December 2016
The Sensitivity of Personal Income to GDP Growth
This article examines how the income of different individuals varies in response to changes in the state of the economy using individual-level data from the Household, Income and Labour Dynamics in Australia (HILDA) Survey. More specifically, the article explores which types of income earners (those in the top, middle or bottom of the income distribution) and which sources of income (labour or capital) are most affected by economic conditions. Results suggest that the incomes of bottom- and top-income earners are the most sensitive to the state of the economy, although for different reasons: during strong economic conditions, the labour income of bottom-income earners rises, due to lower unemployment, while the capital income of top-income earners also rises, due to higher dividend and interest earnings. The effect on bottom-income earners appears to be stronger than that on top-income earners, suggesting that income inequality declines when economic conditions are strong.
Factors Affecting an Individual's Future Labour Market Status
This article examines the ways in which someone's characteristics and circumstances in one year affect their probability of being in a particular labour market state in the next year. People are more likely to be employed next year if they are currently employed and have tertiary qualifications. In contrast, they are more likely to be unemployed or outside the labour force if they have a long-term health condition, have not completed high school or are a migrant from a non-English-speaking background. Additionally, the article considers the changing importance of determinants over time, noting the role that changes in individual and household preferences as well as broader macroeconomic conditions are likely to have played.
Measures of Inflation Expectations in Australia
Inflation expectations have an important influence on wage growth and price inflation. Expectations differ across agents and time and, accordingly, the Reserve Bank monitors a range of measures. This article discusses why inflation expectations are important for inflation and economic activity, the measures that exist in Australia and various issues affecting their interpretation. The financial markets that are used to calculate some measures of inflation expectations are not particularly liquid in Australia, and the financial measures also include an inflation risk premium; these issues can affect the interpretation of movements in the series.
The Cash Market
The cash market is the market for unsecured, overnight loans between banks. The weighted average of interest rates on these loans is the cash rate, the Reserve Bank's operational target for monetary policy and an important financial benchmark. Over the past decade or so there have been a number of regulatory and payment system developments that have affected the cash market, coinciding with a decline in aggregate market turnover. This article examines these developments using newly available data on payment system activity.
The Future of Cash
Australian consumers have increasingly been using electronic payment methods in preference to cash for their transactions. The overall demand for cash in Australia, however, remains strong. There is ongoing demand for cash for non-transaction purposes, particularly as a store of wealth. While the role of cash in society is evolving, it is likely to remain an important feature of the payments system and economy for the foreseeable future. Moreover, the current mix of banknote denominations continues to meet community demand for a secure means of payment and store of wealth. Given the ongoing importance of cash, the Reserve Bank will maintain the public's confidence in Australia's banknotes by continuing to ensure that banknotes are of high quality and secure from counterfeiting.
The Effect of Chinese Macroeconomic News on Australian Financial Markets
Over the past two decades, economic and financial developments in China have become more important for the Australian economy in many ways. This article focuses on the effect of economic data releases in China on financial markets in Australia, and argues that Australian financial markets, particularly the Australian dollar, react more strongly to news about the Chinese economy than in the past.
Developments in Foreign Exchange and OTC Derivatives Markets
The Bank for International Settlements (BIS) conducts the Triennial Central Bank Survey of Foreign Exchange and Over-the-counter (OTC) Derivatives Markets Activity (Triennial Survey) to collect information about the size and structure of these markets. The 2016 survey results suggest that global activity in these markets declined since the previous survey, partly reflecting higher-than-usual activity in April 2013 and exchange rate movements. Over the same period, activity in the Australian foreign exchange market declined markedly in US dollar terms, but only modestly in Australian dollar terms. For Australian banks, the value of OTC derivatives outstanding continued to increase, though gross credit exposure declined.
Macroprudential Policy Frameworks and Tools
Over the past decade, policymakers have increasingly used macroprudential tools to address a range of financial stability concerns. International institutions have identified and offered guidance on the components of an effective macroprudential framework, while noting the need for such a framework to be sufficiently broad to reflect differences in national circumstances. This article outlines key issues faced by policymakers in identifying and mitigating systemic risk and notes the flexible approach taken by Australia's regulatory agencies. In this context, macroprudential policy is seen as just one component of an effective financial stability framework.
September 2016
New Banknotes: From Concept to Circulation
A core function of the Reserve Bank is to maintain public confidence in Australia's banknotes as a secure method of payment and store of wealth. To meet this objective, the Reserve Bank has been developing a new banknote series to upgrade the security of Australia's banknotes. The process has involved integrating artistic designs that reflect Australia's cultural identity with a range of complex technical features designed to make the banknotes very difficult to counterfeit. This article outlines the various steps of the process of ‘banknotisation’ for the new banknote series, whereby the design concept is developed into a finished banknote.
Sensitivity of Australian Trade to the Exchange Rate
The exchange rate is an important determinant of Australian exports and imports. Movements in the exchange rate affect the relative prices of traded goods and services, and thus the competitiveness of domestic producers of exports and import-competing goods and services. This article provides estimates of the sensitivity of Australian exports and imports to changes in the exchange rate at the aggregate and component level. Other things equal, a 10 per cent depreciation in the real exchange rate is estimated to increase export volumes by around 3 per cent and decrease import volumes by about 4 per cent after two years, which implies a cumulative net exports contribution to gross domestic product (GDP) of around 1½ percentage points over this period. However, the aggregate responses of exports and imports disguise substantial variation in the responses of the components. Trade in services is generally more responsive to movements in the exchange rate than trade in goods, although it takes longer for the full effect to be seen in services trade volumes.
The Household Cash Flow Channel of Monetary Policy
Changes in interest rates can affect household spending by directly affecting households' interest income and payments and, in turn, the amount of cash that households have available to spend. This is typically referred to as the ‘household cash flow channel of monetary policy’. Household-level data provide evidence that the cash flow channel operates both for households that are net borrowers and for those that are net lenders, though the effect on borrowers is estimated to be much stronger than the effect on lenders. Overall, changes in household cash flow appear to be an important channel through which lower interest rates can stimulate greater household spending.
Chinese Household Income, Consumption and Savings
Household income and spending in China have grown rapidly over the past few decades, and income inequality has also risen. The various measures of China's aggregate household saving rate have all increased since the 1990s, and variation in saving behaviour by income group suggests that increasing the income of poorer households in particular would boost aggregate consumption. Changes in Chinese household consumption patterns as incomes rise have the potential to lead to higher imports of services and food from Australia in the long run. However, uncertainty around the outlook for growth of Chinese household income, consumption and saving is increasing as economic growth moderates in China.
Developments in the Australian Repo Market
The market for repurchase agreements (repos) – where cash is borrowed and lent using securities as collateral – plays an important role in the implementation of monetary policy and as a source of finance for the bond market. The Reserve Bank has commenced publishing more detailed data about the repo market. This article introduces these data and highlights some key developments. The domestic repo market has grown considerably in recent years, with non-residents emerging as prominent borrowers of cash in return for securities. The spread between repo rates and expectations for the cash rate has risen noticeably over the past couple of years. This increase appears to be linked to developments in the foreign exchange swap market as well as arbitrage related to the Australian bond futures market. Demand from non-residents to fund trading activities and, to a lesser extent, regulatory requirements have contributed to the increase in repo rates.
The Kangaroo Bond Market
Australian dollar-denominated bonds issued by non-resident entities in Australia are referred to as Kangaroo bonds and represent a significant share of the Australian bond market. Issuance has generally been dominated by highly rated issuers such as supranational and quasi-sovereign agency entities; more recently there has been an increase in non-financial corporate issuance, albeit from a low base. Kangaroo bond issuance has increased substantially since the early 2000s, supported by the global demand for highly rated and relatively high-yielding Australian dollar-denominated assets. Kangaroo bonds have been attractive to non-resident issuers as they enable non-residents to diversify their funding bases and have relatively favourable issuance costs (including hedging costs) compared with issuance in other currencies. Kangaroo issuers play an important role in the cross-currency swap market because, by converting the Australian dollars they raise into foreign currency, they act as indirect counterparties for Australian corporations looking to convert funds raised offshore into Australian dollars.
Banks' Wealth Management Activities in Australia
Wealth management activity has grown rapidly in Australia over the past 25 years and the major banks now comprise a much larger share of the industry than they did previously. The returns on these activities across the major banks have varied, being close to those on traditional banking activities in some cases but below the cost of capital in others. By undertaking this line of business, banks have increased their resilience (by diversifying their income) but also face new risks. In part reflecting these risks, as well as a greater focus on capital management, banks have begun to re-examine the nature and extent of their involvement in wealth management.
GDP-linked Bonds
A GDP-linked bond is a debt security with repayments that are linked to the issuing country's GDP. These securities have recently attracted some attention, including within the Group of Twenty (G20), in the context of discussions about possible ways to improve the resilience of the international financial system. In view of this, we discuss the potential benefits and challenges associated with issuing GDP-linked bonds and estimate a range of plausible risk premiums using the capital asset pricing model (CAPM). Our analysis suggests that there is significant uncertainty about how these instruments would be priced and, therefore, the borrowing costs that would be faced by governments. Given that borrowing costs play a crucial role in determining what type of debt governments choose to issue, further work could investigate how private market participants are likely to price GDP-linked bonds in practice.
Sources of Financial Risk for Central Counterparties
Central counterparties (CCPs) play an important role in managing the risks present in financial markets and in increasing the overall stability of the financial system. This requires CCPs to be sufficiently financially resilient so that they can withstand extreme but plausible events that would pose significant stress. As use of CCPs becomes more widespread, increasing attention is being paid to how CCPs conduct stress tests to evaluate the adequacy of their financial resources. This article describes the sources of, and the circumstances in which CCPs are exposed to, financial risks and how CCPs typically manage these risks.
June 2016
Household Wealth in Australia: Evidence from the 2014 HILDA Survey
This article uses data from the Household, Income and Labour Dynamics in Australia (HILDA) Survey to assess how the distribution of wealth changed for Australian households between 2010 and 2014. Average household wealth increased modestly over that period, driven mainly by growth in the value of financial assets, most notably superannuation. The growth of housing wealth was slow in comparison, particularly in Queensland and Western Australia. While most of the changes in wealth were broadly based across households, wealth increased more rapidly for those residing in New South Wales and for retired households with large holdings of superannuation and equity assets.
Why Has Retail Inflation Been So Low?
Inflation in the price of retail goods has been surprisingly low for a number of years. The considerable depreciation of the Australian dollar over this period by itself would typically have led to higher retail inflation. This article considers whether the direct relationship between the exchange rate and retail inflation has changed, or if other developments in the retail supply chain can account for recent trends in retail inflation. There is little statistical evidence that the relationship between the exchange rate and retail inflation has changed. Discussions with retailers in the Reserve Bank's business liaison program suggest that an intensification of competition in the retail sector and firms' efforts to reduce costs along their supply chain are likely to have contributed to low retail inflation.
The Growth of Apartment Construction in Australia
Apartments have become an increasingly important contributor to new dwelling construction over recent years and in 2015 accounted for more than one-third of all residential building approvals. The majority of recent apartment construction has been located in Sydney, Melbourne and Brisbane. Across these cities there have been differences in geographical concentration, the types of buyers purchasing the dwellings and supply-side factors such as planning frameworks. The increase in apartment construction has reflected a range of factors, including the nature of land supply constraints and affordability considerations, together with a desire to reside in close proximity to employment centres and amenities. Given that these factors are likely to persist, apartments are expected to continue to play an important role in providing new housing supply.
Conditions in the Manufacturing Sector
Manufacturing output and employment have fallen steadily as a share of the Australian economy for the past three decades. This article looks at the composition of the sector and draws on the Reserve Bank's liaison with manufacturers to provide an insight into some of their responses to the structural challenges in recent years. According to liaison, the increase in the supply of manufactured goods from low-cost sources abroad, exacerbated by the appreciation of the Australian dollar during the period of rising commodity prices, impaired the viability of many domestic manufacturers and precipitated the closure of some manufacturing production over the past decade. While the recent exchange rate depreciation has helped to improve competitiveness of Australian producers, so far there is only limited evidence of a recovery in manufacturing output and investment.
China's Demographic Outlook
The significant increase in the working-age portion of China's population over recent decades was an important contributor to China's rapid economic growth. In coming decades, however, China's working-age population is expected to contract and the dependency ratio, which is the ratio of non-working-age to working-age population, is expected to increase substantially. Other things being equal, such demographic changes will have fiscal implications and tend to reduce the economy's potential growth rate. Scenarios presented in this article suggest that it appears inevitable that China's dependency ratio will rise and the working-age population will not increase from current levels. As such, the boost to economic growth provided by the demographic dividend of the past decades is not likely to be repeated.
Banking Fees in Australia
The Reserve Bank has conducted a survey on bank fees each year since 1997. The results of the most recent survey suggest that banks' fee income from both households and businesses rose in 2015, due to a combination of balance sheet growth and higher unit fees on some products. Deposit and loan fees have continued to decline as a ratio to the outstanding value of deposits and assets, respectively.
Liquidity in Fixed Income Markets
Fixed income markets in many jurisdictions have been going through a period of change, resulting in a debate as to whether they are continuing to function effectively, or will function effectively in times of stress. Changes in dealer business models and increased use of electronic trading platforms are influencing the nature of liquidity in bond markets. These changes are not as prevalent in Australia as they are in some overseas markets. For instance, while dealer inventories in US and European banks have fallen, in Australia they have been broadly steady, although they have undergone some substantial compositional shifts. Similarly, electronic trading and, in particular, high frequency trading (HFT), does not account for as large a share of trading in Australian financial markets as it does in US and some European markets. As these changes have occurred, market liquidity in some bond market segments in Australia has declined and is lower than it has been in the past. In contrast, market liquidity in derivative markets appears to have improved, such that overall market liquidity across bond and related derivative markets does not appear to have deteriorated. While this is a positive assessment, it is also likely that accommodative monetary policies in many major economies have supported market liquidity in recent years and it is difficult to determine how robust market liquidity would be in the absence of these policies.
Currency Risk at Emerging Market Firms
Exchange rate fluctuations can affect the value of emerging market (EM) firms in several ways, including through trade-related and balance sheet channels. This article examines the effects of exchange rate fluctuations on listed EM firms' share prices. Overall, a depreciation of the exchange rate is estimated to lower the share prices of around 25 per cent of EM firms, while 15 per cent of firms benefit and the share prices of the remaining 60 per cent are unaffected by a lower exchange rate. Among firms with share prices that are sensitive to exchange rate fluctuations, those that are more indebted tend to be more adversely affected by depreciation. However, there is no significant association between the sensitivity of a firm's share price to exchange rate fluctuations and the size of that firm's foreign currency-denominated debts, consistent with the prevalence of natural hedging among EM firms with such debt.
March 2016
The Labour Market during and after the Terms of Trade Boom
During the terms of trade boom, strong growth in output prices meant that the real cost of labour declined from the average firm's perspective and demand for labour increased. At the same time, the appreciation of the exchange rate helped contain the increase in consumption prices, so the purchasing power of employees' earnings rose and growth in the labour force picked up. Australian employment grew strongly and the unemployment rate fell.
Cyclical Labour Market Adjustment in Australia
Since the late 1990s, a larger share of labour market adjustment in Australia has come about via changes in average hours worked, as opposed to changes in the number of people employed. Much of this is likely to reflect that the economic downturns in the 2000s were relatively short and shallow compared with the recessions in the 1980s and 1990s. Had these later downturns been more severe, firms may have needed to shed more workers. It is also possible that labour market reforms over recent decades have provided firms with more scope to reduce labour costs by reducing working hours and wage growth rather than by reducing headcount. Consistent with these explanations, an important driver of cyclical adjustments in average hours during downturns looks to have been reductions in hours worked for employees who remained in the same job, as opposed to changes in the composition of aggregate employment.
Developments in Banks' Funding Costs and Lending Rates
This article updates previous Reserve Bank research on how developments in the composition and pricing of banks' funding have affected their overall cost of funds and influenced lending rates. Major banks' outstanding funding costs fell notably in 2015, following two reductions in the cash rate. The spread between the major banks' outstanding funding costs and the cash rate also narrowed over 2015. This was due to lower costs of deposits and a more favourable mix of deposit funding, as well as lower wholesale funding costs. Lending rates declined in the first half of 2015, reflecting changes in the cash rate and competition for lending, before lending rates increased for housing in the second half of the year; business lending rates are at historically low levels.
The ATM System since the 2009 Reforms
The past seven years have seen two major forces affecting the ATM system. Reforms to pricing arrangements in 2009 have had a number of effects, including establishing an environment that has encouraged a rise in ATM numbers. More recently, the ATM industry has been affected by a shift in consumer preferences towards payment cards, which has seen a decline in cash use and a resulting fall in the demand for ATM services. This article examines how activity and pricing in the ATM system have evolved since 2009. It finds that while ATM transactions are declining, ATM numbers at this stage continue to increase overall. ATM direct charges have risen slightly in real terms, but the number of withdrawals on which a fee is charged has fallen significantly.
The Australian Government Guarantee Scheme:
The Australian Government Guarantee Scheme for Large Deposits and Wholesale Funding (the Guarantee Scheme or scheme) was introduced during the global financial crisis in response to similar measures taken in other countries, and to address extreme funding pressures on authorised deposit-taking institutions (ADIs). The scheme closed to new borrowings in early 2010 and the guarantee over the few remaining liabilities ended in late 2015. This article recaps the operation of the scheme and concludes that it successfully met its objective to promote financial stability and the flow of credit to the economy during a period of extreme global funding pressures. No claims against the government were made under the scheme and the fees paid for its use generated $4½ billion in revenue.
The Rise in Dividend Payments
Dividends paid by Australian listed companies have grown substantially since the global financial crisis, most notably among large resources companies and the banks. These increases have occurred alongside modest growth in earnings. Dividend-paying companies appear to generally smooth these payments, having been reluctant to reduce their dividend payments in particular. The increase in dividends over recent years could reflect an increase in shareholder preferences to receive income payments or a perception among company managers that there are fewer viable investment opportunities; the data offer some modest support to both of these hypotheses.
The Term Structure of Commodity Risk Premiums and the Role of Hedging
A standard theory used to explain commodity futures prices decomposes the futures price into the expected spot price at maturity of the futures contract and a risk premium. This article investigates the term structure of commodity risk premiums. We find that risk premiums vary across futures contract maturities, and that the term structure of commodity risk premiums differs between commodities. Furthermore, the risk premiums on crude oil and heating oil have fallen since the mid 2000s, consistent with increased financial investment in these futures markets. This article also outlines evidence to suggest that the existence of a commodity risk premium is related to the hedging activities of market participants.
Some graphs in this publication were generated using Mathematica.
ISSN 0725–0320 (Print)
ISSN 1837-7211