Transcript of Question & Answer Session Economic Update

So you talked about rising prices helping construction – dwelling construction, but there was an article in The Economist some time back that said Australian house prices are overvalued by about 40 per cent and I'm wondering how do you reconcile the two statements?

Well it's – it's a not uncommon phenomenon for international observers to look at prices in Australia and think that they seem very high. My response to that usually is firstly, you know, never say never. Never say that it's impossible that prices could – could go down sharply. I think that would be tempting fate. But if you look at price-to-income ratios, I think often these comparisons are drawn between Australia and the US, but if you look at a whole range of countries, and I had this in a speech a year or two back, it's actually the US that's the outlier on the downside in terms of price to-income-ratios. Now that's no guarantee that the others are not too high, but the fact is that in terms of price to income over about 10 years we've been up and down cycling around I think what seems to have been a fairly persistent higher mean for that ratio. But we are in the company of many other countries. So I think that's an important perspective to keep in mind. Certainly I would not regard housing values in most of the mainland capitals anyway as cheap, and I think there are actually significant social issues around the level of housing values, but that's a separate question, that's really beyond my responsibility to talk about those things. But I think these international comparisons – you have to be a bit discerning in how they're used. And one day when The Economist says something good about Australia I'll probably die of shock.

Julian Pearce. You indicated that there was nothing in the current housing market that would lead you to believe on the data available that there needed to be some specific policies perhaps directed a bit more to housing than other sectors. There's always the risk that may occur in the future and I think the supply side in the housing sector in Australia is quite constrained so there is a way for – potential for some unfavourable price responses that reflect more the supply side rather than demand side. I'm interested in your comments on – while not relevant to the current situation, but more general comments on the appropriateness of more specific policies that are perhaps directed more to housing rather than the general interest rate structure, so-called sort of macro prudential policies that you might consider in concert with APRA.

Well my view on macro prudential tools is – I'm quite happy for Australia to use them where that makes sense. As I said earlier I think in the main for most owner-occupier borrowers I don't think we've seen imprudent borrowing in this recent period. The area where we need to watch is the investor market in Sydney. As I also said, APRA has actually been reinforcing the need for, given that interest rates are very low, probably interest rate buffers that they apply should be a bit bigger. I mean that is a macro prudential tool really. It's not surrounded by all the theatre and drama and you know stuff that some other countries have, but it is actually a macro prudential tool, that's what it is. So they're quietly, but I think effectively, using the tools at their disposal, very much with our encouragement and agreement to – to kind of lean into the boom a little bit, and I think that's quite sensible. If it took more stringent use of such tools well I think they have them, and I'm sure they'd be amendable to using them if – if there was a macroeconomic stability need because APRA does have a macro stability element of its mandate.

My only other comment about macro prudential tools, and this is well known, is I think they're useful, I rather fear that in some parts of the world too much will be expected of them frankly, but I don't think that's a problem we're going to have. And I very much agree with your points about the supply side, I mean I think that's a huge issue in housing and in a sense if we're too rigid on the supply side then fundamentally housing prices have to be higher. That's not a bubble, that's fundamental, it's not good though. Because really in a country this size, and the land we have, I can't see how we shouldn't be able to have fairly inexpensive shelter really and I wonder whether we've unnecessarily given away a natural advantage we have. But anyhow that's really beyond my area of expertise. And then there's one at the front here.

Michael Knox, Morgan's Financial. My question is about the equilibrium level of short rates and the risk premium and risk appetite. We're going through a period where official rates around the world are now much lower than – and seem to be at equilibrium at much lower levels than they were before 2007. And that may be because with all the tumult of the period in 2007, 2008, 2009, investors have lower risk appetite, they're more scared than they were, and that seems to have generated this lower level of equilibrium. Now some people, for example Ben Bernanke has said in passing he thinks it will be a long time before rates get up to the kind of equilibrium levels they were before 2007. Governor, do you have a view on this?

Well I think I would frame this I guess in the Wicksell world, because I tend to think that way, so we're saying the natural rate of return on capital has gone down for various reasons, that's the argument. And I think there's likely to be some truth in that, at least in some jurisdictions. I'm – you know I think that's a less obvious in our case, but we ourselves have said that, or some of my colleagues have said and I'd agree, that probably what we used to think of as a normal level of the nominal cash rate probably nominal in the near future anyway is a bit lower, so I think all that's true. I'd still be hoping though that even the lower new normal, that we might see one of these major central banks get back to that some time in my remaining career. I hope we see that because it's been a very long time at a very unusual low level; so far.

So at the start of this question session you said you had a question for us.

No I was offering to supply my own question if needed, which would be something like how come the Reserve Bank's done such a great job, could you explain? We don't need that because there are some others here.

Governor, Ivan Colhoun. I was wondering when - - -

Tassie Boy.

- - -Tassie Boy yes. I remember when you were Deputy Governor for a time there the Reserve Bank asked the question could the economy afford to grow more quickly? And I wonder, the Bank has been forecasting the economy growing below trend for some time. A lot of the contribution to growth has come from resource exports, so how would you respond to the question that the economy could afford to grow more quickly at this point in time?

Well I think estimates of non-mining activity, you know these estimates are very rough approximations, but for what they're worth they suggest that non-mining growth has picked up somewhat. Literally speaking it was probably about trend over the last four quarters, it would be good if that continued. But I think the non-mining activity you could probably grow a bit above trend for a while because I think there's a bit of spare capacity has built up in that sector, and as we know the mining – certainly the investment growth has turned down. So I think the economy can grow a bit faster than we've seen over the past couple of years and our estimate is in due course it will, but it's – it is probably a little bit longer yet before we get the clear evidence of that. And I think I should estimate that we – we are fairly modest about our own ability to kind of fine tune that and make it happen faster or better, I think we're doing a lot to help that, but we're not miracle works, so I think the policy settings are in place as I presently estimate it for that non-mining sector to continue to improve, but that's going to take time.

When you think about part of that story being non-mining capital spending by businesses and the evidence is starting to emerge that that's starting to look better, but that's from a low base, and you can't just go turn animal spirits on, there is no lever called confidence that we can go and pull. I'm very happy to go pull it if it's there, but it isn't. Animal spirits take time to – to – they have to be nurtured but they take time to grow and we've got to do what we can to stop negative things happening that would counter that. But in the end these things have to kind of grow and take their time to do so, and I'm not sure that we can kind of hurry that up all that much by – by – certainly not by macroeconomic policies.

So the answer is it can grow faster, I think in due course it will. I think we're going to have for a little while yet though a period of uncertainty as to just how confident we can be that that will eventually happen, I think that's inevitable in an episode like this.

We have time for one more.

Paul Bloxham, HSBC. On the exchange rate, Glenn, you gave a speech last year – November last year with an expectation that the Aussie dollar would more likely go down than up, it's actually gone up a bit since then.

It went down first.

This is very true. And I wondered whether we will really need to wait until the rest of the global central banks start moving towards normality before we could expect that we get the Aussie dollar coming down a bit and helping that rebalancing speed up. I also wondered on another separate point, which you've made in the speech today as well, that you point out that the Aussie dollar has been high and that's uncomfortable for some businesses, it's making them make adjustments to the way they operate, and in fact whether the Aussie dollar being uncomfortably high is a bit of a necessary evil given we want stronger productivity growth in Australia?

Well on the latter point certainly a degree of discipline on various parts of the economy will help promote productivity growth and so on, that's good, but the right level of discipline is good; too much or too little is not good.

On the – and I'm not aware frankly of any conventional metric that would take account of relative costs, relative unit costs, et cetera and prospective terms of trade trends that would suggest to you that the Australian dollar should be as high as it is today. Maybe there's some new fundamental at work here that we haven't yet seen that warrants a higher number, but that case has to be made, and as I said earlier I think – I think investors in their search for yield and in the very low volatility world that we presently live in, where people think that the risk of anything going wrong seems to have completely gone away, I think that's over optimistic and I think part of that is an under estimation of the likelihood of the Aussie going down at some point, and possibly quite materially.

On the question of whether we have to wait for the other central banks, well in some sense there's an obvious truth to what you say. The puzzle right now, actually in my view, is partly maybe why the Aussie is so high, but the bigger puzzle globally is why the US dollar is so low. It's patently clear I think that the US will be the first – it's obvious they're going to be out of quantitative easing within a few months and they themselves are talking about starting the interest rate adjustment next year sometime. The timing of that I suspect will remain a bit fluid for a while yet, but it's clear roughly the way they think and it's pretty clear that Japan and Europe are thinking in a very different way. So how come the euro is as high as it is? How come the dollar is not firmer, I think that is a conundrum, I think it's – when we ask around the markets most people think that's – seem to think that's a conundrum. Somebody must know the answer because they've been the ones doing the selling, but that is quite a big question and it's a much bigger question than just an Australia-specific one; anyway that's what I want to say about exchange rates.