Westpac's Lucy Ellis digs into the RBA's minutes and commentary and finds a central bank not inclined to rush monetary policy easing

By Lucy Ellis*

This week’s minutes and Anika Foundation speech provided plenty to consider about how the RBA is seeing the economy. Inflation has come down significantly, which was welcomed. Unlike many other economies, this has not been at the expense of significantly higher unemployment. (For the technically minded, this means the ‘sacrifice ratio’ has been low.) While the Governor stopped short of claiming vindication, the contrast with other peer economics such as Canada and New Zealand did highlight the role of the RBA Board’s strategy to raise the policy rate by a bit less than in those other countries. Still, the MPB clearly remains nervous about inflation and some members want to see actual data to support their expectation that it is still declining towards 2½%, the midpoint of the RBA’s 2–3% target range. For this reason, we cannot lock in the cash rate cut in August just yet. We do, however, think it is the most likely outcome, especially if the quarterly inflation numbers come in as we expect. 

Supply, productivity and path-dependence: the plot thickens 

Unsurprisingly given the government’s upcoming roundtable, productivity received plenty of attention in the minutes, speech and Q&A. The minutes acknowledged that the expansion of the non-market sector and declining mining sector output had contributed to developments recently. The Governor noted that the staff are doing more work on productivity ahead of the August SMP. It is not clear which way this will go. We know that much of Australia’s living standards challenge stems from the fact that the free kick from rising minerals prices is no longer occurring. This would be true even if productivity growth were robust: when one factor is no longer boosting living standards, something else must adjust to make up the difference.

Concerns about productivity relate to the supply side of the economy. The Governor’s speech acknowledged that much of the surge in inflation following the pandemic stemmed from supply shocks. This is, incidentally, quite an evolution from the RBA’s assessment in late 2023 that inflation was becoming ‘increasingly homegrown and demand driven’. While these supply shocks were more drawn out than some observers initially expected, they did eventually subside. Monetary policy can mostly look through this kind of inflation as long as inflation expectations remain anchored.

But strong demand was also a factor. This was especially an issue in the United States, where fiscal policy remained very expansionary even after the disruptions of the pandemic had passed. The issue was less pronounced in Australia, but the exceptional stimulus during the pandemic and the surge in population when the borders reopened did play a role. (The RBA also today released some interesting findings on the latter.) The differing experiences of economies stemming from different fiscal responses highlights why it is so important that the methods central banks use to disentangle supply and demand shocks are appropriate, and do not fall foul of the ‘other fruit problem’.

More broadly, in the speech Q&A, the Governor acknowledged that weak productivity and weak supply did not necessarily imply anything for demand and so monetary policy. While that clears up any misconceptions that weak productivity growth is necessarily a reason to keep monetary policy tight – a welcome realisation – there are some important nuances here.

In particular, the Governor floated the idea that slow demand growth had less to do with tight policy than with supply being weak. We should not make too much of an off-the-cuff answer in a post-speech Q&A: it’s hard to get all the nuances into a short answer when there is a queue of other people wanting to ask questions. But this does raise the question of which way causation runs, and whether strong demand might in fact induce greater supply or weak demand weigh on supply. If so, tight monetary policy when both demand and supply are weak looks even less defensible. 

The difficulty with this line of argument becomes clearer when comparing this discussion with the Governor’s answer to another question, about the labour market. There, Governor Bullock referenced a Bulletin article published the same day showing that the increase in labour force participation since the pandemic had not been a drag on productivity. The additional workers were not so new and green that they reduced the overall quality of the workforce. (This should not be a surprise: much of the increase in participation came from older workers just not retiring, and women returning to the paid workforce after stints demonstrating the executive management skills involved in wrangling small children.) It was a good thing, the Governor said, that a tight labour market had drawn more workers into employment. In this way, a tight labour market begat its own loosening by drawing in more supply. This kind of path dependence – known as ‘hysteresis’ to economists – is central to the understanding of why unemployment was so high in decades past but declined right across developed economies in the 2000s without spurring inflation. (This is the same mechanism that caused people to worry that the pandemic would cause ‘scarring’ in the labour market. There is a growing academic literature on this mechanism.)

In other words, the Governor was allowing for the possibility of some path-dependence in the labour market but had not quite translated this into an implication for the broader economy.

Communicating in many voices 

In response to a question from another market economist, the Governor reiterated the point she made after the meeting: that these speeches cannot front-run the MPB meeting, because each member is just one member and does not speak for all. Explicitly taking issue with market pricing of future RBA moves is therefore not something we should expect to happen in future. In response to a media question, the Governor argued that surprising the market was neither a reason to do something or not do something. Put another way, the MPB will put no weight on whether its decision surprises he market. The Board will just try to do what it considers to be the right thing. (That ‘it considers’ language is a relatively recent addition to the final sentence of the media release and minutes, first included in the media release following the May meeting.) 

That should not preclude, however, inter-meeting communication that hosed down a misconception in the market about how data is being interpreted. For example, the minutes clarified that models of the so-called ‘neutral rate’ were uncertain and not too much weight should be put on them or recent changes to some of them. It would not have been frontrunning the other MPB members to say in a speech, as the minutes did, that ‘public discussion of the stance of monetary policy had possibly overemphasised the inferences that could be drawn from these alternative models, especially for the near term’. (Looking back at my own note on the subject, I could have been blunter in my language, too, in my efforts to hose down this view.) 

As we noted earlier in the week, though, the view of neutral becomes even more important – and fraught – the closer you get to where you think it is. MPB members who are still nervous about supply constraints and tight labour markets will want to tread slowly. As the Governor said in her speech, ‘[t]he Board continues to judge that a measured and gradual approach to monetary policy easing is appropriate’. That ‘measured and gradual’ language is a bit of an evolution from the ‘cautious and gradual’ language used in the minutes when discussing the views of the members who voted to hold rates in July, and the ‘move cautiously and predictably’ language of the May minutes. These small wording changes are likely to be simply different ways of saying the same thing: this is not a central bank that will rush policy easing.

Lucy Ellis is Chief Economist, Westpac Group.