Transcript of Question & Answer Session The State of the Economy

Let me start by saying thank you and it's a great pleasure to have the deputy governor.

It is actually very interesting to see that presentation of data, not least because of course Australia being not such a large country, we see and continue to see great diversity of data from one state to another which, is a conundrum in its own right because of course a Reserve Bank has to sort of deal with one economy as if it were a more homogeneous body, I suppose, that needs to be slowed down or accelerated. It must be somewhat of a frustration to have for instance the housing market being so different between Sydney and Melbourne and other cities because some of the things that you might want to do could actually affect negatively some areas and help others.

How do you deal with that?

So this question gets asked … it is … Really, the answer, the frame of the question very depends on which state I'm actually in.

From an Adelaide perspective …

So it's interesting because, if you go back five or six years ago everyone was complaining about WA going through the roof and NSW going through the floor. Today it's exactly the opposite way round.

But in the end we are one economy and so we have to take, we do look at, as you said, we aggregate it up and look at the national level. We're mindful of the fact that the different parts of the economy are growing at different speeds.

But how that translates actually, in the end, we just, I mean- we use our aggregate data to assess the aggregate picture. One thing, though, which is interesting. So, the divergence in unemployment rates between states at the moment is one of the lowest it's been in the country's history. So, I mentioned, so, in the early 90s, as some of you here may painfully be aware, the unemployment rate in South Australia was probably seven or eight percentage points higher than it was in other parts of the country.

So today the difference between the smallest, the lowest unemployment rate and the highest unemployment rate is no more than a couple of percentage points.

So yes, parts of the economy are growing at different speeds but actually divergence is a little less than it's been in the past, and in the end there are always different parts of the country growing at different speeds. You know sometimes the Adelaide Hills are growing faster than the Adelaide Plains.

Sometimes it's the opposite. But in the end we've got one policy tool which we use to address the aggregate outcome. There are other arms of government policy which can be more nuanced in addressing some of those differences across states, and indeed they do, but from our point of view, in the end, we're setting policy for the country as a whole. One of the ways, though, that we inform that assessment is to not just rely on the official data but actually make extensive use of our business liaison program in assessing what the different developments are in the different parts of the economy and that's a very important part of the way we come to our overall assessment of the economy.

Thank you. Now clearly that's been a very busy week with the general population being bombarded with information as the two would-be governments kind of launched large numbers and projects. I'm sure people here would have questions in relation to either the forecast or the type of investment that are considered without necessarily displaying your political preferences.

I will probably avoid commenting on particular government, in the circumstances, on particular people's policies right at the moment.

Indeed but it's interesting to see that the debate is so firmly grounded in economics and in forecasts than in in a belief, I suppose, that those levers can actually generate such a such a transformation of the economy. So I'll open the floor for questions. You've heard Guy say he will not actually provide any indication that indicates a political preference, but apart from that, any questions from the floor? Ah we've got one there.

Even though I work for an American company, I am Australian [inaudible], I was born and raised in Adelaide. I wanted to ask three questions.

That's greedy …

I wanted to come back to a nuance here, or basics of the market. In last week's statement there was obviously quite a reaction to the change in the wording of the last paragraph of the Governor's statement about setting monetary policy to support sustainable growth as opposed to would be consistent stated growth which had been the case that many meetings before. Are people reading too much into that? Was there a message behind it? What are they to make of it?

I think one of the things we were trying to highlight is what I was mostly talking about today, which is we've got this, we're just trying to get a handle on where exactly things are and are going in the economy and that's, and how that gets resolved. I mentioned three different ways of looking at things at the moment and that give you pretty deep- the divergence between those three at the moment is about as large as it gets, even though the divergence between the states is about as low as it gets and really what we're trying to resolve.

We've just got this tension between those and we just really need to see how that unfolds over the next little while to get a sense of where the economy is both at and where it's likely to go. And I suppose that's mostly what we're trying to highlight at the moment. That's really the sort of first order issue and first order consideration that we need to resolve basically.

The second one is, tax cuts and cash handouts in the budget. Are they significant enough to move the dial on household consumption? Is it too early to say, do you still think …?

It's neither. It's both too early - I mean, it's probably just not my position to say right at the moment.

There are signs, it seems, that the housing market is starting to stabilise now. Is that how you're reading it? And if so, presumably, you've had a good leg down, an orderly leg down in prices. It is stabilizing now and that's something you'd welcome and the system has worked to some extent. Is that how you're reading it and does that make a rate cut less likely?

I'm not going to answer the last part of that but let me talk. So it's interesting.

We haven't, pretty much, I said this last year and it still remains the case, we're in somewhat uncharted territory in this space in that most of the time when you have large price falls it's because the economy has fallen over.

That's both true here and round the world and they haven't, in fact as best as we've been told there are almost no examples where you've had a large decline in house prices in an environment where the economy has actually continued to go along at a decent pace and unemployment has remained low. But so far that's the way it's played out here and with any luck that's where we'll continue to play out here and we don't, and that's the way we expect it to continue to play out. I mean, I think what Michael's referring to is that we got some data this week that approvals for new mortgages actually ticked up in February after having come down a long way. Is that a sign that the housing market is maybe stabilised in New South Wales and Victoria? Not sure. I mean a few more months of that and I will probably be a little more confident in answering that question. But as you know so far things have unwound in those two states in particular in a reasonably orderly way. Whether that remains so remains to be seen. But then, as I said earlier, it's really one of the things we're paying a lot of attention to but- And so, partly because we don't have a lot of precedent to guide us here because we haven't had seen this sort of situation unfold of large house price declines in two states in an environment where the economy in those two states is actually pretty strong.

Thank you Guy. Do we have any other questions?

One down the front. Yes.

Microphone.

Thanks for that presentation Guy. It's Mike from FundsSA.

I've got a question more around policy and- Globally, interest rates are now very very low, been like that for very long time. And just the other day in the Fin Review there's talk about Modern Monetary Theory at the Reserve Bank. Are you guys worried about whether you've got enough policy flexibility to deal with the downturn were it to come. And this notion of working more closely with the, with fiscal policy and potentially, you know, printing a lot of money and so forth. Is that something that's been used in the past? Is that a policy lever that you guys might think at some point in the future where we had a negative downturn?

That's an interesting question. It's a question I hope I don't have to actually answer in practice and also it's not our expectation that we're going to get that point at the moment.

That is our expectation.

So we do think we have, our policy rate is one and a half percent. We think we can lower that. We can lower that.

We definitely can do that. The, and, have we … I said this again at the end of last year, we have looked at what other countries have done in terms of dealing with addressing the issue of providing more stimulus, when you sort of roughly have lowered interest rates as much as you can. We have looked at that and got some sense of how that might go. So we thought about that but with any luck that will stay as a thought and we won't actually have to answer that question in practice. As I said the expectation at the moment is, our expectation is that we will see decent growth in the economy, a further decline in unemployment and so we won't have to get to that point, but if we end up in that point unfortunately then we have given some thought as to how that might go.

Any other questions? Yes over there.

Thanks very much for your presentation Guy.

I'm just interested with the low interest rate environment expectation, forward looking expectations for returns are lowered. And I'd just be interested in the Reserve Bank's thinking around people that are investing vs. people that have debt, and how that dilemma plays out because I guess what we're seeing is if expectations for returns are lower people are looking at taking on more growth assets to assist them in getting the return that they're looking for. At the same time that introduces more risk into their portfolio. So they have more fluctuations in returns and, yeah, I'm just interested in the Reserve Bank's perspective on that.

So, we're well aware that that's part of the transmission that there …. And we've done a decent amount of work to look at, so another – I'll come to your precise question – but another question we often get asked, the governor gets plenty of correspondence on this one, is that when we lower rates that benefits people with debt but people who are self-funded retirees living on their bank deposits their rate of return goes down, so we get plenty of correspondence on that one. And so we have and that's true. Monetary policy has always had that, always has that effect. It's maybe more stark now than it might have been in the past. And in the end the economic analysis that we have says yes that's true, but the increased spending from the debtors outweighs the decreased spending for the creditors in aggregate, which is what we care about. I can understand if you're one or other of those you may have a different personal opinion as to whether that's a good or a bad thing. But anyway that is part of the overall aggregate transmission.

Your point about overall investments is right in that as rates have come down part of the transmission again is that people shift into, you know, into more equity or the like. And that is, that can be more volatile, but I think it turns out that over the past 12 months the best asset you could have been in actually is fixed income, notwithstanding how low rates are because they've gone down even lower.

But so, but nevertheless-

Yeah. That again is part of the transmission as it pushes people a bit further along the spectrum it's something we take into account. Our financial stability area spends a fair bit of time thinking and worrying about that. That's always been part of the transmission of monetary policy. Potentially, as I said, a bit more stark now with rates at such low levels. The other thing, though, I think, which people do tend to forget a bit, is that people generally think in nominal terms rather than in real terms. So yeah, rates, nominal rates are low but so is inflation. And so real rates of return haven't fallen necessarily as much as nominal rates of return and people, I think, have in the back of their mind that inflation is quite a bit higher than it is at the moment or their experience is based on a period where inflation was quite a bit higher and haven't quite recalibrated for the fact that, you know. Why are rates low? It's because inflation is low, which means real rates of return are actually, haven't come down as much as nominal rates of return.

Thank you. I'm very conscious of time so I will allow one more question, if there was one. There to the left, that would be the final question.

Thank you. Simon Evans, I'm with Financial Review. Guy, I just wanted to ask, a couple of weeks ago David Murray, who's a fair banking doyenne, raised the point at a seminar in Sydney that he was worried that there was a bit of a build up of systemic risk because perhaps there was too much illiquid assets that had built up in industry super funds. Do you have a view on that?

I don't think I'm going to get into a particular super fund's investment portfolios. One thing, and I don't think it matters too much which super fund we have looked at.

One thing we have talked about more, which has been noticeable more generally, is liquidity in many markets. It seems to be less than it has been in the past or historically. Part of that is expected as a result of changes in financial regulations by design . So if you look at a bunch of asset prices these days, be it illiquid investments or other things, there are a lot more … Actually, this is interesting. There's been some fairly large swings. If you actually look at actual volatility, actually most asset classes the moment volatility is actually at incredibly low levels, but then we have these periods. So we have these periods where volatility is low and then these big spikes every once in a while. And that's true right across, right across the board in terms of a whole bunch of asset classes, be it equity prices – if you think about what happened last December, some very large declines in equity prices in a very short period of time – that's been true in fixed income markets, it's been true in foreign exchange. So most of the time these days volatility is very low and then it's not for a short period of time with these big bursts and these large asset price movements. And so the market dynamics out there have changed quite a bit from where they were for quite a long period of time. And some of that, as I said, is by design and some of it again, we're trying to, us and people like us around the world are trying to get a better sense of it.

So that's another thing to think about in terms of your overall investment is that, is the liquidity in the markets that you're actually investing in and that has actually changed. It does appear to have changed in reasonably material ways. Most of the time it is something you don't have to worry about. In fact, liquidity in sort of normal times, for want of a better term, is arguably as good as it's ever been. But then we hit these liquidity air pockets – that's probably reasonable way of describing it – and then you get some pretty decent price movements in a short period of time.

Let me finish on one thing, though, which I think is interesting to keep perspective of, perspective on. So a lot of, while that's sort of generally true, if you go, and a lot of this is blamed on machines and the fact that there are much more machines who trade in markets than people these days. But I'll just finish with an anecdote about how it used to be back in the day in markets. So before there were a lot of machines there were much more people. You also used to get liquidity air pockets, which wasn't because the traders were going out for lunch. Well that may have contributed. But when there were large price movements back in the day, and particularly the foreign exchange market is the best example of this, you used to see liquidity dry up and the way that that used to happen back then was the traders just didn't answer the phone. And so they wouldn't give you a price. So you'd ring up for a price and they just wouldn't answer the phone. That was a liquidity pocket back in the day. Today it's the machine's turn themselves off and pull out of the market.

So it's a different manifestation and it's a lot faster than it used to be, but it, you know, people say ‘oh back in the day it used to be so much better in terms of liquidity’. Like, yeah, but you used to hit, they had these liquidity pockets back then, they just took a slightly different form. So machines have taken over in the trading space like they have in some other spaces and so the way it manifests itself is the same, sorry, is different but there are some decent similarities as well.

Thank you. And at the University we are preparing people for future where machines are some of the work and the humans will do some of the other works so it's not about the machines replacing the people. I'm sure you appreciated the candid and fullsome responses that Guy gave to your questions. Thank you to everyone for providing the question.

Please join me in thanking Guy for the presentation.