THE HON JIM CHALMERS MP
TREASURER
MEMBER FOR RANKIN

MONETARY POLICY IN UNCERTAIN TIMES

CANBERRA

WEDNESDAY, 20 JULY 2022

*** CHECK AGAINST DELIVERY ***

Thanks very much Jackson, and to John and Chris and all of you for the opportunity to make a contribution to the discussion today.

I’m speaking to you from the lands of the Ngunnawal and Ngambri people – I acknowledge them and I acknowledge the Wurundjeri people where you are gathering.

I know you have heard from Philip Lowe this morning, and I know in his remarks he was supportive of the Reserve Bank review I announced just a few hours ago.

I’m grateful to him for that, and for the numerous discussions we’ve had about it on both sides of the recent election.

As I have said many times, I have a mountain of respect for Governor Lowe – and for the professional, hard‑working people of the RBA.

Australians deserve a monetary policy framework that is fit for purpose into the future.

That’s what the review is all about.

And it’s what I’d like to spend my brief time talking about with you today: the role of the RBA and monetary policy in the difficult economic circumstances we are in, and the role of government as well.

Governor Lowe and I have just returned from the G20 conference in Indonesia – meeting with our global counterparts as well as the heads of some of the major international economic institutions, like the IMF.

And it’s fair to say that there is a shared concern – and a substantial concern – about the state of the global economy and its prospects in the near future.

There are global challenges that are affecting all of us: the impact of COVID policies in China and the subsequent slowdown; concerns in and for the United States; and of course, Russia’s invasion of Ukraine.

The IMF made clear at the G20 meeting they expect to make further downgrades to the global growth outlook.

The global economy is entering another dark and difficult period with costs and consequences for us here at home.

These appear in the form of high and rising inflation, rising interest rates – and the slowing effect they have on economic growth.

Our inflation problem is not just a story about demand.

On the supply side, skill shortages, bottlenecks in supply chains and the certainty and affordability issues in the energy market – these sorts of issues are fuelling inflation too.

And when Parliament returns next week I will deliver a Ministerial Statement that will detail some of these pressures on our economy and, as a consequence, on our Budget.

I expect to be able to deliver that statement next Thursday – the 28th of July. I’ll use it to paint a true picture of the economy – the challenges as well as the opportunities.

Because in times like these – the best place to start is with being honest and up‑front about what’s working for us and against us.

High and rising inflation has an impact on real wages. Rising interest rates have an impact on economic growth. You’ll see this reflected in the Treasury forecasts I release next week.

Now, this combination of challenges – on the demand side and the supply side – makes the task for policy makers, business leaders and job creators harder, and for our major economic institutions as well.

The RBA has a particularly difficult job to do.

It is normalising interest rates in the context of already high inflation and strong underlying demand, unpredictable and evolving supply shocks and a precarious global outlook.

Negative supply side shocks can be especially challenging for central banks because they impact inflation and output in different directions.

Not only does the shock itself hurt growth, but the monetary policy response to the inflation challenge comes at a further cost to growth in the near term.

As the Bank for International Settlements has recently highlighted, the challenge of responding to supply side shocks and bottlenecks is magnified when they become more persistent.

While central banks tend to “look through” temporary supply shocks, the timing and persistence of these events can be hard to judge.

What starts as temporary price increases can sometimes become longer lasting – and risks becoming self‑perpetuating if it impacts inflation psychology and the behaviour of households and businesses.

As a result, central bank credibility and the management of inflation expectations is critical to getting bouts of high inflation under control.

That’s why in forecasting a spike in inflation this year, it’s important to remember the Reserve Bank also expects it to moderate next year, with medium‑term inflationary expectations remaining well anchored.

The Bank for International Settlements is also right to point out that tackling persistent supply side constraints cannot be left to monetary policy – it requires actions to boost the productive capacity of the economy – a point I will return to.

Monetary policy’s effectiveness is also impacted by structural changes in the economy that have been occurring for some time.

The decline in the ‘neutral’ interest rate is one major change that impacts monetary policy effectiveness, particularly in a crisis.

The RBA struggled to meet its inflation target in the years just prior to the pandemic.

The cash rate target was at 0.75 per cent, its then‑lowest recorded level in the inflation‑targeting era, when the pandemic hit.

But despite lower rates, inflation undershot the RBA’s target band for much of this time.

I don’t intend this as a criticism – this was common among advanced economy central banks over this period.

One of the explanations is that structural changes in the economy lowered the ‘neutral rate’ – or the interest rate that is neither stimulatory nor contractionary.

There’s evidence that in Australia and many advanced economies, an aging population, flatlining productivity and rising risk aversion following the GFC have been the key drivers of a lower neutral rate.

This is all a pretty wonky way of saying that the economic circumstances we are in are different – and our response needs to be different as well.

There is a necessary role for monetary policy here – a demand management role for the independent Reserve Bank.

But it’s not exclusively a demand problem we are dealing with, it’s trickier than that.

These sorts of complications mean this is a really good time to review and rethink the role of our monetary policy framework into the future.

To review and rethink – and renew and refine where we need to.

This review is the first since the existing monetary policy arrangements were established in the early 1990s.

There have been enormous changes in our economy in this time – but no broad‑ranging opportunity to pause and think about where the setting of monetary policy fits into this evolving landscape.

Now, in the current environment, with the different pressures and constraints on monetary policy, it is just common sense to see if the current framework and its interaction with fiscal and macroprudential policy is working as well as it can.

So we can make sure we have the world’s best and most effective central bank and monetary framework. For the times we are in, and for the challenges coming down the track.

So this review is right to do – and now is the right time to do it.

As corporate leaders, you know the importance of consistent refinement of your business structures and operations – to keep growing and to meet new opportunities and challenges.

Every institution benefits from this from time to time.

Done constructively, as I know the RBA review will be done, it can be a source of institutional renewal and strength.

The Review will be wide‑ranging. It will also be transparent and independent of the RBA to give the general public and markets confidence in the process and recommendations.

It will examine the RBA’s objectives, policies, governance – including its communication and the structure, expertise and composition of its board – along with its culture.

It will provide an opportunity for public engagement and input on the role and performance of the RBA.

I have appointed three highly qualified experts to lead this review – the first three people I asked:

Carolyn Wilkins – an internationally recognised expert on monetary policy, who served as Senior Deputy Governor of the Bank of Canada, and is now advising the Bank of England.

Professor Renee Fry‑McKibbin – a respected academic expert on financial markets and open economy macroeconomics.

And Dr Gordon de Brouwer – who brings 35 years of experience as an economist and leader in public policy and administration.

This is a first‑class team of experts.

They bring the right knowledge and experience – including international experience – which I know was important to a lot of people taking a keen interest in this review.

The panel will produce a final report with a clear set of recommendations to Government by March 2023.

This review is about renewing and revitalising the RBA, not revolutionising it.

And recognising there are plenty of things beyond the RBA’s control.

We’re not looking here at monetary policy in isolation, but how it works with fiscal policy.

The supply‑side story goes to the costs and consequences of our choked supply chains and flatlining productivity growth.

So the role of Government isn’t just to make sure fiscal policy isn’t working at cross purposes on the demand side –

It’s to recognise and respond to the supply‑side pressures that inflame inflationary pressures – something that Phil Lowe has also spoken about today.

On Monday I spent time with Nobel‑prize winning economist Joseph Stiglitz again.

He makes a point that should be obvious but seems easily forgotten: ‘supply‑side constraints call for supply‑side solutions.’

If we ask central banks to solve this problem on their own, then in his words, we are asking for a ‘hard landing’.

Higher interest rates can’t stop war, or grow more food, or produce more oil.

They can’t fix a skills shortage, improve flatlining productivity or repair a broken energy market.

That’s why the economic plan Katy Gallagher and I took to the election – the economic plan we have begun to implement – is a direct and deliberate response to these supply‑side challenges.

It’s about unclogging, unchoking, unburdening our supply chains – creating more capacity and lifting the speed limits on the domestic economy.

By delivering cheaper childcare – getting more parents back into the workforce and boosting productivity.

By investing more in skills and training and the digital economy.

By finding a bigger role for advanced manufacturing in our modern economy – and by recognising the huge potential of our growing care economy as well.

And by providing certainty to business and investors when it comes to the energy market and managing climate risk.

All of this is the job of government, working collaboratively.

If we expect the Reserve Bank to do its job dealing with the demand pressures on inflation – then we need to do our job too.

We are, and we will.

We shouldn’t be daunted by the circumstances we confront.

You’re not and your government is not.

Because in the short time since the election, we are being constantly reminded of the real sense of collaboration and common purpose from business and community leaders across the country.

This is the spirit and the appetite which will underpin the Jobs and Skills Summit in September.

Things will likely get harder before they get better, but they will get better.

And in the meantime, it’s up to all of us to make sure – in the weeks and months ahead – that we are building an economy that is as strong, as resilient and as inclusive as the people we serve.

Giving all the economic levers available to us the best chance to work.

Thanks very much for the opportunity today.