Transcript of Question & Answer Session The Costs of High Inflation

Our audience who watches our news are not economists. They’re people with mortgages or people who hope to get them. So, in terms that they would understand, given that the National Accounts have shown that household consumption has undershot significantly the Reserve Bank’s forecast, they might wonder - in simple terms - if they are spending less according to the National Accounts, why are you not adjusting down your predictions about what you’ll do with interest rates?

In simple terms Hugh, it’s the difference between growth rates and levels. It’s true that the growth rate of GDP has slowed. GDP itself was around where we forecast it would be, but the components were a little different. Consumption was a little softer. But part of monetary policy’s job has been to try and slow the growth of the economy because the level of demand for goods and services in the economy is higher than the ability of the economy to supply those goods and services. So there’s still a gap there. So even though it’s slowing, we still have this gap. Part of that is because the supply side of the economy isn’t performing as well and productivity is part of that. Part of it is that demand was so strong coming out of the pandemic that its level is still above the ability of the economy to supply the goods and services. That’s why inflation is still there. So I understand why people would think that as things are slowing, that should be a reason to lower interest rates. But we need to see the results in inflation before we can do that.

You talked about the RBA’s consideration of both inflation and full employment objectives. The RBA Review recommended they be given equal consideration but then the government didn’t take that on board so it’s still at the discretion of the RBA in effect. I was wondering how you or the Board or the staff come about in determining what the relative importance to inflation and output objectives should be given it is seemingly quite different for the RBA to other central banks and has been important in determining the path of interest rates?

I would have to say I think the Fed has a fairly similar narrative to us as well in terms of the employment side of the mandate. There’s no science to it Jonathan, as you probably understand. What we’ve been trying to do is manage the excess demand down to a point where it’s not recessionary. Unlike some other countries where they now have a negative output gap in effect, so their supply is higher than their demand, we’re trying to do something which means managing down the excess demand to a point where it’s just in line with supply. That’s sort of the way we’re trying to balance the two objectives. I think it would be quite easy to imagine - and you’ve seen it in some countries. In some countries they are seeing - and I’m thinking Canada, New Zealand - they’ve seen their unemployment rate rise quite sharply. I would argue they were a bit more restrictive than us. So we are somehow trying to manage this process to keep enough restriction in to bring demand down but not to the extent that it ends up in oversupply. I’m not sure that quite answers your question. There’s no scientific way of doing this, but we’re attentive to both. Having said that, if inflation doesn’t come down, it might be that the best medicine is, in fact, that we have to end up putting more restriction into the economy.

You spoke about what your predecessor describes as the narrow path the RBA is navigating between bringing down inflation and holding on to labour market gains. The Treasurer used less generous language this week when he said that successive rate hikes under the RBA was smashing the economy. Do you feel that public criticism by the Treasurer and others of the RBA and its high rates is fair?

I understand that people are hurting from high interest rates. I do understand that. But I think as I tried to set out in the speech, it is actually high inflation that is really causing trouble for people and it’s causing trouble for the most vulnerable. It’s affecting everyone. So the role of interest rates in this is to try and temper demand. That’s what monetary policy does and it’s working. It’s clearly working. But we need to see the results in the inflation numbers. That’s what we need to see, inflation coming down because, as I said in the speech … if we don’t get inflation down it’s bad for everyone, absolutely everyone. That’s the job I’m focusing on. That’s the job the Board is focusing on. I really think the Board thinks at the moment we’re still on that narrow path. And that’s what we’re trying to achieve.

Were those comments unfair then, would you say?

I have no comment to make on the comments.

Just a follow-up slightly from my colleague there. From the comments you made in your speech today, debt arrears not particularly picking up, maybe five per cent it seems steady, there were significant challenges, that would imply from your comments you do not think that the economy is being smashed, just to be clear, as the Treasurer suggested. My actual follow-up question, the one I was going to ask: central bank forecasts, as you noted in your speech, are predicated on market expectations for the cash rate. Because the Board sets the cash rate, you in a way can load the dice. Do you have a model output run based on where you think the cash rate is actually going to be and does that produce a different outcome for say how high the jobless rate is going to go? I think the highest in the August SMP was 4.4 per cent, but you keep saying interest rates unlikely to be cut in the near term. The market is factoring that in. I’m wondering whether you have a different outcome about where the RBA thinks the actual cash rate path will be?

We have models obviously which have various cash rate - and you can put various cash rate paths in and reverse engineer them. You can say if I want inflation down to the target range by middle of next year, what would the model imply the cash rate target has to do? Again, I want to come back to that fan chart there. These models and central projections are subject to a great deal of uncertainty and error. As you get closer obviously you get more certain, but going that far out it is difficult. Yes, we can do that exercise and in the Statement on Monetary Policy we did have some scenarios which had some different paths for unemployment and consumption. Some of those could be paths that have different interest rate scenarios in them as well. It all depends on—I think the models itself you would typically use more for reverse engineering what you want to achieve in inflation. I think you would see, I can’t give specifics because I don’t know the actual numbers, but if you wanted to put in the cash rate path that generated a return to inflation much more quickly, then my suspicion is yes, it would increase the unemployment rate.

Given the RBA has one blunt instrument, as you put it, in interest rates, does the Federal Government need to be doing more to bring down inflation?

The Federal Government and the Treasurer said a number of times he is doing his bit to try and bring down inflation. My job is to focus on what I can do, which is only the interest rate. I think all the governments are conscious of it because, quite frankly, all their constituents are suffering from high inflation. So I think they are focused on it.

You told us again that you’re vigilant to upside of risk on inflation and you started your speech by showing us your forecast for trimmed mean inflation. For my sins, I look very closely at that chart and if I get a ruler out, you’re looking for 3.5 per cent year ended for Q3 2024. If it’s 3.6 or above, will you hike?

I couldn’t tell you that, Phil. The Board isn’t going to focus on one single number. They’re going to focus on the breadth of information that they are receiving. Yes, the inflation numbers will be one, but there is also activity, there’s labour market data. So I couldn’t say.

Thank you. It was worth a try.

Back to the smashing of the economy comments from Jim Chalmers, the opposition leader has said today that you and the Treasurer are at war. Are you?

He’s doing his job and I’m doing mine. I wouldn’t use those sorts of words.

Variation of the same thing but slightly less confrontational. Do you think the trajectory of State and Federal Government spending is sustainable?

Slightly less confrontational. I’ve said a number of times in the past, and I’ve said it to the parliament as well, government spending is not actually the main game here. I think as we saw in the National Accounts yesterday, consumption is really weak. We are looking for a recovery in consumption but if that doesn’t occur, then that’s actually going to be a really important piece of information and it’s also going to be really important for the inflation outcomes. I think basically we should be focusing on the breadth of what’s happening in the economy, demand as in total demand and not focusing on individual components and thinking about what that means for the inflationary pressures in the economy.

One inelegant interpretation of your speech might be that high inflation is smashing the economy. Yesterday’s National Accounts showed that the household sector is doing it pretty tough at the moment. Do you think it’s possible that the actual cure for demand being so high of a restrictive monetary policy is actually worse than the problem of high inflation?

No, I wouldn’t say that high interest rates are worse than the problem of high inflation. I think what I tried to demonstrate in the speech today was that high inflation hurts everyone and it hurts the most vulnerable the most, to repeat what I said in the speech. For those reasons, using interest rates to bring inflation back down to target is absolutely worth achieving that. I should say that - back to the narrow path point, we’ve tried to raise interest rates to get them restrictive enough to bring inflation back down to target without overdoing it. We’ve been sometimes criticised for that. Some people have said you should have gone as far as the Feds gone. We haven’t. We tried to maintain an interest rate that is as high enough as it needs to be to bring inflation back down. I do believe and I know the Board believes that that is the best course of action.

My name is Max. I’m actually here as an individual. I’m not representing any institution. I’d like to thank you for your speech today and your address to the House of Representatives last month. I think many people also appreciate your emphasis on the construction sector and the rising costs and shortage of labour. Given most materials from construction come from imports from overseas, is the weakening of the Australian dollar or movements in the Australian dollar in the future going to be a consideration of the Board when looking at interest rates?

The floating exchange rate is good in the sense it gives us the ability to set our own monetary policy based on domestic conditions, so we have a bit of flexibility. Having said that, when setting interest rates it might have implications for the exchange rate depending on what other countries are doing with their interest rates as well. Yes, we do have to take that into account because it does have impacts on inflation. At the moment, though, with other countries easing or looking like they’re going to ease and us sort of staying where we are, the pressures are probably in the other direction for the exchange rate, keeping it slightly more elevated, which is positive for inflation and, therefore, positive for import costs as well.

For many years there was only one monthly CPI indicator and that was published by the Melbourne Institute, which is the entity which produces the HILDA data, which is highly regarded. I was never in love with the Melbourne Institute’s CPI measure but it does seem to track quite well the big trends in inflation. It was below 2 per cent for the pre-pandemic period, it surged to 6 and a half per cent and it came down to four per cent. Then in the latest six months it has come right back down to 2 and a half per cent in August. Does the Reserve Bank follow that measure, keep track of that measure and does it see anything promising potentially signalling that inflation may fall sooner rather than later to where the Reserve Bank wants it?

We do follow that measure obviously and we also follow the monthly variability in the ABS monthly indicator as well … We read some information from that and we read some information from the Melbourne Institute. But really the comprehensive CPI is the best we’ve got in judging what’s happening, particularly to these categories we are focusing on at the moment, the things that are really holding inflation up. Yes, it’s slightly encouraging but again, over the last year we haven’t seen much progress on disinflation. So, we really need to be convinced that we’re going to see it in the actual numbers and we are going sustainably back to target before we think about reducing interest rates.

So, the official Q3 CPI on 30 October is the next good inflation indicator?

It is one indicator and we will obviously be looking closely at it, but there will be other things taken into consideration as well.