Productivity growth needed to underpin economic recovery, RBA says

Speaking at the UBS Australasia conference on Monday (10 November), RBA deputy governor Andrew Hauser said Australia’s economy was poised for a recovery amid the tightest economic backdrop in decades, complicating the case for further rate cuts.

“The Australian economy is in a unique situation. One of the sharpest disinflations in decades has been achieved without a decline in GDP, and with the employment share at an all-time high,” he said.

“That is a great outcome – but it also means that the recovery in GDP growth began last year with the highest level of capacity utilisation in any recovery over the past 40 years.”

Typically, at the beginning of a recovery period, the economy has a negative ‘output gap,’ meaning it is producing below its potential output. This buffer allows for a period of above-trend demand growth without generating excessive inflation, underpinning a recovery in GDP.

When Australia’s GDP growth began to recover in 2024, the RBA estimated that demand in Australia was slightly above potential output. Hauser called this the “tightest economic backdrop to a recovery since at least the early 1980s.”

This has left the RBA to balance supporting an economic recovery while keeping inflation in check. Achieving this would require monetary policy to remain restrictive enough to close the output gap and bring inflation to target, while not stifling growth, Hauser said.

Given recent economic data flows, Hauser sketched out three possible paths Australia’s economy could take over the medium term.

Firstly, he said that the RBA could have overestimated the degree of capacity utilisation and inflationary pressure in the economy. This would leave the RBA with more room to cut interest rates and stoke demand without risking above-target inflation.

Economic indicators, including the slowdown in overall employment growth, stubbornly low consumer confidence and trade uncertainties, would give weight to this case.

Otherwise, Hauser noted that the economy could be “boxed in” by its own capacity constraints, leaving little scope for demand growth to rise without stoking inflation. In this scenario, the RBA would have limited room to make further interest rate cuts.

The broad-based pickup in September quarter inflation, the slightly more rapid than expected pickup in private domestic demand, high unit labour costs and the possibility that the cash rate may be below its neutral setting all add to this case.

If this were true, Hauser noted that the only “escape” would be to grow the capacity of the economy, likely through boosting productivity.

RBA forecasts have predicted a small pick-up in labour productivity as firms made fuller use of staff and capital, and paused investment projects were brought back online. However, Hauser noted that further time and investment would be needed to boost Australia’s productive capacity.

While real business investment has been flat over the past 18 months, Hauser said Australia possesses many assets that make it an attractive investment location. If harnessed correctly, Australia’s mineral resources, high education level, large domestic savings and relatively low public debt could help stoke an economic recovery.

“The bigger picture challenge for the economy over the medium term, if we are to return to the sort of growth rates we have been used to, is how to create more supply capacity. If we fail to do so, we may find ourselves boxed in on the rail. If we succeed, we could be off to the races,” he said.