Transcript of Question & Answer Session Monetary Policy in a VUCA World

Thanks very much, Andrew, and great to have you here. You’ve been in Australia for about a year now after moving over from the Bank of England. You mentioned there in that speech that we’re moving on from the narrow path, and that’s a precarious path that both Philip Lowe and Michele Bullock have spoken about. Are you suggesting that Australia has indeed achieved being able to straddle that narrow path and been successful in getting inflation down without, what some people might, say smashing the economy?

I don’t know why you used that quote, name redacted. We’re not declaring success. We’ve made good progress. People did doubt whether inflation would come down. Everyone did, including us – we were unsure. It has. And employment growth has remained strong. But we’re not there yet. Central bankers sometimes use these torturous analogies of the accelerator and the brake and all this kind of thing. We’ve taken our foot a little bit off the brake; we haven’t got our foot on the accelerator.

As a foreigner that’s come to Australia – there’s lots of business people in the audience here – what’s your brief synopsis or observation of the Australian economy and business generally?

Now or over time …?

At the moment.

As we said at the beginning, I think the long history of Australia should give people confidence. It does, I think, give people confidence. Australia has proved extremely nimble at understanding and reflecting the changing trends in the global economy. I personally have confidence that will happen again. It may not happen tomorrow, it may take time – it often does. But just as there’s this phrase, ‘the lucky country’, I’m not sure that can possibly be right given how many times Australia has gotten it right over its long history. So that’s a medium-term point. Clearly, as I say, the role of monetary policy is to bring inflation down and to help support employment. Clearly, as has been discussed throughout these two days, productivity is the key underlying issue. It’s not something that monetary policy can do anything about, people often use this slightly hackneyed phase from Paul Krugman: “Productivity isn’t everything, but [in the long run] it’s almost everything”. It provides the engine of growth that everyone else can benefit from and that isn’t something that monetary policy can affect. It’s something we have to react to.

Do the recent ructions in global trade in recent days make a potential future rate cut more or less likely for Australia?

Obviously that’s an interesting and important question. As I said, it seems very unlikely that, you know – too many negatives. It seems likely that a global trade war, if it begins – I don’t think we know if it’s beginning yet, there’s so much change, the announcements are changing by the minute – would not be good news for Australian activity. But the challenge about what it means for inflation here is actually quite difficult. Now, people might well say – bloody hell, we’re paying you a lot of money to know what’s going to happen with inflation. That would be a fair question. I got there before you asked me. But look, it isn’t at all clear whether a persistent attack on the supply chains of the world economy will bring inflation down because activity falls everywhere or actually impairs inflation because our ability to buy cheap goods from other countries is harmed. So, we will have to keep a very close eye on what this means for inflation. If inflation did pick up, we’d have to respond one way; if inflation falls, we’d respond in another.

You mentioned the market sell off in recent days as obviously partly a reaction to what’s going on with the tariff tit for tat. You’ve also just hinted there’s been somewhat concerning US data, I’d call it soft leading indicator data – consumer confidence, consumer spending, inflation expectations. We had a lot of Wall Street titans speaking here yesterday who were very bullish on the US economy. Are you a little bit anxious or a little bit concerned about the early data that’s coming out of the US?

I have no comparative advantage relative to the people you were speaking to yesterday in terms of my insight into the US economy. The markets had and probably still have – there would be many in the room trading in those markets – a very bullish view. Not just about the underlying strength of the US economy, which has been a strong narrative for some time. It’s also been justified by the productivity and growth outcomes in the US. But also for what the new administration’s policy package, taken in its entirety, would likely mean for the corporate sector, let’s say – the deregulation agenda, the fiscal boost. Neither of those have started to be discussed yet and some of the potential pain has been discussed upfront. Obviously, it was very hard to find any recognition, even of the risks of that, in market pricing. Some of that has adjusted. Look, there’s been a lot of discussion in recent days about the Atlanta Fed’s projection for Q1 growth in the US, for example, which is some spectacularly negative number because the US was annualised – 0.1 becomes 0.4 and all the rest of it. There is a possibility that growth could be negative in the US in the first quarter of the year. I don’t know that that should make one think that – gosh, suddenly the US economy has fallen off a cliff. But I do think it’s possible the financial markets have been a bit – let’s just say they’ve seen the most positive side of the possible implications of this policy package and there may be some realisation that may not be quite right.

Michele Bullock said after cutting interest rates a couple of weeks ago that it was not a ‘lay down misère’ decision.

I had to look that up. I don’t know what a lay down misère is. Can you explain that to me?

I’m a bit hesitant to go there. (inaudible) She also said it was a difficult decision. Without going into specifics in detail, how robust or vibrant is the debate around the Reserve Bank Board table since you’ve joined?

Some people say it’s a non-expert Board and it’s different from others. As you know, I come from the Bank of England where the monetary policy committee consists largely of expert economists. I wouldn’t necessarily advocate that model as being the best of all possible worlds. You get individual accountability from a lot of head strong economists. It can mean a lot of very long speeches explaining why they have a very idiosyncratic view. Whether that adds to the signal or the noise of monetary policy I think you could actively debate. So, I don’t think there’s a single model. I didn’t know what to expect, but the reality is that the people around that table bring an enormous amount of judgement and knowledge and insight to that policy debate. I can’t think of – not one of them is a shrinking violet, not one of them. As I said at the beginning, when you’re in these situations of ambiguity, rather than – sorry to use a pompous phase, ‘classical uncertainty’ – it’s judgement and instincts that matter almost as much as crunching numbers through large models that may not be the right model of the economy. Having that judgement around that table from a variety of different backgrounds I think has actually served us and Australia quite well. Has the debate been as robust as I’ve been used to? Yes, it has.

One of the justifications you’ve pointed to publicly in the last couple of weeks for the rate cut was that the Board was shown some staff forecasts privately that if you held the cash rate steady at the previous 4.35 per cent you would actually slightly undershoot the midpoint, 2.5 per cent, of the inflation target. And so that gave you confidence to cut rates because you’re going to undershoot the inflation target a little bit. But over what timeframe are we talking about there? People in the markets are keen to know a bit more about that because surely it wouldn’t have made much difference if you cut in February, say, versus May? How long would have you had to hold it to that rate for to undershoot the inflation?

I showed that red swathe earlier – it’s not quite the chart we looked at internally, but it gives a good sense of it. It’s a modest undershoot over the forecast period, so 18 months to two years. And you’re absolutely right – it’s a judgement as to when you cut rates. And so, as well as the central case, which was clearly suggesting something of an undershoot – which wasn’t the forecast we published, which was based on the market curve – you’re also thinking, the Board is also thinking, about the risks around that central case. For a long period prior to February, the Board was still worried, as I think many were, about the upside risks to inflation – not least from inflation itself getting built into price setting and wage setting. As inflation has come down, some of those upside risks have moderated and some of the downside risks that we spent a lot of time over the last two days talking about – the risks from global trade and the possibility that the labour market is slightly looser than our central view – I think weighed on the Board. So, you’re absolutely right – you could have made a decision in February, you could have made decision later. It wasn’t 50/50, but it wasn’t 90/10 either, and that was what the market had thought about. So, a combination of the undershoot, which was modest, plus the balance of risks I think explains why the Board made its decision.

In the detailed Statement on Monetary Policy released on the same day, the Bank revised its guesstimate, I’d say, for what’s known as the neutral interest rate – and that is where the interest rate is neither stimulatory nor contractionary. It was previously up around, you estimated 3.5 to 3.75 per cent. You’re now saying we think maybe it’s around 3 per cent. Does that mean actually you’ve held interest rates tighter and more aggressive than actually what you previously thought, and actually you could potentially over time cut rates by more because you think the neutral rate is lower than previously?

No. So the chart you’re referring to – and I haven’t got it here but I should have done – it actually shows an enormously wide range for the estimates of the neutral rate, by memory from something like one to just under four. So that is a huge range – 3 percentage points. I mean, if you imagine we said we cut interest rates to 1 per cent, some people might rejoice but that’s a huge decision to make. That chart did not play, and the minutes show this from yesterday, a central role in the Board’s policy decision. They are estimates based on partial financial market data and really you can only draw two conclusions from it. One is that the range of uncertainty is very large and the second is that all the estimates lay below both what our rates were before the decision to cut and afterwards.

I do want to go to the floor to give others a chance to ask a question to the Deputy Governor. If you have a question, please raise your hand. Just in the meantime as we get a microphone to anyone who raises their hand – name redacted asks here virtually – what were your thoughts on name redacted suggestion of moving to a more Americanised system of 30-year fixed mortgages? More specifically, does the RBA have the ability to reduce inflation in a system like that?

This is an interesting point. Australia, of course, is at one end of that global spectrum in terms of almost all of its mortgage stock being related to floating interest rates. I think Norway is another one. The UK used to be like Australia but has moved over time to a slightly more fixed situation. The big point that’s often not mentioned in the US is that the 30-year fixed mortgage market is based on a subsidy by Fannie Mae and Freddie Mac that stands behind the market. Now, it’s not crystallised, that subsidy in recent years, because it’s been successful in sustaining that market but I would say that is a social choice and the social choice to stand behind the provision – actually the extensive risk the banks face in providing long-term mortgages of that kind – is not one I think Australia has yet made. I’m not sure whether it would, given the view that people often seem to express about the banking system, which it would effectively be a backstop for. But it could be considered. I think one of the lessons from the UK experience is that a period of sustained low inflation will often leave people to begin to choose fixed rate mortgages as opposed to floating rate mortgages. I don’t think that’s really happened here to a great extent. I think there was a pick-up, if I understand the data correctly during COVID, but from nothing to not much. I think that’s rolled off since then. It would definitely change the transmission mechanism in Australia very substantially, but I think it will be for banks and homeowners to decide if that was the kind of risk they wanted to take.

… it was actually name redacted who made that suggestion not name redacted. Would anyone else like to ask a question?

Andrew, just a question about the strength of the labour market. As your graphs show there – the really extraordinary tightness of the Australian labour market compared to other comparable economies. Now some people might say it’s because of all the government money that’s been pumped into the care economy and so forth. But even with that, do you think that this is a cyclical thing or are we now in a post-COVID structural period where, before that, everybody worried about, well, there’s not enough jobs to go around? And now we’re going to be worried about where is the labour out there, because there’s so many labour shortages? Is that an ongoing structural thing that the Reserve Bank now faces?

Just to correct slightly – the chart I showed, the comparison with other countries, was just for employment. It wasn’t a direct measure of labour market tightness. The measures of labour market tightness – the unemployment rate, vacancies over unemployment, and that kind of thing – which are low relative to other countries, but not as spectacularly low as the employment rate is above. There is a substantially higher participation rate in Australia, which is a good thing, relative to many other countries. I think the world you describe, where companies may be more actively having to think about what it will take to retain their staff and also attract new staff, and perhaps in a world of substantial unemployment, is probably the world of the future. Obviously, there’s a difference between that being a sign of an active, well-functioning labour market in which talent can bid itself around to an appropriate price and one where the labour market is overheating. The possibility that it will lead to the labour market overheating is something we’re very alert to. The possibility, as well, that actually Australia has found a bit of a secret sauce here in terms of the market being more efficient, being more capable of distributing talent around the various people using it, is something we should be putting weight on it too. Anyone who says the labour market is super tight, it’s obvious that inflation is going to the moon – has to explain why, in fact, inflation and wage growth, at least for the moment, is falling rather than rising. But the scenario you describe where companies have to spend more time retaining and recruiting staff in the future probably is one where you keep the economy relative to full employment. That may be here to stay.

I do want to give an opportunity to squeeze in one final question if anyone in the room has one? All right. It looks like we are on time anyway, Andrew. So, thanks very much for joining us – Deputy Governor of the Reserve Bank, Andrew Hauser.

Thank you.