Transcript of Question & Answer Session Non-mining Business Investment – Where to from here?

Now Australian forces have joined the battle in Iraq, I’m interested to hear your views. To what extent is the global economy at risk, given the battles in the Middle East?

Well I think what we’ve said is that financial market prices have been remarkably stable for a period of time. Our volatility is very low, and that’s surprising in light of some of these global events taking place. So it’s possible that such events and conflicts could flare up to be even larger than they are now and lead to significant problems or concerns about the Middle East perhaps, the supply of oil for example. So that could have sort of knock-on effects. Specifically about individual events, I’m none the wiser than you are.

To what extent are we isolated from it do you think?

Oh well we’re not, we’re a small open economy dependent upon trade with the rest of the world and with open financial markets and inflows of capital. So we’re not isolated. Those sorts of things could have an effect on us. It’s not entirely clear to me that those events are particularly elevated at the moment compared to other similar disruptive, difficult events in the past.

Turning to events this week, G20 officials are converging on Cairns, but at the same time the biggest economies seemed to be headed in anything but the same direction in the world. The US is improving, in Europe there are growing fears of deflation, in China there are signs of a slowdown. So how is it possible to co-ordinate global policy in this kind of climate?

Well people often talk about that in the context of central banks, I think central bankers are very conscious of, particularly in the larger economies, what their policies imply for other economies. But in the main they have to follow their own mandates. And ultimately if they do that well, if they manage to create an environment where growth is as strong as it can be, but inflation is contained, well that’s good for all concerned. And I think you’re right though, one of the key issues for us is our forecasts, that we’ve published fairly recently, were for our major trading partner growth to remain around average levels, maybe pick-up just a touch in the coming year or so. And that seems rather strange because all of the economies, that you can point to, seem to have a bit slower growth now than they have in recent years, or in previous years. And part of the reason is just because our exposure to China is growing so rapidly, and even though China’s growth is slower now than it was some years ago, it’s so much more important as a major trading partner. So it’s a fast growing economy still and we’re benefiting from that.

Much was made out of co-ordinating policy worldwide as we were coming out of the crisis, is it still relevant? Are you still talking as much to partners?

Well look I don’t think co-ordination is realistic. I think the best you can hope for is each central bank does what’s best under their mandates. And look they’re in the business these days of telegraphing their intentions, and when their view of the world changes, very clearly. So I think that’s important to recognise. I just don’t know that there is scope to co-ordinate, their economies, as you suggested, are being pulled in slightly different directions and are at different stages in their process of recovery, at least in the advanced economies, with the US much more advanced. Europe’s still got a long way to go.

Now turning towards home, your area of expertise, you’re the Head of Economics Research for the RBA. Despite an easing cycle that’s left interest rates at a record low of 2½ per cent, the Australian dollar has remained stubbornly high and you mentioned just now that’s the case. It fell below 90 cents for the first time yesterday in six months. The benefits of a high exchange rate that you referred to, to some companies, are clear, but how far does it has to fall until it provides a net boost to the economy?

Well I think any decline … as you said, we’ve been at very high levels. It provides net stimulus to the economy, compared to where it had been. I think the issue, particularly in the context of my speech though, and I think the underlying current of your question is: is there some sort of trigger point at which that will help businesses, particularly in the trading sector, to do a whole lot more investment? And I don’t think there is, and probably the one thing we have to recognise is they’re not going to react at a particular, given exchange rate. And they’re going to want to see if they need a slightly lower exchange rate to support that investment. They’re going to need to see that lower for quite a while, I suspect, before they take on major new investment projects. But any fall is sort of helpful.

Obviously it’s a sliding scale, but is the ideal rate, do you think for the economy, does it start with an 8, is it a low 8? It is a high 8?

I can’t comment on what I think is necessary. I think the thing to recognise is that the world’s changing all the time. So when we quite explicitly said the exchange rate remained at high levels, higher than perhaps what fundamental determinants might suggest, let’s say earlier this year. Things have moved on since then; commodity prices have fallen a lot since that period. So it’s really hard, I think, to know exactly where the exchange rate should be, in terms of its fundamentals. You can have quite a bit of a debate even amongst people who sit down and run these econometric models, which aren’t that helpful, but they’re the best we’ve got at times. It’s a moving feast and it’s hard to know. I wouldn’t pick a number.

The NAB joined the debate, they said the Aussie would become the whipping boy of the G10, are they right?

I’m not sure what they mean by that.

I think they meant it wouldn’t be very popular.

Look, people get very emotive about these things, it’s a relative price, it’s a very important relative price. And you know, I’ll just restate, we’ve said that it seems to be a higher than would be justified by long term fundamentals, I talked about this in a speech earlier in the year where I said it doesn’t mean I can predict where the exchange rate’s going to go, but it does mean that I wouldn’t be surprised if it was to fall further. If you want to get emotive about that, it doesn’t cause me to be emotional about it, and use terms such as whipping boy.

Okay, Willy do we have any burn questions on that topic?

We have a variety of questions, but the first order of business is, before you entered the room we took a poll of the audience, and the question we asked was should the RBA cut rates again in the next six months? Now 67.6 per cent said no, and 32.4 per cent said yes, does our audience have it right?

Ah well, let me put it this way.

Just between us.

It would be rather provocative here … my understanding is that that differs somewhat from what the people who are actually putting money down on their bets suggest, which is pretty much for no change – for a while at least - and that’s consistent, I think, with the messaging out of the Board meetings of late. So there might be, if they truly are convinced of this, there might be some money for them to be making later this afternoon.

Now Governor Stevens has been talking a lot recently about animal spirits. Could central banks be killing animal spirits through unprecedented intervention, which is driving uncertainty?

No I mean I wouldn’t, I don’t see it that way. At least in the advanced economies, and not so much here. Remember in Australia, we’ve had growth at or a bit above trend of late, over the past year or so. But in many advanced economies, you know their economies are weak, they’ve still got a way to recover. Perhaps less so in the US which is further along that path of recovery, but that’s being helped along by very easy monetary policy. Monetary policy is doing what it’s intended to do: it tends to push up asset prices, it makes those who have good propositions for investment, it makes it easier for them to get access to money at low cost. So I think they’ve been very helpful. But what we face now is uncertainty about the sort of future course of monetary policy. And as we suggested, different countries pulling in slightly different directions at this stage.

When you look around the world, do you think that the risks are currently weighed towards global inflation or deflation?

I think it’s pretty hard to see global inflationary pressures. You know, inflation is very low and well below target in the US, sorry in Europe. In Japan, the Bank of Japan is trying to do everything they can to move to a world where people credibly think 2 per cent inflation is the norm and they’ve still got a way to go. They’ve at least seen some improvement after a long period of deflation, but I don’t think there’s a risk there. In the US people are looking at this intently as to whether or not there are signs that inflation will start to pick up. That’s a welcome thing, if and when it does happen, because it means the economy is getting stronger. But I don’t think there’s a real risk of excessive inflation at this point.

Okay thanks Will, we’ll come back to you in a minute. Chris there was record Australian jobs growth in August.

There was.

And this is the first time I think someone from the RBA has been free to comment on it. Not everyone trusts the number, do you?

Well we always treat any given release you know with the deal of scepticism. Not particularly that one, not the labour force necessarily. But I think you can’t read too much into any particular series in any given month. Obviously what happened with the unemployment rate over the last couple of months and employment in the last month were rather exceptional. Those were very large movements. It’s hard to know what might have pushed the unemployment rate up, it’s hard to pin it on just the change in the definition of the unemployment rate that came on a couple of months ago. And indeed, more so perhaps when you recognise that it has subsequently fallen. I think the thing I would say about it is, it does make reading of the labour market difficult, but that’s often the case. And you have to marry looking at any particular series, unemployment, employment, with a whole range of other data. I think when you put all of that together what we’ve seen is that the labour market conditions generally are subdued, that there has been employment growth but it hasn’t been strong enough up until the last month to make inroads into the unemployment rate which has been drifting higher. There have, however, been some signs across different indicators of a measure of stabilisation in the market to some extent, in the labour market, over some of this year. And some of the forward looking indicators, job ads, vacancies, the business surveys, our own liaison suggests things are better on the employment front than they have been, but not necessarily strong enough to soak up pretty strong growth in the labour force. Remember the population is growing at a reasonably robust pace, and that means the labour force is too. So with growth, our forecasts have it a bit below trend over the course of the next year. That means the unemployment rate is going to stay elevated. And yeah I don’ t think you can take a particular reading in any one month, particularly when it’s as large as they have been of late, as sort of indications of the truth of the underlying trends as I’ve just to try to outlay them.

Just picking up on the animal spirits in your speech. Now, at times you almost sounded exasperated that companies weren’t taking the bait. They weren’t responding to the elevated, the above average levels of demand and undertaking new investment, what more can be done?

Well I wouldn’t like to suggest I was exasperated, that we’ve been exasperated. I think the point of my talk was to try and pick apart some of the explanations and see what are the most credible reasons. Why it might have been as subdued, and that doesn’t tell us very much about the future. The CAPEX data suggests some modest growth in investment this year is ahead of us. I mean my sense of things is, if you step back, this happens in business cycles. You know, at a point where investments, particularly animal spirits are at their weakest, but those things change. One really helpful element, of course, is very low interest rates. We’re seeing a pick-up in demand in the non-mining economy, firms tell us capacity utilisation, they’ve still got some spare capacity, so they don’t feel the pressing need to invest, but with these sort of strong fundamentals in place I think eventually those weak animal spirits will give way to something much stronger. And again, it’s really hard to pin down because it’s one of those sorts of things where, it’s not just what I think about the future, that entirely does it. It’s what I think you think about the future, and that means it can easily turn quite quickly.

Well one of the elements you refer to is risk, and surely global risk is anything going?

Well no, I mean these measures of uncertainty that I pointed to, they’re certainly lower than they were during the global financial crisis and roughly around levels that are the norm. It’s normal to have uncertainty and businesses have to work in that environment and make their decisions. They can never be certain of anything, but as the measures I’ve showed suggest, it’s not that elevated, if anything its par for the course from prior to the GFC which was a period of reasonably strong growth. So I don’t think it’s uncertainty so much, in the way I’ve defined it.

Okay, Willy.

Now please don’t shoot the messenger, I’m just asking the question. Is the use of the phrase animal spirits really code for monetary policy and fiscal policy losing potency?

Ah no, I think it’s just the reality of what causes investment to swing considerably during you know business cycles. It’s not that we’re really in a business cycle, but at least in the non-mining sector things have been reasonably weak. There has been an improvement in demand. In time I’d expect investment will follow and then as you can see in that last chart of mine, even in a few quarters, firms who tell the ABS at the similar time in the financial year as we’re in now, I think growth will be weak or only modest, it can turn around to be pretty decent growth, in only a few quarters. No, monetary policy I think is working as you would expect.

And what signals are you using to determine if the housing market is indeed overheating and action is required to lean against a potential bubble, what are you looking at?

Well, again we look at a wide range of things to think about the strength of any given market and in the housing market, it certainly is showing signs of some renewed strength in house price growth of late, and auction clearance rates. Much of that strength is in Sydney and Melbourne, and much of it’s in the investor market sphere, that’s where credit’s has picked up more noticeably of late. So we’re also seeing more supply coming forth, we’re seeing building approvals at elevated levels, we’re seeing dwelling investment picking up, that’s sort of how monetary policy works. It provides support to interest rate sensitive sectors and the housing market is one of those. That typically has knock-on effects to other things like household consumption. So monetary policy, I think, is working. You know, are we concerned about it? Well we’re always careful to watch these sorts of developments and we’ve been at great pains to always tell people that when you’re making investment decisions, make them with great care. Don’t assume prices can always, will always, go up. Don’t assume that the price increase that we’ve seen in the past is a reflection of where prices will be going in the future. And don’t always assume interest rates will stay low for the length of your loan. So those are messages, I think, we’ve been saying for a long time.