Transcript of Question & Answer Session The Reserve Bank's Policy Actions and Balance Sheet

Guy, you've kind of answered the first question I was going to ask, which was about how the reputation of the RBA or forward guidance contributed to, interacts with quantitative easing. Quantitative easing is sometimes called money printing. The announcement of quantitative easing in both of the US and Australia, has been followed by a dramatic rise in the money supply in both countries. Is this a result of quantitative easing or are people just holding money because they're so scared?

It's a result of both, not sure whether it's necessarily because they're scared, but it is partly a consequence of our actions. As I said earlier in my speech, when we buy government bonds that puts more deposits in the banking system, so that adds to the money supply. But also, as I said earlier, we've seen an increase in deposit holdings by both households and businesses. You can see that quite easily. In the business case, on the corporate side, some part of what happened was businesses drew down on their lines of credit and then turned around and stuck the money on deposit at the bank after having drawn that down. What we've seen over May and June is some of those deposits being unwound as they've repaid those lines of credit, but nevertheless, it's still higher than it was. And on the household sector side, we've seen an increase in deposits as well. And then finally in your neck of the woods, on the asset management space, we've seen a lot of super funds, asset managers and whatever hold more money on deposits because they need to meet calls on their liquidity as well. All of those things have contributed to that growth in deposits in the system.

My second question now goes back to that time before the pandemic. Before the pandemic, the RBA cash rate was 75 basis points. But even at that very low rate, the RBA seemed to be unable to get unemployment down to full employment of 4.5 per cent, or inflation up to its target of 2-3 per cent. Where do you think the nominal neutral rate of the Australian cash rate should be? Is it between 2 and 3 per cent or is it below 2 per cent?

I don't know at the moment. I think what we do know is it's come down over recent years, globally, this is, because of a decline in population growth and the slow rate of technological progress. I'm not quite sure where we are. I mean, those two things are still there, but there are some other, and sorry, and the ageing of the population, sorry, possibly even more importantly. So those factors are still around contributing to low neutral rates globally. What we have also seen is a very large increase in risk aversion at least for a time, which is also going to affect the neutral rate. It's a little hard to tell where it is at the moment. I'd be very surprised to think that it's gone up, or whether it's come down much further from its already pretty low levels, I'm not so sure.

Sorry I just had to get my microphone unmuted. I've been trawling through the questions online, which are coming through thick and fast, you'll be pleased with that, Guy. There's a number of questions about negative interest rates and the practicalities of those, so we have a question from David Tribe about the RBA's views on the practicalities of negative interest rates, if the current conditions should not improve quickly. I'm going to roll that in with another question from Isaac Gross. He says, alternatively, has the RBA considered setting the term funding facility rate below zero as the European Central Bank has? And would that be an alternative to encourage lending without threatening bank profitability in the same way that a negative cash rate might?

Yeah, they're both good questions. I mean, Phil has talked about negative interest rates over the last couple of months and we don't see in the current circumstances that there is a need for them. If I look at the experience offshore of some of the countries which have adopted negative interest rates, including the ECB, it's not entirely clear how effective they've been. In terms of the TFF rate, I think at the moment, there's not much issue with the supply of funding and it's as much an issue on the demand for funding. So the low level of growth in business lending is not because the cost of finance is too high it's because there's a huge amount of uncertainty about their future prospects and about the future outlook for the economy.That's the number one factor, which is restraining stuff. In all our liaison, no one brings up the cost of borrowing, which is at all time lows here, as a constraint on their willingness, on their appetite to borrow. The banking system at the moment is flush with funds and so they'd happily lend them, should they find someone who's willing to borrow them. It seems to me, it's the lack of appetite for borrowing at the moment, which is a function of the outlook for the economy, which is the really the main issue rather than the actual cost of funds.

I'm concerned about the economic outlook. You mentioned fiscal policy and we don't have particular concerns about fiscal sustainability when r (the interest rate) is less than g (the growth rate). Does that imply the Federal Government should be doing everything it can in terms of fiscal stimulus to get the economy moving and unemployment down and what does good stimulus look like?

The government is providing plenty of stimulus at the moment. There's been a very large expansion in fiscal policy. They're clearly considering that at the moment, as has been made clear by the Prime Minister and the Treasurer over recent days, so they're thinking about what the shape of that stimulus looks like going forward. We'll find out more about that in about three weeks' time or so, later in July. But they have been providing a sizeable amount of fiscal stimulus and they've made it clear that fiscal stimulus will continue in some form beyond here because it's needed to support the economy and I suppose we'll just find out more about that in a few weeks' time.

Do you have any particular concerns about the fiscal cliff when all those supports come off at the end of September?

If everything ceases at the end of September, then yes, that would be a problem. The government, again, the Treasurer and the Prime Minister, made it very clear in recent days that they are well aware of that, it's pretty obvious, and they are considering what they are going to do to address that. As I said, we'll find out more in a few weeks' time.

Okay, great. We've had questions about inflation expectations as well, and as I think you said, the risk is probably on the down side. A question from Matt Cowgill, given the inflation expectations are below the bottom of the Bank's target band, does that remain a concern for the bank and if so, what do you think can be done to bring expectations back up to target?

I'm not sure whether they're necessarily below. I mean, wage outcomes are at the lower end. If you're trying to get them off the bond market, that's not a particularly good read at the moment and it hasn't been for the last few months because of the dysfunction I talked about earlier. But inflation expectations have been on the low side, that's true. I mean the main thing we're trying to do is get stronger growth in the economy, that's the primary objective. How you get people back in jobs, to try and put some upward pressure on wages and prices, but the primary issue at the moment is the economy is operating a very, very long way below capacity. Until we can try and address that, that's going to be the main channel, to try and address low inflation expectations to try and get a much stronger economy going.

Okay. Thank you. Just a reminder. If you do want to ask questions, if you can just identify yourself, I can't see any specific media ones coming in at the moment. I had one flagged from [Lynn Linton] about asset prices. One of the keys to recovery out of this crisis and in the longer term will be increasing productivity and wage growth. But excruciatingly high asset prices have been acting as a massive drag on productivity since the GFC. This question is can't we just let asset values deflate?

Asset prices are what they are. I mean, our main objective is to get people in jobs and get the economy operating at full capacity. Asset prices are somewhat of an outcome of that. I mean, Australian share market at the moment is basically back to where it was in ‘07. Our stock market hasn't risen anywhere near as much as the US has. I mean, asset prices are an outcome. What we're trying to do is to get people employed and try and get consumer price inflation back up between 2 and 3 per cent.

Speaking of getting inflation back up the question from Gigi Foster from our New South Wales Committee, does the RBA see stagflation as a risk in the next year?

Well, probably in the – what quarter are we up to now? The June quarter, there was a very large drop in petrol prices and there was a very large drop in the way ABS is going to measure childcare prices because childcare was free. So those two things pretty much by themselves are going to give you potentially a negative outcome for the CPI in the June quarter, depending on what else was going on and the economy went backwards. So, you know, if what you mean by that is falling prices and the economy is going backwards well, we've probably had that in June. Going forward from here, we do expect the economy is going to pick up some, and some of those things are going to unwind. Petrol prices will come up a bit at some point, potentially you have to pay for childcare again. So there's going to be upward pressure on inflation. Sorry, stagflation, sorry. It's high inflation and low growth. I don't see that as being likely at the moment, as I said earlier, the more likely outcome is low inflation and a subdued economy. I really don't see much risk of high inflation coming from any source at the moment.

Thanks. Are there rules of thumb for the impact of rate cuts on growth? In other words, do you have some way to estimate the impact of unconventional monetary policy on GDP?

What we do have a reasonable handle on is the effect of lower borrowing rates on growth. We can partly calibrate the impact of the recent policy actions we've taken in terms of their impact on borrowing rates, which I went through earlier in the speech. A starting point to assess the impact of them is basically what we've seen in the past in terms of how the economy's responded to lower borrowing rates. One caveat around that potentially is what I talked about earlier, which is there may not be a particularly large appetite to borrow from the corporate sector or the household sector at the moment, which may diminish some of those impacts. But if we go through the various transmission channels of monetary policy, so think about lower borrowing rates, lower deposit rates, the impact on the exchange rate, then you could think about how they may or may not be working in the current circumstance and use that to estimate the impact of what's going on at the moment.

Fantastic. So we have a question on full employment from Phil, why are we pegging the full employment rate at 4.5 per cent. Does the recent experience in the US suggest that it might be lower? And where do you think it actually sits?

I don't know, Phil was asked this question a while back and I mean, the point, I suppose we'd make is that when we were getting closer to 4.5 per cent, it was conceivable that actually it could have been lower. We don't have a strong view on that. It's more a question of see what happens when we get there. So there's no hard and fast rule as to what full employment is. It's a function of the overall state of the economy. We've had a major disruption to the economy right now, which may have an impact on that as well, and we'll just have to see how that unfolds really.

Thank you. A question from Saul Eslake that goes to transparency of operations. He says, unless I'm looking in the wrong place, the RBA, unlike most other central banks, doesn't publish the amount of government bonds it is holding and it's weekly and monthly balance sheet publications.

Saul you are looking in the wrong place.

We have done so for ever and a day, actually. So you can you can look at the links in my speech. So if you haven't found them before now, just read the speech online and it will direct you to the parts of the website where we do publish this information.

Thanks a lot, well, that's a nice easy one to be able to clear up. A question from Jeff around liquidity and super funds, would the Australian financial system benefit from increased resilience to severe unanticipated shocks, particularly liquidity resilience, specifically by allowing access to public liquidity from the RBA by large super funds.

I suppose what I would say, which I tried to allude to. Over the last 10 years or so, there's been a change in the regulatory landscape, which has made the willingness and capacity of the banks to provide liquidity in markets. It's reduced that, and that's been well known and it shouldn't have been a surprise to anyone in particular when that started, you know, as things sort of turned volatile in March. However, it appears it was a surprise to people. The system actually turned out to be fairly resilient to all of that in the end, there were some concerns along the way, but you know, that that environment has changed in terms of the provision of liquidity by the global banking system.

And asset managers, in particular, have continually said that they've taken account of that and that their operations were resilient to such a shock. So, I mean, to some extent they were forewarned and to varying degrees, people took account of that. It's not a question that I think we'd necessarily be considering as to whether we need to be the liquidity provider of last resort to every financial market. There were some stresses there for a while, but in the end, you know, markets settled down and by and large people got through that okay.

A related question around financial system risks from Morgans Financial. He's worried about solvency issues as the lockdowns persist and the fact that we're seeing an increasing number of corporates filing for bankruptcy, are you concerned about by solvency issues and how it will flow through to the banking system?

Yeah, what we have done together with APRA and the banking system is run stress tests on the banking system to assess their resilience to the economy and to various scenarios for the economy. One point I would highlight is the banking system came into this globally, but particularly locally, came into this episode with a much higher level of capital than they did in ‘07/08. And so are much more resilient to a downturn in the economy now than they were then. So they have a reasonable capacity to absorb stuff. Interestingly, right at the moment, notwithstanding a few high-profile bankruptcies, the feedback we get from liquidators is they actually not seeing a lot of bankruptcies right now. They're expecting them to come, but as of today, they're not quite there.

And in fact, so much so that they're concerned that at the moment they don't have enough work, but they can see a very large chunk of work coming down the pipe. So we're not quite there, yet, but given the size of the downturn in the economy and the large hit corporate income across a number of sectors it's going to come. It will be the question of how resilient the corporate sector is going to be. One other point which is worth making is the corporate sector in Australia, came into this episode with a lot less leverage than corporate sectors in some other parts of the world, including the US, so leveraging the Australian corporate sector was not particularly high. In fact, it was at the lower end of recent experience coming into this episode. But nevertheless, what we and APRA are very mindful of is the potential impact of an increasing level of insolvencies in the period.

I think particularly as those government supports come off and the changes to the insolvency laws come off, you know, may see greater risk there. I have a question from one of our high school students online, Catherine Wang. She asks whether you think the inflation target between 2 and 3 per cent is still a suitable objective for monetary policy, considering that we've been outside the band for four years now. She asked, if we would be adjusting the inflation target or looking for other measures to quantify the success of monetary policy?

Ironically, just before the last reading we had on the CPI for the March quarter, inflation was actually just above 2 per cent, but, you know, that's got a bit lost in the wash.

Probably, on average it's been below for an extended period.

Yes, I know that. But as I said, things were looking okay on that front and then this came along, and now it's not. But I still think it remains appropriate as a medium-term objective for policy, getting the economy back towards full employment and inflation back between 2 and 3 per cent. I still think that is a worthwhile, medium term objective. I acknowledge that inflation has been a little bit below that for a few years on average, but I still think it serves as a reasonable guidepost for monetary policy. But a good question, nevertheless.

Indeed, in fact, I see so many high school students online and a great question from Catherine. A question about hysteresis, do you think that's a real phenomenon and do you think the fall in output that we've seen in recent months, is going to have flow on effects for potential output going forward?

Yeah. I mean, I talked about that at the end of my speech. I think, there's a reasonable amount of strong evidence for the presence of hysteresis. I mentioned Olivier Blanchard during my speech. The work that Olivier and Larry Summers did quite a few years ago now on hysteresis, I think, demonstrates it is a very, very real phenomenon with the scarring effects of unemployment. So yeah, absolutely. I think it's out there, it's a real phenomenon and something which is going to have an impact on the evolution of the economy going forward. That's basically how I finished, saying, this has been a major event in the economy. It is going to have long lasting effects. And hysteresis in terms of labour market outcomes is almost certainly going to be present. I would note though that, to some extent that it partly informs the policy decision around JobKeeper. If you maintain the attachment between a business and workers, then that potentially reduces some of that impact. It's still going to be there if there is no business but if it does come back, then that hopefully reduces the potential size of that. But yeah, it's definitely going to be an issue.

And we will have one final question before we wrap up it's Jonathan Shapiro from the AFR. He's asking if the RBA is concerned about the relative aggression of central banks in terms of considering policies such as negative interest rates and potential direct financing that they might create unhelpful, upward pressure on the currency.

Thanks, Jonathan. I mean, we have to be mindful of the actions that other central banks take because they have an influence on global financial conditions and they in turn have an influence on financial prices here including through the exchange rate. And so, yeah, that's something we certainly have to take account of as has always been the case. The only other thing I'd note is, you know, part of the difference in central bank actions, it's also a function of the difference in economic outcomes. And I mean, this is, you know, as I said earlier, we've had a really large drop in output, really large drop in hours worked, a very large rise in unemployment. Thankfully as bad as those outcomes have been, they've been better than they have been in some other parts of the world. So there is an issue of relativity in terms of what's happening in the economy, as well as central bank action. So all of those things play into our consideration of what we need to do here.

Thank you very much, Guy. I think we do have to draw it to a close now, but thank you for being so generous with your time and answering so many of those questions that came in. There were 60 there, so we didn't get to all of them, but I think we covered a fair chunk of ground. I think the RBA's actions are always incredibly important, but never more so than during a major economic event, like we're currently experiencing. It's just incredibly valuable to be able to hear from people out in the coalface about both what you're doing and the effectiveness of that. So with that, I will wrap up, thank all of you for tuning in, and I hope to see you in some of the future webinars