Transcript of Question & Answer Session Remarks to A50 Dinner

We live in a world, of course, with extraordinarily low interest rates. We now have seen the US Fed hit their inflation target in four individual markets since the end of 2018, the ECB and Bank of Japan haven't hit (their inflation targets) since then.

Do you have any comments about globalisation and the continuing trend of accelerating technology? Do you now think that sub-2 per cent core inflation is the new normal?

I expect inflation to pick up overseas, but I expect it to do it only gradually. The central issue here is really the behaviour of the labour market. Wage growth has been surprisingly weak in countries with very low unemployment rates. If you think about the United States, the UK, Germany, Japan, they've got very, very low unemployment rates. In some cases, the lowest unemployment rates in four decades. Yet wages are still, kind of, below average. At some point I expect those tight labour markets will lead to stronger wage growth and inflation will pick up. And we saw a hint of that on Friday in the US, and people then reassessed the outlook for inflation. It's a gradual process because there are forces acting on the labour market.

And the Japanese economy is growing strongly. Apparently, that's on the back of easy monetary policy, but it shouldn't always be on the back of the easy monetary policy and the same case you could make in some of the European economies. So, over time I expect this will correct. But if we stay in a world of multi-decade low unemployment rates at very low interest rates and wages don't pick up, that would be very strange. But in answer to the question, I don't think we're going to stay there, it's going to be a gradual normalisation. I don't see this turning around quickly, but I think it will gradually normalise and we need to be prepared for that, in that will mean higher global interest rates. It will mean, in time, higher interest rates here in Australia as well, more volatility.

That period that we had really the second half of last year, with extraordinary low volatility that lasted for six months; people seemed to start to think this was normal. We had low inflation, low unemployment and low volatility. It was kind of the reverse of the 1970s, where we had high unemployment and high inflation. And there was kind of a belief that we could live in this world forever. I was sceptical about that and, I think, there will be a normalisation, but it's going to take time.

As an investor we oftentimes ask what are the downsides to this, what keeps you up at night? What I want to ask is something opposite. Where would you see the pictures of a surprise to the upside in the Australian economy?

In the short-term, the stronger global growth, it's synchronised. We're not just having stronger growth in one or two countries. It's synchronised across the world, so it's quite possible that we could see a stronger global upswing and that will be good for commodity prices. That would be good for Australian income growth. Businesses will feel better: they haven't been investing very much for a long period of time outside the resources sector. So there are lifting global conditions, higher commodity prices, stronger Australian confidence and you might see more progress on reducing unemployment and getting inflation back to targets. I think that's quite possible.

The infrastructure spending is an important part of the Australian growth story. The New South Wales and Victorian governments have significant plans there and that story could broaden out across other states as well, which would be a positive development. So there are some other things there. And the links we have with Asia, you know, we have tremendous opportunities there. We've really explored them very well on the resources side. But I hear more and more stories of exploiting them, or using them, on the services side of the economy, as I said in my remarks in agriculture, services and high-tech manufacturing. So I see tremendous opportunities there. So there are a lot of very good things here.

I think Australian business is starting to see the good things more. Really, after the financial crisis and the mining investment boom, businesses outside the resources sector were feeling a bit glum. There was this lack of animal spirits and I detect those spirits are just starting to come back. They're not here fully, but they're starting to come back and there's good reason for them to come back.

Can I just ask the question about the return to surplus. You noted the importance of getting back by 2021. What would corporate tax cuts, that imperil that potential surplus, do to confidence and how would that impact the economy?

Well, I'm assuming if there were further changes in the tax system, it wouldn't put us off track on return to surplus. I think this is why there are two perspectives on why this is important.

First of all is insurance. I'm a conservative central banker, so I like insurance and I saw what the strong record of Australia on fiscal policy meant when the financial crisis hit, and the downturn (too). We'd had the insurance through good fiscal policy and we were able to cash in the insurance policy and spend, and that supported the economy. But you can only have that type of insurance, if you pay the premiums. And the premium is getting the budget in decent shape in good times, and now we're, kind of, returning to good times so I think that's important. So insurance is valuable, we have to pay for it and you pay for it by having a balance in good times.

My other perspective on this really comes as the father of three children. The inter-generational issue, the importance of meeting current expenditure from current revenue, with the exception of capital accumulation. So there are important issues. On corporate tax, I think there is international tax competition going on. Some people might think that's a good thing, other people think that's kind of regrettable, particularly if you're worried about balancing the budget. But it is going on, and we need to pay attention to it. The Parliament will have to work out how to deal with it.

I think the other observation I make here is: tax is not the only thing that influences investment decisions. I look around the room here, there are a lot of investors here. I hope you're not here just because of Australia's tax rate. You're here because a lot of other fantastic things in this country. So there's a lot of focus on tax, and I can understand why that is, but you're all here because of the fantastic opportunities our country offers. So we've got to think about the whole mix of things that influence the investment climate, not just the tax system.

Can I just ask a follow up on the corporate tax question? The Japanese government is looking at a corporate tax cut linked to wages, just linking two of your themes tonight, they'll be giving corporate tax cuts based on those companies that give aggressive wage hikes. Do you think there's any academic merit to that?

I haven't thought about whether there's academic merit to it. It seems overly complicated with too many connections. These things are so hard to do. I can see significant implementation problems with that. But the Japanese government is responding to the same pressures many others are. There's international tax competition going on, as I said. You can think that's good or bad, and they're part of this as well and the lack of wage growth has been a major issue in Japan. I talk to the Governor of the Bank of Japan and other officials in Japan and I say, ‘Well why aren't wages rising there? You've got very strong, tight labour markets.' And well part of the answer is well faced with these tight labour markets, firms are finding efficiencies rather than hiring new workers.

Another part of the story is well, and I hear this a lot in Sydney, when I ask business leaders why they're not paying more wages. They say, ‘Yes, well wouldn't it be good if other people paid higher wages. but of course, you've got to understand it's very competitive in my industry. So I can't possibly pay higher wages, but it'd be great if everyone else did' because there'd be more income for the community.

So the Japanese authorities are grappling with the same thing. The tight labour market leads to more innovation, which keeps downward pressure on costs, and there's a very strong competitive environment globally, meaning people take a lot of pushing to push up wages. Whether that can be linked to the corporate tax system, it seems like it might work in Japan, but there's a level of over-engineering here.

Just picking up on what you were saying on retail competition and disinflation there. Obviously, Amazon came late last year, so do you expect retail disinflation will persist, or are we sort of through that process, or is it ongoing? What's your view there, or your expectation?

I find it hard to answer that. It's been very persistent and I expect it will persist for quite some time. We've seen it in food retailing. We've had some foreign supermarkets come in and push down the price of food. If you look at the price index for, basically, supermarket food, it hasn't moved anywhere for five or six years and that's really competition, which is good for consumers. Retailers don't like it, but it's good for consumers. And now clothing and footwear prices in the last year, they're down 3 per cent, and furniture prices are now down 3 per cent and you're getting retailers coming into spaces where they hadn't really been and they're shaking up the Australian industry. They're forcing the Australian retailers to come up with efficiency savings. So this process, I think, has further to run. It's hard to tell exactly how far, but I think it's got a way to go. And this is one of the reasons why we think the pick-up in inflation here is only going to be gradual. This kind of labour market recovery or the pick-up in wages is gradual. This persistent deflation coming from increased competition in retailing is an ongoing story.

Governor, we have one more.

Do you anticipate any further action on the macroprudential controls on housing investment, or is the job there done, do you think?

Well I don't think we need any further controls at the moment. The limit on interest-only loans, I thought that was a very sensible thing to do. When I talk to my overseas peers and explain that more than 40 per cent of the new loans in the country were being made to borrowers who didn't have to make a single dollar of principal repayment on a regular basis. They say, ‘Well how? Why would you allow that?’ I understand why that takes place in Australia, but it didn't feel right to me. It felt like it was building up risk in the system, so that was addressed and I would hope there'll be a permanent element of that.

The growth in investor lending was the other part of the macroprudential restrictions and growth in investor lending has slowed a lot. It's low single digits now. So, at some point there might be an opportunity to look at that, and I'll see how that could evolve into something else, but we'll have to have a look at that over the coming months. So I don't see the need for further restrictions at the moment. I think the restrictions we've put in place have served their purpose. The market, the housing market, looks more stable. Borrowing patents look more sensible and the things that Wayne Byres and his colleagues have done have strengthened lending standards in the system. So, as I said in my prepared remarks, things look less risky there than they have for some time on the borrowing and housing fronts. I hope that continues. Thank you.

Thank you, Governor.