Transcript of Question & Answer Session Global Influences on Domestic Monetary Policy

Let's begin the discussion part of today's event. Let me check a couple of things with Guy first and then I'll open it up to the floor. Make sure I can see everybody and when you ask a question, I'll ask you to identify yourself and say where you're from.

So, Guy, I think what the release of the Minutes set off was some arithmetic, which said that here's something called the neutral rate and the current cash rate's less than that. The inference was drawn that the lower is going to go to the higher. You're saying to us today, just be a bit careful about drawing that inference.

Yeah, that's right. I suppose what I was saying is that the fact that we were talking about, that there was discussion on the neutral rate at the Board Meeting didn't have any implications for near-term policy decisions. It's just one of the things that you need to have in the back of your mind when you're thinking about the policy setting. Amongst other things, having some assessment of where neutral is gives you some idea about how expansionary, or contractionary, for that matter, but today expansionary, this current status of policy is. So without that point of reference it's harder to work out how expansionary the current settings of policy are.

So as you said, if the current rate looks low but if the neutral rate's falling then it's …

Not as low as it looks on the face of it.

It's not as low as it looks on the face of it. Let me ask you one other thing, which was about markets for assets like houses. That's been one of the mechanics at work here, has it not, during this period since the financial crisis with low interest rates, the availability of funds for investment, low investment in regular production processes, people been buying up other assets? Can you talk us through, what's the story there? How does that play into thinking about what the options are?

Part of the transmission of expansionary monetary policy, both interest rates and probably more so in terms of asset purchases, is it does have an influence in terms of pushing up asset prices. The idea then still is to encourage corporate investment and the like. You see equity prices higher, that's one of the transmission channels. In some cases, house prices are higher. One thing which is interesting in Australia is that in some places house prices are higher, like the place I live currently [Sydney]. The place I used to live, here [Adelaide], house prices aren't quite so high, but everyone's borrowing pretty much at the same rate.

Australia's a pretty good example. There's not a universal effect on house prices. We have some markets where the house prices are rising rapidly but somewhere they aren't. In Perth they're falling. But everyone's still looking at the same interest rate. Interest rates are one of the influences but there's clearly a few other ones going on too.

There's not a one way process if you start raising the cash rate that there'll be necessarily some fallout in those asset markets.

Well there's probably going to be an impact on it, but just as there's an impact from lowering rates there's also an impact with rising rates, but as in most things in economics, depends on what other stuff is going on at the same time.

Last one from me was about productivity. The concept of the neutral rate is a very neutral concept it seems to me. It's built on the notion of this potential growth rate of output, but in the context that we're moving into, with an ageing society, demands to harness and provide services for those people. We think we'd like a higher potential rate of growth. That's another big story here. How to increase the potential rate of growth. Is that right?

Yeah, absolutely. And one of the best ways of doing it is this. Is education, particularly University of Adelaide education, obviously! I think a lot of people here would agree with that. Particularly Mike. But in all seriousness, education is actually a big part of the story. Primary, secondary and tertiary, all of those. Human capital is a major driver of productivity growth. If you think about it in the end, mostly it boils down to human capital and technology. Technology normally needs human capital to create it as well.

As you say, I mentioned earlier we've had a slowdown in potential growth mostly because of demographic factors. Those aren't going to reverse any time soon. Both here and even more so in some of the other advanced economies and actually most notably, in China. But something which can go in the opposite direction very much is productivity and a fair chunk of the driver of that was going to come from education.

Good. Thank you. Let me turn to the audience and ask who'd like to ask a question or make a comment. As I said, there's a microphone coming to you. Would you tell us your name and where you're from.

Thank you Guy. One of the other issues of course is exchange rates and our capacity to buy cheap televisions and have wonderful cheap holidays in North America juxtaposed against this agrarian and mining economy and export economy. Your former Chief Executive, Governor of the Reserve Bank, spent quite a lot of time in a public campaign trying to talk down the exchange rate and here it is stubbornly high. What's your comment on exchange rates and how that interplays against the other issues you talked about today?

Well, I think the exchange rate clearly is one of the forces which has a fairly significant influence on what's going on in the domestic economy both in terms of output and inflation. As we've said on a number of occasions, an appreciating exchange rate in the current juncture isn't helpful. A lower exchange rate is probably going to be more helpful in terms of the sort of forces we're looking at the moment. So yeah, the exchange rate certainly matters given the adjustment we've been going through over the last few years in terms of coming off that resource investment boom, we've said repeatedly in press statements, including the past month, that an appreciating exchange rate would complicate that adjustment. So if the exchange rate's appreciating, it's complicating that adjustment.

Is the 3.5 neutral rate a bit like Carlton; it's a long way to a premiership. So do you see the rate adjustment taking a long time to get into play?

I don't know which one's going to come first, Con. Carlton is showing about as many promising signs as the Australian economy. (Which is a good thing!) But as I said in response to Chris' question it's, to use another football analogy, it's sort of useful to know where the goalposts are and working out how far away you are from them. Doesn't mean, as I said it was a discussion. For a while we have discussions at the Board, most of the time actually, we have discussions at the Board, on particular medium and long term issues. Just to make sure the policy discussion is fully informed and this time around it was the neutral rate.

As I showed in the estimates earlier, there's a fair amount of uncertainty about where it actually is. I think we're fairly confident we're below it at the moment. In fact, we're very confident we're below it at the moment. How far below it, where exactly it is, not quite so confident. But as I said, it wasn't something which was a near-term policy consideration. It was more just as much to get some assessment, provide some context about where the current stance of monetary policy is.

I think it's useful for people to have in the back of their minds, both in terms of the Reserve Bank Board, but for people in the economy at large, as to where in the fullness of time, rates might settle, which is probably higher than where they are today. But certainly wasn't anything in terms of implications for the near-term.

Hi Guy. Thanks for your presentation. I wanted to ask you a question about inflation targeting and the Reserve Bank has that as a target and whether other targets are being considered and I guess I raise that in the light of Warwick McKibbin's comments during the week.

We think that inflation targeting has done and continues to do the job, it's a useful framework for monetary policy. Do we think about other frameworks? Yeah. I think what Warwick's talking about in terms of nominal income targeting isn't miles away from what we actually do. I know that he would acknowledge that himself. I think there are a couple of things you need to think about in terms of frameworks for monetary policy. One is the ability to communicate and what influence that has. So if I compare inflation targeting with nominal income targeting, I think most people have some understanding about what inflation is. Prices, going up and down. People have a little bit more trouble getting their heads around nominal income and what that is and also where it's going.

As I said, I don't think the two things are miles apart, but we've been comfortable in terms of the outcomes, which we've seen with the Australian economy using the framework that we've had for nigh on, what are we talking, nearly 25 years. Seems to have gone okay. Doesn't mean you don't need to continually review whether it's appropriate, but we don't see any particular reason to change it at the moment.

Hi. There's an awful lot of liquidity in the market globally, which has been sensational for businesses in the last few years. Do you see that continuing?

I always struggle to work out sometimes what people are talking about in terms of liquidity. Because sometimes there's market liquidity and then there's liquidity in terms of central bank balance sheets … That's alright. I'm going to get to your question. So one thing which I mentioned earlier, is that if you look at the size of central bank balance sheets, they've grown a lot relative to the size of economies.

In the US they've given reasonable indications that they're going to start, or they've said, that they're going to start reducing the size of their balance sheet before the end of the year and do it very gradually, but they're going to start. We'll see how that goes. It's had an influence on some markets, so equity prices are high in part because of the amount of stimulus which has been provided. But then if you look at some other markets, it's not so obvious. The stimulus is out there to try and achieve outcomes in terms of output and employment and that does have impacts on markets as well.

At the same time though I spend, particularly in my previous job as looking after the financial markets, I used to mostly hear complaints about how little liquidity there was in markets and how everything had deteriorated over the last few years. As I said, there's the liquidity if you look at it in the aggregate but when you get down to some of the micro levels, not quite so obvious.

Very interesting to hear there's been a lot of debate about the Reserve Bank Minutes. I'm just interested in your view on the state of economic discourse in this country particularly observing over the last 20 years whether or not you think it's become more or less sophisticated.

Wow. I don't know. That's a really hard question to answer actually. Yeah, that's a really hard question to answer. It partly depends in terms of where the discourse is taking place. I still think, I'm not sure what the implication is, it's worse than it used to be. One thing that I think is interesting in particularly having spent some time living in other parts of the world, is that the economic interest and literacy, I think, of the Australian population is far greater than it is in a lot of other parts of the world, in that some of the stuff which appears on the front page of our papers wouldn't appear anywhere near the front pages of equivalent papers elsewhere in the world. People seem to care about the economy more here than they do elsewhere.

I don't know whether it's better or worse. One thing which is the case, which is not necessarily good for the future of economic discourse in the country, is that the amount of people studying economics, particularly in high school, has declined quite a lot over the past 10, 15, 20 years. People enrolling directly in economics degrees is not necessarily as much as it used to be. They'll do it as part of something else. So that's declined. I'm not sure whether that's great for the future of economic discourse in the country.

That's one thing, at the Reserve Bank at least, we're mindful of and have actually started to try and do something to address by working with the various school boards around the country to try and provide material directly to high school economics, work with them on the curriculum particularly in terms of macro and monetary policy and the like, the stuff we know about, to try and make sure that the economic discourse in the future doesn't deteriorate and that have got the ability to participate in a reasonable way in that.

Let me make a supplementary comment. One other trend it seems to me is that the policy debates also got more noisy. There's more voices, there's more organised voices including around economic policy so there's more, I think there's actually more opinion but coming from groups which are organised around specific issues. And that's very much, there's a little bit of our political science colleagues are thinking about this now, there's a notion of the vetocracy. That it's difficult to get things done because there are coalitions of interest groups around particular topics which when anything comes up will complicate in a way the debate around …

So that's not a problem unique to economics. That's a problem with the policy more generally I think.

Yeah and I take the point on high school education in economics as part of my responsibility. I have a question at the back.

I'm just interested in the RBA's confidence in its forecast. It seemed very upbeat in the Minutes and I know you mentioned that the strong labour market suggested that some of the downside risk for wages had lessened. I put it in the context I guess that John Edwards wrote a very interesting paper looking, who similarly came to neutral cash rate of 3.5 percent like you guys did and he was foreseeing if you were achieving that forecast that you'd have to raise rates perhaps four times next year and four times the year after. Is there a strong degree of the confidence in the forecast or is there a growing degree of confidence?

I'm not going to talk about future rate decisions Michael. I'm glad you're also able to come back to Adelaide for this one as well.

Keep coming, Guy.

The comment was more that we'd had this forecast for the labour market for a while and just the more recent data seemed to more validate the central forecast. It wasn't saying anything more or less than that. The only other thing I would note is that our forecasts are actually predicated on the expected path of policy rates, which at least at the time we put them out back in May was flat. So the forecasts are predicated on that. It was just more that we'd seen stuff which seemed to give us a little bit more confidence. So you're right, yes. Do we have a little bit more confidence? Yes, we have a little bit more confidence that the forecast that we had were actually likely to come to pass. Not that they were necessarily going to be anything stronger than that, but just the forecast that we actually had were, stuff seemed to be coming along which was in line with that which is good and better than the alternative. So it's sort of nothing really more or less than that.

Who's next? Another question or comment?

Let me ask you while people are considering their options, one factor you pointed to was low investment. I should have checked the research first, but the anecdote is that the capital intensity of the economy with new technology looks like it might be diminished. Is that a possibility?

It's a possibility, but you actually still need to spend money on stuff which embodies that technology and virtually use it. So, it's not obvious. The problem we have in Australia is that we just stick out like a complete exception from the rest of the world. Because we've just come off the largest amount of investment spending pretty much, certainly in the last century. So everyone else in the world is talking about the low level of capital in the economy just after we've stuck in the largest amount of capital we've pretty much done in a long time. So a little bit different here than elsewhere, but it's not obvious. There has certainly been a shift to the services sector, normally people have in their mind that services equals when you're doing services. The service part of the economy has less capital than a factory.

Then if you think about the health part of the services sector - the evidence with the building down the end of North Terrace, that has a fair amount of capital in it. It has some people in it too, but it also has a fair amount of capital in it. It's got a lot of technology in it. But not necessarily as you shift toward the services sector that implies that the economy is going to become less capital intensive.

So it's one of the things that people have looked at but it doesn't seem to be a part of the explanation. As I said, there's no really cogent explanation as to why investment has been so low beyond the fact that's it's been a global, rather than a local phenomenon. But it does seem to have something to do with the fact that there has been a bit of a dearth of animal spirits for a while, which may be changing. The only other thing is that the longer we've gone without that pick up in investment, it means that the existing capital stock is more depreciated, which at some point means you need to have a bit more investment, rather than less.

I think the services story is a really interesting one and our own South Australian Centre for Economic Studies recently put out their mid-year briefing and one of the striking points in there is the growth of services exports from Australia. That's a national story too, I think.

Yeah. I was saying to Mike Brooks earlier that the education exports have been one of the fastest growing exports in the country for quite some time. Service exports as a whole have actually been doing pretty well for quite a number of years now. It's very much an export story not just a domestic story.

Wearing my exporter hat, I'd like you to do something about that exchange rate, if you wouldn't mind. Another comment or question? Here's a terrific opportunity to prove to someone who's on the board of the central bank and was involved in that meeting where those Minutes were reflected. I have a question at the back.

In your presentation you touched on wages growth and that misalignment between maybe recent labour market and economic outcomes and the slow rate of growth. I was wondering if you could share some of your thoughts on what's driving that misalignment at the moment?

Sure, and having given the University of Adelaide a plug, I'll give the ABS a plug because we have had one of our staff spend some time at the ABS over the last little while and to look at the unit record data. Which means when the ABS goes out and surveys people on the wages front they sort of do it person by person so we get some longitudinal data. So one of the things we did, a member of our staff did when he was working at the ABS, was he looked at the unit record data which underpinned behind something called the wage price index which was actually the graph that I had up there earlier. And what it shows is that one of the reasons why wage growth has declined here is not that, it's that we've gone from a world where we had a lot of people getting three or four per cent and some people getting two per cent to now everyone roughly or a lot of people getting two per cent. So it's not that everyone's experiencing lower wage growth, it's just the sort of normal wage outcome in the country has gone from being three or four down to two. So we have a much larger chunk of the workforce getting two per cent now than what used to.

Doesn't look like there's been a step below that, but we've just stopped having a chunk of the economy, or workers in the economy, getting more than two are now getting two. And that's why wage growth, at least arithmetically, why wage growth seems to have stepped down here. And also one reason why in our forecast we don't think it's necessarily going to go much lower because through our liaison program, which at least in this part of the world [South Australia] that Matt Carter runs, when they go out and talk to businesses they're not talking about wage growth or wage outcomes slower than the two which gives us some confidence enough in our forecast which has things sort of stabilising here.

But it does seem to have been just this sort of wage norm in the economy if you want to put it that way has shifted from being a number which might have been three or four to a number more like two. As I said, how long that's going to last, we're not sure. Amongst other things, to the extent it's become more of the norm, it's a little harder to budge. But if the labour market continues to improve and the unemployment rate continues to decline you would expect that we'd start to see that turn around. The only caveat on that is that if you take the US as a good example, the US unemployment rate is now below what most people including the Fed thinks is the rate at which you would have started to see wage and inflationary pressures build.

They have a little bit on the wage front but they haven't on the inflation front. And so they've been sitting there with a low unemployment rate for quite a while now and they haven't seen those wage and inflation pressures pick up. Same is true in the UK, same is true in Germany. The German unemployment rate's the lowest it's been in 40 years and they're still not seeing really much in terms of wage or price pressure.

So again, it's a global story that seems to be, some of the research we've done at the Bank seems to suggest there's some global common factor. What that global common factor is we don't know, but there does seem to be a sort of a global element to it. And as I said when I was talking earlier, it remains, the economics profession in central banks and elsewhere is spending a fair bit of time trying to get to the bottom of it but to date not particularly successful which is a puzzle and somewhat concerning but it's really something we're spending a lot of time trying to understand, but ultimately actually don't have a particularly good explanation for it.

Just when you're talking about the low levels of unemployment, how does that then balance out with the level of underemployment? Which is, we hear about the low level, but it's not translating to full time employment, employment for the younger demographics and people are feeling worse off because we've got massive increases in energy prices, health prices, even education. So there are a lot of - we talk about that unemployment, but that's really not the full story there is it?

No, that's right. So we spend a fair bit of time working as you say at underemployment which actually has also come down over the last few months because we've had three or four months now including the numbers which came out from the ABS on Thursday, we've had three or four months in a row of recorded strong growth in employment. I'm sorry, of full time employment and some drop off in part-time employment. So that underemployment rate that you're talking about actually has come down over the last three or four months from a fairly high level. Most of the time the underemployment rate and the unemployment rate tend to move in pretty much in lock step. The gap between the two hasn't widened all that much. Up until about a year or two ago where it did widen a bit. So we've had these levels of underemployment above unemployment for a long time and the gap hasn't moved all that much, but it did widen a bit a year or two ago. It has narrowed a bit over the last few months.

Certainly it's something we pay a fair amount of attention to and it's got something to do with what I was just talking about a second ago as to why you don't see those sort of wage pressures emerging because of that underemployment which is out there. That's certainly one of the most obvious explanations that are around for that. Some of the rises in gas and electricity prices that you're seeing including right now also working on - are not great for the household budget. That's again something we certainly take into account in our outlook including thinking about what that's going to mean to household spending going forward. Both of the two things you said actually. Both the degree of underemployment and the low level of wages growth but also then the effect of things like rising utility prices are something which very much we take into account in trying to work out where household spending is going to go over the next while.

Can you continue on that theme and talk about the participation rate and in the US, as I understand it, the participation rate is now a good three percentage points lower than it was 10 years ago. And I understand that notwithstanding that you've got four percent unemployment the actual absolute number of people employed is now lower than it was. Is the participation rate is it purely demographics or is that some contingent source of labour supply that's depressing wage growth?

Yeah. That's a good question. I think actually in the US they've now got more people employed so the other things that you said were right, but I think they've actually got more people, but a lot of it is demographics and it's true here too. We've had these very large rises in the participation rate over the 70s and 80s and 90s. Mostly because of female participation in the workforce going up. There's a large demographic element associated with that and with the sort of baby boom demographic which is now moving out of the normal or traditional, let me put it that way, working age into retirement and so in the US demographics, I can't remember the exact numbers, but do account for a reasonably large chunk of that decline in the participation rate. It's also true here. But there's both, to your point, there's been a decently large cyclical element as well as that sort of structural demographic element.

In the US though the general assessment is that that cyclical element has mostly passed and mostly what you're looking at now is a sort of structural demographic element. Here it's probably still a bit of combination of the two but that said, we've seen the measured participation rate in Australia actually tick up quite a bit over the last few months. Not quite back to where it was a few years ago, but it's not so far below it now.

Let me ask one while people are thinking about their options. The Bank obviously monitors carefully what's happening in Asia. I think there's a contradiction between the animal spirit story and the opportunities that I see when working with the University and visiting our research partners talking to our partners about recruiting students. Now the prospects for growth remain strong in our region and in the US. Where does this contradiction come from between that circumstance and the way that people seem to be thinking about the research?

I don't know. That's a question a lot of people have asked and they haven't come up with a good answer. I think some chunk of it has got to do with the fallout from the crisis. That sort of left somewhat more permanent long lasting, not permanent, long lasting psychological scars. And to some extent if you want to use the sort of economic investment literature, there was a reward for waiting to see whether things get better and the financial crisis very much reinforced that. The option value of waiting went up a lot. And I don't think we've completely unwound that. Maybe we're getting to the point where that is starting to unwind.

And as I said in my talk earlier, there's a decent amount of self-fulfilingness to this. If you think things aren't going to be all that strong and you don't do stuff as a result, then lo and behold they aren't all that strong and the converse is also true. If you do think things are going to be strong, and you do a lot more investment spending then lo and behold the economy does turn out to be strong.

If you go back to page one of your first macroeconomics textbook, the circular flow of income does actually matter, which is another way of putting it. As you said, the opportunity, I don't think the lack of investment … there is an argument that Bob Gordon for instance puts out there and Larry Summers, the secular stagnation argument or variant of that, which is there aren't opportunities out there. I don't think I'm quite, I don't share that pessimism. I think as you're saying, there are the opportunities out there. People may be reluctant to take advantage of them even though the financing costs or whatever and the corporate balance sheets are actually very strong.

I personally don't think it's the absence of opportunities even though there are some who make that argument. I think it's as much just a long lingering effect of the financial crisis in terms of people's willingness to just wait a bit more rather than take that plunge.

One more to close.

Just when you talk about I guess the level of confidence and the animal instinct and that. What's your view or position about where the role of government plays in driving that sense of drive? I know they're meant to be facilitators and not the doers, but the way we have in our political environment doesn't leave a lot of confidence for business.

Being from the central bank, I am going to happily stay right away from that question. That can only go not well.

Good. Well thanks very much ladies and gentlemen. Don't applause yet. I'm going to invite Vince Pace the CFO from the People's Credit Union to come and give the word of thanks.

Thank you Christopher and good afternoon ladies and gentlemen. It's an absolute pleasure to have the opportunity to provide a vote of thanks today to Professor Christopher Findlay and Dr Guy Debelle. I'm sure I can speak for everyone here when I say how much we appreciate Guy returning to Adelaide to share some really candid insights into Australia's economy.

At People's Choice we know from talking with our members and that's one in five South Australians that it can be difficult to get an objective sense of how the economy is really faring and where the challenges and the opportunities lay. There are lots of commentators and there's certainly lots of agendas that need to be considered. So it is really refreshing interesting and educational to have someone of Guy's standing and calibre here with us to cut through a lot of the noise and to give us a deeper insight into our current economic reality. In his position Guy does have to walk a political tightrope but I certainly have benefited today from his expertise as I'm sure we've all in this room.

To Professor Christopher Findlay, thank you very much for your role today in introducing Guy and facilitating what I found to be a very spirited discussion. I know that many locals in the room here today as am I are very proud of the University of Adelaide, living in a city that can boast such a globally recognised and high calibre university that continues its longstanding success in producing absolutely outstanding graduates.

On behalf of CEDA and everyone here today, I'd like to genuinely thank both of you for your time and ask that you both step forward just to accept a small token of our appreciation. Ladies and gentlemen, if you'd please join me in thanking Professor Christopher Findlay and Dr Guy Debelle. Thank you.