Transcript of Question & Answer Session Panel participation at the Forum on Central Banking, hosted by the ECB

Stephanie Flanders

Philip Lowe.

Philip Lowe

Thanks very much, Stephanie. It's a great honour for me to be able to participate in this panel. In some ways I'm the odd one out here. I come from a small economy, not a larger one. We've had positive interest rates for the last decade, we haven't had to go anywhere near zero, we haven't done quantitative easing, we haven't embraced forward guidance. We've had 27 years without a technical recession; I'm hoping we can extend that a while longer. As I said, the odd one out.

But I don't really feel like the odd one out, though, because the issues we're discussing here in Sintra are really at the core of the issues we're discussing in Sydney. In Australia, the inflation rate has been below the mid-point of our target for some years, and it's going to stay that way, I think. Wage growth has repeatedly surprised on the downside, and the current rate of wage growth isn't consistent with us achieving our inflation target on a sustained basis. So, like others, we're grappling with why we find ourselves in this situation.

The fact that it's happening in so many countries suggests to me that there are global factors at work, and they're probably structural in nature, and the result of those factors is that the inflation process looks very different in many countries, and at the heart of that, I think, is the wage process, which looks different. Whether that's going to be permanent it's hard to tell, but it's certainly persistent enough that it's important for policy. So what I'd like to do in my time is to offer some reflections on two issues that are really at the heart of this conference, and that is why is the wage process different, and how much of it's structural, and what are the policy implications of that?

So the wage process, as I said, is different, so the relationship between wages and unemployment looks to have changed, and there are three sets of factors that I think are really important here. One is the changes in the industrial relations landscape, and we saw a really good example of that this morning in Professor Schonberg's paper. I think the evidence there's pretty compelling. Changes in industrial relations arrangements in Germany have affected wage and employment outcomes, and the Australian experience is very similar to the German one. It's hard to escape the conclusion that changes in industrial relations has changed the inflation process.

The second one, or the second factor, I think this is actually more important. There's increased perceptions of competition arising out of globalisation and technology. Everyone feels like there's more competition, and one of the first things you learn in economics is that if there's more competition, prices aren't as high. We've discussed this in the earlier session and there are a couple of factors that are driving this extra perception of competition.

One is globalisation. Hundreds of millions of extra people have entered the global labour force, particularly in China and India. First of all, that affected manufacturing wages around the world, and now I see it affecting services wages. Many more services sectors are becoming tradable. I see a lot of examples where business services that used to be supplied in Sydney are now supplied in Manila or Chengdu or Bangalore, and that's meaning that everyone feels like there's more competition.

The other factor that's adding to the sense of competition is the nature of technological progress. It's much more likely to be embedded in intellectual capital and physical capital, and we're also seeing widening gaps between the leading firms and the laggard firms, and both of those features are affecting the wage dynamics. With technology progressing so quickly, and particularly for the leading firms, many firms are having trouble keeping up. They're having trouble adopting the new technologies, and to remain competitive, they focus on what they can control, and that is their costs, and the main cost they can control is their labour costs. So the technology progress is leading, for many firms, to have a very, very strong mindset on controlling costs.

Again, I see lots of examples of this in Australia. Almost every business meeting I go to, business people complain that it's incredibly hard to find workers and I rather naively ask, "Well, why don't you pay more? Attract some workers from another firm." And when I do that, they look at me as if I'm completely mad. That'd be the last think they would do, and I typically get a lecture about how competitive the world is. There's competition from China and Japan, and they worry about technology because they say, "The last thing I can do is increase my costs. It's the one variable I can control. So there's a very strong mindset that I've got to control costs, and I think it's coming from competition." It's a global factor and a structural.

The third factor that's affecting the relationship between wages and unemployment is that labour supply in many countries is turning out to be much more flexible, and I'm seeing this in a rise in the participation rate. There are a variety of reasons for this. One is, and we see this again in Australia, rising labour force participation by older people as health outcomes have improved. We've seen big advances in the health outcomes for many people, and our bodies are lasting longer as we're working in services rather than manufacturing, and that's allowing people to stay in the labour force longer, particularly when they're in jobs there. I think that's quite an important factor.

The increasing acceptability of part-time employment is allowing many women in particular to stay in the labour force longer, so the labour supply is turning out to be quite flexible. So even though we're seeing very strong employment growth in a lot of countries, it's not translating into higher wages. So things look different industrial relations, increased perceptions of competition, and increased labour supply. I think those factors are going to be around for a long time, so I don't expect the situation that we're dealing with to change quickly.

So what are the policy implications of this? The main one, to me, is that the system that we're operating in looks less inflation prone than it once was, and that's reflected in most of us worrying about inflation being too low, not too high. It's a very different world than when I was at university. So listening to the discussion over the past two days, I've been trying to think about or trying to listen for ideas about how we deal with this world that is less inflation prone. I can take the liberty of summarising the things I've heard under three broad kind of approaches one could adopt here. One is that central banks should just try harder. The basic conception of how the economy is working is fine, we just need lots of monetary stimulus; we need to keep at that. We need to just try harder, and eventually it'll turn out okay.

The second perspective, a couple of people touched on this yesterday. We just need to accept that inflation will be low for a while. After all, low inflation isn't that bad. The central banks want to achieve their inflation targets. That's clear. But most people out there in the communities that we're supposed to be serving don't really care that much if inflation's a bit lower than the target, especially if the labour market outcomes are okay, if there are plenty of jobs being created. So the second perspective is, well, it's not kind of fantastic, but we've just got to be patient, accept that inflation's going to be low for while, and there's not really a great loss of social welfare from that.

The third perspective was one introduced by Uri yesterday. He said, "We'll just lift inflation expectations. Central banks should embrace social media, they should communicate better, make it very clear what inflation expectations should be, and the problem's kind of solved." I think you can make a case for each of those perspectives, and I don't think there's a right answer. I see a few problems, though, with the try harder approach just keep on solving this problem with monetary stimulus. I don't see the risk return trade-off from that approach being particularly attractive. In terms of return, the effectiveness of monetary stimulus in driving up inflation, I think there's a question mark over how effective that is, and I can see clear side effects, and the side effects come on the financial side.

If interest rates are low, and the economy is growing quite well, that's a great environment to borrow to buy assets, and we've seen some of that. So we see higher debt and higher asset prices. It's helpful now, but eventually interest rates will hopefully need to correct, and some of those developments on the financial side will need to be reversed, and that's going to pose risk. So the effectiveness of more monetary stimulus to solve the lack of inflation is questionable, and I see clear risk from doing that.

So I think that does leave us with the possibility of accepting that inflation might be just a bit lower than we'd like for a while. That's difficult for central banks to accept because they see their job to kind of deliver on the inflation target. But it's not so difficult to accept that if you see your job or your mandate as broader than just delivering on a specific rate of inflation.

In Australia, our mandate was written back in 1959, and it hasn't changed since then. We haven't swung with the fashions in central banking. We don't have a single mandate, we don't even have a dual mandate, we have a triple mandate. That's price stability, full employment, and the general welfare of the Australian people. That's an unfashionable mandate, perhaps, in this room, but I'm really glad that we have that mandate, especially in the current environment, and I use all three elements of that mandate when I'm explaining what we're doing and why we're doing it.

I often ask rhetorically, in public and to the politicians, do you think it would serve our collective welfare to have yet more monetary stimulus so that we can get back to inflation more quickly, if the main way we got back to inflation more quickly was encouraging people to borrow more and push up asset prices even further? Now, not everyone's going to answer that question the same way, but most people say, "Look, no, that's not worth it, especially if the labour market's generating sufficient jobs," which is certainly the case last year. We've had 3% employment growth.

So, in our case, my view has been that the welfare maximising approach, which is really what we're about, maximising the welfare of the people, is to be patient as long as the labour market is improving. As long as we're moving in the right direction, we don't need to force the process more quickly through monetary stimulus. One thing, though, that we have done in an effort to get there a bit more quickly is a version of option three lifting expectations. As I said yesterday, it's lifting wage expectations. My concern has been that a 2% wage norm has become the standard in Australia, and we're getting reasonable labour productivity growth. So 2% wage growth and reasonable labour productivity growth doesn't make for two and a half percent inflation on a sustained basis. I've been talking publicly quite a lot about trying to lift wage norms back to start with a three rather than a two. Whether that works or not, I don't know but I'd rather do that than try and deliver more monetary stimulus to get inflation to rise on track rather than do it by trying to lift wage expectations. Thanks, Stephanie.

Stephanie Flanders

Thank you. Governor Lowe, I'm interested in that context, the conversations that we had yesterday about whether or not central banks can really change people's expectations and the difficulty of talking to households and really changing their way of thinking when they're often really not wanting to pay attention to you at all. How do you think about your capacity to affect that wage growth? You say that's a major focus now. Is it harder to do that because we're so concerned about talking to markets that it's harder for us to talk directly to households, as I think Charles Wyplosz was saying yesterday?

Philip Lowe

Yeah, I'm not trying to talk directly to households on this particular issue. I'm trying to talk to businesses. We've got the situation where we've got the Central Bank Governor calling for higher wage growth, the political leaders on a centre right government calling for higher wage growth and senior members of the business community calling for higher wage growth. Yet it doesn't happen. Then when I talk to individual businesses, they kind of agree in principle the country would be better off having wage growth of three point something than two point something but …

Stephanie Flanders

But they don't like being told what to do though, presumably.

Philip Lowe

But not in their business. The reason that it shouldn't happen in their business is they're so worried about competition. In a market economy, we don't have the coordination mechanism to get to something which I think would be a better outcome, because no individual business wants to put up its wages more quickly than its competitors. It's a first mover problem. The thing that I'm trying to do and I don't know whether it's going to be effective is to help solve that coordination problem by saying look, it's okay to give wage increases of three point something and if that can become the norm, think we'll be better off. I don't know whether it's going to be effective or not.

Lars Svensson, Stockholm School of Economics

I have a question to Philip Lowe. He was nervous about the side effects of lowering the policy rate and raising inflation to the inflation target in Australia, nervous about the side effects of that. I would like to point out to another side effect of undershooting your inflation target. If you do that on a sustained basis, if you accept lower inflation on average than your inflation target, that is like having an implicit unofficial target below the official target.

Once the market and the general public understands that, they will lower their inflation expectations by the official equation. That means that the average policy rate will then be correspondingly lower and the gap to the effective lower bound will be shorter, smaller and we will more likely hit the effective lower band in the future. Doesn't that make the economy less resilient and more vulnerable? Isn't that a pretty important side effect of undershooting your inflation target?

Stephanie Flanders

Okay, I think we'll try and take a question from Ben Friedman as well, and then …

Ben Friedman, Harvard

My question is for any or all of our distinguished panellists. The overwhelming focus of discussion at this conference has been about how the flattening of the Phillips curve has made and is making it more difficult for our central banks to raise inflation up to their stated targets. I hope each of you has been thinking about the reverse of that proposition, which is that in the event, we hope unlikely, that something goes wrong and we wind up with inflation above our central banks' targets, then either because the central banks' policy is behind hand and slowing the economies or something goes wrong with oil prices, there's of course the usual laundry list of things that could go wrong, the same flattening of the Phillips curve we've been talking about would then make it more difficult for our central banks to reduce inflation back down to the targets.

In a world of dynamic strategy for policy, surely that implication has some bearing on policy today. So I wonder whether our central banks have taken account of and are thinking about the potential difficulty in which they would find themselves should inflation for some reason or other over the next some years, wind up being in a situation in which not how do we get from one to two, but how do we get from three or something like that to two.

Stephanie Flanders

We've got a cluster of questions in the same place. I promise I will ask questions from other parts as well but there is a third question just here, actually, right next to … Then we'll go to the panel.

Stefan Gerlach, EFG

So my question is also to Philip Lowe and it's along the lines of Lars' questions. Philip, you mentioned that the public may not care very much if inflation is one percent or if it's two percent but anyone who has borrowed is going to care about what the actual inflation is. In particular, governments are going to care. They borrow under the assumption that the central bank will deliver on the inflation target. If inflation ends up being unexpectedly low, exposed real interest rates end up being unexpectedly high. Now that's not a problem if you have a public debt to GDP ratio of 40%, which I think is the Australian case. It is a problem if the public debt to GDP ratio is 140%, which is the case in some countries. Now one can, of course, argue that this is just an example of poor fiscal policy in the central bank should simply disregard this but in practise, shouldn't the central bank worry about the public finance consequences of running unexpectedly low inflation? Thank you.

Stephanie Flanders

Philip Lowe, do you want to answer the couple of questions that were particularly related to you, but then I think others will probably have remarks.

Philip Lowe

Thank you. I acknowledge the risks that both Lars and Stefan talk about but in my mind, they're relatively marginal. Our fiscal policy, we've had disciplined fiscal policy for a long time so we don't have a public debt issue at all. I remain confident we're going to get back to two and a half percent. It's just going to take us a bit of time. I accept that it's going to be a gradual process and because it's gradual, people might lower their inflation expectations but if we keep communicating that we're shooting for two and a half and we're making gradual progress towards that, I don't think we're going to see a persistent decline in inflation expectations.

There is a risk, though, that happens. Balancing that risk against the risk that would come from pursuing a policy that pursued a more rapid return of inflation to two and half percent and in the environment we've been in, I see the risks being quite large from trying to get inflation up more quickly. We've been one and three-quarters to two. I think we can live with that for a while. To try and get it back to two and a half very quickly, it would be mainly through people borrowing more money and having higher asset prices. I think that's a much bigger risk to our economy than people having surprisingly low inflation expectations. We've got very high levels of debt, very high levels of asset prices and I think that's our number one domestic risk, not people having lower inflation expectations. I'm trying to balance those two things off.

Mario Marcel, Central Bank of Chile

President Draghi made the reference to underlying inflation and core inflation and it seems odd to me that we have been discussing price dynamics over a couple of days, and very little reference has been made to core and underlying inflation, which is quoted by central banks very often in justifying their decisions. So maybe one reason for that is that the most common measure of core inflation that we have, which is excluding food and fuels, may be too crude as a measure of core inflation, so I wonder how much of what we have discussed these days about building alternative price inflation indicators may be already integrated into the kind of analysis that central banks make, particularly President Draghi has made reference on a number of calculations that are made by the ECB.

And a second question is that we have discussed a number of factors that may be pushing inflation down, some of which look like a one-off, but given that there may be a number of those, the effect may be more lasting. But I wonder how would you react to another one off change in prices which is raising import tariffs, how would you look at that in terms of measure inflation and the response of the monetary policy.

Stephanie Flanders

So there was a question about the price setting that happens from tariff setting, I guess the broader question coming out of things like even the retaliation that we had announced today from the European Union is when does this trade issue start to have a meaningful impact on your assessment of the strength of the global recovery, and potentially monetary policy going forward? Chairman Powell?

Jerome Powell

Great. So that's your question for me?

Stephanie Flanders

Well, no, there was a mention of trade that I was just clarifying.

Mario Draghi

Maybe I can take the import tariff questions, if you want, and you take the forward guidance because after all you lift it. We don't. Frankly, what is about tariffs, what is being projected in the last set of projections are the tariffs that have been implemented already which don't have a very significant effect either on output or on prices. A completely different analysis would probably be … well, we haven't done it yet. When we will consider the tariffs that have been announced or implemented since then, first.

Second, it's not easy, but I think at some point we'll have to figure out what is the round of retaliation effects that's going to take place? And what is the effect, and that's probably the most important thing, what's the effect on confidence? And, therefore, what's the effect on business investment? What's the effect on exports? What's the effect on consumers' confidence?

We think there have been lessons that one can learn from the past, and they're all very negative. So it's not easy and it's not yet time in a sense to see what the consequence of monetary policy of all this can be. But there's no reason, there's no ground to be optimistic on that. On underlying inflation … I'm sorry, okay, why don't you answer their question, then I'll answer the underlying inflation.

Jerome Powell

On trade. Yeah, so, first I'm obviously not going to comment on any particular trade policy, but in principle, changes in trade policy could cause us to have to question the outlook. So, we have a very wide range of context in the business world in the United States and around the world. And as we talk to them they continually and increasingly express concern over trade developments. We talk about that in the beige book, and then reserve bank presidents talk about it in the FOMC meeting and we talk about it then in the minutes.

Those concerns seem to be rising. For the first time we're hearing about decisions to postpone investment, postpone hiring, postpone making decisions. That's a new thing. If you ask, "Is it in the forecast yet? Is it in the outlook?" The answer is no, and you don't see it in the performance of the economy and we don't have any way to know how to put it into the outlook just yet. So, that's where that is.

Stephanie Flanders

Before we get on to the forward guidance, I'm sort of interested in what Governor Kuroda and Governor Lowe have to say on the trade point because there's a perception that the countries that are more involved with China will have some protection from this.

Governor Kuroda

Rather than direct impact on the Japanese economy, the indirect impact on the Japanese economy could be quite significant. If this escalation of tariff by US and China continues, and they actually implement it, that would significantly affect East Asia supply chain. Centring China, Korea, Japan, Taiwan, and various Southeast Asian economies. So, I really hope that this escalation could be rescinded and normal sort of trading relationship between the US and China would prevail, so this is a matter of great concern for Japan.

By the way, I just would like to make one comment on Professor Friedman's question. Quite interesting question. If, really, inflation rates suddenly accelerate to 3 or 4 percent, by what factor if it is through external factors like sudden currency depreciation or sudden oil price rise they would have only temporary impact. Unless exchanges continue to depreciate or oil prices continue to rise. So these are temporary factors, so I don't think this would raise a serious problem.

Sudden rise in inflation expectations, that is extremely unlikely. And then, you would find that after all the Phillips curve was not so flat. Phillips curve became steeper so that with a tight labour market, the wages and prices started to rise, inflation accelerate, and so on. Then, of course, you can use a steeper Phillips curve to contain your inflation.

Stephanie Flanders

Governor Lowe did you want to respond on …

Philip Lowe

On trade I think what's happening is incredibly disturbing. Can any of us think of a country that's made itself wealthier and boosted productivity growth by building walls? Probably not. I can think of a lot of countries that have made themselves wealthier and more prosperous by reducing walls to people, capital, goods, and services, and my country would probably be the poster child there.

So, I view what's happening is incredibly worrying. The tariffs themselves I don't think are going to derail the global expansion but I can think of two mechanisms where that expansion could be derailed. The first is through financial markets because they're very good at telescoping future events to today. So far the financial markets have taken a relatively kind of benign interpretation, but that could change very quickly and so we could see a lot of turbulence as people bring those future events forward to today.

And the other mechanism is that businesses … The option value of waiting goes up a lot in, kind of what Jay was saying, kind of people saying to delay decisions. In Canada that's happening. In Mexico it's happening. Quite disturbing that it's happening in the United States. It's probably happening in China and I know it's happening in parts of Southeast Asia. So the option value of waiting is very high at the moment and it wouldn't take that much for financial markets to kind of combine with businesses who are waiting to turn this into a really big global event. So, I hope it has a low probability but I'm very disturbed at what's happening, and it's very worrying.

And so, on a much smaller issue, on underlying inflation I agree with Mario about the importance of looking at underlying inflation, and much about public communication is around measures of underlying inflation. Not the exclusion-based ones where you exclude food and energy, but we put a lot of weight on the trimmed mean measure of inflation and the weighted median, and much about public communication is focused on those two measures.

Stephanie Flanders

President Draghi you said you just wanted to …

Mario Draghi

Yeah, still on trade and on the discussion of tariffs. There is a more general aspect of what's happening that it's, in a sense, if possible, would be even more worrisome. And that is the, I would say, desire for unilateral action that has caught several countries, not only the United States … Yes, we're talking about that in the context of tariffs, but there are other examples of unilateral action that basically undermines the multilateral framework in which I believe all of us grew up.

So the potential changes that this may start are something that is unknown, it's very worrisome, and again, I cannot see any positive side to that. So, a source of considerable … Let me use the word that we use with markets, not with people, uncertainty.

Stephanie Flanders

Well, thank you very much. I can't help wondering whether we will still be saying the same things in a few years' time. We'd still be wondering why wage growth is not stronger and what is the natural rate of unemployment. As the President was pointing out earlier, many of these issues have been discussed for decades, but potentially not by four central bank governors of such important economies. So thank you very much to all of you and thanks for all the questions.