Transcript of Question & Answer Session Trust, Expectations and Monetary Policy

So turning to this question of competence, as you pointed out, different periods have very different degrees of volatility, et cetera, and the RBA might spend lots of time outside the band or mostly be pretty close to the target. That doesn't necessarily tell me much about your competence. I really need to understand which parts of this are because of mistakes by the RBA or outside of the control because of global shocks and so on. Of course, it's probably tempting to always say that any time outside the band was outside of your control, but then of course, I wouldn't believe you. So my question is, how do you think about explaining to people credibly which periods outside the inflation band were mistakes by the RBA and which ones were actually outside your control?

Let me start with an easier distinction, I think, which is the distinction between the choices that the Monetary Policy Board makes about delivering on the trade-offs inherent in the dual mandate from the shocks that you describe. And this is important, and it's relevant, too, because in the aftermath of COVID, the Monetary Policy Board, well, Reserve Bank Board at the time, took the view that it was appropriate to raise rates by less than some other countries did, consciously knowing that would mean inflation took longer to come down in order to, I think as it was put at the time and is still put, to preserve as many of the gains to employment in the aftermath of COVID as possible. I think you're right that actually explaining that choice and explaining why this painful high inflation was partly the result, obviously, of external shocks in the COVID period, but also partly in order to deliver better employment outcomes, was and remains a challenge. It's interesting that one of the survey results I didn't show is that if you ask people what the RBA is responsible for, there's a whole bunch of things that we're definitely not responsible for, which sometimes people think, you know, really quite likely. But although a lot of people know that we're responsible for price stability, and I find this surprising, a much smaller share is aware that we also have an employment objective. And when you think about the public debate about, “Has policy been too harsh?” and all the rest of it, very often experts like you, no doubt, would say, "Why aren't you being harder on inflation," for example. It feels like the employment objective is very much to the forefront of the debate. And of course, it is there in order to take some of sting out of disinflationary pressure, and yet we haven't yet actually managed, despite this having been there forever, to persuade people that it's anything like as important. It's interesting why that is. I think one interesting point is that inflation is experienced by everyone, and unemployment, sadly, is only experienced by those who are unemployed or directly or, in some case, indirectly attached to it. So that has been a very live issue. We have tried to explain that, but obviously one person's benefit, "Thanks very much, I'm still in a job," maybe another person's, "Wow, you've let inflation remain pretty high for a long period of time."

I'm happy to take the mistakes thing, as you say, of course, that's always number one on our list of explanations. I think if I can reframe it as the learning, it's very directly linked to policy-making. We have obviously learnt in the past 12 or 18 months that the extent of excess demand in the economy, and therefore inflationary pressures, has been higher than we, or I think almost anyone else, I won't try to say everyone else, but almost everyone else, had expected. There are some good reasons for that. The world we all thought was going to hell in a handbasket, and it turned out to actually be incredibly robust and resilient, largely because of AI, perhaps also because of the flexibility in global supply chains. We didn't think we were being very optimistic about the supply side of the Australian economy, but I think we probably were being a little bit too optimistic about our ability, the size of our home economy. And financial conditions for a variety of reasons, globally and indeed locally, were I think probably a little bit easier than just looking at the short-term interest rate, would tell you. Now, how many of those things we should have known at the time, and how many of those things we learnt about over time, I think we should rightly be held to account for. But there's definitely a learning process as well as a mistake. A mistake in my sense, in my view, a genuine mistake would be, “I should have known at the time. It's obvious now in retrospect, but it was obvious at the time itself.” Distinguishing that from Captain Hindsight, as I think the survey you kindly showed, is quite difficult.

Thank you. It seems quite ironic that as a member of media, which is one of the least trusted institutions in Australia, according to your speech, I'm asking you about trust. But here we go. It was the third lowest on your chart there. Above politicians, I'm happy to say, but not much. Anyway, you spoke about maintaining trust. You spoke about maintaining trust as being based on being level with people, being open, honest, and evidence-based. You made some comments last month on October 21st talking about your inflation expectations and how you were seeing those at the time, and explaining what you were seeing in the economy and your thoughts on that. Was that your attempt to be open and honest and evidence-based with financial markets and the broader population? And do you think that was successful in explaining what you were thinking at that time? And then a follow-on from that, it seems that some people on the Board disagree with that stance that you took. Is there a disagreement on the RBA's Monetary Policy Board about how open and honest you should be to explain your thinking on policy and the economy? Thank you.

Wow, that's a lot of questions. I can use Michele's trick of picking the one I like the most. I don't know that I like any of those very much. When I see this question, I like to go back to Keynes's quote about economists. He said, "You couldn't do much better than aiming to be as humble, competent, and frankly boring as dentists." I've given 34 public speeches since I arrived in Australia in 2024. Most of them have gone, as we used to say in the '80s, straight to video, have barely moved markets at all, have certainly never appeared in Bloomberg News, frankly, or other major publications are available. So I'm pretty sure my score at being a boring central banker is up there with the very best. When it comes to debates on the Board, I don't really recognize this picture of Board members being driven into a corner. What I see on our Board, and frankly, it's an enormous strength, if I didn't believe this, I wouldn't say it to you, are incredibly diverse group of experienced, able, diverse views, able to challenge and bringing their experience and their knowledge into the room and being fearless to challenge each other and to challenge other views. That debate is absolutely crucial. There's a selfish interest in that, right? Monetary policy is hard. And if you don't spot your hidden corners, your dark corners, your things you don't understand, the things your groupthink, and newsflash, groupthink is a big issue in central banks, then the debate that you have on a Board is absolutely critical for that. I make no apology for the fact that the Board has very, very lively debates about those issues. You saw it in the vote this week, six-three, for the decision when I spoke at Citigroup a week or two ago. My key message was that the Board faced hard choices. We did have hard choices. We faced into them. But we delivered an outcome that was designed to deliver that novel goal of stable prices and full employment.

This is going to be a somewhat rambling question, which will consist of a couple of statements. Well, I tell you what my worry about things are, right? And you don't have to answer all these things. My view looking ahead is it's much easier to forecast what's going to happen to inflation than what's going to happen to the economy, the real economy. And the reason I'm saying that is I keep picking up the newspaper, which says the AI boom is going to be much bigger than the mineral boom. The minute I see that, I say to myself, "Oh, that means the economy is booming," as it were. If the economy is booming, then that means the sort of interest rates we're getting are much too low. On the other hand, if the AI boom is not very strong and we're predicting low growth in the future, then interest rates are probably okay.

So here's the problem that I see. That is, if you weren't a central bank and you were just a forecaster, you'd be saying to people, "One way to increase my strength is to make sure you know how difficult the forecast will be." And I start talking about how bad I've been in the past, which the Reserve Bank has been bad. Not in relative terms necessarily, but if you look at the forecast, gap what actually happens. So if you think trust is a function of that gap about what you forecast and what happens, then you're in this sort of difficult situation that maybe to increase trust, you have to decrease it a little. Do you sort of understand why I was rambling? In other words, you've got to explain the chances of you being wrong are going up at the moment, as they are always around turning points. And when the chances of us going wrong, the way you judge it has got to shift. But if you convince people too much that you're going to go wrong, then you lose your trust. I don't quite know what to do about that. In other places, what you might do is get, and this is a very difficult question, get interested third parties to do the publication for you. Right? Which goes to the transparency point. That is, in my experience, a lot of attitudes in the public don't come necessarily direct from the institution. When I think of the Bank, how you can influence what other people are saying, which it's difficult for you to say, it's very hard for me to think about that apart from lots of meetings and connections with outside groups, which I think you're doing.

So my final question is don't you think that saying 5 per cent unemployment is a bit optimistic? In the sense that each of the extreme scenarios I get, I find it really hard to believe that you're going to fine-tune enough to five. In which case, I'm wondering whether you might do more to prepare people for that.

Thank you. And gosh, I don't know where to start with all of that. One of the reasons, as you know, for introducing fan charts back in the day was precisely for the reason you described. And fan charts are probably best calibrated just in terms of your own historic forecast errors. And they're bloody wide, right? I mean, in general. Some people are more honest than others about how wide the fan charts are. If they're sort of vertical around the line, it doesn't tell you very much. But the width of those fan charts is far, far wider than the kind of tolerance of 25-basis point movements in policy. And in the UK, anyway, I watched this process play out because it's interesting you say inflation is easier to forecast than the real economy. Maybe that's a function of how successful inflation targeting was for a period, and maybe we're not so good now, and maybe actually that's exactly what we're finding. As you probably know, many macro modelers got into the habit of actually tying down their model by saying, "Well, the one thing I know is that inflation equals inflation star, and that then gives me equilibrium conditions for other things because I have complete confidence in the central bank." And of course, those sort of basic New Keynesian models lead you into all sorts of problems when you get kind of expectations drift of the kind that perhaps we're seeing at the moment, perhaps we're not. I always think about there's an interesting test in psychology that you may have played at one time or another. If I ask you 10 questions about quantities that you can't possibly know the answer to, what's the weight, maybe you do, what's the weight of a 747? What's the diameter of the moon? What's the, I don't know, how big were a trillion peas? What volume of a trillion peas would it take up? And I'll ask you two things. I'll ask you, A, for your guess at that number, which you're not going to know, and then I'll ask you for your 10 per cent confidence interval around it. In general, people obviously get the first answer wrong, but then they're wildly over-optimistic about the accuracy of that number, despite saying, "I haven't got a clue." So this tendency to be overconfident about things is not limited, I think, to macroeconomic forecasting. You're absolutely right. And I think about the example of experts, doctors. Doctors started saying to you, "Do you know what? There's a 50/50 chance when I go into your gallbladder or something, I'm going to cut your left leg off, and I'm sorry we're in a VUCA world." They're just going to tell you to get lost, right? I mean, you're not used to the cone of uncertainty getting wider and wider from experts over time. And I do wonder sometimes, we had this debate when writing the speech, do we get a free pass on that? Are we a kind of unusual set of professionals in that we can just say, "Oh look, sorry, mate. The world's got trickier. We can't forecast this thing," when many of our professional colleagues are not allowed to say the same things. I think I win an award for an even more rambling answer than your question since you started by saying rambling. I think it's a good challenge.

So trust needs something people can check you against. With inflation, that's the target band. With full employment, there isn't an observable one. And when your estimate of it changes, as it did on Tuesday, that can look like moving the goalposts. So how can people hold you to account on that side of your mandate other than waiting to see what inflation does?

It's an absolutely great question. Thank you. By the way, I wouldn't say that our full employment goal is necessarily defined in terms of unemployment. I'm sure I don't need to tell you this, but there may be some in the room. Unemployment is obviously the conjunction of labour demand and labour supply, and actually, one of the reasons why we adjusted our NAIRU assumption, as you say, last week, was because of a change on the labour supply side rather than necessarily the labour demand side of the equation. There is no single number. We're often asked, "You ought to have a single number," I guess implicitly in your question, "in order to hold you to account," as you say. There is no single number. We present this thing called an abacus chart, I don't know if you've seen it, in which we try to draw together the range of measures of what it feels like when you're at full employment, in order to give a sense of how far we are. And I think Kevin Warsh said this the other day. If you were to ask yourself, do we feel like we're near full employment, you'd probably say that most economies are close to it at the moment. Not necessarily perfectly there, but they're close. And I think you would probably also say that they were not as close to price stability, obviously, particularly if you were talking about it in price level terms, but including in inflation as well. You're quite right to say we haven't got a specific measure of that. I think if we define one, we'd be changing it so constantly that you accuse us of moving the goalposts even more rapidly than we currently have.

Thank you. In your answer to a question earlier, you said that unfortunately, unemployment does not affect everyone, whereas inflation does. But that's only somewhat true, right? Because it does not affect everyone equally. If I, which I often do in my classes, take a poll who, for example, feels represented by the CPI, you'll probably not get any hands up, right? So there are a number of issues, and when I try to take a pulse of public sentiment, the distributional aspects of inflation and also of interest rate policy seems to be quite central. So I'm curious how you think about that. How does that affect your thinking about trust? If, for example, the public suddenly believes this is capitalist versus workers or whatever, how do you try to work through that, and does that affect your communication strategy? There was a debate, for example, about whether inflation is price-led or wage-led. Those kind of questions.

I would challenge you a little bit if people genuinely thought there wasn't an inflation problem at the moment, and I don't mean that as a narrow comment about Australia. I think people know it when they see it. There are a million... David Gruen is one row ahead of you. I should ask David to come up here. You can tell me how many inflation measures in your lifetime you've worked through. And each of them tell you, as you know, each of them tell you something different. As long as you define carefully what your measure is, you can draw something useful from it. I've been a central banker for 35 years. I've known central banks that target headline. I know that they've targeted trims. I know that they've targeted core. I know that they've targeted salient prices. The honest truth is that when you draw those charts back to back, the things that we used to think were key differences, the point ones, the point twos, are swamped by the size of the situation we have now. So I think the issue you describe is a very real one, but I don't think it should let it obscure us from the fact that it is very hard at the moment to avoid the conclusion that inflation's too high in pretty much whichever measure you choose.

Given the challenging environment ahead with the Australian economy and the role of the RBA, do you think there's greater room for more explicit coordination between fiscal policy and monetary policy? And then if so, how would you balance that against seemingly sacrificing the independence of the RBA monetary policy?

You've almost answered your own question there, haven't you? I think there are moments when monetary and fiscal policy have to work together, and that's in crises or, unfortunately, in periods as well where you may have debt instability. And I had the misfortune to go through a period like that in the UK during the LDI crisis two or three years ago, when it is quite clear that there are interactions between the two that are unavoidable. I have a pretty hardcore view on this, I have to say, and I think it has a reasonable, though not universal, theoretical basis. Which is to say that by far the best way to ensure the best outcomes between fiscal and monetary policy is to have a clearly understood reaction function focused on delivering the dual mandate of inflation and employment, and for there to be little or no ambiguity about what that reaction function is. As you know, you can write models down, I know you can also write models down that don't do this. But you can write models down that so long as every agent in the economy understands what that reaction function is, then you're a sackable leader in terms of inflation. And effectively, that is the best way in those models to deliver those outcomes. As the governor has said many times, independence is a two-way street. We take fiscal policy as given in our forecast. We don't expect to be told what to do with monetary policy. Equally, we don't intend to tell, in normal times, we don't expect to tell the fiscal authorities what they do. Does that lead to the best possible outcomes? You can write models down where it does. Maybe you can write models down where it doesn't. But I've seen an awful lot of effort wasted in trying to do coordination. My God, inflation targeting is hard enough without trying to do some fantastic platonic philosopher king idea of setting every single economic lever in the economy at its optimal level. We know what that's called. A few countries have tried that over the years. It doesn't work.

Given that last comment, you might not like my question. But noting that a lot of households have a perception that there is a unfairness with the blunt tool of monetary policy, noting that this has not been the only tool of central banks in the past, is there a possibility for the idea of exploring other tools, so there isn't just that one blunt tool?

Yeah. So this is a very topical subject. You say that there have been other tools in the past. It's a bit of a rogues gallery, isn't it? Price controls, targeting fixed exchange rates, monetary targets. The UK, by the way, if you really want to go and study the sort of disastrous graveyard of failed alternative monetary policy goals, you couldn't do much better than going looking at the UK's own sort of fairly tattered history. Most of those have been pretty unsuccessful. We obviously have used different tools when interest rates are at the zero lower bound. Those themselves proved, my God, pretty challenging, right? Buying large quantities of government debt had its own implications for central banks that we're still working through. The RBA is still in negative net equity and will be for years. There are all sorts of questions about whether that steps over a line. There were no choices, I think, in that period but to do that, but it was explicitly a second-best approach.

I think that obviously interest rates, monetary policy is getting a bit of a bad rap at the moment. But the honest truth is, I think part of that reason is we haven't done a good enough job, certainly taken on ourselves, to explain how it gets through all the cracks, to use a phrase an ex-Fed guy used to use. It isn't just the cash flow effects on mortgages, although that's important. It's the exchange rate channel, which probably in most models is the biggest single channel. It's the intertemporal substitution effect, which creates incentives on people to save or borrow depending on where interest rates are, and it's the impact on the valuation of assets and liabilities as well. Now, that all sounds rather technocratic, and that's probably why we've done a second-rate job of explaining ourselves, but the exchange rate effect is real. The exchange rate is up a lot over the course of this year. It's largely in line with the rise in interest rates, but it has an enormous effect, not just on the direct cost of imports, but all the indirect costs of imported goods for companies as well. That is affecting the inflation outlook. It's real. Some models tell you it's the biggest single thing. The effect of interest rates on asset prices has been important, and the effect on savings behavior has been important, too. Now, I don't think that's probably... I doubt, I don't know you obviously, but I doubt that you're going to consider that wholly persuasive.

But when you look at different countries with different structures of transmission mechanisms, some countries have a lot of flexible mortgages like we do. Some countries have a lot of market-based debt in the corporate sector. And you just look at the stylised facts of the transmission of policy through to prices. Forget all the gubbins in the middle. Just look at the interest rate tool and the price and output effect. Those effects are actually pretty similar. So there's a lot of stuff that it goes through, that this idea, as my old boss used to say, that in the end, you're setting the price of money, and money is the thing that defines what inflation is. It's quite hard to define inflation in a model without money. It's not like you can ignore the bits in between. Monetary policy works. It doesn't always work with the same lag. It doesn't always work with the same multiplier, but it does work, and there's a great deal of empirical literature that supports that. But challenge accepted in terms of us not having got that argument across sufficiently well and we have to keep working at it.

Thanks, Deputy Governor Hauser. Thank you for your speech on trust and communication. Just going back to your public remarks on October 21 that moved the markets from about a 20 per cent pricing to about a 60 per cent pricing for an expected rate rise. Were you surprised about the magnitude of that response in terms of the jawboning of the open market operations? Is there any sort of internal mechanism into meetings for internal executives like yourself to hook up with the other members on the Board to discuss what the communication strategy is? Or do you do that actually at meetings for the weeks ahead? Just like to get a little bit of insights into that, if I could.

As you know, the RBA Review recommended that the RBA needed to get out and about and explain itself better. We've been trying very hard to do that over the time I've been there, and I know the Governor is committed to that as well. You should be the judge whether we're doing that effectively or not. But we're doing it with the goal in mind of trying to ensure exactly the reasons that I've described in the speech, that people have a better understanding of what we're trying to achieve, in very difficult circumstances. But you ask a lot of detailed questions about internal mechanisms, and I don't have a great deal to say about that, frankly, at this particular point. There was no attempt to do open mouth operations for the market in my comments. I was trying to do what I'm always trying to do, which is to say how I see the data, and I'll repeat the point I made earlier, that in no way to front-run or box in the Board. That isn't our goal. I come from a background where we have a, in the UK, a Monetary Policy Committee of individually accountable monetary policymakers who fiercely defend their independent voice. I see very little difference in practice between that model and the model I see here. And as I said earlier to the same question, the debate on the Board is active, at times lively. I think Kevin Warsh uses this kind of what's the sort of friendly family fight or whatever he's using. I'm not sure I'd use that exact phrase. But you should take some comfort, I think, from the fact that that Board has a very lively and diverse debate about outcomes, and you saw that in the vote this week.

Thank you, Deputy Governor Hauser, for that presentation. I'm a student at the College of Business of Economics, so my question might be a little bit more basic. But my question is on that given that you talked about the fear of inflation expectations setting in last month, and as we are approaching the end of the year where consumers tend to spend more on festive seasons and tending to pick up on their spending, are there fears that consumers will no longer trust inflation to come down and continue to spend now, which worsens inflation later?

Hmm. Well, if David's doing his job well, you shouldn’t have seasonality in CPI. I've got a thumbs up from that. I'd also mention, David, that we're still finding our way on some of the seasonality of the new monthly CPI. But I don't think that was your question, but I guess just to clarify, CPI ought not to be affected by known seasonal factors. The kind of expenditure shifting you described, I think, yeah, it is potentially a real feature, and something that we watch for. I think there was a household spending indicator out this week. It was pretty resilient. And actually, we're watching consumption growth quite carefully because it's not punching the lights out. It's not spectacularly strong. But equally, it has held up more than we, and I think some other forecasters had expected, including in more discretionary items. Now, there's all sorts of reasons why that might be happening. We're not going to take comfort that it will remain resilient forever, nor, I should stress again, is it particularly strong. But some of the factors you describe are definitely potentially relevant, and we're keeping an eye on them.