Transcript of Question & Answer Session The Economic Scene

Well thank you Glenn, it’s certainly not for an accountant to tell an economist that he’s boring, so I won’t do that. So who would like to ask the first question?

This is Con Michalakis, I’m Head of Investments at Statewide Super. You’ve got a world at the moment where the Europeans need quantitative easing perhaps, the US is looking at getting away from zero interest rates, where does that leave you trying to manage monetary policy across that domain?

Before I answer that I should say that there is the joke that economists are the ones who lack the personality to become accountants. It is a complex world as you say. And I think it’s true that if things proceed according to the presently understood schedule from what the Fed has said, and what the ECB has said and actually also what Bank of Japan has said, it seems likely that the Fed will be on the road back to normal sometime, starting down that very long road next year. I think it’s likely that the ECB is a very long way from doing that and as you say there’s speculation of further balance sheet measures, as there could well be in Japan. So the big three jurisdictions are actually on separate tracks. One would … This is in part why people have puzzled about the US dollar. And I think it’s probably the case that many market players have lost money on that trade this year, waiting for it to rise. So that is a complexity. One could wish the world was much simpler, oh please could that happen, but that’s the complexity we have to live with. I think what we’re trying to do, and this has been my view all along, we have to calibrate to some extent for the international setting that we face, but so far as we possibly can, we are trying offer what I would call a normal service monetary policy. That is, there aren’t balance sheet measures, we did do that briefly in 2009 just for a few months, at the heat of the crisis, but quickly unwound since then. Balance sheet’s normal, interest rates are positive, they’re low, but they go up and down in response to what the framework dictates is normal service and I very much hope that we can sustain that for a sufficiently long time to see normal service return in other countries.

Thank you, Eric Neil, retired engineer. Governor, we’ve been used in past years to seeing growth rates from China in the 7 per cent, 8 per cent, 9 per cent area. As the Chinese economy grows, would there not be an expectation that the percentage increases will diminish each year, could you comment upon that?

We actually saw China grow at about 10 per cent roughly on average for 10 years. Nobody grows that fast indefinitely, not even China, and they themselves have articulated the objective of around 7½ [per cent] in the near term which they seem to be achieving. It’s worth noting that China today, growing at seven [per cent], adds as much to global demand as China growing at 10 [per cent] did, 10 years ago, because they’re so much bigger than they were. I think it is true that into the future we will see the Chinese growth rate gradually diminish, not necessarily every year, but five years from now it will be surprising if they’re still growing at seven. It will be more like five or six or something like that. That’s because there’s a massive catch-up, but as you get closer to the point where you’ve caught up, you start slowing down and of course their labour force won’t be growing. They’re probably about now at the point where population is about to peak, start to decline. This is a legacy of the one child policy and so on. And so there’s still a rise in productivity they can get by moving a lot of people from the farm to manufacturing or services, but the shear growth in population of working age is going to slow down. So for a bunch of reasons their potential growth rate in the future won’t be the same as it’s been. But still let’s say they grew at five [per cent], it’s a very big economy. That’s still a powerful force in the world and still something that we’ll need to pay very close attention to.

Thank you Governor.

Governor, one of the things that presumably affords comfort to the Bank in relation to inflation is the slow growth of wages, which is a phenomenon that contrasts with what you read in the press almost every day about the outrageous demands that are being made and met. Does the Bank have a view about the reason for this seemingly surprisingly low rate of growth of pay?

We do, I think firstly it is correct as you say that the rate of growth of labour costs is unusually low right now, it’s running at about 2½ per cent a year, on the best index we have for that. That’s lower than average and lower than experience in the past decade or more. Why is that happening? Well I think the labour market has clearly softened. The unemployment rate was five, now it’s six point something [per cent]. So in that sense, I think the labour market is behaving in a way that you would expect. There’s cyclical slack, the rate of pay gains slows down. That by the way helps to preserve jobs, because the price being responsive to demand helps preserve jobs, compared to the alternative. But there’s no doubt it’s quite modest, and with improved productivity performance as well, as far as I can see, unit costs are not rising very much at all. That is a big part of why we say that we think, inflation notwithstanding, that the most recent number was a high one, we think in the next couple of years we will be consistent with the two to 3 per cent target, even if the exchange rate were a bit lower than it is today. So that behaviour of the labour market, at least directionally in the way you’d expect, is a big part of our story right now.

Peter Hollister from the State Department of Transport. You’re talking about labour market and a number of those things, but the baby boomer cycle going through Australia: just wondering about the degree of challenges and opportunities that come out of the baby boomer cycle that we’re experiencing.

One’s tempted to wax on, I am a baby boomer so, sort of in the second half of it, so I could tell some stories against this, but maybe the best thing to do is to suggest that, I think the phenomenon of aging is understood to be very important. That has fiscal effects, much of which comes through the health system actually, rather than pensions. I think baby boomers, we tend to carry debt later in life than our parents did. We perhaps have been a little bit over-keen on investment property as our retirement plan and we might, at some point, be a little disappointed and most of us have not really saved enough in our lifetime. So there are many issues there, but I think those ones are, at least, conceptually understood. Whether, quantitatively, we have them properly calibrated, I wouldn’t be sure of that. So I think that’s a very powerful force and I suppose, to generalise a little, demographics broadly, not just the baby boomers, but the Chinese population, the Japanese population, which is going to shrink massively, actually, in the next generation. Similar things, directionally at least, will happen in some countries in Europe. These things will be quite important, and there’s not a lot of precedent in history, that I know of, for trying to understand how you get growth and dynamism in a country whose population is going down, but Japan I think is trying to find that answer. So I think these demographic things are probably much more important than we’ve tended to give them credence for in the past.

Bruno Bellon from the Commonwealth Bank. Thank you for your speech today, Governor. I just wanted to pick your brain in terms of a period of stability, it’s been a line that the Reserve Bank has run for a number of months now. You have recently mentioned that you would remove that comment, ‘period of stability’, long before there’d be a change of monetary policy. Now today you’ve articulated a few examples of risk taking that’s taking place in the Australian economy. You also have GDP, which isn’t too far off long term trend, and you’ve also got inflation close to the top of the 2 – 3 per cent band. What else would you like to see before you remove that comment?

Well I’m not going to replace ‘period of stability’ with ‘period of instability’. And I’m not going to engage in a continual dialogue publicly about how the language might change. The point I made a month or two back was simply that this is a device that we’ve employed which has done what it was supposed to do. Which basically was, when we stopped easing, to stop everybody immediately running to the other side of the ship and say ‘we’ll be tightening soon’. It wasn’t going to be, and we wanted to be clear about that. At some point before this language starts to box us in, I’d like to change it to something much more vague and that will probably be something like ‘policy remains appropriate’. But I’m not telling you when I’m going to be in a position to do that, that’s all I’m going to say on that one.

Governor, you’ve referred to the exchange rate being stubbornly high. I was just wondering what you think of – just clarify what the key contributors you think are to it remaining stubbornly high and when – if and when there are levers that we can and should pull to adjust that?

I don’t think I’ve used the word ‘stubbornly’ though others perhaps have. What I’ve said is it remains above, and I think this is pretty clear, above most normal metrics that you would use to gauge its running equilibrium value. It’s above those. I think that’s fairly clear, so why is that? I think the earlier question, that went to the very unusual state of affairs globally, is a big part of the answer. And by the way people think that the relativity in cash rates is a big driver of the exchange rate, well it will be partly a driver, but when you think about it, the whole universe of yield on offer on all manner of assets in this country is high by the standards of other countries. Houses, commercial property, infrastructure assets, as well as debt instruments. All of those yields, most of which we do not control in the Bank, remain quite attractive to foreign investors. And I think a lot of the capital that’s coming to the country is chasing those assets, not just the overnight rate. So that’s a feature of the world we live in and one presumes that that is a major part of why the exchange rate remains in your words, not mine, stubbornly high, but in my words above it’s likely long run equilibrium value. How long that will be the case, I don’t know.