Transcript of Question & Answer Session Joining the Dots: Exploring Australia’s Economic Links with the World Economy

Sarah, you and I were having a furious discussion about some economic issues previously, and I have a couple of questions to ask you. There is a popular view amongst Australian economists that Treasury is much better at forecasting inflation and the RBA is much better at forecasting GDP. Now, you’ve been on both sides of this question. So is this true, and why do you think it’s true?

Thank you, Michael. I’ll just say I will take the chart compliment back to headquarters. Our international team will very much appreciate that. So to answer your question, well, actually, my response when we were over lunch was to say I actually hadn’t come across that view before and I hadn’t heard that view before. And I was a very short time at Treasury, less time than I’ve been at the RBA so far, so I can’t comment too much on Treasury. But in terms of the RBA forecast, we do actually review our forecasts every year. We think it’s best practice to do so. We’re always learning. We don’t always get it right and we really want to identify why we get it wrong. So we spend an awful lot of time on stuff where we’ve gone wrong and we spend a bit less time where we’ve got right but, you know, looking at it holistically.

It’s been interesting, actually, just recently - so our last review was done in November last year - it’s actually the opposite of what you just said. Our misses have been much more on GDP and much less on inflation. Maybe that’s the exception that proves your rule. But in general what we found over the recent period is, actually, the disinflation that we were expecting had come through. So inflation was falling. Obviously, very good news for us. But on the GDP side we found that we were - we seemed to expect that household spending in particular would come through a little more strongly than it has. So we spent a lot of time investigating why that is and digging into it. But that was last year’s review. Other reviews will give you a different answer. And I’m afraid I don’t have a good answer to your question because I’ve not looked at the question, but we’ll take that back and perhaps we can correspond on it once we’ve had a chance to look at the numbers.

So the next discussion we were having was about the level of inflation happens in war time. And I was talking about the American Civil War where the price level at the end was 2.35 times what it was at the start. So I was going to ask you, since your speciality is the Great War and the British economy in the Great War, what sort of inflation did the UK have at that time that made it so difficult to go back on the gold standard when it was over?

It was an incredibly interesting time. I have to say, when I did my PhD I did think that the research skills and the technical knowledge I gained, and writing and presenting, would be useful in my career, but I didn’t expect the subject material to necessarily be useful. So that period also includes the Spanish Flu, which was the last truly global, very disruptive pandemic. So 2020 was a good year for me and now I’m reusing the knowledge again. So I have to say it’s a bit of a tale as old as time. The inflation that was generated was really the relaxing of a lot of constraints that were put in place during World War I, for obvious reasons, and a big influx of men coming back from the front, and it just really drove inflation. Supply chain disruptions on a scale - actually, I mean, we thought COVID was bad; that period was far worse. So lots of things coming together to generate that big inflation. Really, the struggle the British economy had was when they returned to the gold standard. For those that don’t know, that’s like pegging your exchange rates. When they returned to the gold standard, they pegged at the wrong value. They tried to peg it at too high a value, too overvalued.

In that situation, what tends to happen is financial markets will run your currency. They won’t believe your peg is credible and they will sell your currency. And for the Bank of England at the time, they had to buy lots and lots of sterling to hold the value up. And in the end, actually, they did leave the gold standard in the early 1930s. So a whole host of other shocks happened then, as I’m sure everyone knows.

So it was an interesting period where the monetary policy framework, very, very different. The Bank of England no longer has to worry about a pegged exchange rate, it inflation targets, as does the RBA. Obviously very different settings here as well. But it’s fascinating how the interplay of those types of shocks and what they can do to price levels then can come together in terms of what you decide to do with your monetary policy settings and your currency. I’m glad to say I think that central bankers and economists more broadly, we’ve learnt a lot from that period and we’re not trying to repeat the mistakes, which I think is very good.

But you haven’t answered my question. How much did prices go up?

I don’t know the precise number. A very big multiple. It was certainly a very big multiple.

Okay. Questions from the audience, please? There should be a roving mic and anybody who wants to ask - there’s a name redacted wants to ask a question.

Thanks, Sarah, for the presentation. Just a question about the CPI and the inflation measure, that we look at some of the constituents of that when we see rents up by 20 per cent, we see the basket of groceries up 30 per cent, and I just wonder how on earth do we see an inflation rate of 3 per cent when we’re seeing 20 and 30 per cent rises in a whole lot of prices that affect us?

Yeah. No, excellent question. So the answer to your question is the difference between the price level and the inflation rate. So the price level increases you’re talking about, that’s the sort of size of the increase in the price of things from pre-COVID time, so from early 2020-ish, more or less. And in that time, you’re absolutely right, all products have gone up in price pretty much, and on average it’s by about 25 per cent, something in that ballpark. So similar to the numbers you were just mentioning. But that’s over that sort of five-and-a-bit-year period now. It’s incredible to think it’s five years since the start of COVID.

That increase in prices has played out through a bit of a cycle. So in the early part of COVID we didn’t have much inflation through the economy - very weak, obviously we were in lockdown, things like that. Some prices went up but many didn’t. Then as we came out of lockdown we had a burst of inflation and inflation got up to almost 8 per cent at one point. So a big increase over just one year.

Now we’re coming down the other side. So the rate of increase of prices over the last 12 months - headline CPI has been actually low 2 per cent, the underlying inflation rate that we measure is high 2s, just below 3 per cent. But that is just over the last year. It’s not measuring the increase over that five-year period, and that’s the difference that you’re talking about.

But I understand completely. I mean, when I’m going to the shops and doing our weekly shop, I still find it astounding how much I have to pay for milk, in particular, is my product of choice. I’m amazed at how much milk costs now compared to pre-COVID. I used to think it was $1 a litre. So $1 for one litre, two for two, and so on. It’s not that now and it catches me every time. But that’s the reason why. So the rate of increases has come down. That’s really what we were looking to see at the RBA. That’s what we want as an outcome. We want low and stable inflation. But the price level, it won’t go back to where it was before. We are all going to have to get used to high prices. So I’ve just got to make my peace with milk costing significantly more than $1 a litre. It’s never going back there.

Yes. Thank you.

Yeah, we had - through the 2022, and we saw four and a quarter per cent of interest rate hikes, probably the steepest hikes that we’d ever had, but property prices held up, spending in the economy was pretty good. You know, is monetary policy less effective now, or has it been mitigated by other things, like government spending and, perhaps, you know, some other factors? Would you mind just commenting on government spending and the other factors and your view on that, please?

Yeah. So in terms of the trajectory for monetary policy through the last couple of years - so, as you say, the hikes started in May ‘22 and the last one was in November ‘23, and now we’ve actually had a couple of cuts. In terms of that trajectory and what the Board were trying to achieve through that period, they were very much trying to achieve an outcome where we brought inflation back down. So inflation at 8 per cent, too high. We don’t want it that high. High inflation hurts everybody. It’s particularly challenging for those on a low income who are already in a pretty tough spot to start with, and then if prices are moving that fast it’s really hard for them. But it’s challenging for everyone. So we wanted to bring inflation - the Board wanted to bring inflation back down. That’s consistent with our mandate.

So the trajectory for interest rates and the decisions they were making was to try and achieve that outcome. Now, we won’t say that the job is done. The job is never done. I’m paid to worry. Your taxes pay for me to worry. I do worry. This is quite a - not a great job for my cortisol levels. So I’m never going to say the job is done. But certainly where we are or where we were, sort of, pre-April 2nd, we had inflation, it was back in the target band. We had an unemployment rate that was, you know, around about 4 per cent, low 4s, 4.1, very low historically. And that was - you know, if we could hold it there, that would be a great outcome.

That was what they were doing through that period and let’s hope that we can hold where we are now, broadly speaking, because if we can achieve that, I think that would be a great outcome for the country. But that’s a tough job and that’s the job for the next few years.

Okay.

Just following on from your comments about inflation, the 3.5 per cent pay rise with the Fair Work Commission, is there any comments you can give us at all talking about your inflation that is better than 2.4? I know it’s only just happened this morning.

It did. And I have to say I was preparing and reading my speech this morning, so I did see the number flash but I have not looked at any of the details and I haven’t spoken to my team in Sydney, who are digging into that. So I’m sorry, I can’t give you any comments right now.

Okay. No problem.

Yes.

Hi, Sarah, n ame redacted. Thank you very much. Very interesting. So you talked about scenarios like forecast. I think - yes. Okay. Is the RBA considering providing a path for the future evolution of the interest rate, given all these forecasts? Some banks, like the Bank of Chile, do it, and that would be super useful. I wonder if you are pushing for this?

So that’s not something we’re considering at the moment. You know, forward guidance of that form is a pretty tricky thing to provide as a central bank because it’s very - it can be very hard to communicate fully all of the caveats around that forward path. So it really does depend on everything that’s going on and a certain set of circumstances becoming true. As soon as one thing changes, what that path might look like can change as well.

As you might imagine at the moment, there is an awful lot that could change that could change the Board’s decision - our advice to the Board and then their actual decision based on that advice. So it’s really tricky.

What we do do for interest rates, in terms of when we set our baseline forecast is we use what the financial markets expect the cash rate to do. So they have an evolution in financial markets. That’s what underpins our baseline forecasts. It’s also what runs through all of the scenarios as well. So they’re all very consistent with one another. But the Board absolutely do not guarantee that that’s what’s actually going to happen. Far from it. They don’t - you know, they haven’t made that decision. That decision will come in the future. And that’s how we build our advice and then they have their discussions. But no, we don’t have any plans to publish a profile that comes from the Bank itself.

So we have 10 minutes more for more questions. At the back there. Yeah, at the back.

Sorry, I’ll just jump in. Just a question on the currency. You reference it in your speech. It’s sort of gone from 60 to 65 as we’ve gone through the tariff turmoil. How much of the Aussie dollar appreciation is US dollar depreciation? And if that continues and the Aussie dollar continues to rally, as some people are calling it a sort of end to US exceptionalism, how much - what are the potential implications for that, do you think?

Yeah. An excellent question. You’re absolutely right. The movement against the US dollar, in particular, that’s a reflection of broad-based US dollar depreciation. So the US has depreciated against many, many currencies over the last month or so. The Australian dollar is one of them. And on a trade-weighted basis for us, that also flows through into the Chinese renminbi, because they peg their currency to the US dollar. So the US dollar moves have been reflected, in a very large part, in the Chinese currency as well, and in other currencies that are pegged to the US dollar.

In terms of how that might play forward, this is something - this is an active area of research for us, very much so. We’re looking at this and we’re thinking about it all the time. That sits in our international department.

The short answer is we don’t precisely know. What we do know is that this kind of move must be a reflection of a rebalancing of financial market flows away from US dollar assets, in general, towards assets in other countries. And you can look at the relative moves across country. Some have gained more than others, so that tells you where the capital is flowing to.

Whether it continues or not, though, is a good question. We don’t know the answer. It’s something we’re monitoring. And we’re interested as well in whether or not these flows just reflect a change in the flow of new capital, as it were, through the economy, or if it’s a change in the stock positions held by investors. That’s something that we’re investigating, too. But it’s very early days. We’re only a month into it, so we’ll see how it plays out over the rest of this year and beyond that. That’s really when we’ll know the answer to your question.

Hi, Sarah, n ame redacted. We’re representing the students here today. Just wondering how much do you worry about the structural change coming from the movement towards more spending in defence across the world? I’m from a generation towards the end of the Cold War. I could see that spending and I’ve seen, certainly, economies benefit from the fact that they are not in that wartime setting of having to put more and more into defence. But for the young students here, they’re looking towards a different type of world as well. So how much do you worry?

Great. Thank you for your question. And thank you for bringing your students here and for the work that you do. I’m so pleased that people like you are bringing through the next generation of economists, and I would really love to see one of your students up on this stage in 20 years, when I’m long gone from the job, doing it. That would be fabulous. It’s an excellent question. So in terms of monetary policy and how we think about the economy in the short run, the example of defence spending is sort of one example of where you can get additional spending through the economy that in that case would obviously come from - be part of fiscal spending more broadly.

We think about that in the context of thinking about what are all of those conditions across the whole economy; what is the outlook for all of these things. And for that type of spending we’d use government budgets. We don’t forecast it ourselves, we use what the government expects to spend and push that through our numbers. And we’ll be factoring that into domestic demand conditions and then providing our advice around monetary policy accordingly. As a longer-run structural shift, though, you’re right, these are big changes if they come to pass, big changes for the economy to work its way through over a number of years, beyond the two-year horizon, which is typically the horizon we’re looking at.

I suppose my general observation is there are a number of different tracks of spending or increasing size of the economy for a number of sectors of defence, perhaps the climate transition, all of these other factors. That’s something that many countries are going to have to work through, Australia included. But that’ll be, I think, a more medium/long-term transition over maybe a five, even 10 year horizon.

Sarah, earlier on in your speech you said that traditional economic thought is that raising tariffs has a negative impact on economic growth. I think you’ve said words to that effect. If you put yourself in The White House, and put a sort of US White House lens on the question, can you see a valid economic argument for the introduction of tariffs - and I guess, sort of thinking out loud here, obviously there is increased tax revenue, and that tax revenue can go in some way to economic growth. Can you help us understand if you see a valid economic argument for imposition of tariffs?

So when economists say that tariffs generally have a negative impact on output or global growth, we’re looking at that very much through the lens of how are resources allocated around the world. So from a purely sort of activity perspective, you know, what you want is for everybody to take advantage of their comparative advantage and then the world economy should be as big as it possibly can be. And that’s a very simplistic trade theory view of the world.

I mean, I wouldn’t ever presume to sort of give advice to any government, you know, domestic or otherwise. But it’s certainly true that governments have a number of competing objectives that they’re trying to meet and not all of them push in the same direction. So there are many reasons why you might want to impose a tariff that, yes, wouldn’t be, you know, necessarily producing the outcome I just talked about, but that’s just looking at things through one lens. So there are many competing objectives for governments no matter what decision they’re trying to make. It’s a tough job. As I’ve said, I’ve worked in the Federal Government for a while and they’re balancing a lot of trade-offs and this is, you know, an example of that.

Sarah, thank you for your presentation today. I’m name redacted, we’re a government and media relations firm, and we work with a range of clients who are looking to invest or to deploy - to, sorry, deploy capital. Can you make some comments and maybe some observations in some specific policy areas around productivity? It seems to be a big issue at the moment and will continue to be in this, particularly from a political point of view in our world; what that might look like; what sort of policy settings that government could look at in that space, and would give some sovereignty and some security to investors, particularly and including global capital?

Yeah, it’s an excellent question, and it’s clearly a very hot topic of conversation. What I would say is that monetary policy really doesn’t have much of a role to play in supporting productivity growth or, indeed, dampening it.

The one thing we do know is that it is incredibly useful for us to provide is low and stable inflation. Inflation in the background that no one has to worry about that just sort of ticks along so you’re not having to wonder if a price increase is because your products are more attractive and you should invest, or is it just that prices are going up a lot in general. If we can take that off the table - and that’s what we’re trying to do - then that’s one less thing to worry about. So that’s our role in all of this. More generally, in terms of policies that may or - that can help with productivity growth, I always like to defer to my friend, Danielle Wood, who runs the Productivity Commission. That is very much her space and domain. Her team are excellent and I know are doing a lot of work on a number of these issues. So I, like everyone else, will be reading what comes out from them. But I’ll send you in her direction. She’s much better placed than me.

So we have time for only one more question. Do we have - yes.

Hi, Sarah. Thank you very much for your talk today. So you’ve talked a lot about, sort of, this unsurity, about like justifications by the US, and you also talked a lot about currency appreciation and depreciation. I just had a question. I was reading an article written by the US Treasurer, Scott Bessent, and he talks largely about strengthening, not only US manufacturing but also the US dollar.

Given that the US are running one of the largest federal deficits in history, do you think that reassuring American manufacturing in order to decrease the trade deficit could increase the strength of the US dollar?

Yeah. It’s an excellent question, and actually it comes back a little bit to the other question about, sort of, competing aims in government and objectives and how things play out when you throw everything into the pot and give it a mix. Economic theory can tell you that if you impose a tariff, that that can appreciate your currency. So that can be an underpinning for that view. But that’s a very all-other-things-equal view of the world. It doesn’t really consider financial market flows and a whole range of other things that might influence what happens in terms of capital markets, which is really what determines exchange rate movements.

So unfortunately, the answer to your question is maybe, but it depends, it’s not possible to be definitive. The one thing I can say, though, to be a bit more definitive, is we will find out because we are living through this, but unfortunately we’re going to have to wait a year or two to know the answer for sure. But thank you for your question. That’s a great question.