Transcript of Question & Answer Session Lessons and Questions from the GFC

Guy, thanks for such a timely and very topical speech. I think you might have set a record there by somehow getting the plumbing of the banking system wrapped up in album covers as well, unless you've delivered something similar before.

I have before.

Oh, you have? Okay. Well, I thought it might have been a first, but it wasn't, so look, Guy's agreed to answer some questions from the floor, so we've got two microphones. There's one here and there's one just here, so if asking a question, can you please state your name and your affiliation, and keep your questions short and to a point. Stand up there.

Thanks, Guy, for those remarks. They were great. You spoke about the idea that the RBA's still got flexibility and the idea that the RBA could still cut the policy rate if they needed to. For the last few years, or for a number of years of now, we've had inflation that's been below the middle of the Reserve Banks' target band, and one of the arguments for not further cutting interest rates has been that the RBA has a three-pronged mandate, including the welfare of the Australian people. And that's been one of the reasons that's been put forward for not easing policy further. Household debt was rising quickly, the housing market was inflating, and the concern was that overleverage might be a challenge. Now the housing market is cooling and housing credit growth is slowing down. Has that changed and how should we think about the inflation target and the RBA's inflation targeting mandate relative to that third mandate of the welfare of the Australian people in terms of thinking about the policy setting going forward?

I suppose I would just mostly would look and say the reaction function is pretty much the same which is: where do we expect the real economy and inflation to be in a couple of years' time? And the forecast we put out a few weeks back have inflation increasing and unemployment … well, unemployment is five now. I mean, I think, and to your point, if you go back two years ago and said unemployment's going to be 5, inflation is going to be 2 or a fraction below, GDP growth is 3.5, what would your policy setting be? And you'd probably say keep policy unchanged. So if that was my expectation back then, which was around about what it was, then that's what the policy conclusion would have got to.

So moving forward to today, we've got unemployment at 5 and we think it's going lower, we've got wages picking up, albeit gradually, and inflation's a bit low but expected to pick up as wages pick up, then that still leaves me with roughly the same reaction function and roughly the same reaction.

So the additional piece of information we got yesterday, of course, was that the GDP number surprised …

You get to ask multiple questions? You can, you can, but I thought that was Mr Robertson's bailiwick. Anyway, keep going, go ahead, go ahead.

The additional bit of information we got yesterday was the downside surprise to GDP of course, and the fact that there was a weaker consumption growth than was generally expected, so that bit of the story you just described I guess has come out differently to where the RBA, the way the RBA was forecasting as recently as the last seven numbers.

Yep.

So how has that affected the view at this stage?

Yep, so as you say, consumption was weaker than expected. Everything else is pretty much as expected, so I mean, this is a question of seeing how that goes, and we'll see how that goes over the next few months and reassess accordingly. Mr Gillespie?

So I'll ask a question about the US and let you relax a little bit, I guess. So looking at where the next problem is going to come from, we've had Yellen out talking about leveraged loans. We've had Powell out talking about corporate debt being quite normal for this stage of the cycle and not a concern, but there is an awful lot of focus on the US corporate debt picture. Investment grade debt has risen 100% over the last decade. Corporate debt in emerging markets has risen 300%. This is quite what we would have expected after 10 years of QE and zero interest rates. People have run to every corner of the world chasing yield. Haven't they just fanned another bubble again with low interest rates and we're just about to watch another credit bubble burst, which this time's going to be in the corporate sector?

It's not obvious. It comes back to a question I had there at the end there how much is enough. It's not obvious to … I mean, as you said, the US debt, corporate debt level, sorry, have gone up, not obvious to me that they're excessive. Leverage loans have gone up. They're actually still pretty small in the overall scheme of things. I mean, it may be a problem for those who have bought them.

I think one interesting thing on that is the leverage … this comes back to something I said during the talk. So leverage loans are not on the books of the banks, at least not unless they did what the aforementioned UBS did and sold them out one end and bought them in the other, but assuming that hasn't happened, and I don't think it has, then it's on the books of asset managers like yourself, and then it's partly a question of … not saying you guys have them, but it's partly a question of what … from a financial intermediation, sorry. In terms of keeping credit flowing, that's a good thing or a better thing at least in that if there is a problem there and it's sitting on the books of the asset managers rather than on the books of the core banking system, then that may help keep intermediation flowing, so that's one difference now compared to what it was 10 years ago.

That's probably also true for emerging market debt. It's sitting on the books of asset managers and the like and not on the books of the banks. That does I think have implications if something goes wrong with how things might unfold and how that might actually affect economic outcomes. The debt's gone up, that's true, but it's actually being held by different people now than it what it would have been a decade or so ago, and that potentially has pretty important implications for how they might actually play out should things actually go bad, not that I'm necessarily expecting them to do so.

Thanks.

Guy, you mentioned my name, and I thought it was sort of like a cry for help. You wanted me to ask a question? So one of the lessons, I think the fourth lesson from the GFC is keep the credit flowing …

Yep.

The latest Australian housing credit number I think for October was 0.3, and except for some crazy wiggle in 1984, that's the weakest reading in 40 years. How do you keep the credit flowing? The standard way to do it is to cut interest rates, and that's been off the table recently. Is it credible to sort of watch the Australian house prices trend lower, housing credit growth trend lower, and keep saying that the next move in rates is up? Is there any other way to sort of keep the credit flowing? Is there any way …?

I mean, we don't lend. Banks lend, and I think that's relevant here. So the price of new credit is actually sort of roughly going down as best as we can tell. There's a few things going on. One, lending to owner occupiers is growing at about 5 to 6 percent at the moment. Lending to investors is flat, and that gives you the number that you just said, so there are some parts of the household sector which are still borrowing. Lending by the major banks is slowed to the lowest it's been in a long time. Lending by the non-major banks is as fast as it's been in a long time. Now, one's a bit bigger than the other, that's true, but again, the aggregate is what the net outcome of all of that is.

So the credit is still flowing. It's flowing at a slower rate at the moment, but that's something we are paying close attention to, to see whether or not it slows further. At the moment, as I said, it's growing for owner occupiers at about 5 to 6 percent, which is, that's okay. It's a satisfactory enough rate of growth of credit, so it's a question of where it goes from here. That's a function as much of the banks' willingness to lend as much as anything else is that the price for new borrowing is sort of flat to down, not up.

So it's not so much an issue of the price, it seems to be an issue of the willingness to lend. There's also an issue on the willingness to borrow. One of the reasons why I think investor borrowing isn't that strong at the moment, part of it's on the supply side, but part of it's on the demand side. When prices are falling, not surprisingly, investors don't rush in to buy. It was like when I was talking about liquidity provision, market making, sorry, in terms of financial markets back earlier is that when prices are falling, people tend not to want to rush in and catch a falling knife. So there will be a period where prices are falling and investors aren't going to rush in and buy until they actually think that the next movement in price is likely to be up rather than down. I suspect that's some part of the dynamics which is playing out at the moment as well.

Is it a risk? Yeah, it's a risk. Is it something we're paying attention to? Yeah. I think the other thing to point out is that we, as best as I can tell when trying to check that this is actually true, what we haven't really seen anywhere in the world is a decent fall in house prices in two capital cities at the same time as unemployment is going down and the economy is going along at a reasonable pace. Nearly all other house price falls have occurred in environments where there's been recessions and the like. This is to some extent uncharted territory in seeing this sort of dynamic play out in an environment where as of now at least, the macroeconomy is travelling at a reasonable pace and something we expect to continue to do so. So that's certainly something we're playing close attention to, yeah, absolutely, and it's certainly a risk to the outlook.

There's a perception out there that macro-prudential caused … the tightening of macro-pru has driven the sort of downtrend in credit growth, downtrend in house prices, and there's a perception that if only macro-pru were eased, you could stabilise things. But is there any real scope for APRA to announce we'll grow investor credit 10%-plus, go crazy with interest-only loans more than 30% of your flow. Is there any real scope for an easing of macro-pru to stabilise this?

So I talked about this at an event about three weeks ago,

So, yes, the slowing in credit, did have, absolutely, something to do with the tightening up in lending standards. That's been going on for three or four years. That's not new. It's been going on for a while. The investor lending cap came in in 2015. It's actually off for most lenders now, so that actually isn't in place for a large number of the lenders out there now.

I don't know how APRA's going to move on other things, but in the end, if the banks have lost, have a reduced appetite for lending for other reasons, then that's a different set of circumstances. But that's true of some, but not all banks. There's a number of smaller banks out there which have an increased appetite to lend. At least, as reflected in the growth of their lending books, so it's not across the board.

As I've said, there are some banks whose books are growing at 10% at the moment, there are some banks whose books are barely growing at the moment.

Thanks very much.

I have two questions, if I can, please. The first is a follow-up on the housing crisis. At what point will it become a concern for the RBA? I mean, we do know that house prices have doubled, between 2008 and 2016, so a 10% fall is fine, and that was something regulators, in fact, wanted. But what is that point where it starts becoming a concern?

Second question is, since yesterday's GDP data, we've seen a change in OIS pricing, as well as interbank futures, which was earlier pricing in a 40% chance of a hike next year and now it's pricing a small chance of a cut. Do you agree with that market pricing?

Market pricing is what, the market? I don't know, this is the market, right? On the house price point, first of all, house price falls were not the target of the regulator. That's an important point to make, so I wouldn't agree with the way you characterised that. Addressing the quality of the credit was the primary goal, and again, I talked about this a few weeks back.

So it's not something which was desired or engineered, the house price falls, I mean, by the regulatory actions. I'm not saying, it's not a consequence of it, but it wasn't the goal, by any means. As you point out, house prices did indeed double in Sydney. Also, I'd like to point out, there are other parts of the country besides Sydney and Melbourne. I know that's often forgotten, but there are other parts, although, with Mr Fabo up there, I should note that, yes, WA house prices are still falling, have been going for quite a while, but there are other parts of the country.

House prices are up 10% in Hobart, over the past year. They're up in Canberra. They're up in, places such as in my old hometown of Adelaide, as well. So there you go. There are other places where prices are rising, but, as you said … here in Sydney, they did double, 100% rise over eight years. They're down 10%.

So they're, as of today, or as of, sorry, the last observation we had, which was October? No, November, now, they're back to where they were in September 2016, here in Sydney. In Melbourne, they're back to where they were in March 2017, and Melbourne's house prices … so, I thought someone would ask this, so I've got all the numbers here, that Melbourne's house prices went up to the 2017, they doubled over a slightly longer period than Sydney, but only about a year longer than Sydney, and they're down 6% now.

So I do think it's worth keeping some perspective around that. They are still falling, and so, it is something, as I said, in answering Rory's question, that is something you absolutely got to, we're paying attention to. Both the lending side, and in terms of what's happening on the price side, and what impact that may or may not have on the economy.

As I said, it's an interesting environment we've got, where we've got on the … the unemployment rate's been coming down, the economy is growing at a reasonable pace. That's not an environment we've seen really, anywhere else before, where house prices are falling. It's sort of, as I said, it's somewhat uncharted territory, and so, we're sort of seeing how that might play out. Justin?

I just want to ask about wealth effects.

Yeah.

As someone that's a bit sceptical about the strength of them, but I just want to know the Bank's view, and you've got this fancy, new … well, it's not that new now, team, called MARTIN, or something like that, which does some modelling, and I'm sure they've been running the numbers.

I'm sure if you've run, kind of the numbers on wealth effects, they might be telling you something a bit scary, in a forward-looking sense, but is that right? Or how are you guys thinking about the potential here for, kind of, negative wealth effects? Or you are a bit more circumspect about it these days, versus, say, 2003-2004?

Now, I think it's a good question, and sort of, first order question. I mean, part of the issue is, too, we have a doubling in the house prices, as I just said, in answering Swati's question. It's not clear how much of an impact they … it seems to have had some impact, but not that large an impact. It's also not clear, so … given, we had such a large run-up, and then, a fall.

Personally, and this is my personal view, and not necessarily not that of the institution as a whole, I always have a little bit of trouble with housing as wealth, because I regard it more as consumption, because I actually live in it, and that's mostly what I'm after. That's relevant, though, when it comes to wealth effects.

If I bought a place to live in … so if I bought at the peak of the market, I might be pretty pissed off that I bought at the peak of the market. If I'd waited a year off, a year later, I could have bought it cheaper. But I've still bought a place to live in, and that's what I'm doing. I'm living in it. And so, how much of that translates into wealth is not so clear. But, that aside, the extent that the modelling tells you anything, is that the wealth effects are generally small. But as I said, it's also hard, we don't have many episodes like we've got at the moment, as well, on which to base it. But it would say that they're potentially a risk, and certainly, something we should be paying attention to, but it's actually pretty uncertain.

I still think we've got to see how that plays out. I think a more, potentially, a more direct channel, is actually if housing turnover's really low, which it is. Not putting aside house prices. When people buy a new house, they often buy stuff to stick in their house. Then, the fact that housing turnover's low, to some extent, to me, that would be more likely to have a more direct effect on consumption, necessarily, than the wealth itself.

Because you mentioned, too, the earlier episode, went into '03-'04, or 2003, whatever. So, back then, one difference between then and now is that, as best as we can measure it, there was housing equity withdrawal back then. At the moment, or, and for the last number of years, there's been large housing equity injection. So that dynamic is quite different this time around than it was back in the early to mid-2000s.

Okay, go this side and then that's enough.

The RBA is constantly being able to pull the levers of the economy from the top down. I just wondered, if you could work it from the bottom up, what sort of piece of advice would you give say, the 6.5 million home mortgage holders in Australia, about what they should do in preparation for the coming years?

Would you say to them, ‘Maybe adjust your savings rate? Ask for more of a pay rise, spend less, spend more?’ What would be the ultimate thing you would like to see from the bottom up?

Oh, I mean, ultimately, I think it's probably … as long as the banks have done a decent piece of lending, they're probably got a mortgage that they can actually afford, in which case, keep affording you a mortgage. The main thing to do is not lose your job, I think. That actually is the thing which makes it hardest to pay back your mortgage.

I say that in all seriousness. If you've got a job, you can probably afford your mortgage, as long as both you and the bank were sensible in the decision you took. So, if you've got it, that's the main thing to do, and our main job is to make sure that the economy continues at a reasonable pace, with a low level of unemployment. That's going to be the thing which allows most people out there, who have got a mortgage, to continue to handle that mortgage.

Presumably, you took a mortgage out, which you could afford, if you took it. If you could afford it then, you almost certainly can still afford it today. That's, I mean, most cases. Not absolutely every case. But as I said, the main thing to do is, the main thing for us to do, is to make sure that the macro environment remains positive, and in that positive macro environment, most people are going to be able to continue to afford to pay back, or to manage their mortgage, just as they are doing currently.

You don't think you should be telling everyone that they should be asking for a pay rise?

I'm sure everyone would like a pay rise. Phil has talked about this a lot, that we have a low level of wage growth, at the moment, and that's been true for a while. And he talked about this at some length, a few weeks back, and for us to be able to fulfil our goal of getting inflation a bit higher, that's going to need a higher level of wage growth than we see at the moment.

That's what we've got in our forecast. We need that pickup and of wage inflation to occur for us to be able to deliver on the inflation side of our mandate. Part of that, part of helping to achieve that, is also, as I said earlier, a second ago, sorry, is to keep the macro economy going in a decent place. To keep the unemployment rate at the sort of level it is, or lower, or trending down, to generate those sort of wage pressures.

Last, just here.

Guy, thank you. I'll keep that in mind. Try and keep my job, to help make your job, that – easier. I wanted to actually go back to the last sort of key lesson that you drew from the global financial crisis, that history never repeats itself, and the next pocket of risk is going to show up somewhere else, to what we've seen in the past. I just wondered how much attention you and the RBA were giving to emerging markets as a, potentially a source of risk. Obviously, the last crisis came out of the US. Are you looking at China, in particular, and their financial system and position as a potential source of risk for the next crisis?

Yes, and we've identified that as a potential riskl. It's been around about our numbers, as one source of risk now, for, I don't know, a few years. Well, three or four years. So yes, is the answer to that question. Are we paying a lot of attention to China, and its financial sector developments? Yes. I was there last week. I spent the whole of last week there, paying exactly attention to that point. That was the main issue on the agenda.

So, yeah, that's something we have been concerned about for a long time, been paying a lot of attention to, for a long time, continue to pay a lot of attention to, devote a decently large amount of resources as to what's going on in China. I think elsewhere in this part of the region, though, on the EM debt, more generally, things seem to be going okay. Most of the EM countries, which have issues, I think … and we've said this is a number of our publications, a decently large number of them are idiosyncratic issues, and not so much a general statement.

I think, by and large, the EM world, going back, sometimes … we had a EM debt crisis. We've had a few of them before. But in this region, at least, the memories of '97 and '98 are very much burned still in people's memories. That's one thing they haven't forgotten, in this region, and they have learnt the lessons from that, and have done a lot, I think, to increase their resiliency, and that's indeed what we're seeing playing out in this part of the world, not necessarily in all parts of the world, but in this part of the world, over the last year or two.

Guy, we've got two former chairmen, and …

Oh, yeah. Can hardly say no to them.

Life members of the ABE, so if we can go to Rob and Bill, and that is definitely the last two. There's one here too!

I'll give Bill the last world. Rob Henderson from the Independent Economists Group – that will be my hat for tonight, Guy.

I was thinking about your great caricature of what happened during the GFC, and one of the things that you mentioned, of course, was the impact of fiscal policy, so, the ability of the government to stimulate the economy, and to provide a guarantee for the banks. That depended on a very strong sovereign position.

Now, my question is about sovereign risk, because I was driving in the car today, and I happened to hear Chris Bowen on the radio, and he brought up the term sovereign risk, in regards to the government's divestiture proposals for the energy industry. Just recently also, we've had the term sovereign risk use in regard to the potential for revisiting some of the licences for the Adani coal mine, in North Queensland.

So, I guess my question is, does the RBA think of those latitude types of issues as sovereign risk? Or is it more the risk of some government intervention? And secondly, do those sorts of risks, actually, are they large enough to be considered in your scenario building for the future, in terms of looking at the investment outlook for the Australian economy, or not? So I'd just be interested in how you see those sorts of things.

I mean, I said, I'm not going to go down the politics, Rob. But what I was talking about is, in my talk today, is, do we have … does the government's balance sheet have the capacity to, if necessary, in a crisis, do roughly what it did back in '08, early '09? And I think the answer to that question is yes. There is fiscal space for that sort of fiscal policy response, should it be necessary if a similar situation, and I really hope this doesn't happen, but it should actually arise again in the future.

Sure.

Deputy Governor, I'm just interested in your assessment as to how this housing cycle might play out on this occasion. You know, if we look at the last three times, we've had marked falls in house prices, in '11-'12, and '07-'08, and '89-'91. On each occasion, affordability got stretched, partly because prices went up, partly because rates went up, and then, to restore equilibrium affordability had to be restored.

On each of those occasions, it really happened through big rate cuts, so in '89-'91, they fell, the cash rate fell from 17, to 8.5, and in '07-'08, from 7.25, to 3, and then, in '11-'12, from 4.75, to 3. This time, the adjustment to affordability is going to really be on prices, because there's very little scope to provide those sorts of rate cuts.

Do you think it'll be a much more drawn out process this time? And then, the final problem is, you mentioned Perth. So, Perth has actually restored affordability after four years of falling prices, but in the last six months, prices have fallen sharply in Perth, and that looks like a credit supply story, as well.

So even if you get to a level of affordability, where people want to come back into the market, if the supply of credit is restricted, it could further extend the process. Without that interest rate mechanism, and with the credit restriction, do you think it's reasonable to think that this particular cycle will last a lot longer, before we reach that level of affordability, that will attract people back into the market? Or do you think it'll be like, similar cycles, where they've recovered fairly quickly?

I don't know, Bill. I mean, that's what I'm saying. This is a different set of circumstances from what we're seeing before, partly for some of the reasons you just mentioned. I mean, affordability, I would have thought the main clean way you can get things affordable is, actually, the price falls. That is what affordability is mostly about, is whether you can afford to pay for the asset. As you say, there are other things at play, at the moment, which is the appetite of the banks to lend. That's not a price story, that's a quantity story, and price doesn't solve that story. Sorry, price doesn't necessarily solve that problem. That's not going restore appetite to lend, I don't think.

I mean, you work at a bank, you probably know better than I, as to the decision-making around those restrictions on credit supply, which, as I said, is primarily coming through the major banks, not through the rest of the banking system. They're a very large chunk of the market, obviously. So it's a different set of dynamics than what we've seen in the past, as you described. And that, I think, makes it something which is not so easy to work out exactly how it's going to play out. As I said, in partly, in answering, I think, Rory's question, or Swati's question, is that it's as much … so the dynamics are different.

I think it's also an issue of how that translates into the macroeconomy, as well, because those circumstances than what we've seen in the past, too. So, yeah, I think there are a number of uncertainties around there, at the moment, including, as I said, as you were talking about on the supply of credit, and it's not entirely clear how that resolves itself in the near future, too.

So, yeah, it's a new set of … I think it's quite different from the episodes that you described a minute ago. This episode is different from that, which makes having that strong idea as to how exactly it's going to resolve also different. But I suppose the other point I would come back to, which I mentioned earlier, is that we're entering this episode with a much different macroeconomic environment than we did in those previous episodes.

The first one was a large recession. That's the early '90s one was a large recession. '07-'08 was the GFC, which I've been talking about today, so that's a different set of macro circumstances that preceded those episodes, than what we've got now, whereas, as I said, at the moment, at least, over the last year, we've had a decline in unemployment. We got an economy growing above trend. That's a different set of circumstances. How that plays out, I think, is really, is one of the key uncertainties around, at the moment.

Thanks.

Please thank Guy again.