Transcript of Question & Answer Session The Next Chapter

Dr Philip Lowe, thank you very much for that very important speech with such an important title, ‘The Next Chapter’, and I know you've kindly agreed to talk to me, and you've kindly agreed to take questions as well from the audience. So, I hope as many of you as possible will have some at the ready in a short time. Philip Lowe, I was amused that you admitted that you weren't actually going to say very much about monetary policy. Of course, that's what everybody is focused on in the markets. You said that you didn't think that monetary policy has much influence on the economy's potential growth rate.

Ultimately, growth in the economy is driven by productivity growth and labour force participation. Monetary policy can't do very much about either of those things, so, in recent years, central banks globally have taken the mantel for supporting economies. But ultimately, growth comes from decisions made by the private sector, not from the central bank. And this is a point that I think it's kind of good for people to understand. We can do a lot to help the economy, we can support it, we can help it adjust to shocks, but the central bank can't drive medium term growth. It's private business that can do that.

Productivity growth was something you mentioned, and how important it is. How can productivity growth be cranked up? Because it is the key to your concerns about wages growth, isn't it?

Yeah. Well, the Productivity Commission currently has a review. They're doing these reviews once every five years and they're midway through the first review. But the obvious areas to be looking at are taxation policy, education policy, labour market issues, competition policy. So, there's no shortage of good ideas here. The problem is getting the good ideas through the political process. So I don't want to advocate a particular policy, but these are the areas and I know the Productivity Commission are working through these and thinking, well, ‘what are the things that we could really do to make a difference?’

You, earlier in the year, enthused about workers pushing for higher wages, almost from the ground up, but afterwards followed up by saying there's got to be productivity as well. To what extent should we, should business, be looking at higher wages?

Well, I think in the medium term, what type of wage growth should we expect to see in Australia? Well, we have delivered you average inflation of 2.5 per cent, and I would expect that labour productivity could grow at least 1 per cent a year. So, 2.5 plus 1 is 3.5. So, if the labour share of national income isn't going to continue to fall away, then wage growth over the medium term should be able to average 3.5 per cent. At the moment, it's kind of averaging 2. Partly that's because productivity growth is a bit lower than it normally is, but that's not the main reason because the labour share of national income at the moment is the lowest in 50 years.

So, whatever productivity growth is occurring in the economy, at the moment, workers are not getting their traditional share of that, and so the market share continues to rise. So, the point I made earlier in the year wasn't for workers to rise up and demand bigger wage increases, but it was a more general point that I think our economy, and more importantly, our society, would benefit from economic growth being more broadly shared, and that includes, over time, stronger wages growth. To be something more in-line with what we'd expect to see over the medium term because the lack of wage growth is hurting household budgets, but it also means that many people feel that the benefits of growth are not being widely shared, and that's a problem economically and that's a problem socially as well.

The market has priced in, I think, two rate rises in the next 12 months from you. I'm wondering, how much wages growth you would really want to see before you start being confident about raising rates.

Well I don't quite see a direct link between wage growth and future decisions about monetary policy. For many years, we've had an inflation targeting framework and we make the decisions in the context of that. We want to deliver you 2.5 per cent average inflation and economic stability. So that's the framework we use when making these decisions. But, with the current rate of wage inflation of 2 per cent, we will have trouble delivering 2.5 per cent average inflation. So we'll need to see wage growth pick up. This is a global phenomenon. I go to a lot of international meetings, and this is the most common question that I'm discussing with my peers, the governance of the other central banks, why wage growth is as low as it is; especially in economies with very strong labour markets and low unemployment rates.

I noticed Governor Janet Yellen said overnight, on a similar sort of issue, ‘What we need to figure out is whether the factors that have lowered inflation are likely to prove persistent. If they do, it would require an alteration of monetary policy.' What do you think she means by that?

Well, I suspect she's reflecting on the same issues we were just discussing. Inflation is low everywhere. If you take the unemployment rate, on average, in the US, Germany, Japan, the UK, the four biggest industrial economies, it's the lowest in many decades. So, we've got the opposite issue to what we had in the 1970s where we had high inflation and high unemployment. We've got very low unemployment rates and very low inflation. It's a good issue to have, but we've got the very low inflation rates because in many countries, wage growth is very low.

So you see those two things are very much linked. If you get wages growth back, you will get inflation following.

I'm sure that will happen. Inflation can be driven by other things, commodity prices are important and we're seeing here, kind of, higher electricity prices as well. But if you look right around the world, the low increases of inflation are coming about because of low wage growth. I think she was probably reflecting on why that is. Why is wage growth so low? Because, if you're beyond full employment, you would expect wage growth to be picking up. But something's going on in country after country that means wage growth is low. My primary explanation is that we all feel there's more competition. We're worried about competition from foreigners and from the robots and when any of us is faced with more competition, we're less inclined to put our price up. I think that western workers feel that there's more competition out there and so the price of labour is not going up very much. That's changing the inflation dynamics in many economies and that has implications for monetary policy as well.

Philip Lowe, another area I know you're very focused on in Australia is household debt. Now we've recently had reports of mortgage delinquencies hitting a five year high in May here, according to Moody's. S&P data revealing the proportion of Australians behind on mortgage payments also ticked higher. To what extent does this worry you?

It's ticked higher but I think we've got to keep some perspective here. The loan arrears rates in Australia are still very low. They're very low globally, and they're quite low relative to our history. They've increased a little in the last year, but they're still very low. Households at the moment are coping well with the level of debt they've got. I think the issue is an environment in which interest rates are rising or the unemployment rate is rising. That's going to be more of an issue. But I think as things currently stand, households don't like all the debt they've got, but they're coping okay with it.

The other matter that's come up recently is the rise of liar loans which were obviously a very important issue with the United States. We've got a financial system here apparently sitting on $500 billion worth of liar loans. Does that worry you, that Australians are vulnerable to that? Should rates rise?

I don't want to kind of endorse that particular number as being accurate or not, but one of the things that we work very closely with APRA on is the loan assessment standards that banks are using. A couple of years ago, there was a weakening in credit assessment in financial institutions and these loans you're talking about might have been part of that process. In the last few years, there's been quite an effort by APRA and by the financial institutions themselves to tighten up, and we've seen this in a number of dimensions. We were worried a few years ago about the decline in credit standards. I think that's been reversed now. There may be some loans of not very good quality sitting on the balance sheet but the systemic issue I think has been addressed.

And what about people's ability to afford a mortgage going forward, given all these other costs around? We've saw the ACCC's Rod Sims talk very gravely yesterday about the tensions that some of the more vulnerable families have between paying their electricity bills now or paying other things like the mortgage. To what extent do you see this energy crisis impacting the Australian economy?

Well, it's having an effect on household budgets, and particularly for some households, but overall, the cost of the standard basket of goods and services that people buy is only rising at 1.8 per cent a year. And, over time, we would like it to rise more quickly than that because we want the average inflation rate to be 2.5 per cent, not 1.8 per cent. So, the issue, I think, is not the increase in the cost of living, although higher electricity prices do hurt some people. It's the lack of income growth. That's the thing that's unusual. The rate at which the cost of living is rising is actually quite low relative to our recent history, but the growth in income is even lower.

So the higher electricity prices are kind of creating budget constraints for some households. They're making it more difficult for industrial firms that have higher use of electricity to compete internationally, so that's an issue. They're also creating a more uncertain investment climate. So, the generators are not obviously investing, but it's also effecting investment decisions by firms that use a lot of electricity. So, we see this now, liaison program …

How buoyed are you by the jobs numbers recently?

Well, it's been unambiguously positive. I mean, we've had very strong jobs growth, 2.75 per cent over the past year. The participation rate is rising again, so people are coming back into the labour force, they're seeing opportunities there and are starting to look for jobs and by and large, they're finding the jobs, so this is a positive development. Last year, we were worried that all the jobs growth was part time and very little full-time jobs growth and that's turned around. There's been strong growth in full time jobs.

What about when you're having to look at different states, different parts of Australia going at different speeds. We're here in the west. How do you see Western Australia's ‘road to transition’, if you like?

I see light at the end of the tunnel. I mean, it's been a very difficult few years. We know that. But we see the turnaround in a couple of the charts that I showed, we see that employment is actually now rising again in Western Australia after it had been declining. The survey measure of business conditions has improved. We hear in the resources sector things have improved in a number of areas. There's more sustained investment going on and even in exploration there's more activity going on and that's having spinoff effects through the professional services firms. We see the light at the end of the tunnel.

So, to what extent, once Western Australia does pick up, can a 1.5 per cent cash rate still be justified?

We'll make those decisions again in the context of our medium-term inflation targets. It really depends upon how inflation's going and what growth in the economy is like. So, at the moment it's hard to see inflation being above 2.5 per cent anytime soon at the current level of interest rates. So, we'll have to keep assessing that each month as we do.

Phillip Lowe, thank you very much for talking to me.

Thank you.

Now, can I open up please to the audience. Who would like to shoot a first question? One over there. So, please state your name and where you're from.

I just wanted to follow up on what was said about Janet Yellen. If the economy grows well and it grows above trend, unemployment starts to come down and you're getting towards full employment, or you're getting confident about that, and inflation is still stuck low. I mean, you said you weren't inflation nutters. Would you be prepared to ignore that inflation if that was the case?

Well, we've been prepared to be patient. Some central banks with a narrower mandate than the Reserve Bank of Australia might have been prepared to have even lower interest rates to get inflation to come up. The Reserve Bank's mandate, which was written in 1959, so a long time ago, is basically full employment, price stability, and the general welfare and prosperity of the Australian people. So, it's a very broad mandate and for much of the past 20 years, that type of broad mandate was unfashionable in central banking circles. I think it's a fantastic mandate. It's meant that we've been able to take our time in getting inflation back to 2.5 per cent, because we haven't been like some other central banks, whose only job is to get inflation back to their target. I didn't really answer your question. We're prepared to be patient.

I'm confident we will get back to 2.5 per cent inflation. I have a seven-year term. I want inflation to average very close to 2.5 per cent over those seven years and I'm confident we'll be able to do that, but we're in no rush. We don't feel kind of a need to get it back as quickly as possible. Particularly if the cost of getting it back quickly is even more borrowing and higher asset prices, which in the last year or so, I thought, would be the price that we would pay if we sought to get inflation back more quickly. would be more borrowing at higher asset prices, which in my view wouldn't have been in the national interest. So we've been prepared to be patient and we will get back there, but it will take us some time.

All right. Anyone else? Yes, ma'am.

Are you comfortable with the market's view of the pace of rate hikes at the moment?

Well, I think the market pricing, there are two elements to it. One is that it's more likely that interest rates are going to go up than down. I would agree with that. And the second is that it's some time before an interest rate increase is likely to occur and I would agree with that. The market pricing moves around from day to day, but those two points are right, I think. More likely the interest rates will go up and, although not for some time, people should prepare for higher interest rates. They're rising globally, and if things work out well here, over time, I'm not saying when, but over time we can expect higher rates and, in my own view, that would be a positive development for the economy.

So, the only way is up, basically.

No. I wouldn't say that. There are scenarios where I could imagine having to cut interest rates. I hope those scenarios don't eventuate though. I think we will be better off, and people don't like hearing this, but we'll all be better off if the next move is up rather than down.

Indeed. Another one. Yes, ma'am, in the middle.

Hello. I just wanted to ask probably a tricky question, but it's not something you hear much about. Do you have a view on some of the less traditional movements of wealth that are going on at the moment? So, things like cryptocurrencies, et cetera, and how you see that emerging in the future and the impact on monetary policy?

I don't think I it has any immediate implications for monetary policy. Most of the cryptocurrencies, as far as I can see, are really ways for people to do speculative investment. Sometimes they buy these currencies to do transactions in the black economy or the illegal economy, but more often they're people buying them to speculate on the price of the cryptocurrency. So for monetary policy, there are no direct implications. I think one of the issues we're looking at is in the future, if there will be a digital Australian dollar. I don't know how many hundred years back, but people used to use clam shells, for kind of, as a medium of exchange, and then in the state where I live, they used rum for a while, and then we used paper bank notes and now we use polymer, and I hope you've seen our new polymer note that came out yesterday.

So as technology evolves in the world, the medium that we use to exchange value changes. It's possible that in the future, people could want to exchange value through electronic tokens on their mobile devices, and those tokens could be issued by the private sector or by the public sector, by the central bank. So that's kind of a digital form of Australian dollars. We don't have any immediate plans to do that, but it's something that we're looking at and it's certainly possible as technology opens up new possibilities.

But you see it as more of a speculative play and that's why China has actually cracked down on it?

Yeah, it is very much a speculative play. I was just in Basel the weekend before last and it was one of the other issues that we were discussing, there was wage growth, but also the cryptocurrencies and the financial speculation that's taking place and in China. It's a big issue, in Russia it's an issue and in some European countries as well. My understanding is that it hasn't been that big an issue here, but it's really an investor protection issue, not a monetary policy one.

Next one. Down here. Do state where you're from as well. Thank you.

Governor, thank you for your speech. I wondered what you thought were the likely growth sectors in the coming chapter and whether you'd be willing to take a stab at who will win the AFL Grand Final.

Well, after the Sydney Swans lost, I've lost interest in it a bit.

That's a tragedy. Me too, me too.

The likely growth sectors, well it's a bit of everything, isn't it? So, the story for the last decade is really that the economy has been driven by the resources sector, so I don't think that's going to happen again. But it's really the services sectors. 70 per cent of us work in services. So, it's going to be right across the industries. It's very hard for any of us, particularly a public official, to sit here and say, ‘Well, that's going to be the growth sector and that isn't and that one is.' I really don't know. It's really up to private businesses to take the decisions. But I think the general point I was trying to make is that whatever industries grow very strongly in the next chapter, I think the basis for that growth will have to be accumulation of human capital.

In the world we're living in, with the growth of technology and global competition, if we're going to have ongoing growth in our living standards at the rates we've become used to, it must be because we can develop our human capital and, with that, capital in place. Whatever industries grow will have the skills to do it.

Yes. Steven Smith.

Governor, the two most encouraging words I saw in your presentation were the words India and Indonesia. Australia and Western Australia have done very well in terms of prosperity historically because we've been a great trading nation and a great trading state, but also attractive places for overseas capital investment, and historically you've seen that with UK, US, Japan, Korea, China. But where are the next big licks of trade and investment going to come from? They must come from India and Indonesia, but at the moment, our trade and investment levels with Indonesia, despite the best efforts of governments over decades and private industry over decades, are frankly lamentable, and it's very hard to break into what will be the third biggest economy in the world in pretty short order, India. So, what more do governments and private industry need to do to make sure that our prosperity doesn't decline, by getting a share of the Indian and Indonesian trade and investment markets?

Well, I'm not particularly well-equipped to answer that question, but I agree with the premise that in the next 20 years, growth of India and Indonesia could be very substantial. Living standards there will rise. The relative size of those economies will increase, and we have a great opportunity to take advantage of it. I think in the last two decades, we've paid a lot of attention to China and that's been appropriate. The development of China has been to the great advantage of Australia, but I think in the next 20 years, the development of India and Indonesia for us, could play out very similarly to the benefits we've got from the growth in China and how business and government best takes advantage of that, I don't know. My feeling is that it's important we find the answer to that question. People in this room are better equipped to answer that than me.

Yes, sir, in the middle here, and then one over there.

Philip, thanks for coming over and thanks for reassuring me that your attitude is not socialist. It's been quite refreshing. My grey hair gives me away, I do remember the last major productivity crisis in Australia came to a head in the early to mid-80s, under the Hawke-Keating regime and the most influential area that was addressed to change that was industrial relations and that wasn't even part of your conversation, perhaps you'd like to comment on that?

Well, we need to have an industrial relations system that encourages a flexible, adaptive, innovative workforce. My sense at the moment is that, if you could only do one thing, changing the industrial relations system would not be that thing. There are other issues for us to focus on. So the various aspects of the taxation system, competition policy, the way we go about accumulating human capital and the incentives for innovation seem to be the key areas we should be working on.

After all, our labour market has done pretty well. At a macro level it's done well for the past two decades. The variation in our unemployment rate in Australia, despite the biggest mining investment boom in a century, has been quite small. Our labour market has helped us ride through the various shocks. That's not to say that it's working perfectly, but broadly it's worked okay. I think there are other areas really, if you only pick one or two to focus on.

Last couple. One over at the back and one there.

I've just been to Sydney to the AFR Innovation Conference over the last two days. You've mentioned innovation a couple of times. Would you like to expand on the importance you see for innovation?

Well, I don't think I've got that much more to say, other than in response to the earlier question. Growth in the future must come from doing things better and smarter across the whole range of service industries. And how do we do that? It's only if we've got an innovation mindset. Government has some role to play in creating the environment for that, but it's really down to private business and the way they operate. How we actually do it, that's not my core area of expertise. I just have a feeling that if we're really going to really do well in the next 20 years, my kids are going to enjoy a better standard of living, it's going to be because we've become smarter at the way we do things and we can breed innovative and adaptable companies. For much of our history, it's been the natural resource base. The resource base we need to build on now is the one that's inside our heads.

And over here, sir.

It's a question that would have been a wild hypothetical a year or two ago, but it's sadly real now. Has the RBA put its mind towards what would happen to the economy in the event of another Korean conflict and what sort of levers would you see the RBA having to pull in the event of a situation like that?

Well, I don't want to speculate on that because it would depend upon the nature of the conflict and how large and damaging it was. Obviously, I'm saying kind of the obvious here, it would not be good. But beyond that, there are certain things that monetary policy can do, and there are certain things it can't do. If there's a huge regional military conflict, there's a limit to what the Reserve Bank of Australia can do to ameliorate the effects of that on the economy. But we have the standard tools at our disposal, including liquidity support and interest rate policy and, kind of, being a source of calm reason in the economy. If you've got a major military conflict, those things are probably second order relative to other things going on.

Well, Dr Philip Lowe, it's been great. Thank you for talking about The Next Chapter. Thank you for sharing those views, and for taking all these questions. You've been very generous with your time. It's lovely to have you over here. Thank you very much.

Well, thank you, and thanks for the opportunity to be here in Perth.