Philip Lowe just outlined the delicate balancing act currently facing the RBA

(Photo by Miles Willis/Getty Images)

Reserve Bank of Australia (RBA) governor has been on the wires this morning, delivering a speech to the Australia-Canada Economic Leadership Forum in Sydney.

Fitting with recent commentary, his speech was both optimistic and upfront about the challenges facing the Australian economy, and policymakers, right now.

In just three paragraphs, he outlined the balancing act currently facing the RBA in early 2017: weighing the risks of allowing inflation to run too low for too long against encouraging further borrowing from households, potentially creating additional financial stability and economic risks in the future.

Here’s what Lowe said (our emphasis in bold):

In our risk management exercises, we have been seeking to balance the risks from having inflation low for a longer period against the risks from attempting to increase inflation more quickly, which would partly occur through encouraging more borrowing.

If inflation is low for a long period of time, it is certainly possible that inflation expectations adjust, making it harder to achieve the objective. At the moment though, I don’t see a particularly high risk of this in Australia. The recent lift in headline inflation is helpful here and most measures of inflation expectations are within the range seen over recent decades.

In relation to the risks from additional borrowing, it is possible that continuing rises in indebtedness, partly as a result of low interest rates, increase the fragility of household balance sheets. If so, then at some point in the future, households having decided that they had borrowed too much, might cut back consumption sharply, hurting the overall economy and employment. It is difficult to quantify this risk, but it is one that is difficult to ignore. As I said, our focus is on the medium term, not just the next year or so.

Alongside inflation and financial stability risks, Lowe said that while he’s “satisfied that the labour market is heading in the right direction,” he also noted that it was not occurring “as quickly as we’d like”. He also said that it is an area that the RBA continues to “watch carefully”.

It’s a fairly frank assessment on the main domestic considerations for monetary policy right now, and underscores why the RBA — amidst signs that domestic economic conditions are slowly improving — appears more than comfortable with policy settings where they currently sit despite underlying inflation continuing to undershoot its medium term 2-3% target.

Whether that view is maintained will largely be determined by these three areas, along with international considerations, of course.

Lowe’s full speech can be accessed here.

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