Transcript of Question & Answer Session Investment and the Australian Economy

Thank you very much Dr Lowe. Quite a lot of questions and some terrible handwriting so I’ll do my best. One from me to start with, I live in Hong Kong and I wanted just to ask you the big China question, obviously that’s a key driver of mining investment I guess in the main, but when you look at your overall policy mix how important is it to be a China watcher as far as the RBA is concerned, and what are your views on growth in China?

Well China is obviously incredibly important to us, almost a third of our exports are now going to China. So what happens there is very important to commodity prices and therefore the outlook for investment in the economy and ultimately the exchange rate as well. So we spend a lot of resources internally looking at China, we have a team of six economists who study the Chinese economy, including someone who is permanently located in Beijing. By way of contrast we have one person who looks at the US economy. So what’s going on there is incredibly important to us. I think again what we’re finding out is the pessimists about China are being proved wrong again, the recent growth numbers were encouraging and I don’t see any reason to fear that growth will be substantially weaker in the period immediately ahead. I think the challenge for China really is to reform its factor markets, the market for land, the market for labour, the market for capital, the market for energy, the market for corporate control, they’re all incredibly regulated markets and that’s worked well for them up to now, but at some point as they transition into a higher level of per capita income those markets will need to be deregulated. It’s not an issue that confronts them immediately, it’s not a threat to growth this year or next, but over the medium term it is an issue that I think they will need to manage very carefully.

Thank you. A bunch of questions really about the future direction of interest rates as you might expect. I did ask Dr Lowe whether there were any subjects I should steer clear of and he said no, so I can … I’ve got a pass to ask these. And kind of on both sides of the fence really, would the RBA cut rates again to push the Australian dollar lower, is one question linked to your FX comments earlier on. But then going back to that inflation number that was issued yesterday does that uptick in inflation, I know there was some statistics in there that may mean that’s not necessarily the correct interpretation of that number, but does that higher inflation necessitate actually an end to the interest rate cutting cycle and the beginning of nudging interest rates up. So a couple of divergent views there.

Thank you well I said there were no questions that were off limits, there are only answers that are off limits.

Well said.

No but they’re both very good questions. On the issue of whether we would cut interest rates to get the Australian dollar lower, we’ve said a number of times that interest rates and the exchange rate are obviously linked, but not in a way that your question or the question suggests. One of the reasons we have low interest rates is because the exchange rates very high, but the lower interest rates have not been with the intention of getting a lower currency, that being with the intention of setting the effects on the economy of the high currency, and that’s been the high currency as I outlined has been an important factor influencing investment in a number of sectors and that is the low levels of investment there have meant activity in the economy has been a bit softer than it otherwise would have been and interest rates in response to that have been lower. So there is a connection, but not of the one you suggest, because I think at the moment what’s much more important for the value of the Australian dollar is US monetary policy, not Australian monetary policy. The value of the dollar has moved very much in line with changing expectations about whether the Fed was going to taper its asset purchases. On inflation the numbers yesterday were a touch higher than we had been expecting, but only a touch and I wouldn’t read very much into that. The inflation outlook in Australia still looks pretty benign, wage growth has slowed considerably, many workers are uncertain about future employment prospects and the labour market are softened and that’s led to lower wage growth. That’s occurring at the same time that there’s a gradual lift in productivity growth in the economy. So growth in what the economists call unit labour costs has slowed down, and that gives us some confidence that the inflation outlook is relatively benign. Even if we saw a further depreciation of the currency it’s unlikely that would move us away from our medium term inflation target.

Thank you. Couple of questions on the mining boom, I know that wasn’t really one of the subjects you particularly wanted to cover, but really the riches generated by the mining boom, the questions relate to whether Australia has missed the boat a little bit in building up a sovereign wealth fund perhaps with the riches that that mining boom has brought to the country.

Well it’s a good question and it has a long history of political debate in this country. It’s true the mining boom has been incredibly enriching for us, it’s hard sometimes when you’re living in our great capital cities a long way from the Pilbara just to understand what an impact it’s had for us or on us. I’ve described before this kind of chain of events that links what’s happening in the Pilbara to the cafes in Melbourne, and people don’t often see that chain but it’s real and it’s there and it starts with the high commodity prices pushing up investment and pushing up the exchange rate, and that means that the price of all our imported goods, if you look through the CPI, the price of all imported goods are basically no higher or lower than they were 10 years ago; that’s because of the mining boom. And in fact the prices of almost everything we buy in the department store is lower than it was 10 years ago, has generated income that we can spend on other things. And we spent a lot of those on services, including the cafes here in Melbourne. So there is a really clear link, it’s hard for people to see but it’s there and the mining boom is the reason we – Australia has enjoyed over the last decade by the standards of developed economies unprecedented income growth in per capita income. So we’ve done pretty well from it, could we have done better? I don’t know I’ll leave others to answer, but I think we shouldn’t forget that we’ve done very well out of that. Australia is really amongst the developed countries the growth in our per capita incomes over the last 20 years hasn’t been matched anywhere.

And yet that money that’s been generated obviously hasn’t been used in inward investment into some sectors of the manufacturing sector, so I guess that’s really underpinning that question has Australia consumed too much and invested too little of those profits.

No I think it’s hard to support the proposition that we’ve consumed too much through the investment boom. In fact one could have worried based on previous experience that you have an investment boom and people feel fantastic about the future and everyone goes on a spending and borrowing binge; the economy overheats, you have to have high interest rates and ultimately you have a downturn. To our credit that hasn’t happened here, we didn’t have a wage blow out during the investment boom, we didn’t have a consumption blowout, we didn’t have a borrowing blowout, the economy has digested what on any scale is an unprecedented boom in investment without developing major imbalances, the exchange rate appreciation, which has caused so many difficulties for so many people, I think was really key to that and the change in household borrowing. So no I don’t think we’ve spent too much out of this we’ve done a pretty good job, we’ve digested this boom without causing imbalances in the economy and I think if most people, if you said to most economists a decade ago this was going to happen to a mining investment, they would have said Australia was going to have an inflation problem, a wages problem, a borrowing problem, we’ve had none of that.

And sort of a couple of questions on the sectors that you feel are potentials for Australia to be world leading perhaps in terms of exports as well as obviously just domestic issues. One question here speaks to non-mining energy, green energy, renewables and clean tech, is Australia investing enough in that. And a sort of a linked question with that, what are your views on the best policy approaches to address the lack of competitiveness of Australian industry on a global basis, is it solely an exchange rate issue or are there deeper forces at work there?

Well a lower exchange rate would help the competitiveness of many of these industries, but a lower exchange rate shouldn’t be the solution - the long term solution here because a lower exchange rate ultimately means less purchasing power for everyone in this room. So what we want is a strong vibrant economy not based on an artificially low level of the exchange rate but competitiveness that’s based on strong productivity growth. And we see some signs of that productivity growth picking up recently, I think the difficult times that many businesses have felt over the last three or four years has led many to look at their business practices, the way they manage their businesses, the technology they’re using. So I do see Australian business responding here, it’s quite likely that even if the currency was to come down further as we expect it will in time, that we will have a high currency by historical standards, and that’s because the global commodity price is relative to the price of manufactured goods is high because of what’s going on in Asia and that’s not a one or five year development that’s a multi-year, perhaps a multi decade development. So we will have a higher currency, I suspect than we’ve had on average historically, and that means that Australian business needs to compete on the basis of technology, of human capital, of skills, of ideas, and so investment in education, in innovation, in infrastructure, they’re all incredibly important ingredients into that story. A kind of what specific policies encourage that, there are others who are better placed to do it, but the general point is a relatively higher currency than we’ve had historically means we need to compete on the basis of our minds and our ideas, not on the basis of producing standardised goods for the world market.

Thank you. And questions on policy next ready. What is the single most important indicator you look at in setting monetary policy, and this is linked really to a couple of questions that people are asking on house prices in general and whether the RBA has been a little reckless in keeping interest rates for too low and promoting a house price bubble as well, so that’s one angle of attack there as well.

Well there’s no single indicator that dominates all others. If you pressed me I would obviously have to say the inflation rate as a medium term because all our decision making is based around the framework of a medium term inflation target, so that’s the analytical framework we use. So the updates we get on the CPI are obviously very important there. But your question touches on another issue that’s been very topical here and that’s what’s going on, on the housing market? One of the ways that easing of monetary policy works is by obviously lowering the cost of borrowing and people in response borrow more. Lower interest rates also typically mean higher asset prices, that’s what the transmission mechanism requires and what we’ve seen over the past year is lower interest rates, a slight but only very slight pick-up in household borrowing, and higher house prices, it’s what the transmission mechanism should deliver. If that were not happening there would be a real problem, because it would say monetary policy is not working. But the fact that that is happening says it is working, it is creating ripple effects through the economy, it is creating new opportunities, the concern would come if the growth in borrowing or the growth in house prices picked up to unsustainable rates, and at the moment I think it would be hard pressed to conclude that, but it’s certainly possible that could happen but to substantiate the idea that that’s actually happening now I think would be to discounting the standard monetary transmission mechanism which is important.

Okay. And a couple of linked questions, one of them reads slightly controversially, and I’ll try and find it in here, something about Wayne Swan dipping into the Reserve Fund, but can you confirm that former Treasurer Wayne Swan had used the RBA Fund to dip into to fund the abandoned surplus pursuit? Sorry I have absolutely no idea what that means but hopefully you do and it sounded quite challenging as a question so I thought I would ask it. And was there a lot of tension between Glenn Stevens and Wayne Swan over this?

I suspect this is alluding to the fact that yesterday the Government announced that it was going to effectively add $8 plus billion dollars of capital to the Reserve Bank. The history here is that a few years ago when the exchange rate appreciated so much the Reserve Bank suffered very large valuation losses on our foreign reserves, I think over a couple of years we had valuation losses in excess of $5 billion. That’s obviously significantly made a significant dent in our capital, and we’d been saying publicly for some time that it was the Board’s intention, desire to rebuild that capital over time and it is the case that last year a distribution was made to the Government and that was publicly aired at the time and subject to quite a lot of attention. I think the current Government has decided to move quickly to the desired level of capital to make sure that the Bank’s balance sheet is of an unquestionable quality and I see that really is our collective interest because you want the central bank to have unquestioned ability to deal with a whole range of situations and the Board had wanted to get to that position over time, and what we’re doing now is moving directly to that position.

Well I guess a related question to that given that you’re in charge of the Risk Management Committee at the RBA is what keeps you awake at night effectively and what are you doing about that, and does that $8.8 billion effectively give you the comfort level that you need to cope with US budget crises or any other exogenous events that might occur?

Well the lack of capital had not been keeping me up at night but I think we’re in a much stronger position to deal with events of an unpredictable nature that occur in the future, I think it was a prudent sensible decision. What keeps me up at night? Well the things that I kind of worry most about, I think it’s back to one of your earlier questions about China, because if something went wrong there that would really fundamentally reshape our outlook. But as I said the likelihood of something going wrong there in the short term doesn’t seem particularly high to me. The thing that worries kind of me most is that we get stuck in this world where business feels like it’s not willing to invest, it just sees risk everywhere, whereas during the great moderation people couldn’t see risk anywhere, they were prepared to buy any financial investment, investment in real capital was very high. And it’s possible that one of the really enduring legacies of the crisis is just businesses just decide that they don’t want to take risk or they require such a high premium for taking risk. If that is the case then the world gets stuck in a low growth equilibrium and ultimately that’s bad for everybody. I don’t think that is inevitable and it’s not something you kind of worry about a piece of news coming today and causing us great anxiety but it’s one of those deep structural things that are there, that I mean that if it’s true then the world is stuck in a lower growth environment or the developed countries in particular than they previously were, and that would not be good for any of us.

Sort of linked question really, which is the issues that Europe faces and the US faces, how much does the impact of those things tie your hands in terms of policy responses to more domestic issues here in Australia. I mean what sort of constraints does that impose upon you?

I don’t see these developments as tying our hands but they’re certainly a factor in the decision making. The fact that Europe struggled with its debt problems for so long is one of the factors that keep on chipping away undermining confidence. The recent wrangling over the debt problems in the US I think it’s damaging in the sense that it again undermines confidence because what I think, the American … If you look at the American corporate balance sheets, the level of interest rates, the amount of liquidity in the system, the fact that investment’s been very low for a long period of time, all those things say it’s about time for firms to step forward and buy capital equipment and one of the things at least that’s holding them back is this risk aversion, and I suspect one of the consequences of the events of the past two weeks is that it reinforces the risk aversion on behalf of business. It’s another reason to wait, another reason to just see what might happen, another reason to delay buying that piece of capital or committing to that new business or hiring that new worker, and it’s that continual … The political environment in both the US and Europe continuing to give people reasons to delay is a big problem because the fundamentals, at least on the financing side, are there for recovery, we need people to feel that, unfortunately the problems at the political level and the US and the bank problems in Europe keep giving people reasons to delay, and that affects us because it effects the global economy, it affects the outlook for US interest rates and therefore it’s effecting the Australian dollar as well. So these are all important factors in our deliberations but I wouldn’t describe them as kind of constraints in the way that they were limiting our options.

And a very, very broad question here. What is the biggest structural head wind facing the Australian economy to date – structural head wind? That’s a tough question.

I don’t know whether you think of the high exchange rate as a structural head wind, it’s certainly something that as I tried to outline in my remarks that affecting a lot of industries and as I said the fact that it was high, it was useful in stopping the economy overheating but it needs at some point to – as the investment boom comes off we probably need a lower currency. The general business environment I think it’s a similar theme to the US where the willingness of business to step forward, to take a risk, hire a worker, or buy a new business creating that environment I really see, it’s much more important than small changes in interest rates to getting the economy going again and how you do that as I said is very difficult to do, but I truly see this as kind of crucial to the next stage of development in the Australian economy, getting that business environment right so people are prepared to take these risks.

You mentioned in your remarks that banks here in Australia were liquid and ready to lend, I mean is that true in the small to medium sized corporate sector? I mean certainly in the rest of the world there does seem to be a choke point there that banks do have money and Dr Poole was demonstrating that earlier on today, but it does seem to be this willingness only to lend to the big boys.

I don’t sense that’s an issue here. There are obviously, a number of banks have changed their business models and credit is not available as freely on the same terms that it was before the financial crisis, I think that’s clear, but whether that’s the right benchmark or not I think one could debate and perhaps it was the previous set of conditions with the aberration and we’ve moved back to something now that’s more sustainable. So there are clearly a lot of businesses who think the banks are being too tough, but my overall assessment is that there is credit available there for both large and small businesses. You talk to the bankers and they want to lend, it’s the demand for the credit’s the issue not the supply I think.

Brian Singer spoke to us before lunch about consistency of policy how important that is for businesses to be able to invest and for stock markets in fact to move ahead and we’ve had a change of government here in Australia recently. I know the RBA is not prone to political influence, but that must have some impact on your ability to be consistent in terms of your monetary policies, can you just talk to us a little bit about that?

Well I don’t really think it has any impact. As I said before we set monetary policy through the prism of our medium term inflation target, some of you may have noticed that this morning the Governor and the new Treasurer released a new statement on monetary policy understanding, again that reaffirmed the Government’s commitment to the inflation target. We’ve had that arrangement for two decades now, I think it’s served us very well. That statement that was released this morning also reaffirms the independence of the Reserve Bank, the respect the Government has for that independence, and it also reaffirmed the importance of transparency and accountability because we feel this very strongly that with the independence that the Parliament and the Government has granted us, we need to be transparent and we need to be accountable and all that again was reaffirmed by the current Government. So I think in terms of the monetary policy framework, the change of government has very little if no effect.

Great. And the final questions, it’s … We’ve worked you quite hard so you’ll be relieved I’m sure to hear this. But from your experience participating in global central bank meetings, do you have a view on the progress to improve the world’s financial system and systemic risk in general, do you think there’s been enough policy co-ordination and enough progress towards resolving some of the issues that faced us during the crisis?

Well very good questions. Australia’s chairing the G20 next year, so we spent a lot of time in these international meetings and understanding what the priorities are. I think for us the priority here is to actually implement what’s been agreed, because there’s been so much change I can only imagine those in financial institutions the difficulties they’re having to kind of digesting all that. So our perspective here is we need to implement what’s been agreed rather than starting off a whole new reform agenda. Has enough been done? I think only time will tell. The financial services sector got itself into tremendous trouble, it was not adequately capitalised, parts of it didn’t have enough liquidity, the credit assessment skills in some institutions were poor and there were very serious ethical lapses in some financial institutions. And there’s a reform agenda on each of those issues, it’s being worked through, I hope and expect it will be enough but time will tell. Fortunately our banking system has been in good shape so these issues have not been particularly relevant here although obviously we feel the global effects of changes in regulation and APRA is working through that with our financial institutions and they’re very well placed to deal with this. I think the one extra observation I’d make is just how important the upcoming asset quality review in the Euro area is. Because the one set of banks globally where people still have question marks I think are the Euro area banks, and so there’s commitment by the ECB which was announced yesterday to do this asset quality review and stress testing I think is incredibly important, it’s important that its seen as credible, thorough and there are recapitalisation plans if they’re necessary, so I see that as kind of the next key step in fixing the problems up. Thank you.