Transcript of Question & Answer Session Monetary Policy Transmission – What's Known and What's Changed

Thanks Chris, very long more complicated talk than I'm used to, but just looking at all the pictures and thinking about the last decade, the thing that strikes me is the great degree of stability in most of the pictures that you showed; the savings ratio, the last picture that you showed and so on. The liabilities pictures, let's suppose it's true that there is this great degree of stability, and then given that you've been focusing on 100 percentage basis points changes, the question that I would ask, which you may not quite want to answer, is it all suggests that a quarter, 25 per cent basis points isn't going to do much or putting it in other words strongly that monetary policy has run its course and roughly speaking its impact has been pretty weak. So monetary policy has run its course and its impact has been pretty weak. Now obviously you won't want to answer these questions directly but maybe you can look at me and wink occasionally and I'll get the message.

Well Bob unfortunately we're not back in labour economics just in your office with just a few of us and there are cameras here. No look I think it's a question that's worth addressing. This is a little bit the point of my conclusion that my sense is monetary policy is working but it's working against some pretty strong forces in the other direction. It's true any 25 basis point move has a fairly modest effect by itself but the cumulative effect of many of them done since late 2011 starting just before I came into this position, they are working and we do see effects there, you're right maybe we haven't seen a bit pick up in consumption and only a small fall in the savings ratio, but they're not totally out of line with historical experience. In some ways this was a very special period and one that really wasn't sustainable it was just this household sector absorbing much easier access to credit than they'd ever enjoyed before and pushing up their debt to higher levels, and then as you say for about 10 years being reasonably stable in the scheme of things, and that's fine. Interest rates are working because we've had a number of those 25 basis point sort of reductions that have accumulated over a long period of time and I think if we imagined, we try to imagine and indeed you can put the results in sort of models, what the economy would be looking like if we hadn't done any of that, and it's very hard to pin down particularly things like the exchange rate and the like. But I think it would be a very different situation, we'd have much weaker demand, no doubt much higher unemployment, weaker still wage growth than we've got, wage growth is pretty weak. So I think you're right any given sort of minor fall is hard to sort of see through with these models much of an effect, but we've accumulated quite a few of these and more than just a 100 basis points, so let me stop there.

People should feel free to put their hand up in advance for questions, we can have a sort of overlapping generation kind of thing in the back row, the young people have a microphone while the other people are asking questions. There must be more questions.

Thanks Chris I was wondering if you could comment a bit on the implication of lags for the making of policy. I'm sort of struck by on the one hand academic literature which talks about monetary policy having long and variable lags of something like 18 months to two years and your chart suggested the main impact is after about a year. On the other hand when the media talks about the Reserve Bank making monetary policy it's often in terms of they'll move interest rates and they'll wait two months to see what impact it's had and then they'll decide if they want to move more, which would seem to suggest the media thinks the lag is more like sort of two weeks, rather than sort of one or two years.

Well some of that probably comes back a bit to Bob's question, thanks for that question John. Lags yes long and variable. This model, the DSG sort of results they often suggest slightly quicker responses than you might get in some other estimates, although I don't want to get too technical but I'm sure there's enough economists in the audience that will grant me some licence to get a bit technical. Some of those other models, things like structural VARs for example, what do they do? They often assume, and they identify the effect of monetary policy by assuming it doesn't have an immediate effect on a number of variables, so they almost bake in a delayed time frame. I think it's still reasonable that these effects build over time whether the exact peak is within a year or takes a bit longer, 18 months maybe even two years, probably within the realm of uncertainty if you look here even at this chart within the DSG model, the sort of the wide range of estimates between the sort of 95 per cent confidence range is a pretty wide one, so that would accommodate many possibilities here.

So I think they're long and variable, this model's a bit shorter than some, it's a bit hard to pin down. In terms of the point you were trying to make about that focus which is over quite a long period of time and other people's focus on you've moved, you've observed what's the next decision if any within a few months? I think what that's recognising though is that any given small movement, and central banks tend to move when they can and when sort of things are evolving gradually in fairly measured steps try and observe a few effects, you can't observe a lot directly on monetary policy, but it's also more a sort of getting a better sense of well we're right in thinking the economy was moving in this sort of direction when we made that early decision or have things weakened further or strengthen further and looking for those sorts of indications to say does it need a little bit more or can we hold steady for a while. I think that's how you sort of put those two observations together.

Gentleman on the aisle.

Thanks for your talk Dr Kent it was illuminating. I just wanted to get your perspective on perhaps how the structure of the economy had changed, for example the financial sector. So the way I'm envisioning this is perhaps there's a change in the cash rate and as you mentioned ordinarily we would expect players in the financial markets to adjust their expectations with the future time path of interest rates, now what I'd like to ask is, is there any evidence that this path or this mechanism has remained the same over time? So we've got banks which are increasingly exposed to overseas markets and wholesale funds markets abroad, so does this weaken that aspect of the transmission of monetary policy?

I don't think it does, if you look at the evidence, changes in the cash rate they don't need to move one for one through to say borrowing and lending rates that businesses and households observe in the economy and indeed well we often hear when they don't particularly over the course of us cutting rates we hear a lot about times when the full cash rate reduction hasn't been passed through to customers. We don't hear quite as often when they pass through more of it and sometimes that happens as well. Indeed if we go back to this period, this big transition in debt levels, one of the things that was happening, one aspect of the easier access to credit was a big reduction in margins charged on housing loans over things like the cash rate, over a long period of time, so that was increased competition in the financial sector which can often drive a difference between the cash rate and the borrowing rate that households face. But more or less over recent years you know they're not one for one the pass through to the rates that people care about from the cash rate, but ostensibly you know they do move pretty closely. There are times like during the GFC when there were these pressures, these offshore pressures and changes in wholesale markets that were putting pressure on the banks that meant they weren't passing through in quite the same degree of precision but the Board can account for that when they're setting the cash rate, so more or less moving as you'd expect and pretty closely.

Okay so then would I be right in saying that you get as much bang for your change in the cash rate now as you have in the past?

Ah yeah more or less I think, I think that's a fair comment. There's a hand up down here.

Thank you Dr Chris Kent for your interesting presentation. I think initially you mentioned that it seems that monetary policy is less and less effective over time, and I totally agree with that, using time varying parameter, VAR model. With not only Australian data but also US and UK and Canada data I totally agree with that. But my question is, is that one, one of the contributors to the fact that the cash rate or interest rate is decreasing over time for all developed countries? And given that fact then do you see any prospect of Australia going into a zero lower bound like in Japan and the Euro countries and does it mean that the liquidity trap is seeing right or can be seeing in the next one or two years or something like that?

Well I think I agree with some of your question the premise of it but certainly not all of it. I think the evidence for Australia is if you use fairly course or aggregate macro models it's hard to find evidence of a significant change in the effectiveness of monetary policy, the transmission mechanism seems more or less the same, at least statistically with the data that we have to hand. And then I suggested a few reasons for possible changes in households behaviour that might suggest maybe it's a little bit less effective than you might of thought given earlier history particularly with regards to debt and consumption. So that's the first thing. But I think the part of your question that I do agree with is that rates are very low and have been very low around much of the world particularly in the developed economies but that reflects some very adverse effects flowing from the global financial crisis with very weak financial systems and, for example, in the US households are going through a significant deleveraging deciding that they were just carrying too much debt and financial institutions being very much weakened and the public sector having to step in in these countries and rescue and bail out the banking systems. Financial crises are not good things to have for growth and those I think are the essence of why rates are so low and have hit the zero lower bound in these countries. Prospects of that here well let's hope we can avoid those sorts of extreme circumstances in so far I think we've managed to do that, part of the reason is I think we have a pretty flexible economy, we also have despite what I've said about the exchange rate, the exchange rate has been flexible and it has been moving lower as we've been facing these negative forces of lower commodity prices of late. So certainly you can never say never and our forecast we're the first to say how imprecise and inaccurate they are, we do that by having these very wide bands around the sort of central path that we publish and that just recognises that many things are possible but I don't think it's too likely but never say never but again I think rates are very low here because of these other negative forces not because monetary policy is less effective so much but just because there are these other negative forces and those other negative forces are much, much more substantial in some of these other countries that you talked of.

You mentioned that your liaison was telling you that there were problems with supply of available land for I think new apartment dwellings and more generally there was a shortage or the amount of land that's available in the city seems to be particularly low, do you have any explanations for why that might be? Is there land banking going on perhaps by foreign investors, councils not doing enough to make land available, is there some sort of structural impediment in place? And perhaps a second element to that question would be there are various sort of things that people blame for the affordability crisis as some people call it, stamp duty being one and negative gearing being the other, how do you see those three things sort of playing together in effecting prices on houses?

This chart's useful but we should take it with a little bit of a grain of salt because it's just saying what amount of supply is there on the books at the moment available for sale as a share of what's being sold the previous year and if you've been selling a lot the previous year which I think we have, you run down the stock that's there. Councils of course can chose to going through their usual processes add to that but that could be a slow process if its facing a pretty significant increase in demand for land. But having said all of that, there has been a pickup in construction and building approvals are at very high levels including sort of brown fill developments in cities, Melbourne and Sydney stand out but elsewhere Australians are building more higher density apartments than they were in the past, so that's partly in response to people wanting to be close to the centre of cities, partly because of these supply constraints, partly because the price of land is very high. I don't really have much to say about stamp duty, let me say a broad or negative gearing, let me just make a broad point that it's quite often an easy I think for people to focus very much on the demand side of things, anything that makes seemingly any individual better off in terms of more money in their pocket to spend on housing, at a time when demand is fairly strong and maybe the supply is not as responsive as you might think, that's going to just push prices up.

And the other thing just let me finish with a quick fact that I don't think many people are appreciative of, house prices are growing a bit faster in I think most cities around the country than apartment prices, that's because apartments, we have actually been supplying a whole lot more of them, building approvals for higher density apartments have really picked up quite a lot, so supply and demand is kind of working on that front.

Thanks Chris. My question relates to something that Ben Bernanke said the former Fed Chairman said after he left, it's not with regard to what he said, but he made the comment that the Fed had to go very hard on monetary policy because he felt that the fiscal response was inadequate that was his comment I believe. Is this something unique to the US or is there this sort of dance to the extent that you can comment on it, is there this sort of dance in Australia between fiscal and monetary policy like we might observe in the US?

No I mean I wouldn't say that. We've noticed that there is fiscal consolidation that has been occurring and we plan you know the budgets of State and Federal Governments have more of that coming down the line. It's fairly gradual, it hasn't changed much of late, indeed moving from the budget last year through my MYEFO and then to the budget we've just received, sort of the deterioration in the fiscal outlook reflects weaker commodity prices, weaker wage growth, and they've let that flow through the bottom line without sort of tightening up in the near term too much, so that's letting the automatic stabilisers work, that doesn't have a big implication in terms of having to adjust forecasts. When you've really extreme levels of debt as you have in parts of Europe and I wouldn't call them quite as extreme but high levels of public debt in the US, there comes a point which you sort of feel compelled to try and address that and as a macroeconomist you sort of feel like well do that in the future when the times are better but it's hard to convince markets and to convince the public that you're actually going to do it unless you do it to start with a bit now. I think what we're seeing here is not excessive in the history of fiscal consolidations that we've seen I the past and the Bank rightly so takes fiscal policy as given and tries to respond just as we take the exchange rate that the financial markets hand us as given and respond or what's happening on the mining investment front and try and respond as best we can.

Thank you very much again for your conversation or your talk. I'd just like to go to the lending where people are paying more off their loans and higher percentage of loans that are being paid off. I just wonder, do you think that when rates begin to rise again whether or not you'll see that reversed or whether or not there will be a floor sort of put in with a change of human behaviour slightly and whether or not with GFC sort of fresher in people's minds whether or not that might actually reach a level and then stay there or whether or not it will come back down people will start feeding into their or using their redraw for consuming once the rates start to rise again or whether or not it's perhaps a new normal?

It's possible but I wouldn't necessarily fully ascribe this to fully ascribe it to interest rates. I think what's happened in households minds is they've observed perhaps lower income growth than they had been used too, wage growth as I suggested is certainly lower, the unemployment rate is high, that makes people feel uneasy and for a lower wage growth a fixed nominal debt is bit harder to pay off than it might have been in the past. And in response to those weakening conditions which the Bank's responded to via low interest rates, some people are saying I'm a bit uncomfortable with the levels of debt, maybe I'll try and make some in roads and low interest rates help them do that. So I think what you're sort of suggesting is that the cause starts with interest rates and then goes here directly, whereas there's this other factor that's sitting in there behind it and so when we think about a time when interest rates will ultimately some time off in the future as the economy strengthens ultimately normalise that is going to presumably come with it more stronger wage growth, maybe a reduction in unemployment. So those better conditions might make people feel comfortable holding the debt levels at any given debt level and its interest rates responding to that that's the way I think about it, maybe I didn't explain that so clearly but I think you've got to think about these other factors and that's the essence of what I was trying to say in my talk there are these other forces at work.

Chris, how do we marry your comments that the transmission mechanism is more or less working at least we can't be sure that it's not working, it seems to be working, with those of the Governor last week, who said the marginal effect of interest rate cuts maybe smaller from here on the lower interest rates go from already very low levels. Is what the Governor said a forecast of what might happen, in other words, of this relationship deteriorating or how do we put your two views – yours is entire speech his was just you know paragraph of a speech but how do we put them together?

Well I think the first thing is to note as I did maybe if things have changed, if it is becoming a little bit less effective monetary policy that is, it might be a bit hard to know statistically, so that's the first point. The second point I think is I was very much looking at what we've seen to date and his was a comment about what might happen in the future if it was needed to see further cuts and one of the sorts of things that both he's mentioned and I have mentioned in my talk was this behaviour by those who are earning and perhaps reliant on assets which earn them interest, bank deposits, so it maybe that for various reasons they're just unable or unwilling if they feel rates are very low and likely to stay low for a long time to eat into their savings maybe they don't want to or can't access capital gains if they're lucky enough to have a house. So it may be that's the sort of household that may be responding a bit differently now just because rates have been low for a long time, but I don't see them as being inconsistent. Mine's talking about what can we see statistically using macro models that aren't very precise, looking back at the past, his was a comment as much as anything about what if they were lower still from here what might we expect, and it's hard to say but here's one possible aspect where things might be a bit less effective than you would have thought because your own peer impairing the incomes of a non trivial part of the populous.