Transcript of Question & Answer Session How Are Households Placed for Interest Rate Increases?

Now, I'll start by asking the Deputy Governor a couple of questions and then we'll open it up to questions from the floor. There will be a couple of roving mikes moving around. So please signal for that roving mike, and then it will come to you and you can stand up and ask your question. But first I get my go. So, Michele, at the American Economic Association's annual convention this year … Raghuram Rajan, who was previously Chief Economist of the IMF, who forecast the financial crisis and then became the Governor of the Reserve Bank of India, talked about stable coins – and you previously spoke about stable coins at the FINSIA presentation – and he said they behaved … they were like 19th century American banks, unlicensed banks, unregulated banks, and that he forecast back in January that we would see runs on these stable coins; and, indeed, just like he'd forecast the financial crisis, he correctly forecast that. In your presentation to FINSIA, you said that these stable coins aren't big enough yet to cause a financial crisis. But what that says to me is that, as they get bigger, they'll have to be regulated like banks. So my question is: when do you think stable coins will get big enough that they'll have to be regulated like banks?

I won't forecast specifically when that would happen, but I might make a couple of comments on what I think is going to happen with stable coins. For those of you who are not familiar with the crypto universe, I'm sure the younger people in the audience are, we have crypto assets, I won't call them coins because they're not money, like Bitcoin, and the value fluctuates very broadly. Stable coins are supposed to have a stable link to something of value. It might be gold, it's most typically US dollars, there're a lot of US-dollar stable coins and the idea is that, if you deposit your money into that stable coin, you will get one US dollar in and you'll get one US dollar out, and it's supposed to work like that. That, in a sense, sounds like a deposit, it also sounds a little bit like some sort of stable money market fund. So, as we saw, they can be prone to runs. If people lose confidence and don't think that they're going to get their money back, it's every man and woman for themselves; everyone wants their money out. They're not so big at the moment that – they've certainly caused harm to people, people have lost a lot of money, so there is still concerns on a consumer protection perspective – but in terms of financial stability, not so much yet. And the main reason for that is that they're not big and they don't have substantial links yet to the standard financial system. But the regulators are onto this, and it's already been decreed in the United States that stable coins will have to be issued by banks, they will not be able to be issued by others, so people will have to be licensed to issue them. And organisations like the Financial Stability Board, the Basel Committee on Banking Supervision, the BIS Committee on Payments and Market Infrastructures, they are all looking at how you might regulate stable coins as they get bigger because they start to look more like deposits. So I can't tell you when they'll be big enough to have that, but I can tell you now the regulatory machinery is moving and I fully expect that in the next couple of years, you will start to see regulatory regimes for stable coins.

Usually your predecessors have always told me that at about this point they anticipate that I'm going to ask the interest rate question … but I'm not, I'm not. Since everybody else asks about interest rates, I'm going to ask about quantitative tightening instead. There're studies being done by the Federal Reserve and I think there're some Australian work too but certainly US work, which estimates that the effect of quantitative tightening is pretty small, it's only, like, you know, quarter of one per cent. But it seems to me that what's happening, both with the Federal Reserve and even with the RBA, that both of these central banks are running down a really big stock of debt which is equal to a number of percentage of GDP. I did some stuff on … I looked at what's happening in the US, and the total of their sovereign debt and asset-backed securities is running down by 4.6 per cent of GDP every year. Well, that's a lot. That's a lot bigger than a quarter of one per cent, so surely the effect must be bigger than 25 basis points.

We've done some of our own estimates on what we think the impact of quantitative easing was, and they're not far off the 25 basis points, 30 basis points for the $200 billion of quantitative easing that we were doing … I don't think we have any reason to believe that it would be any different on the way up. Recall though that when we were doing quantitative easing, we had no room to move on the interest rate, it was at the effective lower bound. On the way up, we're not limited by the effective upper bound, we can increase interest rates to the extent we need to. So that's my way of saying that quantitative tightening would have some impact, but it would be relatively marginal … The interest rate is the main monetary policy tool and it's the one that will have the most impact … The way that we have described what we'll be doing is just letting our bonds run off as they mature, so there will be a gradual tightening, if you like, as the balance sheet runs down. But I don't think we have any reason to expect that that is going to be anything more than marginal to the effect of interest rate rises.

So that's my two questions. Are there any questions from the floor? Okay. So if the microphones could move around to those putting up their hands?

Thanks for your time this afternoon, Ms Bullock. I have two questions. Firstly, we're entering a phase of monetary policy tightening, it seems clear. Do you see wages rising over the near term and, if so, how helpful do you think that will be in cushioning the impact of the anticipated tightening, referencing your point though that much debt is in high-income household?

We are observing that wages are starting to rise a little more quickly. For those of you who study the Reserve Bank, you might recall that, prior to the pandemic, the Governor had expressed the view that, if we were to have inflation permanently and convincingly within the target band, it required wage rises to be a bit more than they currently were. They were running at about 2½ -- 2¼ per cent and I think the rough rule of thumb is, if we've got productivity of about one per cent, wages should be able to rise by about 3½ per cent and inflation should be about in the band. So, at the moment, we are seeing some rise in wages and that's not unexpected, because we have a very tight labour market, and that's what happens when demand for labour is outstripping supply of labour. So I expect that we will be seeing some of that.

I'd like the microphone, as I currently have a second one.

Okay. Who has the microphone now, could they stand up, please?

Actually, I was given it back.

Thank you.

Is it possible that one of the drivers of the current low levels of unemployment resides in the fact that people, during the pandemic perhaps, became capable of living on, say, 15, 20 hours a week, meeting their costs of living and so on? And so my question is: how much underpinning the unemployment rate do you think might be actually a mask for idle capacity for labour here already in the economy i.e. before we open the international borders and could we see some relief to employers, if the cost of living was to rise and drive people back out into the labour market so that those unworked hours became worked hours?

It's an interesting thesis. I think the evidence though suggests that that's probably not what's happening. Full-time employment, for example, has risen by about seven per cent over the last year. We know that the unemployment rate is at a 50-year low. We know that the underemployment rate, so that adds in people who want more hours, is also at a reasonable low. It's a bit difficult looking at average hours worked because it's been all over the place lately, and it's all over the place because of the pandemic, people are off sick. There's still an elevated level of people that are not working because of sickness. So the data are taking a while to settle, but I'd say that the little bits of partial we've got suggest that that's probably not what's going on. What's going on is there's really strong demand for goods, there's really strong demand for services. People are out there post pandemic, enjoying themselves, at the same time as the borders have been shut, and there's just been a big demand for labour.

Table 9, was there someone on table 9 who wanted to ask a question? Yes, okay, it's coming over.

My question is I'm trying to understand why Australia's following relative to the rest of the world, US, Canada, New Zealand even, with their aggressive interest rate rises, when you've just explained to us that we've got a tight labour market, that we've got wage growth, and high inflation isn't really affecting how much the households can, I guess … what's the word … that they can meet the repayments, even with the increases in interest rates. So how much can our interest rate rises actually help battle this inflation, if we're not really that affected by it?

I wasn't meaning to give the impression that interest rate rises won't impact people. It'll impact people. It'll impact cash flows. To the extent that housing prices start to decline a bit, it'll affect people's feeling of wealth, and that sometimes impacts as well. So it'll have an impact. The point is, like every other country, we're coming off emergency or extraordinarily low interest rates in this country. Much, much lower than you would have in a normal, strong economy. And so at least the first task is to try and eliminate some of that monetary stimulus, so that's what we're trying to do. Demand for goods and services is above supply of goods and services, we've got to try and bring the demand back down. And interest rate rises will, as I've said, have an impact on people's cash flow, their consumption at the margin, and that's going to help bring those pressures down. So that's the mechanism through which we would typically see it work and other countries are doing similar because they've been in a similar position.

Any other questions?

Michele, thanks for your time and the presentation, it was very enlightening. I'm a young guy, so I haven't seen much history and so it's nice to get your opinion on things. It might be a simple and silly question, but is there a part of the RBA that wants to increase rates enough to give us a buffer, because there's whispers, obviously, of a downturn and a recession? How much buffer do you want to prepare for something like that?

No such thing as a silly question. Can I just clarify? I think what you mean is: Do we want to increase interest rates so that we have the ability to drop them again if we need to. Is that what you're …

That's right, yeah.

At the moment, we're at, as I've said, extraordinarily low interest rates, and we've got to get it up to some sort of concept of what you might call … We call it 'neutral', we call it the 'neutral interest rate', which means it's neither expansionary nor contractionary. We don't know where that particularly is, but we know it's a fair bit higher than where we currently are. So that's the main focus at the moment. The focus isn't so much, we've got to get them up in case we need to lower them again. And, in fact, in increasing them, we're just going to have to be alert to the many different complexities going on with household balance sheets, business balance sheets, in order to see the reactions and how inflation is going to respond. So … the answer is, we're probably not really focused on that at the moment. We're much more focused on thinking about how we get it up to a more neutral position.

What do you think that would be? I know that you said you're not sure where it is. Sorry, I know that you said you're not sure exactly where it is, but what do you think the neutral state should be?

Well, it's … This is the vexed question, and many countries have done a lot of work on trying to understand what this might be. Our last piece of published work on this was in 2017 and we estimated it. There's a wide range of estimates, but we thought it might be 'real rate' between, say, half a percentage point and 1½ percentage points, so somewhere in that range, that's quite a range. That's actually only the real component. The nominal interest rate that corresponds to that is going to depend on what inflation expectations are, and inflation expectations are very difficult to measure as well. So they're our most recent estimates for it but, again, it's really, really difficult. What we do know at the moment though is that we're probably well below.

Over there, that way.

Hi, and thanks very much for a very comprehensive presentation. I think it looks like a lot of stability there for the housing market and, of course, for financial stability. I guess there's a lot of young people in the room, and it does seem that, you know, house prices to income are very different to what they were 20 years ago and it's almost an inequality type question that's there. So I'm interested in your thoughts around that sort of inequality and maybe if there's any impacts there on financial stability.

It's a very valid question and I know it gets asked a lot. It's not in relation to financial stability so much. I think it is very much an inequality issue. One thing that happened during the pandemic, of course, was that first-home buyers, in fact, did come into the market quite a lot. I think it's not within the remit of the Bank, but a lot of the things that need to be looked at in terms of housing market, housing prices, relate to issues of supply as well as demand, and there's not much we can do about supply. Interest rates impact demand, but there's a whole plethora of things that impact supply, including government policies, planning, infrastructure, all these sorts of things. And I think possibly taxation, all these things are things that I think need to be thought about holistically, if as a society, we think that there are issues here for our first-home buyers.

Thank you, Michele. My question really relates to how people do respond and so on. And the view that the Reserve Bank has on the period of time that the people have not had any time to respond and their consumption has reduced dramatically, whereas we have looked forward and I would expect, over the next one year, most of that pent up demand will have been used up, dissipated. So, in accounting for that, how do you actually moderate your interest rate increases so that it comes out with a normally smooth run instead of a huge bump?

That, in fact, is the challenge, and I think the Governor has used the expression there's a 'narrow path' here. That's also why, as I've said, we're going to have to be looking at the data. We're going to have to be looking at what people are doing with their consumption, how it's impacting them in terms of their cash flow, their demand. You're right. It might be that once we get over this pent up hump, people pull back quite a lot, and that won't be good. And that sort of information is the sort of thing that's going to be relevant for us in considering how high and how fast interest rates have to rise, taking into account the point I made earlier that interest rates are so low at the moment that they had to come up from those extraordinarily low rates.

Could you just comment on just what's happening with energy? I'm sorry I'm just here.

Oh, there you are.

I'm just here. So you've got hundred-dollar oil and a reasonably low Aussie dollar, and the cost of everything, like building materials. I think 90 per cent of the cost is energy? How do you guys consider that when factoring your rate moves?

The energy issue isn't just an issue here. Clearly, it's an issue all around the world at the moment, and we all know the reasons for that. The way we would think about it is that a one-off jump in energy costs: yes, it contributes to inflation for that period. But, if they just stayed there or they come off a little bit, they're not contributing to inflation anymore directly. The question is, the longer it goes on, does it start to feed indirectly into, as you mentioned, the input costs? So, in thinking about our decisions, what we're trying to think about is the extent to which these energy price rises might start to result in changes in inflation psychology so that businesses are thinking: 'Well, prices are just going up and up and up,' and consumers are thinking: 'Prices are just going up and up and up.' If that psychology sets in, then that's of concern because that would mean that inflation will stay higher for longer. So at least the point of some early interest rate rises is to try and make sure that that psychology doesn't set in, that the one-off price rises to a large extent remain one-off price rises. And, at least at this stage, our expectations are that, going into next year, the inflation stimulus will start to come off, because energy prices hopefully won't rise anymore. They've had a big jump up and they've stabilised and maybe even come off a bit. But the point is … increases in interest rates to try and make sure the psychology doesn't get in there is going to be important.