Tax cuts won't pry open household wallets. Only wages growth can

Extract from The Guardian

Grogonomics

Australian economy

Greg Jericho

As retail and inflation data show, there’s little appetite for spending – and a few extra dollars from income tax cuts won’t change that

@GrogsGamut

Tue 6 Aug 2019 04.00 AEST Last modified on Tue 6 Aug 2019 04.55 AEST

‘People are not spending money as the years of flat real wages growth has now become entrenched into expectations.’ Photograph: Bloomberg via Getty Images

Since the election, there has been little sense that the economy is doing well. The latest inflation and retail trade data have served only to confirm what households around the country have long known – things are tough and there is little appetite for spending.
In the two and half months since the election it is clear from the data that has been released that the first half of this year was terrible for the economy and that nothing appears to be changing the situation.

Just a reminder: when the election was held, the Reserve Bank had the cash rate at 1.5% – already a record low. Since then the bank has cut the rate twice to 1.0%, and far from thinking this is more than enough stimulus in the economy, the market now not only predicts another cut to 0.75% – to happen before Melbourne Cup day – but a further cut to 0.5% to occur by this time next year:

At that point the rate would be 250 basis points below the 3% rate that was reached during the GFC – a rate now so far away that we would likely need a decade of strong growth to achieve. Consider that it took five years of a historic mining boom to see the cash rate rise from 4.25% in early 2002 to 6.75% in November 2007. That rise was not even a doubling of the rate. To go from 0.5% to 3.0% would be a 500% increase.

This suggests that we would need the most amazing economic boom for interest rates to get back to those levels within the 2020s.

How low have rates become? The 10-year rate for Australia government bonds is around 1.2%, which, given the target for inflation is between 2% to 3%, effectively means the government is borrowing at negative real interest:

That is not normal – and effectively means the market expects inflation to keep dropping.
We can see this fall in inflation expectations by looking at the gap between the yield for government inflation-indexed bonds and the 10-year bond rate:

Right now the gap between the two is just 0.95% points which, given the strong relationship between the expectations and underlying inflation, means the next six months at least should see a continuing fall in inflation growth:

And that inflation growth is already damn low.
Last week, the June quarter figures showed underlying inflation grew just 1.6% over the past year using the “trimmed mean” measure, and an absurdly low 1.2% using the slightly more erratic “weighted median”:

Either way, both measures are well below the target rate.

And we all know why. There is no demand in the economy. People are not spending money as the years of flat real wages growth has now become entrenched into people’s own expectations.

There is no sense that wages are ever going back to growing at the rate they once did.
And so households have shut their wallets and purses.
Last week the latest retail trades figures revealed that in the past 12 months the volume of retail spending, in seasonally adjusted terms, grew by less than at any time since the 1990 recession. The trend measure was less terrible – it suggested that the level of growth was only the worst it has been since the depths of the GFC:

In the past nine months the volume of retail trade has not grown at all. That’s recession-level spending.
That we are spending that weekly when the unemployment rate is 5.2% tells you a lot about how poor that measure has become for explaining the state of our economy.
And it is not the case that the bad news for households is contained to only some parts of the country. All states except Queensland have seen the volume of retail spending growth fall:

At this point the government is betting on the tax cuts fuelling an increase in spending. It should in the short-term, but without wages growth no household is going to think about increasing their spending long-term.
And the most troubling thing is the drop in inflation expectations and those for the cash rate have occurred not just since the government was re-elected but since the tax cuts have passed into law.
Few seem to think they will do enough, and instead we continue to look to the Reserve Bank to come to the rescue.

• Greg Jericho writes on economics for Guardian Australia