Transcript of Question & Answer Session The Financial System and Monetary Policy in Australia

Thank you very much, Chris, for a sweeping overview of the Australian financial system and monitoring policy. One of the wonderful aspects of these events, of course, is that you get a chance to ask questions of people that you perhaps in different circumstances wouldn’t be able to. So we’ll have about 20 minutes for Q&A. If you can just briefly identify yourself and then ask a short and succinct question and hopefully we will get through as many as possible. For those of you who are wondering, my name is Timo Henckel. I am also a Faculty member of the Research School of Economics here and a colleague of … I know Bob is also going to ask a question so he is my fallback option if it remains quiet for too long. Robbie, would you like to ask a question?

Thanks, Chris. So in my understanding there is - you’ve got Australian, Norway. You’ve got a dominant transmission mechanism that goes through households. Households and … know that, I would suggest that households who are making decisions based on … if they’re making decisions based on … likely don’t even know that every first Tuesday of most months you say grace and they’re not going to be - I wouldn’t think that they’re going to have an Alex … or somebody like that telling them ration … this. Does that influence the way we would think would be an optimal RBA Board, given it’s households that are in first order affected? Does that influence, in your mind, the way we think? Would the RBA Board then so fully … representative, something that would provide confidence to households, rather than macro economists? We’re basically looking at - for actions, functions and trying to figure out what type of guidance would transmit the best - the most accurate action or function?

Yes. Quite a bit in there, Robbie. I mean, even the US they know even less about the Feds decisions. When our decisions happen, especially nowadays, the Governor gets up in front of a pack of media. She usually is on all the commercial stations, on radio, in the press, of course everyone doesn’t - that’s not the only way people get their news. In the US that just doesn’t happen. I think there still is a really important role, and most of forward guidance probably is focusing, not on the individuals in the economy who aren’t necessarily that well informed about these things or they have a temporary attention to them but markets. That they translate them into what’s the rate on the term deposit at a bank for two or three years or six months or whatever it may be. What’s the rate on a bond for corporate or long-term - a government bond that someone who has money might buy one flows. What are the sticker rates for a household that’s about to go and borrow a variable rate versus, say, a one, two or three-year fixed term loan in Australia. So I think it is really important to recognise, I think as you suggest, there’s a limitation in how much the general populous are going to absorb from this, which is one argument why the central bank doesn’t need to necessarily speak to them and what my former colleague Guyger Bell said, speak to the markets, not necessarily through formal guidance but by having a clear and well understood reaction function and then the markets can do that interpretation that’s quite important.

So we’re keeping order, so far over there, over there and then we’ll get -

If I keep my answers long enough, Bob will have to ask me one of his really hard questions on the side. Don’t worry, Bob, we’ll get to you. Yes.

You were … in your talk that essentially the effect size of … is the same across Australia and the US, despite the very different composition of our mortgage markets. If Australia were to adopt a secondary mortgage market which is normally, as I understand it, given that’s the reason why the US has such a hard share of fixed rate mortgages, so if Australia were to introduce about equivalent of a … do you think that would have an impact on the effect of our cash flow monetary policy or do you think it would simply change the way the transmission …

Yeah. Well, again, I think the results, and I call them out and there are others who have studied using our own model, sort of trying to weigh up the contributions of these different transmission channels overall. Even though I like other Australians focused a lot on the cash flow channel in my talk this evening, it’s actually one of the smaller contributors to the overall transmission. So if we’re changing that bit, it might not make much difference. I’m not convinced it’s all about Fanny and Freddy in the US. I think partly they’ve come about for various reasons but the US - one reason why really long fixed rate mortgages are very attractive in the US, apart from it protects households from interest rates but remember they have to pay a margin. Someone has to cover that interest rate risk on the other side. So it’s not free, sort of, insurance for that mortgage holder. But one of the reasons is because of the tax system. Your own home mortgage is tax deductible in the US. So you don’t want to pay-off fast. Right. So a fixed rate suits that. It’s not true in Australia. Your own mortgage is not tax deductible so you do want to pay that off quite quickly and that’s why we have these offset and redraw accounts. That’s why people, if they fix, they tend not to fix them for too long because they like to be able to pay that down and there is some way of self-insuring against interest rate risk. Right. If you do that over a long period of time and you get ahead of the mortgage after a couple of years many households are able to do that. You can absorb a lot of the interest rate risk and you don’t have to pay someone else to do it for you.

We’ve got another question over here.

Is there a disproportionate effect of tightening monetary policy on those of lower income? And if there is, how do we balance the wider objective of our inflation target with the needs of lower income people?

Yeah. It’s a good question and it’s been looked at, you know, over a period of time. I guess the first thing is, I would emphasise when you’re sort of thinking about the burden of higher interest rates directly, I’m not sure that lower income people pay that because the lowest of the low income households typically don’t have - not only do they not have a mortgage, they don’t even get qualified for a credit card perhaps. The lowest of the low income households. The other thing we know is that lower income households find it much more difficult to protect themselves against inflation for various reasons, partly because of the assets they hold. If they don’t hold housing or they don’t have equities they suffer quite a bit there. So I think that’s one thing. And then, you know, I think monetary policy is quite focused, one, on inflation which penalises everyone, but I would argue penalises those on lower incomes more. It also focuses very much on employment and a lack of employment is usually going to penalise those in society who have the least income and the most to lose.

Chris, could you put up the first slide for me, please?

So many slides.

Yeah, the first one.

Yeah, I’ll get there. That one.

…

That one. Sorry.

So I like all the … but I sort of lost the structure. So when I just look at this picture and I want to draw a slightly different conclusion. So over this picture I see the RBA. I see the fair. I see other central banks. And if I understand it rightly you subject all these country morals to the same shop. The thing that really strikes you about that is let’s look at how there is something about Australia, if I’ve interpreted this right, that means we get very little outlook changes, is that my interpretation?

No. So, look, I think -

Or does it mean the variance is small? I mean -

Yeah. Look, I think it’s tricky, Bob, and it’s because we’re not comparing - it’s not quite an apples on apples comparison. It’s a little bit an apples and orange comparison. And so what do I mean by that? So the blue range is the range that is given by different central estimates of different models and we don’t have many that we’ve thrown in for Australia and they happen to sit quite close to each other. The US has more and then the other central banks we’ve done a bit of a cheat on because I’ve bundled them together so the graph doesn’t spread right out and I’ve got quite a few different ones. They’re not too far away from each other but there are some models which are outliers, which is why you get a higher and a lower end. The central black points aren’t that far apart is the key point.

So let me interpret it the way I want to interpret it.

Sure, go ahead.

And then I’ll ask the question. Let’s suppose I thought that the RBA outlook effect was minus 0.4. And let me suppose that the other central banks was around about 98. Right. And now I take the midpoints of inflation and I get the same sort of thing. That other central banks … effective on inflation. So the question I want to ask then was I want to say that this looks as though monetary policy is less …

I think -

Rather than all the same. And then the second question that I want to ask is if that was true, what does that imply about two questions. Question number 1 is suppose you wanted to make monetary policy more effective, then you would go through each one of your propositions and you would say, if I change this I could do that. And the second question is, if it’s true that monetary policies are less effective, what does that imply for the balance of … monetary policy … that is it’s true that monetary policy was less effective. Then it suggests that in Australia you want to put a link … more emphasis on the fiscal policy. Or alternatively you would try and beef up the monetary policy. So is that question still clear or -

I’ll do my best, Rob. I feel like I’m battling one of your excellent study sessions where we’d sit around your office and pose lots of complex questions but I think - I think - I guess what I’m asserting in the paper but not showing particularly well in the graph, because of the way it’s constructed, is these differences aren’t so great and part of what looks visually to be quite different. You’re suggesting that there might be one effect, let’s say in one of the other -

I’m suggesting this graph sets up entirely different …

But - and I’m just trying to dissuade you from that but I’ll entertain your point later in a sec but if you - if you’re wanting to pick, say, one of the more extreme ends on output, let’s for example of one of the other central banks and you picked a 0.8, but that central bank might have two models and one model might give you a minus 0.8 and the other model might be at the top end of it. Right. And so because I’ve got more models in there, more economies in there, it tends - it’s spanning quite big. So that’s a little bit of it. Let me try a different way.

It’s …

Yeah. Let me try and suggest a different way of thinking about it though, which is how I first came to this and then we went and looked at the models. If you look over a period of time, even in this episode, the differences in the volatility of inflation and output haven’t been so tremendous across many economies, unless they’ve gone and had a financial crisis. That’s a bit different. And the amplitude of the policy tool has not been that different either. So if the shocks have been similar and the policy therefore has been responding in a similar way, you sort of have to say the effectiveness of that policy is similar across central banks. So that’s a different way of thinking about it.

… central bank …

No.

…

No. I mean, it might suggest the shocks are common or - and we’re not talking about shocks always being at the same time and then there are some really big shocks where it’s really important, right, particularly in, say, the GFC and we’re a small open economy so big shocks offshore matter a lot for us so we’re responding often inkind. Yes. So I think that’s - I’m not sure that you can go and sort of play with the channels and engineer the economy to be quite different. I mean, I would argue just that monetary policy has been similarly effective overall across these economies but they’re facing different economies and again it’s like somehow underneath the hood everything runs a bit differently and the engines aren’t all exactly the same but they basically get you to where you need to get in about the same time. Of course, the other thing central banks are doing all the time is trying to get a lot of feedback. So when they’re changing rates they’re looking at the effect of these and they’re looking back in the past and they’re trying to come to judgments whether they need to do a little bit more or a little bit less. But it’s often - yeah. It’s often just set in Australia and it’s been asserted by people, you know, because of the cash flow channel monetary policy just hits that much harder. Well, it does hit some households hard but they manage it okay.

There’s no -

And then there are these other channels. Yeah.

Thank you.

Thank you for finding my most confusing graph.

One more question over there.

Thanks. Chris, I just had one question. You mentioned Norway earlier, and please correct me if I’m misconstruing your comments earlier, but you mentioned that similar composition in terms of variable rate mortgage were a high proportion but also using forward guidance which add a significant amount of backlash here but you seem to indicate that less of that had occurred in Norway. Was there a - like a quantitative reason for that … more conservative thing or was it more something about the Australian obsession?

It’s a good question and when I was sort of writing this I sort of came to Norway a bit late in the piece and added it in some of the charts late and I did wonder that same question. I’m quite familiar with the US economy and having lived there over the years, familiar with the way they respond or don’t respond and the general public don’t know when the Fed meets and what they’ve done, in a way that’s not true here. I’m not sure if that’s the case in Norway. The comment was the Norwegian central bank doesn’t think it’s a problem for their credibility and it’s been argued here that it could be a problem for us and that may well be so. So, yeah, it’s a good question. Are they as obsessed as we are about all things to do with variable rate mortgages.

We’ve got another question here.

In the US there’s some discussion about whether the central bank actually knows more about the economic market and there was discussion about the forward guidance. So I’m wondering how does RBA perceive itself, like you know if you can discuss … your discussion with the forward guidance. Would you …

Yeah. It’s a really good question and a former colleague at the central bank, Peter Tulip, and others looked at this exact sort of question. And I believe part of the answer is that central banks, and we’re the same, aren’t much better forecasters than anyone else. There’s no real secret source they have anymore. Maybe in the past when data was that much harder to come by and that much less timely they had some readings that might have been advantageous. That doesn’t seem to be the case. So when you compare our forecast to things like consensus economic forecasts, we’re not that much better or worse than the sort of consensus forecasts for GDP. I think it turns out we were slightly better on inflation, particularly in the near term. So for some reason we do seem to have some good insight there. Again, that might disappear over time as there’s more and more timely data provided on reflection. So I don’t think it’s the case of knowing more and therefore we can benefit everyone if we get our forward guidance out there. But forward guidance can still play a role and I think some central banks use forward guidance as well to help inform people about their reaction function and as they - my colleague Guyger Bell used to argue it’s the reaction function is really key. Thank you.

We’ve got time for maybe one or two more questions.

I’m not going to be very academically rigorous here so feel free to throw the baby out of the bath whenever you want. But there’s been a - it filters though at least there’s a bit of talk throughout hope and the like that monetary fiscal policy went opposite directions. There also appears to be a bit of talk in the US with the Fed losing some of its neutrality. How important do you think central bank neutrality is?

Well, central bank independence, I guess, I think it is very important and I think it’s been incredibly beneficial in helping to anchor inflation for a long period of time. And then inflation wasn’t anchored, arguably there was some really big shocks. Arguably policy-makers, both fiscal and monetary, not just here but around the world, didn’t anticipate just how quickly we’d come out of COVID and how much stimulus was in the system, including piles of savings that many households and businesses were sitting on and various stimulatory interest rates. But monetary policy tends to be more responsive and it responded fairly quickly and fiscal policy has taken many different paths around the world. And a lot of the influence, not all but a lot of the influence, the reason why we had higher inflation was supply shocks which were persistent but not that persistent and some of them have sort of come out of the system. But I think monetary policy independence is really important. I think that’s widely recognised because one of the reasons why inflation was able to come down more quickly, you could argue, is because inflation expectations were reasonably well anchored. And you could see that if you looked at wage outcomes in Australia because when inflation was pretty high, right, a lot of enterprise bargaining agreements are multiple geared ones so they’ll make an agreement for two or three years but they’ll specify a different rate. And so when inflation was really high often they were looking for a high rate and got a high rate in that first year but in subsequent years there was a recognition inflation would be coming down, just as we said it would, just as others were forecasting and so those wage outcomes were lower. There were lots of those sorts of behaviours evident around the world and I think anchoring inflation expectation is critical and monetary policy independence is important for that.

Time for one more quick question, if anyone still would like to get one in. Okay. One last final question there, please, and then we’ll wrap up.

So if we think that the cash flow channel is quite big, then given the social understanding that lots of people suffer when mortgage rates go up, doesn’t this effectively argue that from a policy perspective we should want something more like fixed rates? Because if it’s not … monetary policy it’s got … but either lots of people aren’t hurting and we should just say … through this role or we’re doing something that’s quite … for not a lot of monetary policy benefit.

Yeah. Maybe but I think this has been thought of more in the US where they have fixed rates and they point out the cost over the life of a mortgage of paying someone else for the insurance in fixing your rate because it’s not for free, especially in the US because you can also refinance and get lower rates, but when rates go up no-one refinances, as I suggested, to get a higher rate. And so there’s a premium that someone in the market who is taking on that burden, of providing that insurance for you, in fixing your rate for 30 years is charging you. So I think you have to sort of weigh off these different costs and I guess what I’m suggesting here is Australian households for various reasons turn out to be self-insurers but when they can see a bargain, right, many of them were very sadly and got very low rates when the banks offered low fixed rates partly out of our policies during the pandemic. So would we be better off with fixed rates? Maybe but we don’t know because they’re not on offer here. Right. You can get them for two, three years but we don’t have an institution set up, as was suggested earlier, like in the US to provide 30-year mortgages but they’re set up partly because of the tax treatment of the mortgage is very different.

Great. Thank you very much. Thank you, all, for coming and for some nice probing questions and, of course, thank you, Chris, for delivering the lecture.