The Reserve Bank of Australia (RBA) has raised alarms about the possibility of the Australian economy becoming stuck in a prolonged period of low growth. This scenario could hinder wage growth and household income for many Australians. However, the central bank believes there is still an opportunity for the economy to break free and achieve growth above its long-term average.

During a speech to investment bankers and economists in Sydney, RBA Deputy Governor Andrew Hauser posed a critical question: "Could Australia find itself trapped on the economic rail like one of the riders in last week's Cup — boxed in by its own capacity constraints?" He emphasized the importance of increasing productivity and investment in new capacity to avoid this trap. "If it does, we could be off to the races," he added.

Hauser explained that boosting productivity would expand the economy's capacity, allowing it to handle increased demand without triggering higher inflation. Despite recent inflation figures showing a resurgence in price hikes, particularly in energy costs, the RBA remains optimistic about the medium-term inflation outlook. Hauser stated, "The further decline in inflation through the end of 2024 and into 2025 gave us greater confidence that it would return sustainably to target over the medium term."

However, he cautioned that without a rise in productivity, increased demand could lead to inflationary pressures. Currently, the economy is operating at or near full capacity, which complicates recovery efforts. Hauser noted, "Most recoveries in GDP growth over the past 40 years typically start with some margin of spare capacity — a negative 'output gap.'" He stressed that a successful economic growth phase requires some degree of spare capacity to avoid excessive inflation.

The RBA's concerns are heightened by the possibility that the economy is already operating above capacity as it enters a growth phase. Hauser remarked, "This time looks different. Our central estimate suggests that demand was slightly above potential output at the time GDP growth started to pick up last year — the tightest economic backdrop to a recovery since at least the early 1980s."

He attributed this situation to a combination of rapid demand growth in 2021-2022, cautious monetary policy, and weak supply growth. Hauser also pointed out that there might be more capacity in the economy than current estimates suggest, which could necessitate further policy easing in the future.

However, he warned that if the economy is indeed boxed in by capacity constraints, there may be limited room for demand growth without exacerbating inflation. This would make it challenging for households to improve their financial situations, as any economic expansion could lead to higher inflation.

Despite these challenges, the RBA believes Australia has the potential to be a leading advanced economy, citing its rich mineral resources, strong educational institutions, and favorable geographic position in the Asia Pacific. Hauser stated, "If that doesn't scream 'investment potential,' I don't know what does."

He also highlighted the interconnectedness of the housing market and productivity. Analysts have noted that high property prices have diverted investment from more productive sectors of the economy. RSM Australia economist Devika Shivadekar commented, "High demand for property means there's always a need for labor," but this often leads younger workers to low-skilled jobs in construction rather than developing technical skills.

AMP's deputy chief economist Diana Mousina added that poor productivity growth in the housing sector has negatively impacted Australia's overall supply capacity. Meanwhile, Betashares chief economist David Bassanese pointed to the incentives for share investors as a factor contributing to weak productivity, suggesting that a focus on dividends may discourage firms from reinvesting for growth.

The RBA's next interest rate decision is scheduled for December 9, and the central bank's outlook will be closely monitored as it navigates these economic challenges.