Transcript of Question & Answer Session The Reserve Bank Review and Monetary Policy

The first question is about two well-known US economists, Larry Summers and Ken Rogoff. Larry Summers, for those who don’t know economists, was the Secretary of the Treasury in the Clinton administration and also became President of Harvard; Ken Rogoff was a former Chief Economist of the IMF. So both of these people spoke at the American economics annual meeting this year – at the beginning of this year – and both of them suggested that there were demographic issues where interest rates were going, and they suggested that labour force growth had fallen as baby boomers retired and Millennials now dominated the workforce and, because workforce growth was lower, unemployment would remain lower; and, because unemployment would remain lower, real short rates were higher. Since then, Larry Summers has suggested that real short rates would also be higher because of the US budget deficit. So do you think we are entering a period where real short rates are structurally higher than they’ve been in the previous period?

Well, it’s a very good question, and the truth is no­one can be sure here. But I can tell you that this is how I think about it: the real rate is being influenced by the underlying rate of productivity growth in the economy and the balance between savings and investment. So, is productivity growth going to be higher or lower in the next 20 years than it has been in the last 20 years? I don’t know the answer to that. There are some people who think that advances in science mean that we’re on the cusp of a new period of stronger productivity growth, which would mean the return on capital was higher and that would generate higher returns on investment. So that’s possible, but the evidence so far is not particularly encouraging for that proposition, with productivity growth having been weak for a number of years. So the other perspective is the balance between savings and investment; and the ageing of the population in the advanced economies will lead to less saving, so that tends to put upward pressure on interest rates over time. The other consideration here is the energy transition. In many countries, countries need to replace their existing capital stock producing energy with a new capital stock to produce and distribute energy, and that’s going to create investment demands as well. So, the short answer is: no­one can be sure, and there are factors working in both directions.

My second question is, again, Larry Summers, and Larry Summers gave the annual keynote address last month at the Peterson Institute in Washington DC and, at the end of that, he made the following interesting comments about the communication of monetary policy and the views on monetary policy, and he said:

‘My broad view is that Paul Volcker and Alan Greenspan understood what the Oracle of Delphi understood which is, if everybody thinks you are, on this, omnipotent and omniscient, it is a very good idea to speak vaguely and in an oracular way so as to preserve the illusion and, therefore, you should not get engaged in specific numerical targets and you should not get into predicting your future action and what it is going to be.’

So my question is do you agree we’d all be better off if forward guidance went back to being as vague as the Oracle of Delphi?

I don’t know that it should be that vague. But from my perspective, what we’re trying to do with our communications is to tell people what we’re doing, why we’re doing it, the factors we’re taking into account and how we’re balancing the trade-offs. So that’s our general approach. During the pandemic, we had a different approach, and that was because we thought – well, we were at the time in truly dire circumstances, and we thought the dire circumstances that we faced called for a different approach, and we were explicit about what we thought was the likely path for interest rates; now it turned out we were wrong there. But we thought at the time, given the circumstances and the forecasts, that was the right thing to do. It’s not going to be the right thing to do most of the time, and we’ve had a review of our forward guidance, which talked about our new approach of explaining what we’re doing, why we’re doing it and the trade-offs we’re trying to manage and allowing every individual to make their own judgements about the likely path of interest rates, based on the information we’ve provided. I think that’s the better approach most of the time, but that doesn’t rule out a more explicit approach in dire circumstances.

Bringing you now to the question that was the subject of a competition in secondary schools’ economic programs – and it was won by Brisbane Girls Grammar; they invented the next question.

So the question runs like this. Since 2022, most advanced economies have been hiking interest rates in a similar pattern to fight inflation. Interest rate changes in foreign economies, such as the US, have an important impact on our inflation and exchange rates, so we wonder – this is the precise question – ‘How much of an impact do decisions made by other central banks have on Australian monetary policy?’

Yes, it’s a very good question; thank you. All the central banks are raising rates, or at least most of them, for the same reasons: inflation is too high, first of all, because of COVID supply disruptions and because of Russia’s invasion of Ukraine and then, more recently, because of strong growth in unit labour costs, strong growth in wages relative to productivity, and that’s keeping services/prices inflation high. So that’s a common story across most of the advanced economies and that’s why we’re all raising rates. We’re not raising rates here because the US is raising them, but we’re raising them because we’re facing the same general economic situation as the United States. So that’s how it works. There is a potential link through what other central banks do through the change rate because if the US was to raise rates and we didn’t, then the US dollar tends to strengthen and the Australian dollar would depreciate and that would bring inflation into Australia. So that could at the margin influence our decisions, but it’s very much at the margin. We’re raising rates because we need to because of our particular circumstances, not because the US is.

Governor, what’s your latest thinking on this ‘greedflation’ hypothesis being advanced by the Australia Institute that the inflation is largely being driven by greedy corporations?

I’ve addressed this before. The aggregate data show that the profit share, excluding the resources sector – I think it’s appropriate to treat them differently – the profit share hasn’t risen in Australia. What we’ve seen is firms being able to increase their prices in line with the higher input costs. So, they’ve been able to pass on the input costs fully and preserve the profit margins, but the profit margins have not blown out. There are some specific firms where you could say their profits have increased but, by and large, they’re contained to specific areas of the economy and, across the economy as a whole, profit margins have not risen. So, it’s not the source of inflation; it’s contributed in some cases, but it’s not the primary source of inflation.

In spite of my almost unbounded love for my friend, patron and co-author Larry Summers, I’d like to counterpose his praise for oracular ambiguity in Central Bankers with something Janet Yellen told me in private in 1999, which was that she thought the decisions of the Federal Open Market Committee in the 1990s would have been vastly inferior, had they not felt themselves anchored very tightly to a quantitative specified Taylor rule. As the Reserve Bank moves forward into its new regime, I think it’s clear that it’s headed for a way in which the pressures on it, following Janet’s rather than Larry’s view of the situation, are going to increase; and it’s premature to think about what the consequences of those would be, but I would ask everyone to think about them.

Perhaps I’ll just ask you a question then. So, the discussion then was about monetary targets, so do you support monetary targets or not?

The Taylor rule was almost overwhelmingly in terms of interest rate targets. There was just a small amount of monetary targets but, with the way John Taylor had posed his original paper, it was very much, in terms of real interest rates, reacting to inflation and on point. At least Janet’s reading afterwards was that the Federal Reserve would head off outside the fences and be bounding away into the outback, if it had not felt that it had to stay within at least shouting difference of what John Taylor would say next month that the interest rate ought to have been.

Canada, the UK, New Zealand and the USA have all started their monetary targeting earlier than Australia and currently have higher interest rates than in Australia. Can you speak on the RBA’s decisions thus far to be less aggressive than our partners in our cash rate hikes; and, given that Australian inflation is higher than in most of these countries, is there potential for not just further tightening but more aggressive tightening as well?

Thank you. It’s a good question because most other central banks have higher interest rates than we have, so it’s a good question about why we haven’t raised rates even further, and there are a number of factors. The first is that nominal wages growth in Australia is still lower than it is in most other advanced economies. At the aggregate level, wages are growing between 3½ and four per cent. In the US, Canada and the UK: above five per cent and, in some cases, above six, so it’s quite a difference. A second – this is related – is that the labour supply in Australia has turned out to be a lot more flexible than it is in some other countries. Our participation rate here is setting record highs every month. So that’s, of the domestic population, more and more have entered the labour force and so the supply side of labour is much more flexible than in the US, where the participation rate still hasn’t got back to its previous peak. So, they are the two reasons why the kind of underlying inflation pressures in Australia are less than they are in some other countries, and it’s really important that that remains the case. If we saw Australia in the same situation as in the US, Canada and the UK where wages were growing at six per cent, that would have implications for our setting of monetary policy. The other element is we’ve been prepared to allow inflation to come back to target a bit more slowly than some other central banks. As I said in my prepared remarks, we’re expecting inflation to come back to the top of the target band by mid-2025. Many other countries have inflation back to target at the end of ‘24. We’ve been prepared to go a bit slower to try and preserve those gains in the labour market that we’ve got over the last two years. It took us nearly 50 years to get back to full employment. Now we’re probably through that, but youth unemployment is the lowest it has been in decades and people have been able to get jobs and get more hours. So that’s a huge economic and social benefit. So, we took the decision to go a bit more slowly back to the target than some other central banks to try and preserve that, and I still hope we can manage it. The risk that we run in that strategy is that people think we’re going too slow and inflation stays too high for too long, and they think we’re not serious and inflation expectations adjust. So, I want to assure you we’re deadly serious about this. We will get inflation back to target, and we’re going a bit slower than others because we want to preserve the gains in the labour market. If it turns out we can’t do that, we will have to take the decision to be tougher and get inflation back to target because none of the problems the country faces are going to be made easier by inflation staying high. We’ve got to get inflation back to target; we’re prepared to take a measured approach. But there’s a limit to how long we can take to get inflation back to target and we think if we get if back in 2025 and preserve the gains in the labour market, that would be a good outcome for the country.

Governor, my question is actually about the case for going slower. Before COVID and since 2014, the entirety, I suppose, of your time as Governor and before you became Governor, the cash rate had been below the centre of the Reserve Bank’s target band. It had been resistant, or the Bank had been resistant to – sorry, the inflation had been below the target band – resistant to attempts to increase it for however many years. Since 2014 – since COVID or since 2021, it’s been above, and the Bank is talking about getting it back down; the forecast is mid-’25. Now, this man here raised this question this morning that I want to put to you. In his talk to the Economic Society conference, he said, ‘Why should the period where inflation is permitted to be above the target be so much shorter than the period you and your predecessor allowed inflation to be below the target?’

There is a balance to be struck here. Remember that the size of—

It’s not the symmetrical—

the size of the deviation is much – I mean, when inflation was below target, it was sitting in 1½ to two for a while; you’ll remember we’ve had inflation at seven-plus per cent, so there’s a difference there. As I said before, we’re prepared to allow time for inflation to come back to target, but the balance we’ve got to strike is to keep inflation expectations contained. If we were to say, ‘Well, it doesn’t really matter that much; maybe we can take four or five years of inflation being high’, then people might rightly wonder how serious we were. And, once inflation expectations start adjusting, firms are more likely to adjust their prices as their input costs go up because they think, ‘Well, inflation is going to stay around; I may as well raise my prices,’ so the whole inflation psychology shifts. So, we’re trying to keep the inflation psychology contained and, I think to do that, we’ve got to demonstrate a clear commitment to get inflation back to target within a reasonable time frame, and I think at the moment we’ve struck the right balance.

I will get to the elephant in the room. Given the Federal Treasury and Cabinet will soon decide your fate regarding another term, would you please – can you assess your views on how you’ve been in this current term as Governor; and, if you give that answer short shrift, which I’m sure you will, I will follow up with a second question about the RBA’s narrow dual mandate. Obviously, do you think it will dampen your determination to get inflation down? Thank you.

In terms of my own position, as I’ve said before, if I was asked to continue in the role, I’d be honoured to do that and I would continue. If I’m not asked to continue in the role, I’ll do my best to support my successor, and the Treasurer has said that he’ll make an announcement before the end of this month. So, I haven’t got anything more to add on that. The RBA has had a dual or actually a tri-mandate since it was established in 1959. We’ve long had a mandate for price stability, full employment and the economic prosperity of the people of Australia. I’ve been perfectly comfortable with that in my period at the central bank; I think it’s the right general mandate. The Review endorsed the continuation of a dual mandate with price stability and full employment and making the welfare of the people an overarching principle of the Reserve Bank. So, the change in legislation on that particular issue is of no real substance and won’t affect decision-making.

I’m a final-year student in finance and economics at Griffith University. Also, it’s quite an honour to be here. You’ve done an incredible job so far in your role; I’m sure it’s not that easy. My question is: the changes you’ve mentioned today following the Review recommendations were all centred around the theme of increasing efficiency in communication to aid the decision-making process of the RBA. And now we’ve seen, as far as AI and ChatGPT, all of the big banks, as I’m sure you’re aware, have already started employing them in a lot of their decision-making processes. So, my question is: what is your thought on how the RBA can employ any sort of AI in their decision-making process?

We’re currently doing it; and John Simon, head of our research department, just here in front of me, is leading much of our work there. It’s new, isn’t it? So we’re all trying to work out how best to use these new technologies, and I’m sure there’ll be opportunities for us, but we’re still trying to identify it. Our main technology issues at the moment are operating the nationally important payments infrastructure. Now I hope everyone knows that you can move money between any two bank accounts in the country in five seconds; that goes through the Reserve Bank’s infrastructure. So, whenever money goes from one bank account to another in the country, it goes through the computers in 65 Martin Place. So, our main technology priority at the moment is to make sure that those systems are safe, secure and robust and protected against cyber risks. In time, John and his team will, I’m sure, come up with opportunities to take advantage of AI.

Governor Lowe, you mentioned greater collaboration through the Council of Financial Regulators as one of the Review recommendations you’re looking to take up and implement. I want to take you back in time. What discussions did you have with APRA and the Morrison government about the removal of the seven per cent floor on the mortgage serviceability test in 2019; and in hindsight, has the removal of that floor increased risks in the economy and limited the RBA’s flexibility in setting interest rates now with the inflation challenges facing Australia?

My memory isn’t good enough to remember the specifics, but we have recently been talking with APRA about the three per cent intra-serviceability buffer, and I think that’s the right size of the buffer because it picks up not just interest rate risk but other risks that borrowers have. So this has not been a major topic of discussion over recent times. I think the macroprudential interventions in Australia, by and large, have been successful. There were restrictions, remember, on interest-only loans and on investor loans. Remember, at one point, almost half of the loans being made in Australia were interest-only and many to investors, and it was a sign of speculative excesses; and, together with APRA, we thought it was the right thing to curtail that. And then a three per cent serviceability buffer on mortgages I think it’s the right thing. So the relationship between the RBA and APRA has worked very well and, when the government’s been involved, it’s been constructive.

This morning, the Treasurer said that, in canvassing options for the position of Governor, he would be giving very careful consideration to the opinions of his parliamentary colleagues. As someone who came through the Reserve Bank to the Governor’s role, does it concern you that consideration is being given possibly to the electoral implications of the Bank’s decisions and that too much weight is being afforded to the view of backbenchers within the Labor Party?

It’s a perfectly appropriate thing to do for the Treasurer to consult his colleagues; I would expect him to and I would hope he’d too. So that’s what he should do and that’s what he’s said he’s doing, and an announcement will be some time before the end of the month.

Thank you, Governor. I have a question on your inflation outlook. You sounded a lot more hawkish on upside risk to inflation in May and June and not so hawkish on those upside risks in July. Are you more confident that interest rate increases so far are working compared to your confidence level in May and June; are you more confident now versus the previous two months about monetary policy tightening?

Well, I’m confident that the higher interest rates are working. Talk to any retailer at the moment; they say, ‘Spending is slowing; people are trading down to cheaper items and, in some cases, smaller baskets.’ So, consumption growth is weak, and that’s largely because of what’s going on with monetary policy but also the decline in real incomes from higher inflation. So, monetary policy is working. The issue is: do we have to do more? And, as I said in my prepared remarks, that remains to be determined. It’s going to be determined by our assessment of the inflation risks and outlook and what’s going on with domestic spending. So, we’re confident that what we’re doing is working. The question mark is: how much more do we need to do and we’ve got a completely open mind on that question.

Lucky last. We know that migration has proven to be a lot stronger than anticipated. We’re seeing that in rising house prices, which comes as a surprise, and rising rents. How is this playing into the RBA’s decisions around interest rates, moving forward?

It doesn’t have a direct influence; it has an indirect influence though through a couple of channels. The fact that there are a lot more people coming into the country has eased pressures in some labour markets, particularly in the hospitality sector, because a lot of the increase in the population over the past six months has been students and they often work in the hospitality sector. So, our liaison with firms in that sector say it’s easier to get workers, and that has taken some of the heat out of that labour market. So that works in the short term to push inflation down. On the other hand, all these people coming in have to live somewhere, and that’s pushing up rents and housing prices. We thought housing prices would continue to decline this year, but they’re not. In Sydney, they’re rising quite strongly again and that’s linked partly to the influx of immigration. So, there are pluses and minuses in terms of the inflation outlook: helping to contain wages growth but putting upward pressure on rents. But the more general point that we talk about at the Bank is, if we’re going to have a lot more people in the country, which is good, we need the capital stock to support those people; otherwise, the output capital/labour ratio declines, and that’s bad for productivity. So, population growth brings huge advantages to the country, but we need governments and businesses to keep investing to build the capital stock to support a stronger population; and the housing market is the clearest example of that, but there are a lot of other examples as well. So, it’s a broader issue than just the short-term inflation element; it’s how do we build the capital stock to support a larger, more diverse population, which I think is in our long-term interest.