Transcript of Question & Answer Session Monetary Policy in Australia: Complementarities and Trade-offs

I’m just going to start Governor, with a question about the global perspective. I think for Phil Lowe, your predecessor, it really was a massive global development that kind of defined his term and the reaction to that, so of course the pandemic, and then we had the surge in inflation everyone is dealing with. So as you’ve started your term we’ve got another big global development, or multiple, so unfortunately geopolitical developments and now two hot wars – one in Europe and one in the Middle East – and of course ongoing impact of climate change. I’m just thinking how do those global developments, the big changes, how are they considered at the Bank by the Board and by yourself and what’s the reaction function that we might expect to those types of events?

Yes, we’ve had – I think I said in another context shock after shock after shock here at the moment. The pandemic shock obviously was of one type, a particular supply shock, particularly impacted supply chains. The Russian invasion of Ukraine – a very big energy price shock, massive implications particularly for Europe. Australia was to some extent isolated a bit, but we’re starting to see impacts of that come through now. The current circumstance with the Israel-Gaza situation also potentially has energy price issues – We did see the price of oil rise a bit on that circumstance – but I think the main issue we’ve got now is this great deal of uncertainty about what next, and it’s not just about energy prices. It’s another symptom of the fragmentation that’s going on around the world. One of the things that’s been happening over recent years in contrast to, perhaps, the decade before was that we are seeing much more countries thinking much more about the security of their supply chains. It used to always be about where do we go to get the cheapest supplies, cheapest goods, cheapest labour, now we’re thinking about, ‘well, maybe there needs to be some sort of security of supply for some of our industries here’. So, we’re starting to see things like that happen and that ultimately isn’t positive for a country like Australia which has done a lot in terms of being an open economy and open to trade. So, I think just the uncertainty of what’s going to happen with this current conflict – Does it spread? What are the implications for the world trading system in those circumstances? Are there implications for oil prices again? And remember that we’re in a period of high inflation already. So one more supply shock on top of that doesn’t help. So, I think in terms of reaction function for monetary policy, I don’t think there is a firm reaction function for monetary policy. I think we’re dealing in just very uncertain times, even more uncertain that usual, and it’s going to be really important to be watching the data and what’s happening overseas even more so.

Certainly plenty to keep your eye on. So domestically, as Andrew mentioned in the introduction, we’ve got inflation numbers tomorrow, so the market is hanging off that number. We’re seeing some deceleration in the inflation rate, but clearly remains too high. So, when thinking about monetary policy and the response of the economy to monetary policy, is there anything particular that you’re looking at or what you’re gauging through? As you know, at CommBank we recently released what we call the household spending insights report, which is spending right across the economy through the Commonwealth Bank network, but how do you judge what impact interest rates are having, how you are through the process over and above what the CPI might print out tomorrow?

I think there’s contrasting forces happening here. On the one hand household balance sheets on average, in aggregate, are actually pretty solid. They’ve still got lots of savings and they’re still saving. The savings rate in Australia is still positive. So, they’ve got lots of buffers, lots of saving. We are seeing housing prices rising again, so wealth is rising again, so household balance sheets in that respect are solid. Again, I want to qualify it by saying that I know that there are differences of experience here, that there are some people doing it much more tougher than others, but monetary policy is an aggregate demand sort of concept rather than individuals. We know it impacts people very differently. So, you’ve got that happening.

On the other hand, real household disposable incomes have taken a big hit and they’ve taken a big hit in three ways. One is interest rates for those that are in debt, but the bigger hit is from inflation and that’s hit everyone. So, we’ve observed that real household disposable income has declined and two of the big reasons are inflation and the other reason in fact is tax has gone up, which you would know, and that’s a product of lots more people being employed so there’s lots more tax being collected obviously from incomes and also a product of the progressive and non-indexed tax system. So, on the other hand then, you’ve got balance sheets look good, household disposable income looks very weak and we are seeing that consumption is slowing. We are seeing discretionary spending slowing and you might be seeing this in your insights data.

We are for sure.

I know that a lot of people talk about the fact that per capita consumption is declining. Aggregate consumption is still at a reasonable level, but population is keeping that up, but per capita, people are spending less. So those are indications to us that spending is slowing, that demand is slowing and it’s not just interest rates that are doing that, it’s also inflation which is doing that. And that suggests to us that monetary policy is having an impact. We are seeing inflation slow. We’ll wait and see what happens tomorrow, but we have been seeing it come down, we have been seeing demand come down and that’s all positive. Having said that, again, these savings buffers, they’re sitting there. Do people use them to support their consumption or not? That’s one uncertainty. I mentioned housing prices again – housing prices are on the rise again and we know from history that rising housing prices tend to result in high consumption, so there’s that as well which is impacting things. So it is a balancing act and they’re the sorts of things we’ll be looking at, the inflation numbers obviously and our new set of forecasts.

Big agenda for November.

Big agenda for November indeed, yes.

Fascinating speech, thank you very much Governor and it’s really good the speeches talk about the framework and how the current situation relates to that. I guess what I heard to some degree was that the inflation target is a fairly hard and fast number and the full employment target is perhaps a little bit more fungible and what relates to that inflation number. So is that correct in terms of the current lay of the land and when we’re thinking about a CPI tomorrow and the outlook? Is that the thing that really is exercising your mind the most at the moment given everything you spoke about is it.

I wouldn’t call it – I mean it’s hard and fast in one sense in that it’s 2–3 [per cent] on average over time, but one of the advantages of our particular inflation target, I think, is that it is flexible which means that if we’re out of target on either, above 3 or below 2, we can allow ourselves time to get back into target. And that’s one of the advantages of our framework, I think. It means that if we think we can bring it down a bit slower, and that’s what we’re trying to do. We could, as I said in the speech, we could actually raise interest rates very sharply and you’d be guaranteed inflation would come down sharply but you might do some damage on the way. So the advantage of our inflation target is that it is flexible, it allows us time if we think we need it, but we still have to be mindful that we don’t want to be out of the target too long.

The point in the current juncture, of course, is that we’re dealing with a situation where initially it was big supply shocks coupled with … and if we think back early on when the inflation issue started, there was a lot of discussion about the transitory nature of inflation. It’s a supply shock, it will wash through, and it soon became evident that it wasn’t washing through. We are observing the transitory components come off ­– so a lot of the energy prices, the goods prices that were caught up in supply chains – those things are all coming off but what we’re observing now, not only here but also overseas, is that services price inflation is elevated. So we’ve observed a situation where businesses and particularly workers have observed that inflation has gone up, and they are now putting up their prices or putting up their wages demands to meet those slightly higher expectations. Now the thing at the moment is we think inflation expectations are still reasonably well anchored, but the longer you remain out of that band the more likely it is you’ll become unanchored. So I hope that sort of answers the question.

Thank you for your speech, Governor. You raise the issue around NAIRU in your speech and you made some recent comments about sustainable balance in terms of employment and the employment market. You also issued …

It’s always good to have a plan B. Okay. So you raised some comments about NAIRU in your speech and thank you for that. You’ve previously made some comments about the employment market being in sustainable balance, however I just wonder if you’re thinking around a number, an absolute number around that, is probably more granular now rather than what it was previously.

You’re asking me what I think the NAIRU is? I’m a little reluctant to talk about it in that sense because every time I do people think I’m targeting it, which I want to make absolutely clear we don’t target a number for NAIRU and we don’t target an unemployment rate. Some previous comments I’ve made have been interpreted that way. We don’t target anything. What we are aiming to do is bring inflation back down while continuing to keep employment growing. If employment grows a little more slowly than the population, the workforce, then that might mean that the unemployment rate drifts up, but that’s not something we’re targeting. So I’m reluctant to give you a number for the NAIRU because the bands around it are so big and if you’d said a few years ago, that we could get unemployment down to 3½ percent and we’ve got some inflation but there’s a lot of supply driven within that, I don’t think anyone would have believed us. So I think we need to be quite open mind about what the level of the NAIRU might be.

I was really interested if you had any observations or compare and contrast the approach that’s been taken in Australia compared to New Zealand. You may be aware the Reserve Bank of New Zealand has the OCR at 5.5 per cent. If you have any observations on that.

Well, I think, I mean they did move early and they did move fast and I think they had certainly a higher inflation rate than we did. I think that we have taken … I think we have taken a more cautious approach. I think the Reserve Bank of New Zealand, in fact, even suggested that they would need to have a recession to get inflation back down. We’ve always been conscious that we wanted to try and avoid that if we possibly could and that’s sort of informed our approach. So, I think a slightly different approach, but also I think quite different circumstances in terms of their inflation and ours.

The statistics said that New Zealand had a recession and then it got revised away.

So they haven’t had one, that’s right.

I just have a question about the CPI report tomorrow. Apparently the trimmed-mean measure of CPI is forecast to rise 1.1 per cent in the third quarter and that’s above your expectations in August. Do you think that’s enough to justify a hike in November?

Do you want me to answer?

I’ll say what I said when someone asked me a similar question the other week, which was I really hope you’re not asking me for forward guidance.

Less than 24 hours.

I’m not going to comment on it like that. What I will say is that since we last did our forecast there’s been a number of things that have happened in different directions. You’ve had fuel prices increase more than was sort of expected, at the same time we’ve had energy prices not increase by much as expected, market services may be up a bit so there’s ups and downs. So, I won’t give you a forecast and I certainly won’t give any forward guidance.

You just said that you don’t want to give forward guidance, but you assess, given your speech, that we are behind the curve in Australia and when will you catch it because you don’t want to get ahead of it. The inflation is it’s still high.

You’re saying we’re behind the curve. In what sense are we behind the curve?

Well, inflation is not coming down as fast as you wish. You say you don’t want to kill the economy, I understand that, but you … I mean the RBA has been saying that you have a very low tolerance to inflation. So when it keeps high at that level, at some point the trend will come to an end.

Our current forecasts have inflation coming back into the top of the band in 2025. So, yes, it is a reasonable tolerance but we don’t have a lot of tolerance for it to shift out. That’s sort of at the end of our tolerance, I think. So I wouldn’t say we’re behind the curve. I’d say we’ve been a bit more cautious. And just remember too that in Australia we’ve got variable rate mortgages that have hit households much harder than they’ve hit many other countries. In the United States with 30-year mortgages their consumers have not been impacted by increase.

(inaudible)

Sorry?

(inaudible)

Yes, but what happens in those circumstances is that turnover falls in the housing market because people don’t want to give up their very low rate mortgages and get new mortgages so there’s a whole lot of things that happen in response to that. We’ve got variable rate mortgages, more fixed rate than we did in the past but they were very short, quite short terms. So we have a much more direct and quick impact on mortgage holders’ finances than many other countries do. So I think that’s one reason why we need to be a bit more cautious than some others. And I wouldn’t say we were behind the curve either. I think you would find that our inflation took off later and therefore our interest rates started to rise a little bit later. We sort of opened up from the pandemic a bit later and it took a little time for inflation to pick up here. So if you sort of looked at where we started raising interest rates relative to when inflation really started to take off I don’t think we’re that far behind the curve.

You’ve spoken about full employment incorporating a lot of judgment and that it’s not necessarily measured by a single figure. I’m just wondering if you could please share what trends you see that are influencing that figure or set of metrics, and what surprised you the most as well in relation to that.

Sorry, I sort of missed your question because I was trying to see where you were.

Sorry. I’ll stand up. I’m only little when I stand though too.

That’s alright.

You’re in good company. It’s all good.

You’re in very good company here. Sorry.

I’m just really interested to hear how you consider full employment. You mentioned that it’s not one single metric and that there’s a lot that goes into that and what particular trends or metrics you’ve seen. We’ve heard today from speakers earlier about underemployment and how that’s also shifted, so I’m just really interested to see how you think about that.

There’s quite a few things that we look at. I guess our assessment at the moment is that the labour market still remains quite tight but it’s not as tight as it was. Things are easing and there’s a few indicators of that. Some of the things we would look at in that context are vacancies, job vacancies, which have come off quite a bit. Turnover. In terms of the employment statistics we certainly look at things like youth unemployment [and] medium-term unemployment, which are things that often turn a bit quicker. We look at hours worked, so that’s often a margin and I think we’re seeing that now, you’re seeing that hours work is coming off a bit, so that’s another margin of adjustment. So these are all things that, in addition to the unemployment rate, give you a bit of a feel for how the market is working through. And I think all of those things at the moment you’re seeing a rise in the underemployment rate, so people would like more hours or they’d like another part-time job, they’re not getting them, vacancies are down, youth unemployment is up a bit. It’s still much lower than it’s been, but it’s starting to rise. Medium-term unemployment is rising as well. So all of these things suggest that the unemployment rate just sitting there, there’s things adjusting around it and that’s, I think, a sign that the market is adjusting.

I might actually sneak one more question in and I think we’ve got one more from the audience. You mentioned briefly about the RBA Review. We’ve got quite a few international guests with us today so maybe just an opportunity to quickly summarise how, if you like, the mechanics are going to change next year, the move to eight meetings per year, Board meetings will take two days rather than one day, a new Board needs to be constituted. Maybe just a quick analysis of that.

Just very quickly. So we are moving to eight meetings a year from our February meeting. We’ve published the dates on our website for those. They will now start on the afternoon of the Monday and they will conclude at lunchtime on the Tuesday, so we’ll have effectively a full day. And the sort of material obviously in those circumstances we’ll be reporting to the Board is going to be a bit different. I think we’re going to be looking at much more scenario analysis, options, strategy – these are all sorts of things that the review suggested we be doing and certainly we are moving in that direction. Having said that, it’s going to be a ‘suck it and see’. We’re going to make some changes and we’re going to see how it goes, but yes we’re definitely moving in that direction, and I should add a press conference after each meeting is the other thing that will happen.

Just following up on Stephen’s question, actually, in terms of the recommendations for the Reserve Bank Review and changing the culture of the Bank. You mentioned before making the dual mandate more explicit, but what other recommendations are you working on right at this moment?

There’s a variety of things. The government obviously is working on things to do with the legislation and Statement on the Conduct of Monetary Policy. We don’t control that. The things we control are the things I’ve already mentioned in terms of meetings, press conferences. We’re thinking about the structure of the bank. You might recall there were some recommendations around appointing a Chief Operating Officer and a Chief Communications Officer, so we’re working on those recommendations. We’re working on the issues surrounding the monetary policy processes that the Review talked about, so more on strategy, how do we think about integrating research more into the monetary policy processes. - So we’re working on that as well. And the other piece that we’re working on is the culture piece. So you might recall there was a piece in the Review that talked about culture and people feeling comfortable to challenge and debate and have different views. We’re actually embarking on a big piece of work on that as well. So they’re the main things that we’re focusing on at the moment.