Interplay between fiscal and monetary policy
4.1
During the COVID-19 pandemic, the RBA supported the economy through implementing a comprehensive range of monetary policy measures to ensure that funding costs remained low, and credit remained available. The Governor told the committee that the RBA and Australian Government ‘worked very well together’ throughout the pandemic—crediting the resilience of the economy to this complementary monetary and fiscal policy support, consultation and knowledge sharing.
4.2
The committee asked the Governor about the future of this interplay between monetary and fiscal policy, given the uncertain economic outlook. In particular, the committee explored what the potential impact on inflation of the tightening of monetary policy would be, were it combined with an increase in fiscal expenditure.
4.3
The coordination of monetary and fiscal policy is, in the Governor’s view, less explicit outside of crisis periods. A hypothetical future situation of ‘significant fiscal expansion … would put upward pressure on interest rates’ if the economy was strong and businesses were having difficulties finding workers. Such fiscal settings, however, were not anticipated from the Australian Government.
4.4
On the issue of fiscal policy in the medium-term, the RBA felt that cutting spending, raising taxes, and structural reform were all potential measures for promoting the growth of the economy and supporting the goods and services needed by Australians:
At the moment, we're the closest to full employment we've been in 50 years and we've got the highest terms of trade ever in Australian history, yet we've still got a budget deficit … That's a significant issue. The community wants the government to provide a whole range of services, understandably. We want really high-quality aged care, great education, world-class disability care, fantastic national defence, great infrastructure. The community wants all these things from our governments—it's understandable. What we haven't worked out as a community is how to pay for it, and this is why we've got these budget deficits despite full employment and the record terms of trade.
At least in principle, there are three ways that you can pay for it. You can raise more taxes to pay for the things the community want. You can cut back in other areas. Both of these things are very difficult. No-one wants to pay more taxes and no-one wants cutbacks in other areas. Or we can get the economy to grow more strongly so the pie is bigger, and that requires hard choices on a whole bunch of structural reform issues. Each of those are very difficult, aren't they? Taxes, cutting back and structural reform—we have to do one of those three things, maybe all three of them, if we're going to pay for the goods and services that the community wants from our governments.
Home ownership and housing affordability
4.5
The committee sought the RBA’s view on increasing housing supply in the long-term, to support financial stability and to enable households to adapt to changing monetary policy—noting that one of the biggest impacts of an increase in interest rates is on housing affordability.
4.6
In response, the Governor emphasised that while cyclical variation in housing prices is driven by interest rates and therefore the RBA, the high cost of purchasing a home in Australia stems from structural factors. These are the preferences of Australians about where they want to live, the investments made in transportation and urban design, the taxation system, and the availability of mortgage finance. The Governor outlined that:
Interest rates influence the cycle, but not structurally. We've seen in countries—parts of the US are a good example—where interest rates have been lower than they were here, but housing prices are much lower because, as a society, they've made different choices about where they live, investment in transport and taxation.
It's the choices we've made as a people that have given us high housing prices, even though the interest rate influences the cycle. The central bank can't do anything about that. As an individual, not as the central bank, I think it would be better if we'd make different choices to give a lower average level of housing prices that would give people more opportunity and people would need to borrow less.
… So everything we have done—if you ask what choices a society could make to give high housing prices, we have made them all. Not to say it's good or bad, but that's what we've done.
4.7
The Governor returned to these themes when considering the committee’s questions on how to increase rates of home ownership among younger Australians. Structural factors such as tax, transport and urban design need to be addressed to ‘increase the supply of well-located land’ and thus sustainably lower the cost of housing relative to incomes for millennials and subsequent generations. By contrast, the RBA‘s contribution to the solution could only be cyclical—raising interest rates for a period would reduce prices and make housing ‘a bit more affordable’, but not beyond the short term.
Climate change
4.8
The committee asked the RBA how it was addressing the impact of climate change from a monetary policy perspective, noting that climate change impacts are likely to lead to more frequent and more severe supply chain shocks.
4.9
The Governor agreed that such shocks would have to be factored into decision-making. Investments into renewable energy will not affect monetary policy in the short term, but would be ‘incredibly important’ over the next 20 years in framing the RBA’s decision-making context—‘affecting the investment outlook, where the jobs will be, and the prices we pay for a whole bunch of goods and services’.
4.10
The RBA is ‘spending a lot of time on climate related issues’, the Governor continued, particularly through its work with the Council of Financial Regulators (CFR)—alongside the Australian Prudential Regulatory Authority, Australian Securities Investments Commission, and Treasury. Climate vulnerability assessments (on how well prepared financial institutions are for managing climate risks) and climate related disclosures (to guide the allocation of capital in support of solving climate risks) are two major focus areas for the CFR. This is to ensure that capital markets have the necessary information ‘to make the right decisions’.
4.11
Further, the Network for Greening the Financial System, an international gathering of central banks to discuss climate change related policy, is an avenue through which the RBA is seeking to put in place the right policy frameworks and disclosure environments to guide the allocation of capital in a global context.
4.12
On this theme, the committee queried how Australia compares internationally on climate disclosure policy, how Australia’s current approach impacts the availability of foreign capital for the transition to net‑zero emissions, and the likely impact of the recent Climate Change Act 2022.
4.13
The Governor observed that it is important to keep pace with international approaches in terms of the standards being developed to attract international investors and to align with global expectations. Based on the RBA’s discussions with counterpart central banks and international investors, the commitment to net zero emissions by 2050 had been ‘incredibly important’ in demonstrating Australia’s intent on the issue.
Productivity reform
4.14
Productivity growth is considered one of the primary drivers for increasing both living standards for Australians and the nation’s capacity to address future challenges such as an ageing population and global economic shocks. The 2021 Intergenerational Report highlighted that growth in incomes and living standards will slow if productivity growth remains at its current underlying rate of below 1.5 per cent.
4.15
While the RBA is not responsible for the policy levers that drive productivity, the issue is vital to the RBA’s foundational assessments upon which it bases monetary policy settings. The Governor told the committee that if productivity growth is low, then the RBA’s job is ‘going to be harder’ when it comes to addressing the inflation challenge.
4.16
In addressing the committee’s interest in the structural reforms needed to improve productivity, the Governor pointed to the Productivity Commission’s Shifting the Dial report published in 2017, which contained ‘good suggestions’ that had not all been implemented—potentially due to the lack of ‘political and other capability to do it’.
4.17
Structural opportunities to enhance productivity raised by the Governor included: taxation system reform; the pricing and selection of infrastructure; developing the nation’s human capital; regulation of the energy system; reducing regulatory system complexity; rewarding innovation; and taking advantage of data.
Labour supply
4.18
Historically, a key challenge for policymakers has been to achieve a low rate of unemployment without fuelling excessive increases in wages growth and inflation. The lowest rate of unemployment that achieves this balance is called the non-accelerating inflation rate of unemployment (NAIRU). As one of the RBA’s mandates is to deliver full employment, the committee explored how the RBA currently views the NAIRU and its place in future models.
4.19
The RBA responded that overall, the outlook for the labour market is ‘as strong as it has been in decades’, with Australia as close as it has been to full employment in 50 years. However, the current unemployment rate of 3 ½ per cent was unlikely to be sustainable given the sheer difficulty for businesses of finding workers at this rate.
4.20
The RBA added that current NAIRU modelling is ‘something in the low fours’ but there is also some uncertainty in relation to this figure. This was because standard economic models used to estimate NAIRU are demand‑driven when, by contrast, the recent pandemic and current environment have been characterised by supply shocks. Accordingly, the RBA is revisiting approaches to managing NAIRU estimates:
These models look at inflation and wages growth and unemployment all together. So there is also an assumption because you also have to infer inflation expectations from the various partial indicators of that. Those standard models are very much on the assumption that everything is driven by demand; they don't deal with supply shocks and they've certainly never seen a lockdown before, so those models would spit out a much higher number. So one of the active pieces of work that the team are working on is how to actually manage a NAIRU estimate when there has been a pandemic and you've had these big supply shocks. We have just had to apply some better judgement in the most recent forecast rounds, but I think it's an active area of research.
Migration
4.21
Another issue raised by the committee was the anticipated increase in migration to 195,000 people per annum (announced at the 2022 Jobs and Skills Summit) and its impact on unemployment. Boosting migration levels, after it was halted during the pandemic, is seen as key to addressing the current skills shortages in the economy.
4.22
The RBA stressed that Australia has ‘benefited hugely from immigration’ and that its long-term benefits are incredibly important. In the short-term, however, higher immigration would have little effect on the unemployment rate. This was because while immigration can address skills shortages and help businesses expand and invest, it also creates additional demand for labour in the economy, as working migrants and their families become consumers.
Payment systems
4.23
The RBA has important regulatory responsibilities for the payments system and plays a key role in its operations. The payments system is essential to settling transactions in financial markets and thus to the day-to-day business of the Australian economy.
4.24
The RBA has indicated that it continues to devote additional resources to payments related issues. This is due to the rapidly changing financial landscape, the advent of new technologies and business models, and an increased focus on the need to lower cross-border payment costs. The RBA is also continuing to support the shift to electronic payments, including by working with industry to ensure that the electronic system is secure, reliable and meets the needs of users.
4.25
Additionally, the RBA highlighted to the committee its supervision of the central counterparties that are operated by the Australian Securities Exchange.
4.26
In the digital currency space, the RBA is assessing the public interest case for a digital Australian dollar. It is envisioned that a digital form would complement the current physical banknotes. The RBA advised the committee that it has an ‘open mind’ on this issue and is currently working with the Digital Finance Cooperative Research Centre (DFCRC) on potential use cases, and with other central banks around the world.