Transcript of Question & Answer Session Australia and Canada – Shared Experiences

All right, thank you very much Governor and before we get into the questions and answers I just wanted to put a bit of a context in today’s discussion. So we’ve done similar events in the past and I’ve had the privilege of interviewing a number of Fed officials. So we did an event with Chairman Greenspan, Chairman Bernanke and the process if fairly typical. You submit questions and then they get the answers and it’s a little more scripted. So in advance of this meeting I’ve spoke with Governor Lowe before the holidays and said “Do you want me to submit questions in advance?” And he said, “No, there’s no need for that.” And then I said “Well are there any questions I shouldn’t ask?” And he said, “No, anything’s fair.” And then I said “Are there any questions I should ask?” And he said, “No whatever you want to do!” So …

I said there were no questions off limits, there are only answers that are off limits!

So in terms of the era of a more open and transparent central bank that pushes on I think you do have the gold standard here in Australia. So thank you for your comments. Listening to your presentation, I have a higher appreciation for the role of the central bankers and the inherent balancing act in the trade-offs that take place almost on a daily basis. So Canada sees it as well, a lot of similarities between the two economies, but the trade-offs are there. You see regional divergence with the boom and bust cycle that we’ve seen and monetary policy is a very blunt tool. Inflation like many central banks, coming in lower than expected and lower than target and yet you don’t want to keep rates too long for too long or move lower in the event that it does run some risks on financial stability. So there are a lot of these trade-offs that are going on.

When you look at the Australian out-performance and I think that’s one – you know, we touched on a lot of similarities between Canada and Australia but one striking factor I think is that for 25 years we’ve not seen a recession in Australia, which Canada would have loved to have had that experience. Some areas you mentioned, terms of trade, higher price movements there, but also a relatively higher weight in that sector. How much of a role do you think the different inflation targeting regime? I mean, we have in Canada risk management quasi-flexible inflation target, but it is still a 2 per cent target, whereas yours is a little more flexible with 2-3 per cent over the cycle. Was that not a factor in terms of navigating through this boom bust cycle in commodities and one of the components for this outperformance in Australia?

No, I don’t think the differences are very stark in reality. We choose different language. The language that I choose really is about medium term outcomes rather than kind of the inflation outcomes over a particular horizon and it’s more of an issue of semantics than actual practice.

Okay. When we look around the globe and you had suggested global monetary policies, we’ve never seen so many central banks so accommodative for such a long period of time. We now have something close to 25 per cent of the global economy operating with negative overnight interest rates. Australia, a record low, Canada almost at a record low – just off the record low. Moving forward as we see an eventual normalisation or whatever that means in terms of the terminal point for interest rates. How much of a factor do you take in account other central bank movements given that the transition, like Canada is going to rely in part on acceleration of exports and a stronger currency may not be as helpful in that environment.

Well what’s going on around the world is obviously very important to both us and to Canada. The central banks get the blame for the very low interest rates and I can understand why that’s the case. But there is something – they’re not just doing that in a vacuum. The reason that central banks have low interest rates is that in recent years there’s been an elevated appetite to save. Governments have tried to repair their balance sheets and households are trying to do that. So a lot of people want to save and the business community hasn’t really wanted to do much capital formation. So there hasn’t been much demand for the world savings and there’s been an increase in the world savings and when that happens savers gets lower rates of return. The way our financial systems work is that that gets delivered through the actions of the central bank.

So that’s why I’ve said a number of times recently I think we should welcome a gradual rise in interest rates in the world because it would mean that the acute appetite to save would be diminishing but more importantly, that the return to underlying capital formation is higher and businesses are prepared to use the world savings to increase capital formation and stronger growth and that’s something that we should be welcoming. So the central banks kind of get the blame but they’re really responding to these underlying forces about saving investment in the world because ultimately there’s a very big influence from global factors on all our interest rate setting decisions. I don’t know whether this happens in Canada, but there’s always incredible scrutiny on our decision from month to month but we’re really responding to much bigger global forces in the world.

Right. You mentioned the saving side of it. Of course part of that is the demographics that many advanced economies are facing with the aging demographics. It also has an impact on the speed limit for the economy. So the potential speed limit which is what, I think many in – Prime Minister Harper had mentioned that people are adjusting down to this new normal secular stagnation, there’s a number of terms for it. I think the IMF refers to the ‘new mediocre’. So that is all a slower speed limit and the role of central banks in that environment, I think that’s more about economic policy and fiscal policy, but is the role of central bank in terms of adjusting to this lower speed limit?

Well I don’t accept the proposition that we have to have lower growth. I mean it’s certainly possible, but by nature I’m more optimistic. I look at the technological changes that are occurring in the world right now and the way the tools of science are progressing and the options that that – the possibilities that raises for my children’s generation. Just the rate of technological progress and we’re still coming to grips with how to harness that. It’s a bit like when electricity was first developed it took decades to work out how to use it and then it transformed the society. I’m optimistic that the technological changes that are taking place now will transform our society in ways that I can’t imagine over the next two decades. This issue isn’t, I don’t think, slower growth as Mr Harper referred to, I think it’s more the distribution of that growth because technology and trade create very strong returns to a part of the population that benefits. It increases the returns to the winners. It increases the size of the pie, but increases the returns to the winners as well and our societies are struggling with how to kind of do that, to make sure that we have the incentives for technology and trade which will increase the size of the pie, but at the same time, deal with the distribution issues. Really, the central bank has very little role in this. All our role is, in the end to set the overnight interest rate, which we’re responding really to the global balance of saving and investment.

So if the more optimistic interpretation is correct, then some time in my seven year term business will get it’s kind of mojo back globally, and say, yep we can find fantastic opportunities to invest and then interest rates, you know, well I can say I hope that’s what happens.

As do I. I think the recent Minutes from your last meeting suggests that a little more favourable toward the global environment and global growth prospects and a little less worrisome, we’ve seen commodity prices, oil prices and inflation generally start to move higher after there has been largely downside inflation expectations. So hopefully that’s a trend that does continue as we go forward. Now are there any questions from the delegates? Does anybody have a question for the governor while we have him here. Thank you.

Governor, Michael Stutchbury, Australian Financial Review. Just a couple of quick related questions. The International Monetary Fund has called on the Reserve Bank to keep rates lower for longer to avoid some sort of low – low inflation trap that you’ve referred to there. But are you concerned that lower for longer would pose a bigger risk to financial stability? That’s the first question, and related to that, the tension showed in that the Reserve Bank seems to be fuelling house prices with very low rates particularly in Sydney and Melbourne but the prudential regulator is trying to hose it down at the same time with lending controls. How much of a factor in this tension do you think are tax arrangements such as the interaction of negative gearing and the discount for capital gains tax for property investors?

Well, thank you, there are a lot of issues there. What I’ve learned in my job is I get lots of advice from lots of quarters. I think as I tried to discuss in my remarks that we are trying to balance multiple objectives at the moment. We would like the economy to grow a bit more quickly and we’d like the unemployment rate to come down a bit more quickly than is currently forecast. But if we were to try and achieve that through monetary policy it would encourage people to borrow more money and it probably would put more upward pressure on housing prices. And at the moment I don’t think either of those two things are really in the national interest. So it is a consideration and we are balancing that. At the moment as Craig was kind of alluding to, I think there are signs that things are improving in the economy. We’ve seen it in a whole range of business indicators in the last couple of months. So the hope is that the current setting of monetary policy will generate stronger growth and we can avoid a further upward pressure on housing prices. So it is an issue.

There was a question – right here, thank you.

Thanks Governor. Tim Harcourt from the University of New South Wales. I’m host of the Airport Economist on Qantas. I was trying to put together Prime Minister Harper’s presentation and yours and Prime Minister Harper mentioned that whilst Australia and Canada had broadly got things right in terms of free trade deals and having an open economy, there was a paradox where there had been declines in working class and middle class incomes in the west. As a central bank governor in the 70s or 80s you would have been worried about the real wage overhang and wages moving, growing too fast. As a central bank governor today, you’ve mentioned about wage growth being too low and not being able to grow incomes enough in the economy.

When you think back to the trade and labour market reforms do you think that whilst Canada and Australia did the right things in terms of opening up to free trade and having very open markets that in terms of the labour market we either went too far with de-regulation, didn’t go far enough or we did the wrong kind of de-regulation and that is one of the things that the US is trying to grapple with, with the growth of the Trump support against protection, rather than looking at issues in the labour market.

We’ve benefited from a flexible labour market over recent years. When we had a resources boom in the past, wage growth would accelerate very quickly, the economy would overheat, monetary policy would have to be tightened and then a recession would follow. That was the pattern we had, I don’t know whether that was the pattern in Canada. In the most recent resources boom that didn’t happen. Wage growth picked up in certain parts of the country, particularly in Western Australia in kind of the mining areas. It didn’t flow through to the rest of the economy, the wage acceleration didn’t de-rail the expansion and it’s one reason why now in the downturn that we’re able to manage this without having very weak growth.

So the flexibility we have in our labour market has served us really well. I don’t see labour market de-regulation as a factor that’s led to the low outcomes over the last couple of years. We’re adjusting to a big decline in our national income, the systems operating really as the textbook would suggest, slower wage growth. I also think that many workers in western industrialised countries feel a bit shell-shocked. They worry about international competition. Service sector workers in Sydney which once upon a time would have felt pretty immune from the forces of global competition, now see potential competition from China and India and the services that can be done globally.

So we all – we all feel like there’s a few more competitors out there and so we don’t – you know, most people don’t really like that but in the end it’s good for us because it makes us kind of strive harder and I see the Australian businesses and I’m sure the same is true in Canada, I see Australian businesses responding to this competition. Even in Australian manufacturing right at the moment there’s an improvement going on because the firms that are able to survive with the high exchange rate are kind of leaner and more efficient. So this competition, or feeling, is kind of making us do things a bit better, but we don’t like it. I think it’s kind of at the heart of some of the unease that Mr Harper talked about. When we feel like there’s a lot of competition we don’t really put our hand up and say, “Can I have a bigger wage rise, please?” We say, “Well I’m happy to keep my job”. My hope is that gradually this will lift as the economy continues to grow at a reasonable pace, the unemployment rate drifts down and wage growth will lift.

For most of my career, at the central bank, we were always worrying that wage growth might be a bit too fast. At the moment we’re worrying that it’s a bit too low and that a slight pick up in wage growth would certainly help us meet our inflation target. I think it would help people in the community feel a bit better as well.

We have a similar issue in Canada. I think the cycle, the preferences, workers look for job security rather than wage gains and then structuralist global competition for the best and brightest.

I don’t think we’ve kind of permanently lost the desire to put our hand up and ask for a larger wage rise. That’s not the Australian way but I think temporarily, because of global competition and technology we’re just a bit reluctant to do that and I hope that will pass.

And it will help with the consumer side, right, that are getting squeezed in real income …

It would make people feel better. Even if it’s not stronger real wages, I think kind of stronger – a bit stronger growth in nominal wages would help people feel better and it would help with the debt situation as well.

Nancy Southern, from ATCO here in Australia and Canada. Just wondered if you might be able to comment on if anti-globalisation takes hold, as Mr Harper pointed out that there may be a very serious trend towards, and if the surplus capacity in the world both from a commodity perspective and a monetary perspective, the surplus cash in the market is starting to get absorbed. And then if governments start to take on a far more stringent fiscal policy to reduce deficits, do you think that the monetary policy will be able to keep up with a seismic type of shift that perhaps is starting to occur?

There are a lot of ifs there. If we retreat from globalisation and we have fiscal consolidation …. So I don’t know what that world looks like. This is a point that I’ve kind of been repeating a lot lately. Monetary policy can’t solve every problem. You know, as a central bank, we can’t turn kind of an okay outlook into kind of a fantastic outlook. We can hopefully stop something kind of bad in the economy, but we can’t turn good into really, really good or excellent. Business and the political class can do that. So the world that you’re painting is probably one where the political class is kind of moving away from good to something not so good. If that’s what happens, you can’t expect the central banks to reverse all that and kind of make things all fine again.

We can do so much, we can mitigate financial stresses, we can smooth out the business cycle, we can deliver on our inflation target, but we can’t lift sustainably the growth rate if the political class and businesses are taking actions that lower potential growth. That’s the reality and I fear sometimes that the community expects too much of the central bank to be able to turn good into really good again. The people in this room can do that. I can’t do that and my colleagues and I can’t do that at the central bank. You can, though.

Bob Onyschuck, CEO of the Forum.Thank you for being here, Governor. Governor, you’ve got a tremendous amount of infrastructure being developed. I mean your cities, this city, has got a building boom second to none, well the same as Toronto. And you’ve got a tonne of projects in the pipeline in the infrastructure space that just goes – it’s mind-boggling for Canadians. So I wanted to ask you how do you see that playing out in relation to the Australian economy and what is the prognostication, how will it help? And the subsequent question is in terms of the private sector companies that have not been spending, at least in the Canadian, in the North American economy, moneys on new capex. What is the situation here and is that an issue or where do you see that going?

There are a number of important issues there on infrastructure investment. We’re doing a lot and perhaps when you walked outside the hotel you saw some of it, but you know, there’s scope to do more. I think particularly in transportation infrastructure. Our population has been growing quickly but we have not built enough transportation infrastructure to deal with that and now we’re having issues with the supply of electricity as well. I think the under-investment in transportation infrastructure is particularly problematic because with the growing population it means our cities are becoming more and more crowded. People are getting frustrated, they partly blame the immigrants and so really it’s insidious. It’s very good news that in New South Wales we’re investing in transportation infrastructure and I think there’s capacity to do that around the country as well. It helps competition, it helps people move around, it makes people’s lives better.

It would also provide a boost to aggregate demand in the economy at the moment. So going through the type of things that infrastructure investment could do to kind of increase supply, increase demand, make people’s lives better, address housing affordability – it’s like tick, tick, tick, all the way down. The issue is, why can’t we do even more? Because there is plenty of money out there and I often talk to the Canadian pension funds and they say what a fantastic place this is to invest in infrastructure, they just want more projects. So the challenge for us is to design the projects, to get the governance right, to make sure that the projects that are selected have a strong business case. That construction costs are well-managed. That pricing of the infrastructure is appropriate – to do the governance right and that’s difficult for us in – well, it’s difficult for anyone in any political system.

So there’s plenty of money out there but I think we could do ourselves a service by having more infrastructure investment in this country, building the assets that a growing economy needs. More broadly in business investment it has been weak for a long period of time and the big forecasting revisions we keep making at the central bank are really to private business investment. We keep on expecting it to pick up and it keeps on disappointing. For the first time in quite a few years now we’re seeing that cycle turn, which if that continues that’s good I think. For quite a few years, many businesses have felt a bit like workers, they haven’t really wanted to kind of spend because they feel a lot of uncertainty. Uncertainty about technology, about China, the political system, the strength of demand with households struggling with high levels of debt.

So there are a lot of – the corporate board rooms that I go to, there’s a lot of kind of, well there’s this uncertainty, that uncertainty. I think when you’re uncertain it’s a good reason to delay. Well I’ll just wait another few months and see if these uncertainties resolve and what tends to happen is one uncertainty gets resolved and another one comes along. So there’s always a reason for delay. I’m hopeful that we’re now on the cusp of that turning because the global environment seems to have picked up, business confidence in Australia has risen a bit. I hope those businesses that have been delaying because of the uncertainties, are now, a few more of them are starting to say, well okay, now’s the time to commit some capital spending. You see that in New South Wales and Victoria and if that were to happen more broadly it could change the dynamics quite a lot because we need to do more capital formation in this country.

Derek?

Thank you very much. I want to try to tempt you just a little wee bit into the political terrain that you’ve been skilfully avoiding so far. If you accept Stephen Harper’s premise about the futility of deficit spending, as an instrument for growth. If you accept that premise, then do you see as part of the role of the central bank, Governor, to provide some cautionary advice to governments that tend to over-indulge in that area? Or is this beyond your purview.

It’s beyond my purview to provide advice – but I do feel it’s my – what I can do it be analytical and a point that I’ve made repeatedly and the previous Governor made this point as well is that, back to infrastructure, we should think of infrastructure, or infrastructure has the potential to – all these positive things I talked about before. We shouldn’t be afraid to borrow for infrastructure particularly where there’s a strong business case. So when you think about, let’s kind of circle back to the deficit issue, we should be very careful about how we think about deficits. Financing current expenditure from debt consistently is problematic. Building assets with debt is not problematic if you address the things I was talking about before, governance and project selection and pricing. So I think that’s the analytical point.

Recurrent spending and taxation need to be in balance and we should be able to borrow to build assets because our country needs more assets. It needs business to invest in new assets and it needs government to facilitate investment in assets. It may not need to borrow that much money, it may need to facilitate some of the people in this room to create the new assets, so that’s the analytical point. Proper kind of budgeting as a business would do. If you said to a business you can never borrow, business would never grow. But if you said to a business you can finance your kind of operating budget year after year with debt, business would go eventually out the … So it’s kind of a subtlety in the argument. That’s the role that I think the central bank can play, not providing political advice, but pointing out some …

[inaudible] of your Canadian colleagues.

I think there’s the analytical contribution and we provide our analytical economic view to finance ministers across Canada and federally and the challenge is then small deficits turn into deficits for I think, as far as the eye can see, I think I’m quoting somebody correctly. Then also the definition of what’s in infrastructure spending broadens out and when you look at the real dollars spent which most economists would argue, you could see a return on that helps productivity, it’s just the definition of what gets included in infrastructure sometimes gets much wider than what we would suggest in …

This is where the issue of governance is so important.

Yes, fair point.

And if you don’t get the governance right then it undermines community confidence in – the government’s doing this because – people get suspicious that everything gets called infrastructure and then gets financed on debt. So our world faces a lot of problems. Doing good governance on infrastructure isn’t one of those really great problems our world faces. It’s a political problem, it’s solvable. We’re an intelligent capable country, we should be able to solve that.

I think we have time for one more question.

I just wanted you to ask you about global reflation. I know you’ve mentioned the increase in the oil price is part of that and other people talk of Donald Trump and the hopes of infrastructure and tax plans there. I just wanted to put to you how important is the re-emergence of PPI out of China after four years of declines. They seem to correspond quite a lot with the problems we’ve had and the more optimism we have now. I’m just wondering your view on that.

The rise in Chinese producer price inflation is really reflecting the higher commodity prices that you alluded to. This is good news, it’s a reflection that the global economy is a bit stronger, the demand for commodities is stronger, industrial production is picking up and that’s helping reflate our economies. I don’t see a very high risk of this turning into a big bout of inflation anywhere around the world. Wage growth, as we were talking about before, wage growth is very weak, or is quite weak almost everywhere. We’re not going to have an inflation problem unless wage growth picks up very substantially and I don’t see many countries around the world where wage growth is accelerating. In some countries, the US it’s kind of picking up gradually, I don’t know about in Canada, but it seems a long way away from the day where wage growth is accelerating to uncomfortable levels. So it’s good news that commodity prices have picked up; that will help stop any talk of deflation, hopefully any further talk of global monetary easing. So I think it’s good news, it’s not something we should be worried about.

All right so with that, Governor you have one short … last one. Please.

Thank you Governor. I’m just interested in your comments on household indebtedness. Australia last year overtook Switzerland as the highest rate of household debt to GDP ratio, peaking over 125 per cent. Is that level – the current level of household indebtedness in Australia unsustainable? How worrying is it to you and what can be done to target it.

I don’t think it’s unsustainable. The ratio of household debt to income, it’s a little higher than the range that it’s been at since the early 2000s. So if it’s unsustainable, it’s been unsustainable for more than a decade. So it’s high. It raises a vulnerability though because I think many households are finding that their debt levels are not declining as quickly as they previously hoped that they would because wage growth was slow and it’s taking longer to pay off the debt. So the concern or the risk that we focus on is at some future point households might decide, well they’ve just borrowed too much and then they, in response to some bad piece of news, really cut back a lot.

So that’s the risk. It’s hard to kind of put a number on that risk, but that’s the risk we’re trying to manage and if household borrowing keeps rising at the current rate or were to accelerate then I think that would be quite problematic because that risk would go up. It’s not something that we target. It’s a consideration though, in our deliberations about the right setting of monetary policy and as I said, we’ve managed with this level of debt to our income for a decade and a bit without particular problems so I don’t think it’s unsustainable. It’s just a risk factor.

Governor, on behalf of the Delegates, thank you for a thoughtful presentation and a great discussion

Thank you.