Transcript of Question & Answer Session The Outlook for the Australian Economy

Giulia Specchia (UBS), Moderator

The first question is: you’ve just said that you revised or you reviewed the process to do forecasts; has the RBA adopted any step to improve its forecasting and modelling, given, as well, the ‘miss’ in terms of inflation?

Marion Kohler

Yes. So, we have done … obviously, last year, as I said, was a humbling experience. I think, though, I’m in good company there, so we all had a big miss in getting out of the pandemic. And we have done a thorough review of our forecasts, and some of the things that we’ve done is, we’ve expanded the range of models. What we found – we and other central banks – is that we need to understand supply shocks better and how they work through the economy, so we’re having, now, some additional models on the side that would allow us to look exactly at that nexus. We are also adjusting our forecasts with off-model information, such as liaison survey information. If the drivers of inflation are not captured in our models, we, like everyone else, have models that are very much geared to the demand side of the economy – so you need to bring that information back in. And we’re looking at our international peers and seeing what they’re doing. We’ve been, to some extent, lucky in that we’re behind the inflation experience of other advanced economies and so we have been able to watch and learn from what’s been going on there. And then, finally, we’ve expanded the range of timely data that we have. There’s not only the monthly CPI now, but we have detailed rents data, detailed micro-data, wages. That’s really expanding something we’ve done for a long time already, but that’s been particularly useful to get a better timely ‘now read’ of the economy.

Giulia Specchia

Thank you. So, when deciding on the direction for monetary policy, how much does the RBA rely on its modelling and forecast, and how much of that is liaison or judgement? And has that changed over the years; do you rely a bit less on modelling now because they’ve been so inaccurate recently?

Marion Kohler

I think you need to use both – and the Board has certainly used both. Models are very good in informing forecasts and, because we have an instrument that affects economic activity with a lag, we do need to take a stance on what is happening in the future. But what’s particularly important is the point estimate further out is actually not the key piece of information. The key piece of information is the risks around those forecasts further out, and that is really what informs the policy setting. So we need both. We use a lot of liaison for where we’re here now. But if you need to look two years ahead, I think it’s a little bit hard to go past the kind of more-structured forecasting exercises around models. But we have become a little bit more nimble in which models we use and how we augment them with judgement. So I would say it’s probably a broader umbrella that we’re looking at now.

Giulia Specchia

The RBA is seeking to cool inflation while pursuing a soft landing or avoiding a recession, and there is a growing debate in Australia on whether what the RBA has done so far is enough to achieve the midpoint of the target band. Do you feel confident that the cash rate is restrictive enough?

Marion Kohler

The cash rate is currently restrictive; I think there’s little doubt about that. The economy is growing below trend. We know that many households are experiencing a painful squeeze on their budgets, but that’s also because high inflation erodes real incomes, and consumption has slowed considerably. So the big policy question that we and other central banks are having is: is it restrictive enough to get inflation down over a reasonable timeframe such that inflation expectations remain anchored? And that’s really where some of the judgement and the debate is around. But there is no question that it is restrictive; there is no question that the economy is growing below trend.

Giulia Specchia

One question that’s from the floor. The RBA has said that current nominal wage growth doesn’t put at risk achieving the inflation target so long as we get a turnaround in productivity. What do you think could drive that pick-up in productivity, and why do you think Australia’s productivity is weaker compared to other advanced economies?

Marion Kohler

This is really a very good question and a very big question. We don’t forecast productivity. We have found this very hard. I also acknowledge there are other government agencies that have better levers around productivity. But what we have observed is that productivity growth outcomes have been rather poor in recent years. It’s a bit hard to look at it year from year because the pandemic has moved the measured productivity around a lot, with employment initially moving into higher productivity manufacturing sectors and then coming out into the services sector that are a lower level of productivity; so, yes, shift share is in there. But if you look through that and take a stance over a couple of years, you find that productivity hasn’t grown for quite a few years now.

It’s actually something we do see in other economies as well. Where we don’t see it is the United States and, if someone has the answer as to why they are ahead, I’d be very happy to hear that. They have always been on the technology frontier, but there is certainly something to be learnt there. But we have seen it in other economies. So one possible explanation of the past couple of years is obviously that the pandemic has just made it harder for firms to focus on productivity increases. There were difficulties to get labour, difficulties to get investment capital into their businesses to [inaudible ] and so, hopefully, that is going to provide a little bit of an uplift, but it is really the big question.

What we are expecting is for productivity to pick up to around about the growth rates we’ve seen before the pandemic. So we’re not expecting a big pick-up, a huge pick-up. I think it’s just under 1 per cent, and that had already stepped down from previous decades; there is a longer run issue happening here. So, all this to say I don’t have the precise answer, I don’t forecast it, but we do need to get productivity pick-up for the nominal wage rates we have forecast to be consistent with the inflation target.

Giulia Specchia

So, a follow-up question: you expect productivity back to pre-pandemic levels and you also expect wage growth or the RBA expects wage growth to remain contained over coming years. What’s the driver of that – that wages growth remaining relatively contained, compared to other economies? Is that migration, interest rates, a combination of?

Marion Kohler

That’s a really good question. So wages growth contained is between 3½ and 4 per cent. Compared to where we were pre-pandemic, that is still quite a bit higher; we were more in the 2s then, so I just should also say that. That’s not by a recent decades-low wages growth, but it’s also not a too-high wages growth. So that’s just the first thing I want to say. But one of the phenomena has been, in fact, that in other countries, wages growth has taken up a little bit further. It’s hard to know what it is, but there are actually very deep differences in the structural settings of wages in Australia. We have a different wage agreement. It is more of a decentralised bargaining agreement. In some other countries, you have automated CPI clauses in the wages in there. We’ve seen in some of the European countries, where we’ve seen, actually, wage rates grow at quite higher levels; and we don’t have that here in Australia and that’s certainly helped us. The other feature to point out is that the EBAs that we have are typically three years, and so that means you get a lagged effect. Now that lagged effect is on the way up. A lagged effect is also on the way down, once you have higher wages. But that’s certainly helped; those parts in the labour market where EBAs are underpinning wage growth help contain the wage rises. I think that’s hopefully answered the question.

Giulia Specchia

For 10 years post-GFC, we had very low interest rates. We saw low inflation, despite unemployment going lower than anyone expected; growth was reasonable but lower than most expected. Central banks called this a ‘conundrum’, given how stimulatory low rates should have been. How do you rationalise those 10 years compared to what we see now, and can global growth be sustained above what we saw in the last 10 years?

Marion Kohler

This is a very good question and I’m going to be here really honest, I don’t think we quite know the answer of why we had the low growth before the pandemic. Some people said, ‘Well, interest rates don’t work anymore’. I think the recent episode showed us that actually they do. So I think this is still a matter of research to fully understand that earlier period where there was a bit of weakness in consumption, and it wasn’t just here in Australia, and there was wages growth that was sitting in there. I think one I want to point out, and I’m not going to go there, is obviously you also need to consider the broader setting. Monetary policy is only one setting that actually affects the demand side of the economy; fiscal policy would be another one. And so, if you look at that, you can kind of explain some differences, but you certainly cannot explain the whole period. And that makes it a little bit difficult to do the ‘future gazing’, if you don’t know what explained that episode. But we are in the very different environment right now, and that is what we’re at the moment focused about. Inflation is too high and we need to bring that down, so that was a very different experience to what we had before the pandemic.

Giulia Specchia

Mortgage costs have increased by almost 3 per cent in Australia since when you started increasing rates – I have a variable mortgage, so I know that very well – and that has increased much more than in any other advanced economy because the cash flow effect here is different. How would you explain the pick-up in housing prices that we are experiencing in Australia; and are you or is the RBA concerned about what that could mean for spending?

Marion Kohler

Fundamentally, house prices: that’s demand for established housing and the supply it meets. Some of that is, in a roundabout way, probably related to the population growth we’ve seen, but certainly not all. We’ve seen house prices pick up since the beginning of the year. But we’ve always pondered and done a lot of research on what explains house price dynamics in Australia, and one theme that keeps on coming up is actually limited supply and the constraints on supply to meet that additional demand. Moreover, it takes, usually, a couple of years for supply to come online. So we have not only had population growth that might explain one part of why they’ve picked up, but we actually have had strong labour markets and, therefore, strong incomes across the economy. A lot of people have jobs who didn’t used to have jobs, and that certainly will also underpin some demand for housing. And there might have also been the issue of expectations of future rate rises that kind of has picked it up. I think, a year ago, no¬≠one quite knew how far interest rates would be going. I think we’re certainly now in the third phase, after you came out of the first phase of moving it – from removing stimulus to moving to restrictive– we’re there. Now it’s really just a question of gauging the level that is required to bring inflation down over a reasonable time. So I think the outlook for interest rates is quite a different one, or the uncertainty around the outlook, for many people who want to buy a property in the housing market. To some extent, what has also been a phenomenon over the recent period, we’ve seen very low turnover and supply in the market, and that might have exacerbated some of those measured house price increases, and that might pick up a little bit further. We’ve also seen not that much credit growth so far to underpin that. So you can kind of see, if you don’t have a lot of turnover and not a lot of credit growth, that might also just exacerbate some of the house price increases. So we’re expecting the house prices to continue to increase but at a lower rate. So there’s the three factors that I think have played a role in the recent pick-up in house prices.