Time for the Spakfilla?

The national accounts confirmed that demand growth remained soft. Revisions to past tourism spending have no implications for future inflation but underline that weak supply is still an issue.

This week’s national accounts confirm that the Australian economy is still soft. Domestic demand has limped along at a quarterly pace of 0.1–0.2% for a couple of quarters. Real household income was flat in the quarter and again lagged population growth over the year.

Consumption over the past two years was not as weak as previously stated. This is because the ABS has revised its assessment of past overseas tourism spending by Australians. This counts as consumption and has resulted in a lower estimated household saving ratio. But because outbound tourism counts as imports, this had no implications for GDP.

With the revisions, Australia no longer looks like such a downside outlier on the performance of consumption per capita relative to peer economies. The United States is still clearly an outlier on the upside, though.

Some observers have speculated that these revisions might imply that households are more willing to spend than previously thought. They might therefore spend more out of the forthcoming tax cuts than predicted. This possibility needs to be weighed against both the
Westpac–Melbourne Institute survey results suggesting the opposite, (PDF 156KB) and the reduced ability to spend implied by the lower savings buffer remaining.

Indeed, the revisions remove some of the puzzle about household saving remaining as high as it had appeared. Some resilience in saving could be reconciled because higher interest rates encourage higher saving, and lower consumption, even when incomes are not outright falling. But household disposable income growth has been unusually weak in Australia. The fiscal consolidation and drag from higher taxation have been larger in Australia than in some peers. It seems these factors have offset each other, and the overall boost to saving has not been material.

At its May meeting, the RBA Board assessed that demand was coming back into line with supply quite quickly. Key to its assessment of the inflation outlook, though, is where the level of demand stands relative to the level of supply. This is harder to assess. It is also important to remember that in an environment of large and more frequent supply shocks, demand outstripping supply does not necessarily imply that demand is strong. It could instead be a case of weak demand and even weaker supply, hampered by various constraints. This interpretation becomes more plausible as high inflation rates become confined to a smaller range of categories of consumption. Recent increases in shipping costs suggest that disruptions are ongoing.

Monetary policy works by hammering down demand to make it in line with supply. In recent years, though, part of the issue is that the demand ‘nail’ is only sticking out because the supply ‘wood’ around it has been eroded away. Some of the supply disruptions related to the pandemic have taken a long time to unwind.

Outbound tourism is a good example of this. According to data from the Bureau of Infrastructure and Transport Research Economics (BITRE), in February 2024 – the latest available data – there were around 2.15 million outbound airline seats available going to 65 cities. This compares with around 1.6 million seats for 52 cities the previous February and just 440,000 seats to 37 cities in February 2022, soon after the borders reopened. The expansion over the latest year occurred partly because China’s borders only opened in early 2023. Most of the destinations added since February 2023 are in China.

There is an element of two-way interaction, too. As tourism demand recovered, airlines would have been willing to put on more flights. That said, most of what we saw was supply recovering and the relative price of overseas travel normalising. It is only since the beginning of this year that available seats have returned to the levels seen in the corresponding month of 2019. For most of 2023, flight capacity was 10–15% short of 2019 levels.

It should be noted that this rebound in the number of available seats and travellers was already in the data. The latest revision to consumption relates to the average amount of spending Australians did when they were overseas. While it is hard to be sure on the basis of available information, it seems reasonable to suppose that the Australians who did go overseas on holiday in 2022/23 ¬– when flights were still constrained and expensive – were disproportionately the ones who could spend up big when they did travel. There might also have been an element of ‘revenge spending’ following the years when overseas travel was not possible.

The key point, though, is that the revision is for several quarters ago. Unlike the long and variable lags of monetary policy, the effect of extra demand on inflation comes through quickly. Whatever effect this extra spending had on inflation, it has already happened. Past inflation data already incorporated the effects of this extra spending, though we did not know this at the time. And since this spending occurred overseas, it did not involve domestic supply capacity in any case.

We therefore regard these revisions as having no material implications for the inflation outlook.

There is a broader point here about how we should interpret and respond to an excess of demand over supply when supply shocks are so prevalent. Instead of only hammering down the demand nail, policymakers and businesses also need to consider what they can do to rebuild the supply of wood surrounding the nail.

Time for some Spakfilla? Simplifying and fast-tracking approval processes, and ensuring skilled migration is directed to activities that add to supply would be a start. At the least, what is needed is some understanding that the ripple effects of the pandemic are not yet over. It also needs to be understood that high inflation concentrated in a few categories is not the same thing as generalised high inflation. Tight monetary policy might still be needed. The assessment of the outlook should, however, allow for these differences.

Westpac Banking Corporation
Westpac Banking Corporationhttps://www.westpac.com.au/
Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.

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