Speech
Joining the Dots: Exploring Australia’s Economic Links with the World Economy
Sarah Hunter
*
Assistant Governor (Economic)
Economic Society of Australia (Queensland) Business Lunch
Brisbane
–
3 June 2025
Audio
49.2MB
Q&A Transcript
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Watch video: Speech by Sarah Hunter, Assistant Governor (Economic), Economic Society of Australia (Queensland) Business Lunch, Brisbane
Introduction
I’d like to begin by acknowledging the Traditional Owners of the land on which we meet today, the
Yuggera and Turrbal people of Meanjin and pay my respects to Elders past and present.
And thank you to the Economic Society of Australia [Queensland Branch] for giving me this opportunity to
talk to all of you.
I’m sure many are familiar with the Lenin quote ‘There are decades where nothing happens; and
there are weeks where decades happen’. It certainly feels like the last few months fit into the
latter category. The broad-based nature of the proposed US tariffs, retaliation from major partners and
other policy shifts all have the potential to structurally alter the world economy. As recently discussed
by our Deputy Governor Andrew Hauser, what happens overseas matters for the Australian economy and is
therefore a key factor in monetary policy settings. 1
In the recently released
Statement on Monetary Policy
(SMP) we outlined our thinking on how
recent developments will influence the Australian economy. To help us understand the implications for
Australia, we have developed a framework that captures the key transmission channels and combined this
with a set of alternative scenarios that flex key assumptions and judgements. Together they underpin our
thinking about how this environment will flow through the global economy and how Australia is exposed.
The key transmission channels we have identified are:
Trade flows between countries are likely to realign, and over time multinational businesses could
start moving production to different countries.
Households and businesses in the countries that apply tariffs are likely to change what they consume,
as some products become relatively more expensive, and as prices change more generally.
Until it’s clearer where policy will settle, businesses and households are likely to become
(understandably) more cautious, and potentially delay major decisions such as capital investment.
Fiscal and monetary policy can respond, potentially helping to offset adverse impacts.
Financial markets will respond by repricing all assets including equities, bonds, commodity prices
and exchange rates. These moves impact financial conditions, which further impact firms’ and
households’ decisions.
I will now discuss these channels in more detail, including how they are embodied in the scenarios in the
May SMP.
Tariff policy and global trade flows
Economic theory and evidence suggest that higher global tariffs will put a drag on the global economy.
This is true in both the short and long run, though here I’ll focus on the short run as that is what
is most relevant for monetary policy. 2
For the country imposing them, tariffs are a tax on imports. In the short term, this makes imported goods
more expensive and pushes up domestic prices, to the extent the tariff is not offset by lower profit
margins in overseas producers and exchange rate adjustments. Higher import prices will mean less imports
and shifts in demand towards locally produced products. 3
But it takes time for domestic businesses to
invest and expand, and for some products (such as raw materials) it may not be possible for domestic
production to fill the gap. This means prices are likely to remain higher in the near term, which will
reduce households’ purchasing power and therefore drag on business incentives to invest.
Collectively, domestic demand in the tariff-imposing country falls, all else equal. If households expect
the tariffs to have a sustained effect on economic growth, and so their future incomes, they may also cut
back further on spending today. 4
For the countries that are subject to higher tariffs,
they will weigh on export demand and in turn their broader economic conditions. Domestic stimulus may
offset some of these effects; in the May SMP our baseline scenario assumes that China will support its
economy through expansionary fiscal policy. But for both sets of countries, any net weakening in demand
growth will spill over to their trading partners.
Overall weaker global growth would put near-term downward pressure on the prices of globally traded goods.
For countries that are not imposing higher tariffs, such as Australia, this could flow into import
prices, making products cheaper and lowering inflation. In the current episode, this ‘trade
diversion’ channel could be amplified by the nature of the changes, in particular the US
authorities’ focus on China. As a lynchpin of the global manufacturing supply chain, Chinese goods
represent a large share of imports for many countries (including Australia). With the US market harder to
access, Chinese producers could lower their prices and try to redirect their products to other markets.
But working in the other direction, the broad-based nature of the increase in tariffs and increased use of
non-tariff barriers such as export bans could create a new bout of supply chain disruptions. By
increasing the cost of intermediate inputs that cross borders, such as commodities, machinery and
equipment and components, tariffs could potentially lift the cost of production globally. This could push
up consumer prices in all countries, particularly for more complex products, such as cars, whose
components are sourced from a wide range of countries.
Our current baseline scenario assumes that, overall, the weaker global growth environment will moderately
dampen prices for tradable goods, all other things equal. That is, we expect weaker demand to outweigh
the inflationary impact of any supply chain disruptions. We will be monitoring global trade flows and
inflation data closely in the coming months to assess whether this judgement is correct.
Uncertainty’s drag on economic activity
Aside from the effects of changes to global trade that I’ve talked about so far, the unpredictability
of where tariffs will settle and changes to other policy settings has the potential to create significant
uncertainty, both around the nature of the policies themselves as well as their impact. And there is
ample research showing that higher uncertainty can lead to declines in investment, output and
employment. 5
Typically, higher uncertainty leads firms to delay decisions that are costly to reverse, like investment
and hiring. This makes sense intuitively, because there is value in waiting to see how things are playing
out before making a decision that is (at least partially) non-reversable – something often referred
to as ‘real options’ value. These ideas are borne out in the historical data. Research suggests
that the negative impacts of higher policy uncertainty – including trade policy – are largest
for businesses, as they typically pull back on investment. Some studies find higher uncertainty also has
a measurable impact on household consumption, but this is typically more modest.
Uncertainty is a bit of a slippery concept and there are lots of different ways of trying to measure it,
but the graph below shows two (Graph 1). 6
One – the global economic policy uncertainty index
– is based on the number of news articles that talk about policy uncertainty. The other – the
VIX – is a measure capturing how uncertain markets are about near-term equity prices. Both show a
sharp rise in uncertainty recently, though the VIX index has declined in recent weeks.
If we see businesses and households respond as they have in the past, then the current level of
uncertainty will weigh materially on global activity. But the unpredictability and unprecedented nature
of the current situation makes it hard to be precise on the size of the impact. In the SMP we have
tackled this by using alternative scenarios that capture smaller and larger responses to uncertainty. The
baseline scenario assumes a relatively modest drag, the trade peace scenario no significant drag, and the
trade war scenario a substantial pull back in activity. Going forward we will be monitoring carefully
which assumption is closest to how things unfold.
Graph 1
Financial markets’ response
This brings us neatly to financial markets. Movements in global asset prices after the United States
announced its tariffs on April 2 capture how financial market participants initially evaluated their
likely impact, and these movements broadly aligned with the channels I’ve already discussed. Equity
prices declined sharply – particularly in the United States – at least in part reflecting
expectations for the direct impact of the tariffs and the indirect impact via slower economic growth on
company earnings. Expectations of lower future growth also meant that expectations for future central
bank policy rates declined, which flowed through to bond yields (Graph 2).
Graph 2
At the same time, increased uncertainty and risk led investors to require larger risk premia to hold risky
assets. This was reflected in increased spreads on corporate bonds, and some increases in equity risk
premia that put further downward pressure on equity prices (Graph 3). 7
In other
words, investors wanted more compensation for holding riskier assets.
Some of these movements unwound in the following weeks after pauses in implementation of some tariffs. As
of 30 May, financial market participants appear to be pricing in some downside risk to global
growth, but they are no longer pricing in a material economic downturn. Consistent with this,
expectations for central bank rate cuts have also been pared back.
Graph 3
Still, there remains a risk that further changes to tariffs or other policy settings, or actual economic
outcomes prompt financial markets to downgrade the outlook, which leads risky asset prices to fall
sharply. If this were to occur, it would lead to a more sustained tightening in financial conditions,
which would make it more expensive for businesses in particular to borrow or raise funds for investment.
This outcome is embodied in the trade war downside scenario we presented in the May SMP and is a
significant amplifier of the initial shock generated by the sharp hike in tariffs.
Exchange rates
One financial market that deserves some deeper discussion is the exchange rate. When the outlook for
global growth weakens, the Australian dollar typically depreciates (falls in value) as investors expect
our economy to be buffeted by the global headwinds and the RBA to respond with cuts to the cash rate.
This makes our exports cheaper in foreign currency terms, which offsets some of the effect of weaker
global demand. 8
An additional driver of the Australian dollar in times of uncertainty is its status as a
‘risk-sensitive’ currency. When global investors are worried, they tend to focus on reducing
risk exposure, moving their capital to low-risk assets in countries like the United States, Switzerland
and Japan. This means the Australian dollar tends to lose value against these currencies, over and above
the depreciation linked to weaker growth and expected cuts in the cash rate. This dynamic partly explains
the movements during the global financial crisis (GFC) when the Australian dollar declined very sharply,
even though the Australian economy was much less exposed to the global downturn (Graph 4).
Graph 4
While the initial response of the Australian dollar during the current episode was in line with historical
experience, the recent recovery against the US dollar in particular has been more unusual
(Graph 5). The exchange rate has been volatile over recent months, but on a trade weighted basis is
overall little changed in response to global events. It has appreciated against the US dollar (and
therefore also the Chinese renminbi and other currencies pegged to the US dollar) but depreciated
against most other major currencies.
This appears to reflect some offsetting factors. Concerns about the growth outlook and related
‘risk-off’ dynamics contributed to the Australian dollar’s depreciation relative to
several other currencies. But at the same time some investors have reduced their exposure to US assets,
leading to broad US dollar weakness.
The weakness in the US dollar during a period of heightened risk is in contrast with many previous
episodes, though it’s too early to know whether this dynamic will continue. The return of the trade
weighted index to its pre-shock value means that, on average, the price of our exports in foreign
currency terms hasn’t changed. But the relative move of capital towards Australian assets compared
to the United States reflects an increase in capital inflows, which could support domestic investment
activity. We’ll be monitoring how these channels play out over time.
Graph 5
The economy’s exposure to the current episode
Trade flows linkages
As previously outlined, when global conditions deteriorate and uncertainty increases Australia’s
exports typically benefit from the currency depreciating, as this improves competitiveness. Although this
channel may be less pronounced than in other episodes, Australia’s exporters are relatively
well-placed to weather the storm.
The fundamentals underpinning our exports make it likely that in volume terms at least they’ll be
less impacted than other countries. Higher US tariffs on Australian exports are unlikely to have a
material direct impact as Australian exports to the United States only account for around
1.5 per cent of Australian GDP, a low share compared with other countries (Graph 6). 9
Graph 6
Furthermore, the structure and composition of Australia’s exports will potentially provide an
additional buffer to export volumes. Resources make up 75 per cent of Australian good exports,
and despite the exposure of China and other resource intensive countries to the tariff shock, we might
expect export volumes to remain resilient in the short run.
This is because Australia’s resource export volumes are less sensitive to movements in global demand
than other exports as we are a relatively low-cost producer of bulk commodities like iron ore. You can
see this on this chart, where most Australian iron ore miners sit on the lower left end of the production
cost curve (Graph 7). Short-run declines in commodity prices tend to lead to reduced volumes from
other higher cost producers, while Australian producers feel the impact via lower prices and so earnings.
So far, the current episode has not seen a sharp correction in Australia’s key commodity prices,
underpinned by a relatively positive outlook for China. This view assumes that the Chinese authorities
will support their economy through fiscal stimulus and is embodied in our baseline scenario, with the
downside trade war scenario encapsulating a correction. If this were to occur the income flows from
commodity exports would fall significantly.
Graph 7
By contrast, trade in services, which comprise around 20 per cent of Australian exports to the
world, are more responsive to changes in global demand and the exchange rate. 10
We can
see this in the below chart, which shows historically how movements of services export volumes have
correlated with changes in the real exchange rate, a measure of competitiveness (Graph 8). In the
years following the GFC, the appreciation and depreciation in the exchange rate contributed to a decline
and then strong rebound in services export volumes. 11
Trade in services tends to react more strongly because some exported services tend to be easier to
substitute and more discretionary. Travel services, for example tourism, are a key Australian export that
might be affected by recent developments. Weaker global growth is likely to dampen demand, but any
exchange rate depreciation will make Australia a more attractive destination. Simultaneously, travel
service imports (i.e. outward tourism) may decline if the Australian dollar depreciates; holidaying
overseas will become more expensive than taking a trip locally.
Graph 8
Uncertainty dampener on households and businesses
While key parts of Australia’s export volumes may be relatively resilient to global demand conditions
and uncertainty, domestic demand is unlikely to be completely insulated. As discussed earlier, greater
uncertainty about the future can lead households and businesses to save instead of spending and
investing, and this is likely to be the case for Australian households and businesses too. And increased
borrowing costs and risk premia in global financial markets are likely to spill into domestic markets,
further weighing on activity.
Previous research by RBA economist Angus Moore found exactly this. Higher global uncertainty has a large
negative effect on Australian business investment, while the negative effect on consumption is more
modest (Graph 9). 12
Though the magnitude of these effects is itself very
uncertain, this does suggest that global uncertainty may weigh substantially on domestic activity if
uncertainty remains elevated. As with all of the other channels, we explore different assumptions for the
size of this channel in the scenarios in the May SMP.
Graph 9
Putting it all together for policy
So how will the current unpredictable and uncertain global environment transmit through to the Australian
economy? The short answer is we can’t be completely sure. The framework I have outlined identifies
what we think are the key transmission channels, and we have used scenarios to simulate different
alternatives. Within this range, the baseline forecast is for recent global developments to contribute to
slower economic growth in Australia and a slightly weaker labour market. We also anticipate that,
overall, the price of tradable goods will be slightly dampened. Together, these two outcomes mean that
inflation is forecast to be a little lower than at the February SMP, settling around the midpoint of the
2–3 per cent
target range.
This forecast is based on several judgements, and assumptions about the potency of the transmission
channels I have discussed today. These include how tariff policies evolve, how fiscal and monetary
authorities around the world respond, whether trade diversion reduces the price of imports or global
supply chains become heavily disrupted, and how much uncertainty weighs on economic activity.
By using the framework and scenarios together we have anchored our thinking and cut through some of the
uncertainty about the outlook. These were provided to the Monetary Policy Board to help inform their
decision-making; taking all the information into account and considering the risks to the outlook, they
decided to cut the cash rate by 25 basis points.
What will happen from here? Going forward, the RBA will continue to monitor domestic and international
outcomes and global policy developments. Benchmarking these against the scenarios in the May SMP will
help us identify the scenario that best reflects current conditions and the outlook, enabling the Board
to adjust policy settings accordingly.
Endnotes
I would like to thank Irene Cam,
Jonathan Hambur and Adam Baird for their assistance in writing this speech and
Tim Anderson, Nick Baker, John Boulter, Michele Bullock, Iris Chan,
Ashwin Clarke, Bowen Hao, Andrew Hauser, Suzanne Houweling, Brad Jones,
Kevin Lane, Jeremy Lawson, Claude Lopez, William Maher, Matt McCormick,
Madeleine McCowage, Marcus Miller, Samual Nightingale, Michael Plumb, Penny Smith,
Harry Stinson, Katie Sun, David Tian, Grace Taylor, Tim Taylor and Tom Williams for their helpful contributions and comments.
*
See Hauser A (2024) ‘
The Ghost of Christmas Yet To Come
’,
Speech to the Australian Business Economists’ Annual Dinner, Sydney, 11 December. 1
See, for example, Auclert A, M Rognlie and L
Straub (2025), ‘The Macroeconomics of Tariff Shocks’, NBER Working Paper No 33726,
which presents a theoretical model and discusses the conditions under which tariffs will be
contractionary in the short term; Furceri D, SA Hannan, JD Ostry and AK Rose (2019),
‘Macroeconomic Consequences of Tariffs’, IMF Working Paper No
2019/009
, which analyses the effects of tariffs over the medium term
from
1963–2014
. 2
In early 2025, US imports surged as businesses
looked to beat the imposition of tariffs. This response is likely to unwind once the new regime
has been put in place. 3
In the longer term, once the supply side of the
economy has had time to adjust (and assuming tariffs are expected to remain at higher levels),
tariffs are still likely to weigh on economic growth. But over this horizon, this would appear as
a shift from imports to less efficient domestic production. That said, there may be other reasons
a country may want to promote domestic production. 4
Londono, Ma and Wilson summarise the different
varieties of economic uncertainty – including policy uncertainty – and the literature
on their economic effects: Londono JM, S Ma and BA Wilson (2025), ‘Costs of Rising
Uncertainty’, FEDS Notes, 24 April. See also Baker SR, N Bloom and SJ Davis (2016),
‘Measuring Economic Policy Uncertainty’,
The Quarterly Journal of
Economics
, 131(4), pp 1593–1636 and Caldara D, M Iacoviello, P Molligo, A
Prestipino and A Raffo (2020), ‘The Economic Effects of Trade Policy
Uncertainty’,
Journal of Monetary Economics
, 109, pp 38–59, which
develop measures of economic and trade policy uncertainty respectively and study their impacts on
economic activity. 5
Deputy Governor Andrew Hauser spoke about the
varieties of uncertainty and the challenge of quantifying them in his speech earlier this year:
Hauser A (2025), ‘
Monetary Policy in a VUCA
World
’, Speech to the Australian Financial Review Business Summit, Sydney,
5 March. 6
It’s worth keeping in mind that standard
measures of equity risk premia are imperfect. They tend to rely on lagged measures of expected
earnings. Moreover, standard approaches estimate them as the gap between the required return on
equity and the return on government bonds, which are assumed to be riskless. But recent events
have potentially seen risk premia on US bonds increase. This would lead to an understatement of
the increase in the equity risk premia. 7
There is a large body of research undertaken by
the RBA and elsewhere that has shown that the floating exchange rate typically absorbs a great
deal of the effect of global shocks over the past 40 years, meaning smaller effects on
activity. See as one recent example Hendy P and B Beckers (2024), ‘
How Do Global Shocks Affect Australia?
’,
Research Discussion Paper No 2024-10. See also Stevens G (2013), ‘
The Australian Dollar: Thirty Years of
Floating
’, Speech to the Australian Business Economists’ Annual Dinner, Sydney,
21 November; Debelle G and Plumb M (2006), ‘The Evolution of Exchange Rate Policy and
Capital Controls in Australia’,
Asian Economic Papers
, 5(2),
pp 7–29. 8
There will also be limited effect on indirect
demand for Australian exports from higher US tariffs on other countries, as accounting for this
indirect demand only raises Australia’s export exposure to the United States to a little
over 2.25 per cent of Australian GDP. 9
This services export share can be as large as
25 per cent under different accounting frameworks, such as when the share includes the
price of getting exports to destination. 10
Cole and Nightingale identified the relative
responsiveness of services exports to exchange rate movements: Cole D and S Nightingale (2016),
‘
Sensitivity of Australian Trade to the
Exchange Rate
’, RBA
Bulletin
, September. Through the years following
the GFC, a number of other elements played into the strong rise in resource exports –
namely strong demand from China, which drove both exports and the exchange rate. 11
See Moore A (2016), ‘
Measuring Economic Uncertainty and Its
Effects
’, Research Discussion Paper No 2016-01. 12