Reserve Bank of Australia Annual Report – 1977 The Economy and Economic Policies in 1976/77

In Australia, as in a number of other developed economies, economic activity continued to pick up in 1976/77. The recovery was generally slow and uneven over the year. Unemployment and inflation remained major problems in another difficult year for the Australian economy; unemployment increased further during the year; despite some moderation, inflation continued high.

Growth in real output in 1976/77 was greater than in 1975/76. The increase in output, which began in the second half of 1975/76, proceeded at a solid pace into early 1976/77, with strong growth in demand for exports and moderate growth in private final domestic demand supplemented by substantial stock building. More recently, with lesser stock accumulation, a worsening of the trade account and hesitancy in final domestic spending, there has been a slowing of growth. Over 1976/77 as a whole, growth in real private final domestic demand was at about the same pace as in the previous year; there was continued budgetary restraint by the Commonwealth Government, and real public spending remained essentially unchanged.

The weakness of demand and the uneven pace of production during the year, together with the continued high level of labour costs, were factors tending to depress employment prospects over 1976/77, and the labour market tended to weaken. Total civilian employment showed little change and unemployment (as measured in the Australian Bureau of Statistics surveys) increased from an average of 4.4 per cent of the labour force in 1975/76 to 4.8 per cent in 1976/77.

There was, however, some progress in reducing inflation in 1976/77. Broadly based price indexes (other than the consumer price index, movements in which have been heavily affected by special factors in the last two years) increased less rapidly than in 1975/76. There was also some easing of the upthrust of award wages and wages, salaries and supplements per employee. The slowing in rates of increase of both prices and wages was marked in the first half of the financial year. This downward tendency was not sustained into the second half, in part because the flow-on from devaluation began to show up in some prices.

Both exports and imports were buoyant in 1976/77. The total value of exports benefited from generally high world commodity prices; export volumes grew rapidly early in the year and then levelled out. Imports were high in both volume and value, despite the sluggishness of aggregate demand and, as a result of devaluation, the movement of relative prices against overseas goods. There was, however, a wide range of fluctuation within the year in capital flows, and, consequently, in the level of reserves. Net outflows of private capital in the early part of the year combined with the current account deficit to reduce reserves despite substantial official borrowings abroad. Following devaluation in November, private capital inflows were sizeable in the three months to February and boosted reserves substantially. Capital inflow was lower in the last four months of the year largely because of a tightening in January of restraints on external borrowings. Reserves were moving downwards at the end of the year. The net result of trade and capital transactions in 1976/77 was a deficit of $492 million for the balance of payments.

Financial flows during the year were dominated by the size and seasonality of the Commonwealth Government's budget deficit; another important, though lesser, influence was the balance of payments. The huge seasonal budget deficit expanded private sector liquidity rapidly in the early part of the year; with this liquidity base, lending by financial institutions was also strong. The private sector balance of payments deficit and a reduction in the Reserve Bank's holdings of commercial paper were no more than partial offsets to the injections of liquidity from government transactions. For the period immediately following devaluation in November, the surplus in the external accounts added to the effect on liquidity of the budget deficit. Over much of the first half of the year, the money supply broadly defined (M3) was growing at an annual rate (not seasonally adjusted) exceeding 20 per cent (around 15 per cent in seasonally adjusted terms).

With moves to tighten the monetary instruments in the middle months of 1976/77, and with the heavy seasonal tax flows to the Government after February, conditions in financial markets became firmer, and monetary aggregates grew considerably more slowly in the second half of the year. For the year as a whole, money supply (M3) increased by 10.6 per cent, a rate of increase well below that of recent years.

Non-bank take-up of government securities in 1976/77, at about $1,100 million, while high by historical standards, was below the previous year's figure of about $1,450 million, much of which had been accounted for by very heavy subscriptions to the first two series of Australian Savings Bonds. Sales of securities to non-bank groups were slow in the four months to October when liquidity was abundant but increased sharply later in the year. Initially, the increased take-up was of Treasury notes acquired to finance the seasonal rundown but, with a changed attitude from about the middle of May, there were substantial purchases by non-bank groups of longer dated bonds in the closing weeks of 1976/77.

Economic Policies

With the need to reduce inflation seen by the Government as the vital element in the basis for sustained economic recovery, the rate of growth of public outlays was, as in the 1975/76 Budget, again reduced substantially in the Commonwealth Budget for 1976/77. The Government's submissions in the National Wage cases during the year sought to restrict increases in award wages to levels considerably lower than the increases in consumer prices. Monetary policy was designed to reinforce these measures by providing sufficient funds to aid recovery in the private sector while ensuring that financial conditions were not such as to facilitate resurgence of inflation. Although the focusing of economic policies against inflation pointed towards maintaining the exchange rate at as high a level as practicable, its growing concern over other developments in the economy led the Government to devalue the Australian dollar in November. As a complement to this action, domestic policy instruments were tightened further. A listing of policy measures since July 1976 appears at the end of this part of the Report.

1 Selected Indicators

2 Selected Indicators

Many of the measures which were embodied in the 1976/77 Budget had been foreshadowed by the Treasurer in May 1976. A halving of the rate of growth of outlays was achieved mainly through administrative savings, the transfer of some of the costs of hospital and medical care to the private sector, and the limiting of growth of payments to State Governments and Commonwealth public authorities. The lower growth in these payments reflected, in part, the prepayment of some expenditures to States late in 1975/76 and the requirement that Telecom finance some of its capital expenditure in 1976/77 by direct borrowing from the public. Growth in receipts was expected to be a little lower than in 1975/76, but was nonetheless faster than for outlays. The Budget was thought likely, in conjunction with appropriate monetary policy settings, to be consistent with growth in the volume of money broadly defined (M3) in the range of 10 to 12 per cent in 1976/77.

A primary task of monetary policy was to avoid the translation of the still large deficit into a rate of monetary expansion that would provide additional stimulus to prices. A major need was to place with the private sector and, in particular, the non-bank sector a substantial amount of government securities. The Bank also sought directly to limit the expansion of bank liquidity and lending by financial intermediaries.

After Budget time, a number of actions were taken towards a tightening of monetary policy in opposition to the strong upswing in liquidity then taking place mainly because of the large seasonal budget deficit. The issue yield on Treasury notes was increased in August and September. In early November, market yields on short and medium term government securities were moved up and the Bank increased the major trading banks' Statutory Reserve Deposit ratio. Trading banks were asked by the Bank to reduce the level of their new loan approvals, and a series of consultations over October, November and December was held with savings banks and, for the first time since the commencement of the Financial Corporations Act, with other major intermediaries seeking moderation in the growth of their lending.

The downward tendency in international reserves which had been evident over much of the early part of 1976/77 persisted in November and, late in the month, the Australian dollar was devalued by 17.5 per cent; at the same time there was a further tightening of domestic financial policies. A substantial inflow of capital immediately followed the devaluation; under a changed regime of more flexible handling of the level of the exchange rate, the Australian dollar was appreciated by about 6 per cent in a series of steps during December. Firm measures of restraint on overseas borrowings were reintroduced in mid January. With a rising level of reserves and the continuing budget deficit adding strongly to liquidity, the Bank raised the SRD ratio of the major trading banks in successive steps over the three months to February from 6 to 10 per cent to keep a firm hold of banks' free LGS assets.

The seasonal rundown in liquidity began in March. Most institutional groups had been made aware by the Bank that the rundown would be heavy and had (to some extent helped by the capital inflow after devaluation) made substantial provision for it, largely through increased holdings of Treasury notes. The seasonal transfer was aided by an increase in major trading banks' free LGS assets of 5 percentage points as their earlier temporary arrangement with the Reserve Bank for a higher minimum LGS ratio lapsed on 1 April 1977. These various sources of liquidity in fact proved almost sufficient to finance the seasonal transfer of tax funds to the Government. However, with an increase in the appetite of the non-bank sector for government securities and a downward tendency in foreign reserves, the liquidity of major trading banks tightened sharply and the Bank lowered the SRD ratio by two percentage points in two steps, each of one percentage point, around the end of the financial year.

The volume of housing finance approvals was tending to fall in the second half of the financial year. Steps were taken in the closing months to ensure that lenders were not inhibited by official constraints from providing adequate finance. The ratio of prescribed assets (mainly liquid assets and public sector securities) for savings banks was lowered from 50 to 45 per cent of deposits in May. In June and July, in consultations with savings banks and permanent building societies, the Bank indicated that, over the months ahead, some growth was expected in new lending for housing.

In July 1977, the Budget shifted back into deficit and with the seasonal upswing in prospect, banking and financial policy continued to be directed at providing an overall level of finance that was consistent with sustainable growth in activity while, at the same time, contributing to the reining in of inflation.

Some further progress was made in 1976/77 towards restoring economic stability. Though progress was uneven as between sectors and time periods, the year's growth in output was a little higher than in 1975/76, and there was a modest reduction in inflation. Progress towards stability, however, was also clouded at times by uncertainties about the external accounts and the effects of devaluation. The Budget outturn was close to the figure initially projected, and the rate of growth of the money supply was again stepped down. These were important elements in creating financial conditions more appropriate to lowering inflation and the provision of more adequate levels of finance to the private sector.

Major economic imbalances remain in the Australian economy. Inflation persists; and unemployment, particularly for juniors, is at seriously high levels; and capacity utilisation is low. Business and consumer confidence remain low; and at the start of 1977/78, the challenge still remains to bring down the rate of increase in prices and wages to levels consistent with the attainment of satisfactory levels of demand, production and employment with longer run external balance.

Selected Policy Measures – July 1976 to July 1977

1976

1977