Transcript of Question & Answer Session The Committed Liquidity Facility

Good morning, everyone. I’m Michael Heath, I’m the economics reporter for Bloomberg in Sydney, and Chris’s annual interlocutor, it seems. I was just going to start off in terms of questions with a couple on the CLF, and then we’ll probably switch across to more macro, but if you do have any CLF questions, feel free to ask them, and then I’ll open to the floor as well. So I guess we’ll open, Chris. I’m not big on acronyms, so I’ll sort of spell it out.

Please do.

With authorised deposit-taking institutions, do they primarily hold high quality liquidity assets to meet their liquidity requirements, or do they use a mix of the high quality assets and the committed liquidity facility?

So it’s a mix. I’ve got it here somewhere. The bulletin article that I’ll commend you to has a lot more detail than in my speech. It’s got a lovely table in there which answers exactly this question. It’s a mix. The CLF accounts for a little over half of their liquidity needs, but that need has decreased a little bit over the past five years because as I suggested, the HQLA stock has increased somewhat, and yet their needs have been little changed for liquidity. So, they’ve used a little bit more HQLA and a little bit less of the CLF over time. That’s why we saw a reduction from 275 billion or close to, to about 250 in the CLF.

Sure. And obviously, the government’s projecting a surplus, which sort of raised again this issue of a fall in bonds, and obviously high-quality liquid assets. I mean, does this create issues in terms of ADIs … sorry, authorised deposit-taking institutions, meeting their liquidity requirement if this comes to pass?

Well, of course, I think in … it’s worth remembering in earlier times when, in circumstances where net public debt was very, very low, and this was a concern; it was recognised by the markets, by regulators, and by the government of the day, the value of maintaining a pretty healthy bond market. And so, it was also recognised you can have low net debt, but still issue a healthy amount of bonds for use, exactly for these sorts of purposes, and other purposes to which they put. So I think that’s worth remembering.

Even so, I think we’re some way away from that point, but if we were to get there, well, the CLF operates already somewhat flexibly. So if we were to see a decline in the stock of AGS and semis, not just the Fed’s bonds, the government bonds, but the local state and authorities, if we were to see that, then because what we say is the banks will be, in time, able to hold up to 30 per cent, it’s not an absolute amount, it’s a share. So they’ll just hold a smaller share, a smaller absolute amount if that market does contract.

Now, the CLF obviously is for authorised deposit-taking institutions, which are regulated by APRA. What about shadow banks? Where do they go in the event of a liquidity squeeze?

Right. Well of course, almost by definition, they’re shadow banks, so they’re not taking deposits. So one hopes their liquidity needs are a little bit more modest. But even so, they may have well have important liquidity needs, and they need to attend to those. They can do that by just holding HQLA themselves, right? And then use that in various markets to obtain liquidity at short notice, just as the banks can.

They could also go to a bank and get a committed line of credit. They’ll have to pay for that, but that’s the point. They have to pay for their liquidity needs and insurance just like anyone else. I think the other point to recognise though is that they can do all of those things without disrupting those markets or being a big influence, because they’re still relatively small in the scheme of things.

Sure. Okay. Let’s get to the good stuff. So the Governor has repeatedly said when he’s referred to easing monetary policy, the key transmission channel now, when there’s this discussion on how much traction you get with rate cuts now, is through the exchange rate. Now the Aussie appears to found a base on both the twine against the US dollar, and particularly given other major central banks are turning dovish, how much of an issue is this turning into for the RBA?

Well, it’s an issue we in every central bank play close attention to, because the exchange rate is an important part of the transmission mechanism. I think it’s been broadly working as you would expect, that is, other things equal, the reductions in the Aussie cash rate that you’ve seen of late will have tended to put downward pressure on the Aussie dollar. But other things are never equal. And the other things that are not equal, well, there’s a couple of them.

One, commodity prices are continuing to sort of hold up in a way that hadn’t been fully appreciated by forecasters, us included, and that’s a welcome and positive thing for the economy, very much so. And the other thing is, other central banks as you suggested, have turned more dovish, but I think the thing to remember is that that doesn’t mean the reductions in the cash rate here have not had their effect on the exchange rate in the normal way. It’s just that there are other forces possibly working the other direction but you could say, well, absent those reductions in the cash rate here, the Aussie dollar might have been higher than otherwise.

Right, okay. But is there any degree of frustration that you’re still seeing it above 70 cents after a couple of cuts? Or not much you can do about it?

I wouldn’t focus particularly on any given level. And I wouldn’t describe it as frustration, because I think the thing to remember is, when the major central banks around the world ease monetary policy, that’s an easing of global financial conditions. And one of the things it’s intended to do is to support stronger inflation to soak up the spare capacity that there is in the global economy, and that’s kind of a positive thing for Australia. It has less of an effect through our exchange rate than you otherwise might like, but we’re not in the business of trying to dial up a particular exchange rate.

Okay. To the floor, has anyone got any questions … hand up the back there.

If the banks end up holding the 30 per cent stock of AGS, has there been any work done on what the effect on the liquidity of those instruments might be, if they reach that upper threshold?

Well, I think that’s a very hard thing to do with any science. I think what we have done though, is just looked at that market and realised it has become increasingly liquid over time as I suggested, partly because non-residents are acting a bit less like the buy-and-hold investors that they were, and they’re willing to sort of provide these assets back into the market for various purposes. So I mean, our assessment is, you might be concerned to see a rapid increase in the bank’s holdings of HQLA, of AGS, and semis from 25 per cent to 30 [per cent] in one short go. That’s why we’ve staged it, gradually just 1 per cent a year, but I think that market’s shown itself to be quite liquid, and increasingly so, and that’s why we’re confident that we can require the banks to hold a bit more as part of their liquidity needs.

Anyone else?

What about the impact of the RBA holding bonds on repo to that calculation of the 30 per cent? Does that play a factor in your assessment of the availability of the amount that banks should hold?

Not so much, but I think what you’re suggesting is the banks themselves through our open market operations are providing this collateral in the form of repo, so they can obtain cash over a short period of time.

Yeah, you’re funding those bonds, that’s how I …

Yeah, I mean, I don’t think that’s sizable enough to sort of … I mean, that’s part of the market, an important part, but that sort of action helps to in fact, convince people that these, amongst other things, not that they need convincing, but that’s part of the act of them being liquid assets, right? We take them, everyone else takes them, under repo. So, you know if you’re holding these assets, you can provide them to many people, including the banks who will happily take them, and then they can use them exactly for the purpose you’re suggesting. So I think that, if anything, is contributing to the liquidity in the market rather than somehow withdrawing liquidity from the market.

Anybody else at this stage? Bill Evans?

Chris, you’ve talked about the … we’ve had two rate cuts. We’ve had two rate cuts, and there’s a lot of talk about looking at other parts of the world with regard to the use of quantitative easing. Is there any sort of guideline that the bank would use in terms of deciding when to switch from rate cuts to quantitative easing, if it was seen that the economy needed more stimulus?

I think the first thing I’d say about quantitative easing, or the broader sort of term of unconventional monetary policies, is that I still think we’re … it’s a very low likelihood event. We’re a long way away from something like that. Having said that, of course it’s prudent for us as good central bankers to sort of be thinking about these things, and what we’ve been doing of course, is looking at what others have done, and their experience, and what we can learn from that. I think what you can learn from that is that perhaps one of the most important lessons is, you need to tailor these policies to your own circumstances, to your own economic circumstances. In most cases, these were policies that were started in the depths of the financial crisis when the credit system was quite impaired. That’s not the sort of thing I think people have at the back of their minds here.

The other thing you have to do is tailor it to your unique circumstances of your financial system. What’s the structure like? How much of a banked market do you have? So those are the things we’re sort of looking at and thinking about. Again, I come back to emphasise, we see this a pretty unlikely event.

Chris, obviously, the Fed is expected to cut later this month. I mean, it was put to the Governor I think, after the first cut, what it meant, and things were a little bit less probable then, what it might mean for Australia if the Fed does choose to ease, particularly with the currency, and I think he mentioned it would make things more complex and more complicated, something along those lines. I mean, how much pressure would it put on you if they do cut it more than once, cut it a couple of times? Does that really put the onus back on you to then act as well again?

Well, the markets are fairly convinced that the Fed is going to reduce rates. I guess the question is of course still how much they’re going to do, and is part of this expectation accounting for some of the downside risks. So they’re not central, they’re not the central projection. Having said that, I mean, the markets including the FX markets should already encapsulate that information in the exchange rate. Fine. That doesn’t mean that the exchange rate won’t react, if and when the Fed does cut rates, particularly if it has implications for people’s expectations, even further down the track as to how much they might do, assuming they get started with the first one soon.

I’d come back to … I mean, every central bank that faces inflation that’s low, they’d like to see the unemployment rate decline to generate some more wage growth, to generate some more inflation. That’s the situation we’re in. Every central bank in that situation would like it if they could be delivered with a lower exchange rate, because that’s a way of delivering that extra demand they need, to try and generate the extra strength in the economy that they’re looking for, but we can’t all dial it up, they’re exchange rates. We can’t all have a lower exchange rate, and we’re not in the process of trying to do that. The flexible exchange rate served us well.

So, is it a complication, maybe at the margins. But again, I come back to what I said earlier. This isn’t easy, and global financial conditions, if it comes to pass, that’s a strengthening in the global economy, other things equal.

So coming out of that, the markets are sort of pricing in a pretty good chance that you guys will go again by the end of the year, as is Bloomberg’s poll. Is that a reasonable take on where things stand?

The good interest rate question, even more fun than the exchange rate question. Look, what I’ll do is just emphasise, I’ll replay what we’ve said very clearly after the board. The Governor said the board will continue to monitor developments in the labour market. Adjust monetary policy if needed. I’d highlight the "if needed" part to support sustainable growth in the economy, and the achievement of inflation target. I’d emphasise that, right? We’re still trying to achieve the inflation target. We’re not trying to achieve an unemployment rate target. Markets. I think before this came out, were pricing in the possibility of the cut that came to pass, and then a second cut of 25 basis points before the end of the year. That’s where they were before this, that’s where they were after this. So, I think that they have interpreted this in that weigh-in.

I’ll come to Andrew in one second, but I guess the point being, as Bill sort of pointed out yesterday, that your forecasts on inflation and that sort of thing in next month’s monthly policy statement become a bit more significant perhaps in that sense then?

To a degree, but we’re always, every month, even though we might not be publishing full detailed forecast every month, we’re thinking about how the inflow of data is affecting the outlook for inflation for the labour market, for the economy more broadly. So I wouldn’t get overly fixated on those months where we happen to sort of publish detailed forecasts in that regard.

Okay. Andrew.

Let me take half a step back and ask you a slightly different sort of monetary policy question. We’re clearly in an environment where global growth has slowed a little bit, global risks are more elevated, uncertainty around trade, and we’re seeing central banks in the region and all the major ones as we’re talking about, either cutting rates or signalling that they might. This is pushing yields on HQLA type assets to very low levels, and encouraging a search for yield, which is almost desperate. Maybe desperate is too strong a word, but my interactions with investors, I definitely get that sense.

So in an environment with more elevated risk, but because of central bank actions, very, very tight credit and risk spreads, is that an inevitable consequence of monetary policy as it’s currently being practised? Is that material negative side effect, is that something that concerns you?

I think you could turn the argument around the other way. If central banks had signalled the need for a bit more monetary stimulus by, you know, in our case, dropping policy rates, and that’s what’s on the cards for many banks around the world, and long-term bond markets didn’t respond by lowering yields, then that would be of some concern. I think this is how monetary policy operates.

We’ve said a little bit over various times as to why those long-term yields are very low. They’re very low because people just don’t see any upside risks from inflation. But central banks, part of their intent here, is to try and help increase inflation, and convince people that they can achieve their targets. So, one way they do that is through lowering the yield curve, and I think that’s how monetary policy works. So I think, turn it around, you’d be very worried I think, in a world where they were doing and saying what they have said, and bond yields went the other way, or were unresponsive. Then you’d say they have no potency, there’s no potency in monetary policy, whereas I think there is.

Are there other questions around? Over here, please.

And there’s one down there.

If you did decide to commit to QE, what role would the CLF play within that?

Well, I’ll start again by emphasising I still think that’s a very unlikely event, but I don’t see that it would play a substantial role. I’m not sure here if by QE, people talk about the purchase by central banks of assets, I’m not sure that that would necessarily have direct implications for the CLF. I think it would continue to operate as normal.

Just a question on the labour market. Given the high participation rates that we’ve been seeing, could you give some colour on how the RBA’s thinking about the trade-off between on the one hand, a higher participation rate, which is a sign of labour market strength, versus on the other hand a low unemployment rate, or an unemployment rate that’s been kept high as a result of kind of a pure accounting identity? And to what extent is the RBA just going to bluntly target a low unemployment rate if we keep saying the part rate go higher?

Well, I don’t think we’re going to, as I tried to emphasise before, not targeting an unemployment rate, but we do want to see it lower, and the goal there is to see spare capacity in the economy more generally, but also in the labour market to be reduced. So wage pressures, price pressures can lift, and we can get back to inflation that’s consistent with our medium-term inflation target.

I think you’re right though in characterising sort of the rise in participation rate as an element of strength of the labour market. It’s being helped along by pretty strong employment growth. The employment growth has really been holding up. And that’s fine, that’s well and good, but when we look at something like wage growth, say the WPI, the last couple of readings which were a bit lower on a quarterly basis than the two prior to that, that says despite that strength in employment, rising participation, those sort of good elements of what’s happening in the labour market, there is a lot more flexibility, a lot more spare capacity in the labour market than you otherwise might have thought. If you just look back at history and said, well where did we get wage pressures, at what levels of unemployment did we get wage pressures before, you would have thought maybe we would have started to see more sooner than we have currently.

So, higher participation, strong employment growth, that’s an element of strength, that’s a good thing. But there’s a lot of spare capacity, which is not a bad thing, but we want to reduce that spare capacity by getting the unemployment rate down, eating into that, so people feel more confident with higher wage growth and more price growth as well at the same time, because there’s spare capacity in the labour market, there’s spare capacity in the markets for goods and services as well.

Questions? Okay, good. The neutral rate. I just wanted to raise this. This obviously caused a bit of interest. I think it was 2017 when you released an estimate. In the minutes, you had a special research paper I think, that you’d looked at the board meeting, and you were estimating the neutral rated at about 3.5 per cent, which I think people thought was quite high. My question I guess is, is that still the bank’s general view? And I ask in the context of Fed Chief J Powell saying this month, that the Fed’s was probably lower than it used to be, and that as a result, their policy had been a bit too restrictive, I think were his words, or words to that effect as well. I mean, is it something you’re constantly monitoring, or is there … what’s the take there now?

Constantly, would be I think a slight overstatement, but something we monitor regularly, yes. So as you said, so we had some research, and it was published in a bulletin article as well, which showed in 2017, that the nominal neutral interest rate was around 3.5 [per cent]. So that was a real rate of around 1 per cent in its … but I’d emphasise, the thing about that publication is it also showed there’s a wide range of uncertainty. And so, we’re sort of only reasonably confident that it was centred around 1, but plus or minus three quarters of a percentage point, so a lot of uncertainty.

And it had also come down over time, and that was not unique to us. That’s a global phenomenon, and there’s lots of reasons for that, including a reduction in trend growth, productivity, and there’s all sorts of other reasons, demographic included. Has it Fallen further? Maybe, but again, there’s such a range of uncertainty around that, and it’s very hard to pin down some of these things that precisely. I wouldn’t overestimate that.

In terms of what it means for us, I think it means with a nominal neutral rate of 3.5 [per cent], the cash rate at 1, we’re still clearly in stimulatory territory.

Sure. This is obviously not an issue that’s facing you now when people are talking about QE or very low rates, but we just had a tightening cycle in the US, which is sort of a rare beast. Have you taken any lessons from that? I mean, it seems extraordinary that their economy looks very strong on so many elements, and yet they didn’t really manage to get rates up that high before they’re ready to cut again. I mean, are there any takeaways for you from that cycle?

Well, I think it comes back to the point you were just raising. The neutral rate is lower, and that’s a global phenomenon. So in order for monetary policy to take effect in a tightening cycle, you might not need to see rates go up to where they were in the past, and that’s really a story about the real rate, the real neutral rate being lower, because I still think it’s … and the Fed has showed, it’s possible to achieve your inflation targets, that many other advanced economies are doing that currently. The Canadians are just one example.

So, it’s not for want of lack of inflation, but central banks are concerned that inflation expectations might ratchet down if inflation stays a bit too low, and lower than their targets for too long. So, but I think that lower real neutral rate is a global phenomenon. It’s going to be with us for some time.

Okay. Last call, if anyone has any questions, please? Yes.

You mentioned in your speech about the transmission effect. In the current environment, would that have extended from, I guess, the theoretical, I think I remember it was nine months, or from rate cuts, and taking effect and seeing the effects of rate cuts like you’ve just done. Is that something that you think about, and has it extended or [inaudible].

I think it’s reasonable that … it’s always plausible that it’s changing at the margins, but I don’t think we know exactly the speed of all of the different mechanisms that well. I don’t see there’s any reason why it would have shortened or lengthened particularly. It might be changing in slightly different ways, but I don’t see the time element would have changed obviously, one way or the other.

Last call. Anybody else? Okay, if we could put our hands together for Chris.