Transcript of Question & Answer Session The Business Cycle in Australia

Thank you Stephen and thank you for the glass half-full speech there, Dr Kent. My question is in relation to some points you made about consumption, household consumption. Globally, at the moment, we’ve seen a positive supply shock with respect to oil. US production is picking up, we’ve seen a price fall for a number of global oil metrics including the reference price for Australian petrol. If you look at the relationship between the Tapis price and the price for petrol in Australia, particularly unleaded I’m talking about here, it would suggest that there’s a further scope for petrol prices at the bowser to actually fall. I was just wondering if that was likely and we were likely to see sustained low prices, or relative low prices for oil, what’s the likelihood of a positive income shock that we can see to households that might actually support consumption growth?

Well I think that’s definitely on the cards, but not just for Australia, for any sort of major economy that imports a good degree of petroleum as we do, even though we produce some ourselves. I wouldn’t overstate its magnitude; I think it’s marginally helpful. Interestingly enough, some central banks that are worried about low inflation are worried about this, but I think that’s not necessarily the best way of thinking about it. I think as you suggested it’s a positive income; sorry, it’s positive for households’ disposable income, but I wouldn’t overstate it, I think it’s a marginal thing at this stage.

Considering the RBA still believes that the Australian dollar remains above its fundamental value, has the RBA ruled out currency intervention to push the Australian dollar lower?

No, I think the Governor’s been quite explicit that we haven’t ruled it out. And I think he was asked at a recent Parliamentary testimony under what conditions he would pursue it and I think he sensibly said ‘well that wouldn’t be a sensible thing to do’, to outline that because it would, by its nature, sort of lose its effectiveness. So we haven’t ruled it out, it’s still there as an option if needed.

I have a question about quantitative easing. Quantitative easing, at least in theory, would do two things. It would support the economic growth in the country in which it’s occurring, but it would also affect the exchange rate to possibly the detriment of Australia’s economic growth, so you have two opposing effects. One is our trading partner, maybe I should make it specific, so like the US. So quantitative easing increases, allegedly increases US economic growth, but it adversely affects our exchange rate. Has the Bank done any work on which of those two effects outweighs, in other words is quantitative easing helping or harming the Australian economy?

It’s an excellent question. My take on it is, you have to be careful and ask well what would we have without it and there’s much debate about how effective it is. But I think my assessment is, particularly for the US, is that the US economy, you know, after the global financial crisis needed a lot of support and this was one means of doing it given that they’d hit the lower bound on their policy rate. And I think you have to ask the question, well what sort of world would we have been in without that extra monetary stimulus? And if that’s a world that is a much weaker world then ultimately that’s not good for us. But as you suggested, at the same time it has, and I’ve noted in my speech, it has had this effect of, sort of, whatever they would have been possibly buoying their exchange rate, and the flip side of that is ours. Sorry, reducing their exchange rate and the flip of side of that is buoying ours somewhat.

So I think it’s sort of hard to say, because the real extreme question you have to consider is what would conditions have been like without very stimulatory monetary conditions? And I think there’s no debate that that was needed in the US, post-GFC. But it’s very welcome that we’re getting to a point where they’re no longer expanding their balance sheets, and we, the world, is looking forward to the time at which they can start, at least, to normalise rates, but that’s because the US economy is a stronger one and I think that’s good for us, that it has the additional benefit potentially of helping move exchange rates in a way that’s somewhat favourable, given we think ours is still, sort of, too high relative to our fundamentals.

Mr Kent, in regards to your wording about businesses not taking risk and also about easing monetary policy. Many supply side economists believe that, if we use the equation MV = C, there has been a lot of money printing, but there is no circulation of money as you seem to imply. And many supply side economists believe that the velocity of money, the circulation, to circulate, to generate growth, is a function of three major things which is, of course, the Laffer curve based on the income tax incentive, the round curve, which is the size of the economy as a percentage of GDP, government’s claim on it, and the cost benefit analysis of the regulatory environment to provide a rewarding environment for the money to circulate. Now, one of these can stop the velocity of money, which means there will be stagnation. My question is that isn’t the business cycle more of a, rather than underlying economic causes, is really the onerous influences of government on one or more of these economic fundamentals or tools and, if it is, what main tool do you think the government needs to use to get back to sustained, robust, economic growth? Thank you.

That’s a good question, but I think there’s sort of two parts. What central banks can do is when there’s spare capacity in the economy, when inflation is below target, they can and should do what they can to try and support stronger growth and ultimately lift inflation back to target. And that’s ostensibly what’s been happening globally. It’s just been more extreme in some countries because they’ve hit the zero lower bound for interest rates. But monetary policy has its limit and it cannot drive growth higher over the longer term. Over the longer term what it does is it can, sort of, anchor inflation appropriately around a target and that makes a good contribution, I think, to an economy including, because people can focus on the business of getting on with business rather than trying to avoid big swings in inflation or deal with big movements in interest rates, if you can manage that process relatively smoothly. So, then as you say I think in the longer term it’s really a structural issue, which is not the domain of central banks but I think it’s about trying to make sure we have things like good and high participation as much as we can. And, in terms of the labour market, encouraging productivity growth and the like. And, in the long run those sorts of things government can’t really drive, it can potentially get in the way of, but it can’t really drive. It tries to set the right environment and one of the environments is sort of, lots of good competition in product markets, reasonably flexible labour markets with the right sort of protections and safety nets in place. But it’s a big question for countries like Japan. What the Bank of Japan’s trying to do is lift inflation, but the Bank of Japan cannot drive growth higher in a sustainable and long-term basis in Japan. They have to look for this so-called third arrow, these structural reforms that they need to undertake.

We’ve seen quite a run up in house prices, although the data this week showed it’s really Sydney-centric. As the RBA is apparently looking at macroprudential measures, is there a risk that we move to the implementation of those relatively late in the cycle and possibly exacerbate a downswing, or at least a natural curbing of demand that would occur of its own accord (and hence policy becomes pro-cyclical rather than counter cyclical)?

Well I could say a couple of things. The starting point is, it’s not my area of expertise within the Bank, so I won’t say very much about it. Having said that, I think firstly what we’ve said is that we’re in discussion with APRA about this, it’s APRA that has the tools. And then the third thing is, look, it’s always possible in any field that you can make policy mistakes and timing is an important issue there, that’s a critical issue always for monetary policy as well. I think in this case what has been said quite clearly by APRA and others in the Bank who are expert on this is that the steps being considered are modest ones in a direction that’s already been taken, in gradually just tightening up lending conditions sufficiently and making sure lending standards are appropriately prudent, so these are fairly modest steps.

The labour force figures at the moment are, sort of, being mucked around a little bit and we’re sort of working through that. Are you taking the numbers at face value? You stuck the chart up there so you’re reasonably sure of them I would imagine. How much confidence do you have in them or do we need to wait for some more work to be done and obviously the seasonal reanalysis in January and February? Are we still going to be a little bit uncertain about this for another three or four months?

So, well there’s quite a lot in there. I think the picture that we get from something like the unemployment rate, so we step back from it, don’t worry about the latest wiggle in the latest few months, is broadly consistent with the picture of somewhat below-trend growth over the past period. And so if anything the, sort of, annual national accounts made that a bit clearer because the quarterly accounts were showing GDP growth growing at, or above, trend so I think what we have now from the annual national accounts and the generally subdued labour market conditions is a fairly consistent picture. In terms of the recent labour force statistics, I mean they have been quite difficult to read and the ABS has sort of struggled to generate a picture that sort of makes sense, I think, from the data. And what’s happened, I’ll try not to go into too much detail, but I think what’s happen is they’ve made some changes to the supplementary surveys which are integrated and added on in different months and they target slightly different sorts of issues. They’ve been making changes there to, sort of, broadly improve the quality of those things and one of the things they’ve been doing is changing them slightly and moving the months in which they occur. And it turns out that when you add one of these supplementary surveys into the standard labour force survey questions, it has a small but noticeable effect on people’s answers. And so what they’re trying to do is deal with a fact that some of those surveys have changed this year, having been very stable in terms of their timing and the nature over a number of years.

But one thing we’re always very cautious of at the Bank is not to read too much into one particular series, into one particular month. And there are other labour market indicators which I think paint a reasonably clear picture that conditions are subdued, but there are some indications that at least employment and the prospects for future employment have improved, including things like the various measures of job vacancies and job ads which have turned higher, they’re not particularly strong, but that’s positive and encouraging.

So the US, the UK and New Zealand are growing above-trend and unemployment is falling, yet inflation is not picking up much. So what I’m wondering is do you think that’s just a reflection that the upswing in those economies is still very immature and there’s still slack and so it’s going to take a while, so it’s just purely a question of the cycle not being mature enough yet to generate inflation? Or do you think that there’s some structural things happening as well which maybe we’re not sort of fully aware of at the moment which could be sort of dampening the inflation response to the above trend growth?

Well my sense, particularly of the US economy at least, for what it’s worth, is it’s probably a bit more cyclical but it’s been a cycle that is rather, it’s been a deep recession in the US that they’re coming out of. So in some sense it’s perhaps not surprising that it’s taking a while and there’s an active debate as I’m sure you know about what’s the right measure of slack in the US, is the unemployment rate sufficient, perhaps not, there are other elements of subdued conditions in the labour market that you need to account for and they’re not looking quite as promising as the unemployment rate has. So I think there’s that and then in addition and coming back to the first question, you know, where possibly commodity prices have come off, oil prices are sort of lower now, so maybe that’s being thrown into the mix as well. But those things are sort of reasonably positive things for those economies in the longer term and, you know, even right now they may keep headline inflation a bit lower. I think if you look at the US, the broadest measure of wages growth looks like it’s just picked up in the last couple of quarters and if you kept getting that sort of growth then that’s going to underpin stronger inflation and it’s move a little higher over the course of this year, not much more in recent months. And they’re not that far from, in the US at least, in terms of their preferred measure the PCE index of inflation, from the 2 per cent target that’s there for FOMC, so I think there’s reasonable prospects that in time they’ll be heading in that direction or become clearer to people.

Commodity prices as we all know have fallen a lot, in thinking about the business cycle, how much weight should we give to the flow through to the broader economy of lower commodity prices, and in particular how much weight should we give to the lower tax revenues and the lower revenues to states and the potential flow through to government expenditure?

It’s a good question, I mean it depends in part what they’re going to do in the near term in response to those pressures on their revenues and that’s not for me to say what they’re going to do, I mean. I think more broadly though, you know, it is going to have an effect that is going to weigh on growth. The trick at the moment though, particularly for iron ore is that it’s not a classic sort of weakening in commodity prices driven by a weaker demand. It’s finally a lot of supply coming on, on-stream, so there are big increases in volumes and so from that perspective it’s got to be less worrisome than otherwise. But it’s still going to weigh somewhat on the strength of activity in Australia and one of the mechanisms is through lower tax revenues and the like. But that’s where the movement in the exchange rate’s sort of important; it’s normally an automatic stabiliser, helping to offset those effects. We’ve seen a recent welcome decline, but it’s really only taken us back to the level we were at earlier this year, and yet commodity prices are much lower than they were then. Because the other beneficial thing of having lots of foreign investment in the resources sector generally is that some of those pressures are sent off shore to the extent that there’s slightly less profits than there otherwise would have been, foreigners bear some burden of that. So that’s kind of a positive thing in that regards.

You actually said in your speech and I’ve heard a few RBA people say this, that there’s a tightening of fiscal policy. But I think we’re finding that you know the amount of tightening the Federal Government wanted to put in place is not happening, well certainly not as quickly as they had planned. And if you look at state budgets, you know big boom in revenue from stamp duty, particularly here in NSW and Victoria, and with elections you know coming in the three larger states, I’m thinking there might be a bit of fiscal easing at the state level and particularly the infrastructure spending’s that planned in this state. So could we actually end up with a fiscal positive to the economy in the next year to two rather than the negative the RBA’s been expecting?

Well let me clarify, I wouldn’t call it, for the negative, I think what I have tried to say is, sort of, weigh on growth. There’s still in the national accounts, looking back over the past year, even though there’s been a degree of, you know, the budgets have a degree of fiscal consolidation at state and federal levels overall, there’s still been growth of public demand, so it’s still making a positive contribution, just much less than it’s long term average. So I think that’s the first thing. And then the second thing is yeah there’s significant variation, I think, across the states and maybe this is a bit relevant to Alan’s question with the fall in the iron ore price going to weigh more heavily in WA potentially, although shareholders who sit back in NSW and other states will also bear some burden of that.

But you’re right, it’s possible that the state governments, you know, those under less pressure feel less need for constraint in terms of the infrastructure that’s been talked about and on the books and I think that’s important that these things often take a while to get up a head of steam, so I think they’re sort of issues further out.

Thanks, the ABS produces measures of the capital stock which we can split into mining, non-mining and the mining capital stocks is obviously, I think it’s almost doubled in the past 10 years, so that’s sort of good news. But the history of the non-mining capital stock is that it’s at a very low point compared to the last 40 years, it’s actually been falling for quite some time. But it is an argument, at face value, to say that, you know, we should be getting some investment and you know we need to update our capital stock. Is there merit to this? I mean theoretically there’s merit to it, but in terms of the data that we get from the statistician is there merit to it and what are some of the issues about, sort of, using that sort of approach to, you know, looking for rationale for why non-mining investment should lift?

That’s an excellent question. I think there very much is so another way of thinking about the same sort of thing is, and I think I mentioned it when I gave a speech on non-mining investment in this same venue a few months ago, we’ve pushed out a little bit our forecasts over a period of time for the recovery in non-mining business investment. It seems like the conditions have been in place for a while, but it hasn’t been taking place. And you could ask the question, well if it’s, to the extent that it’s been delayed beyond where you might have thought it might have started lifting, how should I think about that in terms of it influencing my outlook from here? And I think the right way is, in time, it just means there’s more strength to, sort of, pull you up because it means if you’re not doing very much investment, it means you’re sort of falling further behind in terms of some sort of optimal or profitable level of the capital stock, and that’s my sense of what’s ahead of us, a strong cyclical recovery. To what level? it’s hard to know. When will it start? Anyone’s guess, but I think all the fundamental forces are in place and that’s what I was suggesting, that the fundamentals suggest that we’ve got a pickup in non-mining business investment ahead of us, but it’s very hard to know when that’s going to come about.

If you look at some of the measures that are available in some of the business surveys, the NAB one comes to mind because it’s come out recently and it’s got a long history, which makes it useful, but capacity utilisation is actually around average and it’s lifted over the course of the last year or so. Now it may be that it needs to move higher still before you get a big increase in business investment. The most recent readings, I wouldn’t overstate, it’s just sort of a few months, but the trend in actual investment the businesses report in that survey has been moving higher and the latest reading is above average. So I think there are reasonable prospects, but I think as you suggest it’s a cyclical recovery that we’re looking for here.

Chris, thanks for your speech. You mentioned the US and Japan and Europe a fair bit, but didn’t mention anything about China except in the context of Australia’s major trading partners. How concerned are you about whether it’s a cyclical slowdown in China, perhaps signalled by what’s going on in commodity prices that it’s not just a supply response or is it something more sinister about the banking system and property markets in China?

Well I wouldn’t use the word sinister. I mean, I think we flagged for a little while that there’s the weakness in the property market, the housing property market is something that is a source of uncertainty. We have to remember though that it’s the authorities that tried to bring about a slowing in their fairly rapid house price growth. It’s also the authorities that are trying to bring about a broader easing back in the growth rate of their, what they call total social financing, sort of a broad measure of credit in the economy. And their efforts to, sort of, bring those things about, which I think are good things in the longer term ultimately are paying fruit and the question is it’s very hard to manage though these sorts of cycles.

We’ve seen cycles in the property market before, this one’s a little bigger than those already to date, but they’re now taking off restrictions stopping a lot of purchases of property in many cities across China. They’re providing modest stimulus in some ways and those things will take a bit of time to play out, so I think it’s sort of watch and wait. Meanwhile, I think, as you suggested in your question, some of the weakness in iron ore prices has come in probably from the steel market being a bit weaker, linked into property and an easing in the growth. It’s not a decline, an easing in the growth rate of investment broadly in China which is fairly intensive in the use of steel and therefore iron ore. But they’re trying to manage a difficult transition to a more, sort of, sustainable pattern of growth both in terms of sort of environmental considerations, the financing considerations, shifting more growth towards consumption, which is ultimately a good thing. And I think the signs are that so far they’ve been doing a pretty good job of that, but it’s a slow and gradual transition. There are risks and we’re sort of attuned, watching those, but the China today growing at seven, you can have an argument about exactly what it is, but it’s seven and a bit percent, is a much stronger economy in many respects than one that was half the size but growing at less than twice that rate seven years ago. So I mean it’s still a very positive news story for Australia I think.