Transcript of Question & Answer Session The Recovery, Investment and Monetary Policy

Thanks Dr Lowe for that illuminating speech. I'm John Kehoe the economics editor of The Financial Review. Dr Lowe, in your speech you mentioned that business investment has been slow to click into gear, for understandable reasons during the pandemic, but this was a problem for many years prior to COVID-19 hitting. Do you believe that the current policy settings of federal but also state governments are going to be adequate enough to get a sustained revival in business investment that you're talking about to get productivity and wages going and if not, as I think many in this room probably suspect, what are the sorts of policies that you would hope to see maybe even after the next election or before the next election, once the vaccine is rolled out and maybe there's a bit more headspace to think about these things and prosecute the case for reforms?

Thank you. I don't want to comment on government policy. I think the one thing the Reserve Bank can do is try and make sure the economy is growing strongly and I think if people in this room have confidence the economy is going to bounce back and grow strongly I hope that you'll invest. So that's the contribution we're making, keeping funding costs low is also helping and through our Term Funding Facility we're giving banks incentive to lend to businesses. So that's what we're doing.

You've got to remember though it's not just government that creates the environment for investment, businesses actually do most of the investments. So in the past I have drawn attention to the risk appetite of business, the hurdle rates of return, and the willingness to take risks, so this is something that all business people should be thinking about. What's the hurdle rate of return on investment in a world of very low interest rates? If you're still requiring hurdle rates of return of 12 or 15 per cent in the world we're living in where policy rates are zero you're probably not going to undertake much investment but if you lower the rates in response to lower rates on capital around the world there are more investment opportunities. So it's not just government, it's business as well, and the Reserve Bank will do what it can do to keep funding costs low and the economy growing.

Economic history and theory suggests that if you have higher business investment you'll get higher productivity and that should eventually flow through to wages as well. In recent years that's been somewhat called into question because more of the productivity gains, although they've been modest, have been going to the profit share less to the labour share. That sparked calls for perhaps doubts about whether productivity increases are actually going to lead to higher wage increases. I mean what would you say to that sort of naysayer sort of criticism and it's also led to calls for perhaps more direct intervention such as a higher minimum wage or direct more rigidity in the labour market because they don't believe they can rely on the productivity gains to flow through to wages?

Well ultimately where does advancement in our living standards come from? It comes from better technology and doing things differently and better doesn't it? I mean the reason that we enjoy such a fantastic standard of living in Australia is we do things very well, we've got great technology, and that's the source of growth in our collective living standards. So there's a question at the moment about how those gains in living standards are distributed and it does seem that over the past decade or so that workers have got less than their normal share of that. The solution to that is to have a tight labour market to get firms to have to pay higher wages to attract workers. So this is the core of our strategy, to get the unemployment rate down, create a tight labour market, and for everyone in this room to have to compete more aggressively including pay workers more to get them.

I know that's the strategy in the United States as well, under the new administration, get the unemployment rate down, have real wages increasing. And the way you get that is having quite a tight labour market and that's the strategy of many countries at the moment to get there. Unfortunately we're a long way away but we're going to stay the course until we get there here.

And just on that topic you say in your speech that we need wages growth with a 3 in front of it essentially to get inflation back into the sustainable 2 to 3 per cent band, you mentioned that now you believe that unemployment could sustainably fall to the low 4s. Now I think previously the Bank's guidance on what's known as the non-accelerating inflation rate of unemployment was around about 4.5 per cent, maybe a bit lower, is that something you've reconsidered that the NAIRU might be lower and is it even possible? There's a discussion now going on that the NAIRU might even have a 3 in front of it, that it might be below 4 per cent, you might need to get unemployment below 4 per cent to get wages growth up towards 3 per cent.

It's entirely possible, none of us know. There's a huge amount of uncertainty here. We haven't been at such low rates of unemployment for a long period of time and there are a lot of structural factors going on, so we can't be sure. What I'm sure of is that the unemployment rate needs to be below 5. How far below 5, it's hard to tell and I certainly hope, and it's not inconceivable, that we could sustain an unemployment rate in Australia starting with a 3. But we're a long way from that so we've got a bit of time to learn, we've got a bit of time to study the experience of other countries. I suspect given the fiscal developments in the United States they'll get down to these low rates of unemployment before us and we'll, as we have done over the past decade, see what happens there and learn lessons from it.

And speaking of the US fiscal stimulus, $1.9 trillion has just passed the US Senate. As you said, it's about 9 per cent of GDP, I think it all adds up to about 25 per cent of GDP if you include their previous COVID fiscal stimulus. There's a discussion now or a debate underway, Janet Yellen says now is the time to go big, former US Treasury Secretary Larry Summers, who for many years has argued that we need to do more fiscal support, is now saying this might be too big, he's raising concerns about inflation. What do you see as the implications of this huge fiscal stimulus from America for Australia and for potentially global bond markets and inflation?

For Australia I think it means a stronger US economy and that's going to be good for the global economy, isn't it? It's quite possible, no one can be sure, that the US gets back to quite low unemployment rates towards the latter part of next year. It's a very large fiscal stimulus on top of what was already a large fiscal stimulus and there's a prospect of more infrastructure spending in the United States as well. So the strategy, and Janet Yellen has talked about this, is to get the unemployment rate down and they're spending enough money that that could actually be the outcome here. If it is the outcome the global economy will be stronger, that will have spill over effects to everyone else, there'll be stronger commodity prices as well.

If they do get the unemployment rate down as they hope they do, we'll be back in the world we were before the pandemic where people will be wondering how low it can go and does a 4 per cent or a 3.8 per cent unemployment rate in the United States generate inflation? The structural factors that I talked about are sufficiently powerful. I think even there in the United States they're going to have to sustain a low unemployment rate for a long time to get inflation picking up.

I notice that inflation expectations at the moment in the bond market – which have risen, which is I think broadly a healthy thing – are still not suggesting that we're going to have a breakout of inflation. I expect inflation's increased but it's returned back to the target. I think that's a plausible central view that the unemployment rate comes down in the US and they get inflation back to target and there's not going to be a kind of massive inflation outbreak. The Fed has said, they have the tools to address it if inflation does increase so I'm a bit perplexed by the story that we're going to have this massive inflation outbreak in the next few years.

The fiscal stimulus from the US does appear to take in some heat out of the Australian dollar, it was trading up around 80 cents a couple of weeks ago, now it's pulled back to around 77 cents, is that a rough level that you're a bit more comfortable about where it is now compared to where it was a couple of weeks ago?

The US dollar has strengthened against every currency in the last couple of weeks and so the Australian dollar has weakened as everyone has. I'm more comfortable with lower rather than higher. I'd be even more comfortable if it was lower still, because we need to get the unemployment rate down and inflation back to target and a lower currency would help us get there. Having said that, I cannot say the currency's overvalued. Commodity prices are very high, interest differentials are stable, so I understand why the currency is where it is, I'd like it to be lower though, but we don't have the tools to deliver that.

Yesterday at The Financial Review Business Summit we heard from the likes of the Future Fund Chairman, Peter Costello, raising concerns about these ultra-low and extraordinary rates potentially blowing asset bubbles, Mohamed El-Erian spoke about a couple of potential market accidents that nearly happened in the bond market over the last six weeks with liquidity evaporating temporarily, and generally concerns raised about financial stability risks. Is that keeping you awake at night? Is that a primary concern for you and the RBA at the moment with these very low rates that appear to be staying low for several years?

Our primary concern is the people who are unemployed, who don't have a job and whose wages aren't growing at sufficiently high rates. So to the extent that anything keeps me awake at night, that's what worries me is the social and economic cost from a protracted period of unemployment. We know that low interest rates do push up asset prices, that's part of the transmission mechanism. What would concern me, if we saw on the back of these rising asset prices, lending standards deteriorate and people go into the bank and borrowing ridiculous amounts of money in a speculative boom. So this is why our focus is very much on making sure these lending standards remain sound because that would be a big problem if we saw a debt financed speculative boom in asset prices. We are not seeing that at the moment. The equity market is below its previous peaks, housing prices in Sydney and Melbourne, while they're rising, they're not really higher than they got to a little while back in some of the smaller capital cities. In regional Australia housing prices are rising quickly, but there are fundamental factors at work here. So the issue is if prices are rising, are people borrowing responsibly and carefully? And to date they are.

Just back on the bond markets, we did see some dysfunction there globally one to two weeks ago, the RBA stepped in a bit more aggressively with some of its bond buying both at the shorter or longer end of the curve. What do you think was the underlying cause of that, and there has been calls from some former RBA officials, academic economists, to suggest that the RBA should be doing substantially more quantitative easing at the moment because in a low inflation environment, it's basically costless. How do you respond to that?

The first part of the question was about the …

The bond market dysfunction.

… bond market and the bond market dysfunction.

I mean what we saw as I talked earlier in my remarks, bond yields moved from historic lows up, and we know from experience that every time there's this kind of reassessment and repricing in the bond market there's kind of dislocation. Bid-ask spreads wide and people have trouble finding the new market price and there's a period of dislocation, so that was what was going on. It happened in the United States, it happened here, it happened in most bond markets around the world. We stepped in during that period to help the smooth functioning of the market and bid-ask spreads on most bonds have now narrowed again and conditions are returning to normal. So it was really just the difficulty of adjusting to a price change.

The second part of the question if we can go on, or do you want to finish off with the amount of time?

Yeah, I mean the suggestion that maybe the RBA should be doing more QE because some people suggest in a very low inflation environment it's basically costless for the Central Bank to do that.

Well we're doing a huge amount already. You put together the QE and the Term Funding Facility, each of those are roughly $200 billion so that's $400 billion over a relatively short period of time. That's $400 billion. That's the injection we're making, that's very substantial. It's occurring at a time where the economy's doing better than we thought it would do, the bounce back globally and here is stronger, so we think that given the very substantial contribution we're making and the stronger bounce back, the most sensible thing to do is to see how this develops, we'll learn each month how things are progressing and we'll understand how developments in the bond market are working out, so we're in watch and wait mode. If it turns out that we need to do more we can, but I think right at the moment we're doing a huge amount and it's appropriate to watch and wait and see how that plays out.

You suggest there that maybe you'd be prepared to do more under certain circumstances, are there any potential prerequisites that you'd need to see to potentially do more?

I wouldn't draw your attention to a specific kind of criteria but the general principle or the question we're asking ourselves is are we making sufficient progress back towards full employment and the inflation target and can, through our policies, we accelerate that progress in a helpful way. So that's the question that at each Board meeting we ask ourselves, what's the progress like, can we do more to help that progress, that's the only kind of prism we're looking at this through.

Dr Lowe, thanks for your time this morning. I think people would have got a lot out of that discussion and your speech so thank you very much.