Transcript of Question & Answer Session Regional Variation in a National Economy

Thank you, Dr Lowe. I'd like to invite Fiona Drummond to ask the very first question today. There is a mic coming.

Thank you. We're all attuned to the pace of disruption unfolding around us and obviously the Reserve Bank would be attuned to this as well. Given this, we would be interested to know whether the Bank has changed the way it views the world and in particular, do the economic models and theories that the bank might have used in the past remain relevant today?

Well, thank you. That's a very broad question. I think at a higher level the models still remain relevant, but there are things that are happening that are very unexpected. The one that I've talked about previously and I think it's really critical, is the lack of wage growth. We're seeing in country after country around the world unemployment rates being at the lowest level in decades. It's the case in Germany, in the UK, Japan. Unemployment is very low in the US, but wage growth, remains low. It's gradually picking up, but it remains low. We've got a similar experience here. The unemployment rate it's a bit higher than full employment, but the unemployment rate is relatively low but wage growth is very low. That's a very different world than the one that we've lived in the past and everyone is still struggling to understand what's going on there.

In the past if you had had unemployment rates like they are, wage growth would have picked up, inflation would have picked up and interest rates will be higher. That's not happening. That's one big policy challenge we face. The other issue that the central bank community is grappling with is the implications of high level of debt. The ratio of debt to income is much higher than it used to be in Australia in many other countries as well. And how is that affecting the structure and the economy and how people respond to various shocks. It's wages growth, and the high level of debt that are the things that we're most focused on.

Thank you. We are also going to ask the media to pose a question. Any of the media in the room, and there are many of you: put your hand up and receive a mic and you'll be in line for a question. The next question comes from Associate Professor Margaret Giles. Margaret, where are you? Do you want to, would you like to ask your question or would you want me to read it out? All right. Here we go.

Economic Principles textbooks refer to the transmission mechanism. RBA decision, followed by bank interest rate changes, responded to by households and businesses. Students query whether this mechanism no longer works. My question from Margaret from ECU, respectfully is, is monetary policy redundant?

I don't think so. I certainly hope not. Think about the global level, the response by central banks since the financial crisis has been really one of the critical elements in stopping the global economy turn into a very serious depression like it did in the 1930s. You might agree or disagree with extent of quantitative easing, but the fact that the central banks were able to stand in, provide assurance to the market place, inject liquidity and have low interest rates was really important in stopping the financial crisis turning into a huge depression.

That's kind of at the very broad level. The monetary transmission mechanism in Australia still works although kind of probably in the downward direction, interest rates aren't having the same positive effect that they once did. Lower interest rates do give people who have mortgages, more cash flow and they spend that, that helps. Lower interest rates should also see a weaker currency. They should also improve business confidence and they clearly lead to a lift in dwelling construction. Those standard mechanisms still work.

One thing though that has changed is a cutting interest rates don't have the same stimulatory effect that I think that they once had. Previously, maybe a decade or so ago when we cut interest rates it didn't take long for people to run off to the bank and borrow and spend a bit more, but today people have borrowed as much as they want to, so it's harder and I think quite sensibly, to induce people to spend more by borrowing. That means that on the downward direction, interest rates probably don't have as much effect. That doesn't mean when the day comes that interest rates need to go up, that they won't have an effect. I think they will because it will be quite a shock to many people when interest rates go up and I'm sure that will have some effect on the economy, hopefully in a way that sustains the expansion.

Thank you. Our first media question for today comes from, to our right.

Just wondering if you could talk about how you would assess the probability and the implications of a full-scale trade war between the US and China?

Well, if there was a full-scale trade war that would be very damaging to the global economy, it would be damaging to the Australian economy. The lesson from history is incredibly clear here. I don't know of a single country that has made itself wealthier through erecting barriers. I know of lots including this one that has made itself wealthy and prosperous by reducing barriers. Reducing barriers to the flow of people, the flow of goods and services and the flow of investments. So reducing barriers, increases growth and building barriers, reduces growth.

It would be incredibly destructive to have a full-scale escalation. You asked about the probability of it. It's hard to tell like we saw last night, President Xi in China make broadly reassuring comments, continuing to make the case for openness. I think this is the thing we should all be doing is the best response to the tensions is to speak loudly and proudly about the benefits of openness and Australia is probably the best example there in the world, the country that's made itself incredibly prosperous through being part of the international trading system, international investment, situation and by having people come here and build this fantastic country and we need to speak loudly and proudly about that.

Thank you. Rowan Munchenberg from Bankwest is here. You have a question, you have a question Rowan?

Dr Lowe, given you have an opportunity to see those similarities and differences right across the country and can compare states that at quite a detailed level, what advice would you give to WA policy makers, WA business leaders in thinking about how to energise the WA economy, attract people back to a state where housing prices are lower than the east coast, but we're not seeing that population growth that flows or follows those low prices.

I tend to not give advice to governments because governments don't give advice to me, they're not supposed to. So I think that's a decent equilibrium.

Doesn't stop me from asking.

There's a broader point here and it touches on the discussion John was having right at the beginning about Israel. And think about the future for Australia, and the future for Western Australia. The comparative advantage in the future is going to be built on what's in our minds and what we can do. Australia, and Western Australia in particular has had a fantastic history because of the endowment of natural resources and that's made Western Australia, a fantastic place and Perth, a great city. That's been the basis of the investment in the past, our natural resources.

I think in the next 20 years, maybe less than that, the basis of comparative advantage won't be what's in the ground. It's what we can build. That really comes from innovation, a very strong commitment to education, to human capital accumulation, innovation, creating a risk culture that encourages risk-taking.

That's my generic advice to anyone who asks. It's: whereabouts is our comparative advantage going to come from for growth over the next two decades? We might be lucky and we might find new resources and the price might go up again, but probably not. But Israel has built comparative advantage through, kind of, what's in people's minds in a difficult part of the world, with not many resources. They've built a wonderfully successful prosperous country and we can do the same and we should be aiming for to do that.

So that's a yes to coming to Israel.

[Laughs] I would love too.

Just seeing what's out there in terms of your hands in the air. I've got plenty of questions here. I want to make sure that media and anyone else gets the opportunity to ask a question before I read some more. Dean Pike, PKF Mack and board member of the AICC.

Thank you for that speech, my question relates to how concerned should we be that the government will have more influence over our economic success by way of I guess the renewed significance of fiscal policy? I guess also the voting be behind those, you know, the popular short-term sentiments that is behind some of those fiscal measures being undertaken by our competitors and neighbours.

I don't think there's been a shift in the relative importance of monetary and fiscal policy in Australia. There's a fairly broad consensus at the political level that in most circumstances, monetary policy is the main policy tool to manage the economic cycle that really hasn't changed. I don't really have any concerns in that area. I think at the broader level for the community, which influences the direction of policy is kind of the weak growth in people's incomes is a really major issue. In Australia, we used to have real wage growth of one or two per cent a year and people were becoming more and more prosperous all the time and we kind of jointly shared in that for the last four or five years there's been very little growth in real incomes.

People are unhappy not only because the previous trend isn't continuing, but there's just very little growth in real incomes and many people feel like the cost of living pressures are very strong. I think that's problematic. It's affecting the political process and it makes it difficult for me as the Reserve Bank has got to deliver average inflation for you of 2.5 per cent on average. That's one of my key goals and the current rate of income growth and wage growth isn't going to be enough for me to deliver your 2.5 per cent average inflation.

It's a problem for me, but it's a broader problem for the political class because people are angry and when they're angry they kind of vote for different things.

Thank you. Dr Lowe, Table One have workshopped a question over lunch. They didn't eat lunch. They actually …

Sounds dangerous.

… beavering away like a seminar, and there's some amazing brains on that table. This is their question: Given the risks associated with the outlook for the Australian economy and our current political situation, not sure what that means, what keeps Philip Lowe awake at night?

Nothing keeps me awake at night. I'm fortunate enough to be one of these people who sleep relatively well, but I think about the risks facing the economy. As I said, something going wrong in China would be right at the top of the list. Since the financial crisis, the level of debt in China has increased by an astronomical amount. The ratio of debt-to-GDP is very high. Some of those loans are probably not the best quality. So there's fragility in the Chinese financial system. The authorities there recognise that and in the past year we've seen a number of decisive measures to address those risks. So those risks aren't building anymore. But if something went wrong there, it would have a first order effect on our economy.

The second thing that keeps me nervous is the possibility of a trade war. I think probably, hopefully we've edged back there and sensible minds will prevail. Domestically the risk that I'm most focused on is just the high level of household debt. We haven't been in a situation before where household debt to income has been this high. That brings with it a certain fragility. I think many people borrowed on the expectation that their incomes would grow at the old rate of three and a half or four and they're growing at one and a half to two and they're finding it harder to deal with the level of dept.

At the moment the household sector in aggregate is coping fairly well with that, but if we had some type of negative shock either from offshore or some other reason, there's a certain fragility there. This is why in the past two years we worked so closely with APRA to improve the lending standards by financial institutions because we did get to a period a few years ago where the lending standards deteriorated. One thing that had caught my attention was that two years ago, 45 per cent of new loans being made in the country, housing loans, did not require the borrower to repay $1 of principal on a regular basis; 45 per cent didn't require the repayment of principal. I understand why that was the case, but it made me nervous. APRA has taken measures there and we're in a better position. So across a whole range of measures lending standards have improved, which has reduced this vulnerability in the household sector. So they're some things that worry me, but none of them are severe enough to keep me awake at night.

I didn't really have a question but now I'm on the spot. Philip, look, you deal with all the other central banks in the world. I'm pretty familiar with the RBA's position on cryptocurrency and Bitcoin and things like that. I'd be really interested in your perspective on other reserve banks' views because there seems to be quite a divergence of views and particularly the Bank of Finland issued a very detailed, and I thought, pretty good report on Bitcoin. So just from the sort of ‘investment bankers’ club or sorry, the ‘central bankers’ club, what the feeling around the table is on that subject?

I don't think there is that much difference amongst the central banks. At one kind of level there's a great degree of scepticism about Bitcoin and some of the similar – we don't call them in a central bank community cryptocurrencies, we call them crypto tokens, because we shouldn't think of Bitcoin as a currency. Now as a means of payment it's terrible. The average cost of making a payment is $5 to $10, a fair share of the payments don't actually go through, they use huge amounts of electricity and it's not kind of a sensible payment method. So it's not a currency, it's really a kind of crypto token that people trade and in my own view, it's part of a speculative mania.

I saw this a couple of months ago when I was catching a taxi home from the airport and the taxi driver recognised me and he quickly wanted to talk about should he buy Bitcoin and it was just an illustration, and family members are asking about it. I thought this is just ridiculous. There was a fear of missing out. It was a speculative mania and people need to be very careful so that view is shared widely amongst the central banks.

I think the second point is that many central banks have been exploring the issue of whether they could issue the currency, their own currency in an electronic form. Rather than us issuing these fantastic polymer bank notes that we issue, could we issue some type of token in Australian dollars that's set in an app on your phone and then moved around the apps on the phone rather than passing banknotes you pass these kinds of electronic tokens. That will come to be technologically possible at some point. I don't think we're going to do that and I don't think any other central banks are going to do it because in Australia I hope you know about the new payments platform.

This will allow you to move money between any two bank accounts in the country in 10 seconds very easily and efficiently. That will become a very popular payment method for people to use and you won't need kind of crypto tokens because you'll be able to move money between your bank accounts in a safe, secure, efficient, low-cost method. I don't think any central bank is going to replace bank notes with electronic money any time soon.

The third thing the central banks are talking about we've done quite a lot of work on this is using that technology to issue tokens into a closed settlement system, so the tokens can be used with smart contracts and payment versus delivery on an exchange of physical goods. There are various kind of closed systems we could issue tokens in, using distributed ledger, that would allow more efficient business processes. We're all looking at whether that's a possibility.

So the underlying technology is good. Some of the things that are out there at the moment, I wouldn't advise people to invest in them. I don't provide financial advice, but there's a speculative mania in some of these tokens.

Thank you. A question down here on table three, it will be almost our last question.

I've just got a question on before when you were talking about how we can really get growth is to build things and considering that Australia and Western Australia have a considerable amount of, some of the best quality resources in the world, there's been a lot of discussion recently about the fact that we're giving away a lot of value to other countries. We process it to a point, and then we send it offshore. I'm just wondering what your thoughts are around can we be adding more value here within Australia to then produce the products that we're going to use to build things? Just wondering what your thoughts are on that.

I'm not close enough to the details to know what the problems are, why we can't do this, but if we're competitive we'll do it, and that means that we've got to focus on how to be competitive. That's a flexible labour market, a well-designed tax system and people with the right skills. It seems to me they're the preconditions to be competitive in not just processing a resource, but anything in the economy and that's got to be the focus. I don't know enough about specific industries to say whether we could be doing more or less.

Thank you. We've got one last question from the gentleman at the back there. Just a minute the mic is coming. Roger, if you can make your way up here in a second, thanks.

Thank you, Dr Lowe, I really enjoyed your speech and presentation. The last decade you've touched on the printing of money globally by the countries, the Reserve Bank, central banks. I'd like to get your view on how serious they are of starting to undo that and unwind it and the implications flowing through. Because it's effectively, as we all know, stopped what would have been massive deflation and hence, part of the problem of high debt and low wage growth. Thank you.

Well, the US has, of course, started, the US interest rates are now higher than ours and they're starting to shrink their balance sheet. They've set out how they're going to do that and they're clearly serious about doing it. In Europe and in Japan, I think they're some way away from higher interest rates and shrinking of the balance sheets. You ask whether they're serious about normalising and they are, but they're going to do that in the context of what's going on in their domestic economies as we would here. Inflation remains stubbornly low right around the world, partly linked to the weak wages growth.

That means that the central banks are prepared to keep the monetary stimulus to get strong employment growth, to help their economies recover up until the point that inflation starts to pick up and inflation has been a long time coming. I suspect it will come at some point. In tight labour markets, eventually, workers and firms will agree to higher wages. But it's just taking a long time. That means that the central banks are on a very gradual process of normalisation. There shouldn't be any doubt to their commitment to finally get there. But it's a gradual process because the pickup in inflation is very gradual at the moment.

Thank you. Well, we'll close the questions there and we'll allow you to enjoy the hospitality. This event finishes at 2:30, so there's plenty of time to schmooze in this room with tea, coffees and the beautiful deserts. Now with Roger Davies from Ashurst, maintain our tradition of you doing the vote of thanks to the Governor of the Reserve Bank. Thank you, Roger.

Thanks very much John. Ladies and gentlemen, I'm just slightly disappointed actually that Hendy got the full treatment on the walk on music. I didn't really get anything at all so clearly the next time I negotiate the sponsorship, Hendy you'll have to let me know how much I have to put it up to get the film and the walk on music!

Thanks very much. As John mentioned, previously, actually I did help co-host a session a while ago with the previous incumbent. It wasn't 2005 John obviously because of the current Governor and I were both in high school in 2005 it was 2015, but it's more or less right. You caught me on the hop there a little bit with the question of as everybody in the room would have heard, but I learned my lesson the last time actually, because I did the Q and A last time. I did ask the Reserve Bank Governor a question, which I thought was particularly insightful actually – I can't remember what it was now, but at the time it was particularly insightful, about interest rates. And it taught me a lesson, which is that humble lawyers should never ask senior economists a question about the economy because he turned and he looked at me and said, "why would you want to know that?"

I didn't really have an immediate answer, I've never forgotten it. I'm sure he has. In all seriousness, thank you very much for running an insightful presentation. Actually, it was excellent. As Ashurst, we run a regional business and I am constantly battling with those in the East and obviously, talking about regional variations and differences and how we need to look at the economy. It's heartening and obviously expected that the Reserve Bank would be looking at all of those variations and differences and taking them to account in its monetary policy. But it is really excellent and we're really grateful that you actually are coming over to WA so often I didn't realise you were quite such a frequent visitor actually. But to hear that you are over here and listening and talking to people is outstanding I think, and there are a number, just about everybody in this room is a passionate advocate for Western Australia and everything that we add to the Commonwealth of Australia, I'm sure.

So to have that opportunity to sort of to listen to you, but also to sort of give you some pointers in terms of the questions that we ask is very much appreciated. Thank you very much for taking that time. We do appreciate it. I should also thank our major sponsor, ECU, Hendy, with your walk on music. Thank you very much indeed. Also, of course, to our hosts, EY whose magnificent premises we use very often and they're really outstanding for this sort of presentation. Of course, John, I should think the tireless work of the AICC. Ashurst and the AICC have enjoyed a very long and a fruitful partnership together and the AICC and John and Diane and all of the team do an absolutely magnificent job as I'm sure you all appreciate. Thank you very much indeed for that. I think, John, we have a presentation for Dr Lowe, I believe.

We do.

Thank you.

If I could ask everybody to thank Dr Lowe in the traditional manner, thank you very much.