Transcript of Question & Answer Session Inflation Targeting and Economic Welfare

Thanks, Phil, your speeches are always timely and topical, but I think particularly so today. So, as Phil said, he's happy to take questions from the floor. As always, please state your name and affiliation when asking a question and please keep them very short. We've got microphones down the front on either side and we've got a candidate already.

I'm just wondering if your comment on rates remaining low for an extended period, does that reflect a shift toward forward guidance as you get towards the lower bound of rates?

I wouldn't characterise it like that. I've always tried to be transparent around our thinking, and our thinking is that interest rates are likely to stay low for an extended period, because it's hard to see inflation comfortably within the target range for some time. So, I wouldn't describe this as a shift in approach to explicit forward guidance. It's just consistent with this view that I've long had that we need to be as transparent as we can about our thinking.

Good afternoon. Governor Lowe, thank you for your important talk and thank you for taking our questions. I actually attended your previous two speeches. One in Brisbane, in May, and in Adelaide in June, and on each occasion the thing that struck me about your talk after two or three years of not much happening in the monetary policy space the thing that struck me in those speeches was your explicit inclination to cut rates, and I stood up and asked whether it was fair to say you had a red hot easing bias.

You wouldn't use those words, but subsequently you did cut rates in June and July. So, now with rates half a percentage point lower, and as you've just said the government has cut taxes, and you see some promising straws in the wind, n terms of promising signs in the economy, would it be fair to characterise the Reserve Bank Board, it's current approach as a patient wait and see approach?

Again, I wouldn't use those words. I would say that we're monitoring a whole range of developments very carefully. What we want to see is more pressure on the economy supply capacity. I think to get that we need stronger demand growth, we need a lower unemployment rate and there are a number of developments that can give us some confidence that we're on that track – lower interest rates, the tax cuts, the pickup in the resource sector and infrastructure investment – but we remain uncertain as to whether that's going to be enough. So, we're looking at the various pieces of data as they come in to try and make an assessment about what the likely pressures on capacity are going to be over the coming period. As I said in my prepared remarks, if those pressures are not enough, then we're going to need further stimulus to aggregate demand and one way of doing that as monetary policy.

Thank you

Thank you for your speech, Dr Lowe. In the July Minutes, you noted that a decline in interest rates was unlikely to encourage an unwelcome material pickup in borrowing by households that would add to the medium-term risks in the economy. However, in light of the easing, coordinated easing from the RBA, APRA, and the government, are you at all concerned that we could see a repeat of 2016, its rapid price and credit growth, and if so, what would be the appropriate policy response?

I think it's unlikely we're going to see a repeat of what happened in 2016, and I say that for two reasons. First is banks have less appetite to lend at the moment than they did a few years ago. There's been a significant tightening in lending standards, and in some respects, it seems to me that some institutions have become excessively risk averse, so we haven't got the same kind of credit supply impetus that we had a few years ago.

The other thing that's different is the appetite by the household sector to borrow is less than it once was. I think many people in the community feel like they've already borrowed too much, and now is a period to consolidate your balance sheet rather than to go and take out more debt even at low interest rates. Of course if either of those two things changed, and borrowing started rising quickly again we'd have to take that into account, but that doesn't seem to me is the central scenario at the moment, but the supply of credit and the demand for credit is less than it was a few years ago.

Dr Lowe, recently we've seen inflation expectations trending lower, both market-based and otherwise. How concerned are you that those inflation expectations might be anchoring at lower levels that might be inconsistent with the 2-3% inflation band, and how important is managing inflation expectations in achieving your 2-3% mandate?

We monitor market-based measures of inflation expectations carefully, but I don't put too much weight on them. What I put much more weight on is inflation expectations of people in the real economy, of workers and firms, because they're actually making decisions all the time about prices, firms about their own prices, and workers about what type of wage increases that they can get. So, it's inflation and wage expectations by people in the real economy that's really important and this is one reason why over the past two years I've been making the case publicly that a stronger rate of wage growth would be a positive development. In a way, I've been trying to lift wage expectations. I've been concerned that last year or maybe in 2017 that wage growth had fallen to kind of 2% and was perhaps going to fall lower and try and put a floor under wage expectations. If that were to happen, and people thought that wages were going to increase at 2% indefinitely, that would be a major issue. It would make it very hard for my Board to achieve its inflation targets. So, paying much more attention to what people in the real economy are thinking and saying rather than financial markets.

Thank you for taking our questions. As you said, the evidence does not support moving the inflation target, you believe, but today the Treasurer was quoted in saying that he would take advice from Treasury on that. Are you confident that Treasury will come to the same conclusion as you? And secondly, you made it clear today that you remain of the view that the federal government could do more to support the economy. Do you believe it should?

I'm not in the business of telling the government what it should do. Part of my role is to lay out options, and I've done that in previous speeches, and I've talked about the option of monetary easing, further fiscal stimulus through infrastructure spending, and in my own view, the best option is to create an environment where firms want to innovate, expand, invest, and employ people. That requires a reform agenda built around productivity, so that's the best option.

Whether the government's going to do that, I can't speak for the government, but they're the options, and it's not appropriate for me to tell people what they should do. Am I confident that Treasury will come to the same conclusions? Reasonably, but we've not yet started discussions, but I have had multiple discussions with the Treasurer about the benefits of our flexible inflation targeting regime with the inflation rates centred somewhere in the 2s. He and I both agree that it's been the central element in Australia's economic success. So there's a possibility of some drafting changes to the wording on the statement of the conduct of monetary policy and we'll consider that over coming months. I think there's broad agreement the political level, and certainly the central bank community, and I hope amongst people in this room that the framework we've had served the country well.

Thanks, Phil. Two quick questions. The first one, if everything is becoming more traded, so less non-traded, where's the productivity growth? Because we were kind of taught at Uni traded sector had much higher productivity and productivity growth than the non-traded sector. I think most countries are struggling with lower productivity growth, so maybe the counterfactual is it's weaker.

The second one is on your thought experiment about the part rate not doing much, doing less. That's kind of interesting. I'm reminded though that your 2IC Debelle said we shouldn't do that. That we shouldn't assume that part rate does this. I agree with him. The part rate moves with employment to population ratio. The other work by the Bank shows that cyclically, it's women and older workers that kind of throw that around. I think that's been the case the last couple of years as well. So why are you then, not that I disagree with you, but why are you then confident that the labour supply side of things has changed that much? Because I don't think that shows it. Maybe other stuff does. Thanks.

On productivity, I'm not sure where the productivity is, because over the past year employment growth has been 2.5%, and actually it's averaged 2.5% for three years. So, it's strong growth in employment in the economy and output growth has been less than that. I think there still remains a puzzle about where the extra output is that all the extra workers are creating, and as we were talking about my table before lunch, everyone you meet tells you how hard they're working at the moment. There are a lot of people working, and we're all working harder, but we don't see the output, so please explain, I don't know.

The part rate, I can assure you, I discuss in my remarks with Dr Debelle, so there's a close alignment in our thinking.

Did he respond?

Yes, he agreed. I think what's happening is, as labour demand has been strong, older Australians have stayed in the workforce in a way that they haven't done previously, and more women have either returned to the workforce, or stayed in the workforce, and this is a … I hesitate to say, but it's almost a structural change. Partly it's been driven by strong demand for labour, but there are other things going on in this society that mean that older people stay in employment longer, which is a good thing, and there are more options for women, and people returning from parental leave to work.

After all, a third of the workforce now work part-time. A few decades ago, it was like 10%, so working is much more flexible, and that flexibility means more people can work, and add to the labour supply. So, I think there's something structural going on in addition to just the strong demand for labour, and that extra supply of workers is keeping downward pressure on wage growth, because when firms want to go and hire people they might complain that it's hard to find someone, but in the end they find extra workers without having to increase the rate of wage growth. It's something that's fundamentally different this time. How long it will last? I don't know.

Hi, Dr Lowe. Thank you for taking the time today to support a great cause. I've got a two part question, so I'll try not to take too much time. This month the RBA dropped the cash rate to 1%, historic low. Obviously, trying to adopt an expansionary stance. Now, looking at the RBA snapshots, the most recent ones, we see that economic growth is now at 1.8%, inflation 1.2%, and unemployment is creeping back up at 5.2%. Now, the first question is, what is your forecast for the Australian economy in the near future?

And secondly, I recently read that you stated that you urged the Morrison government to increase spending through fiscal policy, and they responded with that the tax cuts would be enough to stimulate aggregate demand. Now, the second question is if you believe that the tax cuts will be sufficient enough to support aggregate demand and lift it? Thank you.

Thank you. Well, just to be clear, I haven't urged the government to do anything. As I said in response to an earlier question, that's not my job, but I did set out some options, because I do think the country should aspire to a lower rate of unemployment than we currently have. Perhaps a substantially lower rate of unemployment, I think it's achievable and there are various ways that we can do that. We can't just do it with monetary policy. So, I'm laying out some of the options. You asked about our forecast, and I can't answer that precisely, because we're currently going through a forecasting round, and we'll release those in a couple of weeks' time, but the central outlook still remains reasonable for the Australian economy. As I said before, the tax cuts, the lower interest rates, finally a pickup in the resource sector investment. Resource sector investment has been declining for six years in a row.

Next year it's going to be positive. So, that's going to be quite a turnaround, and I'm hoping after very large adjustments in the Australian housing market, that process is running its course and that will give people a bit more confidence to spend. Whether that's going to be enough, to come to the third part of your question, I'm unsure. Is there enough growth in aggregate demand to put pressure on the economy's supply capacity? That remains the question, and that's why from my perspective interest rate cuts are still on the table, because it may be that there's not enough aggregate demand growth to put pressure on the economy's supply capacity, and we need that pressure to lift inflation up, and to get the unemployment rate down. But the questions you are grappling with are easier than the ones that I grappled with 40 years ago, so you can take hopefully some comfort from that.

Hi, good afternoon, Phil, I just wanted to ask your thoughts of with rates so low on the back of subdued inflation, are you worried about the ability to stimulate the economy? Should the global economy go into a more worrisome downturn? After all, we got German PMI data out overnight, with the German PMI at its lowest levels since July of 2012, and the US PMIs at its lowest levels since September of 2009. I was just wondering for the benefits of the students in this room, particularly who are going to be sitting their HSC, I was just wondering, were you able to elaborate on what the RBA may or could do in that situation?

Well I am worried about the global environment, and the thing that worries me most at the moment is the disputes about technology and trade are making businesses right around the world very nervous, and when businesses are nervous, they don't want to invest. The option value of waiting goes up, and so businesses sit on their hand, and you're seeing in country after country investment intentions downgraded, investment actually declining, and it's a problem, and it's a problem that's being generated from the uncertainty from the trade and technology disputes. So, the best outcome here is to remove that uncertainty. Whether that will happen or not, I don't know. Central banks are responding, or at least the markets are expecting central banks to respond to this, and so in almost I think every major economy at the moment, the markets are forecasting interest rate cuts by the central banks, and they're really responding to this deterioration in the investment climate. At the margin that will help.

I think there are limits here what can be done with monetary policy. If the underlying shock is businesses don't want to invest because of uncertainty generated by political events, there's a limited amount that monetary policy can do. It can help, but there's a limited amount.

The best thing to do globally, and I think in Australia as I said before, is to create an environment where firms want to invest. Where they want to invest, expand, innovate, and employee people, because it's investment that's the problem globally. If we can do that with low interest rates and pressure on capacity in a number of economies, I think the global economy can do well, but we need to create this environment where firms want to invest and expand.

That would mean higher interest rates, which would be a good thing for all the savers who write to me complaining. It would mean I think higher wage growth, because the capital stock will be stronger, and it would mean a higher productivity growth. So, the critical issue is to improve the investment climate. Monetary policy can help, but it can't really fundamentally shift that environment.

We're almost out of time. So I will just restrict the questions to those that are up already. Thank you.

Governor, thank you very much for that speech. That was great. I suppose you speak about there being an extended period of low rates in Australia from here, and you mentioned before that you don't think the housing market's about to take off like it did a couple of years ago. That seems quite convincing, but what about some of the other potential risks, or downsides from this having an extended period of low rates? Where do you see them and what work is the bank doing to understand them?

So, what are the major risks from having an extended period of low interest rates? The main one is more borrowing, and as I said in response to the other question, that we'll probably see a modest pickup in borrowing, but because of reduced credit supply, and reduce demand by households, I don't see this likely to go into another period of very rapid credit growth. If we did, then we'd have to rethink, but at the moment I don't think that's going to occur. That's the main risk that we worry about with low interest rates and it doesn't seem particularly elevated at the moment.

No other major risks?

I don't want to use this opportunity to list the kind of series of things in the tail, but the primary one is the risk of an extended period of rapid credit growth in an environment where households are already very leveraged. I just don't see that as particularly likely in the next little while for the reasons I talked about.

We also have to worry about the capacity to respond if we get hit by an external shock, along the lines that I was talking about before. So, we still have scope to respond with monetary policy. We have a very flexible exchange rate, which in years past has been the great stabilising force for the Australian economy, and I'll expect that to continue to be the case, and we also have fiscal options, so in the event that we do get hit by an external shock we still have options.

Hi, thanks, Dr Lowe for your time. Are you worried that the focus on expenditures in home loan applications will make applicants game the system by reducing consumption in the lead up to an application? And secondly, what about the privacy concerns of banks combing through transaction records?

Am I worried that households are going to game their expenses? Not particularly, but what I do hear is that households are paying a lot of attention to making sure that their expenditure record is clean. So whether you call that gaming, I wouldn't … People are kind of diligently preparing, and gutting their expenditure records and what's going through their bank accounts. That's probably a good thing.

So, for example, cancelling Netflix Subscriptions, etc.

Well, that's a personal choice. If they want to kind of have a clean record, so they can show the bank, well fine. So, I'm not particularly worried about that. No. The privacy issue is a real one. The banks have a responsibility there to do the right thing. I haven't seen any evidence to suggest they're not doing what they need to do properly. Thank you.

Thank you for your speech. Dr Lowe, it would seem to me that your job would be made a lot easier if the government got rid of its ambition to generate a budget surplus. Would you prefer the government drop its ambition of creating a budget surplus?

I think what I would prefer is that the government has a strong agenda that encourages firms to invest, expand, innovate, and employ people. As I have said on a number of occasions, that's the primary thing, and that will increase the return on capital, make firms want to invest. It'll allow us to get out of lower interest rates and increase aggregate demand in the economy. So, that's what I would prefer, but otherwise I'm not in the business of giving the government public advice.

Does it hinder your policy making at all?

I wouldn't say it is hindering our policy making, no. The passage of the tax cuts I think was important. As I've said on other occasions last year, taxes paid by the household sector rose ten per cent when gross income was up by four. So, one reason for weak household spending, and weak net income growth is people have been paying a lot of taxes. I think it was appropriate to give some of those taxes back. So, that's helping, and both the state and the federal government have strong infrastructure programs, so they're helping them as well, and in the end the real help that we can get is an environment that creates a strong investment, and a strong climate for businesses to, you heard me, expand, innovate, invest, and hire people. That will really help.

So, I just wanted to ask you if you were choosing the level of the inflation target now from scratch, would you choose the current 2-3% target, or would you choose something probably centring on 2% like most other advanced economies? And if you would choose the current 2-3% target, what are your reasons for thinking that inflation should be higher here in Australia than other countries?

I think that the truth is I don't have a particularly strong view about what the right number is. What I do have a strong view is you've got the number, and it's worked for a long period of time, you shouldn't be moving it around, because once you move it once people might reasonably say, "Well, they moved at once, maybe they should move it again if the situation changes."

So, that would diminish the benefit of the inflation target as a strong nominal anchor. I can't say that 2-3%, with a midpoint of 2.5, is fundamentally better than 2, or 2 is better than 2.5. The evidence doesn't exist to support that, but I think there's a real benefit in sticking with what we've got, unless it's very clear that something else could be better, and I don't think that evidence exists. So, I'm very happy with the flexibility we have in the current formulation. I don't see a strong case for changing it. Thank you.

You exhausted the questions.

Please thank Phil again.