5 JUNE

Royal welcome

President Donald Trump has praised the "eternal friendship" between the United Kingdom and the United States at a state banquet at Buckingham Palace with the British royal family. The event is part of the president's three-day UK state visit, which includes the 75th anniversary of the D-Day landings. The first lady, four of Trump's five children, and two of their spouses were also in attendance at the dinner.

Prime Minister Theresa May did not hold a one-on-one bilateral meeting with the president during his visit, but hosted Trump in Downing Street on Tuesday for a series of events as one of the final acts of her premiership.

Trump also met with Brexit Party leader Nigel Farage at the American ambassador’s residence on Tuesday afternoon. Trump said at a news conference on the same day that he believed Brexit would eventually happen. Labour leader Jeremy Corbyn – who boycotted the state dinner – is due to attend and speak at a London demonstration against Trump's visit, a party spokesman has confirmed.

NEWS WRAP

Canberra's new man in Washington

• The decision to appoint Liberal stalwart Arthur Sinodinos as Australian ambassador to the United States will see one of the country's most astute political operators head to Washington during a trying time in the Australia-US relationship. Senior Fellow Jared Mondschein and Research Associate Elliott Brennan wrote for ABC last week on how Sinodinos can navigate the Trump challenge. READ MORE HERE.
   

• "He's a consigliere," says CEO Simon Jackman of Sinodinos. "He's a great counsellor to prime ministers and to his party. He's a straight shooter, which is exactly what you need when there are hard conversations to be had about what Australia can do and what it is less likely to be able to." Professor Jackman spoke to The Sydney Morning Herald's David Wroe about the appointment last week. READ MORE HERE.
   

• As tensions between Beijing and Washington harden, there is a growing fear that China and the United States are entering a new cold war—another multi-decade struggle to shape the international system. USSC Senior Fellow Charles Edel and Johns Hopkins University’s Distinguished Professor of Global Affairs Hal Brands wrote for Foreign Policy this week on the growing debate about who or what is responsible for the deterioration in the relationship. READ MORE HERE.
   
• Ronald Reagan was the first US president to win an election campaign on a promise to "Make America Great Again" back in 1980. But is that where the similarities between the 40th and 45th presidents end? Reagan's executive assistant for 10 years after he left office, Peggy Grande, joined the 2020Vision podcast to talk about the similarities and differences between the two men, and whether she thinks the Democrats have what it takes to win in 2020. LISTEN HERE.
   
• Is President Trump too popular to impeach? That's one of the questions being asked following Robert Mueller's unexpected public address about the Russia investigation last week. Having effectively told US Congress to re-read his report and think again about their power to impeach the president, how likely is it that they will actually do it and could Democrats be afraid that impeachment might risk making the president more popular? Senior Lecturer David Smith spoke to the ABC's The Signal podcast last week to answer some of these questions. LISTEN HERE.

The fact some 23- or 24-year-old person went to that site and said, ‘Oh my goodness, there’s the John McCain, we all know how the president feels about the former senator, that’s not the best backdrop, can somebody look into moving it?’ That’s not an unreasonable thing to ask.

White House Chief of Staff Mick Mulvaney on the decision to have a US Navy ship named after late Senator John McCain hidden from view during Trump’s recent visit to Japan.
(NBC's Meet the Press)
2 June 2019

ANALYSIS

US Fed shows RBA it's not about to run out of ammunition

Stephen Kirchner
Director, Trade and Investment Program

The experience of the US Federal Reserve shows the Reserve Bank of Australia (RBA) has plenty of options when it comes to easing monetary policy. After 30 months of sitting on its hands, the RBA lowered its official cash rate by 25 basis points to 1.25 per cent at its June Board meeting. Since the last rate cut in 2016, inflation has continued to drift below the RBA’s 2-3 per cent target.

With inflation so low and forecast to remain so, why has it taken so long for the RBA to resume cutting rates? The RBA has previously cited financial stability risks, even though its regular Financial Stability Reviews have emphasised that these risks are low. The RBA also assumed that a tightening labour market would see stronger nominal wages growth, which would in turn see higher inflation.

Based on much of its commentary, one could be forgiven for thinking the RBA was targeting the unemployment rate rather than inflation. But its view that inflation is largely driven by the labour market has always rested on weak empirical foundations. In reality, both price and wage setting behaviour are driven by inflation expectations, which in turn reflect monetary policy.

While the RBA has been sitting on its hands waiting for wages and inflation to accelerate, those actually setting wages and prices were waiting on the RBA to return inflation to target, setting in train a disinflationary spiral. The RBA’s undershooting of the inflation target has also undermined the credibility of monetary policy.

Some commentators have suggested the target can no longer be met and should be lowered, but low inflation is not an accident, it’s a policy choice. Others have suggested that monetary policy is less or no longer effective. Too many commentators assume that monetary policy must already be easy because the official cash rate is low by historical standards. But we cannot infer the effective stance of monetary policy from the level of the cash rate. Inflation outcomes and inflation expectations have been signalling that monetary policy is too tight.

The RBA has undermined confidence in monetary policy by choosing not to meet its inflation target. This is unfortunate, because it leads to demands for bad interventions in other areas of public policy to offset the effects of tight money. For example, the weakness in nominal wages growth due to low inflation has almost certainly been an important driver of calls from the labour movement for a return to non-market wage policies.

RBA Governor Lowe has appealed to other arms of economic policy to support economic growth, including government spending on infrastructure and measures to raise productivity growth. Lowe is correct in identifying the contribution other policies can make to driving economic growth. But these calls conflate structural policies aimed at increasing long-run growth with the short-term task of stabilising nominal spending.

No one seriously thinks monetary policy can or should substitute for productivity growth. Monetary policy is neutral for long-run economic growth. But in the short to medium-term, the RBA is singularly responsible for stability in nominal spending. Governor Lowe would no doubt like other arms of policy to be working with him rather than against him, but monetary policy cannot shirk its unique responsibility for inflation and nominal spending.

With a floating exchange rate and an inflation targeting central bank, fiscal policy is ineffective in stabilising nominal spending. Fiscal stimulus leads to foreign capital inflows that appreciate the exchange rate and crowd-out net exports. An inflation targeting central bank should in any event offset the influence of fiscal policy on aggregate demand. As US economist Scott Sumner likes to say, to believe in a positive fiscal multiplier is to assume central bank incompetence.

The RBA’s inaction has made it more likely that interest rates will have to fall to lower levels as monetary policy plays catch-up. With the official cash rate now expected to fall below one per cent, some have suggested the RBA is ‘running out of ammunition’. But as the US Federal Reserve demonstrated between 2009 and 2014, the RBA can always transition to changes in the size and composition of its balance sheet as its main policy instrument, also known as quantitative easing (QE).

While QE has its critics, the evidence from long-term interest rates in the United States implies that QE worked largely as intended. However, the Fed also short-circuited much of the potential effect of QE through the way in which the policy was framed and implemented, fearful it might lead to excessive inflation. US monetary policy under QE was far less expansionary than it could have been.

If the level of the cash rate becomes a constraint on monetary policy, especially in the context of an adverse shock to the Australian economy, the RBA should transition to outright asset purchases as its main policy instrument. By learning from the Fed’s mistakes, QE could be made much more effective than in the United States, resulting in a smaller overall program of asset purchases by the RBA.

Dr Stephen Kirchner's latest report, Lessons from quantitative easing in the United States: A guide for Australian policymakers, will be released later this month.

DIARY

The week ahead

• Thursday, 6 June: The 75th anniversary of D-Day.
   

• Friday, 7 June: President Trump scheduled to return to the United States following his trip to Europe.
   

• Monday, 10 June: US House Judiciary Committee hearing on the Mueller Report.
   

• Monday, 10 June: Queen's Birthday public holiday (Australia). 

EVENT

The future of the US-Australia alliance: Report launch and panel discussion

VIDEO

Jared Kushner is asked by Axios' Jonathan Swan whether President Trump is racist

THE WEEK IN TWEETS

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University of Sydney NSW 2006

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