‘Volatile, uncertain, complex and ambiguous’: The current monetary policy environment
The Reserve Bank’s monetary policy decisions have been hampered by increasing ambiguity as the world changes in ways that cannot be predictably forecasted using economic models.
Unpredictable global trade policy and an unusually strong domestic labour market were key considerations in the Reserve Bank’s February rate decision, according to RBA deputy governor Andrew Hauser.
“New geopolitical realities are dawning. Artificial intelligence, the energy transition, demographic change and the long shadow of COVID-19 are fundamentally changing our concepts of economic activity and work,” Hauser said in a speech at The Australian Financial Review Business Summit.
Global trade policy uncertainty, which is at a 50-year high, was a strong point of ambiguity considered by the Reserve Bank when making its February rate decision.
RBA modelling of global trade war scenarios suggested “some downward impact on Australian activity; and an impact on inflation that could be either positive or negative, depending on whether supply or demand effects dominate,” Hauser said.
“But many other alternatives are possible too,” he added.
Australia is unlikely to see strong direct impacts from US tariffs as they make up less than 4 per cent of our export market, according to data from the Observatory of Economic Complexity.
However, a worldwide trade war would pose economic risks to Australia due to our integration with the broader global economy.
Most notably, a slowdown in the Chinese economy sparked by trade wars would weigh on demand for Australian commodity exports. China is Australia's closest trade partner and comprises over a third of its export market.
“As Australia’s long history has shown, we thrive when trade, labour and assets flow freely in the global economy, but we suffer when countries turn inwards,” Hauser said.
Another key uncertainty for the RBA was the strength of the labour market, which has remained unusually resilient throughout subdued GDP growth.
The surprising strength of the labour market has caused the RBA to project that core inflation will stabilise at a level above the target midpoint of 2.5 per cent but within the RBA’s target bands.
Hauser said the sustainable unemployment rate must be lower than the RBA’s current forecasts, which typically expect that an unemployment rate below 4.5 per cent will exert upward pressure on inflation.
Overall, the RBA was cautiously optimistic about the trajectory of inflation and the broader economy but noted significant uncertainty ahead.
“The pervasive uncertainties we will face over the forecast period are orders of magnitude larger than the sorts of differences to the target midpoint I’ve discussed here,” Hauser said regarding the RBA’s messaging on interest rate decisions and the possibility that inflation could remain above the target midpoint in the near future.
“The rate cut in February reduces the risks of inflation undershooting that midpoint, but the Board does not currently share the market’s confidence that a sequence of further cuts will be required.
“Progress towards that target has been good – but it is too soon to declare victory. Many households and companies are continuing to struggle – and the Board will continue to take decisions, meeting by meeting, in the interests of all Australians.”
