Speech
Inflation and Recent Economic Data
[*]
Philip Lowe
Governor
Keynote Address to the Financial Review Business Summit 2023
Sydney - 8 March 2023
Thank you very much for the invitation to join this year's AFR Business Summit. It is a pleasure to be
able to join you again.
The number one near-term economic challenge facing Australia is to make sure that the current episode
of high inflation is only temporary. High inflation is corrosive and damaging. If it were to persist, it
would require even higher interest rates and more unemployment to bring it back down. So, it would be
dangerous indeed to allow the current period of high inflation to continue. The RBA's job, as Australia's
central bank, is to deliver low and stable inflation. The Board is resolute in its determination to do this
by making sure that inflation in Australia returns to the 2-3 per cent target range.
Some legacies of the pandemic
The high inflation that we are currently experiencing is one of the legacies of the pandemic and of
Russia's invasion of Ukraine. The pandemic interrupted the supply side of the global economy and this
pushed up costs and prices. And on top of this, the monetary and fiscal policy response to the pandemic
underpinned a strong recovery in demand that has also pushed up costs and prices.
Before I discuss inflation and the monetary policy response in more detail, I would like to highlight
another remarkable, but less remarked upon, legacy of the pandemic - that is, the significant
improvement in Australia's labour market. This is a positive legacy and it is in the national interest to
preserve as much of this as we can.
Over recent months, the unemployment rate has been around 31⁄2 per cent (Graph 1). The last time the
unemployment rate was this low was in 1974 - that's nearly 50 years ago. Over recent times,
Australians have not only found it easier to get a job, but have also found it easier to obtain more hours
of work. As a result, measures of underemployment are around multi-decade lows.
Graph 1
Unemployment and Underemployment
Per cent of labour force
% %
12 12
Unemployment rate*
9 9
6 6
3 3
Underemployment rate
0 0
1967 1981 1995 2009 2023
*
Quarterly data from 1959 to 1964 are spliced from historical national
accounts data.
Sources: ABS; RBA
These outcomes have coincided with a record number of Australians joining the labour force. The
participation rate has increased and the share of working-age Australians with a job has never been
higher than it has been recently. The youth labour force participation rate is the highest it has been in a
long time and the youth unemployment rate is the lowest that it has been in many decades (Graph 2).
Female labour force participation has also been at a record high.
Graph 2
Youth Labour Market Outcomes
% %
Unemployment rate
20 20
15 15
10 10
% %
Participation rate
70 70
65 65
60 60
55 55
1978 1987 1996 2005 2014 2023
Source: ABS
These are positive outcomes for the country and society as a whole. For decades, Australia struggled to
achieve what was considered to be full employment. Too many people couldn't find a job or the working
hours they wanted. This was one dark spot on what has otherwise been a very successful economy over
recent decades.
There are still significant issues in our labour market, but the outcomes I have just highlighted are much
better than most people thought likely, or perhaps even possible. There is a positive social and economic
dividend to this. Our communities are stronger when people who want to work can find a job and the
hours they want. Paid work not only generates incomes, but it also helps people develop skills and
progress up the ladder of opportunity.
The positive labour market outcomes largely reflect the policy stimulus during the pandemic - the same
factor that lies behind some of the recent inflation. For a while, the disruptions caused by the pandemic
made it more difficult for firms to operate and some had to hire extra workers to deal with this. But the
more important factor has been the support to aggregate demand provided by both fiscal and monetary
policy through the pandemic. This support was primarily designed to protect against catastrophic
economic outcomes, which it successfully did. But, it also had the effect of underpinning a strong
recovery in aggregate demand that has created jobs and achieved a substantial reduction in
unemployment. As we battle with inflation, it is worth remembering there is another side too.
I would now like to return to the battle against inflation.
In the December quarter, the headline inflation rate reached 7.8 per cent (Graph 3). This is the highest
rate in more than three decades.
Graph 3
Consumer Price Inflation*
Year-ended
% %
15 15
10 10
5 5
0 0
-5 -5
1970 1983 1996 2009 2022
*
Excludes interest charges prior to the September quarter of 1998;
adjusted for the tax changes of 1999-2000.
Sources: ABS; RBA
As we know from the 1970s and 1980s, high inflation is damaging and undermines people's living
standards. While the circumstances that gave rise to the current inflation are different, the effect of
inflation is the same. It erodes the value of savings, puts pressure on household budgets and hurts
people on low incomes the most. And the economy doesn't work well when inflation is high. It is harder
for businesses to plan, and people spend time protecting themselves against inflation rather than on
more productive activities. And if inflation becomes ingrained in expectations, it requires higher interest
rates and a large increase in unemployment to get it back down again. To illustrate the point, in both
the United States and Australia, when high inflation became entrenched in the 1970s and the 1980s, the
unemployment rate ultimately ended up rising by at least 5 percentage points to get inflation back down
(Graph 4).
Graph 4
Disinflationary Episodes*
% %
United States Australia
12 12
8 8
4 4
0 0
1978 1982 1986 1987 1992 1997
Inflation Unemployment
*
Shading indicates labour market downturns, from trough to peak
in unemployment rate.
Sources: ABS; RBA; Refinitiv
This is one reason why the Reserve Bank is determined to ensure that this current period of high
inflation is temporary. We will do what is necessary to make sure that high inflation does not become
ingrained.
The tool that we have to do this is interest rates. I acknowledge that the effects of higher interest rates
are felt unevenly across the community. The most direct effect for households is on the cash flows of
people with variable-rate mortgages. But this is only one of the many channels through which monetary
policy works.
Higher interest rates also affect the prices of all assets, including the exchange rate and the prices of
housing. They affect the cost of new finance for borrowers and the incentive for everybody to save and
spend. Higher interest rates affect residential construction activity and the investment environment
facing all firms. They also affect expectations of the future and thus the pricing decisions of firms and
wage outcomes. So, there are many channels through which monetary policy works, other than the
impact on mortgage rates. These various channels take time to work, but they do work, and they are
working to establish a better balance between supply and demand in the economy.
As I have discussed on previous occasions, the Reserve Bank Board is navigating a narrow path. We are
seeking to bring inflation down in a timely way while keeping the economy on an even keel.
If we can successfully navigate that narrow path, inflation will return to target in a reasonable time and
we will be able to preserve some of the gains in the labour market that I spoke about earlier. That is our
ambition. It is still possible to achieve this, but we do need to be prepared for other outcomes as well,
including a sharper rise in unemployment. Given the world we are living in, there are many sources of
uncertainties at present and we could be knocked off that narrow path.
Recent data
As the Board navigates this path, it is paying close attention to developments in the global economy,
household spending and the outlook for inflation and the labour market. I would like to say a few words
about each of these in light of the recent data.
First the global economy, which is in a challenging position. The IMF is predicting a period of weak
growth, especially in advanced economies (Graph 5). Even so, recent forecast revisions have tended to
be to the upside, following stronger news on labour markets and household spending on services in
several countries. A change in China's COVID policy has also improved the near-term outlook there.
Graph 5
Advanced Economy GDP Growth*
PPP-weighted
% %
IMF forecast
6 6
4 4
2 2
0 0
-2 -2
-4 -4
-6 -6
2004 2009 2014 2019 2024
*
IMF estimate for 2022; IMF forecast for 2023 and 2024.
Source: CEIC Data
The main global issue though is still inflation. Headline inflation has peaked in most economies and is
now coming down due to the resolution of supply side problems, softer demand for goods and a decline
in some commodity prices (Graph 6). Even so, there is still uncertainty about how quickly inflation will
come back down. In many countries, the prices of services are still increasing quickly and wages growth
is above the rate that is consistent with sustainable achievement of inflation targets. Reflecting this, in
underlying terms, inflation is proving to be uncomfortably persistent. While most central banks are
forecasting that inflation will be back to target within two to three years, there is a range of other
plausible scenarios where it occurs quicker or slower.
Graph 6
Consumer Price Inflation
Year-ended
% %
United States Euro area
10 10
8
6420 86420
% %
Canada United Kingdom
10 10
8
6420
-2 86420-2
2013 2018 2023 2013 2018 2023
Sources: RBA; Refinitiv
In Australia, the monthly CPI indicator for January published last week provided support to the idea that
headline inflation has also peaked in Australia (Graph 7). This monthly indicator is still experimental and
can be volatile from month to month, so some caution is required. But the year-ended inflation rate
showed a welcome decline from 8.4 per cent in December to 7.4 per cent in January.
Graph 7
Monthly CPI Indicator
Headline inflation, year-ended
% %
8 8
6 6
4 4
2 2
0 0
-2 -2
2018 2019 2020 2021 2022 2023
Source: ABS
Within the aggregate result, we now have the first sign that the slower rate of goods price inflation in
global markets is being transmitted to Australia. In January, clothing prices declined and the prices of
household furnishings fell for the first time in quite a while (Graph 8). This is just one monthly figure, of
course, so we will be looking for further evidence of a deceleration in goods price inflation over the
months ahead. In contrast, the prices of many services are continuing to rise briskly. Over the summer,
strong demand for travel, accommodation and entertainment contributed to large price increases in
these sectors. Rents are also rising rapidly, with rental vacancy rates at very low levels in many parts of
the country.
Graph 8
Monthly CPI - Select Items
September 2017 = 100, non-seasonally adjusted
index index
Furnishings, household
equipment & services*
110 110
100 100
Clothing & footwear
90 90
80 80
2017 2018 2019 2020 2021 2022 2023
*
Two-thirds of this inflation category by weight are goods; none of the
services items in this category are measured in the first month of the
quarter.
Sources: ABS; RBA
Overall, we expect that inflation will trend lower this year and next, but there is still uncertainty about
the exact path. Inflation is still too high and it will be some time yet before we are back within the 2-3
per cent target range.
As part of the Board's assessment of the future path of inflation, it is paying close attention to trends in
household spending, with the recent data showing a clear moderation.
In the December quarter, household consumption increased by just 0.3 per cent, which, in per capita
terms, represents a small decline (Graph 9). The bounce-back in spending following the pandemic has
now largely run its course. More fundamentally, the combination of cost-of-living pressures, higher
interest rates and the decline in housing values is weighing on consumption. The household saving rate
has declined from the very high rates of recent years to be now slightly below its pre-pandemic average.
A further decline is expected due to the ongoing pressure on household finances.
Graph 9
Household Consumption and Saving
Quarterly
% %
Real consumption growth
10 10
5 5
0 0
-5 -5
-10 -10
% %
Net saving ratio
20 20
15 15
Average (2015-2019)
10 10
5 5
0 0
2016 2018 2020 2022
Sources: ABS; RBA
Within the overall consumption figures there are divergent patterns (Graph 10). Per capita spending on
goods has softened recently, after surging during the pandemic. In contrast, per capita spending on
services has been strong, following its COVID slump. Spending on many services is now back in line with
the pre-pandemic trend, although spending on international travel is one exception. These divergent
patterns are also evident in the Bank's liaison, with some firms reporting that demand is still strong,
while others are reporting a noticeable softening. It is also worth noting that business surveys continue
to report that trading conditions are above average.
Graph 10
Household Consumption per Capita
December 2019 = 100
index index
Goods Services
105 105
Trend (2014-2018)
100 100
95 95
90 90
85 85
80 80
75 75
2018 2022 2018 2022
Sources: ABS; RBA
Looking forward, we expect a period of subdued consumption growth, especially in per capita terms.
This slower growth will help establish a better balance between supply and demand in the economy and
support the return of inflation to target.
There is a range of offsetting factors bearing on this outlook. On the positive side, households' wage
and salary income increased by more than 10 per cent over the past year, people have been finding
jobs, and a large stock of additional savings was accumulated over the pandemic period. On the other
side, though, interest payments are increasing quickly at a time when inflation is also high; based on the
interest rate increases that have already occurred (including yesterday's), total required mortgage
payments are expected to reach 91⁄2 per cent of household disposable income later this year, which will
be around a record high (Graph 11). Housing prices have also been declining, although it is difficult to
determine the effect of this on spending as there had earlier been a large run up in prices. And the pool
of additional savings is spread unevenly across the community. Given this wide range of factors
influencing consumption, the Board will be closely monitoring the spending data at each of its monthly
meetings.
Graph 11
Housing Mortgage Payments
Quarterly; share of household disposable income
% %
Scheduled payments
projections
12 12
Historical
10 10
estimate
8 8
6 6
4 4
2 2
0 0
2006 2010 2014 2018 2022 2026
Interest Scheduled principal Extra payments
Sources: ABS; APRA; RBA
Turning now to the labour market, the recent data suggest that conditions remain tight, although the
rapid pace of hiring in some sectors last year has slowed. The number of job vacancies is still very high
and many firms in the Bank's liaison program are reporting that they are planning to increase headcount
further (Graph 12). Notwithstanding this, in January employment declined by 11,500 and the
unemployment rate ticked up to 3.7 per cent. Our interpretation is that this decline in employment
largely reflects changing seasonal patterns in hiring. It was notable that in early January there were
around 100,000 more people than usual indicating that they had a firm offer to start a job within the
next four weeks. We expect that many of these people will begin work by February as planned and we
will be looking to see evidence of this in the February data.
Graph 12
Job Advertisements
Per cent of labour force
% %
2 2
1 1
0 0
2007 2011 2015 2019 2023
Sources: ABS; Jobs and Skills Australia; RBA
In terms of wages, we recently received new readings on the Wage Price Index and average earnings
from the National Accounts. Both indicate that wages growth is stronger than it was a few years ago,
which is a welcome development. It is also positive that the rate of wages growth remains consistent
with the inflation target, provided that productivity growth picks up to something like its pre-pandemic
pace.
In the December quarter, the Wage Price Index increased by 0.8 per cent, bringing the year-ended
increase to 3.3 per cent (Graph 13). This is the strongest year-ended outcome in a decade, confirming a
pick-up in wages growth in response to both the tight labour market and the high inflation.
Graph 13
Wages Growth
Year-ended
% %
Average earnings per head*
6 6
Wage Price Index**
4 4
2 2
0 0
-2 -2
2010 2013 2016 2019 2022
*
Non-farm.
**
Excluding bonuses and commissions.
Source: ABS
The National Accounts measure of average earnings per head increased by 0.9 per cent in the quarter
and 4.2 per cent over the year. The per hour measure increased by just 2.5 per cent over the year.
These measures have been volatile over recent times due to large compositional shifts in the labour
market and changes in hours worked. This has made interpretation difficult, but the general message
from these data is similar to that provided by the Wage Price Index.
Together, these data suggest that the risk of a prices-wages spiral remains low. This is helpful as we
navigate that narrow path and it means that Australia is in a better position than some other countries.
Notwithstanding this, we remain alert to the risks here given the combination of a tight labour market,
the high level of capacity utilisation and the run of high inflation numbers. If this risk did materialise, the
costs would be very high. In particular, if prices and wages were to chase one another, the end result
would be persistently high inflation, even higher interest rates and higher unemployment. It is in our
collective interest to avoid this.
Monetary policy
I will conclude with yesterday's decision by the Board to increase the cash rate by a further 25 basis
points to 3.60 per cent. This brings the cumulative increase in interest rates since May last year to
31⁄2 percentage points (Graph 14). The initial increases were required to remove the extraordinary policy
support provided during the pandemic. Our assessment is that the more recent rate increases have
moved monetary policy into restrictive territory, which has been necessary to ensure that the current
period of high inflation is only temporary.
Graph 14
Australian Cash Rate Target
% %
7 7
6 6
5 5
4 4
3 3
2 2
1 1
0 0
1998 2003 2008 2013 2018 2023
Source: RBA
When the Board makes its decisions each month, it is managing two risks. One is the risk of not doing
enough, which would result in high inflation persisting and then later proving very costly to get down.
The other is the risk that we move too fast, or too far, and that the economy slows by more than is
necessary to bring inflation down in a timely way.
It is a complex environment in which to be making policy decisions, with many of the variables we
monitor at near record highs or lows. The inflation rate is at a three-decade high. The unemployment
rate is around a five-decade low. Australia's terms of trade are close to their highest level ever. There
has been a record boost to savings over recent years and interest payments as a share of household
income will soon be at a record high. At the same time, measures of consumer confidence are as low as
they have been in a long while. This all means that there is range of scenarios for the economy and
there are uncertainties in both directions.
Given these uncertainties, the Board is monitoring the data very carefully month to month. It has the
flexibility to respond as needed.
Our judgement, though, remains that further tightening of monetary policy is likely to be required to
bring inflation back to target within a reasonable timeframe. Inflation is still too high and while it looks
to be on a declining path it is likely to remain higher than target for a few years. If we don't get inflation
down fairly soon, the end result will be even higher interest rates and more unemployment.
At our Board meeting yesterday, we discussed the lags in monetary policy, the effects of the large
cumulative increase in interest rates since May and the difficulties that higher interest rates are causing
for many households. We also discussed that, with monetary policy now in restrictive territory, we are
closer to the point where it will be appropriate to pause interest rate increases to allow more time to
assess the state of the economy. At what point it will be appropriate to pause will be determined by the
data and our assessment of the outlook.
Thank you for listening. I would be happy to answer your questions.
Endnotes
[*] I would like to thank David Norman for assistance in preparing this talk.
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