A rare thing: the RBA snookered in public debate

Christopher Joye

Coolabah Capital

It's not often the boffins at the RBA are snookered in a public debate. But so it was on Friday, when the very bright Governor of the RBA, Dr Phil Lowe, and his side-kick, Deputy Governor Dr Guy Debelle, came head-to-head with a formidable adversary in the form of the politician and Harvard PhD, Dr Andrew Leigh. 

I cannot recall such an intellectually aggressive interrogation where the RBA has come off a bit worse-for-wear. The key issue that Dr Leigh targeted and the RBA effectively left unexplained is why they are not doing more QE - say, $150 billion or $200 billion every six months, which is of course still possible when they come to consider QE3 once QE2 expires in September. I have highlighted in italics a few of the choice exchanges.

Dr LEIGH: Thank you, Governor and your colleagues, for appearing before us today. As you know, since I came onto the committee in 2019, I've been quite critical of the bank for being, in my view, too timid in focusing on getting inflation up into the target band, and I'm still concerned that it might be the case for the entirety of your term as governor that inflation sits below the target band, with the consequence that there are fewer jobs in Australia than there would otherwise be. If you had announced $200 billion of QE on Tuesday rather than $100 billion, would your forecasts for wages in 2022 be higher or lower?

Mr Lowe: I think any shift in those forecasts would have been marginal because the channels that $200 billion, as opposed to $100 billion, would have worked through would be perhaps a slightly lower value of the Australian dollar and perhaps a lower value of bond yields. That would have had some marginal effects. That's true, yes.

Dr LEIGH: Some marginal effects in producing higher wages, right?

Mr Lowe: Analytically, that's certainly possible, but there are other structural factors that I've talked about working as well. We haven't ruled out further bond purchases after the current program. I think the best approach is to repeat what we've done so far, with effectively $100 billion of government bonds, including $80 billion of Australian government bonds. The $80 billion represents almost 10 per cent of the stock of government bonds. That's what we've bought over the past five months or are buying now, and we'll buy another 10 per cent of the stock, so that's 20 per cent of the stock over this bond purchase program. If we need to keep doing that, we will.

Dr LEIGH: But surely your own MARTIN model [an economy-wide model used to produce forecasts and scenario analyses] would suggest that, if you had doubled the size of QE, inflation would be higher, wages would be higher and we'd be closer to full employment?

Mr Lowe: It could. By that logic, though, you would just keep going and going and going. If $200 billion would do that, you could make the same argument for $300 billion, $400 billion or $500 billion.

Dr LEIGH: Until eventually you're in your target band and achieving your mandate. It's not obvious that this is a bad thing.

Dr Debelle: I would just note that macro models don't do a very good job of modelling the financial sector. They failed pretty poorly in 2007 when macro discovered finance. I think there's an issue around transition which those models don't take into account. They're linear. Actually, they assume that financial markets don't exist, broadly speaking. So, yes, you're right. The issue is: at what point do you start not getting the transmission through to those prices that you might expect? We don't know what that point is.

Dr LEIGH: But surely the downside risk of this is less than the upside potential of getting us back to full employment faster.

Dr Debelle: My point is it's not clear. Those models do not take account of transmission. They don't have bond markers in them. Very few macro models do. Basically, they ignore plumbing of the financial system and how likely that is to get the transmission that you're after. So we just do not know.

Dr LEIGH: You're not seriously telling me, Dr Debelle, that if you went from 100 billion to 200 billion, suddenly the sign would flip and the impact on inflation and wages and jobs would be negative?

Dr Debelle: No, but it's also possible you get minimal pass through it all. I'm not saying it would be negative, but it's plausible that you get not very little at all. And there are other consequences. If we end up with a dysfunctional bond market, that creates issues for the government down the track and its ability to finance itself.

Dr LEIGH: But the AOFM's increased Australian dollar liabilities by $245 billion. There is certainly scope, is there not, for you to increase the size of your bond market purchases.

Dr Debelle: Yes, and we have. By the time we finish this current program we're on, the one we're in now, we'll own around 20 per cent of the stock of AGS. We'll add another 10 per cent to that by early September; we'll potentially be up at around 30 per cent. We'll be buying more than AOFM's issuing—we are currently, and we will continue to do so. At some point, there will be a limit as to how effective that's going to be and how effective you're going to be in a bond market, which is something we want for the good of the country as well.

Dr LEIGH: Jay Powell has recently said he'll tolerate, or maybe even induce, a period of above-average inflation in order to ensure that average inflation is consistent with their target. Would you take a similar approach—tolerating a period of above three per cent inflation in order to offset the recent period of below two per cent inflation?

Mr Lowe: The truth is I haven't thought too much about that. Following the previous conversation, we are struggling just to get inflation back to two per cent. It would depend, I think, in the circumstances, whether the period of inflation was temporary. A temporary period of inflation above three per cent may make sense. But we are talking about things that, on current forecasts, are five or six years away. I feel like it's premature to be speculating on how we respond when inflation is above three per cent.

Dr LEIGH: The risk is that if you have a 'let bygones be bygones' approach, you effectively move down the anchor for inflation expectations below the target band.

Dr Debelle: Admittedly, we may be experiencing a period of above three per cent inflation in six months time.

Dr LEIGH: If that were the case, would you tolerate that for an extended period?

Dr Debelle: We don't expect it to be extended at this point.

Mr Lowe: It's important that Australians understand that, over time, inflation in Australia is going to have an average rate of two per cent. It hasn't in the last five or six years. I accept that. It's regrettable, and it's a combination of a whole bunch of structural and other factors—you might argue that we haven't done a very good job. It hasn't recently, but Australia should have a reasonable degree of confidence that, over time, inflation will average two point something. That allows inflation to be above three per cent for a period of time—not forever. Just like we're not happy with inflation starting with a one for a long period of time, we wouldn't be happy with it at three for a long, long period of time. We want to see it return to the central tendency of two point something. I'm sure future governors will be able to answer that question better than I can, because they'll have to confront that issue. I'm not expecting to have to confront the issue by the end of my term.

Dr LEIGH: Paul Keating this week said that, within the bank, there is little contest of ideas. As we discussed at the last hearing, the bank hasn't made an external appointment at the senior levels since the Spice Girls got together. You are one of the more insular central banks in the world, with many of your senior staff having spent their entire careers within the organisation—an approach which, if it were to persist in a private sector organisation, would surely see that organisation fail. Your board are in their 60s, with only one monetary policy expert appointed outside. When I put this to you last time, you said, 'Each month, I listen to many of my staff telling me I've got it fundamentally wrong.' Are those differences ever presented to the board for adjudication?

Mr Lowe: There are a few points there. Your point about the Spice Girls—regrettably, it's wrong. Actually, I'm glad it's wrong. One of the assistant governors at the bank at the moment, who runs corporate services, is a key part of the executive committee. She joined the bank two years ago. Our new head of finance is an external appointment. The head of our economic analysis department is an external appointment. He came in as head of the international department from the IMF and a private-sector background. So we have over recent times had a number of external appointments, which have been very effective. We look outside and we choose the best people, and sometimes we find them outside, and sometimes we find them inside.

You asked whether views of the staff that are the opposite of mine are presented to the board. The answer to that is yes. At the board meeting, we say to the board periodically that staff have this view or that view and we discuss that. So the board know that and we've got independent thinkers from the board who are bringing perspectives from lots of different places. I'd push back on the proposition that there's no testing of ideas.

Dr LEIGH: I don't see that reflected in the minutes, Governor. The board minutes that I've read don't seem to reflect moments in which staff views different from your own are presented to the board. Why are they cleansed from the minutes?

Mr Lowe: They're not cleansed from the minutes. The minutes aren't a transcript and they shouldn't be. They're a summary of the considerations that we discussed at the meetings. You'll have seen over time in the minutes' discussions of rising housing prices and the financial stability implications of that, and the many other considerations that we're grappling with. The minutes are an accurate representation of what goes on at the meeting, but they're not a transcript.

Dr LEIGH: Stephen Kirchner recently wrote a paper for the Mercatus Center, suggesting that monetary policy decision-making should be delegated to a committee of the Governor, Deputy Governor, Assistant Governor and four full-time external board members with monetary policy expertise. That would then allow you to have transparent voting, which you don't have under the current model of having amateurs rather than experts largely populate the board. What's your view of that proposal?

Mr Lowe: Again, I'm going to push back on you terming my board members as 'amateurs'. They're all people with a lot of experience in both the business and economic world. Carolyn Hewson has just been appointed to the board. She was on the Murray inquiry and has a deep background in finance, Alison Watkins has been appointed to the board—a lot of corporate experience. These discussions we were having before about what can be done to lift investment—these people are bringing lots of perspectives to the board.

Dr LEIGH: But they wouldn't characterise themselves as monetary policy experts and they wouldn't be appointed to the boards of most other central banks around the world.

Mr Lowe: What they bring—and I really value this as the chair of the board—is an appreciation of the difficulties of making decision-making under uncertainty. I feel, with due respect to the economists, that these business people are better at grappling with making decision-making under uncertainty than the economists. You want people with different perspectives—the people who bring their model and say, 'If you run the model, this is the outcome.' I think it would be, at least in our context, a backward step to have all people of the same background on the board. It's better to have business people, people with backgrounds in finance, economics and people who are dealing with complex and uncertain issues all the time and grappling with the trade-offs. For me, having all those people come together and discuss the ideas, that's a much better decision-making process than having people with the same background. It's this tension that comes from having people with different backgrounds and different experiences, and understanding decision-making under uncertainty, that I think has served us well. You might have a different view.

Dr LEIGH: The different view and the view adopted by pretty much every other central bank around the world is that you want your technical analysis to be able to be challenged by members of the board. You're in the quite comfortable position that, when the conversation becomes technical, you're on a board in which virtually no-one in the room has the expertise to challenge the staff. That's not a position which your counterpart governors face around the word. You also don't face consequences, if you undershoot your target band, as best I can see. What do you think the consequences should be for the Reserve Bank if it persistently fails to meet its central mandate? Is it enough that we come and ask you questions every six months, or should there be some other consequence—should you have to write a letter explaining yourself to the Treasurer?

Mr Lowe: I'm explaining myself to the population all the time. Is it enough to answer your questions? I can tell you I take this process incredibly seriously. I'm explaining every month, sometimes more frequently, what we're doing, why we're doing it and how we're achieving our objectives to the public. I personally don't think writing a kind of formal letter is going to add anything to the process. If the Treasurer asked me to, I would give him a letter. But I don't feel that would add anything to the process. You're asking me questions now every three months. I get asked questions frequently. I was at the National Press Club earlier this week also explaining this set of issues. If the government of the day wanted a different accountability mechanism, there'd be options that could be considered. But at the moment I feel we're doing a reasonable job at explaining ourselves to the public—what we're doing and why we're doing it.

Dr LEIGH: How often does the Reserve Bank's board overrule the staff's recommendation?

Mr Lowe: I don't think of it in those terms. The Reserve Bank board meets every month, except for January. You can think of it almost as a continuous dialogue. At most board meetings the decision on the recommendation has come from a discussion we had at a previous meeting or previous set of meetings. There's very rarely—at least when I've been the governor—a point where the board is surprised at the recommendations the bank was brought. By the time we get to a meeting, I think most of the board members are understanding the direction we're going to go, and we'll have discussed that before. So, at the actual board meeting, most of the time I'm reasonably confident that the board will agree to the proposal because we've already discussed the proposal at the previous meeting. And if I had a sense that there was disagreement with that then we'd have done things maybe slightly differently.

Dr LEIGH: It does seem like an unhealthy level of groupthink. But I'm at the end of my questions.

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Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs over $8 billion with a team of 40 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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