Transcript of Question & Answer Session Low Inflation in a World of Monetary Stimulus

The first question, how close are we to the point where the cash rate reductions are ineffective in stimulating demand and what options remain for the RBA in the event of another crisis?

There's a lot there. As I've tried to outline here, our judgement is that monetary policy is still working and still effective. It's working as I said, and you can see it clearly in the residential construction sector, it's having an effect on the exchange rate, it's having an effect on asset prices and at the margin I think it is helping boost consumption as well. So I don't think we're at the point where we'd conclude that monetary policy is not effective in supporting the economy, I think we're some way from that, which means that we do have scope to lower interest rates if we deem that that's appropriate.

What do you think is now fair value for the Australian dollar? (I'm just reading the question!)

It might surprise you that I'm not going to answer that with a number. We're much, much closer to it than we were any time over the past couple of years. I mean, remember against the US dollar we've come down nearly 30 cents since its peak, so that's a very large adjustment. And as I said in my remarks I think we can now see the effect of that on the economy. It's still I suspect too low, sorry too high, for where it needs to be given the overall state of the economy but it's certainly a lot, lot closer to whatever the right number is than it has been for the past three or four years.

I guess in the same vein, a terms of trade shock is best mitigated via currency adjustment. How does the RBA plan to foster a further fall in the $A dollar when so many other central banks are addressing their own demand shortfalls by pursuing policy that encourages weaker currencies?

Our intention has not been to foster a decline in the currency and I think this is actually quite an important point and many of my colleagues in other central banks have made the same point. What many central banks are doing are responding to weak domestic activity and subdued prospects for growth and the way that you respond to that is to ease monetary policy. One consequence of that is having a weaker currency than would otherwise have been the case. So many central banks have responded with easy monetary policy and put downward pressure on the currency but they have not responded to get their currency lower; it's part of the transmission mechanism. And so our intention is not to get the currency lower, our intention is to set the right level of monetary policy so that the economy grows on a sustainable basis and that inflation averages two and a half per cent. That's our objective, that's what we're trying to do.

As I said in my remarks I think where we are now is the currency is higher than it otherwise would have been because of the global monetary developments and we've got lower interest rates in response to that, and arguably it would be better if that configuration was slightly different. But I think it's a mistake to think what we've been trying to do is to have an objective of getting the currency lower. Our objective is strong growth of the domestic economy consistent with the inflation target.

Thank you. What tools on the macroprudential side would be most impactful to keep house prices in check?

I think we have to be realistic here, you know, the main objective I think of the macroprudential instruments – if you want to call them that – is to stop the current trends from accelerating and so we don't get into a cycle of ever rising prices, ever rising borrowing and declining lending standards. And I think what APRA has done there is very sensible, it's consistent with its supervisory – it's approach to supervision rather than regulation. It's basically trying to short circuit or reduce the possibility of one of these kind of cycles of declining lending standards and higher property prices developing. We've got to give some time for that to work its way through. I think it's too early to tell what effect it's going to have and APRA is looking very – I know it's looking very carefully at the lending portfolios of a number of institutions that are growing very quickly and it's entirely appropriate that it does that.

I think what other countries have found in this general area is you have kind of one round of this and then the system is very good at finding ways of getting money to the people who actually want to borrow. And in a sense it shouldn't be that surprising because we went through this in the 1970s. All the macroprudential instruments that are now in fashion, we had those in the 70s. We used to call it financial regulation, but we had most of them and ultimately they turned out not to be that successful and the system was liberalised.

The lesson that I take really from that is that these measures can work for a while, they can help and I think what APRA's done now will help at the margin, but we can't rely on these type of measures to control housing prices or ultimately control aggregate borrowing in the economy. If you want to control housing prices you've got to address supply, land supply and transport infrastructure. It's not APRA tinkering around with prudential instruments.

Should governments – I'm not sure how you're going to go – should governments with AAA credit ratings be taking advantage of that by borrowing more to spend on infrastructure, particularly transport?

Yeah that's a very interesting question. I think this is one of the reasons why being very disciplined on recurrent expenditure is incredibly important. If the budget is in such a situation that recurrent expenditure and revenue are in close alignment and you expect them to stay in close alignment, I think that does open up opportunities in the government balance sheet. The issue that many, many countries face at the moment is recurrent expenditure is greater than revenue and so that part of the budget is not in alignment, and I think you could make that point here. And one of the reasons why it would be better globally to have those two – recurrent expenditure and revenue – in alignment is that it would open up the possibility to use the government balance sheet to help support, in whatever way it could, infrastructure spending.

After all, you know, as I said in my remarks, governments around the world can borrow at negative – zero or negative rates for 10 years. There must be many investments in our societies that earn positive rates of return. So for an institution, a government entity with a strong balance sheet, there is the possibility to use that balance sheet to take advantage of those possibilities to improve infrastructure or whatever other capital works you think are appropriate. But I think you can only do that if the recurrent budget is in a sound shape and as the Governor has said, here, at the trajectory we're on probably isn't the right one there. And that if you're on the wrong trajectory on the recurrent expenditure with respect to recurrent revenue you don't have the same options to take advantage of lower interest rates that a different fiscal setting would allow.

Do the post GFC experiences around the world suggest that inflation targets have been set too low?

Well my answer to that is no, and I'm thinking what would be the logic to draw, how it would lead you to that conclusion. No, I don't. The important thing with the inflation targets is they anchor the community's inflation expectations and provide a sensible and sound way for the central bank to communicate with the public and with financial markets. So I think – and they've done that successfully and I don't know why having an inflation target of 5 per cent would make this process any more effective. But I'd be interested if someone wanted to make the case.

Immigration to Australia appears to have weakened notably over the past year, how does this affect the economy and policy?

I mean it's slowed down a little but I mean we've got to remember that our population growth is very strong. I mean you look at the population projections, the official population projections, and it looks highly probable that we will continue to have the fastest growing population in the OECD. If the current projections are correct, then in five years' time I think we'll have nearly 10 per cent more people living in this country, even with this current – so that's a position that no other western country is in. And this is one of the reasons that I kind of remain fundamentally positive about our prospects because this steady growth in the population opens up new opportunities for business and we'll have 10 per cent – in five years' time we'll have 10 per cent more people who need to live somewhere, work somewhere, play somewhere.

The other aspect of, you know, this is a related issue, is with our demographics. Our population is incredibly internationalised. You know 40 per cent of people who live in this country were either born overseas or have a parent who was born overseas. Again, no other western country has a number like that and many of those people were born in Asia or their parents were born in Asia. So there are tremendous connections between the Australian population and countries abroad and that opens up a whole set of business possibilities. So we've got a rapidly growing population, an internationalised population, we shouldn't forget that because I think it's one of our fundamental strengths.