Transcript of Question & Answer Session Panel Participation at the WEAI Monetary Panel

Hello, everyone, and welcome to Melbourne Business School. I’m David Frankel, the organiser of today’s two panel discussions. I’ll start by acknowledging the Wurundjeri people of the Kulin Nation, the traditional custodians of this land, as well as paying my respects to their elders past, present and emerging. Our first panel will focus on the monetary policy lessons that we’ve learned during the pandemic and its aftermath.

Our chair is Professor Chris Edmond, Professor of Economics at Melbourne University and a Fellow of the Econometric Society and of the Academy of the Social Sciences in Australia. In alphabetical order, our first panellist is Michele Bullock, Deputy Governor of the Reserve Bank of Australia. Also with us is Begona Dominguez, Professor of Economics at the University of Queensland; Ian Harper, Dean of Melbourne Business School and Member of the RBA Board of Governors; and Greg Kaplan, Professor of Economics at the University of Chicago. So, without any further ado, I give you Professor Chris Edmond.

Thank you, David, and thank you everyone for attending this panel. So the goal of the panel discussion today is about monetary policy and what we can learn from the pandemic. But I thought it would be useful to start with a kind of slightly backwards-looking focus, just kind of taking us back to those heady days of 2018 and 2019, when life was still perfect or close to it, and to ask — I’m going to start with Ian — why was the RBA doing such a bad job of getting inflation into target in those heady days? So life was tranquil and yet the RBA was systematically undershooting the inflation target; what combination of factors do we think was causing that?

A leading question; thank you, Chris. They were intriguing days. I’ve been on the Bank Board since 2016 and, subject to being corrected by my colleague, we went through that period where we didn’t move the rate for a very lengthy period of time. Notwithstanding, as Chris has said, that the inflation outcome was consistently below our target range, which was two to three per cent, on average, over the cycle, as says the target in the agreement with the government.

I think there were two factors going on, Chris, as I look back over that period myself. The first is that there was a great deal of uncertainty, and there still is in a way, as to what the non-accelerating inflation rate of unemployment was. We figured that it was somewhere close to where we were, but we weren’t absolutely certain where it was. And I think I’d emphasise in this audience, Chris, that we’re talking about non-accelerating inflation. So we were concerned, given the history of inflation in this country, not knowing quite where that was in the fog, that if we were to stimulate the economy more than we were doing, there was a danger that unemployment would fall below that level, a level which we couldn’t see, and then inflation wouldn’t just go up but would become accelerating. With hindsight — with the benefit of hindsight —obviously, we were well above what we would now accept to be the non-accelerating inflation rate of unemployment, as a result of which it looks like we did a terrible job. When you look backwards, oftentimes of course you see things much more clearly than you do at the time. That was one factor. The second factor was that there was a significant build up in household debt, primarily as the result of rising house prices and people borrowing a lot of money to get into the housing market, and household debt, which is still very high, was growing quite rapidly. Not every central bank in the world also has a responsibility to look to financial stability, but the Reserve Bank of Australia does; so there’s a monetary policy target to be looked at and there are concerns about financial stability. I would emphasise that the argument that I’ve just put about the non-accelerating inflation rate of unemployment, I would argue, was the dominant argument or dominant reason, but financial stability is never far behind. And both of those things led us to be extremely cautious — with hindsight, excessively cautious — in how we set interest rates during that time. That would be my answer.

Michele, would you agree with that?

I wasn’t on the Board at the time, but I would agree. I was actually in the financial stability part of the Bank at the time, and we did use to have a little bit of a discussion about that particular issue. And there were two camps in that: one was ‘don’t lower interest rates too much, because you might inflate debt more’; the other side of the argument was ‘just lower them as much as you like and use macroprudential tools to make sure that you clamp down on debt’. But I think the dominant view — as I say, I wasn’t on the Board — was ‘just be a bit more cautious on the way down to protect against that financial stability risk’.

Do you think it’s a problem that we can have a specific numerical understanding of the inflation target and whether the Bank is or isn’t sort of delivering that inflation target but then, when you invoke financial stability, it’s much less clear what it means in practice to be delivering or not delivering financial stability? So already in this conversation there’s been sort of several different potential indicators reference a household indebtedness and other things of that kind. So how should we think about that asymmetry of those potential objectives, putting aside just for the moment a broader discussion of whether it makes sense to have multiple objectives, given the limited number of instruments at hand? But just supposing one is to take financial stability seriously as an objective, how do you feel about that lack of specificity?

The way I would think about it is that — Ian expressed it well – the target remains inflation, and unemployment is also in there. Financial stability is a background consideration that I think we just need to take into account, so I don’t think it matters that we don’t have a really specific measure of financial stability. It’s actually very difficult to explain what financial stability is. It’s easier to explain what financial instability is than it is to explain what financial stability is, in my view. So, really, I think it’s a background consideration. But I wouldn’t say we are using interest rates to dial up and back on financial stability. It’s really about vulnerabilities building and, as we’ve seen in the Global Financial Crisis and we’ve seen a little bit recently, financial vulnerabilities build up and then there might be a shock that results in those vulnerabilities generating financial instability. But financial stability of itself, I don’t think you can actually say ‘Well, I’ve dialled it up,’ or ‘I’ve dialled it down.’ That would be my response.

Greg, I just want to ask you: do you think then that the RBA should be sort of attempting to take financial stability more seriously? I guess a kind of response to that might be — and I’m going to ask Greg to comment on this — that the difficulty with that line of argument is that it puts the financial stability as a consideration in this sort of catch-all position that can be invoked or not invoked. It’s a little bit like the checklist approach to monetary policy back in the late ‘80s, where sometimes it’s a significant consideration; other times it’s taking a back seat to the sort of more mandated inflation and unemployment objectives. So, to a degree, I guess my question would be: should we be sort of thinking about ways to operationalise this so that we’re not in that position of kind of using it as an argument of convenience but, instead, have more of a sense of when to invoke it?

I think it’s a great question and it’s a difficult one to grapple with. I would say that the starting point is to accept and embrace that monetary policy is a very, very narrow set of instruments. And, whether we like it or not, we can legislate all we like about what the Bank should do. But each time you change a policy setting, you have impacts on, we hope inflation, we hope employment, certainly on financial stability and certainly on distributional considerations as well. It would be wonderful if we had a tool that could pinpoint one of those.

Coming back to that question of ‘Where was the RBA between 2016 and 2019?’ I think a lot of what was going on at that time was almost an over consideration of those core concepts that a lot of the criticisms that we saw were that the central bank was undershooting its inflation target. And now that seems to be — I think the one place we will agree is that we think that, if the central bank can do anything, it can impact inflation. We could talk about under what circumstances can that generate real effects on the economy? And one thing we saw then is that monetary policy settings were very loose at that time and the discussion was: should they be even looser? I was one of the people at the time saying, ‘No, I don’t think that they should be looser because, yes, we are understating a target but we can legislate all we want there are limits to what we could actually achieve.’

It might be worth just adding too that undershooting the target and low wages growth and the idea that we might have overestimated the under-acceleration, this wasn’t just an Australian issue. This was going on abroad as well. A lot of central banks were undershooting their targets. They were … underestimating the degree of slack in the labour market and, I think, as Ian mentioned, has been borne out now. We could have had the unemployment rate going down much further without putting a lot of pressure on wages, but we didn’t know that at the time. And we weren’t the only ones; others were experiencing the same thing.

I just want to bring Begona in here, so I’m going to cannibalise a question a little bit. So does that mean, Begona, perhaps that central banks around the world — it seems like there was something of a kind of common set of circumstances and perhaps a common conceptual framework in mind, and so it kind of leads one to wonder whether there was too much of a reliance on a kind of mechanistic relationship between inflation and/or wage growth and the level of unemployment. And so I’m wondering whether you think that there was too much reliance on that sort of mode of thinking.

A sort of stable Phillips curve.

Yes, is there a stable Phillips curve?

Well, it seems there’s not.

Well, can I comment on that?

Yes, please.

I think we need to call out the myth of the exploitable Phillips curve for what it is. It is a myth and I think — I guess we’ll talk about this — one thing that we’re looking at right now is more and more evidence that such a thing doesn’t exist. But if we go back to 2019, most of the criticisms of the RBA were coming from, I think, a perspective that: ‘Hang on, if we’re undershooting our inflation target, that means we’re missing out on some candy to be had; we could have employment —the labour market could be doing even better than it already is.’ And I think that sort of thinking comes from an overreliance on this idea of an exploitable Phillips curve that’s not really there in reality.

I’m going to push back on that to say that I think — I mean, I’m sure that there were people that had that view, but I think there are well-founded reasons to take inflation and/or price dispersion seriously as a source of welfare losses, even if you put aside the unemployment considerations. There are reasons to think there are welfare losses with undershooting the target, absent that sort of that labour-market side of things. But I take your point about that.

I’d push back on that. It’s hard to argue — certainly, the costs of inflation that we’re seeing now at five per cent inflation over and above whatever they have on the direct real effects are there and different to being at two per cent. But to argue that they’re significantly different welfare losses from being at one per cent versus two per cent in that direction is sort of a hard argument to make without a Phillip’s curve in the background.

Yes, especially if your concern is that you could accelerate it quickly, not just back to the target but out the other side.

Yes, like I said … it’s hard to get a little bit pregnant.

That’s correct.

The risk of inflation in Australia has been pretty low, but I don’t think — in Europe and in other places they would see it a little bit more.

Alright. Well, this panel is supposed to be looking forward, so I want to spend a little bit of time sort of transitioning to looking forward, and that’s to talk about monetary policy during the pandemic itself. I guess, in kind of crude terms. So Begona, with hindsight, to kind of take Ian’s favourite word at the moment, do we think that monetary policy was too expansionary during the critical phases of the pandemic itself, say, in 2020?

I think so; I think so. From (inaudible) perspective, it probably was the right thing to do. We were hit by a very big shock, negative shock, and we didn’t know when we would be recovering from it. But actually we recovered really quickly and it took us by surprising inflation started picking up in 2021, and I think at that point central banks responded a little bit too late, in my view. Most central banks around the world didn’t respond until 2022, when we were seeing masses of inflation that we haven’t seen for 30 years. And, when we look at the RBA, the RBA was actually one of the last to respond to the increasing inflation. We didn’t stop the bond purchasing program until February 2022, and the first hike in interest rates was in May, when inflation was already at five per cent.

should central banks have responded earlier, and by how much? And my view is that they should have responded a bit earlier, maybe six months. It was clear by the middle of 2021 that we were on our way up; measures of inflation — expectations of inflation were rising and becoming more skewed, so I think we should have responded maybe six months earlier or so. Now, by how much? I think maybe we could have increased the interest rates earlier. But offsetting all these shocks is probably undesirable, because it would have then taken the economy to a very big recession.

So, Michele, do you kind of agree that — I’ll state the analysis maybe in a slightly different language — perhaps there was too much emphasis given to the adverse demand-side effects of the pandemic and not enough to thinking of this as essentially a supply-side phenomenon; and that, in light of it being essentially a supply-side phenomenon, the bounce back in the real economy could be quite quick, and that sort of stimulus measures that were put in place in early 2020 may then have been ex-post proved to be unnecessary.

Look, again with hindsight, I think what we underestimated was the power of fiscal policy and monetary policy, not just here but around the world, all pushing in one direction. This was unprecedented and I think people forget that we had shots of morgues in the streets in New York and Italy and, it was shocking stuff. We were worried about the potential for people to lose their jobs and never get them back again: basically, to end up with a really big structural unemployment problem. So I think what we did and I think what others did was —and the United States is a really good example — we completely threw everything at it and we relied on the ability that, with monetary policy, I think we could respond quickly. There’s a question about whether or not we responded quickly enough, so I think there was a bit of an underestimation of that.

To the points Begona was making about we should have responded earlier, I think you’ve got to remember too that we came out of our lockdowns and so on later than everyone else. So we were observing inflation happening overseas, and everyone was of the view ‘transitory’ was the word of the day. Everyone was talking about it’s transitory, it’s supply chain issues to do with the pandemic, we’ve got Russia’s invasion of Ukraine on top of that. So we had these two massive supply shocks, and I think there was a sort of feeling that this was going to be transitory. What people hadn’t taken into account, I think, as well as we could have, was that there was a big demand element to it, and we’re seeing that now, and that’s why I think we’re all behind the eight ball. So, yes, in a sense, I think you could say that we threw too much at it, but we were in completely uncharted territory is what I would say.

We also had a much larger labour market response here in Australia.

We’ve had a much higher labour force participation rate and, therefore, much less action on wages than was occurring in the United States, for example.

So there was sort of no signs of inflation, either in the labour market or elsewhere, while we waited. And then, yeah, sure, it came around the corner.

I have a couple of — I planned a couple of things for discussion.

Yes, yes — please.

So I think the points about fiscal policy are really important. And supply side shock, yes, but we issued a tremendous amount of nominal liabilities, that if you just do the simplest, simplest monetarist arithmetic on it, will tell you that we should see something like a 15 to 20 per cent increase in the price level if nothing else was changing. Other things did change but just at a basic level. So that’s sort of my apology for the RBA. Somehow, sort of out of central bank’s control, regardless of what one would have done, that’s got to show up somewhere, right? Now I’ll be less nice. I think the concern really is not so much the delayed reaction but the unconditional guidance that was given prior, and I think this ties into that discussion about Phillip’s curves and the critiques that were coming earlier on. My view is that it’s irresponsible to be giving unconditional guidance so far out into the future. And it’s even more, I think, unjustified then to hold onto that for so long, once the shock did hit. It is one thing to say that it’s not the central bank’s job to be giving unconditional forecasts, in the sense that they give — there’s lots of things that might happen and it should be expected that, as those things unfold, we will respond to those in appropriate ways.

The language that was sequentially rolled out over that period that we’re talking about sort of unwound that in the public’s perception that we went away from unconditional forecasts to actual here’s exactly what we’re going to do. And I think that put the Bank in a difficult position relative to other countries. And what Michele said is absolutely right that things played out slower in Australia. But we printed the money at the same time, and I think there were a lot of reasons to expect that we would see exactly what we’ve seen right now.

Do you want to comment on whether it was unconditional?

Well, I will comment, because I don’t actually agree that it was unconditional. We were always conditioning it on the state, and there was a time bit: ‘and we don’t expect that we will reach that state until 2024’. What I will accept — and we’ve said this in our review of forward guidance — was that the message got garbled and I think it got garbled for two reasons. One was that the media and people latched onto a date; they latched onto a date much more easily. And what’s really interesting is that, even now, while we’re raising interest rates, they still want us to put a date on when we’re going to stop doing it. People are clamouring for a date; they just want one. So we should have resisted, I guess, a little bit more there. So that was one reason.

The second reason that I think we didn’t get the message across really well is we talked around the sorts of things that we thought were going to be important and we got a little bit fixated on wages and — the Review makes this point as well — instead of focusing on saying ‘We want to get inflation back in target,’ and leaving it at that, we actually went on to say: ‘And we’ll therefore be expecting this to happen to wages’ and ‘this to happen on demand.’ So we muddied the communication, I think, and so we didn’t do as well as we could have there. I would say, no, we didn’t offer unconditional guidance at all, but I will do a mea culpa in terms of communication.

Yes, your subsequent words ‘in the public’s perception’ are very important.

It was perceived in that way. I mean, I think there was something interesting on wages as well, which I’ll just add to that, which is we did have a big supply shock. What is a big supply shock? It is a reduction in real wages, which is the level of nominal wage growth relative to the level of price growth, and so we should have expected to see a slowdown in nominal wage growth relative to nominal price growth relative to what we were expecting previously. So I think that’s yet another reason why that overemphasis on the slow growth in nominal wages was indicative of a stance on the demand side, but perhaps not.

I want to come back to this in a question of whether the RBA could have done a better job of kind of communicating some of the subtleties in, like, time-dependent versus state-dependent policies. So, Begona, I want to bring you back in here. One might think that it’s a little bit difficult to say to kind of like a lay audience that: ‘You haven’t understood our complicated messaging.’ In some sense, it feels like the institution that is the locus of expertise in this space has, in some sense, an obligation I think, to provide education about what its language means; whereas I think what we see from the RBA is perhaps a little bit more — it’s communication tends to be a little bit more stand­offish and not actually teaching the public what it’s language means. So do you think there’s like a role — how would you imagine or how could an institution like a central bank educate the recipients of its communications about what that language means, without sort of undermining the message, as such.

That’s a tough question. Also, I see what Michele is saying, because the journalists are going to try: ‘No, I really want to know the date.’

Right, Michele, exactly. But we don’t want to take it for granted. Journalists are always going to want a simplification, but it’s the role of experts to guide people in forming their experience. So, if you’re a criminal and you say, ‘I want to get off,’ and your lawyer says, ‘Well, you’re not going to get off; this is the situation,’ it’s the job of the lawyer in that sense to provide realistic expectations and guidance as to the situation you’re in and …

Yes. You need to be able to kind of communicate the model that you have in your mind of how you are going to be implementing that policy. So, if you think that the right variable that you are going to be paying attention to is wage growth or whether it is unemployment or you want to have a look at vacancies, well, you don’t want to muddy the waters, but you want to be able to say it in a way in which it makes that state contingent clear.

I think I was trying to ask a sort of similar question but with different language. So when do you think the RBA realised that their communication on this front was not working and that people were misunderstanding the policy? At what point was that clear to internal policymakers?

I think it was starting to become clear at the beginning of 2022, when we were …

As late as that?

I think it was, yes, yes. Ian might have a different view because I joined the Board sort of April 2022 and I thought it was starting to become clear then that there was a lot of emphasis being put on the date. You’ve got to remember too that this was one part of a package of things that are done: lower the interest rate to 0.1 per cent; the yield curve target, which was the other thing that was challenging and which was also a sort of three-year target, which was the 2024 date. There was the TFF, which was also three-year funding. So all these things were sort of self-reinforcing. And I think part of the challenge of the whole thing was that, even though it was a state-based forward guidance, there were all these other things in place, which gave …

The same date.

The same date on it.

It reinforced it.

It reinforced it.

So I guess the question, in some sense — sorry, Greg; jump in, please.

I just wanted to finish a thought. I had a question related around forward guidance and around this discussion, but —

Well, I guess my question was just going to be like: so suppose that we accept that at some point the bank sort of recognised that there was too much focus on the date and a misapprehension had developed for whatever reason about the meaning of that date in that communication. Suppose that one stipulated that’s the case, is it obvious then that the right thing to do is not to try and correct that misapprehension, to try and provide some additional messaging around that and to kind of try and build up again a sense of education or understanding in the public’s mind?

Well, I think …

That happened, right?

Yes.

I think I’m not telling tales out of school here if I point out … Well put it this way, right? The Governor was asked by The 7.30 Report, which is a quite widely seen current affairs program on our public broadcaster here in this country, and there was significant debate at the Board as to whether or not the Governor should appear for two reasons: (1) because it was highly likely that the interviewer would be hostile and seek to twist the Governor’s words against the interests of the Bank. The other faction on the Board said, really, your argument, right: ‘Here’s an opportunity for you, the Governor, to now explain the subtleties of this to what is a sophisticated audience.’ This is the public broadcaster, so a lot of people who do think through the issues would watch this. And, in the end, the Governor decided to do it, and it turned out to be, I think, an exceptional performance on Philip’s part, if I may say so. So, Chris, the notion that the Bank sat there like the proverbial deer caught in the headlights, not wanting to do anything: that’s false, right? Whether or not the Governor’s attempts in speeches and interviews were successful in allaying that impression, that’s another matter.

And he was softening the language on the time base … through that period. So, we were trying to get the message across. But our traditional methods of communication used the financial press, for better or worse, and speeches and interpretations of those. Is there a way we can get more to the people that we want to get to without going through that layer, that filtering layer? I think it’s a really good question and, I think, something that we’ll be thinking about. We have our speeches program and we have a ‘school sort of university education’ sort of program. But what about this other group people that we really want to try and educate, how do we get to them? And I’m not sure that’s easy, but I think we’ve got to try and think about it.

Greg, you had another point that you were going to—

Well, I was just wondering, given the audience here, whether it might be a good time to talk about what the role of this guidance is, in the first place. And, maybe to sort of kick off that discussion, I think there are, broadly speaking, two sorts of objectives, and it would be good to hear this from the Bank’s perspective. One is that one thing the Bank doesn’t want to do is create unnecessary volatility in financial markets and destabilise the financial system, and providing guidance on what relative price is going to look like in those markets is important. To that extent, you don’t want to be continually surprising market participants. And I’ll put in that broad class as well what ended up being interpreted, which is you’re going out to buy a house and, ‘What can I expect in terms of my mortgage payments?’ because, at the end of the day, that is where the transmission is happening.

But there’s sort of a second reason as well — which is less spoken about but I actually think is there without being spoken — which is, when interest rates got really low after 2008, banks around the world started turning to forward guidance as a stimulatory policy. And it’s not without coincidence, the time of these discussions that we’re having about the nature of the guidance, the nature of what those statements were and having to go on The 7.30 Report. If it was just about stability, we should be doing it and that would be happening all the time. But it happens at this period of really low rates, and what’s going on there is this idea that it’s an additional source of stimulus. My own view and I think that of an objective outsider who came down from Mars and looked at the evidence on this …

Chicago is not Mars, Greg; anyway, go on.

… the view, I think, of an objective outsider that came down from Mars—the same with the Phillips curve, by the way — is that, at best, there’s no evidence either way that this has any effect and, at worst, maybe — at best nothing. So it would be good to get the thoughts on what do we think are the primary motivations, and how do we reconcile these two motivations for giving guidance in this way?

So can I just summarise that? So one motivation is stability and the other is using forward guidance as sort of a statement about the expected path of future short-term rates …

Stimulus.

as stimulus through long-term rates.

Well, we can talk about that. That may or may not be a transition mechanism, but the announcements of future short-term rates having a substantial effect on the economy.

I think I’d have a third one, which is the credibility of the central bank. If you follow with that, you are (inaudible) the reputation.

Well, certainly, as I recall it, the idea was to try to encourage people to see through to the other side of what was a massive dislocation. And the expression I think that Philip Lowe, the Governor, used at the time was ‘building a bridge to the other side’. So encouraging people not to shut their wallets, not to shelve their plans but to keep spending, as a way of trying to prevent the state from having to fill that gap in other ways. That involved the Bank giving this type of guidance.

The alternative of saying nothing — and, again, this is another matter which is often discussed at the Board level, as you would expect — people don’t interpret silence as conveying no information; on the contrary. We often discuss whether we should say anything at all and, if so, what we should say in order to try to encourage confidence as far as we can. Now, that’s a tricky business, as you would appreciate. Just to swing across to stability for a moment here, Chris; and picking your point up, Greg—that is why the Treasurer of the Commonwealth, as advised by the Governor of the central bank, who happens to be the Chairman of the Council of Financial Regulators, made a comment the other day about the soundness of the Australian banking system. Now, that’s forward guidance, brother. That’s exactly what that is ‘Don’t run on the Australian banks; you don’t need to do that. Why not? Because they’re sound. Turn off the television and watching what you’re seeing happening in Europe and the United States.’ That’s forward guidance. And why would the Treasurer do that? In the public interest.

But I think that highlights, like, a sense that the forward guidance of the RBA during this episode is distinct, which is the appearance of specific numerical aspects to that guidance. So, if the RBA had simply said in 2020, ‘We are going to keep the cash rate low for an extended period of time; when circumstances start to change, when inflation starts to pick up or other signs of recovery start to pick up, then we are going to revisit our kind of commitment to’…

And that’s, in effect, really what we started off saying.

Yes.

And then the sort of clamouring kept coming, ‘Well, how long is that?’ and our forecasts — everyone was at sea on forecasting by now, of course.

A tsunami.

So, basically, what you said was exactly where we started, and then what crept in was: ‘And we don’t expect that will be until about 2024.’ That was how the whole thing played out and that was, I think, where we slipped. And I think we acknowledged in our review of forward guidance that we erred — we didn’t do great on that. But, to Ian’s point about forward guidance, the Fed dot plots are all forward guidance. I mean, central banks around the world use forward guidance and have used forward guidance in the past.

Sure, of course.

And some of them use time base, so the Fed dot plots are all time based. So forward guidance is all around. Having said that, I think we don’t feel that we would be heading back in a hurry to time based at any sort of time with forward guidance. I think our more usual practice is much more qualitative for conditions that we would want to see before we move interest rates. So I think we have learnt something from that episode that we’ll take forward with us.

I want to start talking about our more recent experiences. But, before I do, I just want to touch on something that was brought up in passing, which was the yield curve control experiments. Begona, I was going to ask whether you think in the future the yield curve control is something that will still be on the table, or whether the end of that — so, essentially, the run at the end — is in some sense damning of the experience.

Going back to what Greg said about forward guidance, I think actually there is more forward guidance in the real economy than the yield control. It seems to me that there is no clear evidence of what yield control has on the economy. At the end of the day, businesses and households in Australia had plenty of liquidity, so it’s not that they weren’t providing liquidity. It seems that it was mostly driven due to the three-year mortgage fixed term in Australia. I haven’t written up a model and evaluated how much of that has played into the economy, but I’m not sure that we should start using these events.

Michele, I’ll ask you then: how do you think about this in retrospect?

Well, in retrospect, I mean, again, we’ve done a review of this and it worked really well until it didn’t.

Yes, exactly. That’s my concern, exactly. So then, all things considered …

So, all things considered, since then, I think — so we did that first.

Can I just say, for the purpose of the audience, when you say ‘it worked well’, maybe you should just elaborate on what the objective was.

Okay. So the objective — well, as I said earlier, it was part of the package. So we had a very low interest rate, we had a Term Funding Facility that was extending cheap funding to financial institutions out for three years, and this was another way of getting the short end of the yield curve down at a low rate to, again, lower funding costs across that front end of the yield curve. And, as you highlighted, it actually did find its way into the economy because it found its way into all of those very low fixed-rate mortgages, which we’re coming back to. But, a lot of people, 40 per cent of loans, ended up being on these very low fixed-term mortgages, so people took advantage of them and it was really …

In 2024.

Yes, that’s right. It’s not the US but, nevertheless, that was the purpose: to get that front end of the yield curve down. What I mean when I say that it was successful was, while it was credible, we didn’t actually have to spend much money defending it, because everyone just believed us.

Well, that’s a nature of fixed home rates.

So, you know, it was—

But the effect on the balance sheet was huge.

The effect on the Bank’s balance sheet came from the bond purchase program. So we had the yield curve. The bond purchase program was rolled out subsequently when we thought we needed to get them down at the longer end –, so that was more aimed at the 10­year sort of end – the longer end of the yield curve. And that’s the one that’s had the really big impact on the balance sheet; that’s the $200 billion to $300 billion worth of bonds … and that’s the one that’s left us in negative equity. The purchases under the yield curve target were actually pretty small because, as I said, while it was credible, you didn’t have to spend a lot of money defending it. And it was only towards the end — I think we called it in the review a ‘disorderly exit’ — of the program that we were actually spending money, but the bulk of it was the bond purchase program. Now, would we do it again? I think our general view is that it’s not that flexible and it’s hard to get out of. And Japan has still got one by the way. The Japanese have still got a yield curve target on the 10­year bond. So it’s not easy to get out of. So I think our feeling is that we would lean more towards — even though the financial risks are more with the bond purchase program, it’s more flexible because you can dial it up and you can dial it down a bit, you’re not aiming at a particular yield, you’re aiming at quantities. So I think that would be the way we would think about it into the future.

Well, I want to transition a little bit more to contemporary, so to speak: contemporary policy issues. I’m going to start by picking up on this idea that any sort of inflation is transitory kind of coming from the supply side. It’s a view that was prevailing sort of 12 to 18 months ago and certainly in certain circumstances. I’m going to ask Ian: I think a lot of people outside of central banking circles, outside of macro sort of policy circles, maybe struggle to understand the role that monetary policy might have in dealing with supply shocks, let’s call them that. So how should we think about the role of monetary policy in that circumstance; and are there other tools that we could be bringing or should be thinking about, if supply shocks are kind of dominant or playing a significant role in our current inflationary episode?

Sure. Thanks, Chris. Well, those people would be right to struggle with that, thinking, ‘So this is a supply side problem, so why are we trying to deal with that with a demand-side instrument?’ Well, the fact is, as the aggregate supply curve shifts off to the left or you’ve got a reduced aggregate supply for whatever reason, then you’ve got to make aggregate demand match that or else the outcome is inflationary. And so you end up dealing with a supply-side problem by managing aggregate demand in order to try to bring the two back together again. Now, this is against the backdrop of an environment in which aggregate demand had been deliberately expended to deal with what we thought was the opposite problem: a collapse of aggregate demand. So two things happened. Firstly, the aggregate demand didn’t collapse as much as we thought, so the stimulus arguably was too much; and now you’ve got the aggregate supply curve shifting off to the left and doing its own work. So you’ve got two reasons to try to bring aggregate demand under control quickly, and that’s precisely what central banks have done.

So should we be thinking — is there a role for other instruments? Greg, you might like to comment on this.

So, maybe just to start telling about how I think about this, a supply shock is a reduction in real wages. If we think nominal wages can’t fall, then the way that that might be realised is an increase in prices. That doesn’t necessarily mean an increase in sustained inflation. I think part of the role of the central bank is the one that you were describing earlier, Ian, which is about coordinating expectations, about coordinating multiplicities, so you can have the bank-runs up. A bank run is a really good example of that. You can think of that as forward guidance; I think of that as the role of — as being a big player of coordinating expectations and coordinating beliefs. And the bank has a role to play in coordinating beliefs about what the future path of that required increase in prices is going to be and so that we don’t fall into a trap of a wage/price spiral and end up somewhere where we have persistently more inflation than we need.

I must admit that I don’t quite understand it. If there’s a shock to the real side of the economy and it requires a fall in the real wage to bring us back to equilibrium, then that is the real equilibrium. If demand was high in the past because the government — the fiscal side really expanded, it doesn’t really make sense to me that then the central bank should be pushing back on that. That seems to be a separate issue, but …

I was just going to say that I think there’s a distinction here between ongoing inflation and a rise in the price level.

Yes.

Correct.

What you’re talking about is the need for the price level to adjust and what—

Yeah, and what are the—

That’s right. And what Ian is talking about is: how do we make sure that it’s a price level adjustment and not ongoing inflation?

Correct.

So I’d sort of assert that it’s—

Yes, exactly. So one thing you’re keeping a weather eye on throughout this process, including now, is what the markets think the long-term expected inflation rate will be. And in our case, throughout this whole experience, the market has said that the long-term, 10­year, expected rate of inflation in this country is 2½ per cent, right in the middle of the Bank’s range, throughout. And that, for me as a Board director, is one of the key charts that’s presented every month; it’s to watch that like a hawk. Now, part of the demand response that looks like it’s a bit odd when you’ve got a supply side problem is to switch off one channel by which that long-term expectation could escape. By giving people the impression not just that you had monetary policy too loose for so long — and just flipping back to the earlier conversations; as you rightly remember, Greg — lots of people were saying to me at that time, even though interest rates were very low, ‘You wouldn’t dare put them lower; you’re just putting more fuel on the fire that one day will come.’

You were just mentioning: what were the long-term inflation expectations at that time, when inflation was (inaudible)?

Well, at one stage, this government — our government, could borrow for 30 years at less than 100 basis points and did, briefly. But they locked stuff in for 30 years. Bluntly, this university has borrowed for 30 years at less than 100 basis points. So a lot of people, not just mortgage holders, did very well out of that. But, throughout that process, the expected rate of inflation — if you asked people on the street, some of them would say exactly the same thing, but park that to one side; ask the markets, people have got money on it, and they’d say 2½ per cent. Now, that’s not true in the United States. So, in the US, it’s still the case that the market thinks inflation is going to be higher than the central bank’s target. That’s not true in Australia, and part of the reason for that, I believe, is that we responded with demand-side management over against a supply-side problem to deal with that issue, well, amongst others.

I’d add that another part of that has got to do with our very different long-term fiscal position in Australia relative to the United States.

Do you mean a structural deficit?

Yes.

But a much smaller one, relative to the size of …

Oh, I beg your pardon. Yes, yes, okay. Yes, okay, sure, sure, sure.

So the chances of someone having to monetise it are much lower …

Or a significant …

Monetise it.

Yes, quite. I accept that.

So, lurking in the background here, I want to talk about the current pause in the increase in the cash rate and some of the circumstances around that. I guess, sort of a month ago, we had the failure of the Silicon Valley Bank and other kinds of financial market disturbances. So, I guess, lurking behind that pause and some of the related discussions of central banks around the world is the ongoing sort of tension between inflation control and financial stability concerns. So I guess I’m going to ask you, Begona: is that something that we should be concerned about? In crude terms, is there a trade-off between financial stability concerns and inflation control? Well, I can put it even cruder: should the RBA have paused the increase in interest rates?

For the RBA specifically? I would say no. Well, first of all, in general, I would say no, because central banks aren’t governed … countries have different instruments to deal with each of them. For the case of Australia specifically, we have APRA, and my understanding is that the standards of APRA are fairly strong in terms of capital requirements. And not only that; it seems that — I didn’t know this, but it seems that Australia is the only country that has this interest …

Interest rate risk in the banking book (inaudible).

Yes, which means that they require banks to hold an additional capital requirement to hedge against the risk of interest rates going up, which means that actually, for Australia, there is very little trade-off between the two objectives. Having said that, there is a caution to be made for the US and Europe because it seems that many commercial banks have been buying all those bonds and now they have many—

As in Silicon Valley.

… like you have read in the news, they have many losses, unrealised losses. And I read in the news that it seems like the … what is the name of the federal deposit?

FDIC.

FDIC, the Federal Deposit Insurance Corporation.

In February, they said that there was $620 billion in unrealised losses in the US. So it’s clear that, if you have this cycle of monetary policy tightening, that does want to bring some banks down. Why did they take so much risk, these banks? It seems like actually there may be some reasons for that. Maybe could be mismanagement, which seems to be the case for Silicon Valley. But it seems that there are also some reasons. I found this paper by Dan Ciuriak and—

that they found that it might be optimal for banks to actually take some of this risk to hedge against the deposit risk so that … But actually, I mean, there needs to be a bit of a balance there and then, since, some banks went over this. Having said that, still the US and Europe

they have ways of dealing with these situations through appropriate capital requirements, monetary in the banks and managing this risk. And, as long as they keep it managed, which is the case now, I think they should focus on bringing the inflation down and not …

I’ll ask Michele the same question but in a slightly different way. So do you think that, absent the kind of Silicon Valley Bank and related events a month ago, the Bank would have paused?

Yes. Even before the problems with Silicon Valley Bank, we had already suggested that we were thinking about pausing because we’d moved 350 basis points, 3.5 percentage points, in quick time. Normally, we don’t. In fact, in other tightening cycles, we typically move a bit and then we stop and watch and then we move a bit more. But we had to get from emergency low levels, remove all of that stimulus, and get into restrictive territory. Now, I think what we observed was that we feel we are in restrictive territory because we’re starting to see signs on the housing market, consumption and these sorts of things, retail sales. Now, just stop for a minute and watch because we are — the Governor uses this term and he’s got great terms, hasn’t he — ‘the narrow path’. He likes ‘the narrow path’. So, to your point earlier, it would be ideal if we could get inflation down but keep as many of the gains on employment that we have managed to get through this period. So I would say, yes, that was always on the cards. The other point I would make is that, if you read the statements by — in fact, the Fed and the ECB continued to increase interest rates, even though this had happened and they both made the point that financial stability concerns can be managed with other instruments; they don’t have to do it with interest rates. Having said that, what is likely happening over there, at the moment, is financial conditions more generally are tightening. People are running to sort of safer assets; the banks are pulling in their horns a little bit. So that’s going to be a factor. It’s not saying that the Fed is not increasing as quickly because of the financial stability concerns; it’s saying they’re taking into account the fact that financial conditions have tightened and, therefore, they have to maybe do a little bit less. So that’s the perspective I would give on that.

The other point, not to labour on too much about it — but we did write about this in our recent Financial Stability Review, a little advertisement for you all if you haven’t read it, it’s a great read. We set out what we know about Silicon Valley Bank and the particular issues in those banks in the US. The US has bank failures on a regular basis. They have lots and lots of banks, thousands of them, and some of the smaller ones are failing all of the time.

Yes, but they don’t resolve them through emergency FIDC measures …

No, because …

(inaudible) the largest ones.

… but this one was a large one of the small ones. But it had —and the ones around it that were particularly at risk had — these particular characteristics: (1) was that they had a lot of bonds sitting with unrealised losses on their balance sheet.

Unhedged.

Unhedged. (2) They had concentrated deposit bases, concentrated in two ways: large amounts of money by a small amount of people, and also the types of people; they were all tech people.

It had a run.

Absolutely. It speeds that up.

And some of the feedback you get when we listen to regulators around the world talk about this; they say they had never seen a run so quick. It was basically a quarter of the deposits in that, because they were uninsured …

The size of it.

The size and the speed of the run had just never been seen before, so that’s why the regulators had to step in.

They didn’t have to stand outside in the cold.

Yes, so, sorry, I’ve …

No, no, no. I think we can all understand that they are well-founded reasons why (1) a special authority was granted for the FDIC to intervene and then — in a situation where, at face value, they may not have. But I’m more kind of interested in the issue of the interaction of these sorts of mechanisms with monetary policy and whether — you kind of gave a fairly direct statement that you think conditions are tightening in Australia and that …

No. I would say overseas they are tightening. I’m sorry if you misinterpreted me.

Okay. That’s what I wanted to ask about. Go on.

No. In Australia we are actually not seeing signs of financial tightening here. The banks here: again, you’ve already highlighted the way that they’re very, very well regulated here. Interest rate risk in the banking book meant that they have to hold capital as the prices — if they’re not hedged. In fact, what they do is they do hedge, because they do know that they have to hold capital if they’re not hedged against these sorts of things. So there’s no doubt that the banks are very solid here. There’s no sign that there’s any tightening in financial conditions because people are worried about the banks or runs against banks. And, as yet, there doesn’t seem to be Australian banks reacting in any way to tighten financial conditions either. So, no, I would say that’s not an issue.

I’m glad you clarified that because I was going to ask Greg this: do you think then it was correct to kind of pause in this most recent sort of decision, or whether we should have been continuing to tighten, given that inflation continues to be significantly in excess of target?

Look, I think the more important question is: where are we going and how are we going to get there? My view is that the difference between 25 basis points now or in three months’ time over the sort of period that we think the central bank really can control inflation, is probably neither here nor there. It’s more understanding what our members of the Board here are thinking about in terms of what they’re keeping their eye on. I think Ian nailed it on the head when he said, ‘We’re keeping our eye on what the lows those long-term inflation expectations are.’ And I feel quite comfortable as long as those are being kept under control because, at the end of the day, that’s what we want to make sure: that these temporary shocks that we’ve been hit with don’t translate into persistently higher inflation over time.

That’s fair enough, I think, at one level. But on another level, that’s sort of like a rationale for not doing anything this month and then next month. Like, it can take — at what point does that argument sort of strain credulity, in the sense that — is it kind of like —

(inaudible) some point between now and when it doesn’t. I mean …

Well, let me put it this way. Exactly, that’s very useful. So let me kind of make it a little more concrete. One might think, that once you see those measures of market inflation expectations start to move significantly to the point where you would then change the actions that you would otherwise have taken, that in some sense you’re too late.

You might be too late; maybe.

So then the question is: ex ante, what should we be doing? So just let me make this really concrete. Let’s suppose that you were never going to see ‘along the equilibrium path’, if you’ll excuse the expression, a kind of a change in inflation expectations, right? So the question is: ex ante, what kinds of developments would lead you to change your monetary policy actions, supposing that, if you did things correctly in the rational expectations of equilibrium, you would never see those inflation expectations change?

Well, I’m just going to say the obvious, I think, which is that you’re going to look at the signals that we see in the world that give us some confidence that the mechanisms by which we think we can impact inflation are actually starting to play out. In the model that you describe, you never see that; it doesn’t happen; fortunately, we don’t live in that model. But in that model, we also know ex ante exactly how much inflation we would see from a particular shock. So we saw the big issue in sort of nominal liabilities; we saw a temporary supply shock. In that model, we know exactly what to do. Fortunately, we’re not in that model because we don’t see that, but we have a lot of things that we can be looking at and we want to be seeing turning points in there. So I suspect that’s what goes on at the Board level and probably why they see in the communications that we’re starting to see some pressures on wages.

So you think that we’ve seen enough of a turning point. So we’ll just junk all equilibrium talk and just say: so we’ve seen enough of a turning point, you think, that a pause is fully warranted.

Well, I’m not going to add to what the Deputy Governor said about that. The minutes haven’t even been released. But the minutes of the previous meeting, as she rightly pointed out, spoke about a pause as one of the scenarios or one of the recommendations that was put alongside another recommendation, which is that we go with another 25 basis points; and, as it turned out, the Board went for the 25 basis points. So the pause proposition had come up well before any bank failures. And in this discussion, well, I think you can read the minutes when they’re released.

But, I mean, I think an important — obviously, I’m not privy to the minutes, so I can …

You can speculate.

I can speak freely and nothing I say has any weight to it. But it is the point that expectations don’t move that fast. Now, it’s true that …

Well, they do.

Until they do. But the idea that realised inflation is …

But this is the case of a problem or the fixed exchange rate problem: all of these things are—so we have very recent dramatic examples that they don’t move until they do.

Yes, in currency markets, yes …

And yield curve markets.

And yield curve markets. Well, I’m sure …

That’s three years.

But I mean in the trade for goods and labour, no. In fact, it’s the opposite; things take a really, really long time to (inaudible) we’re going to get a lot of warning there.

I mean, the point really is: yes, it’s comforting to see that long-term inflationary expectations are anchored. But I tend to agree that it would be too late if you saw them shoot up, it’s almost too late.

Well, to the point, they stayed constant throughout the episode. So, if you thought, that’s the only thing to worry about, you would neither have relaxed monetary policy nor tightened monetary policy; you’d just sit there, which nobody is going to do.

So you are back to looking at — if you think we have an excess demand problem and we’re trying to wind it back, you end up looking for the signs that you’re seeing it come through in demand, the sorts of things that we’re looking at. And we’re also looking at, obviously, inflation itself.

Yes. And look, I mean, the Bank has moved — what was it — 375 basis points.

It’s 350.

It’s moved 350 basis points. That’s a big movement. I’ve been out on the record, saying that I don’t think 25 basis-points movements here or there actually do anything …

But they add up.

They add up. that’s exactly right. And I often get criticised, by people saying, ‘Oh, so you don’t think monetary policy has an effect at all?’ I didn’t say that. I just said it doesn’t really matter if we’re 25 here or a bit late or a bit later there. The reality is that it’s probably not going to matter. There are no people out in the street who it’s really going to make that much of a difference to. But it will add up and it will accumulate, and that has — so you’re asking is the point — well, I don’t know.

The only thing is that, once you pause, when do you go up?

But the history …

So they can do it.

It shows that that’s exactly what we can (inaudible).

That’s right. When the facts change, you change your mind.

Pausing is more common than not pausing.

Well, pausing in the past has been more common. This one where we’ve done it at every single meeting is actually the exception.

Let me come in here. It’s more the pause …

It’s almost like you’re looking for an algorithm. I think his line of reasoning is in want of an algorithm. It says, ‘Here are the inputs into our reaction function and they will spit out what we do,’ and I suspect that’s going to be really difficult to articulate.

I’ll put the point slightly differently. It’s more like a pause relative to other major central banks. So that’s, I think, like we’re seeing the dollar depreciate significantly and like we might …

Not significantly.

No, we haven’t seen it. It’s basically on a TWI …

On a TWI basis, it’s rock solid.

That’s more important; it’s rock solid.

Absolutely.

So, for whatever reason, the market path in Australia for official interest rates is lower than it is overseas. Now, partly that’s reflective of wages increasing more sharply overseas, particularly in places like the UK, New Zealand and the US, so it might partly be reflecting that. But that’s what we’re seeing in the markets and, as Ian said, they’re the people who are putting their money on it.

Well, I’m going to switch gears a little bit to go to institutional questions more broadly understood. We’ve already touched on, I think, the interactions between monetary and fiscal policy, so I’m going to kind of advance a thesis statement and invite people to comment on it. So I’m basically going to make the claim that monetary and fiscal policy can’t be thought of as being functionally independent, in the sense that the path of fiscal policy matters for monetary policy and the path of monetary policy matters for fiscal policy. We have an institutional setting where it’s very difficult to comment in what I’ll call a ‘mature way’ about the interactions between monetary and fiscal policy without creating a lot of noise. It seems somehow undesirable that we can’t talk in a kind of open way about the implications of the stance of monetary policy for fiscal policy, especially with issues of long-run fiscal policy; and we can’t talk about the implications of fiscal policy for monetary policy, especially with issues of short-run monetary policy. So are there things that could be done to allow that conversation to take place in a more constructive way; or do you disagree with the premise? I guess that you can just say, ‘I don’t agree.’

I’m not sure I agree entirely with the premise. The way I would think about it is that, over (inaudible), fiscal policy needs to basically — it needs to go into deficit when it’s needed for purposes of supporting the economy. Then we need to be able to make that back, so obviously it needs to move with the cycle. And it has a structural element to it, and the government has to figure out ways to pay for the services that they want to offer to all of us Australians, and that involves them making hard choices about taxes and debt and those sorts of things.

Monetary policy is much more a cyclical thing, so I see it much more as … it’s difficult if fiscal policy is working completely at odds with monetary policy. You saw that in the UK, when the government tried to expand fiscal policy markedly while the Bank of England was trying to fight inflation; the markets did not react very well to that. So there is a sense in which fiscal policy and monetary policy need to be pulling together, but I do think that one is much more structural and the other one is much more cyclical.

Having said that, there’s a strong cyclical element, given the automatic stabilisers in fiscal policy and, at the moment, those automatic stabilisers are working very much in sync with monetary tightening.

Yes, they are.

So the budget that the Treasurer will announce next month is likely to look a whole lot more in the black than people are expecting off the back of the result of cyclical tightening.

Let me just kind of push that. So, if the next budget is unexpectedly not as constrictive as currently expected — there is sort of surprise spending or surprise tax initiatives — then that is going to matter for the operations of monetary policy over the next year or the next …

To the extent it adds to demand in the economy and to the extent that we’ve got excess demand, then it does matter, yes.

And you won’t be able to say a single thing about it.

No, that’s not true. I think …

The Governor has often …

He has often talked about that.

Yes, to the extent of being criticised for making comments about …

Well, no, because then it was kind of construed in his much less direct terms; whereas it would be good if we had faster … I’m thinking back to 2018-2019, and it would be good if we had faster wage growth in the public sector and things like that, which you can construe as relating to fiscal policy, broadly speaking, but I think you wouldn’t narrowly (inaudible) the monetary-policy transmission mechanism and where we think wage growth comes — normal wage growth come from.

Anyway, I was going to say one more thing about that. The other structural element — and, as you’re aware, in comments that people have been making in advance of the Review of the Reserve Bank, that’s yet to be released —people have said that it’s a problem for us that the Treasury Secretary is a member of the Board of the Bank. And I would say that, even if the Treasury Secretary is there, that officer is not there to represent the government; that officer is there — in this case his – his own capacity as an economist. But that doesn’t mean that the Treasury Secretary can’t inform the Board about thinking with respect to fiscal policy and does. So right in the room there, with one vote of nine, is a person whose day job is setting or at least advising the government on how fiscal policy should be set and, if we have questions about how that might feed into the decision the Board is currently discussing, there’s the person right there.

I think everyone is very conscious of that. And, if you think back to when we were talking earlier about having inflation below target and the challenges of getting it up to target prior to the pandemic, one of the things that was going on at the same time as we were lowering interest rates was that the government …

JobKeeper.

was tightening fiscal policy as well, so it was working sort of a little bit against it.

I agree, and that’s the kind of episode that’s then guiding my question, where I feel like commentary about the extent to which fiscal policy was unnecessarily contractionary in that episode was quite muted, I would say, relative to the fundamentals. I mean, you might say, ‘Well, if you listened carefully to the right people in the right places, then you would hear it.’

But isn’t that the idea? At the end of the day, central banks can set interest rates independently of what’s happening with (inaudible).

So a fiscal instrument as opposed to policy.

Yes. Fiscal policy can issue nominal liabilities and raise real surpluses or run real deficits …

Yeah, like all independently of monetary policy.

… independently of what’s happening. The fact that there is an objective of the central bank that says, ‘You have to target inflation,’ and the reality is, whether we like it or not, that the outcome of inflation is a result of the combination of both what the fiscal authority and monetary authority do …

Are doing, yeah.

… that’s neither here nor there. The central bank can still comment on, ‘Well, we have to target inflation and, given the fiscal environment, this is what we’re going to do.’ And there’s nothing stopping the Treasury saying, ‘Well, given what the RBA is doing, this is what we’re going to do.’ It turns out that the Stackelberg game normally works the other way, with the fiscal authority moving first and the central bank reacting to it. I don’t think it’s legislated though, that it has to be that way.

No. But fiscal policy typically moves slightly slower than monetary policy.

That’s the other thing.

But also the rules of the game are different now. As you say, the RBA has a mandate while the fiscal authority doesn’t have it. They are more prone to this question about choices. But I think there is a need for improving the coordination. I’m glad to hear that there is this information going through. I’m not sure there should be a representative of the Treasury in the Board.

I’ve represented the Treasury.

I think that’s mixing things. But, at the minimum, there is needed to have that information going on. Together with (inaudible), he’s going to be presenting a paper tomorrow in which we see that the way central banks need to respond depends on what is their fiscal stance. But not only that; I think, to improve the coordination, we would need to have kind of some mandates also for fiscal policy to have some — we have the knowledge that fiscal and monetary policies are very different. Modellers agree that inflation is a bad thing, high inflation, all of us. But, if we start talking about what is the optimal size of the government, we might disagree very much. However, even if we disagree on that, we could agree on certain principles of efficiency or transparency and accountability, and all these things would help that coordination to work in a better way. Recently, Professor Eric Lippert from Virginia has been talking about the importance of transparency from fiscal policy. Like, we have been talking about forward guidance but also that kind of forward guidance to be also on the fiscal side so that that helps anchor expectations of fiscal policy, and that would help with your job and understand what is going to go (inaudible).

But there’s sort of a little bit of that, isn’t there, though, because when you do the budget, they do forecasts for it and they do …

Yes, at the forward estimates.

that in forward estimates and, yes, there are some assumptions in there and so on. But they do a little bit of that.

There’s more than there used to be.

Yes, so it’s moving that way.

I think we’ve had a good discussion and I cede the terrain, so to speak, but what I’m going to do now is throw the floor open to questions from the audience. We’ve got about half an hour left. So just put your hand up and we’ll take questions as they come to Kevin.

(inaudible) It’s probably a quarter of a century since I’ve really focused on monetary policy. But, reflecting on that, I think four words were very important or very common, and they’re related to this issue of the dates that things are going to happen, and there was ‘long and varied’ in there (inaudible).

Yes.

I wonder whether the thinking on that has changed. The second one was, Michele, you said we’re in the unknown. But, if I think back to the early 1970s (inaudible), do you think there’s anything by virtue of that that’s relevant now?

‘Long and variable lags’: yes, it’s a term that’s certainly back in fashion. And that’s another reason for pausing, basically. You know, we’ve done — in 10 months, 11 months, we’ve done 3.5 percentage points and so, yes, we’re waiting now to see how long it takes the lags to come through. One of the things that’s been interesting about this particular episode is that, as I said earlier, 40 per cent of people are on fixed rate mortgages, so it’s coming through slower into the cash flows of households than it has done in the past. So that’s another reason why the lags might be slightly longer and more variable than they might otherwise have been, so another reason for the pause.

The lesson I would take away from the earlier ‘70s episodes is that you cannot let inflationary expectations get out of control, and I think that’s all the more reason why — interest rates, actually, at 3½ per cent and the official cash rate, they’re still not that high relative to history. So I think we’ve just got to keep in mind that, yes, they’ve gone up quickly and, yes, some people are hurting, but it’s not the whole population; there are other things going on here as well. And I think we just have to keep in mind — the lesson for me at least is – inflationary expectations need to be kept under control. So we’ve got to keep an eye on the long term, but we’ve got to make sure that we are observing what’s going to bring aggregate demand back. So that’s, for me, the lesson.

Michele, can I add one that we can learn from the 70s?

Yes.

So we raised interest rates by a lot more in the ‘70s. It was very, very clear that …

Eventually.

Eventually. But we got to a point where real rates were undoubtedly positive at all horizons …

Okay, that’s true.

… but now we have to look up quite a long way to those inflation expectations to get a world of positive real rates. But I think we’ve got — I think there’s something positive to take from the ‘70s in the Australian context, which is that there was also a lot of fiscal coordination at that point. If you look at what happened ex post, in terms of fiscal policy, it’s that, over the coming decades after that, there was return to surplus, and in the United States as well. Now, here, what you were talking about earlier, we’re in a much better position than a lot of other countries, and I think that’s another argument for the pause. It’s that, when we think about what we’re going to see on the fiscal side, that played a big role in the ‘70s, and we’re more likely to see that playing a role, I think, in Australia than in other countries. So I think you might have an easier job then.

Yes. Just more on the 70s: we’ve been …

You remember them!

Yes, I do remember the ‘70s, Kevin, just like you.

I just read about it.

We’ve been criticised — the Governor’s been criticised in talking about the risk of a prices/wages outbreak and of thinking ‘in 1970s terms’. In other words, people referring to the fact that, back then, there was a much higher degree of unionisation, much greater centralisation of wages fixing and, therefore, the chances — well the during the 1970s, we had actual indexation, as you’ll recall, where literally wages were indexed to prices. So it is true that, when the ACTU, our union peak body, and others make the point that that’s all outdated thinking, it doesn’t mean that there won’t be a prices/wages spiral, but not for that reason. So we’ve learnt from that, I think, Kevin. Just to your point briefly there, Greg: of course, in the 1970s, the exchange rate wasn’t floating …

Yes.

… so we didn’t really have an independent monetary policy. That’s one way to get fiscal monetary coordination: you just don’t have an independent monetary policy.

That’s a fair point.

There are a few questions here.

(inaudible) In terms of (inaudible), talking in the post-pandemic—monetary policy in the post-pandemic — and thinking about the post-Global Financial Crisis as well — one thing that’s completely different from, say, raising interest rates in May 1998 and by 300 basis points now is the (inaudible). And in terms of the political and (inaudible) implication of raising interest rates now, you have in the Bank — you know, the Feds are holding huge amounts of unrealised losses on their books and the impact of the C-note has just been sent back to the fiscal authorities. At some point, it gets noticed and it’s going to have, at least in the US, an impact in terms of monetary policy going forward. But now you’ve got these huge expansions of the balance sheets. So thoughts about that: relative to sort of what we learnt about dealing with inflation and handling inflation in the 1990s versus now, the big difference is the balance sheet.

Well, the balance sheets are certainly different, but I can make the point in our case that the central bank’s balance sheet is mark to market. So we know exactly what the losses are and we know exactly how much we’re underwater with capital. And there was a discussion at the Board as to whether we should ask the government to recapitalise the Bank or whether we would just carry this loss —because, after all, it disappears into the public sector in the wider scheme of things —and work it off as the bonds mature. Because it is a mark-to-market loss, we will still lose, but the loss won’t be as great as we approach the maturity date for these different bonds, it will come good. And the result of that conversation between the Bank and the Government was that, no, we would just carry it; it will be announced in the annual report; people all know about it. I don’t think that that’s made any difference to the effectiveness that the Bank has in terms of its monetary policy; it’s public information. The reason that it’s occurred is completely understood. The alternative would have been, as has happened once before, for the Government to recapitalise the Bank and to realise the loss on its own balance sheet straight up, but nobody thought that would make any difference really. And, in respect of the seigniorage point that you make, the Treasury is well aware that the Bank will not be paying dividends for the next, what, five years is it? And so they already know and have built that into their estimates that they’ve got to find that additional money to keep their own accounts in order, because the Bank is not paying dividends for five years. So none of that is a secret.

I think we had a question here.

Hi, Ed Burton, from the University of Virginia, and thanks for the shout-out to my colleague, Eric Lippert. The Federal Reserve — I’m not that familiar with Australian banking or New Zealand banking — but the Federal Reserve system has been criticised quite a bit for its targeting policies. It was criticised for targeting rates, overnight rates, to be too low for a long period of time; and now there’s a huge chorus from many directions that they’ve stayed the course too long on targeting rates at higher levels. My question is — you always have to wonder what might have happened in the absence of some of these policies – and the question I’d like to ask is: if, on March 15, 2022, the Federal Reserve had said — I can just imagine Jay Powell coming out and saying — ‘We’re announcing today that we’re no longer going to target overnight rates; we’re going to let them just go wherever they want but without changing the planned reduction in the Federal Reserve balance sheet,’ what then might have happened? It strikes me as unlikely that rates would have stayed low, with inflation clipping along at about a six per cent pace; so how much different would the pattern of rates been, had the Fed simply abandoned rate targeting in March of 2022?

Can I just ask for clarification because I’m not sure that I fully understood: and did what instead?

Yes.

Continued the balance sheet reduction plan that they had announced in December; suppose they’d simply left that in place.

Let the bonds mature and they don’t buy any additional bonds back.

So they basically run down liquidity.

They just run down liquidity.

Exactly. They just left the balance sheet (inaudible).

Yes. I don’t really know the answer to that question, I have to say. I mean, we do know that, in the past, post GFC, when they ran down their balance sheet, it did get to a point where the markets did, in fact, tighten quite significantly in the Taper Tantrum, for example. So I guess my question back to you is whether or not that would just result in a lot more volatility, which would be unhelpful, rather than the more stable process of saying, ‘Well, we’re going to control the rate and we’ll move it up in a controlled fashion rather than just running down the balance sheet and having volatility in the rates, which might be unhelpful.’

(inaudible) have a paper (inaudible) on how to manage the balance sheet. One thing that we learn is that it is good to do these things slowly to keep the economy stable. I’m not sure about doing something quite different on — when you are in the middle of all those bad shocks happening in the economy. I’m not sure it’s that good to add more volatility into it; I would be concerned with that. One thing that is different nowadays compared to the ‘70s is that actually we have central bankers that know much better how to do the job — I need to say this — so, to throw everything out of the window, I wouldn’t do that in the middle of a crisis.

I think the rates were moved 11 times or 10 times in a row, so my question is about the credibility of the Reserve Bank. Yes, there was a message that, until 2024, rates would not go up, and people made investment decisions on that. Another question is about countries, and the central bank would recall bonds as well of the foreign currency, especially with the USD bond sales going down and now they are investing in gold and gold prices are shooting up. So, in future, if there is another way around where Reserve Bank wants people to spend money and they’re lowering interest rates, why would people trust that that will stay in the foreseeable future and really spend money rather than paying off their mortgages?

Well, I think — and we concluded this in our Review of Forward Guidance — that, actually, our credibility, we think, did in fact suffer through this process, so I think you’re right. But, if we were lowering rates in the future, I don’t think we’d be giving forward guidance in the same manner that we have given it in this emergency situation. So I think people would be responding based on their classic decisions about intertemporal substitution: do they want to save, do they want to — but we do know — one thing we do know is that Australians do like to save; they do like to sock money away into their offset and redraw accounts …

Even when rates are going up.

even when rates are going up, and they’re still doing is. So, yes, I think the credibility issue is a good point.

Given that we’re in a post-COVID world, I’m curious about the learnings from that event. So I think we faced a pretty unique situation, where there was uneven impact on certain job sectors versus not; and my understanding of monetary policy is that that’s relatively broad brush. And so, in the future now, in dealing with targeted interventions, do you have a better method of dealing with this, or are you coordinating with the Government better on fiscal policy, for example, or are there new methods still (inaudible)? I’m just curious: what’s been learnt in that situation?

Well, I’ll start and, Ian, you might have a view. I mean, we’ve discussed this before. We’ve got one — I mean, despite the fact that we’ve used these other policies, we’ve really got one instrument, and that’s the interest rate. And, yes, it’s blunt. That’s the other word that comes up a lot: ‘long and variable lags’; and interest rate use is ‘blunt’. It affects different people differently. And what we’re hearing a lot about now is the people that it’s squeezing, which are the people that have mortgages; that’s the one-third of the population. There’s two-thirds of the population that don’t have mortgages, and quite a few of them are seeing the interest rates rise on their deposit accounts. So there’s difference. So I guess I would say that heaven forbid that we ended up in a similar situation like this again. I think we’d probably — and this, again, was one of the findings out of the Review – we insured really heavily for the downside risk. We threw everything at it because we were really worried about the downside risk. Maybe, in retrospect, going forward, we might want to do a little bit more thinking about what if we’re wrong on the upside and how bad could it be. So I think that would probably be the main learning. But, in terms of the interest rate, it’s what we’ve got, it’s blunt.

Michele, my question is to either you or Ian on whether there is any nervousness around the housing market, which is rising, and there are some commentators who are calling the trough in the market. So what kind of inflation will follow through from the housing market? We are seeing rents rising as well and continuing to go up. And a follow-through on that is whether you’re putting hope over prudence in taking longer to bring down inflation.

I’ll have a go at half of that.

Do you want to have go at houses?

No, no; you go.

I’ll have a go at houses. So there’s actually so many bits in that question. So the established housing market: yes, it’s fallen quite a bit since its peak, but then people forget it went up 20 per cent in the pandemic.

It’s still above where it was.

It’s still above where it was …

pre-pandemic.

pre-pandemic; that’s right. Interestingly, initially it fell and then it rose very sharply. So it’s still above that and it has stabilised. One of the things we do know is that there are wealth effects. People do respond — consumption does respond when housing prices are — when housing prices are falling, it’s typically having an impact on the way people are thinking about their wealth and also their consumption. So, to the extent that it has stabilised, that might indicate that people have sort of stabilised at a lower level of consumption, but they’re not falling any further. So that might be one.

So we’re watching that because of the things that have been turning down. We talked about consumption and we talked about housing prices. The other thing in the established housing market, of course, is that there is quite a big pipeline to be run off from all of the stimulus that went into the housing market through fiscal programs and state government programs. But there’s actually quite a big cliff coming housing approvals and starts and so on, six to nine months out, are not looking very good at all. So there’s a few things in the established housing market. Some suggest that maybe things are stabilising; others are suggesting, no, they’re not.

The question about rents is a different one. Vacancy rates are really low; they’re at historically low levels in many places, and they’re below average in Sydney and Melbourne. We haven’t been building much high-density; all of the pandemic spending went into freestanding detached housing. The other thing that has happened is that household size has declined to historic lows. Through the pandemic, people didn’t want to share anymore; they wanted to have a spare office in the house. So there’s a few things going on there; and, on top of that, we’ve got immigration.

Immigration, exactly.

We’ve got strong immigration. So, yes, there is trouble brewing in rental accommodation, and that has implications for inflation because rental inflation is going to rise. So, if you put all those things together, I’m not sure what sort of pudding you get. But it’s complicated and it means that we have to continue to watch what’s going on in the housing market, because there are some things that are playing on the downside and there are other things that are actually going to be playing on the upside for inflation. So that’s where I’d say we’re at with that.

Yes, that’s right, yes.

Hi my name is Sydney Libby, I’m an undergraduate student at the University of Virginia, and I just want to thank you all for hosting this panel today; it’s been recently interesting to be a part of and listen to. So my question is regarding the long-term inflation expectations that you were talking about before and, admittedly, I’m only familiar with the history of inflation expectations in the US. And, looking at the empirical data, really only in one instance — I believe, 1981 — the inflation expectations predicted what inflation did. For basically the entire history of tracking inflation expectations, there has been really no correlation between inflation expectations being able to predict what happens with inflation. Really, it’s been, unsurprisingly, that expectations are trailing the actual inflation pattern. So, going back to your mention of the importance of looking at inflation expectations before, I would love it if you could just elaborate more on that and why that’s so important in your determinations of policy.

Well, for me, it feeds into what I think the markets are thinking is likely to happen and the impact of that. Now, the fact that they may well be wrong ex post is — I take your point, but what matters is their ex-ante expectations and what they’re thinking now is likely to happen and how that feeds into the decisions that they’re making about buying and selling securities, which feeds into prices and interest rates. That’s the relevance of that.

If the markets start to — if those expectations become unanchored, then people are going to start changing their behaviour about how they can demand and buy and sell securities, let alone what they buy and sell in the markets, and that changes the response that we have to make at a policy level. So it’s really giving you a window on what people who are putting money on the table — what their guesses are about the future. And your valid point is that their guesses — it may just be a random walk; it may just be like throwing a coin or tossing a coin or throwing a die, when you look back at it, true. But what matters for us making policy is what we think they think

what they think we’re going to do, right? So it’s a window on their expectations of what they think we’re going to do, as a policymaker, and what the impact of that’s likely to be over the long haul.

So what they think is going to happen in the future is always wrong; it never correlates (indistinct).

Yes. But the question is whether it’s systematically wrong.

Yes. This is on average.

So that would be a big problem. And, yes, I take your point; I think it’s a really good one. If it’s systematically the case that expectations undershoot or overshoot realised inflation, then you start to worry about if it’s just that they’re a mean zero …

We (inaudible) take that forward, so there’s no inflation. People don’t expect inflation and then, once inflation starts to increase, that’s when expectations — so they see what’s happening and then they expect more inflation.

Well, that’s okay. What I would worry about is if I could predict inflation on the basis of inflation expectations.

Yes.

If that were the case, we’d be in trouble; and, if that is the case, probably we’d have to start looking at other data. I don’t know whether or not it is. It’s still consistent that that’s not the case and they still follow; that’s possible as well.

There may be also many different forms of expectations of inflation. You just think about the standard (inaudible) model firms that are setting up prices and are going to be thinking about what is going to be the cost of the inputs that they need to buy to produce. That is going to affect how there are then going to be setting prices.

So feedback on behaviour.

It’s a good point.

I’m going to ask a typical Australian question. I’m from Monash University. So it is a common fact that both the economic condition of Australia and the physical policy were benefited by the commodity price boom during 2005 and during the pandemic crisis, and it’s likely that the commodity price will have to go down in the next one or two years and the Commonwealth Treasury is likely to have a fiscal consolidation. So my question is: will you worry that the current hike in interest rates will lead to a possible economic recession or a possible economic slowdown in Australia in the next two or three years; and how will the central bank respond to it?

Because of the commodity price cycle?

Well, I think the question was that the current commodity price cycle is supporting the fiscal position of the Government; is that your point?

Yes.

And, therefore, as that unwinds, then the fiscal position is going to basically wane and we’re going to end up sort of having — with the reverse of the boom from the commodity price, we’ll end up with a recession from the commodity price.

So monetary policy would have to be recalibrated.

Monetary policy would have to be recalibrated. The other thing that happens is the exchange rate can move and—

And you get a natural hedge.

It does tend to — at the moment, commodity prices have risen, but our models suggest that the exchange rate is where it probably should be. In terms of commodity prices and interest differentials, it probably looks about right. But the other thing that could happen is that the exchange rate could fall if you ended up in that position.

Thank you very much. I’m from the University of Technology Sydney. My question is similar to the one that Chris asked to all of you, and it’s about the trade-off. Do you see any trade-off between the macro prudential policy and the expansion and contraction of different lending charges, in Australia particularly?

‘Trade-off’. I’m not sure I’d use the word ‘trade-off’ for macro prudential policy. The rise of macro prudential policy, I think, has been quite interesting over the last decade or so. It’s always been used quite extensively in more developing countries to try and sort of control where lending is going and lending standards and so on. It’s really only, I would say, over the last five years grown much traction in Australia. APRA started to dabble in this about five years ago. They’ve more recently sort of also added a very explicit one now; they’re going to have a countercyclical capital buffer, so they’re going to build it in now rather than just relying on lending standards.

But to your point, we talked earlier about the trade-offs between interest — well, interest rates and their potential impact on financial stability, and this is one way in which APRA has, in the last little while, tried to address some of those financial stability concerns. So we talked about pre-pandemic when inflation was low, we were trying to lower interest rates a bit further; we were trying to be a bit prudent. The other thing that was happening was APRA was trying to crack down a little bit on lending standards. So they were, in fact, moving into interest-only lending, for example, and saying, ‘Well, we’ll put limits on that.’ Higher LVR lending is another thing; in recent times, they focused on high debt-to-income ratio lending. So there is an increasing push in this. And I think you’ll see more of this from APRA because they’ve got a framework now that they’re working on, and that’s not done independently of the Bank.

Ian mentioned earlier the Council of Financial Regulators. In considering what role macro prudential policy might play in thinking about financial stability concerns, it gets discussed with the Bank and it gets discussed in the Council of Financial Regulators. So I wouldn’t say it’s a trade-off; I’d say it’s a part of the package of things that we’ve got available to manage the economy, and it’s getting more legs.

I think we’ve got time for one more question. I’m aware that there’s someone there.

There’s someone over here? Okay. Right, we’ll have two very quick questions.

I agree with you; we definitely should end on time.

This is a very quick question. I’m from Uni SA. My question is about productivity. So there was a lot of talk previously about how, you know, the real wage is not increasing, whereas the nominal wage is increasing, and then whether the level of productivity is actually increasing in that place or not. So what are your thoughts about that one, in the context of the Australian situation post-pandemic times?

Well, Greg, I think — well, I could say that we’re not happy with it. That’s what I would say.

Well, look, there’s two ways to bring inflation down. Either you can lower the price of goods in terms of money, or you can raise the price of money in terms of goods; and higher productivity would be the best way out of this for everyone. So then we don’t have to do anything and so that would be great.

That’s right. There’s a thousand pages worth of proposals on the government’s, on the Treasury’s desk.

Yes, exactly; at least.

And over here.

I’ve got a very high, particular question. I’m not a finance student. I was just listening to Michele about rent and talking about going down to an interest rate of 0.1 per cent. What stopped you from going to a negative interest rate?

Well, I actually wasn’t on the Board at the time, and Ian might …

I can give—

So that’s my out.

… you an answer to that.

But I would say — and correct me if I’m wrong, Ian — that it was considered by the Board quite extensively, but it was felt that it wouldn’t give you much. And, observing what had happened with negative interest rates in a number of European countries particularly, overseas, it potentially introduced some quite damaging impacts. So I think the feeling was that the Board decided that, really, it wasn’t a path we wanted to necessarily go down. It was not ruled out completely; but it was really not a path we wanted to go down, given other experiences.

Yes, a fair summary. Remember that the rate of interests on currency is zero, and the last thing we wanted was for people to run in favour of currency and out of the banking system. The banks, similarly, wouldn’t or at least have shown great reluctance to offer negative interest rates on deposits and so, as interest rates go down and down, it narrowed bank margins. If you talk about your trade-off with financial stability, the last thing you want is for monetary policy running interest rates at such low levels that you start to compromise the income to the banks.

Okay. Income to the banks is a good place to stop.

I want to thank everybody for coming. Also, please join me in thanking our esteemed panel of experts for sharing their wisdom with us today.

Applause—