Transcript of Question & Answer Session Economic Conditions and Prospects: Creating the Upside

Governor I was – I was really interested to what you said about falling wages and falling inflation. You said that in a normal circumstance those falling wages would have generated falling inflation and I got the impression from you that that could have put some downward pressure on interest rates if that occurred, but you said in fact that didn't happen because inflation was higher because the exchange rate went down therefore import prices were a touch higher. So can I read from that that if inflation stabilises and the exchange rate stabilises later in the year that might give the Bank room for more action perhaps?

So we've gone straight to the interest rate question Michael.

I've gone straight to the interest rate question.

With a very elaborate ploy to get there but let me respond to some of the premise that you put. What I'm saying is there seems to be some evidence that growth and labour costs is a bit lower than you would expect given the rate of unemployment. That could be because there are measures of under employment that are more of the story, possibly that, but certainly labour costs are very restrained. Where does the benefit quote/unquote of that go? Part of it could go to profit margins and it may have just a little bit. Part of it comes from to lower core inflation and then the exchange rate declining, which is the relative price shift that we have thought we needed, pushes up the prices for traded goods and services.

The inflation outlook, monetary policy has responded to that actually because we've said on a number of occasions that we had scope, one of my favourite words, to ease if that was helpful, to support demand because inflation outlook looked pretty secure and we've done to the tune of 75 basis points since I was last here or 100 points actually on lending rates, so it's not as though policy hasn't taken opportunity.

From here I would only repeat what I've said, we will look at the incoming data, this is what the statement said on Board day and assess what that tells us about the outlook and what the appropriate stance is and whether this stance or another one would be better for fostering sustainable growth. But again emphasise sustainable; some short-term burst that then fades and gives us a bigger problem later might not be the trade-off to make. So that's probably as much as I want to say about that one today.

Last time you were here we talked about the risk appetite and we talked about the way that you had to move interest rates further to get the same effect in the world after the global financial crisis as you did before the global financial crisis, it seemed that business was a bit more scared after the financial crisis, and that therefore there seems some risk was greater, but anyway the appetite for investing was needed lower interest rates that have the same effect. Do you have a broad guesstimate of what that interest rate effect is? Do you need interest rates now maybe a per cent lower or a bit more than a per cent lower or 2 per cent lower than you did before or is just you're working through it step by step to discover where the right interest rate is?

Well there's no precision on these things. We have said many times that it seems that what used to be thought of as the neutral quote/unquote rate you can think of reasons why that would be lower in the present circumstances than it used to be and that would probably stay the case for a while. And most countries I think believe that and have found that. But this is a conceptual device, the natural interest rate, it's not an empirical magnitude you can go look up in an ABS release any more than the natural rate of unemployment and so on. So there's always I think an element of learning in policy formulation, the world is never quite the same as it used to be, there are always new things happening and you have to keep in the back of your mind we've got to extract new information out of the data that we receive as to how effective policy can be.

That having been said, it does seem to me that in many cases the rates of return on an investment that businesses think should be earned haven't really fallen in a world of extremely low funding costs. Now some people claim that in some cases it has come down so that's good, but my suspicion is that in many places in the world and in many lines of business including here the rates of return that shareholders, analysts, management think they have to earn, haven't really responded much to the fact that the riskless rate is incredibly low and won't be this low indefinitely but likely that low risk rates are pretty low for quite a while.

This is in a sense why there isn't much evidence that monetary policy directly affects business investment because we can't simultaneously determine the riskless rate and the risk premium that the investors want to apply, the risk premium they want to apply is in their hands.

I went to a presentation earlier in the year by Larry Summers who was previously a US Treasury Secretary and he was a candidate for a time to be Chair of the Fed, and he was saying in his presentation that when the Fed starts to tighten it'll really only go part of the way towards what previously would have been regarded as normalisation, he was saying that he thought that interest rate the Fed Fund Rate get up to 2½ per cent, and then some time in the next cycle it will fall down zero again and maybe we'd have QE again. A year ago you talked about the idea of normalisation and that Australian interest rates would eventually after this cycle go back up towards a level that might be something like the not long-term average levels. Last year you thought, you hoped, that that would happen in a couple of years, but how long do you think it will take now or how many cycles will it take do you think?

I'm not sure that we will see normal quote/unquote even here any time soon. I think it's quite some time before we even think about interest rates going up. And where normal is, is going to be a judgement call the world is a different world so you've got to try to factor all that in, and in a sense that's what Larry Summers is saying the Fed has to do.

Just on the Fed though 2½ is a fair distance from where they are now and that's quite a lot of adjustment to manage carefully along the way. So I think the key thing is to get off to a measured reasonable start, that will itself if that can happen this year for them start to reduce uncertainty and that will be good.

Now do we have questions from the audience? Okay so if we could go to Jean Tully. Do you have a mike? Okay sorry Ken Howard.

Michael, Glenn Stevens I'm interested in your concluding comments about opportunities for structural change and the mix to the Australian economy and what's going to drive us into the future? Clearly we've enjoyed the boom of the primary industry, but what's going to be the boom for the next decade to lift Australia forward?

Well I can't tell you. If we'd sat here 20 years ago, 25 years ago in the depths of the early 90s recession and asked the question ‘where will the growth come from?’ we'd have concocted some answers as a bunch of economists, there's 400 of us here we'd have come up with 1000 answers probably between us. I bet none of those answers would have accurately predicted the way the structure of the economy has altered in the intervening 25 years or so and so you can't predict actually exactly in what areas the growth will come. I think the thing though is not to try to predict that, it's to try to think about what capabilities we need to be working on so that we can adapt to whatever changes come along, that's the thing we need most to be doing I think is asking ourselves are we equipped to cope with a rapidly changing world, technology, internationalisation all of that stuff, and be ready to seize opportunities when they present, which they will. If we don't grab them someone else does, so are we adequately equipped in all our structures to do that, that way wherever the growth comes from we will be positioned to take advantage of it.

You would not have predicted actually in 1990 that in 2015 we would be talking about how to manage the downward phase of the largest terms of trade boom for 150 years, nobody picked that, that I know of anyway 20 or 25 years ago. So that's an example of the fact that you just can't tell but what you can do is try to ensure an economy that where people are well trained, have the right technology, the right adaptability, flexibility, capability, to respond to what comes along. So it's again back to Gary Banks' ‘to do list’ speech, for which I feel I should get some royalties because I was actually at a presentation in Brisbane that I coined the term ‘the list’ and he very kindly went and wrote it down.

Flexibilities, capabilities and incentives, that's what that, they were the three sets of things that he talked about and then fleshed them out you know get the list, they're the things to do. What it won't come from is cheap money.

I think there's a question in the middle there.

Governor just wondering on that question of the return to more normal interest rates which is obviously you know an important question when that will occur, and you say it won't happen anytime soon, but given your views on you know forecasts and accuracy of it, would you agree that this is not something that you really can forecast and that when it does happen, it will happen abruptly and there will be a major discontinuity there?

Well if you can't forecast it then I'm not sure you can forecast it will be abrupt either, it could be abrupt or slow, I certainly agree with the premise that you can't forecast very well. What will we be doing in a year, I don't know. I think all one can do is observe that you can think of reasons why whatever normal is today it's for a while lower than it used to be, and you can talk about how gingerly central banks might need to reapproach that and I think generally central banks will be quite careful in doing that. And then you have to say but we really don't know what else is going to come along absolutely.

Is there a question over there?

Yes so just looking around the world's financial markets at the moment there has been a lot of money sort of pumped around the globe, we've seen a lot of investment go into the Chinese domestic market from the Chinese Bank sometimes at the direction of the Chinese government and that's led to you know a fair bit of property investment and more recently quite a run in their share price which you know has been fuelled to a degree by margin loans. If there was to be an issue in the Chinese banking market, is the Chinese Government adequately equipped to basically cover that before it spreads any further than China?

That's a good question, all of what you say is true and we've held the view for some time that managing all of that back down to earth without crashing is no small feat. My guess is that if anyone can do it they can, but that's not a guarantee they can. The two comments I'd offer I guess is my sense is that the Chinese authorities and the central bank, the supervisory areas and so on, are very well across the problems and secondly I would expect that if it requires financial resources of the government at some point they have those resources.

So those are both supportive points for an outcome that's not too bad, but it is a difficult thing to do, to try to do what they're doing and they are pretty determined to move off this model of force feeding credit into the system as a macroeconomic tool, and I think it's right that they are determined to get off that. But they've got to manage this legacy of previous policies that have left something of a hangover and that will involve a whole host of things, better regulation of you know the so-called shadow banking, more liberalisation of the regulated parts of the economy, done very carefully because we know ourselves it's all very well to say let's take the shackles off but silly things happen when you do that, so done with care. Provincial governments need a better source of revenue than property development sales, that's an inherent weakness and danger in the system, so those things and more all have to be addressed, they're across that but no small task which is why I say in the talk it's a work in progress.

Further questions? Yep if you could just identify yourself before you ask the question. I think – excellent.

Tim Lawless from Corelogic RPData you mentioned Governor, thank you for your presentation by the way, you mentioned leverage across the household is now at record levels, about 153 per cent or so and most of that is housing debt, we've seen Sydney dwelling values rise by about 15 per cent the last year and about 65 per cent post 2008, do you think if housing values continue to rise at that pace that will stay the RBA's hand for lower interest rates?

This is another oblique, not that oblique actually approach to the interest rate question. Do you want me to comment on the housing market? What's happening in housing in Sydney is clearly I find it acutely concerning for a host of reasons, many of which are not to do with monetary policy, I think it's a social problem. I would simply make the point that firstly asset booms – there are asset booms and asset booms, the ones that do the damage are the ones with a lot of leverage, which is why in housing you have to pay attention and you have to focus on lending standards and credit growth which is exactly what we're doing, trying to ensure that lending standards are maintained and indeed improve; I think Wayne's speech the other day showed areas of concern there and it need not just for maintenance of lending standards but an improvement. And we have to take account of the housing price dynamics. Of course that's Sydney, Sydney's not the whole country, prices in Brisbane I think are rising but nothing like that pace, there's not much happening in Adelaide, Perth they're probably falling, Canberra not much happening, regional centres around the country not much happening. So when you're devising macroeconomic policy for the country yes I'm very concerned about Sydney, I think some of what's happening is crazy but we've got a national focus to manage as well and that just increases the complexity. On whether or not that stays any hands I have no comment to make today.

So we have time for just one more question, which I think is from the front here.

Matt Wright Commonwealth Bank. With regards to your point on the economy split between households, corporates and governments, in that households cannot materially take on any more debt. Then I guess my question is why would the Federal Government be hesitant to take on more debt? It seems that corporates from my point of view are sitting on the sideline a little and combating on that state government are also doing the same with their debt burdens, not just Queensland but several of the other governments have significant amount of state based debt. So I guess that all being said the rating agencies have come out and said that the Fed's can borrow more for infrastructure so why wouldn't they and that being – and on top of that wouldn't that grow the economy significantly more than what's happening now?

I haven't come to Brisbane to give a gratuitous lecture to the Federal Government about whether or not to borrow. The points as in the speech it matters what you borrow for, so when we're thinking about whether debts are good or bad we've got to ask what's the debt for, because I think that matters, and I think the other observation is that the Treasurer I think rightly has made a major point of trying to talk up and actually grow the infrastructure pipeline. I think personally and all that's good we need that pipeline if anything in the longer term to be bigger but we also need it to be more supported on a more bipartisan basis as I don't need to tell you in Queensland when one party commits and another party reverses, regardless of who was right or wrong, that makes it difficult for the industry difficult for certainty, so can't we get a better agreed set of what we're going to – plan for what we're going to do, make it a long-run one, and have governments State and Federal stick to that. The financing part is the easy part, the hard part in infrastructure is which projects, through which electorate, upsetting which group of people, but in the greater good and how do we govern that, how do we choose? How do we govern the process? How do we share the risk and how do we price? They're actually the hard questions, funding is the easy part.