Reserve Bank of Australia Annual Report – 1975 The Year in Brief

During 1974/75 the Australian economy experienced more instability than for many years. Aggregate output declined for the first time in any financial year since 1952/53, consumer prices rose by about 17 per cent, faster than in any year since 1951/52, while the unemployment rate rose to almost 5 per cent, the highest recorded in the post-war period; private fixed business investment fell for the third time in the last four years. There were substantial alterations in external, fiscal and monetary policies and sharp variations in the course of imports, the overall balance of payments, the Budget deficit and the money supply. At the same time, the share of income and output accounted for by the government sector rose sharply. A short period of acute financial strain in October required special actions on the part of the Reserve Bank.

Many other countries also experienced an unusual degree of instability during 1974/75; most had both rapid inflation and high levels of unemployment during the year. Demand was sluggish through-out much of the world and there appears to have been a slight fall in world trade. Authorities in many countries placed heavy reliance on monetary policy in their attempts to curtail inflation and financial conditions were fairly tight early in 1974/75. A number of companies, including financial corporations, experienced difficulties during this period. With output declining in major industrial countries and unemployment rising strongly, financial conditions were eased as the year progressed. Wages rose rapidly over the year and, although profits were reduced, prices increased at a fast rate for much of the year; nevertheless, in countries such as the United States, West Germany and Japan, the easing in demand conditions was associated with a reduction in inflation rates over the second half of the year. In some other countries price rises continued unabated. At the end of the year unemployment was at relatively high levels in virtually all industrialised countries.

Early in 1974/75 Australia's balance of payments was in substantial deficit, a significant element in the contraction of liquidity which occurred then. Despite the depressed state of world activity and trade, the volume and prices of Australian exports rose in these months. In part this probably reflected the shipment of goods ordered earlier when world demand was more buoyant but there were also increased exports of some rural products in short supply in world markets. However, imports were extremely high and rising strongly in the September quarter 1974, due to earlier conditions of excess demand in the Australian economy and changes in relative prices brought about by tariff cuts and currency revaluations. Controls on private capital inflow were eased during this quarter and, with financial conditions tight, there was a small capital inflow, but this only partly offset the large deficit on current account, and reserves fell rapidly.

Financial conditions tightened further in the early part of 1974/75 when the substantial deficit on the balance of payments compounded the lagged effects of restrictive monetary policy and the seasonal liquidity low. The volume of money (M3, which is defined as currency, total deposits with trading banks and deposits with savings banks) declined sharply in the September quarter and private interest rates, especially short-term rates, were at very high levels; inverse yield curves established on private and government paper over the last few months of 1973/74 continued.

Wages rose at a record pace in the first quarter of 1974/75, reflecting the decisions in the 1974 national wage case and large rises obtained in the metal trades and other important awards. Falls in productivity and the phasing in of equal pay further increased labour costs per unit of output. Mainly due to these rapid rises in labour costs, prices were continuing to rise at an accelerating pace. Nevertheless, the rise in labour costs was much faster than that in prices, and company profits fell sharply. The fall in company profits occurred at the same time as a rapid involuntary rise in inventories. Many companies had severe difficulties in financing even their working capital requirements.

Partly because of the tight financial conditions, spending fell sharply during the early part of 1974/75 but the uncertainty associated with continuing inflation and, later, rising unemployment also played a part. Private investment was falling steeply and consumption was subdued; on the other hand, government spending was rising strongly. There was a strong rise in real wages, a sharp fall in domestic output, and unemployment began to rise steeply.

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In mid September, the Government introduced a Budget that provided for an increased deficit, a very rapid rise in receipts and an even larger rise in spending; this was the third consecutive big-spending Budget. On 25 September, shortly after the presentation of the Budget, and in the light of the outlook for the balance of payments and the slow-down in the domestic economy, a 12 per cent devaluation of the Australian dollar was announced. Although both the Budget and the devaluation began to contribute to an easing in financial conditions, for the time being liquidity conditions remained very tight; in October this tightness was accompanied by a short period of financial disruption during which there were substantial shifts of funds from non-bank financial intermediaries to banks, authorised dealers and into government securities.

In a slightly lagged partial response to the fall in liquidity, the Reserve Bank had already reduced the Statutory Reserve Deposit ratio by stages from 9 per cent in early June to 4 per cent in late September. The Bank had also initiated modest purchases of bank-accepted bills. In view of the failure of a large property development company at the end of September, there was growing concern at the possibility of disruption in financial markets, and the Bank informed trading banks that it would assure their liquidity to the extent that requirements arose out of actions to meet immediate needs of soundly managed and financially viable businesses. As mentioned above, a short period of disruption occurred in October when some permanent building societies and finance companies experienced substantial outflows of funds. Early in that month action was taken to increase the liquidity of the banking system and the economy generally. Yields on short-dated government securities were reduced sharply, the Bank increased its purchases of bank-accepted bills, and the SRD ratio was reduced by 1 percentage point to 3 per cent. The trading banks were also encouraged to increase their lending appreciably to meet the immediate, basic needs of the economy for finance; nevertheless, it was not intended that all demands arising out of inflation would be met. Subsequently, additional steps were taken to add to the liquid assets of banks. In late October a special facility was established; under this arrangement the Reserve Bank lent to the trading banks amounts equal to 1 per cent of their deposits. Over the latter months of 1974 actions were also taken to encourage the savings banks to increase their lending for housing; regulations governing savings banks' holdings of assets were amended in September, the banks were asked to bring forward portion of the new lending for housing they would otherwise have undertaken during 1975, and the Government provided $150 million for on-lending for housing by banks, mainly savings banks.

After October, financial conditions began to ease and most non-bank financial institutions were again able to attract funds. Yields on short-term government securities fell further; between September and the time of the February loan yields on two year bonds had dropped 2.5 percentage points to 8.5 per cent per annum. Interest rates on long-term government bonds remained unchanged at 9.5 per cent per annum.

A major factor in the easing of liquidity conditions was a substantial increase in the size of the Australian Government's Budget deficit. With unemployment continuing to rise, the Government further increased the already rapid rise in government spending, and in November announced further reductions in income tax rates effective from 1 January 1975. In the event, the Government's deficit for the full year totalled $2,561 million, by far the highest recorded in the post-war period, even after allowing for price changes.

The drain on liquidity previously caused by the balance of payments was also gradually reduced over the months following September, until, in March, the balance of payments moved into surplus. Exports remained fairly high while sluggish demand in the domestic economy, changes in relative prices brought about by the devaluation, and the introduction of quotas and increased tariffs on some items, all contributed to a sharp fall in imports after September. For the year as a whole, the balance of payments was in deficit by $498 million; however, this was made up of a deficit of $764 million in the first half of the year and a net surplus of $267 million in the six months to June 1975.

As their liquidity improved, lending approvals by banks began to rise rapidly and by March 1975 were, in money terms, close to peak levels of 1972/73; however, the growth in advances outstanding was much less rapid. Over the six months to March 1975 the money supply grew at an annual rate of 25 per cent. With funds more easily available, almost all trading and savings banks moved to reduce deposit and lending interest rates in March. Other private sector short-term rates also fell. Although some easing from the stringent financial conditions experienced early in the year was appropriate, the rapid rise in the major monetary aggregates became a cause for concern, especially as the rate of inflation showed little sign of easing. In mid March the Reserve Bank indicated to trading banks that lending policy would not envisage further expansion in aggregate provision of new finance beyond levels that had recently been recorded. In April savings banks were asked not to offset a moderation in their lending for housing, which would follow from the cessation of lending from government funds. Money supply continued to grow strongly over the final months of the year; in the June quarter the underlying annual growth rate remained in excess of 20 per cent.

With the marked easing in financial conditions and changes in budgetary policy, demand began to grow again over the second half of 1974/75; nevertheless, the rate of growth remained fairly subdued. Government spending continued to rise strongly and spending by households began to respond; however, investment spending by corporations remained weak.

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Graph Showing Selected Indicators

Much of the increased level of final demand was met by a fall in stocks; but, with competition from imports easing, domestic output may have started to rise again over the final months of the year. However, industrial production remained depressed; on preliminary figures industrial output in May 1975 was 12 per cent below its June 1974 level. There was some improvement in the demand for labour towards the end of the year. Civilian employment rose and unemployment remained fairly steady in June after falling in May, but these figures would have been influenced to some extent by a strong rise in the numbers covered by government employment schemes.

Wages increased less rapidly during the final six months of the year; this was partly due to the timing of major wage decisions. In the 1975 national wage case the Arbitration Commission proposed a system of conditional indexation, with hearings to be held every quarter to consider the adjustment of award wages for price increases; an increase of 3.6 per cent, equal to the rise in the consumer price index in the March quarter, was granted to apply from mid May. Over the year as a whole, company profits fell sharply; the operations of the Prices Justification Tribunal, the depressed state of domestic demand and competition from imports early in the year limited the ability of companies to recover cost increases through higher prices. Nevertheless, consumer prices, excluding food prices, rose by 21 per cent during the year. A moderation in the rate of increase in food prices was mainly due to a fall in meat and potato prices. Overall, consumer prices were 17 per cent higher in the June quarter 1975 than in the June quarter 1974. Variations in the quarterly movements in prices were influenced by the timing of major wage decisions and technical factors. After allowing for these influences, some easing in the rate of inflation was apparent in the final quarter of the year; nevertheless inflation remained at a high level.

At the close of the year, banks' liquidity was at an exceptionally high level. Other financial institutions were also in a better position to expand lending than they had been earlier in 1974/75. Early in 1975/76 the Bank took steps to reduce the free liquid assets of the major trading banks. The SRD ratio was increased to 3.6 per cent by mid July with a rise to 4.6 per cent to follow in early August. During the first half of July the banks prepaid to the Reserve Bank the loans that had been made available to them under the special facility. In early July there was also a reduction in the issue yield of Treasury notes and a steepening of the yield curve on other government securities; the yield on long-term securities rose from 9.5 per cent to 10 per cent per annum.

In the opening months of the new financial year the economy remained racked with rapid inflation, high unemployment and low business investment. There were hopes that decisions of the Arbitration Commission could produce a moderation in the rate of growth of wages and prices, but the success of this initiative remained in the balance. Signs of an improvement (albeit uneven) in domestic activity had appeared, and demand and output seemed likely to be boosted further by the delayed effects of earlier policy measures; the longer term viability of the recovery was uncertain. Although the balance of payments was not an immediate problem, lower inflation rates in major overseas countries raised doubt whether this situation would continue if high inflation persisted in Australia. The novel and complex combination of very rapid inflation and unusually high unemployment was clearly the major challenge for economic policy at the outset of 1975/76; meeting it effectively within a reasonable time-span seemed vital to maintenance of living standards in Australia.