Speech Summary Managing Two Transitions
Speech at the Corporate Finance Forum
The speech looks at two transitions – the transition faced by the Australian economy, following a period of significant growth in resources sector investment and strong commodity prices, and the global economy's transition to a world of lower interest rates than we have become used to.
On the domestic economy, the speech discusses the transition that is taking place following the boom in investment in the resources sector. It recognises that this adjustment is not seamless, but suggests that there should be confidence that it will occur successfully. The speech discusses some of the factors that are assisting with this transition, including a lower exchange rate, moderation in wages growth and low interest rates. A pick-up in business investment outside the resources sector (which is occurring more slowly than expected) is identified as a ‘critical ingredient’ for a successful transition to occur. It is contended that whilst a number of preconditions for this are in place, a sustained improvement is ‘some way off’.
The speech then discusses the transition in global interest rates to the current record low levels. It explains that while the low interest rates are the result of decisions made by central banks, these decisions are not made in a vacuum. It argues that they are in response to a global increase in the appetite for saving and a decrease in the appetite for investing in new assets. Over time, there is thought to be a reasonable prospect that business confidence will improve and that there will be some normalisation of interest rates. However, the speech proceeds to suggest that the average return on savings could be lower than in the past for a protracted time. Consideration is given to factors that may influence global saving and investment decisions and it is noted that even if current monetary policy settings are entirely cyclical (having no structural element), low interest rates are proving to be ‘highly persistent’.
The challenges posed by low interest rates are then highlighted, including the effect on those who are seeking to fund future liabilities. On asset prices, the speech explains that although a rise in such prices is part of the monetary transmission mechanism, these developments need to be ‘watched carefully’. The implications for the hurdle rates of return used by business for new investments are also discussed.
The speech closes by discussing the effect of global low interest rates on the domestic economy and local currency. It notes that the Australian dollar is higher than would otherwise have been the case and that a depreciation in its value would help the economy's transition. The Bank is said to have sought a ‘prudent’ balance in setting monetary policy, so as to encourage consumption growth and business investment but avoid imbalances that may lead to future problems in the economy. And the speech acknowledges that the more enduring solution to the transition in the local economy and low returns to savers is an improvement in the underlying investment environment.