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Convex Phillips Curve Explaining Openness and Inflation Nexus

It is also uncertain how long the factors that are contributing to higher utility price inflation will take to resolve. There are a number of key uncertainties in relation to the forecasts. They are similar to those discussed in the November Statement. For the global economy, investment growth could have more momentum and positive spillovers to activity could be larger than currently forecast. Some risks, such as escalating geopolitical tensions and increased global trade protectionism, have the potential to derail the current economic expansion, as do the longstanding financial stability risks associated with high levels of debt in the Chinese economy.

Domestically, a key source of uncertainty for the forecasts continues to be the outlook for the labour market. This comes from two sources. First, it is not clear how much spare capacity there is in the labour market and how quickly it might decline, particularly given the recent strength in the participation rate.

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Second, it is unclear how much any decline in spare capacity will translate into building wage pressures. Both of these factors affect the outlook for inflation and household income growth, which is a key driver of consumption and therefore the GDP growth forecast. Another key source of risk to growth is developments in the housing market that reflect both demand factors, such as population growth, and supply factors. In addition, high levels of indebtedness increase the sensitivity of households to changes in their income or wealth, which has implications for consumption.

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The outlook for activity in Australia's major trading partners has been revised up over the past year. There are, in addition, some upside risks to this central forecast. Tight labour markets in the major advanced economies could see wage growth increase faster than expected and labour shortages could induce a larger and more sustained increase in investment as companies face difficulty in expanding their operations by employing more people. In addition, the recent US tax changes could boost consumption and investment by more than currently forecast.

The realisation of these upside risks would increase inflationary pressures and could prompt a faster tightening of monetary policy in the major advanced economies.

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The effects of stronger global growth on the Australian economy depend on the drivers and the location of that growth. Stronger growth driven by increased demand in the major advanced economies, for example as a result of stronger investment growth, would be expected to increase growth in the Australian economy and result in a lower unemployment rate and more domestic inflation through two main channels. The direct demand effect would result in higher Australian non-resource exports, and should also support commodity prices, which would raise the incomes of resource exporters relative to current forecasts.

The other channel is the exchange rate. Stronger demand and higher inflation would be expected to lead central banks in major advanced economies to tighten monetary policy faster than currently expected, which could result in a depreciation of the Australian dollar, all else being constant. This would provide additional support to the Australian economy by making domestically produced goods and services more competitive and would directly flow through to higher domestic inflation via higher import prices.

Given that the financial linkages between Australia and the major advanced economies are generally stronger than our direct trade linkages, the implications for the exchange rate may be the more important factor for determining the effect for the Australian economy. But the implications of stronger global growth depend on a broad range of factors, which are at this point uncertain. One downside risk in the scenario described above is that a large increase in long-term interest rates in the advanced economies could engender further market volatility, as well as tighten financial conditions in emerging markets and result in financial market disturbances there.

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  • This could offset some of the initial boost to economic activity. Although financial conditions tightened a little in China over , growth in aggregate financing and public spending was strong. Residential real estate and infrastructure investment moderated towards the end of the year, but a further easing could lead the authorities to adopt a more accommodative stance of macroeconomic or housing policy in , which presents an upside risk to Chinese growth and the demand for bulk commodities.

    The full effects of the winter cuts to Chinese steel production remain uncertain, but so far appear to be relatively modest. The risks of financial disruption in China have also shifted slightly. Recent regulatory and supervisory announcements indicate a strengthening of the authorities' resolve to reduce financial sector risks through tougher and more coordinated financial oversight. To date, these announcements do not appear to have triggered any material disruption to funding markets.

    But these policies are likely to constrain growth in the short term. Leverage also remains high, which continues to present risks in the medium term. Uncertainty about demand in China, particularly in the property and infrastructure sectors, translates directly into uncertainty about demand for bulk commodities and commodity prices. Indeed, the impact of pollution-control policies on Chinese steel production has been more modest than had been anticipated, which has contributed to higher commodity prices in recent months, as have supply-side factors, particularly for coking coal.

    Because the current production cuts required of heavily polluting industries are expected to be in place until mid March, there remains considerable room for future volatility in Chinese iron ore and coking coal demand and bulk commodity prices. This has implications for the terms of trade. Movements in oil and other commodity prices also represent an important uncertainty in the forecasts. Oil prices are up by around 20 per cent over the past year.

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    This has directly affected headline inflation both domestically and overseas through higher fuel prices. The weight of automotive fuel in the Australian CPI basket is around 3 per cent. Higher oil prices are also likely to have boosted business costs, which could be passed on to consumer prices. The size and timing of these indirect effects are difficult to determine. Input-output tables suggest that oil accounts for between 2 and 3 per cent of the prices of non-fuel items in the CPI.

    In practice, however, movements in oil prices are partly absorbed into margins for these items and any pass-through tends to occur over a long period. While supply factors have been an important driver of commodity prices over the past year or so, global demand is likely to be an increasingly important influence.

    Highly correlated increases in commodity prices would be further evidence of strengthening global demand and, given that many economies are operating close to capacity, could signal a more significant increase in global inflation than is currently forecast. In turn, this could lead some central banks to remove their policy accommodation faster than currently expected, which would have consequences for financial market prices, including exchange rates.

    There is considerable uncertainty about whether the future demand for labour will be met by people entering the labour market, by people who are currently unemployed or by employed people working more hours. Participation rate outcomes will depend on a large range of factors, including the retirement decisions of older workers, the participation decisions of prime-age women and labour market conditions for younger workers.

    It is hard to gauge whether some of the trends of recent years, such as the sharp increase in the participation of older workers, will continue, or whether they are simply a function of strong employment growth. If the participation rate does not increase as expected, employment growth will probably also be slower than expected, but it could also imply a larger-than-forecast decline in the unemployment rate or an increase in average hours worked. The sources of the expected growth in total hours — a rise in participation, decline in unemployment or increase in average hours worked — may affect how the decline in spare capacity translates into wage growth pressures and consumption decisions.

    For example, it may be that the propensity to consume rather than save additional income is higher for those who move from unemployment into employment than it is for incumbent workers increasing their hours. If wage growth does not pick up as expected, and households start viewing lower income growth as being more persistent, consumption growth could be somewhat lower than forecast.

    Alongside this, there is always uncertainty around estimates of full employment, the point at which wage growth might start to build. Over recent years, declining unemployment rates accompanied by subdued wage growth have led estimates of the level of the unemployment rate consistent with full employment to be revised down in a number of countries. The experience of low wage growth in those countries with tighter labour markets suggests that structural factors, such as technological change and globalisation, have also had an important bearing on wage outcomes and could continue to do so for some time yet.

    On the other hand, more firms have been indicating that they are finding it more difficult to find suitable labour, which might lead to wage growth picking up more quickly than anticipated. The annual minimum and award wage decisions will also have an influence on aggregate wage growth over the next few years. Conditions in the established housing market have cooled in recent months. Housing prices in Sydney have declined a little, conditions in Melbourne have eased following several years of strong price growth and conditions in most other capital cities remain subdued.

    If housing prices were to fall significantly, households might respond by curtailing their consumption expenditure and dwelling investment. Employment in the construction sector would also be weaker. Lower housing market activity would affect state government revenues, which may affect decisions about expenditure on activities such as infrastructure projects. If, on the other hand, population growth were to pick up or the reported reduction in foreign demand for newly constructed properties turns out to be temporary, housing prices may be stronger than expected.

    In such a scenario, dwelling investment could increase, rather than broadly stabilise, or stay higher for longer than currently forecast. Household indebtedness is high and debt levels relative to income have edged higher because household credit growth has continued to outpace weak income growth.

    Steps taken by regulators to address the risks in household balance sheets have seen the growth in riskier types of lending to households moderate, but risks remain. A highly indebted household sector is likely to be more sensitive to changes in income, wealth or interest rates.

    For example, a highly indebted household facing weaker-than-expected growth in disposable income or wealth may be more likely to respond by reducing consumption.


    Consumption growth may also be weaker for a time if indebted households choose to pay down debt more quickly rather than consume out of additional income. Skip to content JavaScript is currently disabled.


    The Globalization Hypothesis argues that the internationalization of goods and financial markets has already affected the domestic macroeconomic determinants, such as inflation rate and business cycle, through international influence [ 11 ]. The U. According to Bernanke [ 13 ], increased trade with China and other developing countries has led to slower growth in the prices of imported manufactured goods. He cited a study concluding that trade with China alone reduced annual import price inflation in the U. On the other hand, as technology is more prominently used to produce more goods and services, companies in all industries are achieving lower production costs.