Reserve Bank governor Glenn Stevens backs inflation target

Glenn Stevens warns an economic boost might have to come from government spending, not interest rates.

RBA Governor Glenn Stevens was delivering his last speech before retiring next month. Pic: AAP

Outgoing Reserve Bank governor Glenn Stevens has warned that if the economy needs a big boost it might have to come from government spending rather than interest rates.

In his final speech as governor before retiring next month after a decade at the helm of the central bank, Mr Stevens said he had serious reservations about the reliance on monetary policy around the world.

All the major developed economies have interest rates set close to zero in an attempt to lift economic growth, but with only modest results.

Actions by central banks have not been enough, and could not be enough, to restore demand fully after a recession and a big build-up in debt, he said.

“It isn’t that the central banks were wrong to do what they could, it is that what they could do was not enough, and never could be enough, fully to restore demand after a period of recession associated with a very substantial debt build-up,” he said.

For Australia, where the trend in economic growth has slowed, the path back to budget balance is proving to be a long one.

But Mr Stevens said the most powerful expansionary push from low interest rates comes when “someone, somewhere” has the capacity and willingness to take on more debt and to spend.

“So for policymakers looking to use low interest rates to boost growth, the question is: which entities, if any, in the economy can accept higher leverage (borrowing) safely?”

He pointed out that household debt in Australia is currently about 125 per cent of gross domestic product, while public sector debt is only about 40 per cent.

“It’s an interesting question which sector would have the greater capacity to take on more debt, in the event that we were to need a big demand stimulus,” he said.

He made it clear he was not advocating government borrowing to fund routine spending on pensions, welfare and the like.

“The point I am trying to inject here is simply that popular debate in Australia about government debt and how we limit or reduce it seems so often to be conducted while largely ignoring the size of private debt.”

Mr Stevens used his speech in Sydney to defend the RBA’s performance over his decade at the helm.

He said Australia over time “has achieved the inflation target, avoided a major economic downturn, seen remarkably little variability in real economic activity in the face of enormous shocks, experienced a fairly low average rate of unemployment, and had a stable financial system as well”.

Mr Stevens also pushed back on suggestions that the RBA’s 2 per cent to 3 per cent inflation target was no longer valid, given deflationary pressures locally and in the global economy.

“Frameworks that have a degree of flexibility, that can bend with the circumstances but retain their essential integrity, like an aircraft wing in turbulence, stand a reasonable chance of coming through,” he said.

“I think the inflation target as we have operated it has the requisite degree of flexibility,” he added.

“If it were the case that undershooting the target for a period while achieving reasonable growth was the least bad option available, the inflation targeting framework has the requisite degree of flexibility to allow such a course,” he added.

The RBA last week forecast inflation will remain below the target band to the end of its forecast horizon in December 2018.

Some economists have suggested the target needs to be lowered, as there are growing risks associated with lowering interest rates too far to seek a high inflation outcome. Among those risks are the threat of a surge in already elevated house prices.

Mr Stevens said the RBA’s board has discussed those risks, but it wasn’t the job of policy makers never to take risks.

“I can assure you that the board has been very conscious of that possibility and, accordingly, has proceeded very carefully,” he said. “Our job is not to avoid all risk; it is to balance the various risks.”

Over recent years, measures have been taken to tighten the mortgage lending criteria of Australia’s major banks to take steam out of the housing market.

So far, that has worked well and the RBA was able to cut interest rates last week to a record low of 1.50 per cent from 1.75 per cent, saying risks associated with house prices have diminished.

AAP, Dow Jones