What does the Reserve Bank really want?

Reserve Bank governor Philip Lowe appears before the House of Representatives Standing Committee on Economics at Parliament House in Canberra on Friday. Picture: AAP

“The Governor and the Treasurer have agreed that the appropriate target for monetary policy in Australia is to achieve an inflation rate of 2-3 per cent, on average, over time.”

— The Reserve Bank’s inflation target, as described on its website.

At what point, we wonder, does the “over time” bit of that agreement with the Treasurer get called? Five years? Six years? Not four years, apparently.

Inflation is 1.4 per cent and has been below the target for four years. I’m guessing that if it had been well above the target band for four years, we’d be in recession by now, with the cash rate at 10 per cent.

In his National Press Club speech this week, governor Philip Lowe said: “We continue to expect a gradual increase, with underlying inflation expected to approach 2 per cent over the next couple of years.” So, more than six years is OK then.

In fact, has the target been quietly ditched already, evidenced by the decision not to cut the cash rate this week with inflation at 1.4 per cent?

The beauty of a thing like the RBA’s inflation target is that it’s like the kids in the back of the car when you’re driving over to Nana’s (“Are we there yet?”). You can just keep saying “Sshh, it won’t be long” unless, perhaps, the person in the back seat is the federal Treasurer and he calls you on your agreement about the time it takes to get there.

Not much chance of that, though, because the current Treasurer, Josh Frydenberg, wants a budget surplus with which to beat up his political opponents, and in pursuit of which he has been contributing to the low inflation by raising taxes through fiscal drag and squeezing government spending.

Any phone call by him to Dr Lowe that started with “Now Phil, about that inflation target …” would be interrupted with an emphatic suggestion that the Treasurer might consider doing his bit towards the target as well, instead of just buggering it up.

But while we all know what the government wants — a surplus — the big unanswered question is: what does the Reserve Bank actually want?

It obviously doesn’t really want 2 per cent inflation and full employment because if it did, interest rates would be zero and it would be doing quantitative easing like billy-oh, like the US Federal Reserve.

You might protest that the reason the US has full employment (3.6 per cent) is not the Fed’s QE, but Trump’s fiscal expansion and massive budget deficit, and you’d be right, up to a point, except that the Federal Reserve is printing money right now as well as cutting interest rates — three times in 2019, the same as the RBA.

The Morrison/Frydenberg government has been doing the opposite of Donald Trump — shrinking the deficit, not expanding it — yet the Reserve Bank of Australia has chosen to respond to that with tighter monetary policy than the Fed, not looser.

Yes, the Aussie cash rate is 0.75 per cent, lower than the US Fed funds rate range of 1.5-1.75 per cent, but it’s the change that matters — not so much the absolute level — and in any case the RBA has been avoiding quantitative easing as if it’s a form of self-abuse that only foreigners do — not in Australia, please.

That’s not necessarily to advocate money printing and zero interest rates from the back seat, so to speak, but it must be said that unemployment here is stuck above 5 per cent, underemployment is stuck at 8 per cent, and inflation is stuck around 1.5 per cent. It’s merely to wonder what the Reserve Bank is actually up to.

In his speech on Wednesday, Dr Lowe said: “we find ourselves in a world of low unemployment, low inflation and low interest rates. I expect that we are going to remain here for quite some time given the structural factors at work, although it does remain possible that a re-acceleration of growth in economies with little spare capacity could see inflation re-emerge.”

In other words, he’s got no idea what’s going on, which is fair enough — nobody else does either.

He also said: “With our economies seemingly less inflation-prone than they once were, it is now possible to sustain lower rates of unemployment than previously thought to be the case. This is a good thing.”

Agreed. It is a good thing. So what are we waiting for? How about we have a go at sustaining some lower rates of unemployment?

Dr Lowe says he is confident that over the next couple of years further progress will be made towards full employment and the inflation target, “although that progress is likely to remain quite slow”. He then went on to talk about the structural shifts in the global economy related to technology and globalisation, which we all know about, and also the adjustment in household finances in Australia, all of which, he said, monetary policy was responding to and providing “considerable support to the Australian economy”.

So having said that progress towards full employment is slow, but also that monetary policy works, he then explained it would have been too risky to cut interest rates on Tuesday. He didn’t say it would have been too risky not to do it.

This is pretty confusing. It is either an acceptance that the RBA targets can’t be achieved, full stop, or an implicit admission that monetary policy doesn’t work any more so there’s no point, even though Dr Lowe is explicitly denying both of those propositions.

If the governor’s speech was an attempt to explain what the RBA is up to, it didn’t succeed.

Alan Kohler is editor in chief of eurekareport.com.au