Transcript of Question & Answer Session Buffers and Options

Thank you all and thank you very much for your talk earlier, a very thought provoking interesting thought and a good reminder about whilst there are uncertainties ahead there are certainly a lot of cause for optimism. We have got a great opportunity to ask some questions, so Phillip has kindly agreed to come back up and take a bit of Q&A so I’ll be asking everybody in the audience if they have any and please put up your hand and we’ll bring around a microphone. We’ve also got some coming through on live stream Phillip so I’m told they’re being censored so I hope they are. I’m just going to kick things off with a nice easy over arm one to get you in the mood and ask you the question that I’m sure you’ve been asked 50 times over the past week, but the impact of globally looking at BREXIT, looking at Trump in your position as Governor of the Reserve Bank how do you approach those great uncertainties and how do you make sure we’re positioned to deal with what’s coming, whatever that may be?

Well as you point out there are a lot of uncertainties there but as the Reserve Bank what we can do is I think draw attention to the issues and try to do that partly tonight and say one of the things that society can do to prepare for uncertainties is kind of to make sure that we build up these buffers and that gives us options no matter what happens in the world.

It is kind of interesting since the President Trump was elected. Seeing bond yields in the US rise 40 basis points the US dollars risen a little bit and the US equity market’s kind of up a little bit. And I think what people have focussed on is the fact that he’s amongst the various things … Sorry I’m not on here. Do you want me to swap over there?

I think people would rather hear you.

Let me give you the questions or they’ll be even censored more. So one of the things that people have focussed on that he’s said a lot of things but one of the things he has said is he’d increased spending on infrastructure and he would attempt to deregulate the system. And I’ve been attending the G20 meetings for the last 3 or 4 years and a constant theme of the G20 has been the need to increase spending on infrastructure and to do supply side reforms. So at least to date the markets have reared into some of the things that he has said that he’s going to do those things. So if that happens that would be good for the US economy.

I think what could be very, very bad is something that we need to watch very carefully but it’s not something the central bank can do anything about is a retreat from openness, because if that were to happen that would be very bad for the global economy, it would be very bad for us, Australia as for the more than 200 years has benefitted from openness we’ve kind of sold stuff to the world, gold and then wool and wheat and now minerals and that’s really the basis of much of the wealth that we currently enjoy. So if we saw a retreat from openness that would be costly for the US and it would be very costly for us. It’s not something the central bank can do anything about but it’s the things I worry about but that’s probably right at the top of the list and you can see in country after country there’s a political movement away from support for open trade, in goods and services and open movement of capital and I think that’s dangerous for the world and it’s particularly dangerous for us. So we like everyone else is watching, waiting to see what transpires in the US because it’s a bit hard to tell.

There was a question over.

Thank you Dr Lowe it’s Ben Potter from the Australian Financial Review. Little bit of a follow up really; the I was going to observe that central banks have been calling on governments to spend more freely on sound infrastructure projects for a long time and you mentioned that. What they are also concerned about is borrowing to fund ongoing recurrent expenditure or in the case of Mr Trump quite possibly large tax cuts and I wonder is that the downside of the program he’s outlined that you worry about that it could rattle bond markets and send yields even further up and bonds down and generally create more uncertainty?

Well yields have gone up, as I said 40 basis points in the US and that’s really been transmitted right around the world and part of its due to people expecting higher inflation than they previously were and if that’s what’s happening, to the extent that that’s sustained that’s a good thing. Because there was a concern in international policy community that lower inflation expectations were getting entrenched. So the movements in the US have reduced that risk a little bit so that’s good. And to the extent that stronger growth pushes up interest rates and pushes up bond yields that’s not bad for the global economy. So a bit more debt in the US I don’t see as particularly problematic as I said before what could be particularly problematic is a retreat from openness.

While we’re on global BREXIT did you want to make a comment on how … On what you see the impact of BREXIT may be.

Well again that’s another thing that’s very hard predict. I basically see the decision that the UK citizens made was a decision to make themselves poorer but have more control that’s a perfectly legitimate choice for the population to make. What implications that has for the global economy I’m not sure I think it really depends upon what happens in the rest of the Europe, because if the UK decides to be a little bit poorer well that’s not that’s not good for them but they get the control they want, it needn’t be damaging to the rest of us. What could be damaging for us if that was a pull in the thread of the European fabric and the whole European project came unstuck. My sense is that talking to my colleagues in Europe that that’s quite unlikely to occur and at least in some quarters there’s been doubling down to make sure that that fabric doesn’t get that that thread doesn’t get pulled too much and destroy the fabric; again I think it’s manageable.

Poorer and more control I think I saw that slogan in the UK debates that sorry.

Yes Bob Edgar Governor, you did mention I think at some part in your speech about the quantitative easing that concerns a lot of us in the people that worry about the financial system is this is an unparalleled expansion in liquidity by central banks and it’s - in stability sense it must be based on the concept of it will draw some sort of measured fashion this injection which increasingly seems to have run out of any oomph in terms of its intended impact. Not particularly an Australian question but global impact for Australia I mean how seriously can we take the fact that what can be sort of expected can also be contracted by central banks order and report for the inevitable consequence historically of this massive expansion of underlying liquidity.

Well it’s a very good question and just can I take one step back that the central banks that have essentially created electronic money to buy assets that’s really what we’re talking about so that’s supposed to …

It doesn’t work.

effect the economy in two ways, one it pushes up the price of the assets that you’ve purchased so it might push up the government securities and so the yield comes down or it might you now seeing in the UK now they’re buying corporate bonds and in Japan the Bank of Japan is buying ETFs so presuming that’s supposed to push up the stock market. So that’s part of the mechanism. And the other is that the money creation leads to banks having very large balances at the central bank, earning in most cases nothing and some cases zero. And that’s supposed to be stimulatory because the banks are supposed to say I can find an asset somewhere in the global economy that’s more attractive on a risk adjusted basis than leaving the money and the central bank earning zero. And as banks find things to do with all this extra money that’s supposed to stimulate the economy and my observation is that that that really hasn’t worked because the banks haven’t found better things to do with their money than leave it at the central bank and the lower interest rates on bonds haven’t really stimulated very much demand in the economy. So it’s been relatively ineffective, not completely ineffective but relative ineffective.

And your question is what happens when all this ends and if the central banks start selling the assets and forcing the prices down all this extra liquidity sitting in central banks starts to be removed. I’m not particularly concerned about that because the central banks can lock up that liquidity that’s sitting on their balance sheets they can require through various ways banks to actually hold higher balances at the central banks so there’s not while there might be a lot of liquidity there it needn’t be free liquidity it could be kind of tied up through kind of various requirements.

And I don’t think central, in the unwind process the central banks I don’t think are going to start selling on mass the assets that they’ve purchased and they would only do that if the economy could sustain those asset sales. So I think the unwind is not – it’s not really a problem I don’t see that kind of as problematic that the thing that’s taken up most attention the discussions I’ve been involved in is going to be effectiveness of these two channels they’ve talked about why it is that the lower interest rates aren’t stimulating spending around the world and why financial institutions but in some cases billions and billions of dollars sitting at the central bank earning zero can’t find something better to do with it.

Dr Lowe Michael Heath from Bloomberg; you mentioned in your last speech and again tonight that you’re – one of your greatest fears is the rise of protectionism presumably we’ve gone further into that now, what are the implications for Australia if we wind up with 45 per cent tariffs being slapped on Chinese exports to the US and some sort of trade war begins to unfold?

Well I don’t want to speculate all the ramifications on them, my short answer is it would not be good for us. It would not be good for the world because one could imagine if those type of tariffs got put on Chinese goods by the United States then there would be some response by China as well which would not be good for the US economy or the Chinese economy and by extension it wouldn’t be good for us. So I hope that wiser heads will prevail here we as an open trading country it’s really built our wealth on international trade and open capital markets but for 200 years Australia has been an importer of capital, almost every year for the last 200 years we’ve invested more in this country than we’ve saved, and we’ve built up our capital stock. The only way that we’ve been able to do that is to have capital flow to Australia withdrawn on savings elsewhere in the world, so we’ve built this fabulous country partly on domestic savings but also partly on foreign savings and being able to sell kind of the natural resources and the kind of the manmade things we can make here with our talents.

We’ve made our wealth by selling it to the world and by borrowing money from the rest of the world to build the assets that have allows us to do that. So anything that threatens that is a huge threat to our economy. So I hope that in the end wiser heads will prevail here.

The recent minutes reflect that there was a discussion about the China slowdown I wonder if you wanted to share your views on the China economy more broadly.

Well recently the Chinese data have been a bit better than earlier. Two things have happened, one is the central government, the provincial governments are spending more on infrastructure and that’s made a difference. And the housing markets have strengthened as well, so there’s a bit more housing construction and the housing prices are rising. So that’s good for the short run. It’s been good for the iron ore price, it’s been good for the steel price, some cut backs in supply of iron ore production in China have also helped, so that’s good. The issue is at what cost does the pickup in short term growth come with? Because the fundamental issue in China or the fundamental risk is the very high levels of debt that have been run up and really over the course of this year they have not addressed that in fact the debt problems have got better, sorry have got worse rather than better. The benefit we’ve got is stronger short term growth but at what cost? No one really knows how that’s ultimately going to play out but as things have transpired this year it’s been good for us and as I said in my remarks the terms of trade are up really it’s the first time in four years we’ve seen them and that’s going to be good for us in the short run.

And positively that what we’ve seen in China is the … A significant cut back in excess capacity in coal production and iron ore production. Because when the iron ore price fell so far and the coal price fell so far one of the reasons that occurred is that the Chinese continued to supply a lot in the market even loss making production and many people including us were surprised that the cut back in production in China didn’t occur more quickly but it is no occurring, and I think that’s a positive sign because it pushes up commodity prices but it also suggests the Chinese are addressing over capacity in some industries which in the long run must be good.

Got a question from this side.

Campbell Rose from Vic Track; Philip thank you for your presentation. A different question from a different angle, what’s the Reserve Bank’s view on central banks and in particular the Australian Reserve Bank on the advent of block chain technology?

What’s the view? Well we’re watching. I think maybe this is perhaps too simplistic, but the distributor ledger is really another form of database technology and the new database technology may transform the way that financial services are provided or it may not, I don’t know. You talk to some of the proponents of innovations and they have kind of fantastic stories how it could be transformational but at least to date they’ve not been really strong business cases put forward and implemented so it’s possible but watching. Another area the central banks are closely following is the possibility of some type of block chain technology leading to a digital currency to replace bank notes, so that’s something that we’re watching. Australia isn’t at the forefront of that some other countries have spent more effort thinking about that but again it’s something that we’re watching. So it’s perhaps transformational but maybe not.

Dr Lowe I’d be interested in your views on how you think the emerging market economies are placed to deal with the volatility that we’re about to I guess experience over the next period.

Well since it depends which emerging market countries we’ve talked about I mean Mexico their currency’s fallen by 10 per cent and their stock market’s down quite a long way and that’s really reverberated right through Central and South America. We’ve even seen … So that’s problematic. And we’ve seen in the last few days some of the Asian currencies fall by a reasonable amount and their equity market’s been quite weak and I think what that’s reflecting is the fears of a retreat from open free trade. How well are they prepared to deal with it? Reasonably well it’s not like the possibility of higher interest rates in the US and retreat free trade have come completely out of the blue, so these countries have had quite a lot of time to prepare for it. I remember back a year there was a lot of concern in emerging market countries about what would happen when the US first raised interest rates, they raised interest rates and the emerging markets kind of dealt with that reasonably well because they’d been able to prepare for it and you talk to my colleagues in a number of, particularly the South East Asian Central Banks they’ve spend a lot of time trying to prepare their system. But if we do see a generalised retreat from free trade it will be difficult for everybody I don’t think we can escape that.

Thank you Ross Jackson from Maddocks Lawyers Dr Lowe thank you for your presentation tonight. You spoke of our better than expected performance in adjusting to the end of the mining boom, here in Victoria of course we’ve seen the cessation of manufacturing at Ford, we have the cessation of manufacturing from Holden and Toyota, next year and obviously the closure of the Hazelwood Power Station. How effectively do you think our buffers are expected to perform in relation to those quite significant adjustments within the particularly Victorian and South Australian economies?

Well they’re obviously very significant events and very difficult for the communities involved but I would make the observation though despite that all happening the Victorian economy is doing reasonably well. Now the population growth for Victoria is 2 per cent, now people are moving to this state, to this city, Victoria’s I think got the fastest population growth in the country, it’s doing well in quite a number of areas of the economy including in education, so I’m confident that the system has enough adaptability that we can deal with structural changes like the one you have talked about. Now our economy has gone through huge adjustment in the past decade, we accommodated the biggest resources boom in a century, mining investment went from 2 per cent of GDP to 8 per cent of GDP haven’t seen anything really like that before. We didn’t blow ourselves up in the past when things like that happened we had wages blow out, prices went up too quickly, lending got out of control, didn’t happen and then on the down side we had huge decline in commodity prices, decline in mining investment is 80 per cent over and we’ve adjusted to that you now right through that period we’ve grown kind of average 3 per cent and the unemployment rate’s been five point something most of the time. So for whatever reason I think it’s really hard to be too specific but for whatever reasons our system has quite a degree of flexibility and I’m confident Victoria will see that as well. As difficulty as it is for the communities concerned but we have a lot of resilience.

You can’t be specific you say Phillip but you must have some sense of what it is that allows us to be resilient in the face of those shocks?

Monetary policy’s helped; the fact that we have the capability to lower interest rates the long way I think that’s played a decent, that’s played a fair role. The flexibility of the exchange rate’s very important. When the exchange rate was $1.05 or $1.08 against the US dollar I’d have people come to see me all the time complaining and I can understand why they were and they said if only you could get below a dollar we’d be okay. And then it was kind of if we could get below 90 cents it would be okay. And now we’re at kind of 75 cents and the firms that have survived that, that very high exchange rate, found efficiencies are now in many cases competitive and some of those firms here are right here in Victoria and doing kind of specialised value added manufacturing and it’s not employing as many people as cars but it’s happening and the exchange rates are a factor. And the other one is the flexibility in the labour market, there are certainly issues that need addressing in the labour market but aggregate wage flexibility has been a real asset to us.

It wasn’t that long ago where the standard wage increase in Australia was 4 per cent if you got less than 4 per cent you felt hard done by. And now the kind of the default wage increases is 2 per cent and in some businesses workers agreed to even smaller increases than that. And that ability of kind of a wage cost to adjust to the changing labour market’s been incredibly important in keeping people in jobs. So the flexibility of the labour market, the exchange rate and interest rates and the basic kind of dynamic nature of our economy and Victoria with a very strong population growth will help. The population growth is something that gets is under rate. Just think in Australia in five years’ time there will probably be 8 per cent more people, 8 or 9 per cent more people living in our country, so the pie’s getting bigger all the time. Compare that to Japan where in five years’ time there will be 3 per cent less people. So it’s one of our kind of fundamental advantages that the pie here is growing because of population growth and that creates a dynamism in the economy that the economies of North Asia and Europe do not have, it’s important.

It’s probably something we should talk more about. Is there any other questions from the floor? I can’t see. Yes thank you.

We need sunglasses up here.

I’m doing a budget at the moment, have you got your crystal ball, what is CPI doing in the next 12 months? It is so hard to pick and I’ve got all the banks together and I’ve divided it and multiplied it what’s your go for CPI next year?

Well it’s I don’t have a crystal ball here but it’s very similar to what it’s been in the last year and I hope it’s a little higher. Just kind of make a serious point here; now underlying inflation in Australia is 1½ per cent, so our medium term target’s 2½ per cent, so it’s – we’re a bit below where we would like to be. But because we have a flexible medium term target that’s okay and some of my colleagues in other central banks say well I’m away from the targets so I’ve got to keep kind of cranking the monetary stimulus machine to get inflation back as quickly to 2½ per cent as we possibly can, that has not been our perspective, but as long as we think that inflation will gradually get back to 2½ per cent it has not been worth the risk of just encouraging yet more borrowing through lower interest rates to get inflation back even more quickly. So I kind of digress really but the point is we hope inflation will be a bit higher and I think there are reasonably prospects that inflation will return to 2½ per cent in this country and really I want to do my best to convince everyone here that that’s what inflation’s going to average. Two point something, 2½ per cent we shouldn’t be worried that inflation’s going to get stuck at 1½ per cent in this country I think that’s very unlikely. My job is to give to the community an average rate of inflation two point something and yeah I hope over my seven years I’ll be able to do that.

But you won’t have to wait seven years for it.

Dr Lowe I’ve just got one more question sorry where are we. So Janet Yellan has talked about the benefits I guess of running a high pressure economy, what are your views on doing that to help get back to our inflation target?

Well I don’t really want to comment on kind of the argument for doing that in the US, I can probably explain to you kind of the what I see as the analytical argument for doing that and it really would rest on what’s going on in the labour market, because the thing that has surprised many of my peers around the world is that even though the unemployment rates are quite low wage increases are even lower than you would think. So we’ve got quite low unemployment rates but wages aren’t really responding to that and you’re not seeing wage growth pick up. So if you take the average unemployment rate in the US, Germany, Japan and the United Kingdom, it’s the lowest in 30 years. You wouldn’t, reading the press, you wouldn’t kind of understand that, but the wage increases are very low and we run models of what wage increases should be given the rate of unemployment and even in Australia the actual outcomes are less than the models and many other countries they feel that as well or they see that as well. And I think one of the reasons that that’s occurring is that workers in Western countries feel like they’ve got very little pricing power they worry about globalisation, they worry about technology, they feel uncertain after the financial crisis so they don’t really want to put their hand up and say look can I have a bigger wage rise, there are exceptions to that but this comes as a stylised characterisation. So the argument for a high pressure economy would be to re-energise people to feel like they’ve got market power and get inflation to return more quickly to the target. So that would be an analytical argument for running a high pressure economy to kind of re-energise the pricing power that both workers and businesses feel they don’t have. And many businesses that I talk to say well look we can’t really put our prices up because if we do there’s a competitor or we’ll lose market share to someone in China or India or somewhere else around the world, so people feel like they’ve got really good pricing power which makes for a depressed inflation environment and if you ran a high pressure economy you would re-energise the pricing power that would be the argument. There would be risks involved in that particularly on encouraging kind of borrowing and credit expansion and so you’ve got to trade off the benefits you get from a quicker return from inflation to target against the financial risks that you run from doing that.

Yes hi one more question. Governor Lowe thank you very much for your address this evening. I guess my question follows from Dr Bob Edgar’s question around global liquidity Andrew Tait from Westpac, you’ve covered the banking system, the fiscal arena and household balance sheets, you’ve mentioned buffers and options under each and various scenarios, I’m wondering what your observations are or what you are looking for as both the RBA Governor and as the RBA, in terms of what external shocks could come into our system that might simultaneously affect all three areas as that one in 25 year event?

Well I’ve got to be careful here because I don’t want to predict bad news. But the things that we worry about are kind of there are three kind of at the global level, there’s one about trade which I’ve spoken about that, the second would be something going badly wrong in China and if something were to go badly wrong which I think is unlikely it’s mainly around the problems of excess debt and that the high levels of debt in the corporate and state owned enterprise ultimately cause a financial meltdown somewhere in China and that causes problems for the Chinese economy and ultimately us, so that would be the second thing.

And the third one would be coming back to a question we talked about before is the European fabric starting to tear apart, the whole future of the Euro coming under a cloud, that would cause … That would be a much bigger deal than Britain kind of deciding to leave. So I think each of those things is quite unlikely. As I said on trade I think wiser heads will prevail, China’s got a demonstrated ability to manage its problems and in Europe the policy makers are doubling down onto whether they can convince the electorate to support the European project. So I think in each of those cases if something were to happen it could be quite bad for us but the probability is still low. And I think a final observation I’d make is it’s very hard to predict these where the shocks are going to come from, at the moment we can go … I can list these things I can probably list a few more for you but I don’t want to worry you, but the reality is it probably won’t be any of those there will be something else that happens somewhere in the world and this is why kind of tonight I wanted to draw attention to the kind of the importance of making sure that whatever the shock is we’ve got this kind of protective buffers that really have served us well for 25 years and in a number of areas they’re not as strong as they once were and we need to strengthen them again.