Transcript of Question & Answer Session Building on Strong Foundations

Hi my name’s Tim Perich from State Street. Just in regards to some of the things you said is the RBA concerned that there’s potential for asset price bubbles in Australia, in particular in the housing market and what sort of macro prudential policies have you considered or would be considering in terms of addressing that issue?

Thank you, there’s a lot there.

Easy one first.

I’m not going to duck the question, but I just want to start off by putting kind of this in a global context because I think what’s happening is you’ve got very low global interest rates and as I said people in most countries are being offered zero on their savings in bank accounts and they’re looking for other assets and its pushing up the price of the existing assets and that’s how the transmission mechanism is supposed to work. And we’ve got some of that in Australia I think the interest rates are low, they’re not as low as they are elsewhere but they are low and they’re encouraging people to buy other assets and that’s pushing up the price of those assets and housing is the most obvious example of that. And in a sense that’s really what we wanted to happen, we wanted the higher housing prices to make it more attractive for people to undertake new construction and by enlarge that’s happening, residential building investment’s up I think 8 per cent or 9 per cent last year and it’s going to be up almost again that much again next year. So that broadly is playing out as we expected and as we hoped.

I mean problem in many other countries that transmission mechanism from higher asset prices to higher real activity is not working. I think the issue that you highlight is whether that process is going too far, and that’s always a difficult judgement to make, our judgement so far has been that what’s happened there is broadly okay. The issue we are focussed on is the increased investor loans and particularly the investor loans that are interest only, that our sense is that as a whole those portfolios have become a little more risky, just because the ratio of house prices to income’s the top end of the range that it’s been, the momentum in the market has been strong. So we’ve highlighted that issue and said it’s appropriate to look at whether if you think this is more risky whether there are some actions, extra actions that could be taken. Probably just close with the observation, and I’ve made this before and I think the Governor has made it as well, that the issues … the measures that are being discussed are not a return to very tight regulation that we saw in early decades and it’s not really the same as we’re seeing in some other countries with high or with caps on LBR loans, it’s more graduated approach that’s similar to things that have been said in the past. So it was a long winded answer.

Hi, Justin Faber from ANZ, it was a good to see a speech on the long term so that was good. I guess my question is more straying to political things, I know you don’t want to do that, that’s not an option, but I guess it’s about market failure. You talked about the maths and science and generating an atmosphere for people to be entrepreneurs which I thinks important, I guess do you think then were you hinting that there’s market failure there and that there’s a role for government to play. And I guess maybe putting it a different way are you highlighting for our political leaders that maybe we’ve had 20 years of good time and the voters haven’t pushed them yet to make some hard decisions around various range of things and do you think that time might come?

Well obviously I don’t want to get drawn into any political debate here. The message that I think I’m trying to highlight is the need for us to take these culture issues seriously. And I don’t think it’s just a matter of the politicians to do that, it’s collectively as the leaders in the economics profession and as business leaders to ask what it is or what we can do to promote that culture, it’s not just in the area of government and I suspect that you’re probably right, 20 more than 20 years of good progress has made us collectively and it’s not the government it’s business and labour as well, a little relaxed. And I think that process is now changing, with kind of the difficult conditions that many businesses have had over recent times is, and I hear this from talking to business people all the time, it’s forcing them to go back and look at their management practices, their technology, their approach to the supplier chain and they’re finding efficiencies so I’m moderately optimistic that that process is working, but I do think as a society we do need to focus on what we can do, what individually we can do to promote a culture of risk taking and of entrepreneurship because I think both here and globally, there’s a real deficit of that spirt and we’re seeing kind of globally a deficit of aggregate demand and that’s having some of the spin offs that I talked about.

Deep down I do not think that the rate of underlying technical progress in our societies has slowed down, so the underlying momentum, the underlying growth momentum I don’t think is fundamentally slowed down, we could be wrong on that but that would be my judgement and it’s really kind of the entrepreneurial spirit, the drive to find new ideas and implement those ideas and to have the confidence to do that I think that that’s the thing that’s globally it’s lacking and collectively I hope that we can work on a culture that then promotes that again. Because the alternative of just relying on ever loose and monetary policy it might ultimately work but it does carry very large risks as well.

Phil, Bill Evans from Westpac. Phil you referred to that insightful speech that you gave two years ago and this one of course is also equally insightful. But in that speech you did note that you thought that interest rates would continue to help the economy all the way down to 1 per cent, I guess my question is do you still believe that because we’ve heard a lot of talk about there’s no point in cutting interest rates it won’t do any good. And the second part of the question along that theme was that in the Governor’s speech earlier on in the week, he commented that cutting interest rates would just bring forward finite activity in housing and then when rates had to rise would coincide with the time when the mining boom would be really turning down, so it would be quite counterproductive. Could you comment, could you clarify that second point and could you comment to me as to whether you still believe the 1 per cent argument?

I can’t quite recall saying 1 per cent but anyhow, I may have. And I think what you’re really asking is about the transmission mechanism and whether it’s still working and how effective it’s working and in Australia thankfully that monetary transmission mechanism is still working, we are seeing lower interest rates lead to higher asset prices and that’s inducing more real activity in the economy. The problem that many other countries have is that mechanism is not working or not at least not working very effectively so my judgement would be that if further interest rates reductions were required they would have some effect in stimulating economic activity.

One of the issues that we talk about internally within the Bank is the confidence effects of - this is globally but also has implications domestically - the confidence effects of yet further stimulatory monetary policy that you reach at some – and I think this is why there is a limit one of the reasons why there is a limit to the continuing benefits of stimulatory monetary policy or even more stimulatory monetary policy is you get to the point where the confidence effects don’t seem to be as strong as they were in more normal times. I don’t think we’re there yet so we’re in a fortunate position that if we do need to lower interest rates we can. And I think the other general point I’d make here is that stimulatory monetary policy largely works through what the economists will call intertemporal substitution, that is bringing forward spending that we would have done tomorrow to bring it into today and by doing that hopefully we stimulate activity and make people feel better and then the economy ends up doing better overall.

But to do that type of intertemporal substitution requires people to borrow, and people globally but there’s some element of this here as well people don’t want to borrow, they’ve had enough and so the effectiveness of that part of the transmission mechanism I think is globally is impaired and it’s reducing the effectiveness of interest rates, of low interest rates and to some extent I think that’s an issue here as well, but overall I think if we needed to lower interest rates I think that would be stimulatory.

The point about housing bringing housing forward which will be counterproductive because there’s a finite amount and then when rates had to go up that would coincide with an ongoing downturn in mining.

DR LOWE: Well that could happen but I don’t feel like that’s a major constraint, that’s part of the transmission mechanism the bringing forward of expenditure that would have occurred at some future point, bringing it to this period here, making it and as a result the economy is stronger, and that helps lift sentiment and we all end up being better off. But they’re clearly, you can bring too much of that forward and then later on you pay a price for that. And so I think an issue how do you balance that and ultimately I suspect we are going to be better off if we have a prolonged period of elevated levels of housing construction rather than trying to bring it all forward right to today and then have it collapse later on and perhaps that was the point the Governor was making.

Thank you.

Thank you.

Yes, Michael Potter, I’ve got a question about two points that you’ve made in your speech. First of all you said that you were aspiring to an economy which has got sustainably high purchasing power and then later on you reiterated a point that the Bank has made several times which is you’d like to see a lot lower value of the dollar. So I’m wondering if you might be able to unpick the distinction between those two statements. Is the first statement about higher purchasing power is that a longer term proposition? And lower dollar is that a shorter term proposition? And why would you like to … How would you see us transitioning from a lower dollar to as you put higher purchasing power?

Well I think if we end up delivering on this aspiration, if we end up being this really high productivity, high value added economy, sustaining higher real wages then the purchasing power of our currency will be higher and that’s something that we should, that’s a sign, a structural sign of success just as high real wages are a structural sign of success and high returns on saving are a a structural sign of success. But overlay or overlaid those set of structural considerations as I said the exchange rate plays a role in how the economy evolves at any point in time and the real exchange rate in Australia is still quite high and that reflects these … I think largely reflects these positive fundamentals that I’ve talked about. So we do have a high exchange rate and I would hope that over time our exchange rate if we’re successful would stay high, higher than it had been, than it certainly was in the 1990s but that doesn’t mean that any given point in time you want it to be higher than it is at that point in time. And we’ve made the point and I think this has turned out to be borne out to be reasonably accurate that two years ago we were saying that given our view about where the terms of trade were going, given our views about where investment was going, the exchange shouldn’t be at $1.05, it should come down if it’s going to play the stabilising role that it has.

And we said basically a year ago the Governor said when it was at 95 it should probably come down and it has. So it’s basically doing the type of thing, the stabilising role that we would expect it to do, that we would hope it to do, it doesn’t happen on the day that we want it or maybe the kind of the month or the even the quarter that we think but broadly the exchange rate has continued to play the stabilising role and as I said in my remarks our assessment of the fundamentals is that it will continue on that trend, but I think it will still stay structurally higher than it was in the 1990s and we should really hope for that, because that would be a sign that our economy was delivering on this aspiration of being highly productive and highly competitive globally, at a high exchange rate which is what we should hope for.

Dr Lowe you mentioned there that there were downsides to having very low interest rates, the US has had virtually zero interest rates for five years, what are the downsides of having that for the US?

It’s a very good question, I see the downsides more evident in other parts of the world, because in the US I think you could argue that now there’s healing processes is well advanced and I’m relatively optimistic about how that’s going to play out that the higher asset prices there and sort of wealth effect on consumption it’s making people feel better again and that process is kind of working its way through. There are some vulnerabilities that are being built up but by enlarge I don’t think they’re too worried. It’s in other parts of the world where the money, you think about Japan, JGB yield is for 10 years is point four and the Bank of Japan is promising to deliver 2 per cent inflation so you’re being promised a return of each year for the next 10 years of minus 1.6 per cent, so that cumulates to a negative real return on a JGB of 20 per cent, almost 20 per cent over 10 years and that’s what the government is promising you. And so people are then trying and you’re starting to see this process now, people say well is there an asset somewhere else around the world that will give me, over the next 10 years, a better return than minus 20 and people are starting to do that and that pushes up the price of other assets including in Japan, you’ve seen the effect on the stock market and that can work if the underlying investment climate improves enough to ultimately validate that but if the underlying investment climate doesn’t improve to validate it then all you’ve done is pushed up the asset prices to unsustainable levels and ultimately there’s a day of reckoning there. I think it’s much less, it’s much harder to tell that story about the United States and I will add here Australia than it is in some other parts of the world.

Dr Lowe, John Peters from the CBA I won’t ask you about cash rate question here but just on the main theme of your talk about the billing of Australia’s capital and the broad human capital, broadening and deepening thereof, where would you put the full implementation of the Gonski Report and the current ideas on tertiary changes in that context in terms of maximising the human capital in Australia in the future?

I feel in my remarks I’ve kind of tested the boundaries. I think you’re asking me to go over the boundary there, it’s no and I really just don’t know enough about the particular reforms. I see – personally I find it – I think it’s incredibly important that we do education well. I grew up in a small country town, in a family with limited means I’ve seen in my own case the benefits of education, the way that it changes your views about the world and I think as a society we need to do that well. Now how we need to do it, or how we do it, how we fund it, how we set the incentives for teaching, how we do the incentives for research and collaboration that’s not my area of expertise all I know it’s important and I hope people in this room share that view and I’m sure there are more experts here than me.

Rory can be lucky last.

Rory Robertson Westpac Treasury, Dr Lowe thanks for a great talk. I too agree that the medium term outlook for Australia is very bright in fact looking at your population chart I wanted to rush out and buy another house, massive out performance in population growth.

Can I just interrupt what you should want to do is go and build another house. Sorry.

Have you tried to renovate lately? So my fearless forecast is that 2014 is going to be the first year in two decades that the Reserve Bank left the cash rate unchanged, got one month to go but fearless forecast. 1995 was the previous one, the Bank gave a heads up in February that a period of stability was a likely scenario and the Bank’s delivered on that. Apparently the consensus of economists today was that the economy is going to be sufficiently strong next year that you’re going to break that period of stability and hike rates. I wonder given the Bank’s outlook for growth which is subpar growth, further rise in unemployment from 6.2 per cent, what sort of unemployment rate do we need for the Bank to decide that actually the outlook’s not as bright as it needs to be and the economy can grow faster, is it 6.5, is it 7 per cent. Obviously there’s a range of indicators to look at but the one that most people care most about is the unemployment rate. Do we need to get to 7 per cent before the Bank sort of wants to have a go at testing whether lower rates would be helpful for the economy?

Thank you it’s a good question and we don’t think about kind of critical thresholds under which we would or would not move interest rates, as I’ve probably talked about on previous occasions the framework we use is very much the flexible medium term inflation targeting framework and the interest rate decisions are taken in the context of that framework, so the questions we’re asking ourselves is how fast is the economy likely to go and what’s the inflation outcome likely to be. And in our recent set of forecasts we’re expecting inflation to stay around the middle of the inflation targeting band and we’re expecting the economy to grow a bit below trend for a while but then to gradually pick up and that’s with the current setting of interest rates. And we would move away from that setting or contemplate moving away from that setting if we thought that the world, that the outcomes were going to be noticeably different from that, either inflation was going to be too high or too low and that’s very much our anchoring framework and so we don’t have critical thresholds we say if this variable gets above this level then we’re going to change its discussing how the outcomes are consistent with the medium term inflation targeting framework.

Thank you.