On 6 September 2016 the Reserve Bank of Australia (RBA) decided to leave the cash rate unchanged at 1.50 per cent, after cutting official interest rates by 25 basis points to 1.50 per cent on 4 August 2016. The RBA commented:
…having eased monetary policy at its May and August meetings, the Board judged that holding the stance of policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.
The Governor of the RBA, Dr Philip Lowe, remarked at the public hearing on 22 September 2016 that the Australian economy is continuing ‘its transition following the boom in commodity prices and mining investment’. He reported that GDP growth has been better than expected and increased by 3.3 per cent over the year to June, while the unemployment rate has declined by about half a percentage point in the past year.
In his opening statement to the committee, the Governor explained that the economy was in transition following the end of the resources boom, and that its success was being assisted by the lower exchange rate and accommodative monetary policy:
Those parts of the economy that most benefited from the resources boom are now experiencing difficult conditions and other areas are doing considerably better. In these areas, business conditions have improved, employment is growing and there have been some signs of a pick-up in private investment. So, overall, the picture is of an economy adjusting reasonably well to the unwinding of the biggest mining and investment boom in more than a century. It is a quite significant achievement. We are managing this partly because of the flexibility of the exchange rate and the flexibility of wages and through the support that is being provided to the economy through monetary policy.
However the Governor also stated that income growth has been ‘disappointing’, with nominal GDP increases averaging around three per cent per year over the last five years. This is down from an average increase of around 7.5 per cent per year between 2000 and 2007.
According to the Governor, the main reason for weak income growth has been a large fall in the prices of our exports, which have decreased by about one third since late 2011. The Governor noted that while this drop in prices has been significant, ‘it does need to be kept in perspective, because export prices do remain considerably higher than they were in the 1990s and in the early 2000s, especially relative to our import prices’. The Governor also remarked that while we are receiving reduced prices for our exports, ‘the more positive news is that we are selling more’.
Inflation is expected to remain low in the near term with domestic cost pressures remaining subdued, before picking up to around two per cent by the end of the forecast period as the depreciation of the Australian dollar in recent years continues to exert upward pressure on the prices of tradable items for some time.
Similarly, wage growth is forecast to remain low in the near term, before picking up over the forecast period as the adverse effects of the transition away from the mining boom diminish and labour market conditions improve.
The RBA reports that the housing market has eased since last year, with housing credit growth lower; consistent with the tightening of lending standards in late 2015 and the drop in turnover in the housing markets this year. The rental vacancy rate is slightly higher approaching its long-run average, while inflation in rents has ‘eased to multi-decade lows’.
Globally, there have been a number of significant developments that have affected the Australian economy, including the continuation of accommodative monetary policy in most jurisdictions as inflation remains below the targets of most central banks. The Chinese economy has continued to ease, with the RBA commenting that ‘the outlook for the Chinese economy remains an important source of uncertainty for global growth and demand for commodities’.
Global financial markets have been volatile, particularly around the time of the United Kingdom’s referendum to leave the European Union (Brexit) in June 2016. Despite this, financial markets have continued to function effectively, including those in Australia.
During the hearing the committee questioned the Governor and other RBA officials on monetary and economic policy frameworks and their effects on the Australian economy. Areas of discussion included the cash and exchange rates, inflation, business and the labour market, housing, the performance of Australia’s major trading partners, and infrastructure and investment.
The committee also questioned the Governor about the new Statement on the Conduct of Monetary Policy, the operation of the four major banks, and a number of projects being undertaken by the RBA, including changes to the payments system, and other issues relating to corporate governance.
In its August 2016 Statement on Monetary Policy, the RBA reported that the Australian economy grew by more than expected over the year to the March quarter 2016, largely as a result of an expansion in resource exports due to favourable weather conditions. However, the RBA noted there was little change to Australia’s GDP growth forecasts since the May Statement, with the forecast to remain around 2½ to 3½ per cent in 2016, increasing to around 3 to 4 per cent by December 2018 (see Table 2.1).
Table 2.1: Output Growth and Inflation Forecasts (per cent)(a)
Source: Reserve Bank of Australia, Statement on Monetary Policy, August 2016, p. 67. (a)Technical assumptions include A$ at US$0.76, TWI at 63.5 and Brent crude oil price at US$45 per barrel.
The RBA forecasted growth of Australia’s major trading partners (MTPs) to be somewhat below average over the next few years, remaining unchanged since the May Statement. Over the next few years, growth in China is expected to moderate gradually, while the United States economy is forecast to grow at an above-trend rate. According to the RBA:
US monetary policy remains very accommodative and, after a few years of consolidation, fiscal policy has become less of a drag on growth. Conditions in the US labour market remain strong and should continue to support growth of consumption. This is likely to offset the ongoing weakness in overall business investment, much of which reflects the decline in oil-related investment.
The committee was interested in what was driving Australia’s growth and questioned the Governor about the outlook for exports, particularly in the non-mining sectors of the economy. The Governor responded:
The housing construction cycle is in a strong upswing, and that is providing a reasonable amount of impetus to aggregate demand. Consumption growth has been okay. It has not been too different to trend. And public demand has been growing reasonably as well. There are some signs that private business investment, particularly in the non-resource states, is picking up as well. So it is reasonably broad based. As I was saying in my opening remarks, it reflects the depreciation of the exchange rate, the low interest rates and the underlying population growth of the economy. Our population is still growing at 1½ per cent a year, so that naturally creates demand in the economy.
On the outlook for exports, the Governor said that ‘very large increases in LNG exports are still to come, and that is going to make a significant contribution to GDP growth over the next couple of years’. The RBA expects coking coal exports to be somewhat higher as Australian resource companies respond to improvements in prices, while thermal coal exports are not expected to increase given weak international demand and relatively high production costs in Australia. For the non-resource sectors, the Governor said that there has also ‘been a marked change in net service exports’, highlighting growth in the tourism and education industries.
The committee asked the Governor whether the forecasts needed to be adjusted since growth has been stronger than expected. Dr Kent responded that the RBA had not revised its forecasts:
Things were a little bit stronger than we thought in the June quarter, but not especially so. I think that is where we were in August, when we published our forecasts in the statement as being a reasonable starting point, and that was for sustaining reasonable growth and particularly holding on to some of the good growth we have had in the non-mining sector. I think the other key feature of our forecasts is that the big drag that we have seen from the fall in mining investment has affected WA and Queensland as well. Those forecasts of ours over recent years have been pretty accurate. There is more of a fall to come in the current financial year, but the biggest drag is behind us as best we can tell and, in terms of the sort of annual numbers, occurred last financial year. That is a good thing.
The committee asked the Governor how he saw the future of the Australian economy. The Governor responded that ‘I see the glass as half full’:
Our country just has so many opportunities. We have so many things going for us. I would not want to be the central bank governor in any other country than this one. So I am fundamentally optimistic about our prospects, I am fundamentally optimistic about technology, and I see our economy having adjusted through an incredibly large external shock. I used to talk about this all the time—and how we could convince other people to have their glasses half full as well.
The committee questioned the Governor about the conduct of the recent census, whether the data might be compromised, and if this would adversely affect RBA forecasts and other activities. The Governor noted that ‘many areas of government and in the private sector rely on these data to allocate resources and make decisions’ and said ‘it is a concern for us all’.
When the Governor’s attention was drawn to comparable census completion rates for the current census, compared to previous censuses, he remarked ‘that is encouraging if that is the case. As we talked about before, those data are incredibly important for lots of public policy, so that is good to hear’.
The cash rate and monetary policy
At its meeting on 6 September 2016 the RBA decided to leave the cash rate unchanged at 1.50 per cent, following its decision to cut official interest rates by 25 basis points to 1.50 per cent on 4 August 2016. In August, the RBA noted that ‘prospects for sustainable growth in the economy, with inflation returning to target over time, would be improved by a further easing of monetary policy’. In its decision to keep rates on hold in September, the RBA said that it would be ‘holding the stance’ after easing monetary policy at both its May and August meetings.
Given the cash rate was at a record low level, the committee questioned the Governor about whether the RBA was running out of monetary policy options. The Governor responded that ‘I think it is very unlikely that we will find ourselves running out of monetary room’.
The Governor acknowledged that there was a sense, internationally, that monetary policy was not working as effectively as it had in the past, and outlined three possible responses:
That central banks continue with increasingly accommodative monetary policy, which the Governor stated ‘has not been particularly useful’
That ‘some entity in the economy’, including governments, use low interest rates to increase spending, or
That measures are taken to improve the business investment climate ‘through structural reform so that the private sector actually wants to use the low interest rates to increase its own spending’.
The committee asked the Governor if interest rates could be lowered again. The Governor replied that a further rate cut was possible:
It is going to depend on a whole range of factors: what happens overseas, what the next inflation data look like, how the labour market is performing, how the housing market is performing. Certainly there are scenarios where rates would fall again and there are scenarios where they would not need to fall again.
The committee asked if the RBA was concerned by declining living standards and rising income inequality in Australia. The Governor responded by acknowledging that while real income per capita has declined in recent years, this needed to be understood in the context of a ‘remarkable’ fifteen year period from the early 1990s where annual growth in real per capita income was around three percent a year:
…it was a kind of remarkable period, and I think many of us started to think that that was the normal state of affairs. It would have been nice if it was, but it was the confluence of three very favourable developments: productivity growth, demographics and the terms of trade.
The Governor said ‘that period now looks like it is behind us’ and suggested that ‘…the only way that we can go back to having anything like the previous rate of growth in our living standards is by focusing on productivity growth’. The Governor added that while the RBA was concerned about income inequality, ‘…monetary policy cannot really do very much about that in the end’ because ‘the structure of income across Australia is…determined by things other than the level of interest rates’.
The committee questioned whether accommodative monetary policy was mainly benefiting those Australians who are asset rich. The Governor agreed that lower interest rates generally push up asset prices, and those people who already own assets benefit disproportionally from those circumstances. However, the Governor said that it was more important that accommodative monetary policy was helping the economy overall, particularly in terms of jobs:
If we did not have interest rates where there are now…a lot fewer Australians would have jobs. So that is what we are doing for income inequality, and that is the really big first-order thing that we can do. So we can focus on the distribution of financial wealth, but, from my perspective, making sure people have jobs is the first-order priority.
The committee asked the Governor to explain if there was a connection between uncertainty in the community around job security with a lag in the transmission of monetary policy. The Governor said that under these conditions, monetary policy may take more time to pass through the economy:
The uncertainty aspect is one part of it, but the other is that many households feel like they have too much debt, so when interest rates come down what we are seeing is that many households decide to pay off the debt more quickly rather than to spend. We see this in the offset accounts that people hold. When interest rates come down the balances in those tend to grow a bit more quickly as people make the same nominal payment—it just doesn't go off the principal; it goes into the account. The main effect of that is to delay the transmission of monetary policy to the rest of the economy. The lower interest rate helps those people get back to their desired debt levels more quickly than would otherwise be the case. Then once they get back their spending behaviour is the same as it once was.
The committee was interested in whether the RBA considered current inflation targets to be adequate in informing monetary policy, and if it was satisfied that inflation data was accurate. In his opening statement, the Governor said since inflation targets were introduced, the RBA has been a proponent of flexible inflation targeting:
We have not seen our job as trying to keep inflation always within a very tight, narrow range. We have not been what some have called 'inflation nutters'. We have had a more balanced perspective, recognising that some degree of variability in inflation from year to year is both inevitable and appropriate.
In responding to the question on inflation targets, the Governor further commented that the RBA’s tolerance for keeping inflation between the two to three per cent range had not changed:
If you look over the inflation-targeting period, I think 46 per cent of the time inflation has been outside the two to three per cent range. I think 23 per cent of the time it has been above and 23 per cent of the time it has been below. It has averaged, over that whole 25-year period, to 2½ per cent. But it moves up and down and, as I said, we have never been a central bank that felt our mandate is to keep inflation kind of in the range.
In relation to the accuracy of inflation data, Assistant Governor Dr Kent said that it was possible that the deflation of the price of some goods and services due to technological efficiencies was not fully reflected in inflation data. However, Dr Kent said that ‘to the extent that there are some services that you are not spending money obviously on, that means you have got money to spend elsewhere. So, ultimately, it is not lost to the economy; it is just showing up somewhere else’.
The committee asked if the RBA could put a specific timeframe on when Australia would return to the inflation target. The Governor responded that he could not, but that the RBA worked to keep inflation within the target range over time:
So I want our institutions—and this is the board's view as well—to be able to deliver that two point something in average inflation. I cannot say over exactly what horizon. We want to be able to do that in a way that promotes both employment growth and the stability of the financial system.
The exchange rate
In its August Statement the RBA outlined general trends in the exchange rate since the previous Statement. It noted that while the Australia dollar has appreciated a little since May, its overall depreciation since 2013 is ‘continuing to support the rebalancing of economic activity towards non-resource sectors’ and has been assisted by low interest rates.
The RBA noted that the exchange rate has recently been influenced by changes in expectations for monetary policy in Australia and the United States, in addition to uncertainty around the referendum in the United Kingdom. It reported that, since the previous statement, the Australian dollar has appreciated by about 11 per cent against the UK pound, around 10 per cent against the US dollar and was 8 per cent higher on a Trade Weighted Index (TWI) basis than its low point in September 2015. From a long-term perspective, however, the Australian dollar remains 20 per cent lower against the US dollar and about 12 per cent lower on a TWI basis than its high point in the middle of 2014.
The Governor noted that the exchange rate was supporting the expansion of non-mining sectors of the economy, in particular the services sector:
More overseas people are coming to have holidays in Australia. It is not as expensive anymore. That is the exchange rate adjusting, and we are seeing that. And fewer of us are going overseas, because it is more expensive for us to go overseas, so more of us are holidaying domestically. We see the effects of that particularly in Queensland and even in some of the hotel markets in the capital cities, where vacancy rates are quite high.
So the movements in the exchange rate have affected people's choices on where to take their holidays. We are seeing it in the education sector, where it is more affordable now to come and study in Australia, and people respond to changes in affordability. We even see in some parts of manufacturing that there is a chance that businesses, having gone through the difficult adjustment period with a high exchange rate, can look for export markets again. They are kind of in niche markets, but the exchange rate has made a material difference.
The committee asked the Governor if the RBA was happy with the current exchange rate. The Governor responded that a lower exchange rate would be desirable, noting that the exchange rate has appreciated in recent months on the back of stronger commodity prices and demand from overseas investors for Australian assets:
…the exchange rate has appreciated recently. It is partly reflecting the higher commodity prices and the continued attractiveness of Australian assets to foreign investors, because the returns here are still higher than you can get in many other countries—not just because of our cash rate but because the underlying returns on real assets are higher here, and that is good news. It is understandable that the currency has had an appreciation over recent months, but it would be good if we had a slightly lower currency. It would amplify some of these positive things that we are seeing. I do not want to put a number on that, but it would be good if it were a bit lower.
Business and the labour market
According to the RBA August Statement, employment growth has been slower this year following a period of strong growth in late 2015. The RBA noted that while this trend was mostly anticipated, recent employment growth has been concentrated in part-time employment.
The unemployment rate has stayed around half a per cent lower than a year ago, remaining at 5¾ per cent over 2016. The RBA noted that while future indicators of labour market conditions are mixed, there is evidence to suggest that employment growth will continue at a modest pace with little change in the unemployment rate.
The committee was interested in whether the RBA considered current employment growth to be greater than anticipated. The Governor said that while employment growth in the Eastern states has been strong, the level of employment in Western Australia has been much weaker for some time.
The Governor also emphasised that while growth in part-time employment has been strong, growth in full-time employment has been week. The Governor said that the reason why part-time employment was so strong was because the personal services industry was performing well, where part-time work ‘tends to be characteristic of those sectors’.
The committee asked the Governor if he was concerned about low wage growth and its impact on inflation. The Governor agreed that it was an issue, however it was more important from the RBA’s perspective that more people are able to access employment:
I would not express it as a concern, though, because the low wage growth is one of the factors that have helped strong employment growth. Workers are not expensive to employ, and so there are more people employed. That is the good news. If you have got a job, it is not that great that your wage is not rising that quickly, but the positive element of that is a lot more people have jobs.
The Governor also said that low wage growth should be understood from an international perspective, where many countries are experiencing similarly low unemployment rates accompanied by low wage growth:
If you take the average unemployment rate across the US, Germany, Japan and the UK, it is the lowest in 30 years. People who worry about or focus on the weak growth in the world economy do not focus on the fact that a higher share of the labour force have jobs in these countries than at any time for the last 30 years. But the low rates of unemployment in many countries are not leading to wage pressures.
Despite this, the Governor said he was not worried about low wage growth continuing in the long term:
I think that is temporary. It is persistent but temporary. I am confident that in Australia we have not lost the desire to ask for larger wage rises if the labour market is strong. If we can continue to eke out modest growth in employment, hold the unemployment rate and actually get it to come down a bit lower then wage growth will gradually pick up here. It is not going to race away—I am not worried about that—but I think it is quite unlikely that we get stuck in a very low wage growth world, because, if we can get enough employment growth, workers will again ask for slightly larger wage rises, which will then return inflation to the two to three per cent range.
The committee was concerned whether the Western Australian economy was technically in recession as a consequence of declining investment in mining. The Governor said that he ‘would not characterise it as a technical recession’, but noted that the labour market in Western Australia is currently weak with a decline in the number of jobs in industries supporting the mining industry. The Governor also noted that this was part of a cycle and that the Western Australian economy is adjusting. The Governor added that ‘just as it went up it comes down and it will come back’.
The committee asked if the decline in mining investment in Western Australia and Queensland could be considered the opposite of a two-speed economy. The Governor agreed with this characterisation, and replied that:
We had parts of the economy four or five years ago—Western Australia and Queensland—doing remarkably well, and the rest was not; it was subdued. That is what happens when you have the biggest mining investment boom in a century: the exchange rate goes up and the exchange rate sensitive parts of the economy are weakened. Those adjustments, picking on the exchange rate, helped the overall economy get through that. Now we are on the other side and the reverse of that is playing out.
The RBA reported that while overall economic growth in Australia’s major trading partners has remained somewhat below average over the first half of 2016, overall commodity prices have increased over the course of the year as a number of high cost producers have reduced supply of various commodities including coal and iron ore. Australia’s terms of trade are forecast to remain around current levels for a couple of years, around 35 per cent lower than their peak in 2011.
Growth in China has continued to ease, as policy measures to support demand have only partially offset subdued growth in private sector investment. While growth in the Chinese services sector has remained strong, conditions in China’s residential property market have eased. The RBA noted that overall, the outlook for China’s economy remains uncertain and presents a number of risks, including the effects that any substantial slowing in demand in the Chinese property market would have on property developers and related industries, for example the steel industry.
The committee was interested in whether debt levels in China, particularly the rate of accumulation of private debt, was concerning for the Australian economy. The Governor said that the main concern is ‘the quality of that debt and the assets that underpin it’. The Governor stated:
While the Chinese growth story is an exceptionally positive one, to date and even into the future—I think they have got so much potential—there are pockets, particularly in the industrial sector, within some of this state owned economies within the mining sector, within China where there is clearly excess capacity, where profits are low—in fact in many circumstances companies are losing money. Normally that would lead to these sorts of companies shutting down and then you would have to have some debt resolution process and so on. But there are incentives for various reasons, particularly at the regional level, to keep some of these companies going. I do not want to overstate the problems. The authorities there are extremely aware of them and monitoring them closely and would like to see excess capacity worked off in a gradual, carefully managed process.
The RBA noted in its August Statement that expansionary monetary policy has continued to support growth in most economies. The US Federal Open Market Committee left the target range for the federal funds rate at 0.25 to 0.50 per cent at both its June and July meetings and the next monetary policy contraction is not expected until late 2017. The European Central Bank has left policy unchanged since its March meeting, when additional stimulus measures were announced. The Bank of England has indicated that it expects to ease monetary policy further, while the Bank of Japan has left monetary policy unchanged. The People’s Bank of China has left interest rates steady and reserve requirement ratios unchanged since February.
The committee asked if the RBA took into consideration rates overseas when deciding on rate movements in Australia, and if the negative interest rates of some central banks was concerning. The Governor noted that interest rates overseas had a bearing on monetary policy in Australia, and discussed some of the associated complexities:
If interest rates round the world are very, very low and we have a higher rate, money will want to come here, it will push up our exchange rate, we will be less competitive and then, as a result of that, we will feel the need to lower our interest rates. Money is fungible around the world, so we do not think that because foreign rates are lower we automatically have to have lower rates. But low rates elsewhere round the world will affect our currency and capital flows, and that will have an influence on our interest rates.
The Governor said that, in the case of Japan, the move to negative interest rates was placing strain on the Japanese financial system. RBA Deputy Governor Dr Debelle added that there are constraints on how far into negative territory rates can go, and that as far as the RBA was concerned, it was a case of sitting back and observing what happens. The Governor also remarked that ‘there are better ways to stimulate the economy than to set the interest rate at zero or below zero’.
In its August Statement, the RBA noted that while Brexit has been a source of uncertainty and is expected to have a negative impact on growth in the United Kingdom, its global impact is likely to be limited.
The committee asked whether the RBA had monetary policy responses in place for global market shocks brought on by external political events, such as Brexit, and the potential election of Donald Trump as the President of the United States. The Governor replied that from a financial perspective the Brexit event ‘occurred relatively smoothly’ because the markets were able to adjust:
In the last couple of years, people worried that if there were some political event that caused big movements in prices, the system could come under incredible strain; it did not happen. The global financial system has been strengthened a lot since the crisis.
What Brexit showed us was that the market has a demonstrated ability to adjust. It did that smoothly, and I would expect that would happen in the US if there was President Trump. We would all be watching and looking at how things evolve.
The Governor added that the RBA planned for the aforementioned potential political shocks in the same way as it did for other contingencies, stating that:
…our plan really is to keep the system liquid, to be a source of stability and confidence in the Australian economy to make sure that the financial markets are operating smoothly. The broad elements of that plan are in place and deal with a whole series of adverse events. There are a lot of other things can happen in the world that can cause dislocation as well. We do not have a specific plan that depends upon the outcome of the US election; what we have is a generic plan that can deal with a whole range of adverse events.
The committee was interested in why, despite a number of global shocks, financial markets were continuing to function effectively. Dr Debelle referred to the example of Brexit, where financial markets that were under considerable stress, and said the key element was that there was ‘reasonable liquidity in the market, so whether it was easy for people to transact’. Dr Debelle stated:
In fact, if you look at what happened after Brexit, that was one of the largest amounts of turnover in financial markets we have seen in a long time, so this was not a case where everyone was sitting on their hands and watching things unfold. There was actually a large volume going through the market. So the market can process a large amount of volume in a fairly effective way. The fact that prices move is not a sign of any sort of stress; it is just how they move. As I said, we look at things like liquidity, whether prices jump a lot, and whether markets trade continuously. Those are the sorts of things we look at in terms of assessing whether markets are functioning effectively.
The RBA reported that housing market conditions have eased this year following strong conditions in recent years, with housing credit growth lower than a year ago, a decline in turnover in the housing market, a higher rental vacancy rate and lower inflation in rents.
According to the August statement, household consumption growth is expected to remain near its long-run average over the next few years. The RBA notes that there is evidence suggesting that households’ expectations of unemployment are lower now than in recent years, while households’ perceptions of their finances have been above average recently, despite relatively weak income growth. According to the RBA, this suggests the household saving ratio will ‘decline gradually, extending the downward trend of the past few years’.
The committee asked the Governor about the effect of interest rates on house prices. The Governor explained that lower interest rates do push up house prices and that this was the mechanism through which monetary policy is transferred to the economy through wealth creation and increases in consumer spending and construction. The Governor noted that some of the heat had gone out of the housing market recently and commented:
I think we are in a better position than we were a year ago, but we are watching it very carefully. It is not in our society's interest for house prices to keep rising a lot faster than our incomes; that progressively corrodes the health of our balance sheet. So, we watch this very carefully. I am more comfortable about the state of affairs than I was before.
The committee asked the Governor if he considered Australian houses to be overpriced. The Governor responded that there were two elements to the issue: the current cyclical position, which he described as better than it was a year ago, and the long term context which requires greater housing supply and transport infrastructure. He said that:
…if you put what has happened in the last year in a longer term context there was a very big run-up in the 1990s in the ratio of house prices to income. That was because we could all borrow more as inflation came down and the financial system was liberalised. We all borrowed more, and the main effect of that was to push up the average house price relative to our income. Then, since 2002-03, the ratio of house prices to income has moved; it is up and down, but it has broadly moved sideways and it is a bit up over the past year. As the father of three children, I worry about that because people are paying so much for their housing. The solution to that—and I am going to sound like a broken record here—is housing supply and investment in transportation infrastructure.
The committee was interested in whether more accommodative monetary policy affected house prices more than other aspects of the economy. The Governor said that ‘the high level of house prices relative to our incomes is not primarily a result of our interest rate policy’, and that a broad range of factors were contributing to house price inflation:
This is the broader point that I was making there of some of the broader things that are going on in the society—the access to credit, where we want to live and location restrictions or zoning restrictions. That is why house prices are high relative to our incomes. From quarter to quarter, I agree with you that our decisions do influence housing prices, but those movements are really ripples around a longer term trend which is determined by these more fundamental factors. I have observed that the two interest rate cuts we have had this year do not seem to have stimulated a new round of house price increases. In fact, house price growth has slowed over the course of the year, and I think that is good.
Infrastructure and investment
The committee was interested in whether the Governor considered the level of public investment in infrastructure to be adequate, and asked how the Government could borrow money to fund infrastructure without raising the ire of credit rating agencies. The Governor noted that there were concerns about Governments borrowing money for recurrent expenditure, stating ‘we need to be very disciplined about borrowing to fund recurrent expenditure, because ultimately that does have to be paid by somebody’.
However, the Governor also saw opportunities for Governments to work with credit agencies to fund infrastructure while remaining disciplined with recurrent expenditure:
That does not mean that you cannot simultaneously borrow to build assets. That is what most businesses do; they meet their ongoing costs through their revenue flow and they borrow to build assets. So the test is: can the government, can any of us find assets to build that generate a return for society? If you can do that in a structured, disciplined, rigorous process with good governance, I am hopeful you could have a conversation with the rating agencies about that—but whether you could convince them, I do not know. If we are going to have any hope of convincing them, it is really about the governance of infrastructure selection—the project selection, the way the risk sharing is between the private and public sector, the control of the construction costs and then the business case for infrastructure.
The Governor also remarked:
As to how much more we can borrow, I do not know the answer to that. I do not feel that is the major constraint—our ability to borrow here. The constraint is coming up with the projects that pass the strong business case and have the good governance around them. That is the constraint. I do not feel that access to funds, either by the private sector or the public sector, is the constraint. It is developing the solid business case.
The committee asked the Governor why the Government’s AAA credit rating matters and what impact it may have on consumers if it changes. The Governor responded that:
The main impact of a changing credit rating would be on the interest rates that the government pays on its debt and that banks pay on their borrowings, but the effects are fairly small. For the type of credit rating changes that we might face, the effects on borrowing costs are quite small.
The committee asked the Governor if the international economy was slowing, and whether there were mechanisms available apart from monetary policy to stimulate demand. The Governor pointed to investment in infrastructure as one way to stimulate demand without relying on increasingly lower cash rates:
Someone in the economy has to be prepared to use the low interest rates. Government can do that or it can facilitate the private sector to do that on infrastructure. As the G20 has repeatedly emphasised, it is creating an environment in which the private sector wants to take advantage of the low interest rates. It seems to me logically that they are the possibilities: get more monetary easing to try to stimulate, government using the low interest rates, or government creating an environment where the private sector wants to use the low interest rates. Logically, they are the option.
The committee was interested in the role of psychology in achieving sustainable growth through investment. The Governor suggested that global uncertainty around a number of events, including Brexit, the declining value of the Euro, and China, has created a problematic environment for investment, and that it was important for governments and institutions to provide certainty to facilitate growth:
I see it as around uncertainty: what can we all do to provide a bit more certainty to people when they are making their spending and investing decisions? The Reserve Bank's contribution here is to be seen as a sensible institution that is predictable and operating within the normal bounds of what central banks do—being predictable and competent. We hope that helps bring a bit of certainty.
The payments system
The Governor outlined a major project being undertaken by the RBA to modernise aspects of the electronic payments system, in cooperation with the payments industry:
When this work is finished we will be able to make instantaneous payments to one another, with the money transferring between our accounts in a matter of seconds—and that is regardless of who we bank with. The addressing will also be simplified. All you will need is an email address or a mobile phone number. The payer will no longer need to give their bank account number or their BSB; just the mobile number or the email address will do. We will also be able to send a lot more information with the payments. You will no longer be restricted to just sending 14 characters if you go onto your internet bank to make a payment. You will be able to send whatever information you like with your payment. The first payments using this system should be able to be made late next year. And as one of the contributions of the Reserve Bank to this project, we are building the necessary infrastructure to allow the funds to be transferred in real time between financial institutions.
The committee was interested in hearing how the new payments system will assist bank customers with the portability of their accounts when shopping around for the best banking deal. The Governor said that the new payments system was relevant to the issue of portability:
I do not want to go too much into the technical details about how this works, but you can think of a central database that might have your phone number in it and a link to your account. You can change that link if you subsequently want to change where your money is going to if someone sends you the payment through this system. It may well make the whole issue of BSBs and account numbers less important and people will be able to change their transaction accounts more easily by changing the links between the central database and where their money resides.
The committee asked how changes to interchange regulations would assist with portability for bank customers. The Governor responded that the Reserve Bank’s Payments Systems Board examined interchange fees and found that, due to a lack of ‘effective competition in this market the interchange fees needed to be regulated’. The Governor said that interchange fees have subsequently come down and that it ‘is working out okay and has benefited consumers’.
The committee asked the Governor to comment on the Government’s ban on excessive credit card surcharging and how it is progressing in its implementation. The Governor noted that this issue arose from the Payments Systems Board’s decision a decade ago to allow businesses to charge a surcharge to recoup the cost of accepting credit cards, which subsequently enabled some operators to increase their surcharges to excessive levels.
The Governor said that the Payments Systems Board responded with tougher rules where a surcharge has to be directly related to the cost of acceptance of the credit card, and the government gave the Australian Competition and Consumer Commission (ACCC) the power to enforce those rules. The new rules came into effect on 1 September 2016.The Governor added:
The next round will apply to small businesses and it will come into effect next year. I expect that we will see lower surcharges as a result, and the surcharges, by law, will have to be directly related to the merchants' cost of accepting the cards. I think this is a much better situation and I look forward to it being spread right across the community.
The committee also asked if similar surcharging rules were being brought to bear on the taxi industry, which was regulated by the states and territories. The Governor said that:
The taxi surcharges have been very high but there is a process that is being undertaken by the state governments and in a number of states now the surcharges have been halved. We have taken the view to date that while ever that process was underway and delivering lower surcharges for taxis, that we would let that run its course, rather than introducing yet more regulation, when there was already a reasonable process that seemed to be addressing what is a legitimate area of public concern.
Operation of the major banks
The committee was interested in a range of issues relating to Australia’s banking system, including why the four major banks have not passed on recent interest rate reductions, the net interest margins of the banks, the spread between the cash rate and housing, business and credit card interest rates, and on the adequacy of the financial framework.
The committee asked the Governor to provide his perspective on the major banks not passing on the full rate cut when the RBA cut interest rates in August. The Governor said that:
It was not unexpected that they did not pass that through. That was what we thought was likely to happen. Over many years we have said we have taken into account the decisions of the banks in adjusting their margins in setting the cash rates, and that remains the case. It does not fundamentally adversely affect the transmission of monetary policy to the rest of the economy. There are a lot of other channels through which monetary policy affects the economy. At the margin it probably weakens one of the channels but it does not fundamentally undermine the transmission of monetary policy to the economy.
The committee was interested in the RBA's perspective on the net interest margins on what Australian banks charge to borrow and lend at compared to banks in other countries. The Governor said that while it was difficult to make direct international comparisons, the ‘rate of return on bank equity in Australia is higher than in most other countries now’ (see Figure 2.1). He added that, overall, net interest margins have been reduced because of competition and banks lowering their costs, although the process of reducing costs has probably run its course.
Figure 2.1: Large banks’ return on equity (after tax and minority interests)
[Number of banks: Australia (4), Europe (52), Japan (4), Canada (6) and United States (18); adjusted for significant mergers and acquisitions; reporting periods vary across jurisdictions.]
Figure 2.2: International comparisons of banking system concentration: Market share of the five largest banks
[Data are the latest available in each jurisdiction; Australia, Canada, China, Japan, Sweden and US data are the share of domestic bank loans held by the largest five banks; France, Germany, Italy, Netherlands, Spain and UK data are the share of domestic banking system assets held by the largest five banks.]
Additional information supplied by the RBA (see Figures 2.1 and 2.2) outlined that:
The major Australian banks’ return on equity has averaged around 15 per cent over the past decade
It is similar to the return on equity for large Canadian banks, but higher than in the United States, Japan and Europe
Data on banking system concentration are compiled from multiple sources and on different bases in different countries. All estimates shown focus on the domestic business of banks operating in each country, and
These data indicate that concentration in the Australian banking system is relatively high but is not unusual compared with that in other countries.
The committee asked the Governor why there was an increase in the spread of interest rates for standard variable, housing and small business rates in the last decade, and if this was because of a repricing of credit risk. The Governor responded ‘that would be a good question to ask the banks’, and said he thought that it was caused by some under-pricing of credit risk in the past:
The banks found going into the financial crisis that their credit losses on many of these loans turned out to be larger than they had previously thought, and they judged that they were underpricing it, and they moved quite early on during the financial crisis to reprice the credit spreads they charge over the indicator rates on many small business loans.
When asked if many of the small business loans would be residentially secured, the Governor again said this was a line of inquiry for the banks, and said that ‘the probability of default might be higher, but the security in the house gives the bank protection against losses’.
The committee also questioned the Governor on why credit card interest rates remained high while other rates had come down. The Governor said that ‘I wish I knew the answer to that’ and suggested that the banks could provide a more complete answer. The Governor remarked that:
This is something that happens right around the world: credit card interest rates do not seem to be very sensitive to the central bank rate. One of the explanations that I hear is that the main focus of competition is not on interest rates; it is on reward points or temporary interest-free periods. The consumers, for whatever reason, when selecting a credit card, are not particularly sensitive to the interest rate on that credit card. They often want to get a one-year, interest-free period; they are quite sensitive to that. They are quite sensitive to the reward points or the reward scheme. That is where the effort of competition, or the focus of competition, has been. The result of that is the rates do not move very much over time and people who are borrowing on credit cards pay very, very high interest rates.
The Governor added that while the interest paid on credit cards was small as a proportion of total household debt, the total interest bill on credit cards remained significant and any decreases in credit card interest rates would support the cash flow of households:
Credit card debt is $50 billion, which is only three per cent of total household debt, so in the overall scheme of things it is relatively small. Of that $50 billion, $32 billion attracts interest. The rest is just kind of revolving credit. So my calculations are that the total interest bill in a given year, on credit cards, is around $5 billion, so the household sector is paying to banks $5 billion a year. If the interest rate were to fall five per cent—let us say the average interest rate were to fall from 17 down to 12—that would give the household sector an extra $1½ billion a year in cash flow.
The committee asked the Governor if the return the banks were making on credit cards was being passed on as a benefit elsewhere. The Governor again replied that this was a question for the banks; however he said that:
…it is important to keep in mind the magnitude here. This is three per cent of total household debt, and then banks obviously make a lot of business loans as well. If you think about the overall share of the banks' portfolio in credit cards, it is probably one, 1½, two per cent. So is quite a small thing. And I do not know where the offset is.
The committee was interested in whether the RBA considered the financial framework to be adequate. The Governor noted that the Australian Prudential Regulation Authority (APRA) has made a number of recent changes to financial regulation, particularly in relation to capital and liquidity, and that the financial system has therefore undergone a period of rapid regulatory change. The Governor said that it was best to ‘let that settle and see how the system adjusts to it’.
The committee asked the Governor if the banks were passing on the cost of APRA’s requirement to hold more liquidity to their customers by not reducing their mortgage rates. The Governor agreed that this was one factor in the spread between lending and borrowing rates, responding that:
It would appear that that is one of the things that has happened—that the banks are holding more of these assets which earn very low returns, and the spread between lending and borrowing rates has widened a bit in response to that and left the return on equity broadly unchanged. There are other things going on as well, because there are so many moving pieces in this, but this is a significant increase, or the banks will think it is a significant cost impost, because there is an extra five per percentage of their portfolio earning maybe one per cent rather than the five per cent which they would get if those assets were in loans. They will say that that has to be compensated somewhere in the system, and it is an interesting question who should bear the cost of that—should it be the equity holders, the borrowers, the depositors?
The Governor also noted that he expected that the major banks’ return on equity would decline over time and that ultimately it will be increased competition in the market that will result in better rates for customers. He added:
The system has sufficient safeguards in it that if rates of return are too high then eventually someone comes in and says, 'Well, okay, I can take advantage of that.' Society is frustrated by how long that process takes, but I am confident that over time it does happen.
The Governor remarked that the Australian banking system has performed well under the supervision of APRA, particularly during the lead-up to the global financial crisis:
The Australian bank system has performed well over a couple of decades. We did not have the excessive risk-taking culture in the lead-up to the financial crisis. I think that is really important. If we had a really bad risk-taking culture, we could have ended up in the same situation as many other countries did. Part of it is due to APRA's good regulation, but the banks did not develop this culture that we saw overseas. So that has given us more stability.
The Governor said that, in terms of incentive structures within banks, he would like to see ‘banking return to be seen as a strong service profession’ as opposed to a marketing or product distribution business. The Governor added that earning the trust of consumers should be a cornerstone of banking practices :
I like the Banking and Finance Oath. I do not know whether you have seen this, but a number of people have signed up to this, including me, and I encourage others to do it as well. Its first line is: 'Trust is the foundation of my profession.' We have got to move beyond people just signing this oath to actually making that in practice. I do not run a commercial bank. I do not know how to embed within a commercial bank the idea that trust is the foundation of the noble profession that we do. It is largely about incentives and remuneration.
The committee asked the Governor if he could provide details on whether the Australian banking system is more concentrated than banking markets in the United States, Europe and Japan. The Governor replied that ‘most banking systems are now very heavily concentrated’ following the global financial crisis which led to a number of mergers around the world. The Governor added that ‘we are not unusual in having four or five banks that account for the vast bulk of financial intermediation’.
The committee was interested in how Australia could foster increased competition in the banking sector, and what could be learned from examples overseas, including the United Kingdom. The Governor said that :
The observation I would make from looking back over the last 25 years is that the competition really comes from new entrants. In the three examples I talked about—stockbroking, deposits and mortgages—it is the new entrants that bring the competition. The existing institutions have a large back book and if they are earning high rates of return on that, they do not want to compete aggressively for new business and reduce the profitability of their large existing customer base. So it is the new entrants. So I think you are right to kind of focus on what can be done to make it easier for new entrants in our system. I think there is merit in kind of systematically thinking about what the barriers are to new entrants, and, on those barriers to entrance—some are completely legitimate—what is the public policy case for them. Because inevitably competition comes from the new entrants. It is not likely that all of a sudden existing incumbents will decide to compete a whole lot more aggressively. If there is a high rate of return being earned in a particular business line, what we want is another entity to come in and compete that away and then the existing institutions respond, and we saw that again with deposits, mortgages and stockbroking.
The committee was interested in the new Governor’s perspective on corporate governance at the RBA, and asked whether he was satisfied with the internal culture of the RBA following certain events including the alleged leaking of information relating to rate decisions.
The Governor responded that he did not have any concerns and had a ‘very high regard for the staff of the bank and the way they go about their job’. The Governor stated that:
There was, as you say, some speculation last year that the monetary policy statement was made available to people earlier than it was publicly released. We looked at that forensically, as you could expect. ASIC has also looked at it. We have had an external firm come and look at the way we did the investigation. I am 100 per cent confident that our processes stand up to scrutiny.
The committee asked the Governor to explain the key implications of the new Statement on the Conduct of Monetary Policy. The Governor said that the new Statement represented continuity with previous statements and contained drafting changes that provide a clearer link between monetary policy and financial stability:
In the previous statements, monetary policy and financial stability were dealt within in completely separate parts of the document, yet over the years financial stability considerations have been a factor in our monetary policy deliberations. Recently, for example, we have considered that a very quick return of inflation to the two to three per cent range, at the cost of a material deterioration in the health of private sector balance sheets, is unlikely to be in the public interest, so the revised drafting recognises that the inflation target is pursued in the context of the bank's broader objectives, including financial stability. That is the monetary policy framework.
The committee questioned the Governor about the RBA’s performance following the Government's decision to bolster the RBA’s reserve fund by $8.8 billion in 2013. The Governor noted that in recent years the RBA has ‘made a decent profit’ and that dividends had been returned to the government in accordance with the Reserve Bank Act. The Governor added that this profit was ‘…largely due to the depreciation of the currency’. The Governor further commented:
The running yield on our assets is quite low because we are investing overseas in euros and yen. As you can imagine, we are not getting high returns there. The underlying running yields are not particularly high, but we have made capital gains on the foreign holdings.
The committee asked the Governor if the RBA was concerned about an increase in the level of counterfeiting. The Governor responded that while the level of counterfeiting in Australia had doubled in the last decade, it was still low by international comparisons.
The Governor added that investments in new technology for Australian banknotes will enhance note security and he was confident that counterfeiting rates will be low. The Governor remarked:
I think these notes have the best security features of anywhere in the world. We are really proud of our scientists down in Victoria that have developed this, together with some of the international ink manufacturers, to put security devices on our banknotes that no-one else in the world has.
Australia’s economic growth is expected to gradually increase over the next few years, assisted by an increase in capacity of some liquefied natural gas (LNG) projects, a modest increase in coking coal exports as a result of improved prices and continued strong growth in the services sector. There is evidence that the Australian economy is transitioning to more balanced growth, which is being supported by accommodative monetary policy and a weaker Australian dollar.
Employment growth has been slower this year, following strong growth last year, with recent employment growth being concentrated in part-time employment. Growth in dwelling investment remains strong, with the pipeline of dwelling construction at high levels. This is expected to support dwelling investment for some time; however there are concerns of potential oversupply in certain markets.
Inflationary pressures are expected to remain subdued in the near term, before increasing modestly in the next few years as the long-run depreciation of the Australian dollar continues to exert upward pressure on prices of tradable items. Labour costs pressures remain weak, reflecting spare capacity in the labour market. Wage growth is forecast to remain low in the near term, before increasing gradually over the forecast period as the economy transitions away from the mining boom and labour market conditions improve.
Mr David Coleman MP
19 October 2016