Transcript of Question & Answer Session The Usual Transmission – Monetary Policy and Financial Conditions

So we've got time allocated for a number of questions, and knowing the normal FTA crowd, I'm going to advise that you give us some time for your questions to work through and Christopher's indicated that he's more than happy to work through whatever we throw forward this morning. So I'm going to just ask if you raise your hand, if you have a question. I might just kick us off, and I have a roving mic here. So if we can use this for asking the questions as we're recording the session and I'll just make sure this is working. Is that working? Great technology. So what I might do is if I can just bump up this here, Christopher, and I can use this mic a little bit. Do you know how to work that? Sorry.

So stubborn low inflation seems to have shifted the RBA's chief focus, what is it now? Unemployment, under-employment or inflation?

Well, we're not, as I said this a little while ago, we're certainly not unemployment rate targeters. We still are inflation targeters, but it's a dual mandate. So we care about inflation, we care about full employment. We care about the general welfare of the populace.

I think the thing we've been saying is that there's more spare capacity in the economy than perhaps had been appreciated. And there's a number of reasons for that. We've had very strong employment growth, which would normally eat into that, but we've also had a very substantial increase in the participation rate. That's fundamentally a good thing, but it means there's more spare capacity.

The other thing we've seen in recent months and around the time just prior to the board reducing rates in June, was a slight tick up in the unemployment rate, despite that strong employment growth. So the board's objective in reducing rates and providing a bit more stimulus is to try and help soak up a little bit more of that spare capacity. But the idea there is to try and spur on a bit more wage growth, and inflation in general and move us towards the target.

So if I could just add onto that question, because we seem to be sitting here in an environment where we've seen interest rates drop down, we see a real fear that interest rates might be going to drop down lower, and we come from an environment where six months ago, we thought, well hang on, we're moving along okay.

And now we're in an environment where we're worried about what's going to be coming next and we've got these global headwinds coming that we know are coming from, for instance, from the trade war and maybe some other things that we can't anticipate yet. Are we more fearful than we need to be at this point in time?

Well, I think that is the fundamental risk that collectively, particularly businesses, they're very concerned about these downside risks and the uncertain environment. And in that environment, they're naturally going to hold back on making large investments.

So they're hiring people, and that's not just true of Australia. That's true globally. Labour markets are relatively tight in many advanced economies. So businesses are hiring people but they're not undertaking really major investments as much as they otherwise would in an environment of that uncertainty, and certainly the trade dispute and the technology dispute, because it has more than just the trade dimension to it between China and the US, but that's broadening out to other economies. Korea and Japan are having a significant trade dispute at the moment. Those sort of things are potentially going to weigh on people's minds, and there is a risk that that does weigh on business investment. In fact, it has been already.

So I think the hope is two-fold. One, that some of these can be resolved or at least not get worse from here. And two, the additional support that looks like it's being provided by monetary policy will provide a bit of impetus globally. There are easier financial conditions globally that should help spur on a bit of demand.

Thank you. The Governor has recently spoke about the possibility of negative rates in Australia. I just really want to know what you think of the mechanics of that. So in particular, we've looked at our loan docs and most of them do have the BBSW float at zero. So in particular, will negative rates impact savers more than borrowers?

Well, let me start, so the general discussion has been about sort of unconventional monetary policies. Some people call that quantitative easing, but probably unconventional monetary policies is a broader term. That would include, and in some economies, has included negative rates. I should start by saying I think the need for such policies here is unlikely, but as the Governor said, certainly possible, and what we've been doing is studying that overseas experience and that's a very prudent thing for us to be doing.

Yet, it's true that some economies pursued very low or even negative rates. I'm not sure. I think one of the lessons though, that we've taken from the overseas experience, is that not all of those policies and not all of their dimensions are necessarily appropriate for Australia. I think it depends very much on your circumstances. Some of the more extreme policies were driven by a desire to really push along credit creation in a financial system that had totally gummed up where the banks were quite weak. So I think it depends very much on the circumstances and you'd want to tailor the package, and I think negative rates would be at the more extreme end of that.

I think it just, again, I'd emphasise it depends on the circumstances. The problem offshore, the concern if you like, of authorities offshore where rates have been quite negative is that that can really impinge on the banking system's profits. And if you impinge on the banking system's profits for too long, that impinges on their ability to provide credit and sort of for the reasons you suggest, banks haven't been willing to push negative rates through to their depositors for various reasons, including because if they're too negative for depositors, the depositors will just want to demand cash and take that home with them.

All right. So I think that's the concern with negative rates. But again, I'd emphasise that I think these things are unlikely, but possible and a key lesson is it depends very much on the circumstances we're facing.

You referred to risk-free rates, which in this context is the sovereign curve. In other comments, the risk-free rate refers to something else, which is the replacement of LIBOR. Could I caution against using the term risk-free rates for sovereign debt?

Of the four governments that you had up there, I'm going to call Europe the European, not Germany, credit rating. Only one of them is AAA, and the financial markets have all got material CDS spreads at 10 years. I think to kind of use the term risk-free when applied to sovereign debt is a misuse of the word, really, because the markets price a risk for everything and I think one of the problems of lower rates is people are taking more risk to imply something's risk-free when the financial markets clearly tell us it's not.

Well, I think that's a good issue. I just want to address it very briefly. It's worth reflecting on, because I think … I use it in terms of as about as risk-free as you can get, as low a risk as you can get. But there's a caveat and you mentioned a couple of examples, but it's risk-free for economies that have their own currency, right? It's very hard to default when you have your own currency.

It's possible to default, more likely to default of course, if you don't have your own currency, which would be the case of some European economies, or if you've borrowed a lot in someone else's currency, right? And you can default on that. So think Latin America for example. But I think it's a reasonable point you raise, but I think even without high credit ratings, as high as they had been, some advanced economies that have their own currencies are still able to borrow at extremely low rates. There's very little concern about default, because you might be concerned about inflation, but not now, it would seem, because everywhere is experiencing very subdued inflation. But I take your point.

You've referred to the continued reduction of interest rates in the passing on of those cuts to both business and household. But I have two questions. Do you think that the fact that you have no longer the qualitative supervision of bank lending practises as such, because of APRA's involvement, which dictates what lending in a sense can be done.

And the second thing is that we have a significant dichotomy in interest rates that if you can't get money out of the banks, you're into the private non-bank market. And whereas banks, you might get money somewhere between 5 [per cent] and 8 [per cent] for SME in particular. But then in the private market you could be paying for working capital, anything between 15 [per cent] and 30 per cent, in which case, the Reserve Bank's ability to reduce rates is not getting passed on to the economy at large.

And more importantly, SME that is a significant part of business, is not able to sustain those sorts of rates for a long term. So perhaps you might care to comment.

Sure. I don't see it as an issue that the supervision is overseen by APRA, which is separate from the monetary authority. It's really not appropriate, I don't think, for them to be moving around their lending standards and their approach to that month to month, like a central bank with monetary policy. Of course, they have made some adjustments recently. That means at least for households they've eased some of the tightening there that was imposed by that cap of 7per cent that banks had to apply when judging someone's borrowing capacity.

I think you raise a good point in terms of this difference between different entities' access to those good rates that I suggested. Most concerning, and we've been noting this for some time, is the fact that large businesses are able to get access to good funding, whether it be through the bond market where issuance has picked up lately, or business credit growth, the usual channels at relatively favourable rates, considering the risks. It's a lot harder for small, medium enterprises to get access to that and indeed, credit or lending to a small businesses has really not picked up. If anything, it's actually dropped a bit in the past year or more.

One of the concerns there I think is just that banks are applying responsible lending obligations to businesses, many businesses as if they were households, so that's one concern. Another concern had been the fact that house prices had fallen and they're a key source of collateral for many of these businesses. So we would definitely acknowledge that it's something you have to watch closely and would have some concern about. It would be good to see a way through this, but I don't think it's easy.

Chris, I just wanted to ask you about the dollar. You had mentioned that the transmission mechanism is working because the dollar is depreciating, given the rate differential. Just wondering, I mean, we're sort of back to levels against the US dollar at least we last saw in 2009, when it was I think fairly uniformly agreed that we got quite good stimulus from that, that the structure of the economy's obviously changed since then. We had a car industry then, we probably had a bit more manufacturing. Are you likely to get the same growth stimulus from a depreciating currency now in a more services-orientated economy than you perhaps would have got 10 or 15 years ago?

Absolutely. We've got a slightly different configuration of both exporters and import competing industries, but I wouldn't think it's changed significantly in a way that would mean that the exchange rate wouldn't have a similar effect. The trade shares as a share of GDP imports or exports are of similar orders of magnitude, and education and tourism benefit just as much through depreciation in terms of their competitiveness as any other industries, which are no longer so prominent. So yeah, I think it's, it's going to have about the same sort of effect in terms of its stimulus.

Hi, Chris. As rates go to zero globally, and central banks struggle to lift inflation around the world, is there a possibility that inflation targeting disappears in the long term, perhaps in favour of something like GDP targeting instead, or another mechanism?

I wouldn't imagine it would be replaced by, let's say, nominal GDP targeting. I think the benefit of inflation targeting is it's pretty simple. It's pretty well understood by the public. I would emphasise that there are a number of advanced economies that are pretty close to their inflation targets. Canada is one, the US was there recently. They've had a soft patch in inflation of late, and the UK is another. There are others around.

I think it's a simple framework because it's focused on one measurable item. It tends not to be revised. Nominal GDP gets revised all the time. I think people on the street don't see it quite as a tangible thing as the prices that they're paying for goods and services. It's a more nebulous concept. It's harder to pin down, and it doesn't really address the issue that faced many economies during the time of the global financial crisis and thereafter, about the difficulty of running up against the effective lower bound.

So that problem is not about having an inflation target, and it's not going to be fixed by just saying, let's target something else, we'll target a different level of inflation. That's about your instrument, and looking for a new instrument. So I don't see that that is an argument against inflation targeting.

And can I just, just to carry on that question. Might come back to the discussion or the first question that we talked about is, you know, is therefore employment that better target because it gives you more of a broad impact across the whole economy in regard to GDP, which is really just focusing on that growth stimulus. So if we think in terms of how we think, where we are from a society point of view, I would have thought employment is that better measure to look at.

Well, as I said, we do have a mandate that is trying to pursue full employment. I think one of the tricky elements with that is knowing what full employment is, and indeed that has recently been an issue that we've spent quite a bit of time addressing. Structural changes in the economy can mean that NAIRU, the non-accelerating inflation rate of unemployment rate can move around. And it looks like that's been declining, not just here, but that seems to be a global phenomenon.

And so I don't think it's particularly helpful to spell out a particular target for such a variable. We'll know when we're there when we get wage growth and inflation consistent with the inflation target. So we're aiming for that point, but not as a target variable, and it certainly doesn't help anchor people's expectations. It's really helpful to anchor people's inflation expectations just as much as to stop inflation getting too high as well as to bring it up when it's a bit low.

We probably have time for maybe two or three more questions. Is that all right?

Sure, yeah.

We can keep going a little bit? Okay. So I think this one here and then we'll go …

Hi. In relation to the RBA's objective in targeting inflation, do you find the fiscal direction of the country to be helping, or more of a resisting factor?

Well, I think one thing that we've talked about at some length is the weakness in household consumption, and some of the reasons for that, low wage growth is part of the reason. Offsetting that we've had stronger employment growth and wage growth had been picking up. One thing though, that had been picking up by more, had been taxes paid by households. So their disposable income had not been growing by as much as you otherwise would expect and I think that had had some effect on consumption. So the fact that we've had tax cuts of late, I think that's a particularly helpful thing. And it's one of the positives I think you can point to in terms of the outlook. Lower interest rates, the tax cuts, we do have a lot more mining investment it would seem, coming along. There's lots of infrastructure investment. The housing market seems to have turned a bit of a corner, at least stabilised.

So all of those are positive elements. Broadly though, I think it's important to have, in terms of the recurrent fiscal budget, both at a state and at a federal level, to have some prudence there. And that prudence provides you options if things go really bad. For example, during the GFC, we had a lot more capacity here than others, and we still do. So I think it is important to have that discipline. But you can also still, as the Governor suggested, you can still build quite a bit of infrastructure by financing it in different ways that doesn't necessarily impinge on your budget position.

Chris, can I ask whether the RBA has got any concerns about the financial stability of the banking sector in a low interest rate environment? I ask this in the context that larger banks are more easily able to absorb low interest rate environments than say, smaller ADIs are.

Well, again, that's sort of moved to the need for unconventional policies. Very, very low rates, even negative rates. Unlikely, but possible. I'll start with that. And then again, I'll come back to the thing I mentioned before, which is that what we have done very carefully is study what's happened elsewhere and what they've done and the lesson for that is you very much want to take account of the structure of your financial system.

And an important element I think that you raise, is that smaller banks might be more impinged at lower rates than others because of their reliance on deposits, more so than say, wholesale markets. So I think it would be an important consideration you'd want to take into account if we found ourselves in those circumstances of needing some of those policies. Again, unlikely, but still possible.

Might have been one question at the very back, I think.

Hey, thanks Chris. My question is about the reaction function of markets, and in your speech, you mentioned notwithstanding expectations for global policy is in the Australian dollar is still low. There are expectations that other banks will lower. They haven't yet with Fed or ECB. How do you, I mean, you can't really ensure market reaction, but will that put pressure on the RBA to do something more drastic like the RBNZ did to make sure that policy transmission via Aussie dollar actually is as effective going forward as it is today?

Well, of course, market expectations should already be embedded in those long-term interest rates, and those yield curves that I showed you, and be behind what we've already seen. Having said that, if we came to pass that the Fed in reasonably short time did actually reduce rates by a hundred basis points, I suspect that may have some effects on exchange rates.

But in terms of financial conditions, I think even then you have to be a bit careful because that's providing easier global financial conditions. That's providing support to the global economy. So I think you can't just sort of say, well, they're cutting rates and the world remains as problematic as you might've thought it being at the start of that process.

The cutting of rate provides more stimulus and support for the global economy and so that's a positive thing. What it does for exchange rates, hard to know, because it should already be embedded in exchange rates. They should be forward looking and they should already know these low rates are embedded in the yield curve for the US, whether that comes to pass or not, I'm not sure. We'll have to wait and see. Thanks.

Right. If you can join me in thanking Christopher.

Thank you very much.