Transcript of Question & Answer Session The Neutral Rate: The Pole-star Casts Faint Light

I think, as an economist, I found that incredibly informative and I really do appreciate the fact that you’ve actually brought down to first principles, how the RBA thinks about the neutral rate. I actually think that, as we go back and digest this speech, I think this will prove to be one of the most important RBA speeches, I think, that’s been given since the start of the pandemic. I really do think it was that good. We do have time for questions, and I’ll be moderating those. I will take the prerogative of being able to ask the first one.

You did mention in your speech that, you could in Australia- the r* is at least 2½ per cent- and you showed the range of estimates around what looked to be closer to sort of 3, maybe 3½ [per cent], in a neutral nominal sense. I’m just wondering whether, having moved the cash rate from 2.35 to 2.6 per cent at the most recent meeting, whether that thinking about’neutral’ was something that impacted the decision to move from 50 basis points to 25 [basis points], or if you could tell us what other considerations the Board and the staff made in making that new decision?

Thanks for that, Josh. Look, I’m not going to talk specifically about the discussion in the Board. The minutes will provide some more information about that when they come out. I want to just acknowledge that a lot of my speech was based on a briefing that we gave to the Board in July and to thank the team who put that together. So it was part … Certainly, you know, we’ve had those discussions with the Board over a couple, over a range of months and, particularly in July, and so that is part of the background of the discussion. But, yes, there were plenty of other decisions around those tactics. So I guess the way you can think about it is, we knew zero was not right anymore, we needed to get back to somewhere that was not obviously out of whack, where we end up with, really, as I said in my speech, just depends on what else is going on. There have been so many significant shocks in the economy. We’re seeing, a lot of the supply-base shocks that stem from the pandemic are starting to come off now, but we’re now grappling with a global energy cost shock, and that could persist for a while. So other things are going on but, we’re no longer, manifestly, in an expansionary place. And so, there are a number of factors that went into the decision about how much to move this month, but the knowledge that we were no longer, incredibly expansionary was part of that background.

Thank you for that. We do have some roving microphones so if you’d like to ask a question of Dr Ellis, please put your hand up. Yes, we have some questions already. We have Matt Sherwood and Brett Gillespie, they can fight over who gets to ask first. The microphone is coming around.

Thanks. Brett Gillespie from CBA Treasury. I noticed quantitative easing or global quantitative easing doesn’t figure in any of that calculation. Is that something—can you explain— is that something that has no effect on neutral interest rates? Is there any sort of savings/investment dimension there?

I think, the neutral rate being a long-run concept, it doesn’t … it shouldn’t affect your neutral rate, but it does affect where you are at the moment. And so, quantitative easing/quantitative tightening are in that bucket of’other things were happening’ and you have to allow for that.

Thanks for your presentation, Dr Ellis. I’m really intrigued by the usefulness of r* more broadly, particularly in the world we live in now with decarbonisation and where energy prices in northern-hemisphere winters may skyrocket and then just come back when demand falls away. But the big interest is actually the confidence intervals around it and how you balance the average estimate around that confidence interval, because you couldn’t be statistically confident that you actually know whether you’re stimulating the economy or restricting it.

Yeah, I mean … thanks, Matt, and such formality, we’ve known each other long enough. But, really I mean, I think this is one of the reasons I gave the speech I gave is, I want people to understand that these star variables are not just these point estimates that you can say,’Well,’I’m going to go to here and then I’m going to do that’. That’s not how the world works, and the uncertainties of the task that we’ve been given are huge, so I think it’s important to acknowledge that. You know, I think it’s fair to say, when we had rates at zero, it was clear that policy was stimulatory. Where we are now, I think one could say there is some positive probability that we are not stimulating the economy, but I wouldn’t put that probability at anywhere near 100 per cent just yet.

Good morning, Dr Ellis. It’s Rory Robertson from Westpac Group Treasury. Dr Ellis, thanks for your talk on the detail of the neutral rate in Australia. I hope it is not unkind of me to observe that, across the world, from a practical perspective, pretty well all central—major central banks put rates way below neutral, near zero, the lowest rates in the history of humans across the world. And I think the consensus criticism from market investors and lots of other observers is that rates were kept ridiculously low for too long and fuelled a boom in labour markets and home prices and so central banks are part of the, causing, amplifying the cycle. Like, central banks in history have wanted to knock the tops off booms and, you know, put a base in recessions and in this case it seems to be the other around is the criticism. In Australia, I guess I was very surprised to see the Bank’s published liaison data in a six-panel chart that showed neatly that by the middle of last year, the economy seemed to be … So we’re all sort of fumbling around, trying to look at ANZ Job Ads and SEEK and NAB surveys and the GDP numbers and this, that and the other thing, trying to triangulate all the data and understand what’s going on. The Bank had, internally, a set of data that was perfectly consistent, was custom-made in the way that economists want, and all the data, the demand, the wages, the employment costs, prices, they were all normalising, and yet the Reserve Bank sort of wandered into 2022 with this extraordinarily low interest rate setting and with saying it would be patient. So there’s a criticism that says central banks should avoid fine-tuning and yet the Reserve Bank was busily fine-tuning, trying to get inflation up another quarter or half point, and then everyone across the world got caught with their rates down by the invasion of Ukraine. So you’ve got, now you’ve got, everyone is doing aggressive rate hikes, introducing new problems for—anyway. So rates were too low for a long, moving up very sharply, causing a lot of problems. So my question is if the Reserve Bank had its time again, given it’s got this great liaison data and given that there’s always the potential for shocks, would the Reserve Bank have started normalising rates earlier, given that the emergency seemed to be over, a year or two before? I mean, the other question, so would the Reserve Bank have moved rates up earlier and also is it fair to observe that the official families across the world grossly overestimated the potential damage to society and economies from what turned out to be a relatively weak virus?

Well, thanks Rory … And once again, the formality, we’ve known each other a long time. Look, there’s a big red ticking clock that says I’ve got one minute 59 left before Larry Summers comes on screen, so let me try to do what I can in one minute 53. And, look, I think two points I’d make. One is, thinking back to a year ago or just over a year ago, we were still in lockdown. This was not … We were … It was quite unclear that Australia would continue forward with opening up. At the time, the discourse was all about’go hard, go early’ and Omicron hadn’t happened yet, we were expecting things to still be very weak and even the lack of clarity we had about … We knew that things tended to bounce back pretty quickly after lockdowns, but we didn’t have a whole lot of faith in that over the summer. And I also want to remind everybody of the context where, prior to the pandemic, we had consistently overestimated inflation and wages growth in our forecasts, we’d been continuously disappointed about wages growth, we didn’t fully understand why that was and we wanted to see inflation actually in the target band and be confident on the basis of, as you mentioned, not only hard data but our liaison, that wages growth was picking up as we expected so that we could be confident that inflation would actually be sustained in the target band; and I think the Governor has addressed this in some detail in the past as well. But, yeah, I acknowledge that that is a perspective and I can see why people have come to that conclusion, but I would … It seems like a long time ago now, but I think the context of where we were last year was one where you could not be confident of that fast bounce back. Thanks.

Thank you.

Thanks, Luci, and we are exactly out of time. I think we’ve had the fantastic introduction to day one the conference. As Luci said, we have Larry Summers in here now. But, if you prefer, there is actually a consumer grocery panel in the room across the hall. Thank you very much for your attendance.