Transcript of Question & Answer Session Inflation and the Monetary Policy Framework

Thank you, Phil, for a very timely and engaging speech. As Phil said, he's very generously agreed to take questions from the floor. I'll try to wrangle those as best I can. You'll note that we have some microphones strategically placed on either side of the room. When you're asking a question, please state your name and affiliation. I encourage the students to come forward and ask a question. I was going to suggest that we get our members and their guests to ask some questions before the journalists, so can we please attempt to do that? Then we'll go to the journalists. There'll be time for everyone but, if I could get our members from the ABE and others and our guests to ask some questions first, that would be great. I'll kick us off, Phil, given that no­one has come forward yet. I'm a member of the ABE, so I can ask a question.

You mentioned wages growth being a bit slow to pick up and you may have noticed there was a jobs and skills summit in Canberra last week, and one of the discussion points out of that was a push towards multi-employer bargaining. I'm wondering what your thoughts are in terms of what that impact might be on wages, based on what we've seen in the past.

This is not my area of expertise, so I don't want to offer any comment on the benefits or costs of multi-employer bargaining. There's a more general point though that I want to make here, and that is the world's very uncertain and the economy needs to be flexible in response to that uncertainty. We've got a flexible exchange rate, a flexible monetary policy and, hopefully, some flexibility with fiscal policy. So we need to be flexible and the labour market is part of that. So, whatever changes that are considered in the labour market, I think we need to preserve the flexibility we have because the world is uncertain and we need the flexibility to respond to that. And, whether the changes in the bargaining system will enhance or damage that, I'll leave to others to decide.

Hi, Nicki Hutley, independent economist. Dr Lowe, thank you for that interesting talk. We know it's RUOK Day today, and you talked about the scourge of inflation and its impact on inequality. But how is the Bank considering the effects of these very dramatic increases in interest rates on inequality in Australia, particularly as to how it affects low-income households?

Well, we know interest rates affect the economy very differentially. Most people with mortgages don't like higher interest rates, do they? It puts pressure on their budgets. It might come as a surprise to you that some people write to me saying 'thank you for the higher interest rates'. They rely on interest rates, higher interest rates for their interest income. So we're acutely aware that higher interest rates affect the community differently and we've spent a lot of time over recent years examining the various datasets, disaggregated datasets, where we can see how consumption responds differentially across the income distribution. So that's what we're doing, and we're going to continue to pay close attention to that. We're very conscious of this differential effect.

We're also conscious of the need to get inflation back down. I mean, that's … as difficult as it is for many people, we need to get inflation back down and that means higher interest rates. And that means that aggregate demand has to grow a bit more slowly for a while to bring it in line with the capacity of the economy to supply. That's the reality we face, because it's not in anyone's interests, particularly lower-income people, for the higher inflation to stay high. That will damage the economic prospects of low-income people, so we've really got to get inflation down.

Jo Masters from Barrenjoey. Thank you for your speech, Governor. I just wanted to reference your comments about your uncertainty about the housing … the reaction function of the consumer. You referenced those big savings buffers. We know that the stock of saving and the flow of saving is very high, but we don't in Australia have much understanding of where those savings sit, what sort of households hold them. We know in the US it's predominantly those upper-income households who probably aren't going to need to lean on them as much as some of the lower-income households.

That's a good question and it relates to Nicki's [Hutley] question before. We spent quite a lot of time trying to understand where the savings sit, and the reality is that they mostly sit in the upper and middle-income households. Many people who have white-collar occupations were able to keep their jobs during the pandemic. They couldn't spend, so they kept their income, they couldn't spend and the money went into their offset accounts. And I think you saw in one of my graphs there – excuse me – the very large rise in balance in offset accounts, and that's mainly from middle- and upper-income people. So, you know, we're very conscious of that and the fact that the higher interest rates are going to affect more people – people who have lower incomes and haven't built up the bigger buffers.

Thank you.

Diana Mousina from AMP. Thank you, Dr Lowe. My question is around the impact of supply to inflation. You spoke about some of the global central banks making some assumptions around how much supply has driven the increase in inflation compared to demand. I was wondering if the RBA had done any similar analysis? And, if supply has been the main driver of higher inflation over the past six to 12 months, then how can you be so sure that such aggressive rate rises will slow inflation?

Well, supply has been an important part of it and I went through some of the facts on the cost of energy and its contribution. But I think it would be wrong to conclude that it's all supply. In fact, I think a lot of it is demand. The fact that we have the lowest unemployment rate in 50 years isn't largely a supply story, it's a demand story. Many households built up these buffers during the last few years, they kept their jobs, people are getting more hours of work and higher nominal incomes, and people are spending that. So there is a significant demand element to the higher inflation.

If I could just make one other reflection, the policy response during the pandemic was to deliver low interest rates and the government delivered a large fiscal stimulus. We did that because the downside to not doing it, we thought, was very, very large. Remember, back in 2020, we were talking about 15 per cent unemployment, our hospitals being overfull, tens of thousands of people dying, a generation of Australians having lost opportunity and a vaccine being years away. That was the environment we made these decisions [in] to deliver very significant monetary stimulus on a government fiscal stimulus. And it turned out we avoided the worst of the possible effects of COVID, which meant that all this stimulus is sitting in the system and the health situation was better than was predicted. And people are now spending that money and that's causing inflation. So that's part of the story, and the higher rates are part of the way we calibrate this back to something more normal. So there is a demand element, it's not just supply. If it was just supply, I think we could look through it, but it's not just supply.

Governor Lowe, thank you very much for your remarks today, Phil O'Donaghoe here from Deutsche Bank. In your speech, you noted that as the cash rate rises, the case for slowing the pace of increases gets stronger, I guess. When I look around the world, though, it feels like the exact opposite is happening. The European Central Bank started the year with a negative interest rate, tonight they will meet and the expectation is that they're going to hike by 75 [basis points], after a 50 [basis point] hike previously. The Federal Reserve – Jackson Hole, Chair Powell – almost intimated that, you know, the sense is that the case has to be made for dropping back to a 50 [basis point] hike rather than a 75 [basis points]. And the Canadians: a 100-basis-point hike followed by 75 [basis point]. When you're looking and think … when the board is thinking about setting policy in Australia, conscious that monetary policy is as much art as it is science, how much consideration do you give to that global backdrop, that resolute message from global central banks, that inflation is intolerant and we need to hike and we need to hike aggressively?

Well, it's certainly an important factor but, at the end of the day, our monetary policy is going to be determined by Australian-specific conditions. And I showed a graph today of the aggregate growth in wages in Australia relative to the US, and it's a very, very different story. At least at the aggregate level at the moment, wages growth is consistent with inflation returning to target. It's picking up and it can pick up a bit further and still be consistent with inflation returning to target. In the US, wages growth has spiked 5 per cent, north of 5 per cent, and it's difficult to see how that's consistent over time, with inflation returning to 2 to 3 per cent.

So the labour market dynamics in Australia are very different to what they are in the US and the UK, I would say, where wage growth is running at close to 5 per cent as well. So, while ever that remains the case, I think we can at least have the possibility of it being on a slightly different path. But if that doesn't remain the case, then we'll have to be on the path that everyone else is on. I'm hopeful that inflation expectations remain contained, that the inflation psychology remains contained and that aggregate wage growth doesn't pick up that much further. If that's the case, then I think we can navigate the narrow path to a soft landing.

Thank you.

Bill Evans from Westpac. Governor, thank you very much for your speech. Thank you for pointing out how things have changed so much in the last 12 months and, particularly, thank you for not naming any names of that group whose forecasts were in that grey area.

Governor, if a handbook existed for central bankers – and maybe it does, but certainly we've not been made privy to it – would part of that handbook be that, if you're starting a long way away from neutral, you have to move really quickly to get to that neutral level or normalising rates. But, in doing that, you create the risk of treacherous lags, because you just don't have enough time to make an assessment of what you've done because you've moved so quickly? So a reasonable approach would be, once you get to that neutral level, then you need to start slowing things down to take account of those lags. And, in reference to Phil's point, the concern about these treacherous lags is more important than what might be going on with other central banks, whose economies may be quite different in terms of their sensitivity to their policy rate.

I don't know about the relative importance, but I can say we're very conscious that there are lags in the operation of monetary policy, and the effect of interest rate increases we've already done isn't yet evident in household mortgage payments, and that's to come over the course of the next 12 months. And, as that comes, together with continuing high inflation putting pressure on people's budgets, there will be difficult times ahead for some households; we know that.

What's really critical as I said in response to the previous question, is what's going on with domestic labour costs. Now, it's quite possible that, because of the institutional structure of our labour market, wage growth doesn't pick up that much further. It is going to pick up further but perhaps not that much further. And, if it does, then we can get through this period without having to have interest rates go up by as much as in some countries where inflation expectations and the whole psychology has shifted more. That's the main uncertainty we have, how the labour market is going to respond to this period of high inflation.

I know it's very difficult for people to accept the fact that wages are not rising with higher inflation. That's very difficult, and it's causing a lot of people to stress. But the alternative of wages picking up with inflation is, when inflation is protracted, it means even higher interest rates later on and even more unemployment later on, and that's going to hurt low-income people more. So I know this is difficult at the moment. It's going to be difficult for the next year or so until inflation comes down. But the alternative, I fear, is even more difficult. That's the critical issue we're focusing on, how is the labour market responding and wages responding to the higher inflation?

Paul Bloxham HSBC.Thank you, Governor Lowe, for a very interesting speech. I'm going to pull two bits of what you said in the speech together to frame a question. You talked about the idea that one of the lessons from the pandemic and the episode we've been through is that we should spend more time, or the RBA should spend more time, looking at sectors and working out the sectoral issues to properly potentially foresee a pick-up in inflation. I guess a question related to that. You've got a lot of resources already. You have a huge liaison program, we know … we get told about it on a pretty regular basis, and it goes down to the sectoral level. So what more is needed, in order to try and put the sectoral story together in order to paint that aggregate picture for the inflation story? And then a sort of related question, you know, how does the sectoral story then feed through to the actual policy process? Because that's the bit that I think is where one of the questions is. And in a way that ties back to your point about flexibility, which is, you know, you need a flexible approach. A flexible inflation targeting regime allows you that approach. Did the forward guidance that was so strong and so forward-looking and such in the distance at ‘24. Did that actually constrain the ability to be as flexible as you might have needed to be in response to the information you had coming in about things and inflation, particularly that sectoral story?

There are a lot of elements to that question.

There are.

On the sectoral story, we rely very much on our liaison. And you'll see, in the next Statement on Monetary Policy, we're going to introduce an extra chapter, an extended Box, about the stories we're hearing from liaison. So we hear that many of the business economists have been for calling us to talk more about what we're hearing from liaison in our monetary policy statements, and we're going to respond to that next quarter, and we'll do that going forward.

On the forward guidance, we could take the rest of the time on that. But, to answer your question directly, the forward guidance didn't constrain the Board at all. We made the forward guidance for reasons we thought were appropriate at the time and then, when we met at each meeting, we reviewed whether the policy settings were right, so the guidance didn't constrain our actions. But we could talk about forward guidance all day, and I'll give a speech later in the year on it. You'll have to wait until then, I'm sorry, Paul.

Phil, we'll go to Sarah and our very bold student right behind her, and then we'll go to the members of the media.

Sarah Hunter from KPMG. I wanted to pick up a bit, actually, on your comments on the labour markets. And what struck me from when you showed the chart comparing US wages and wage growth here was that they're obviously very different. But the labour market response, the employment response here has been much more positive. We've got many more people working now, whereas in the US, the UK and others they've really struggled. So I have a two-part question. One was, how do you see that response playing forward? Do you think there is any more to come from the local labour market, in terms of continuing to increase and meet demand? And, secondly, we now have the borders reopened, of course, and the latest visa data suggests that we have finally got some applicants coming through, and hopefully they're all going to get here at some point in the not too distant future. How do you think about the return of international migration and inflows playing into the labour market and playing into your decisions over the next 12 months?

Those are good questions. First, on domestic participation, it's increased a lot. More young people are working than ever before and more women are working than ever before, and that's not the case in the US and many European countries. It partly reflects the success I think we had on the health front during the pandemic, not as many people got sick and not badly sick, so they've participated in the labour market and that's really great. More and more people are working, they're earning incomes, they're supporting the incomes of their households. So that's a very positive development. Female labour force participation in Australia, it has increased, but it's still not that high. I hope we can make further progress there, and I know the government shares that hope and it's had a whole series of policy measures there.

In terms of the opening of the borders, it certainly helps firms that have specific skill shortages. You get a project manager or an IT specialist come in, and that helps you to do the investment or the output that you would have otherwise not been able to do. So, from that perspective, it's positive. But I'd just caution you in thinking that it's a solution to the tight labour market because when that project manager goes home from working for you, they've got to live somewhere, they occasionally go to the doctor, they go out, they eat, they entertain themselves, maybe they have to educate their kids, and when they do that, that creates more demand for labour.

So most of the evidence is that the supply and demand balance out from increased population growth, but what opening the borders can do, if we do this well, is address those really acute skill shortages, and that will allow more output and investment. So I think the focus needs be to be on the skills, not the numbers.

Thank you.

I'm Taylor Riddle from Pittwater House [School]. Hi. We're actually learning about policies to address economic issues. And, with the monetary policy, macroeconomic policy addressing the demand side of the issue, I was just wondering at what point do you reassess if inflation remains high, that contractionary policy is no longer effective if there are still supply-side constraints?

Well, it's a good question, Taylor. I think the supply-side constraints in the end get resolved. They might take longer than you want, but eventually they get resolved. The private sector is very good responding and solving problems, and you saw there in one of my graphs there where the cost of shipping has come down and delivery times are improving. So, eventually the supply side will get fixed up and I think price growth will be lower, and that will help bring inflation down.

So the critical issue is the level of aggregate demand. As I said before, the demand is strong because people got a lot of income during the pandemic years and they weren't able to spend that income in the same way they normally could. So demand is strong. So our issue is really to bring back growth in demand now to be in line with supply, and higher interest rates are part of that. And I'm confident that will work and we can navigate that narrow path I talked about, provided the global economy doesn't take a turn for the worse and inflation expectations don't ratchet up.

Thank you.

Hi, Governor Lowe. Julia from UBS. My question is the RBA told us that the cash rate is the key tool for monetary policy, but would you consider active QT as an alternative way to tighten financial conditions and support the Aussie dollar in the same way that you did with QE?

Sorry, I missed part of the question.

If you would consider active quantitative tightening, so selling bonds that you have in your portfolio, as a way to tighten financial conditions, support the Aussie dollar, like you did with QE?

No, it's not on our agenda at the moment. I think the approach that we're going to pursue is just let those bonds mature over time and our balance sheet shrink. I think any incremental benefit we get from changing that strategy is pretty small. The main tool of adjustment is going to be the cash rate, and hopefully the balance sheet will just run off in the background.

Governor, Hugh Riminton from Channel 10. I wish my question was as elevated as my colleague's from Pittwater House. You've achieved the unthinkable, you've managed to get the Queensland conservative Matt Canavan on a unity ticket with the Greens, both this week have called for you to be sacked. What do you say to people who think that your resignation would help matters?

Well, I can assure you I have no plans to resign. I think what I would point [out] to people is that the unemployment rate in Australia today is the lowest in 50 years, female labour force participation is at a record high, young Australians can get jobs in a way that they haven't been able to do before, people are getting more hours of work and underemployment is down. That is a huge economic and social benefit. Having a job is the first step on the ladder of opportunity. Well, having an education but then getting a job is another step on the ladder of opportunity, and more people today are on that ladder than ever before. We've struggled for 50 years to get to full employment. It's been, from my perspective, a blight on what's otherwise been a very successful economy. So we're closer to full employment, we may be there, than we've ever been in 50 years. So that is a legacy of what we've done.

We've certainly got higher inflation, and that's partly because of the insurance policy we took out during the pandemic. During the pandemic, I know at our Board we said’ 'well, what's the bigger policy error to make, do too little or do too much?' If we do too little and the unemployment rate is 15 per cent and tens of thousands of people are dying every month, the economy, our society, would have paid a very heavy cost. If we did too much, then we'd have to increase the interest rates and I'd get all this criticism and calls for my resignation. But, in the end – and different people have a different judgement of this – I think we made the right choice. We provided the society with insurance based on the health advice that we had. It turns out we didn't need as much insurance and we're having to increase interest rates. But people have jobs, kids have opportunity, household income is rising. That's what I would say to people who don't like me in my job.

We've only got time for two more questions, so we'll take one from this side and one from that side. We'll start over here.

Gordon Scott RBC Capital Markets. So I have a question about … So the last monetary policy statement obviously removed a reference to 'normalising policy'. Does that mean in your view that policy has already normalised and that further moves will be into restrictive territory and, if so, how restrictive do you think we need to go?

I removed that language because I didn't think it was useful anymore. We'd raised rates already by 2¼ per cent, they were off those extraordinarily low levels. On previous occasions, I've talked about the neutral cash rate. I think it's at least 2½ per cent, but I have a lot of uncertainty around what the actual number is. So I don't like kind of saying, 'well, when you cross over some threshold, you've moved from restrictive to neutral'. I just don't like thinking about it that way. But we are closer now to estimates of neutral, but we could still be stimulatory, we could be too tight. So, you know, there's the debate amongst people at the moment. Some people say we've done too much and others say we haven't done enough. And I think that reflects the general uncertainty about what is the neutral setting of policy, and we share that uncertainty.

Edward Boyd Sky News. Governor, last year you promised interest rates wouldn't rise till 2024 and now you've lifted the cash rate 2.25 per cent in five months. Can you give Australians some certainty around where the cash rate is likely to peak in Australia? Should Australians be prepared for 3½ per cent?

I'm not sure whether you were listening to my answer to the previous question. There's a lot of uncertainty. And I don't like doing this, but can I correct you, because I did not promise that interest rates wouldn't go up to …

But in your statement …

I know many people interpret my previous statements as saying that. But, if you look back carefully, I never said that. What we said was we thought the pandemic was going to have long-lasting disruptive effects on the economy that would keep inflation low, would keep unemployment high for years, and we wanted to do what we could to prevent that. And that meant that we were likely to keep interest rates low for a long period of time out to 2024. So it was highly conditional. We did not make a promise. I know it was interpreted that way. But we did not say that, it was a conditional statement. And the health situation improved much faster than the advice that we and others had, and we've had to rewind those decreases in interest rates. And it's been, obviously, a difficult thing for the community to accept that interest rates have gone up much more quickly.

But I also ask you to reflect on the fact that the economy is so much better than what people thought was going to be the case. A 50-year low in unemployment, people have got jobs, underemployment is low, kids have got jobs. I mean, the economy is so much better. Interest rates are higher. I know people don't like that, but you should be welcoming the stronger economy. Again, that's what I'd say to people who are kind of unhappy with the promise, which wasn't a promise. But that's what I'm saying and you've got to remember that: the economy is so much better.

That's a great place to finish, I think, Phil.

The economy is so much better? Yes.

That's a great line, I think.

Please thank Dr Lowe again.