Reserve Bank of Australia Annual Report – 1964 Introduction

There were solid grounds for satisfaction in the performance of the Australian economy in 1963/64. At the beginning of the year there was some excess capacity in industry and unemployment was too high. The prospect of expansion proceeding sufficiently to absorb these unused resources was by no means assured. However, with the public sector continuing to impart stimulus and financial conditions remaining favourable to growth, expansion gathered momentum and broadened and by the end of the year resources generally were fully employed.

Most components of expenditure increased in the first half of the year, with the sharpest rises occurring in building, exports and the public sector. However, the rise in expenditure on plant and equipment was rather hesitant, despite a strong rise in rural investment. These trends in expenditure were accompanied by increases in industrial production and in employment to the extent that certain types of skilled labour became scarce.

By early 1964, business confidence had improved and investment in plant and equipment was rising more strongly. The upward trend in industrial production continued and, with the broadening of expenditure and reduction in excess capacity within industry, imports began to rise strongly towards the end of the financial year. The labour market tightened as unemployment fell and vacancies rose; shortages of skilled labour became more widespread. The increasing pressure on resources contributed to the tendency for prices to rise after almost three years of stability.

Exports were buoyant in 1963/64; prices were higher for most commodities and rural production was at record levels. Our terms of trade improved markedly, despite some rise in import prices. Overall, earnings from the sale of goods and services abroad almost matched payments overseas for purchases of goods and services, leaving in effect, the whole of the substantial amount of capital inflow to be added to reserves. This large increase in reserves was an unusual experience in a year of strong domestic expansion. Although it was of course very welcome on general grounds it aggravated the problems of monetary management by adding to the already high level of bank and public liquidity.

The liquidity of an economy is essentially a relationship between the supply of liquid assets and the demand for them; the assessment of the liquidity of particular assets depends upon expectations (and hence involves some subjective elements) about the readiness with which they may be converted quickly into money without capital loss. The supply of money and other liquid assets can vary greatly due to factors beyond the immediate control of the public. In recent years, the balance of payments and government financial operations have been responsible for large additions to the money supply. Increases in bank lending also add to the money supply while increases in the supply of money substitutes come from new issues by other intermediaries or final borrowers. Money is the most liquid asset, but certain other items, such as loans to the short term money market and short term Government securities, are close substitutes. Other assets, such as debentures, shares and property, have differing degrees of liquidity (or illiquidity). These degrees (or assessment of them) may vary from time to time with changing financial conditions.

Money is held both to finance transactions and as a component of the asset holdings of people and businesses. The demand for or willingness to hold money will vary with the level of transactions, the total value and structure of asset holdings and debts, and preferences regarding the desired composition of assets and debts. These preferences change over time and revised expectations may create changes in the demand for money. Thus, a given supply of money and other liquid assets may fall short of demand for liquid assets in some circumstances and exceed demand in other circumstances.

Although it is customary to discuss changes in the state of liquidity of the economy in terms of the relative movements of holdings of liquid and other assets, the critical issue from the viewpoint of policy is the risk of imbalance between supply and demand. Recent large increases in the supply of liquid assets had taken place while the demand to hold wealth in liquid forms was strong. A decline in this demand could lead to rises in the prices of less liquid assets (thus encouraging speculative tendencies) and provide stimulus to expenditures. Experience has shown that prolonged excesses in either demand for or supply of liquid assets can create serious instability which cannot then be corrected without harsh measures.

In 1963/64, monetary policy sought to contain and counter increases in the money supply, without disturbing business confidence or inhibiting growth, and to discourage marked changes in people's preferences concerning the structure of their asset holdings. Because the liabilities of trading banks form a major part of the liquid assets of the community these banks must bear the brunt of attempts to limit the supply of such assets. Banking policies, including policy in relation to Statutory Reserve Deposits, were therefore directed towards avoiding some of the possible consequences of the substantial increases in liquid asset holdings of the trading banks. Financial institutions and the public were provided with a ready avenue for investment of liquid funds through the large volume of Government securities offered to them and, in the last quarter of the year, interest rates were increased.

Events in 1963/64 suggested that selective changes in policy, implemented promptly and appropriately in the light of changes in the demand for and supply of liquid assets, can make an important contribution to financial stability. Fortunately, we were not faced with a really explosive situation. If and when more serious challenges arise, monetary measures by themselves might well prove inadequate. The currently rising trend of expenditure, both on public and private account, could present us with such a challenge.