RESERVE BANK OF AUSTRALIA

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THE CHALLENGE OF PROSPERITY

Glenn StevensGovernorAddress to the Committee for Economic Developmentof Australia (CEDA) Annual DinnerMelbourne

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29 November 2010

THE CHALLENGE OF PROSPERITY

Thank you for the invitation to play a part in marking the 50

anniversary of CEDA.It is particularly significant for me to be here because 2010 also marks 50 years sincethe commencement of central banking operations by the Reserve Bank of Australia.There were in fact a number of significant beginnings in 1960.It was a time of rising prosperity after a long period of difficulty. Between thedepression of the 1890s and the end of World War II, real GDP per capita inAustralia had risen by about 35 per cent – or around half a percentage point per year.But in the 15-year period from the end of the war to 1960, it expanded by about25 per cent – or about 1½ per cent a year.The long post-war boom would eventually see growing excesses from the late 1960s,which ended in the disastrous instability of the 1970s. But in 1960, the boom still hada long way to run.

So 1960 was a time of optimism. There have been many ups and downs for theAustralian economy since then. CEDA has played its role in informing discussionand debate along the way.Two years ago, when I last addressed this group, optimism was anything but the orderof the day.

But we have to turn that confidence into lasting prosperity. So I would like to offer afew observations about some of the things we need to be thinking about. I do nothave definitive solutions, but offer these observations as a modest contribution to thediscussion.The global financial system was in serious disarray and the globaleconomy was heading into recession. It was obvious Australia would be affected butI suggested that there were good reasons for quiet confidence then about the long-runfuture of Australia. There still are, two years later.In so doing, I am not trying to convey anything about recent or prospective monetarypolicy decisions. Tonight, at an event marking the 50

anniversary of a body devotedto Australia’s economic development, it is more useful to lift our gaze beyond thenext interest rate decision to look at a broader canvas.

In 1960, some saw that care was needed. In the

Economic Record

in August of that year, there appeared thefollowing statement:

‘In July 1960 the Australian economy is producing more, and expanding its production faster … than at anyearlier date. … One outstanding economic problem seems to remain, and it has been frequently discussed academically and in public debate: can the boom be sustained without a dangerous degree of inflation?’

(Bowen 1960)

‘The Economic Situation’, address to CEDA Annual Dinner, Melbourne, 19 November 2008. Available at:<http://www.rba.gov.au/publications/bulletin/2008/dec/pdf/bu-1208-3.pdf >.

3.I have one picture to show.

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Terms of Trade*

1900/01-1999/00 average = 100, annual

* RBA estimates for 2010/11 to 2012/13Sources: ABS; Gillitzer & Kearns (2005); RBA

2020IndexIndex19801960188019205-year centredmoving average1940200019001900/01-1999/00trend

This is a very long-run chart of Australia’s terms of trade. You may have noticed theReserve Bank saying a lot about the terms of trade in the past few years. Before Idescribe the chart, why is it important?Our terms of trade have a big bearing on national income. In economic commentary,there is typically a very strong focus on GDP – the value of production – as asummary of national material progress. There is also quite rightly an emphasis onlifting productivity – real GDP per hour worked – as the source of our growth of material living standards.For open economies, though, our standard of living is affected not just by the physicaloutput we can obtain from our resources of labour and capital, but also by thepurchasing power of that output over things we want to have from the rest of theworld. This is what the terms of trade is measuring. It is the relative price of ourexport basket in terms of imports. At the extreme, if the economy were open to theextent that we exported all our production and imported all our consumption, then theprice of exports relative to imports would determine our living standards entirely, forany given level of productivity per hour worked. As it is, Australia is not

that

open,and not as open as many smaller economies, but it is considerably more open than thereally large economies like the United States, the euro area or Japan. So the terms of trade matter.When the terms of trade are high, the international purchasing power of our exports ishigh. To put it in very (over-) simplified terms, five years ago, a ship load of iron orewas worth about the same as about 2 200 flat-screen television sets. Today it is worthabout 22 000 flat-screen TV sets– partly due to TV prices falling but more due to theprice of iron ore rising by a factor of six. This is of course a trivialised example – wedo not want to use the proceeds of exports entirely to purchase TV sets. But the