Transcript of Question & Answer Session Monetary Policy During COVID

Okay, well thank you very much Guy. It was very clear and lucid. So we're getting a few questions coming in and I'll just flick you one. This came in a few minutes ago and I think you did answer it partially but I'll read it and you can see if you want to reflect on it further. ‘What's the risk of inflationary expectations rising in response to this higher unexpected GDP growth that we've seen and then forcing the cash rate up sooner than expected?’ You did talk about that a little bit but I guess you mentioned wages but do you think there's any chance of expectations of inflation can drive inflation itself without necessarily seeing the wage growth?

It's a possibility. It's a great question to ask and it's something we think about a lot. So is it a possibility? Yes, but I think it's a very, very low possibility at the moment. As I said, we've seen inflation expectations come up since the beginning of the year but they've only risen -- in terms of market expectations of future inflation -- to a level which is just barely consistent with our inflation target, just barely above 2 per cent and nothing more than that, and what we haven't seen really is any evidence of any pick up in wages to date. We've seen some of the wage reductions which went through last year reversed but nothing more than that. And so while we hear about some wage pressures around the economy in particular pockets, that's really all they are, small pockets of the economy. So yes, there's always a risk that expectations may shift higher and shift higher than what we currently expect, but we really don't see any evidence of that to date. But it's certainly something that we will continue to be vigilant about.

Okay, thanks. ‘Employment has come back strong however where is under-employment currently sitting and how does this affect the landscape?’

Another good question and I actually skipped over the bit in my written speech where I talked about this. But under-employment has actually come down in line with unemployment and it's also back to where it was basically pre-COVID. Part of that is being reflected in the very high rise in participation. But we've also seen strong full-time employment growth alongside strong part-time employment growth. So under-employment has actually moved down pretty much one-for-one with the reduction in the unemployment rate and so also indicating that the labour market is tightening up although it still has some way to go.

Okay. Next question is …‘This QE program is fairly new territory for us all so eventually inflation will increase and yields will rise driving down bond prices’, so his question is ‘Can you please explain the impact of this effective loss to the RBA's holdings? What happens to this large amount of bonds that have been purchased if they suddenly lose value?’

Good question, something we also are very mindful of. One thing to bear in mind is we bought these bonds at a particular yield on the day we bought them and we funded them at – this is where the ES rate comes in as well. So we have a fixed rate asset which is going to pay out over the life of the asset. When bond yields rise, we do have a mark-to-market loss at that particular point in time, and the final value of the bond on maturity is affected by that. Bond yield rises distribute the value of the earnings we get from buying that bond over the life of the bond, but in the end we still earn money from it. It's just a question of the profile of those earnings. We get paid the coupon yields all the time, so it's a question of how the rise in bond yields offsets the value of those coupon payments but it's still a profitable investment for us.

There's an opportunity cost element to it that if we bought bonds at a particularly low yield or a particularly high price you could have done something better with the funds down the track. Bond yield rises do cause a mark-to-market loss but not a loss on the income flow we've earned from owning those bonds over the life of the bonds. So that again gets a bit into the minutiae of accounting for bond purchases. But it is something we are going to provide quite a lot more information on in the coming months because it is a question we get asked a lot and it is an important one for people to be aware of.

Okay, a slight change in tack then. ‘Thoughts on cryptocurrencies and is the RBA considering a digital currency itself?’

Are we looking at a digital currency? Yes, we are, we've got a program of work which is looking at that. We are open minded as to whether there's a need for a digital currency. It partly comes back to what I was talking about the way bond purchases work. We increase the money supply digitally not by actually printing money. We have a lot of digital money in the Australian economy, most of our payments are done digitally. The share of cash in payments these days is a lot less and declining and we have a very efficient payment system in Australia, particularly with the New Payments Platform where people can actually get basically real-time value for their payments through the NPP. And so we have something which delivers a lot of the benefits that a digital currency would deliver, not necessarily all of them. And so we are open and looking at that possibility. We're open to it but at the moment we don't quite see the cost benefit stacking up. But that is certainly something which we continue to look at and if that cost benefit does stack up then it's something we'll certainly look to pursue.

Okay, so returning to inflationary expectations and global labour markets and demographics, so ‘Some economists argue that demographic forces will bring an end to low labour costs and will this bring a return to inflation?’

Charles Goodhart has got a very interesting book out on this with Manoj Pradhan on exactly this topic and it's generating a reasonable discussion. So Charles' thesis is basically the low inflation we've seen over the last couple of years has been a function of demographics, those demographics are changing so it's not been much of a function of central banks but purely a function of demographics and we're going to be beholden to the demographic shift in the opposite direction. I think it's something worth thinking about. I'm not completely convinced about that because I think other things are probably going to change at the same time including technology which is probably going to have at least as an important impact on all of this. But it's certainly an interesting thing to think about how those big secular forces have driven some of the developments that we've seen both historically and where some of the change in some of those secular forces might deliver going forward.

Okay … ‘Has there been discussion at the Reserve Bank that the three year bond yield target could undermine the effect of bond purchases and more broadly that the purchase of liquid government bonds could have a small effect on the broader monetary aggregates as financial innovation takes place?’

No, our assessment is the three year bond yield has been effective, it is holding down and continues to hold down the structure of the yield curve and borrowing rates. We still see borrowing rates as I showed earlier at the historic lows. So no, we are mindful of the possibility of dysfunction but by and large, our assessment is that no, it still very much remains effective.

Thank you. So we'll change tack again a little bit. ‘What was your biggest learning during this crisis and how has this crisis shaped the way you will respond to future crises?’

I'm about done with future crises at the moment because I've had the GFC and now I've had this, so I'm sort of hoping to avoid a future crisis but that's probably a vain hope. But that's a very good question, and I'm also hoping that we won't have to experience another pandemic for another century or so, but a couple of things. One learning has been the resilience of the Australian economy. So why are we where we are today, and I showed a few graphs which showed that compared to a lot of other countries we're in a lot better place, and I think that is the resilience of the economy as a whole and actually the flexibility of the economy as a whole. Obviously the large fiscal and monetary support has been important as obviously has also been the great health outcomes and health policy that we've had here. But through all of that the Australian economy has been really resilient and I think that's one learning. We did see this actually back in 2008/2009 as well, but I think we're seeing it again and possibly even more so this time around, so I think that's one.

The other thing is that one thing we have done, and I think we'll continue to do, is place more emphasis on thinking about scenarios in terms of how the economy might evolve rather than be too wedded to particular forecasts, particularly when you've got such large uncertainties as we've had to deal with over the past year. In our statements of monetary policy, we've placed a lot more emphasis on describing how different scenarios play out and how that might affect things rather than being too wedded to any particular central forecast for the economy. So I think that's another learning from the past year or so but, to be honest, I'm really hoping that we don't have to worry about another crisis at least for more than another 10 years.

Fair enough too. Maybe if we could have a couple more questions and then we'll wrap up. ‘Do you anticipate negative consequences to the increased RBA and state involvement in the free market?’

No, I don't think so. The involvement of the RBA and the government in the Australian economy has actually been very positive for the economy. As I said a few minutes ago that it's got a lot to do with particularly the fiscal side as why we are where we are, so I don't think so. And the other point I suppose I'd make is if you think about what the alternative would have been, and the alternative would have been an Australian economy which is doing nowhere near as well as where we are today and an unemployment rate a lot higher than where we are today and that has material cost. So I'm not saying that the interventions are costless, but from a cost benefit point of view, from my calculus at least, the benefits are significantly outweighing the costs.

Thank you, Guy. So another question …‘Can you please explain how relative exchange rates feature into your decisions on interest rates?’

Good question. So exchange rates today and always have been an important part of the calculus on the setting of monetary policy because the exchange rate which is affected by the relative policy stance here and in other countries, amongst other things, does have a material effect on an economy like Australia. We've seen that any number of times through history that movements in the exchange rate have a sizeable impact on the economy, and I suspect in WA you all see that at least as much as anyone else in the economy. So it is something we take account both for its effect on inflation but also for its effect on economic activity. So a higher exchange rate does dampen economic activity, it puts downward pressure on inflation, a lower exchange rate does the opposite. So exchange rate movements are something that we today and historically always have placed a reasonable amount of emphasis on in our monetary policy considerations.

We've got another question about crypto markets, it is a bit related but I'll give it to you. So the low cash rate has boosted real estate and relevant industries … will it potentially boost the crypto market as well? Is the RBA considering regulation policies on the crypto markets? In the end do you think the crypto market is a healthy investment?

I am not in the business of providing financial advice. Prices clearly have gone up … in my view crypto has got a lot of elements of gold historically, including when the price goes up and down, including its price potentially is a fair way removed from its fundamental value in terms of actual use value. Obviously prices have gone up, it conceivably does have something to do with the settings of monetary policy right around the world.

In terms of regulation, that's not so much an issue for us, that's very much an issue for the government as a whole as to how they want to approach that but prices clearly have gone up on a bunch of crypto assets over the last while and it's probably got something to do with settings of policy but there are a lot of other influences on that too.

Okay, so there's another question from Shamit Saggar, Shamit is the Director of our Public Policy Institute, and he wants to take you up on the possibility of future crises, so you didn't want to talk about it, fair enough, but there's obvious tension between Australia, China and the US. So I guess his question is what would be the implications for monetary policy in the RBA if these kind of situations escalate?

Well, I'd leave that to Shamit probably to talk about the likelihood of those events. I suppose we'll have to deal with that as they come as we deal with anything else. But I'm not in any great position to provide any particularly informed insight on the likelihood of that. But, if something bad happens to the Australian economy that generally requires a monetary policy response and if something good happens that does too. But I don't think I could provide any great insight as to the likelihood of that, certainly not compared to other people who are much more expert in that than I.

International relations people. Good, okay, maybe this might be the last question because we are getting on time. ‘The bank is forecasting the unemployment rate back towards 4.5 per cent by the end of next year, which is incidentally the bank's previous estimate of NAIRU …’ – that's the non-accelerating inflation rate for listeners, ‘… but if inflation isn't rising to the bank's target until 2024 how much lower is NAIRU and why has it decreased further?’ So I guess what's your …

Looking forward, we have estimates of the NAIRU based upon history but we're open minded about where that might be, and it comes back to the point I was making about forward guidance. So we're not going to consider raising the cash rate until inflation is sustainably within that 2 to 3 per cent target band, which means we're actually going to have actual inflation sustainably within that range. So we're going to wait and see when we get there and, as I said, one of the things we would want to see to provide that sustainably higher inflation is sustainably higher wages than we have currently and so we are open minded about how low the unemployment rate can fall before we see those sort of developments. But I'd put the emphasis on the fact that we will be looking to see those developments not just forecasting those developments. Our estimate of the NAIRU is helpful in guiding that, but we're actually going to be driven much more by the lived experience rather than what our estimates might be. So that's an important element of that forward guidance is we're actually going to wait to see what actually happens rather than what we forecast might happen based on a model which may or may not be appropriate for the changed economic circumstances.

Okay, I'm going to leave the last question then to one of our Honours students in economics here and I'm going to paraphrase it. I'll just throw you one for the last question which is how confident are you in your three year forecasts?

As I said, we're much more going to be driven by what actually happens than by our forecasts so that's one response to that question. Let's go back to January last year, were we confident that we were going to get a global pandemic? No. So we have seen that things do come along which tend to throw these forecasts off quite a bit. There are often some very large events that are broadly unforeseeable, which can cause you to end up quite a long way away from where you thought you might be. We had a period in the first half of the 2000s at least where that wasn't too much the case but the experience of the last 10 to 12 years is forecasts are useful in framing your thinking but you've got to be a bit careful about placing too much reliance on them because stuff does actually happen and we've seen that in spades over the past year or so.