDP by up to $45 billion a year, equivalent to about $5,000 per household.
• Related, a new report from the BCA examines Australia’s flagging competitiveness and productivity.
• Australia’s Parliamentary Budget Office (PBO) has released a new Budget Explainer on Australia’s Tax Mix, where ‘tax mix’ refers to the broad aggregate of taxes and how they relate to each other. According to the PBO, Australia’s tax mix has been stable since 1980, although there has been a rebalancing in indirect taxation away from tariff and wholesale taxes and towards the GST during that time. Still, even the introduction of the GST – the most substantial tax change in at least half a century – did not produce a significant, sustained change to Australia’s mix of indirect and direct taxes. The PBO estimates that only very large policy changes would be enough to generate such a significant shift, since changing Australia’s tax mix by only five per cent in any form would require policies worth around $40 billion per annum – roughly the size of the entire medical and pharmaceutical benefits system, and almost the size of defence spending. As one example of such a major policy change, the PBO runs through the implications of doubling the GST rate to 20 per cent and using the proceeds to reduce income tax, which it reckons would lower personal income tax from 42 per cent of all tax in Australia now to around 30 per cent, while increasing the GST share from 11.5 per cent to 23 per cent. Absent that scale of policy change, the PBO’s baseline reckons bracket creep could see personal income tax rise to around 46 per cent of the total tax take – well above the post-GST low of 36 per cent, but still a little below the mid-1980s share of more than 47 per cent.
• Sticking with fiscal issues, a new publication from the CIS examines government off-budget spending.
• Grattan CEO Aruna Sathanapally’s recent speech on Bridging generations argues that Australian institutions are facing a trust problem and that a large part of the problem is the product of a ‘wretched intergenerational bargain’.
• According to the ANZ CoreLogic Housing Affordability Report 2024, rising home values and higher rents meant that housing affordability metrics deteriorated across most of Australia this year. Estimates put Australia’s annual gross median household income at around $101,000 as of September this year, up 2.8 per cent year-on-year. That rate of increase failed to keep pace with both the rise in the median dwelling value (up 8.5 per cent) and the increase in rents (up 9.6 per cent) over the same period. The median dwelling value to income ratio rose to eight, equal to the record highs of early 2022. Assuming annual savings rates of 15 per cent and based on current average mortgage rates for owner occupiers, the Report estimates it now takes the median income household 10.6 years to save a 20 per cent deposit for the median value dwelling, with more than half of median household income then required to service a new home loan.
• The ABS reviews Home building through the pandemic. By 2019-20, total dwelling approvals and commencements had fallen to their lowest annual totals since 2013-14. Both then surged in the second half of 2020-21 in response to record low interest rates and government stimulus measures to support home building. Total approvals surged by 27 per cent and total commencements jumped by 23 per cent. Both then fell each year to 2023-24, leaving approvals six per cent lower than their 2019-20 levels and commencements eight per cent lower, with both totals the lowest recorded since 2011-12. The surge in commencements led to bottlenecks in construction as the average new house completion time rose by 50 per cent from September 2019 to June 2024, up from 2.2 quarters to 3.3 quarters. The average cost of completed homes rose from $345,410 in 2019-20 to $443,828 in 2023-24, reflecting an average annual cost increase of 6.7 per cent.
• RBA Assistant Governor Christoper Kent gave the Sir Leslie Melville Lecture on The Financial System and Monetary Policy in Australia. One key theme of his speech was that, despite the comparatively large stock of variable rate mortgage debt carried by Australian households and their consequent elevated level of exposure to interest rate risk, there ‘is no evidence that monetary policy is stronger in Australia than in other advanced economies’. Granted, the prominence of variable rate housing debt might mean the so-called cash rate channel of monetary policy is stronger in Australia than in other advanced economies (although some of this could also be offset by different household borrowing behaviour - for example, most Australian borrowers tend to enjoy relatively high levels of financial buffers). At the same time, however, other features of the Australian economy might mean some other policy transmission channels are less strong. For example, Kent cites the large share of Australian savings tied up in compulsory superannuation, which means that the transmission of monetary policy via asset prices might be lower than for countries like the United States, where households have much larger direct holdings of financial securities.
• New (2023-24) ABS data on patient experiences in Australia, with numbers on access and barriers to healthcare services.
• The WSJ on how US Democrats blew it on inflation.
• And an FT Big Read on Elon Musk’s mission to reinvent American government.
• The OECD’s International Migration Outlook 2024 reports that permanent migration to OECD member countries hit a new record in 2023, with 6.5 million migrants arriving, up 10 per cent from a record-breaking six million in 2022 (the numbers exclude 4.7 million Ukrainian refugees under temporary protection) and 28 per cent higher than pre-pandemic (2019) levels. About a third of OECD countries experienced record immigration levels last year including Australia, Canada, France, Finland, Japan, Korea, Switzerland and the UK. Most of the 2023 increase was driven by family migration (43 per cent of all new permanent immigration and up 16 per cent). Labour migration accounted for 20 per cent of permanent migration in 2023. Humanitarian migration also rose strongly (up 20 per cent) and accounted for 11 per cent of the total. The number of new asylum seekers to the OECD also hit a new record (up 30 per cent to 2.7 million applications).
• Turning from flows to stocks, by last year, there were more than 150 million migrants living in OECD countries, with most living in North America (38 per cent) and the EU (37 per cent). Australia’s share was five per cent. By 2023, the share of immigrants in OECC countries had risen to 11 per cent from nine per cent a decade before. Australia is one of a group of OECD countries where immigrants account for more than 20 per cent of the population (29 per cent), along with Luxembourg (51 per cent), Switzerland (31 per cent), New Zealand (27 per cent) and Austria, Iceland, and Canada (all at 22 per cent). Migrants account for more than 14 per cent of the population in half of all OECD countries.
• Also from the OECD, Pricing Greenhouse Gas Emissions 2024 finds that the share of emissions covered by either an explicit carbon price or by fuel excise taxes in 2023 was unchanged compared to 2021. Approximately 42 per cent of GHG emissions were subject to a positive Net Effective Carbon Rate (a measure which accounts for carbon taxes, emissions trading schemes (ETS), fuel excise taxes and fossil fuel subsidies) while only about 27 per cent were covered by explicit carbon prices (a tax or ETS) and 23 per cent by implicit carbon prices in the form of fuel excise taxes.
• The OECD’s Climate Action Monitor 2024 reported that this year is on track to set new records for global warming with ‘unprecedented natural temperature levels’. According to the report, the global average temperature was 1.5C warmer than the pre-industrial era for 12 consecutive months, while by August this year, 15 national temperature records had been broken across the world. Meanwhile, global emissions continued to grow last year, rising by 1.3 per cent.
• Related, this week’s Economist magazine argues that the energy transition will be much cheaper than you think. Some of this is down to good news. Economic modellers have tended to consistently underestimate the rate of technological change and the associated pace of cost reductions for recent technology - particularly solar panels and lithium batteries. Some of it is down to neglecting the counterfactual. Even in the absence of efforts to drive decarbonisation, the world would anyway need to invest trillions of dollars in national energy systems and some calculations of the cost of energy transition sometimes neglect to take this into account. But some of it reflects bad news. Global growth (and therefore energy demand) is likely to be lower than expected and the chance of limiting warming to just 1.5C in line with the Paris Agreement now looks to be gone, allowing for a slower (and therefore less costly) pace of transition if the effective target is now 2C.
• Also related, via the AFR, a scathing assessment of the COP process coupled with optimism on decarbonisation.
• From the Economist magazine’s The World Ahead 2025, Ten trends to watch in 2025. The list comprises the repercussions of the recent US elections, the broader anti-incumbency mood among voters, rising global disorder, intensifying protectionism, a China-led clean tech boom, fiscal challenges, an ageing world, crunch time for AI, disruptions to global people movements and some ‘wild cards’.
• In the Harvard Business Review, Agrawal, Gans and Goldfarb argue that Generative AI is still just a prediction machine.
• Daniel Waldenstrom’s new history of wealth inequality in the West argues that in the 20^th century Western nations managed to combine remarkable growth in per capita wealth with falling wealth inequality. Contrary to narratives that attribute this trend towards equalisation to adverse shocks to the capital of the rich (via wartime destruction and redistributive taxation), Waldenstrom argues that the key drivers were rising home ownership and pension funds. His conclusion was to promote home ownership and long-term savings to foster both wealth creation and economic equality.
• Comparing the responses of Meiji Japan and Imperial China to 19^th Century Western imperialism. The authors discuss the importance of ideologies, including ‘the willingness to adopt from cultures perceived as inferior, the worthiness of Western ‘rational’ education, and the benefits of adopting Western financial and economic institutions’. The proposition here is that centralised states are less likely to be able to adopt new ideologies. In Japan, a decentralised political system allowed the flexible adoption of Western technology and institutions while in China, a centralised bureaucracy hindered significant reform.
• The best economics books of 2024, according to the FT’s Martin Wolf. I must confess, I haven’t read any of these, or even have any of them pending on my guilt-inducing to-be-read pile.
• The Economics Show podcast asks, would Donald Trump’s proposed new tariffs really be that bad?
• The These Times podcast considers whether Donald Trump could be a Peacemaker President.
• The LRB Podcast in conversation with James Meek on the Endgame in Ukraine.