philip lowe : low inflation in a world of monetary stimulus speech by mr philip lowe, deputy governor of the reserve bank of australia, to the goldman sachs annual global macro economic conference, sydney, 5 march 2015. * * * i would like to thank marion kohler for excellent assistance in the preparation of these remarks. accompanying charts can be found at the end of the speech. i would like to thank goldman sachs for the invitation to speak today. it is a pleasure to be here and be part of your annual macro economic conference. it is perhaps stating the obvious to say that an important part of the macroeconomic environment is monetary policy. the actions of central banks have material effects on financial markets and can shape macroeconomic outcomes. indeed, over recent decades it became widely accepted that monetary policy was the primary macroeconomic stabilisation tool and that monetary policy could effectively manage the business cycle. from today ’ s perspective, the picture looks a little different. in many ways, the current global monetary environment is quite extraordinary. there has been unprecedented money creation by the world ’ s major central banks. policy interest rates are negative across much of europe. long - term government bonds yields in most advanced economies are the lowest in recorded history. lending rates for many private sector borrowers are the lowest ever. and some banks in europe are now charging customers to accept deposits. in earlier eras, one could have predicted with some confidence that this type of monetary stimulus would have created a boom in economic activity and subsequently a substantial lift in inflation. yet, today, many parts of the world continue to operate with considerable spare capacity, inflation rates are low almost everywhere and inflation expectations have generally declined, not increased. so this afternoon, i would like to talk a little about these very unusual times. i will begin by showing a few graphs that summarise the current global monetary environment. i would then like to explore some of the possible reasons why we are in this environment before addressing some of the implications of all this for australia. the current global monetary environment so first, to the facts. since the global financial crisis, we have seen an extraordinary increase in the size of central bank balance sheets. this first graph shows the size of the combined balance sheet of the us federal reserve, the bank of japan and the european central bank ( graph 1 ). this combined balance sheet has increased from the equivalent of us $ 3½ trillion in early 2007 to almost us $ 10 trillion today, and a further substantial rise is in prospect.

to 1973 / 74 average 1974 / 75 to 1995 / 96 65 / 66 70 / 71 75 / 76 80 / 81 85 / 86 90 / 91 95 / 96 another measure of fiscal activism is the size of government expenditure relative to the economy. it will come as no surprise to see that general government outlays relative to gdp were much lower in the 1960s than they are now ( diagram 2 ) ; in the earlier period they accounted for about 25 per cent of gdp, but over the last two decades they have averaged 34 per cent of gdp. the stance of monetary policy is more difficult to analyse because interest rates cannot be used as the measure of comparison. this is because before the early 1980s the financial system was heavily regulated, with the government imposing interest rate ceilings on most forms of lending. tightenings and easings in monetary policy showed up largely through credit rationing - the ease or difficulty in obtaining a loan at a given interest rate. this would be familiar to people who can remember the difficulty of obtaining a housing mortgage at that time. the best way of judging whether monetary policy was tight or loose in such a system was to see how fast it allowed money and credit to grow. the growth of the money supply is shown in diagram 3, and again we see relatively low and stable expansion during the 1950s and 1960s ( except for the korean war boom ), before the turmoil starts in the 1970s ( in this case, the very early 1970s ). i referred earlier to the fact that monetary and fiscal policy had to operate under an important constraint during the 1950s and 1960s. the constraint to which i am referring is the gold exchange standard, whereby virtually all oecd countries fixed their exchange rate to the us dollar, which in turn fixed to gold. in australia ’ s case, our exchange rate to the us dollar did not change between 1949 and 1971. this was in a way the centrepiece of our economic policy. monetary policy and fiscal policy could not get too expansionary without either inflation or the balance of payments threatening the exchange rate. this mechanism effectively meant that our macro - economic policies ( and those of most oecd economies ) could not get too far out of line with the policies pursued by the us government. a recognition of this link means that if we wish to fully understand what happened in the 1950s, 1960s and early 1970s, we have to look more closely at the trends in us economic policy. this also means that we will have to stop looking at the 1950s, 1960s