Transcript Panel participation at the ANU Crawford Australian Leadership Forum


Welcome everyone.

Now just to set the scene a little bit, at the end of last year we saw a correction in financial markets, the tightening of financial conditions and I think that rattled more than a few people, in terms of thinking about where our economy here and elsewhere was heading. Particularly, it started raising questions about vulnerabilities if economic growth was to deteriorate significantly. The IMF and some of its most recent work highlights that this year is a delicate one for the global economy. And it's emphasised that an extended period of low interest rates and accommodative financial conditions has enabled and allowed vulnerabilities to build up. If you look at the US, corporate debt to GDP is at record highs, the profile of government debt is described as unsustainable by the IMF. In the euro zone and the US, the stock of speculative grade credit has almost doubled since the global financial crisis and measures of political and policy uncertainty around the world have increased and remained very high. So, that's a little bit of the scene setting for the context of our discussions today.


(12:30) Good chance now to toss to the Governor. Su-Lin has raised a particular view around where Australia is at, where the globe feels like it's heading and questioned the amount of global policy ammunition, particularly on the monetary policy side. So, how is the RBA seeing things? And, by the way, you can answer this later as a question on notice, if and when are you going to adopt the tweeting approach of the US president to influencing markets in Australia?

Philip Lowe

(13:02) Well, I can answer that now: I'm not. It's great to be back at the Crawford Forum. I was last here two years ago and I remember Ken Henry asking me a question about wages. And the forum two years ago was the first time that I started talking about the very low wage growth in the economy and how that was a significant issue. So it's great to be back. I want to start off with the global economy and to remind you it's really important we keep perspective here. Two weekends ago, I was at the G-20 meeting of Governors and Finance Ministers in Japan and the IMF was telling us that next year the global economy is likely to be better than it was this year. So they're predicting 3.6% growth next year and 3.3% this year. So the IMF, who is often prone to negativity, is saying ‘well things could be a little better next year’.

It's true, the global economy has slowed but it's still reasonable. We wish it were better but it's still reasonable. I think we need to keep that in perspective. The other major theme at the G-20 conference was that the risks are tilted to the downside. And the main risk is the uncertainty that's being generated by the trade and technology disputes between the US and China. And in Europe, you could add to this, the uncertainty that's generated by Brexit. This uncertainty is now having a major effect on investment around the world. Investment plans are weakening and capital spending is declining. In a way, it's not surprising because uncertainty increases the option value of waiting. What we're seeing right around the world, is firms wait before deciding to undertake investment. They're sitting on their hands and if enough people sit on their hands, then it's going to have a major effect on the global economy.

It's interesting at the moment, firms while they're not wanting to invest, are very happy to hire people. So, the unemployment rate in the United States is the lowest in 50 years, in the UK it's lowest in 40 years, in Germany 30 years, in Japan 30 or 40 years. So employment growth is strong. The services sector is strong. People are consuming but businesses are not investing and it's understandable. They're sitting on their hands; they're waiting for the uncertainty about the trade and technology disputes to be resolved. It's an open question about whether that will happen. If it doesn't happen, then I think firms will not only decide not to invest, but they might decide not to hire people as well and we could be looking at a much weaker global economy. So for me, that's the really big issue. Can the uncertainty around technology and trade be resolved?

A question that was posed in the written material for this session was, are we likely to face another global financial crisis? And in my view, that's quite unlikely, and I say that because the financial system is much stronger than it was a decade ago. Capital levels are much higher, liquidity ratios are much higher, bank balance sheets are simpler, the financial structuring that took place a while ago is not there so balance sheets are less opaque. So the financial system looks a lot stronger than it was a decade ago so I don't think we're going to see the financial amplification or the financial shock that we saw a decade ago. The weakest spot is the European banks. The market value of their assets is significantly less than the book value, which says that investors don't really believe the value of those assets and if we have a downturn in Europe, then that uncertainty about the value of bank assets in Europe could become quite an issue but at the moment it looks okay.

So the other question posed, and you posed this as well, Melinda, what are the possible policy responses if things do slow? And here there's good news and bad news. The good news is that we do have policy options and the bad news is most of the policy options that we have, face significant constraints and complications. I'll run you through some of those.

So if we start off with monetary policy. As the downside risks have come into sharper focus recently, markets are now pricing in cuts in interest rates in all the major jurisdictions. Su-Lin said in the US the markets are now pricing in four cuts in interest rates over the next year and the Euro area markets are pricing in cuts again after the ECB's rate has been held steady for a long period of time and markets are now pricing in cuts.

The same is true in Japan where their rate is minus 10 basis points. So that's quite a big shift in just 3 months with the US, the ECB and the Bank of Japan all expected to cut rates over the next year. That's all despite the central scenario for the global economy being quite reasonable and as the IMF says, probably a bit stronger next year than this year.

I think what's happening is the uncertainty that's affecting investment intentions around the world is now affecting market sentiment. Markets have become very nervous about their outlook because they're looking at the uncertainty generated by the trade and technology disputes as well.

But investors also seem to think that central banks will ride to the rescue once again. So if you look at equity markets they're very strong. If you look at credit spreads, they're very narrow. So the same investors who are worried about the future aren't worried about the kind of future profits of companies or credit risk in companies. So to me it's a strange world. The market investors view that the outlook is sufficiently weak, that they expect central banks right around the world to cut interest rates, but they're not worried about corporate profits or credit risk. I don't really understand that fully.

It's a legitimate question to ask, how effective further monetary easing would be? If you just got a single country and it eases monetary policy, one of the main benefits you get from that is a weaker exchange rate, which improves the trade position.

So, the exchange rate channel is an important channel through which monetary easing stimulates growth. But if everyone's easing, there is no exchange rate channel. We trade with one another, we don't trade with Mars. So if everyone's easing the effect that we get from exchange rate depreciation, that part of the transmission mechanism, isn't there. So we don't get the same stimulus that you would normally expect from monetary easing. It might be possible if you ease a bit more than others, that you get a bit of extra growth. But that's quite a dangerous path to go down and that leaves the other transmission mechanisms for monetary policy, which in my view are weaker at the moment. So it's not realistic to expect stronger growth from exchange rate depreciation globally and the other transmission mechanisms I think are quite weak. So there are limits on what further monetary easing can achieve.

I think we can still get benefit from it, but there are limits.

In my mind that means that we need to focus on fiscal policy and structural reforms. It's true that public debt is quite high in a number of countries but it's not so high that all should rule out further fiscal expansion if the global economy slows. I've long been talking about the benefits of infrastructure investment in our economy. It would benefit the demand side of the economy and would add to the productive capacity of the nation and they tend to be quite high multipliers from public investment and infrastructure. So in Australia, but also globally, I think there's a lot to be said from further spending on infrastructure. So I think governments here and right around the world should have their top drawers full of really good ideas that are shovel ready in case global growth slows. Increased spending on infrastructure and fiscal expansion in the current environment is going to be better than further monetary easing.

We need to remember that interest rates at the moment are record lows. I think the 10 year bond rate in Australia today, is the lowest it's been since Federation,1.3%, and the whole government yield curve in Australia is below 2%. The Australian government can borrow for 28 years at less than 2%. There must be projects out there that yield risk adjusted rates of return greater than 2% particularly given the strong population growth in Australia. Both Australia and also around the world I think we need to be thinking of ways of capitalising on that and building on infrastructure, adding to demand, increasing the supply capacity of the country. And we can do it at low interest rates.

But beyond fiscal expansions, I think the best policies are those that reduce uncertainty and that create a positive environment for firms to invest, expand, innovate, and hire people. It's not easy to do, but it's not impossible. And there are so many reports in Australia and right around the world that tell us the areas to be looking at.

They include the incentives in the tax system for innovation and entrepreneurship. The way we train our workforce and equip them with skills for the future. The way we tax land wealth generation and consumption. The way we deliver public services. The framework that underpins strong competition in our markets and the provision and pricing of infrastructure and the processes that we use to select which projects. So these are the areas that both the domestic and international evidence suggest we should be looking at. None of them are easy, but if we work on enough of these areas, then I'm confident that we can create an environment where firms feel sufficiently positive that they will invest, they will hire, they will innovate and they will expand and that's going to be a much better approach than further monetary easing globally or further fiscal expansion. None of those areas are easy but they're possible to work on and I think if we work on those, then we can make a difference. Ultimately that's the only durable way to increase our living standards. We can't do that through monetary policy or fiscal expansion. Thank you.


(42:35) Phil, I just want to ask if you've been pushing the cheap funding story, you know lowest funding since Federation. Are you sort of slightly suggesting also that maybe the government should take on more debt and rethink having or keeping a surplus?

Philip Lowe

(42:56) My main point really is about infrastructure investment. If the government can build productive capacity by borrowing at low interest rates, it seems like that's a good thing to do as long there are good projects out there. And given how fast the population's been growing over a long period of time, and chronic underinvestment in infrastructure, I conjecture that there are a lot of projects out there that would yield a risk-adjusted rate of return greater than 2%. And if there are, and the government can borrow to finance those, that seems like a good thing to do, especially at a time when the economy needs extra demand which it does at the moment. So it's not a comment about the plans for a budget surplus, I think you can do part of this infrastructure investment off budget and now is the time to do it.

Philip Lowe

[44.58] Can I just add to that because I think that's really important: project selection. The pricing of the use of infrastructure, the management of the construction costs and the project selection, are really important issues. And if we don't get those right then the public doesn't trust the government to build infrastructure, because they see it being driven by political considerations. So the governance of infrastructure is really important, it's not just about spending money.


[53.22] It really is just a question of a bit of detail on what you're saying earlier Phil about infrastructure at Andrew's question and I think a couple of others … The Grattan Institute did a pretty major report on Australia's modern history and infrastructure investment and they concluded that it was uniformly bad. I think they found virtually no exceptions to the rule that the wrong infrastructure was upgraded or created. How can we kind of avert what otherwise is inevitable and that is that politicians will say this is really attractive, it's in the marginal seat or whatever.

How can we get independent analysis by some sort of semi-autonomous organisation such as Infrastructure Australia or something like that so that when we do go into these situations, you said you hoped that there would be shovel ready projects. The only ones I can think of frankly are widening existing roads like accelerating that presumably the works been done on that, but I am just not confident and I wonder if anyone has any views as to whether there are good infrastructure projects out there and if there aren't, how we can create the institutional systems to make sure that there are whenever we need to invest in them.

Philip Lowe

(54:37) Well I think the issue is really the governance of project selection and how do we get that right. And if we don't get it right, the public doesn't trust the politicians to spend our money. So it's insidious if we don't get the governance right. I don't know the answer to this but some more independence of project selection from a political process would be a good idea. I think there's a parallel with monetary policy. 30 years ago, it was considered just kind of crazy to give people like me and my board the power to set interest rates. It was too important, it needed to be done by the government and the society correctly decided that we got sub-optimal outcomes by leaving those decisions just to politicians, and you're better off giving them to people like me and my board. You get better outcomes over time and I think the same logic can be used for infrastructure selection and finding a way that the public can have confidence that the right projects are selected, the construction costs are managed and the pricing of infrastructure is done properly. The world faces a lot of problems but that isn't the biggest one we face. I think with the right application, we can solve that.


[1.03.00] Well I think I'm going to verbal the Governor here because in his speech he gave last week, he spoke at length about underutilisation of labour and looked at trends in rising part-time participation, which of course has been very strong for women. And we had a very interesting conversation around whether in fact we stopped thinking about the delineation between part-time and full-time and just think about are people working and are they working the hours that they want to work. And I think one of the things that we also had a conversation around was, how our education and training systems adopt this and how we make sure that people who are in and out of the labour force, whether it's women leaving to have children, whether it's people who have episodic employment, how we're making sure that the skilling and training keeps them and their skills relevant for a rapidly evolving workplace.

And I think, we looked at some of the stats on mobility which were declining. So I think there's a whole mix in here about where the labour force is at and where it's going that is particularly important to women, but increasingly it's going to be important to all employees who want to be in a rapidly changing workplace. Did you want to add anything else?

Philip Lowe

(1:04:08) We clearly need to do better here, but I want to remind you that Australia is actually doing pretty good in this area. A third of the workforce work part-time now that's quite high by international standards and that's allowed more and more women to enter the labour force. Half of women work part time, which is high by international standards. Right at the moment, more Australians, as a share of the labour force, are in jobs than has ever been the case before. The participation rate is the highest it's ever been. So Australia is actually doing quite a good job here. The female participation rate is now above the OECD average. It's not the highest, but it's above average and we're making progress. There's more progress to be made along the lines that Su-Lin just talked about. We are making progress.


[1.09.00] We did run an analysis about, well more technically not post budget, but pre-election promises in the Commonwealth election. It's in the Conversation but in short, the two parties are almost identical. About half the projects on their list, both by number and by value but were not on the infrastructure Australia list at all. About half are on the list, but not yet with a business case. In other words, IA knows it's there, but it has no idea whether it's a good idea and a very, very small number about one or two and very small by value actually had a business case that IA had signed off on. So that's where we are.

But I wanted to ask more generally about whether additional fiscal stimulus through infrastructure is in fact realistic given where we are? So historically Australian major spending on major road and rail projects has run around about $6 billion a year in nominal terms. Jumped up to about $10 billion in the mining boom, essentially with the WA railway projects at associated with mining boom. It's then dropped back down to about $6 billion as late as about 2016. We are now running at around about $15 billion a year in major projects, so we've gone from $6b to $15b. All of the states are reporting very significant capital constraints and on macro monitors numbers, announced projects, which of course by this stage are quite likely to happen, take the total to about $23 billion by 2023. So is it realistic to expect that governments are going to do even more than that?


Stunned silence.

Philip Lowe

(1:10:46) From my perspective, what's really important is the pipeline keeps full. I wouldn't like to see the level of spending on infrastructure decline, I think the economy could at the aggregate level deal with a modest pickup. Whether there's the capacity to do that, I'm not sure, but what I am sure of is the volume of activity should not decline and to make sure that happens, you need to keep the pipeline full.

Philip Lowe

(1:23:02) I was at the G20 Governors and Finance Ministers meeting two weeks ago and Australia has a loud voice there supporting the open rules based international system, and it's important that we do that. People look to us to speak up. And we do, the Treasurer does and he's a powerful voice for the open rules based system. And we need to find our friends and get together and amplify the power of our voice.


Can you join me in thanking the panel for what's been an interesting conversation.