Transcript of Question & Answer Session Household Debt, Housing Prices and Resilience

Governor Lowe, thank you for a thought-provoking address. Am I on? Very good.

Look, the Governor has agreed to take some questions. I’ll lead off with a few of my own, but I expect that while the Governor was speaking you’ve come up with a few questions of your own and we’re keen to hear them. If you wish to pose a question to the Governor, I’d ask that you raise your hand and we will get one of the young economists, people walking around with mics, to come to you. I’d ask that you wait until you have a microphone to ask your question so that the rest of the room can benefit from what you have to say. When asking a question, I’d invite you to state your name and organisation if applicable. Again, thank you for a thought-provoking address.

In a speech you delivered in Melbourne on 4 April, and again reiterated here today, you noted that from 2000 the supply of housing in Australia was not keeping pace with demand. You noted that the supply deficit was compounded by insufficient investment in transport infrastructure. What might be done to increase investment in transport infrastructure and for example, do you believe that the federal government should be providing loans to help kick-start infrastructural projects, the cost of which might later be recovered through value capture?

There are a lot of issues there. The point that I have made repeatedly is that the higher housing prices really come from higher land prices. We can’t do very much about that, but supply and demand does work. If you can increase the supply of well-located land, then the average price of residential land that goes into each house dwelling will be less. How do you increase the supply of well-located land? There are two things you can do. It’s kind of the location of jobs and transport. I think makes well-located land by being accessible to other parts of the city or wherever you live. I think the best housing policy is really a transport policy. How do we get the extra investment in transport? That’s kind of a related question to what you were asking. The governments can play an important role here. You’re seeing this in New South Wales with the government building both road and rail and it’s making a difference. I think over time it will help.

How the government finances that, that’s a matter for them, but there is the possibility of greater investment in public and private transport actually helping on housing price and I think it’s important. It’s probably the single best thing we can do. The supply deficit that you referred to is in the process of being corrected. As one of my graphs showed, the rate of home building now is at the highest rate in decades and it’s going to make a difference. How do finance the investment in transport, that’s a good question. I think in the end we’ll be better off if we can find a way of doing that.

Thank you. In my introduction I referred to your work at the Bank of International Settlements, specifically that with Claudio Borio and the relationship between low interest rates, market stability, and higher asset values. You drew on some of the macro prudential measures being used today, but I would say for how long is it sustainable to keep interest rates very low and rely on these measures to temper asset values?

The current measures are not designed to temper asset values, they’re designed to build resilience in the system. I think that can help provide some breathing space because of the adjustments on the supply side and some of the other things I’m talking about. I think we can look forward to a better balance in supply and demand in the housing market over the next few years. The various measures that are being undertaken APRA will help give us a bit of breathing space while that better balance is established. They’re not designed, as I said, to address the higher level of housing prices.

We have low interest rates in Australia for basically two reasons. One is global developments. We live in an interconnected world, world real interest rates are low. We have low interest rates in Australia as well. There’s nothing we can do really about that. The second reason we have low interest rates is that we’re coming off the biggest mining investment boom in more than a century. In a way it’s kind of remarkably been managed to digest the downside of that boom while still growing at kind of an average rate of 2.5 per cent. The low interest rates that actually help that. We’ve got low interest rates because of the unwinding of the mining investment boom and the global situation. I think that’s been appropriate if … Just imagine kind of a world in which interest rates were, let’s say, at 3.5, not 1.5 per cent. The exchange rate would be higher, there’d be fewer jobs in tourism, in education, in parts of manufacturing that are doing better now, wage growth would be weaker, inflation would be even lower, unemployment would be higher. So I think we’ve needed these low interest rates.

The financial stability considerations are a relevant issue here. Some central banks at the moment, faced with the configuration that we’ve been facing, would actually have had lower interest rates than we’ve got. Because if inflation’s a bit low, the unemployment rate’s a bit high. The standard inflation targeting regime would probably lead you to have lower interest rates than we have. I’ve said this probably a few times, some of my own staff argue that kind of continuously. My sense is though that with interest rates as low as they are they’re providing significant support to the economy that lower interest rates at the moment would risk increasing the imbalances in the system. That’s not say that we couldn’t reduce interest rates if we thought it was appropriate, but at the moment we haven’t. So the financial stability issues do affect the setting of interest rates but not kind of in any mechanical way. I hope that’s helpful.

No, that is helpful. Thank you so much. Look, I have more questions, but I’d like to see if anyone in the audience would like to ask a question. If you do have a question, please feel free to raise your hand. One moment. There’s a mic coming up from back here. Can you put your hand back up again? Thank you.

Governor Lowe, Tony Dennis from Morgans Financial. You mentioned in your speech about the difference between Sydney, Melbourne and the rest of Australia in terms of housing prices, et cetera. How does the RBA look at that dichotomy and when do you decide – you say that can help to smooth out, I guess it’s smoothed out on the bottom as you’ve just mentioned, but in terms of smoothing out, you know, maybe those bubbles on the top. How do you decide between those centres of the Australian universe and the vast rump of Australia what you should be doing with your policy?

Our policy is really decisions are really guided by the framework. Our flexible inflation targeting framework, trying to lever you an average rate of inflation for the country as a whole of 2-point-something over the next seven years, the term of my governorship. That’s our basically framework and we try and do that in a way that preserves economic stability and this is why these financial stability issues that I’ve talked about are a relevant consideration. We cannot smooth out housing price fluctuations nationally or even in particular markets. We take them into account, we try and understand what’s going on, understand the dynamics here in the Brisbane apartment market, we spend time doing that. That all kind of together makes the overall picture that we’re trying to respond to. But the decisions are really taken within this well-established framework for flexible medium-term inflation targeting set up with a strong emphasis on preserving economic and financial stability at the same time. We make judgments, not everyone agrees with the judgments, but we sit down every month and we make those judgments.

Right. Harriet?

Harriet Smith. I’m from QUT and also on the Economic Society Committee. As a young person with a large superannuation but no assets, what kind of effect do you think that will have on markets if they were to implement that idea that we can use our superannuation to put into our first home instead of the first home buyer’s grant, for example?

Well that’s highly politically contested at the moment, but I think I can make an analytical argument, which probably answers your question. You don’t address housing affordability by adding to demand. You address it by adding to supply. It’s the supply of dwellings and the supply of well-located land. That’s where the focus needs to be. Policies that increase demand will just be capitalised into the prices.

Right. Doug McTaggart?

Sorry, can I just add …

Sorry.

I mean I do understand the difficulty of young people getting into the housing market. One of the things that concerns me is that the higher housing prices reinforce the existing distribution of wealth within society because if you come from a wealthy family, you’ve got the bank of mum and dad that you may or may not be able to rely on. That’s fine for those children, kids who come from those families, but if you don’t come from such a family it’s much, much harder to get into the housing market than it once was. I think that’s a social problem. There’s nothing the Reserve Bank can do anything about, but I think it’s quite a significant issue. It affects the mobility within society and reinforces the existing distribution of wealth, which can’t be a good thing.

Governor, Doug McTaggart, independent. A great talk, very well-balanced and terrific positioning of where that market is. Can I ask you a somewhat different question? Tim spoke about the legacy of central banking in Australia has been terrific and I agree with that, but other central bankers around the world speak in the rhetoric of generating some inflation. Do you think that that’s what central banks around the world should be doing, and if they are, do you think they’re good enough to get the right level of inflation and have it stop, or can trying to generate inflation create even bigger problems?

I think the primary reason we have a low inflation around the world at the moment is low wage growth. I think western workers feel under threat. They feel under threat through technology or through globalisation. We all feel like there are more competitors out there, either from the robots or from the foreigners. When we feel like there are more competitors, we’re less inclined to put our hand up and ask for a bigger wage rise. I see evidence of this in Australia and our wage growth seems to be now at 2 per cent. Probably the first central bank governor to have said, "Well, it’d be good to have a bit more there." At the moment we’re stuck at 2%. You see this even in the US, Japan, Germany and in the UK, they’re all at full employment and wage growth is kind of gradually picking up. But it’s only very, very gradually because I think workers feel under threat.

So a number of central banks are trying to run their economy at quite a strong pace and hopefully that will lead to wage growth picking up and inflation rising. That would be a good outcome. Can that occur without the thing getting out of control? I think it can with some modest lift in wage growth and inflation, then that would be good. I don’t see any reason why workers would go from accepting quite modest wage increases to demanding very, very large wage increases. It could happen but I don’t think it’s the central scenario. If that starts happening with central banks we’ll tighten up a bit.

That’s what happened in the late 60s.

Yeah. It could. Because of the robots and the foreigners, we all feel like – and I don’t think that’s going to change. We’re all going to feel for quite some time there are more competitors out there, you know, competition’s good for us but none of us actually like it. It gives us less pricing power as well, we got feel under threat so kind of a bit more kind of a bit more subdued. I think many firms feel this as well, there are more competitors out there. The system is less inflation prone at the moment with that [audio cuts out 00:13:55]. I don’t know, we’ve got, as I said, four very big western countries now at full employment. Fortunately for us, we’ll get some kind of examples of how that plays out because we’re not at full employment yet.

I saw a question right over here in the corner and another one here and here.

James McCauley, Brisbane Grammar School. How influential is the demand for investment properties in driving up the housing prices?

It’s certainly a factor. The underlying reason is this kind of supply-demand situation. The population’s been growing strongly, we haven’t built enough houses, the transport hasn’t been enough. That’s the underlying reason. Once prices start going up and interest rates are low, investors think, well, what a great thing to do. Go and buy residential property, borrow the money, take some leverage and buy into an asset whose price is rising, and I do think in some markets, not everywhere, that has pushed prices up even more. One of the things that the prudential measures are designed to do is to try and take some of that amplification from the investor side out of the market. Whether the measures will be successful in doing that? I think that remains to be seen. But at least analytically that’s what I see we’re trying to do, is to try and take some of that amplification from investors out of the market while there’s better balance between supply and demand is being established. We’ll have to see how it plays out.

There was a question right here.

Hi. I’m Damien Lillicrap, QSuper. Question a bit like Doug’s about the philosophy of central banking. You mentioned in the talk about limiting credit growth to be largely in line with income growth. That was a philosophy that Volcker used to have and he’s a highly esteemed central banker. Greenspan, when he came in, broke that link and let credit growth run well ahead of income growth. From that, you had a lot of credit going towards the purchase of existing assets and arguably that sort of led to the tech bubble, the US housing bubble, and subsequent sort of corrections there. I guess the question is largely, would you agree that Greenspan’s relaxed that relationship too much?

I don’t really want to comment on US monetary policy. I want to make it clear that we’re not talking about a limit on credit growth. We don’t have a target for that. I think it would be inappropriate to do it. The point I was making is if the next few years credit growth and house price growth were no faster than income growth, I think that would be a good outcome. It’s not an objective of ours but that’s what, I think, success here would look like. Whether we can achieve that, I don’t know. We do need to pay attention to the financial side of the economy. We’ve got a flexible inflation target. We’ve never been a central bank that’s kind of saw the need to keep inflation in the 2 to 3 per cent band all the time. It’s very much about delivering a low average rate of inflation at a time.

I think by paying attention to the credit side we can deliver you the low average rate of inflation and produce a greater degree of stability than if we just put the blinkers on of the credit side. It’s not an objective. It’s kind of something we’ve got in our mind. It influences the decisions that we take each month.

I saw a question right over here.

Thank you. Dean Gannaway from Aurizon. My question’s unrelated to housing, but it’s more around the reference to low interest rates. A recent decision by the ACCC on regulated pricing applied long-term market expectation of inflation of 2.4 per cent to a 10 year risk re-rate of 2.12 per cent, thus implying a negative real long-term interest rate of -.28 per cent. So I’m just wondering what methods does the RBA use to estimate long-term inflation expectations and would the RBA’s own estimate produce a negative long-term negative interest rate?

My expectation is that the inflation rate, over the long term in Australia will average 2-point-something and probably close to 2.5 [per cent]. That’s what it’s done for the last 25 years. I and my board want to deliver that for you. I think kind of writing in a number that’s close to 2.5 per cent for long term inflation expectations is a very sensible thing to do. You can get estimates from the various bond markets. At the moment they’re a bit lower than that. We also track consumer inflation expectations but they tend to be fairly short-term. They’re low at the moment because inflation’s low. If you want an estimate for long-term inflation expectations, I would encourage you to write in 2.5 per cent. We’re trying to deliver that for you. That’s what we’re trying to do. You can make your own judgement whether we’ll do that or not. I don’t know. That’s what we’re trying to do.

Sorry. Janet Yellen, as a follow up to that question, Janet Yellen last month was talking about the neutral rate, so the rate at which monetary policy neither has a foot on the gas or has it off. Does the RBA do an estimate of the neutral rate, and if so, what would that …

Do we do an estimate? We talk a lot about it. We can come up with various numbers. Really, there’s not particular science to it. I think we can understand the factors that are at work. Lower productivity growth, if that’s the world we’re in, will deliver a lower real interest rate on average over time. Demographics can have an influence as well and attitudes to debt can have an influence as well. When people were happy to borrow a lot and increase their borrowing, they were spending with gay abandon and the economy was growing more strongly and you need a higher real interest rate to deal with that. In a world where people want to pay back debt, the real interest rate for a while is lower while they do that. Ultimately, it comes down to productivity growth. If you’re a productivity pessimist you think we’ll have lower real interest rates because they’ll be lower return on capital.

If you’re an optimist, which is, I tend to the optimistic perspective that we’ll find ways to invest in good projects that generate decent returns. That will allow savers to get decent returns, higher than they’ve got in the last decade. We talk about this a lot at the central bank. You can imagine with a couple of hundred economists they kind of like talking about these issues. In truth, no one can really come up with a very precise answer to the question.

Look, I think we may well have run out of time. Thank you all for your excellent questions and thanks to the Governor for your clear responses. The Governor and I are going to return to our seats and Brian Sheahan, the Executive Chairman of Morgans Financial Limited is going to come up and deliver a vote of thanks. After the vote of thanks, Julian Pearce, the Vice President of the Economic Society will briefly run through some of the Society’s future events. So thank you so very much.