Panel participation Rethinking Macro Policy Frameworks for a Transforming, Shock-Prone World

Maybe adding the perspective from Asia Pacific region or Australia specifically how do you see it?

I agree with many of the comments that have already been made, certainly from a monetary policy perspective. These trends are going to make it harder for us to understand what’s going on in the economy and I think our role as central bankers is stability, and stability is more important than ever if things are changing and moving and evolving rapidly - but the job gets harder because we’re not going to fully understand what’s happening. So, I think a couple of things crossed my mind. One is that we’re going to have to build our tool kits out. We’re going to have to have this framework ourselves to understand what’s going on, and two, and to pick up a little bit on the point I just made around time horizons and how does policy respond, we’re going to have to be able to communicate in a much better way. We need to land that nuance. The markets need to understand what we’re doing, and the general public needs to understand what we’re doing for us to really be achieving our mandates and ultimately working for our communities. That’s going to be really, really tricky, and it will look different in different countries. Some countries will be on one side of the line or ledger on some of these shocks while others will be on others so that nuance and subtlety is going to be really important for us to understand and help everyone else understand as well.

(Panel discussion)

How can central banks maintain price stability when they are more frequent supply shocks? Can they afford to wait and see when they can do that? And when do they need to act? Can you share your perspective from Australia?

I will try and keep it short. I think really for me it’s about if we’re in this world where we get repeated supply shocks then ‘shock’ is perhaps not quite the right word because it’s has somehow a sense of it being a surprise but also relatively rare and unusual. If they’re becoming normal, if we’re having to deal with them more and more, then I think we can’t necessarily look through them and we have to just start dealing with them, which is my earlier comment on building frameworks and tools that help us understand them. Taking the current example, and you mentioned 2022 as well, I think there’s a few factors that spring to mind for me with a supply shock, and supply shocks or perhaps in economic parlance relative supply shocks, are not great for inflation targeting central banks. They make the job really, really hard, much harder than when we get a demand shock on either positive or negative. So, for me it’s all about what that does to the monetary policy trade-off. How much of an impact on inflation does it have, and inflation expectations, and how much of an impact on activity? So, inflation expectations have to be the ‘Northstar’ in all of this - the credibility of the institution. I think we’ve actually learnt that through 2022, 2023, 2024. We managed to bring inflation down, back down to not quite there to target for Australia but then other countries I know that was achieved, with relatively small sacrifice ratios in our labour markets and our economies, and I do think that’s because we had anchored expectations in so many countries. If we lose that then we go back to a world of the 1970s and 1980s where it’s much more costly. So, we’ve got to hold onto that, and we’ve got to maintain that. So, we have to be worried about not only the headline impact, the immediate impact of say an increase in fuel prices, but also pass through into our supply chains, what other indirect second effects we might see, and of course the persistence and the size of the shock are really important in both of those as well as perhaps our starting conditions. If you start from a tight economy, if you’re already at full employment or maybe even beyond it, the potential for the second-round effects I think is probably larger. That’s on the inflation side of the ledger, but of course on the other side this is a real income shock. Many households in Australia and in all countries will be struggling with, and grappling with, higher fuel prices. They will be making some really hard trade-offs, and that could well, in many countries, slow growth down and put pressure on our unemployment rates, and feed through into our labour market more broadly. We do have to balance these two things but, at the end of the day, that credibility is absolutely vital and we’ve got to keep that front of mind. And, in a repeated shocks world, especially if they’re all in the same direction, that credibility I do think becomes more and more important to protect but perhaps more challenged overtime. It’s tough.

(Panel discussion)

Maybe you can add something from the Central bank perspective, especially about this theme about repeated shocks, and how do you see frameworks evolving over the longer term?

I won’t pretend to give authoritative advice on this - I think we’re all learning – as Phillip said – but I can certainly give some reflections on what we’ve been doing in the RBA. We’re certainly using scenarios more now than we have in the past. I think to pick up on what Philip was saying, the key question for me is what are you trying to communicate with the scenario? In a very technical decision-making sense, it is a risk exercise, it’s considering alternative different risks, different states of the world, and how monetary policy would respond under those different states. That’s what our policy committees are having to grapple with. I think though in terms of that external communication point, it’s really about trying to help people understand what our reaction functions are. We can’t possibly model every outcome, that’s impossible, there are an infinite number of them, but what we really want to land in our communication is a sense of if conditions evolve in a certain way then this is what we’re likely to do with policy. So, for me, a key question is what is the sort of trade-off the policy is facing and how can we use our scenarios to communicate that trade-off to the public and to financial markets, so that they can understand that as things evolve, as conditions change and they see that change, they understand where policy is likely to go. I think that should be our ‘North Star’ for our scenario analysis. The other point I would add on a slightly separate note in terms of what we’re trying to do internally, and I personally think it’s really important, it’s very easy to get caught looking in this direction. I can see this risk and focus on here and you forget about the thing over here. We need our teams, our economists, and our analysts to be curious. They need to be asking the tough questions, sometimes asking the leftfield question, talking outside of the building, connecting with our colleagues in government, in treasury and finance ministries, talking with the private sector, academics, as wide a possible group, so that they are considering all the possibilities and we need to create an environment for them, a culture, that lets them explore, play and be curious and not be afraid to fail. Maybe you try something - you look at something and it’s not what we need to focus on, that’s okay. It’s another version of acknowledging that we don’t know everything, that we are going to at times make mistakes, but we have to live with that and, in a world where lots of things are changing, you need to be looking in lots of directions. So, I think there’s multiple things that we need to do, we’re trying to build at the RBA, and I’m sure colleagues elsewhere as well.