Transcript of Question & Answer Session Inflation, Productivity and the Future of Money

Good morning, Daniel Ziffer ABC News. Good Morning, Dr Lowe. The government's review is wide-ranging, it's almost every aspect of the bank. How can that not be an implicit criticism of essentially everything that is going on under your leadership, Sir?

I don't view it in those terms at all. I think it's an entirely appropriate thing to do, to take stock of our monetary policy arrangements, I view this as a health check. We've been through a very difficult period. We've had to have unconventional monetary policy, and we're now going through a period of high inflation. So I think it's entirely appropriate for the government to take stock of Australia's monetary policy framework. It's something that we welcome. Other central banks have periodically reviewed their frameworks, we've done it internally, continuously. But I think it's useful to do that in the public domain as well, so we very much welcome it.

Another question over here, yes?

Hi, Hannah Wootton Australian Financial Review. A lot of what you've said in your speech today is predicated on sticking to that two to three per cent range, and that's something that this review says it's going to consider. What will you do if, in six months, you get this finding that says that actually needs revision or scrapping altogether?

We would respond to the results of the review as they come in. I'd observe that, in most other countries that have under-reviewed their inflation targeting arrangement, they've come to the conclusion that a flexible inflation target centred somewhere around the two per cent mark is the best we can do. I don't want to prejudge the conclusions of the review, but I think that general conclusion that flexible medium-term inflation target is the right monetary policy framework, I think it's a pretty robust conclusion. If the review panel come to a different conclusion, we have to assess that and discuss it with the government at the time. But my view is that flexible inflation targeting, while it has some limitations, is the best monetary-policy set of arrangements for Australia, and we'll look at how best to implement flexible medium-term inflation targeting, and it really will help us do that.

Any questions from guests on the floor? I haven't seen any hands up on this side. There's one over here at the back. Yes, Sir. Perhaps we can get someone to you. Andrea is coming right now.

Can you comment on the need to moderate demand when household savings is above normal now? That would suggest almost the opposite, that there's a precautionary stance by households that are running the savings rate above normal. And secondly, can you comment on why the Fed and the Reserve Bank are trying to normalise rates and do quantitative tightening at the same time? It would seem that the market disruption from quantitative tightening might defeat the purpose of trying to normalise rates of interest. Thank you.

I don't see quantitative tightening as problematic in any way and I don't think it's affecting financial markets. The path ahead has been pretty well laid out by both us and the Federal Reserve. Markets have adjusted to that, and I don't think it's a major consideration at the moment. The focus rightly now is very much on higher interest rates and how high interest rates need to go to bring inflation back to target. To answer the first question … You said, households are saving quite a lot at the moment. I think there is still a degree of cautiousness out there. We've been through some very large shocks over the past couple of years, as we know, and so people are still a bit cautious and they're facing the prospect of higher interest rates still. Even though they're cautious, household spending is still pretty strong. The high-frequency data we track at the moment, even though consumer confidence has come back a bit, suggests spending right at the moment is strong, and the fact that people are getting jobs really helps. The best way for people to have confidence about their future is to have a job and be confident there will be a job tomorrow. And the labour market is an incredibly positive story. We've wanted to get back to full employment for decades. We've struggled to do that, we're now pretty close, maybe even we've gone past the point of full employment. But the fact that people have jobs is a very positive thing for our society. I know it makes it hard for firms to recruit workers but, for the societies a large, people having jobs is a wonderful thing and it gives people confidence to keep spending. And our task now is to bring inflation back to target while keeping the labour market reasonably firmer. As I said in my prepared remarks, I think there is a path that we can do that, but it's a pretty narrow path, we're hoping to tread it carefully.

Okay. Looking around for more hands up from the floor. One over here. Thank you, Sir.

Dr Lowe, in regard to Australians' higher level of savings, which are cushioning the effect of interest rate rises at the moment, given the RBA is guided by data which may have a lag to it, at what point does the RBA consider a pause in the increase in interest rates to allow that data to filter through to see the effect on the economy before continuing?

Well, the key consideration in the outlook for interest rates is: how confident are we that inflation will come back to two to three per cent over time? So that's what we'll be focusing on. But we'll get a reading on inflation next week that will be important, and beyond that, we'll have to look at trends in spending and the inflation dynamics both in the global economy and the Australian economy. So I think, in the next little while, we're going to need to have further increases in interest rates. A cash rate of 1.35 per cent in an economy with inflation that's soon to be six and perhaps seven per cent and an unemployment rate of 3½ per cent. You know, we need higher interest rates. That level of interest rate is too low, and we're going through a process now of steadily increasing interest rates, and there's more of that to come. We've got to move away from these very low levels of interest rates we had during the emergency. We took out a lot of insurance, we have to remove the insurance, and there's more work for us to do there, and we'll be guided by the outlook for inflation.

I've got a question over here.

Dr Lowe, I'm thinking back to the 1980s, when interest rates reached 17 per cent, and I think commercial rates were around 23 per cent in the early eighties as well. Now we've got a generation or several generations who have never experienced that climate. Even at five per cent, that would be a shockwave, I guess, for rates and the economy. Can you just comment on how you see that sort of landscape playing out this year and into 2023?

As I said in response to the previous question, we've got more interest rate increases to come. I think 2½ per cent is our rough estimate or at least 2½ per cent of the neutral rate, so at some point I imagine rates will get to at least that level. How quickly we need to get there and, indeed, whether we need to get there will be determined by the inflation outlook. It is coming as a shock, as you say, to many people, and parts of the community are having to restrain their spending, that's unambiguously the case. We need some slowing in growth in aggregate demand. The current growth in aggregate demand is putting pressure on the capacity of the economy. I presume many of you in this room have stories about how hard it is to get workers. You're running up against capacity in the construction sector and in the food production system as well. So we need some moderation in aggregate demand and higher interest rates, even though many people don't like that, it's part of the way we do that. Let's just think of the alternative. If we don't have higher interest rates, then we're going to have higher inflation persist. Eventually, that will have to be addressed and we know from history how that's addressed. It's addressed through much higher interest rates, not as high as the 17 per cent you were talking about, but much higher interest rates and a sharp slowing in the economy. So the mindset we have is one of steady increases in interest rates now to forestall a persistent shift in inflation and inflation expectations. And, by doing that, we can have a lower peak in interest rates and, hopefully, avoid the need for a sharp slowing in expenditure. It's better to have a modest slowing in expenditure at a time of full employment than a sharp slowing later on when inflation is much higher.

We've probably got time for, I think, one more question. Anyone else? A hand up over here? Yes, Sir. Someone is come to you right now, one second.

Thank you, Dr Lowe. Looking at the medium term, you were saying that you were looking at an inflation rate of two to three per cent on average. Seeing that we're looking at 10 per cent in many countries, and probably Australia is going to see a similar increase in inflation, would part of that average be dictated because of, in the next year or two, a short recession that would create deflationary pressure and lead to the RBA having difficulties maintaining the mandate of full employment?

You're right, inflation is high now. But it's more than plausible that it's going to come down globally in the next little while because, as I showed in some of those graphs, commodity prices are no longer rising, in fact, they're coming down. And remember, inflation is the rate of change of prices, it's not the level of prices. So, even if commodity prices stayed high, the rate of inflation in those commodity prices goes from very high to low. And if prices are coming down, obviously we're going to get negative price impacts. So we'll see some moderation in inflation pressures because of what's going on on the supply side now in the global economy. The critical issue that we're focusing on and other central banks are focusing on, is what's going on with inflation expectations. Because, if this period of high inflation feeds through into the expectation that people expect it to continue, then they'll adjust their price- and wage-setting behaviour and it will continue. And, if it continues, that will have to be met with higher interest rates and a sharper slowing in spending. So the critical issue that all central banks are focused on and I was in Bali at the weekend, with the Treasurer, talking to my colleagues, and this is the key issue: to keep inflation expectations anchored. If that doesn't happen, then we're going to have trouble returning inflation to two to three per cent over any reasonable horizon.

So …

Sorry. You were just saying, financial markets at the moment? You know, inflation will come down. And I think the message to the community from the Reserve Bank and from other central banks is: be confident that it will come down. We're going to do what's necessary to make sure that that happens.

One very quick question left, if there's any hand left up. Yes, just over here, thank you, and that will be the last question.

I was wondering, you mentioned productivity as well and I just wanted to ask if you have any recommendations. I know it's not directly the mandate of central banks, but if you have any recommendations for increasing productivity, I'd be interested to hear.

As you say, it's not our responsibility, so I don't want to kind of advocate any specific policy, because there are lots of good ideas and the challenge is one of implementation. But, when people look at what we should be doing, the areas that they focus on I think are well known to you all, taxation, the balance we have in between taxing land, income, consumption, pollution. I think most people look at Australia's taxation system and say we haven't got the optimal balance there. There are issues in regulation of the labour market, energy production and distribution, and I think we're going to talk about that later today. The way that government delivers services, particularly in the health sector, the way as a society we invest in human capital and the development of skills, particularly IT-related skills, the way we price and build infrastructure, the nature of our competition policy and the way we design and manage our cities. So they're the areas where they're a lot of good ideas, and I don't want to advocate any specific idea in each of those areas, because it's also contested. But there are a lot of things we can do here. It's a matter of choosing which ones we do and finding the political ability to do it so that we can do that, because there are lots of good opportunities here.

And let's look forward to those.

Everyone, please thank Dr Philip Lowe.

Thank you.

Thank you for your time, and thank you so much for taking the time to take so many questions from the floor as well.