“In less than a year, the RBA has stated it believes the most likely next movement in rates is up, then that rates would remain stable, then reduced, and now that the economy is at a turning point. Can the RBA outline what confidence it believes Australians can take from such a claim, given that the RBA has not [offered] a consistent position on the direction on the Australian economy over that period?” RBA governor Philip Lowe was asked by the House of Representatives Standing Committee on Economics.
According to the RBA’s published response, “In the first half of 2018, the economy was growing at an above-trend pace, the unemployment rate was declining quite quickly, wage growth was picking up and inflation had lifted to be just above 2 per cent. In that environment, our assessment was that we were making progress towards our goals, but that progress was gradual.”
As such, the RBA had believed that the next movement in interest rates would be upwards, but some time off.
The RBA said that things changed abruptly in late 2018, with lower than expected growth and inflation, but more upbeat employment growth than had been anticipated.
This shift, it said, was exacerbated by a global slowdown, and business sentiment easing back from “well above-average” levels.
“In light of that new information, we revised our outlook such that in February 2019, when we appeared before the committee, our assessment was that the risks to the outlook for the economy and the probability that interest rates would rise or fall were more evenly balanced. This primarily reflected the change in the outlook for consumption.”
But things changed again, it said, in the early part of this year, as inflation remained stubbornly low while the unemployment rate began to rise.
“The unemployment rate edged up, which together with information that the pick-up in wages growth had stalled, caused us to assess that the economy had greater spare capacity than we had previously estimated. This in turn provided scope for monetary policy to be eased [in the form of interest rate cuts in June and July] to make further inroads into the spare capacity and ensure greater confidence.”
The RBA concluded its response by stating that it “seeks to be as transparent as possible regarding how it views the economic outlook, recognising that often things turn out different[ly] from what was expected”.
Unconventional monetary policy options
The RBA was also asked to expand on the idea that it could look to “unconventional monetary policy” to support the economy, with little room for interest rates to fall from their current record low of 1 per cent.
It replied that such options are “unlikely” to be needed, but that it was “prudent” to examine their usage in other countries around the world. These were identified as:
• very low and even negative interest rates
• explicit forward guidance that policy rates will remain at a very low level until some time has passed or until certain conditions are met
• purchasing government bonds
• providing longer-term funding to banks to boost the supply of credit
• supporting financial conditions more broadly by purchasing private sector assets, such as mortgage-backed securities, corporate bonds or even equities
• foreign exchange intervention
The RBA determined that the effectiveness of such measures “depends upon the specific economic and financial conditions facing each economy at the time as well as the structure of its financial system”.
Some had been very effective where the supply of credit had been severely restricted, the central bank said, but that it is important such exceptional measures are clearly communicated to the wider market ahead of their implementation.
Further rate cuts are also not being ruled out.
“At a cash rate of 1 per cent, the Reserve Bank Board still has scope for conventional policy easing, should it be required,” it said.
In June this year, a NAB economist suggested that more “radical” measures to stimulate Australia’s economy could be explored by the RBA, but that “helicopter money” — including cash payments made directly into the bank accounts of taxpayers — would be an option of last resort.
“It generally does work, but it’s often hard to stop,” economist Kieran Davies said.
The full list of questions and the RBA’s responses can be found on the RBA website.