philip lowe : inflation and monetary policy address by mr philip lowe, governor of the reserve bank of australia, to citi's 8th annual australian and new zealand investment conference, sydney, 18 october 2016. * * * i would like to thank james bishop, andrea brischetto and merylin coombs for assistance in the preparation of this talk. i would like to thank citi for the invitation to speak at this year ’ s investment conference. i am very pleased to be here. this is my first speech as governor of the reserve bank of australia, so i would like to organise my remarks around the topic of inflation and monetary policy. nominal interest rates around the world have been at record low levels for some years and there has been extraordinary balance sheet expansion by a number of the world ’ s major central banks. yet, at the same time, inflation rates in most advanced economies remain below target. there are also concerns in some economies that inflation expectations have declined too far and are perhaps stuck at levels that are too low. this is quite a different world to the one that has existed over the past half - century. indeed, i am the first governor of the rba to have taken office where the concern of the day is more that inflation might turn out to be a bit too low rather than a bit too high. this morning i would like to focus on three interrelated issues. the first is why we have seen these low inflation outcomes across much of the world. the second is how we think about the low inflation outcomes in australia in the context of our flexible medium - term inflation target. and the third is decisions on monetary policy by the reserve bank board over recent times. low global inflation : why? it is always useful to start with the facts. this first graph ( graph 1 ) shows the average rate of inflation for a range of countries over the past two years ( the blue bars ) as well as the average rate over the past 20 years ( the black dots ). in almost all economies, inflation has recently been noticeably below its long - term average. 1 / 13 bis central bankers'speeches this second graph ( graph 2 ) shows a time series of headline and core inflation rates averaged across the major advanced economies. again, the picture is clear. while headline inflation has picked up a little recently, the outcomes over recent years have been the lowest for many decades, with the exception of a short period during the global financial crisis. core inflation rates have also been

per cent had the second best, aa, while ten per cent were rated a. five per cent of bonds were rated bbb. only one per cent of the fixed income portfolio has a lower credit rating. realised losses as a result of bankruptcies have been low. how then can an excess return become negative from one year to the next? the fund ’ s fixed income portfolio is well diversified across different types of bonds and different regions and the active strategies had low correlation in normal markets. however, the financial crisis revealed that these strategies were exposed to more underlying, systematic risk. correlation was not expected to be high between investments in, for example, japanese inflation - indexed government bonds, bonds issued by international organisations such as the european investment bank, european covered bonds and us mortgage - backed bonds. these experiences and the abrupt turnaround in market liquidity suggest that active management of the fixed income portfolio should be limited and measured on the basis of a number of criteria, as laid down by norges bank ’ s executive board. the fund currently has extensive holdings of bonds that are difficult to trade in today ’ s market. realised losses related to these investments have, as mentioned above, have been limited. the flipside of large book losses is that this portfolio has a high return, reflecting not only the increase in credit risk but also high liquidity premiums and fears and uncertainty in the market. the return, measured as the difference in the effective interest rate between the actual portfolio and the benchmark portfolio, is now close to two percentage points. history has seen a number of deep financial crises, and market conditions will return to normal in time. the final results of the management of the fund ’ s fixed income portfolio since the beginning of the financial crisis cannot be deduced from the quarterly results while the crisis is at its peak. values are not lost as long as borrowers fulfil their obligations. the fund is prepared to retain ownership of a large volume of bond holdings until they mature in a few years. moreover, unless the economic outlook goes from bad to considerably worse, the fund will record a substantial excess return in the years ahead. conclusion the norwegian pension fund has been hard hit by the crisis. norges bank ’ s management results in 2008 were weak in both absolute and relative terms. relative returns were significantly worse than might have been expected based on the investment strategy chosen. in the management of the fixed income portfolio, the crisis in the financial system revealed that risk exposure in the various mandates