Transcript of Question & Answer Session Some Echoes of Melville

Thanks very much for that very comprehensive and compelling lecture and I'm sure there'll be a number of questions. We do have limited time, so could I ask you to keep the length of your questions down to a minimum so we can maximise the number of questions asked. There are microphones on both aisles and could you raise your hands if you have a question?

Good evening everyone. My short history is that I did a one year master of economics course at ANU in 1991. You know, reading ahead of tonight one of the anecdotes that I enjoyed was back in 1948, I think it was when Prime Minister Ben Chifley chose Nugget Coombs to be the next governor of the Commonwealth Bank, which then was the central bank. Nugget was kind enough to tell his friends that Melville actually was better qualified for the job. That sort of modesty is a nice touch, but I note that Nugget actually accepted the job and kept it for nearly 20 years.

Governor Lowe, thank you for your talk tonight. I've been touring with you a little bit recently. I attended your talks in Brisbane, in Adelaide and in Armidale, in May, June and September. On each of those occasions you seemed to signal fairly strongly that Reserve Bank was going to cut rates at its next board meeting. We're in Canberra tonight and there's a board meeting next week, should we be seeing signals of another move next week, or is the Reserve Bank moving into wait and see mode. And if the latter is the case, I wonder if you could talk about the role of house prices in the monetary policy process. You know, for a long time we were told that the sharply rising home prices were a bad thing and then falling home prices were a bad thing. In recent times there's been a sharp turnaround in home prices as the Reserve Bank cut rates. In fact, the five-city house price index is up three or four per cent, over the three or four months since you've started cutting rates. ANU grads know, that's a double digit annualised rate and it looks like home prices might go to new record highs, late next year. Is that a good thing or a bad thing, or is that just part of the transmission mechanism of monetary policy? Thank you

And well there are a few issues there. Today I was trying to steer clear of any signals about interest rates in the short-term and trying to provide some perspective about the longer-term factors that are really driving interest rate decisions around the world. And I think it's important that we keep those longer-term factors in mind.

As I said in my prepared remarks, the board is prepared to cut interest rates, if we think it's in the collective welfare of Australia and we'll have to make that judgement, as I said, every single meeting and we'll have another meeting next week where we have a discussion.

On housing prices, I think it's undeniable that that's part of the transmission of monetary policy. Lower interest rates do push up asset prices and higher asset prices are supposed to encourage more investment and there's a wealth effect and people spend a bit more. So, that is part of the transmission mechanism. Is it a problem? I don't think so. Could it become a problem? I think only if housing credit growth were to pick up a lot. Now at the moment credit growth is modest. Investor credit growth is still negative, so the outstanding credit owed by investors is still declining and credit growth to owner occupiers is only modest. So that's our main focus, is on what's going on with credit growth. Not with what's going on, the asset prices per se.

My question is about the effect that zero interest rates have on investment. This was Melville's second point that you spoke about. Now an investor doesn't just think about interest rates today, in the current year, for example. The investor has to think about what happens to interest rates in the future. So this point is about intertemporally, what happens to interest rates? We know that if interest rates are just zero today, this will not have a very large effect on investment at all from the basic markets. It all depends on expectations of what happens to interest rates in the future. I wonder whether you want to comment on that. The intertemporal aspect.

Well, I think that's true, but at least if you take the market's view, the markets are saying interest rates are going to stay low for a long period of time. And that's why in Europe 10 year interest rates are negative and the forward yield curve is negative for a very long period of time. I think it's quite possible that's the world we end up living in, where interest rates globally are going to be very low for a long period of time. Because the things that are driving global savings are not going to go away quickly. And unless there's a revitalisation of investment around the world, there's going to be this elevated appetite to save and not much desire to invest. So I think we're in for a protracted period of very low nominal interest rates and we've got to change the saving investment balance to change that.

Do interest rates affect investment in the short run? I agree with you, they don't have very much effect. But, lower interest rates, through giving people more money to spend and in a small open economy by affecting the exchange rate, should increase aggregate demand. And when aggregate demand picks up, firms need to invest more, so there's an indirect channel. But I also think there's another important channel and that's through lowering the hurdle rates of return. If you can invest and finance that investment at lower interest rates, that makes investments possible that were not feasible at higher interest rates. And as I said in my remarks, you see in country after country, businesses still requiring 13 to 14 per cent return on new physical capital. And the reason we have low growth and low interest rates is because those returns are not achievable in the world we live in. And many businesses I think need to make an adjustment to lower hurdle rates of return to go with the lower interest rates and that would help as well.

There's a report in the paper this morning that the Commonwealth Bank had said that only 7 per cent of mortgage holders actually reduced their mortgage payments after recent interest rate cuts. Is that number comparable to history or is it quite a low number? And if it is a low number, does it concern you and does it take away some of the veracity of monetary policy?

No, I don't have a time series on kind of the normal percentage of people who they cut their payments when interest rates go down. I think many people have borrowed a lot of money and their income growth is slow. It's not surprising when interest rates come down that they try and pay off the debt because the real value of their debt is not being eroded as quickly as it previously was, because their wages are not rising as quickly. So, they're having to make more of an effort to pay off the mortgages. Not everyone's in that case, but there seem to be a lot of people that are.

In the end, though, I don't think it affects the effectiveness of monetary policy. It may mean that the effect is a bit delayed, but if people pay off their mortgages a bit more quickly, their balance sheet gets to a position they're comfortable with more quickly than otherwise would have, and then they start spending. I think it's quite possible that it delays the transmission of monetary policy. I think people at ANU, no doubt, teach long and variable lags. And this is one of the reasons they teach long and variable lags because this adjustment can take longer or shorter in various episodes and we're probably in an episode where it's taking a bit longer. But I still think it works. It's just long and variable.

I thought this was an excellent speech by a central banker. And I was just wondering about what other people might say. So, when you think about savings for example, one of the things that is fairly obvious is that not everybody in the income distribution saves the same proportion of their income. And that some people are interested in the growing inequality of income. With the suggestion that it's "the poor" that would save in some sense, who would spend rather, but income is being redistributed away from them.

You can see debates about that both in terms of technology and in both in terms of what governments believe they should do with regard income taxes for example. So, income distribution obviously matters. Do you think it's a sort of fairly trivial or do you think it's a big factor in what's been going on with regard to savings rates?

In terms of global aggregate saving, I think …

In terms of Australia. In terms of Australia as well?

I think it no doubt has had an impact on people's saving decisions. And the income distribution really, it's kind of moved up and down, or the inequality has moved up and down. But in recent times, it hasn't really changed dramatically. So, I don't think you can argue that a big change in income distribution is driving saving outcomes in Australia.

What's more important is people are having to get used to slow growth in their nominal wages. In Australia, people used to have wage rises of 3.5 per cent or 4 per cent a year. That was the norm. Now, the norm for many people is two or two and a half and numbers starting with three, not many people can aspire to at the moment. As that's going on year after year after year, people are having to adjust down their expectations of their permanent income, and that's affecting their saving and investment decisions.

I think that's a much more important thing rather than the distribution of income. It's we're all having to get used to our wages going up, starting with a two. Which as I've said on other occasions, I think at ANU, I think that's too low because the inflation consistent rate of wage growth in Australia is close to three or three and a half. We wanted to deliver you an average rate of inflation of 2.5 per cent. And I hope we get at least 1 per cent labour productivity growth and workers get their normal share of that. So, two and a half plus one is three and a half. That's the inflation consistent rate of wage growth at the moment, we're at two, or two and a bit. I think that's the much bigger issue than income inequality.

Question at the back.

Thanks Dr Lowe, I'm an economist in the APS and a post-grad economics student here at the ANU. I was wondering what your thoughts were on Stanley Fischer's recent BlackRock paper on unconventional fiscal and monetary policy coordination. Noting that a lot of unorthodox ideas have sort of broken out into the mainstream over the last 12 months. It was actually just last month that Mario Draghi declared that the ECB governing council is actively examining unconventional policy, including so-called modern monetary theory. And Goldman Sachs, Chief Economist, Jan Hatzius has actually said back in April that without endorsing some of the more unconventional monetary ideas floating around, we think that proponents make a couple of points that are important and correct. Including the point that governments with their own currency and central banks like the United States and Japan, but unlike Greece face inflation constraints rather than solvency constraints on their fiscal policy. And that another major point being the private sector deficits tend to be more destabilising than public sector deficits under those criteria.

I was wondering what your thoughts and the Bank's thoughts were, now that there are central banks around the world that are seemingly paying a lot of attention to some ideas that have not had a lot of attention over the past few decades.

Just to make sure I've got the paper in mind as the one that was co-authored, both Stan Fischer and Phillip Hildebrand?

Yes.

I've read that very carefully. I think it's very interesting. Really, it boils down … I think what they're arguing is really boils down to its fiscal policies job. Because at some point the monetary policy can't stimulate the economy anymore and they say, well the fiscal authority can keep spending and it can be financed by the central bank at relatively low cost.

So, really they're arguing for more activist fiscal policy. There's a debate kind of in this country about whether that would be appropriate as well. I don't want to comment on it tonight. There's a deeper question they raise, kind of in some circumstances is there a case for coordinated monetary and fiscal policy to stimulate the economy? At least conceptually, I can think of circumstances where that would be appropriate. If the economy were in a very difficult place with a sharp rise in unemployment and little standard monetary policy options available, I could see there would be, in principle, circumstances where coordinated fiscal and monetary policy would help. We're a long way from those circumstances in Australia. So, it's really an issue of how much extra fiscal policy support we should get. Different people are going to have different views on that here.

I'm an undergraduate student staying economics. My question is cash rates are currently 0.75 but the big banks are charging between 3 per cent to 4 per cent on mortgages. Are you concerned by the level of competition in the banking sector?

Well, we'd all like to see more competition, wouldn't we? Probably, just a few facts are helpful here. We've lowered the cash rate by 75 basis points. The standard variable mortgage rate has come down by 60. So, 60 out of the 75 has been directly passed through. But what's happening every single day out there, and I encourage everyone in this room who's got a mortgage to be part of this is people are going to the banks and asking for a better deal. Many people are actually getting better deals.

So, the average mortgage rate has come down an extra five basis points in the last three months just because people are going and shopping and knocking on the door and saying, ‘If you don't give me a better deal, I'm going to go to another bank.' So, we're seeing people switching all the time. At the moment, the average rate on new mortgages is 30 basis points, 0.3 per cent below the average rate on standing mortgages. So, if you're prepared to shop around, there are actually good deals.

There is actually competition there. It's occurring for the new borrowers or the people who are prepared to switch. The people who are just prepared to stay with the same old bank all the time and not knock on the door are paying higher rates than they should and I encourage them to go and knock on the door. The best thing we can do for competition is for the people in this room and every other room around the country. If they're unhappy with their mortgage rate to go and ask for a better one, then the banks will have to respond.

A follow on from that question actually about competition. Why hasn't any of the lower interest rates washed through to other forms of consumer credit? We always talk about mortgages, but what about credit cards and other forms that people are acquiring debt?

Well, I don't really have a very good answer to that. Credit card interest rates are notoriously sticky. They don't move very much at all. I think the way that we get more competition here is actually people go and force the banks to compete by complaining and switching.

Is there a cartel attitude to anything but mortgages?

Well … Sorry, I didn't hear that. Credit card interest rates are sticky right around the world. They don't move very much. And there are kind of particular dynamics of the credit card market that kind of can lead to that outcome. But I don't really have a good answer to that. I'm sorry.

Hi. Thank you very much for a fascinating lecture. I'm an undergraduate student here at the ANU studying economics. And I just have a question in regarding how can the RBA continue to sort of foster investor confidence, particularly when lowering interest rates seems to be having more of a modest impact than perhaps anticipated? And also, taking into account that banks don't necessarily seem to be passing on the full interest rate cuts. Thank you.

Well, how can we foster confidence? So, I think by being transparent about the challenges we face and acting consistent with our mandate and explaining to people what we're doing and why are we doing it and how we're balancing the trade-offs. There's a lot of discussion about the kind of incomplete pass through. I remember I just said the 60 or 75 has been passed through. And if you take account of all the extra switching that's going on all the time, there's another five basis points. So, that's 65.

If you take my advice and go and ask for a better deal, I expect that over the next few months we'll see another about five basis points. So, I could imagine 70 to 75 will in the end we pass through, which you might say we should have 75. But 70 out of 75 is, from my perspective, is reasonable.

We also need to remember that monetary transmission isn't just about the mortgage rate. It gets a lot of media coverage and the politicians are obviously very interested in what happens to the mortgage rate. But that's only one interest rate in the economy. The rates that most businesses pay move with the cash rate. And people who are investing in Australian dollar securities and making national transfers aren't really worried about the mortgage rate. They're worried about wholesale rates and the Reserve Bank's cash rate. So, there's full kind of transmission on those channels.

So, I think broadly speaking, the transmission is working reasonably well. As I said in response to the other question, the lags are long and variable.

I think there's one at the back. I think we're going to make this one the last.

Oh, Depending on your time, I'm happy to take a few more.

You mentioned in your speech that low inflation creates a fertile ground for financial stability risks. Can you just flesh out those risks and how that works?

Well, in principle, as I said in response to Rory's question, lower interest rates can push up asset prices. We know in asset markets, that rising prices can take on a life of their own and we get kind of bubbles developing. I don't see a very high probability of that at the moment. Housing prices are going up, but I don't see it being particularly problematic. You could have a financial stability risk emerge if people started borrowing a lot again. If our income is only growing at 2 per cent on average per person a year, but borrowing starts rising much faster than that, I think we build up future vulnerabilities which could be difficult.

In Europe, there's a lot of concern about the effect of negative and low interest rates on the profitability of the banking sectors. In Europe, banks used to welcome having a lot of deposits on the balance sheet rather than having to go to wholesale funding, because deposits were cheaper than wholesale funding. But it's turning out now in Europe that deposits are an expensive form of funding. Because the deposit rate gets bounded at zero. So, banks are issuing securities in the wholesale market at negative interest rates and deposits have to pay zero. So, deposits are becoming a costly form of funding. So deposits are kind of becoming a liability now, which is kind of an unusual state of the world and things have tipped on their head.

So, that's causing stresses in the banking systems in Europe, particularly for banks that are largely deposit funding. Another issue that's arising in Europe is many citizens are concerned about the sustainability of their pension arrangements. In some countries, they've got pension funds earning negative returns, nominal pensions are having to be cut. Citizens are worrying that their pension might be cut and so, they're having to save more again.

The effect of negative interest rates is complicated, and pernicious in many ways. So, this is one reason I say it's extraordinarily unlikely we'll have negative interest rates in Australia. The evidence is mixed on whether it's been a success elsewhere.

Question here, and then that will be the last one, I think.

You've made reference to one of your predecessors Ian Macfarlane, and he is one of a number of economists who questioned the merits of any further interest rate cuts and he did that quite recently. In addition, David Bassanese writing in the Fin Review said he'd hate to see unemployment rate any higher than it is now. He went on to say that he is a part of a small but increasing number of analysts who think the official cash rate has already been cut too far, and even lower rates will probably hurt more than help in our longer-term economic challenges. Would you like to comment on those criticisms?

Well, I don't really want to run commentary on people who are commenting on me. I think what I can say, I feel confident the reductions in interest rates that we've had so far have made a positive effect. If we hadn't cut interest rates, think about where the currency would be. It would be, perhaps substantially higher and that would be bad for both achieving the inflation target and for lowering unemployment. The fact that interest rates are lower has put more money in the hands of people. Gradually, that gets spent maybe not as quickly as it used to be.

So, those channels are still working and I'm confident in the end we'll have more jobs and better income growth because of the cuts in interest rates. But as we move down further, I think the interest rate cuts are less effective. I would agree with that. I wouldn't agree with the fact that there's no positive benefit. I think we'd still get some benefit. And my board will have to judge whether that's appropriate in the circumstances we face.

Last one.

Thank you very much for a fascinating talk. Could you discuss to what extent underemployment and also employment uncertainty is a constraint on the effectiveness of monetary policy at the moment?

I don't think it's a constraint. It's certainly a factor that it's influencing the labour market outcomes. And as I said in response to an earlier question, the main challenge is to get wage growth up and have that consistent with inflation targets. So, we've had three years in a row of employment growth of 2.5 per cent. That's pretty strong. The population is only growing at 1.7 per cent. Population is growing at 1.7, labour force growing at 2.5 per cent. You would expect to get substantial inroads into the unemployment rate. But over the three years, unemployment rate's hardly moved anywhere. Because what's happening is we get more labour demand, you get more labour supply. So, the participation rate is rising very strongly. So, it's proving quite hard to create a tight labour market. So, wage growth isn't picking up.

The other element that you referenced is underemployment. There's quite a lot of underemployment. And that's affecting wage dynamics. The underemployment though is really part-time workers who want to work more hours. And the Bureau of Statistics asks people when they do the labour force survey, if you're a part-time worker, do you want to work more hours?

The vast bulk of part-time workers actually don't want to work more hours. They're quite happy working part-time and happy with their hours. But around 20 per cent of the people who work part-time want more hours. And on average they want two days extra a week. So, that acts as a kind of an extra pool of surplus labour. We're finding kind of labour supply is very flexible. So, labour is rising quickly. And of the people in the labour force, there are a group of them who want more hours. So, that's the issue we face. How do you create a tight labour market, particularly when supply is very flexible? And my board discusses that a lot.

Well, I think we'll finish up there. On behalf of the audience and also on behalf of the ANU, I want to thank Dr Lowe for a very stimulating lecture and for readily agreeing to answer questions, and so many questions at that. I want to thank Professor Martin Richardson. Thanks, Martin, for the work you've done organising this lecture, and also Michelle Burke too. Thanks Michelle. Just reminding you that refreshments are available outside out in the foyer there. So again, thank you very much. I nearly forgot, there's a packet of ANU souvenirs.

Thank you so much.