Reserve Bank of Australia Annual Report – 1965 Introduction

In 1964/65 the Australian economy was exposed to considerable strain as all types of domestic spending increased strongly. The effects of this rapid growth in expenditure spread increasingly to the balance of payments at a time when foreign currency receipts had been reduced by lower returns from some of Australia's main exports. As a result, it was necessary to draw heavily on accumulated overseas balances.

At the beginning of the year there was little slack left in the economy, so it seemed unlikely that the volume of domestic output could continue to rise at the same rate as in the previous couple of years when reserves of labour and productive capacity were being absorbed. Early prospects indicated that expenditure would rise faster than output but, as overseas reserves had risen for four consecutive years and were at a record level, the likelihood of a higher rate of imports for a period could be faced without undue concern. The main question was whether it was possible to contain expenditure sufficiently to avoid undue strains on domestic resources and to keep the economy on a growth path consistent with internal and external balance in the longer run.

It was realised that the effects of a strong rise in imports would be uneven. In some of the fields where pressures were strongest—particularly building—there was little scope for shifting demand to imports and other action would be necessary. At the same time, some efficient domestic manufacturers, with capacity for increasing their output further, would continue to face import competition. Nevertheless, it was soon clear that by adding to overall supplies, imports were acting as an effective safety valve.

In the short run at least, monetary policy must usually work through influencing demand rather than supply, and in 1964/65 it was directed to restraining the growth of expenditure. The broad strategy was to slow down the transfer of funds to financial intermediaries and final users; to maintain the strong preference throughout the community for liquid and secure assets; to restrain the growth of bank lending; and, by making money more costly, to encourage the postponement of expenditure.

The net result of the forces acting on both sides of the supply-demand balance was that although resources remained under pressure, a serious boom did not develop. The employment situation tightened, but such shortages as emerged were in special fields and not as general as had been the case in some earlier years; prices and wage costs rose significantly, but a substantial part of the increases could be attributed to factors other than demand pressures; and, with a continuing strong preference for holding funds in liquid and near-liquid forms, there were no general increases in asset values.

On the other hand, the balance of payments outcome was worse than generally expected. At the beginning of the year a big current account deficit seemed inevitable, but there was a good chance that it would be not much greater than the capital inflow. However, at the same time as imports rose sharply, export prices continued to weaken. Reserves showed little net change in the early months but after November fell rapidly.

In 1963/64 reserves had risen by £228 million; in 1964/65 they fell by £158 million. This turn-round of nearly £ 400 million was a major factor making for tighter money, particularly in the later months. Traditionally, the liquidity effects of a large import surplus have played a major role in the process of adjustment. Although there are limitations on the extent to which these liquidity effects can be allowed to operate unchecked, there is no doubt they are effective in introducing tendencies of restraint. Partly reflecting the change in market conditions, security yields rose appreciably, while bank interest rates were raised to historically high levels.

As we entered 1965/66 it seemed that some of the strains of the previous year could well continue. Some types of expenditure were showing signs of levelling off, but rising outlays on defence and other government commitments and on major developmental projects seemed likely to keep resources fully employed overall. Further increases in wage costs were in prospect, imports were continuing at high rates, and the immediate outlook for capital inflow was more obscure than usual.

Gross National Product and Expenditure— Seasonally Adjusted

Graph Showing Gross National Product and Expenditure— Seasonally Adjusted

In the longer run, some of the big development projects now being undertaken or planned will make a major contribution to the balance of payments through increasing exports or reducing imports. Prospects for the next few years might give more cause for concern, although reserves are still at a comfortable level. Developments abroad could increase price and marketing difficulties for Australia's exports, and less favourable seasons could check the remarkable growth over the last decade in the output of our main export products. At the same time, there could well be large increases in expenditures with a relatively high import content; the major projects themselves, defence, and outlay on industrial equipment, which is vital to maintain productivity growth, are examples.

Although consideration is continuing to be given in international discussions to ways of increasing international liquidity and avoiding restrictive trade policies, recent events and trends suggest that the industrial economies of the world are moving in the direction of tighter restraints on payments and trade and perhaps slower rates of economic growth. World-wide deflationary tendencies and restrictive policies would be very serious for Australia, which is dependent on markets for its exports and a free flow of capital to provide the imports it needs for economic development.

In any case, it would seem prudent to exercise reasonable economy in our use of overseas funds. One implication is that if we are to maintain satisfactory growth of output and real incomes, we will have to increase our rates of domestic saving; other changes might also be necessary. The adaptability of the economy over the last two decades has been due in the main to a rapid increase in productivity. It could be even more important in the future to concentrate on measures which will promote efficiency, and to avoid protecting the inefficient.

The financial system has a part to play in this. Recent years have seen a good deal of financial innovation, much of it beneficial. The banking system has shown its adaptability in moving into new fields and in devising better ways of doing old tasks. In the years ahead, flexibility and adaptation to change will continue to be important in the banking system, the financial system as a whole, and the economy generally.