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Standing Committee on Economics
07/03/2014
Reserve Bank of Australia annual report 2013

KENT, Dr Christopher, Assistant Governor (Economic), Reserve Bank of Australia

LOWE, Dr Philip William, Deputy Governor, Reserve Bank of Australia

STEVENS, Mr Glenn Robert, Governor, Reserve Bank of Australia

Committee met at 09:25.

CHAIR ( Ms O'Dwyer ): Ladies and gentlemen, I declare open this hearing of the House of Representatives Standing Committee on Economics. I welcome representatives of the Reserve Bank, members of the public, school students who are with us today and the fourth estate, the media. This week included the release of the ABS national accounts data for the December quarter of 2013. Gross domestic product grew by 0.8 per cent in the December quarter to be 2.8 per cent over the year. While this result is a little faster than in the previous quarter, 2.8 per cent growth over the year is not enough to reduce unemployment. We need to do better and aim for growth above three per cent, which is the pace of growth widely accepted as being necessary to bring down the rate of unemployment.

On Tuesday the governor stated that the bank expects domestic unemployment to rise further before it peaks. Pleasingly, he said that growth is expected to strengthen over time. More generally on the economy, in their recent Statement on monetary policy the RBA noted:

The outlook for the domestic economy is a little stronger over 2014 than at the time of the November Statement. The revision reflects, in part, the effect of the lower exchange rate, which is expected to provide some boost to activity in the traded sector.

The statement said:

The Australian dollar has depreciated by around 5 per cent since the November Statement in response to economic developments both at home and abroad. This unwound the appreciation over the preceding few months, leaving the currency around 12 per cent lower than it was at the time of the May Statement. If sustained, lower levels of the exchange rate will assist in achieving balanced growth in the economy.

The RBA also notes in its February statement:

Mining investment appears to have declined over the past year and is expected to fall further over the next few years.

This is confirmed by the national accounts data from the ABS released on Wednesday. The RBA statement continues:

This … will continue to be, associated with lower capital imports and rising exports as more resource projects reach completion.

There has been recent strong growth in exports, 'largely reflecting higher resource exports'.

Exports of services and manufactured goods have been little changed over the past year, although the depreciation of the exchange rate should provide support for these exports over time.

Elsewhere the statement says:

Consumption growth was a little below average over the year to the September quarter, consistent with little growth in employment and slow growth of wages. However, indicators of consumption have been more positive of late.

…   …   …

While dwelling investment made only a minor contribution to growth in the economy over the year to the September quarter, a strong increase in approvals for residential building points to a pick-up in investment in the coming year.

…   …   …

The labour market has remained weak—

due to below-trend economic activity. The RBA board decided at its March meeting earlier this week that it would be prudent to hold the cash rate steady at 2½ per cent and that 'monetary policy is appropriately configured to foster sustainable growth in demand and inflation outcomes consistent with the target'.

In view of these trends, the committee will continue to examine the Reserve Bank on its current monetary policy settings and whether they are achieving their policy objectives. The committee will also be interested in the RBA's views on the recent G20 accord to increase global growth by two per cent above the current trajectory over the next five years and the policy settings that will be needed to achieve this.

On behalf of the committee, I welcome the governor and senior officials of the Reserve Bank of Australia to this hearing. I remind you that, although the committee does not require you to give evidence under oath, the hearings are legal proceedings of the parliament and warrant the same respect as proceedings of the House. The giving of false or misleading evidence is a serious matter and may be regarded as contempt of parliament. Governor, would you now like to make your opening statement?

Mr Stevens : Thank you, Madam Chair. Thank you for the opportunity to meet with you today in this rather intimate set-up. Perhaps the committee wants to get closer to us in some way. Anyhow, thank you for this opportunity.

When we met just prior to Christmas, I suggested that, from an international point of view, 2013 could be described as a year that turned out to be not quite as good as hoped but certainly not as bad as had been feared at some times. I would say nothing has occurred since then to change that assessment. One prominent international event, of course, was that the US Federal Reserve has commenced the so-called tapering of its monthly asset purchases. That was a possibility we talked about last time and, although the timing of that was not known, it was widely expected to occur before long, and indeed it did begin within hours of that meeting. A further reduction in asset purchases was decided at the Fed's January meeting, and indeed it is expected that that process of tapering will continue.

After all the anticipation of that change, the actual announcement itself in December did not really cause much disruption in markets. In the January case, there was a bit more volatility and a few emerging market economies have come under pressure, with yields on bonds spiking and exchange rates declining. I think it is, though, important to keep this in perspective. Periods surrounding changes of course by the Fed often are times when market participants reassess their positions and their appetite for risk, and this occasion has been no different. It is not necessarily the Fed's action per se that is most important, but what it conveys about the change in the general economic and financial environment. At such times, investors often start to focus more closely on risks that they had hitherto not paid that much attention to.

Investors have not, however, fled from risk indiscriminately on this occasion, at least not so far. They have drawn distinctions between alternative classes of investment and different countries. Long-term yields of sovereigns in the core countries have gone up a little, but they are actually still quite low. With compressed risk spreads, that means that borrowing costs for many private investors globally remain, in fact, very low. Spreads over German yields for European sovereigns have not risen; they have in fact kept declining through this period. That suggests that actions by European policymakers have had more influence in Europe and European markets than actions by the US authorities. That is as you would expect, but that has not always been the case in some instances in the past.

Moreover, not all emerging markets are experiencing the same pressure. Some that had experienced considerable turbulence in the middle of last year, when tapering was first mooted, have in fact been travelling a bit better of late. That owes something, I think, to the policy responses in those countries in the intervening period. Among those countries that have been under more pressure of late—and there are some—genuine sources of risk domestically can be observed in many instances, and in several cases these market pressures have resulted in policy responses in those cases, which were probably needed anyway. So in general I would say tapering is proceeding so far about as well you could expect under the circumstances.

In the meantime, forecasts for the global economy have not changed much. If anything they have inched higher, though not by very much, and they still suggest that 2014 growth globally will be higher than last year and perhaps at about average pace. More of that growth is coming from that advanced countries and proportionately a little bit less from the emerging world. In some respects that is probably a welcome rebalancing, given how weak the advanced countries have tended to be over recent years. Australia's terms of trade have been little changed over the past year. They are at a high level, though we still assume they will decline further in future.

Turning to the Australian economy, for some time our view has been that growth has been running below its trend pace. The national accounts released a couple of days ago do not significantly change that assessment. For the year to December, real GDP rose by about 2¾ per cent, which is roughly in line with the forecasts that we have had out there for a little while now, albeit slightly stronger. The drivers of growth, as we all know, are shifting. We have been saying for some time—and this has been confirmed in the recent data on capital expenditure intentions by firms—that the very high level of investment spending by mining companies has now turned down and that decline will accelerate over the coming year. It appears that other areas of demand will at least partly offset that.

Let me go through a few of those. Export volumes for resources are growing very strongly as the capacity that is in place from the high levels of mining investment is now being used. One example is iron ore shipments; they are 85 per cent higher now than the level of five years ago, running at about 1½ million tonnes a day. That will increase up to two million tonnes or so over the next couple of years. It is clear that dwelling investment activity will rise quite strongly over the period ahead. During this week we received data on this area covering the last three months. Over those past three months approvals to build private dwellings numbered almost 50,000—that is, 27 per cent higher than a year earlier. That is in fact the highest three-month total in the history of that time series, which goes back to 1983.

Consumer demand has also had a firmer tone over the summer, after a fairly long period of rather subdued outcomes. This is in evidence not only in retail trade data but also in the national accounts data, and it is confirmed in the liaison that we conduct with firms each month. Consumer sentiment, as measured, remains a little skittish. While we expect consumption to grow in line with income, or maybe just a little faster, consumers are unlikely, as I have said before, to be the drivers of growth in the way that they were in the years prior to the financial crisis.

Business investment spending outside of mining, which has been very low in recent years, is bound to pick up at some stage. There are some signs of improved conditions and confidence in business surveys. We talked about that last time and, by and large, that has been sustained. The early indications of an improvement in capital expenditure expectations in the non-mining part of the economy are apparent, but they are quite tentative at this stage. Our sense is that firms are looking for the recent signs of improved conditions to continue before they commit to bigger expansions in investment spending. Public final spending is scheduled, according to the announced plans of federal and state governments, to be quite weak.

As you said, chair, the expected ongoing effects of low interest rates and a somewhat lower exchange rate have resulted in a slight lift in the forecasts of growth for the second half of this year and into 2015. That was reflected in our most recent published forecast, which we released last month. We have not made any further changes since then.

Turning to the labour market: with growth having been below trend for a while now, job vacancies declined, employment growth weakened and unemployment rose in 2013. Some forward indicators here have stabilised and turned up just recently, and that is promising. Even with that, and even with the improved growth outlook, the labour market probably will remain rather soft for a while, given that it lags changes in economic activity. That softness has already seen a slow-down in the growth of wages that is quite noticeable.

Turning to inflation, the recent data show inflation in underlying terms at about 2.5 per cent over the past year and a pace somewhat above that in the second half of the year. That is a change from the middle of last year, when we tended to get information on prices that was probably a little lower than had been expected. Part of the increase in inflation is explained by the fact of the depreciation of the exchange rate, which of course has resulted in a rise in the prices of traded goods and services. But that does not account for all of the higher result and it is, at least on the surface, something of a puzzle actually that underlying inflation for domestic goods and services went up a bit, even as clearly the pace of growth of labour costs has gone down. That may be telling us that there is a rebuilding of profit margins in some areas, particularly those where demand conditions may have improved a little. There may also be an element of noise in the quarterly data. The view that I have taken so far pending any further evidence here is that there is probably a bit of both noise and signal in this result. Hence our assessment is that inflation is not quite as low as it might have looked six to 12 months ago but nor is it accelerating to the extent that a literal reading of the latest data might suggest. If you think about the general situation, 18 months of growth having been below trend, unemployment having gone up and wages growth having slowed, that is not one that would obviously be associated with a sustained rise in price pressure. So our view remains that the outlook for inflation, while a little higher than it was three or six months ago, is still consistent with the medium-term target.

Monetary policy is very accommodative. The cash rate has been unchanged since last August. It and most borrowing rates are at multi-decade lows, and the sorts of things you would normally expect to see from a very accommodative monetary policy setting are increasingly in evidence. What are they? Well, savers are looking for higher return assets because the yields on safe assets are very low. Asset prices have risen. Credit growth has picked up. It is still actually quite low by historical standards but it has picked up for households and particularly for investors in housing, where it is now running at an annualised pace of nearly nine per cent. Construction of dwellings is set to rise, and probably quite strongly, over the year ahead. Our liaison suggests that lenders are becoming more accommodating to potential borrowers and relatively few people complain now about credit availability. Finally, the exchange rate has depreciated more, as you would expect, with monetary easing, though it is still high by historical standards. So on the whole, then, accommodative monetary policy is doing the sort of things you would normally expect and it is playing its part in supporting sustainable growth in demand consistent with the inflation target.

The outlook contains many uncertainties, not least the handover so-called from mining investment spending to other sources of demand outside of mining. In some important respects the basis for that handover is coming into place, as I have just said. The question really is whether that additional demand likely to be generated outside of mining as a result of all those trends will be just the right amount to offset the large decline in mining investment that we know is coming, so keeping the economy at near full employment. The honest truth is that no-one can answer that question with great confidence. For a start, forecasts are not all that accurate; we know that. Even if it were the case that forecast accuracy could be much better than historical experience could possibly let us hope, it cannot be assumed that a shortfall in demand can necessarily be made good in short order by monetary policy. Monetary policy has a powerful effect on the general environment but it just cannot fine tune quarterly or even annual path of demand that well. We harbour no illusions of our capacity to do that.

At the present time, our judgement is that monetary policy is doing the things that it can reasonably do in the circumstances we face. And we have signalled the likelihood, if the economy evolves more or less as expected, of a period of stability in interest rates. I think as well as the low level of rates generally, a sense of stability, if we are able to offer that, is something that at the margins should be of some help to businesses and households as they make their own plans. So with that, we are here to respond to your questions, thank you.

CHAIR: Thank you very much, Governor. I will begin the questions and I am going to touch on four different areas in my line of questioning: unemployment, inflation, housing and the Australian dollar. I am going to start with unemployment. As we know the unemployment rate rose to six per cent in January, which is the highest in more than 10 years. The RBA on Tuesday said that it expected unemployment to peak at higher than this. For how long has the RBA held the view that the unemployment rate will peak at greater than six per cent?

Mr Stevens : I think that has been a feature of our forecast for a few months now and we have said in a few of the recent statements that, firstly, we thought below-trend growth would continue for a little while. It follows from that that unemployment would rise further. I would be hopeful not too much further and, as I said, we have seen most of the leading indicators of labour market conditions turn up lately, and so that would be several measures of job vacancies, indications of hiring intentions in surveys and so on. That is very recent—only a month or two—so early days, and that needs to be sustained and continued. I think they are positive signs but, realistically, I would say the unemployment rate will edge up a little further yet before we see a peak, hopefully, some time this year.

CHAIR: The most recent Mid-Year Economic and Fiscal Outlook forecast that unemployment would go up to 6.25 per cent in 2014-15. In your opinion, has the recent increase been consistent with the MYEFO forecast and is it in line with your current estimates?

Mr Stevens : I would say that what we have seen just in the most recent monthly data is broadly in line with the sorts of things we were expecting and I do not think there is great reason to revisit the sorts of forecasts that you are talking about at the moment. The 2014-15 numbers probably are a year average, which would not preclude a peaking and then a start to decline during the year.

CHAIR: It is generally accepted that the labour market is a lagging economic indicator with changes in the labour market responding to with a lag to changes in economic activity. Is this the case? How long is the lag between changes in economic activity and changes in the labour market?

Mr Stevens : It is the case that all the evidence from history is that output leads employment. I think that will still be true in the future and I would say probably one to two quarters—would that be a reasonable estimate, Chris? I think that is the rough rule of thumb.

Dr Kent : About two quarters.

Mr Stevens : So if growth is starting to firm now, within a few months, one should start to see leading indicators respond to that. As I say, we have had some signs of that already. So you are looking at one to two quarters, I would say.

CHAIR: Moving onto inflation and related to the labour market, why isn't the weakness of the labour market feeding through to lower, non-tradeable inflation?

Mr Stevens : That is a good question. That is in a sense the slight puzzle with the recent data, and I think possible explanations are, firstly, you do get a certain degree of quarterly noise in these figures, so it could be that we have had just in the statistical sampling process an unusually high number that will be followed then by lower ones. Certainly, for quarterly outcomes in core inflation in a couple of quarters' time, we would have lower figures in our forecast.

Another explanation that one has to consider is that the gap between the costs and the prices has widened because profit margins have gone up, to put it simply. That is quite possible. That is probably happening to some extent, though when we try to get an independent gauge of that—there are figures you can look at for retail margins—I think it is right to say there has been a slight increase, but not very much. Is that right, Chris?

Dr Kent : I think the data on retail margins really does not allow us to drill down that much because we do not really understand the full costs of doing all of their business. It is not inconsistent with a small increase in margins but it would not be large, from that data.

Mr Stevens : So, understanding this has to be, inevitably, a work in progress. As always, more data will help us understand it. That is the reality of the situation.

CHAIR: I am interested in teasing that out a bit more. Do you think that being an economy that makes things and having to compete globally enforces a certain discipline on inflation, which might start to slide if the services share of the economy keeps rising? Do you think that that has an impact?

Mr Stevens : I do think that, obviously, international exposure exerts a discipline on prices, conditional on where the exchange rate is going of course. The higher it goes the more punishing that discipline becomes, and vice versa—at least, temporarily. In the end your competitiveness as a country is really going to be driven by your ability to manage your domestic cost structure and your productivity—not from the exchange rate.

Those things are important but there is no doubt that international exposure is a discipline. The part of the consumer price index that is generally regarded as 'tradable' is probably close to half. A lot of the things we buy here, if not actually imported, could be imported; if they are not actually exported, they could be. So, that international discipline is quite important.

I do not know that I agree that a higher share of services, in itself, would necessarily lead to a weakening of that discipline, because services can also be traded. Indeed, they are. We can fly on foreign airlines, for example—and apparently most of us do. I do not want to get any closer to Qantas than that, but that is a tradable service.

CHAIR: I am also interested in your views on Australia's potential growth rate and whether you believe that the December quarter inflation print is an aberration, bringing all of that together.

Mr Stevens : For the business we are involved in it is, in a way, a signal extraction problem. We have various bits of information about economic activity—demand, supply prices and other costs—and there is a fair bit of slippage in how all of that fits together in any given quarter. Our job, really, is to try to take the pieces of the jigsaw and work out in what way they fit together most plausibly. They never fit exactly, in any given quarter, or even in any given year. The job really is to try to answer the question: how do all these pieces fit together in a way that makes most sense? How can we get the most consistency from all the various pieces?

It is a possible reading—I think, maybe—to say that the CPI print in December tells us that the economy's supply potential is much worse and that we cannot grow very much at all without generating inflation. That is one reading. It is not the reading I would jump to, because I think a better reading is that we have had a little bit faster flow-through of the effects of the exchange rate than average. That is not particularly a problem if that is the case, because the flow-through has finished earlier—if that is the story. We have had, maybe, some rise in profit margins in some areas, or maybe there are some other costs that are not wage costs that are flowing through, and we have got some noise.

So I am not drawing from this at this point a strong signal about potential growth. I would say still that the potential growth rate of the economy is three per cent or a touch more. That is conditional on a view about productivity, but in fact I am probably a bit of an optimist on that score for the future. We know we have labour force growth of 1½-odd per cent. Putting that together, you would expect that potential growth would be a number starting with a three. It is not much above three, but three-ish. Longer term demographics impair that, but at the moment that is still what I would say. We know that unemployment has risen. We know wages have fallen. I do not think you would read that as a rise in the structural unemployment rate. So I do not think I would change my view about potential growth just yet on the basis of that set of outcomes. If it keeps happening, then you have to revisit that, but that would be my view at the moment.

CHAIR: Governor, I have spoken with you a number of times about the inflation target for the RBA and the fact that our inflation target is higher than comparable countries around the world. Do you think that that potentially makes Australia less competitive over time? And do you think that we tolerate too much inflation here?

Mr Stevens : The inflation target of two to three—let us for the sake of argument call that 2½ as the midpoint of that zone. It is true that some other targets are a bit lower, but they are not that much lower. The Europeans have a formulation of close to but below two, so they are only a little bit lower. The US is similar. I think some other countries are one to three. So you are really talking about, amongst comparable countries, a half a per cent difference. In the emerging world they typically have higher targets than ours.

I think there was a long period of our history where we were too tolerant of inflation. From 1970 to 1990, the average inflation rate was eight per cent, which means the value of money halves about every nine years. That is way too high, and I think we were too tolerant of that for too long, but in the 20-plus years since then we have done rather better. I think that if we were to open a debate about, 'Is the inflation target in need of reconfiguration?' you are really only talking about half a percentage point. I have not felt any discomfort with the target. The main thing is to achieve it, which we have.

In terms of competitiveness, in the textbook, countries that have higher inflation typically have a trend decline in exchange rates over time. The emphasis there would be on 'trend' and 'over time', because the exchange rate does not always deliver exactly what you might want to make differences in inflation completely neutral. But, over time, you would expect that a country that is, in a sense, damaging its own competitiveness by high domestic inflation—or, for that matter, low productivity performance—at the end of a long period is going to also see that its exchange rate has gone down a lot and its purchasing power over foreign goods and services has similarly gone down to reflect that. That should neutralise over the long run, but I emphasise 'over the long run'. Realistically, genuine competitiveness, I think, comes from innovation, productivity, cost control and so on. It comes from those things more than from the inflation target you might choose, I would say.

CHAIR: I will move onto the issue of housing, because this is very much a barbecue stopper in Australia. With house prices continuing to soar in major cities, there is a lot of talk about foreign investment underpinning those house prices. Are you worried about the role of foreign investors in driving up capital city house prices? Also, we recently saw the Canadian government make it more difficult for foreign investors to buy homes in Canada. Will this have implications, in your view, for Australia?

Mr Stevens : The question of how prominent foreign investors are is a difficult one to answer. I travel through Singapore a number of times a year on the way to interminable meetings in Basel. It is quite noticeable when you pick up a Singaporean newspaper on the plane to see advertising for Australian property, as well as property in other countries. So there is no doubt that wealthy foreign investors have an interest here. In particular parts of our cities, including where we are sitting right now, the role of foreign investors is quite prominent indeed. I suspect it is rather less prominent around most of the metropolitan areas than some of the headlines might suggest; nonetheless, there is a role. As a country we tend to feel that we should be open to foreign investment—we generally like that. This is a form of that, just as foreign investors buying shares in listed companies or doing direct investment in resource projects or whatever it might be is a form of it. It has its effect on asset values and the exchange rate, just like all the other forms of foreign investment.

I suppose the question is really: how big a problem do you really think it is? Foreign investors are generally confined to buying new structures. That is where it is easiest for them to come in. It cannot be beyond our capacity over time to meet that demand and to meet the legitimate demands of our own citizens for structures as well, can it? If we cannot do that, if there is a supply side constraint, I would say that is an issue worth addressing in its own right. Beyond that, it probably goes to broader questions of how welcoming we wish to be to foreign investment generally. That can be a vexed issue at times. With all due respect, that is a matter for our parliament to manage.

CHAIR: Certainly. I am sure there are lots of people with a range of views on that at this table alone.

Mr HUSIC: I think that was the 'over to you' comment.

CHAIR: I would like to pick up on the final part of my question, regarding Canada and their decision. Do you think that is going to have broader implications for us in Australia?

Mr Stevens : I cannot say I am across the fine details of their decision, but perhaps your question is whether that will divert—

CHAIR: Correct.

Mr Stevens : I am not sure that I can give an informed answer or quantify that. I suppose decisions like that just show that this is an issue in a number of countries. I am aware that Canada has had a fair bit of investment from Asia into the west coast, and we have had some of that ourselves over quite a run of years. But I cannot quantify the extent to which that might lead to a spillover in our direction.

CHAIR: What are the expectations that you have for credit growth in 2014, and at what point will credit growth become a concern for the RBA?

Mr Stevens : We are seeing, as I said, some gradual pick-up in credit to households. For households in aggregate that is still in the five or six per cent a year range. I think that is okay. I do not think we are going to go back to the 15 or 17 per cent growth that we saw for many years. If we did see that, I think we should be asking whether that is wise, given the levels of debt that households begin from. As you know, I have not been amongst the people who say that the present level of household debt relative to income or assets is disastrous. I am not in that camp, but I am in the camp that says it is pretty high now and we would surely be asking for trouble if we see a big step up from where we are. So, if we saw that, I would be concerned.

Credit to business is still growing more slowly than it is to households, so I suspect we may see some increase there and I think that would be welcome. I think that is what you would expect in an environment where policies are accommodative, where we would be wanting firms to step up investment intentions and plans over the next few years and where banks are keener to lend—I think rightly. Over time, you would expect somewhat faster growth of credit to business than we are seeing now.

Credit to households for investment in housing is eight or nine per cent a year. I would say that is probably fast enough. I repeat what I have said before that in Sydney in particular—but not just Sydney now—there has been a very big run up in investor activity. That is okay, but people need to keep in mind that prices do not just rise; they can fall and have fallen. We need to be careful that we do not take on too much leverage on the expectation that ever-rising prices for the asset make that work out, because I think that would be a dangerous assumption.

Mr HUSIC: I want to focus on the overseas economic environment, particularly in Europe and the US, and take the perspective of its potential impact here. We received warnings in January from the IMF about signs of deflation in Europe. In the US last week a lot of us noticed the new Fed chairwoman, Janet Yellen, talking about—she probably used a different word to 'noise'—a bit of consternation about the economic data emerging there that has been used to make decisions about tapering. What are you seeing in terms of Europe and the US? I will come to China and its potential impact on us later.

Mr Stevens : Europe is growing. They have had, I think, three quarters of growth now. It is pretty subdued growth and it is after a very weak period. Mario Draghi, my counterpart at the ECB, has referred to it as 'uneven', 'tentative' and 'fragile'. He has used words like that, which I would agree with. He has also said that he does not think that Europe is at serious risk of encountering deflation. I know the IMF has talked about that possibility, but the people on the ground there do not seem to agree with that right at the moment. I guess how that could change is if they went back into a downturn starting from an already low inflation rate. Then that might come more into focus, but at present they are growing.

It is probably also important to note that something that has gone quite well in Europe—that might not have—are the spreads on the so-called debt for the peripheral countries, which have kept narrowing. In fact, I think some Greek entities are about to float a bond for the first time in a while. So access to capital markets has been improving for a number of the countries in Europe who were struggling.

Growth has resumed, slowly. They really need more growth than they are getting, but that has turned in the right direction. Coming onto the radar is the asset quality review that the European Central Bank will be doing for the large banks, which they are now going to be responsible for supervising. I think this is important in a couple of respects. The first is that I think there remains doubt in the minds of market participants just how strong or in what shape the balance sheets are of large European banks. This is why you need to have a process which is done consistently across countries and which is transparent about just what is on those balance sheets.

It is striking, for example, that listed banks in Europe trade in the market at a price which is below the asset valuations they claim to have in their accounts. Why is that? That has to be because the markets have doubt about the shape of their balance sheets. It would be good to clear that up. In doing that you also have to be ready for new capital to be put in, if that is needed. So they need to make sure that that device is available. Looking forward through the rest of this year, that will be an important milestone for them to approach and get past.

In the United States there have been some weaker data points but they have had this very bad winter and I think most people would hold the view at the moment that it is hard to get a clear read on the economy in the data that is still coming through, because of the effects of the weather. In a few more months, of course, we will be past that. By then, hopefully, the data will be giving a clearer read on just what the underlying trend is apart from the weather effects. At this point, as far as I know, the Fed would be saying that it is probably pretty-much the weather that accounts for the weakness so far. In a couple of months they will be able to get a clearer read.

Mr HUSIC: If events confirm the anticipation that job growth might not be as strong in the US, do you see that as having an impact on the pace at which tapering occurs? What do you see as the markers, obviously bearing in mind that it is the Fed making the call?

Mr Stevens : They have put labour market outcomes as a very important marker. My suspicion is that it will take quite a bit of weakness to get them off the track of tapering. After all, tapering just means that the Fed balance sheet is still growing. It is a very large balance sheet and it is still growing—just not by quite so many billions a month. So, strictly speaking, I think people would say that in a way you are easing policy, but you are easing more slowly. I think they would probably take a fair bit of dissuading, having started on this path, to stop it.

They are quite a long time away, yet, from actually raising an interest rate, of course. That is, from the things they say, well into the future. So we are not really talking about an actual tightening by the Fed this year. It will probably be quite late into next year, at the earliest, before that would happen, based on what people have said.

I am not going to sit here and opine, from afar, on what Janet and her colleagues will do. I just offer the observation that I think it will probably take a fair bit of weakness for them not to take the next few steps in the taper. And we should hope that they will take them, I think.

Mr HUSIC: I will come back to China later, because I want to look at it in the context of some of the questions that the chair raised with respect to investment in property here.

With regard to productivity, some of the statements of the RBA have appeared to be relatively up-beat about recent productivity growth. I was wondering if you could talk us through the recent two- to three-year experience with growth here, just to get your take on where productivity is headed.

Mr Stevens : As you know, we had quite a lengthy period—probably the best part of ten years—during which productivity growth had clearly slowed. My view is that productivity is likely to improve a bit. I think the data are consistent with that over the past couple of years, subject to lots of caveats—for example, it is hard to measure; it is highly volatile over short periods, even as long as a year; and it is even harder to do by industry. Subject to all that, I think what the data show is that, after that lengthy period of rather sluggish performance, things have been a bit better. I think that probably owes something to the fact that the period of high investment but not much output in the resources sector is basically coming to an end—the output growth is really ramping up now. That is showing up in productivity. Excluding mining, it is probably improved performance but it is not quite so easy to draw the conclusion that that is sustainable yet. I remain of the view that the acute pressure that the traded goods sector has been under because of the exchange rate and all the structural changes going on—that that is another way of saying that they are under pressure to lift productivity, and they will. I think we will see that come through over time. That is my hypothesis. I cannot prove it. It is not proved in the data at this point.

Mr HUSIC: The RBA anticipates that, as we go from the investment to the extraction phase in the mining sector, that will have a noticeable impact on productivity?

Mr Stevens : I think we could reasonably aspire to a productivity performance that, on average, is a bit better than that period from about the early 2000s up until the last couple of years. That is my view.

Mr HUSIC: Moving to housing affordability, you spelled out a view that you thought housing affordability had actually improved over the preceding years. Is that a view you still hold?

Mr Stevens : It did improve because prices stopped rising and went down, and interest rates came down. So for the metric people typically want to use here, which is some kind of gauge of how much of your income you need as a new entrant to take up the average new loan to buy the median house—that kind of metric—that clearly improved a lot. In the last few months—Chris might help me out here—I think that metric has started to turn adverse again. Interest rates have not kept falling—they cannot keep falling indefinitely—and prices have risen. As I have said before, the biggest threat to affordability in this country would be if we get a very large increase in house prices, which those of us who have a house will enjoy. But, if we think about our children, we will be having second thoughts.

Mr HUSIC: How much of the purchasing at present is being driven by investors as opposed to owner-occupiers?

Mr Stevens : I think they are both quite prominent. If we look at loan approvals, it is certainly true that investor loan approvals have risen quite significantly, but so have approvals for owner-occupiers. They have both risen quite a bit. I would say that the investors are probably doing more of the driving in certain locations. But the ordinary first-time buyers or trade-up buyers—and trade-up buyers will be most of the buyers—are doing a lot of the driving too, across the broader metropolitan areas of the country.

Mr HUSIC: I will come back to that point in a moment. I represent a lot of families in Sydney's west and they will be interested in knowing what to expect on interest rates. I know you are not going to give us the full detail, but what are the key data the RBA will be looking at in terms of decisions on the trajectory for rates?

Mr Stevens : The thing we have said about interest rates—this will be a reasonably close quote— is that on present indications the most prudent course appears to be likely a period of stability. I have not said how long a period because I do not know. But that is a bit of a shift on our part from where we had been, which was saying that there might be scope to go down a bit more if needed. Well, I do not think we do need to at this point in time. As I said in the beginning, I think that if it is possible for there to be a period of stability, that in itself at the margin is probably helpful to people. In terms of the data we look at, as you know, our framework is a medium-term target for inflation. We are achieving that target right now. Our present forecast is that that will continue to be the case, and that forecast is predicated on an assumption of no change. When the forecast changes then we have to rethink, but at the moment we are talking about a period of stability.

Mr HUSIC: On the issue of overseas interest in Australian property, particularly from the perspective of Chinese investment, how much do you see this as reflecting what is happening in China in terms of the growth of shadow banking there? Is the RBA keeping tabs on how the Chinese government is managing that issue and do you see that it is going to continue to grow in the medium term?

Mr Stevens : We do put quite an effort into trying to understand what is happening in the Chinese economy and I think all the issues with shadow banking are really the key issues right now. I think public commentary really frets a little bit too much about monthly ups and downs in Chinese PMIs. I do not think that is really the issue. The issue is whether the build-up in credit that they have had through these sort of off-balance-sheet devices can be effectively managed. That term 'shadow banking' is in some ways a bit apt because it is not terribly transparent, from this distance anyway, and so it is very hard to know and to form a good judgement here. All I can say is that we are acutely sensitive to that set of questions. On whether shadow banking in China is the source of Chinese investment in Australia, I do not know, but I suspect that the bigger force is probably that the Chinese population, or segments of that population, have become quite affluent pretty quickly and, as people do when that happens, one of the things they do is acquire assets in other places. Just as Middle Eastern and Russian money likes to have places in London, I think there is a certain sense in which many affluent people in Asia—and it would not just be China, it would be other countries in Asia too—like to have property in Australia. That is a feature of the modern world.

Mr HUSIC: Picking up on your point about shadow banking not being transparent. I have been alarmed at a dramatic description this is a Sino equivalent of subprime. Is there reason to be concerned if there is not an ability to get a handle on where this growth is headed and what impact it might have?

Mr Stevens : People do like to dramatise things. I think it is likely that asset quality in some of these entities is poor. It is very likely that—and I do not think that the authorities in China would deny this—the big surge in credit they had during the financial crisis when everybody was stimulating their economies by pumping a lot of credit into the system is problematical. In fact it is virtually certain that some of those loans, if they have not gone bad yet, will go bad. I think the question really is: how good a handle do the authorities there have on that problem? I would not have much doubt that they have the resources to fix it in time. The question will be how quickly they can get on top of it and get ahead of it. I cannot give you a very accurate answer to that, but my observation is that they are very competent people. They are acutely sensitive to this problem and so there is as much confidence as you can have that they will get on top of it.

Mr HUSIC: In relation to reports that have emerged in the last 24 hours reinforcing concerns that have existed for some time about the way multinationals are able to structure their tax strategy in such a way that potentially has an impact on the ability of government to gain revenue, how much of a concern is this? Where are the areas, the avenues, that the international community can work on to try to address what appears to be a lot of profit-shifting at the expense of government revenue?

Mr Stevens : You are getting onto areas that I do not know a lot about, but this is an issue that is very much front and centre for the G20 meeting and the G20 group this year. They are looking to try to get some agreements. I am not sure whether my deputy can add any more detail, because that is really all I can tell you about that. It is on the radar. I suppose what I think is significant is that it looks to me as though it is on the radar for all the major jurisdictions and so the chances of getting some kind of agreement are much higher when that is the case.

Mr BUCHHOLZ: What is 'jawboning'?

Mr Stevens : What is it? Whose term is that—

Mr BUCHHOLZ: I do not know. I see it in the press with reference to the exchange rate and I thought I would ask you to explain to me what jawboning the exchange rate is.

Mr Stevens : I suspect these colourful references in the media may refer to the fact that the Reserve Bank, and I personally, have occasionally made some remarks about the level of the exchange rate. I suppose it is assumed that these remarks were made in an effort to move it. I have certainly been prepared to give an opinion. It is a fairly vaguely-couched opinion, as I think it should be with these things, but I have been prepared to say that at various times I thought its long-run equilibrium was probably somewhat lower than where it was trading at the time. That is probably what they are referring to.

Mr BUCHHOLZ: Is there anything that the RBA can be doing to lower the exchange rate?

Mr Stevens : Apart from jawboning, which I think has a limited effect, in principle the options would be—and we have covered these in previous hearings—you can lower interest rates, and in principle that is a thing that might be done; you can intervene in the market, and there would be a whole debate about that and there is ongoing debate about how effective that is; and I suppose the biggest thing you could do if you really want to lower the exchange rate, is have a weak economy and say that you do not want foreign investment. Seriously, with strong economies that are attractive to foreign investment, it is likely that you are going to have upward pressure on your exchange rate in that world.

Mr BUCHHOLZ: So lower interest rates help at the moment, so there is a relationship between fiscal and monetary policy. The government has indicated that it will hand down a pretty tough budget, with a view to returning budgets to surplus. What impact do surplus budgets, as opposed to structural deficits, have on interest rates and then back to the exchange rate?

Mr Stevens : This is really getting to a topic we have discussed many times in these hearings in the 17 years I have been coming.

Mr BUCHHOLZ: But it is always topical.

Mr Stevens : It is the relationship between fiscal and monetary policy, so I will restate the position we have given many times: to the extent that something in the budget affects the path of aggregate demand in the economy one way or another, assuming that that is of significant magnitude—if you are talking $1 billion, that is not noticeable in the forecast demand track, but if you are talking $8 billion or $10 billion then it is—that obviously has to be built into our outlook on which we base the interest rate decision. So, if fiscal policy is quite contractionary and that slows down the economy, other things being equal that means interest rates lower than they would have been, just as if the world economy slows right down and that slows us down. In the same way that that would in principle lead us to think about whether interest rates might be lower, such is the case with the budget. That has always been true and that remains true.

Mr BUCHHOLZ: Just picking up on the previous questions on that investment coming from offshore into the housing market, do you have not a concern but an opinion on the number of cash purchases that are coming in? Some of the reports are that we are seeing an increase in price, but some of the feedback from the banks is that mortgage data is not on the same trajectory, which would lead you to the perception—

Mr Stevens : I do not think the foreign buyers are borrowing money from our banks.

Mr BUCHHOLZ: No.

Mr Stevens : Most of them are probably not borrowing money from any banks. As I said earlier, these are quite possibly quite affluent people. This is very anecdotal but, if you are sending your children to study in Australia, you are probably an affluent person and quite possibly, in some cases, you have purchased an apartment in which they would live or which you might come and stay in when you come to visit them. There are people who are wealthy enough to do that. So we do not really know. We do not have data. If they are borrowing from a bank in another country, obviously we do not know. I would hazard a guess that many of these people are not borrowing money.

Mr BUCHHOLZ: On a point in your comment here about the resources sector coming off, from a historical data perspective—because we have seen booms and busts in the resources sector historically—what normally takes up the fat? Is it the ag sector or are there are other sectors that traditionally fill that void?

Mr Stevens : The other 90 per cent or 80 per cent of the economy.

Mr BUCHHOLZ: That has now moved down.

Mr Stevens : There have been booms and busts historically, as you say. That is right, and they have their impact. The thing that is different about this one is just the size and the longevity. Typically in history, mining sector investment runs at about two per cent of GDP, and maybe it is three per cent at the peak. This peak is eight per cent, so it is nearly three times the normal size. It has stayed up for a while, and then it is going to go down. So the reason this is so prominent this time is just the sheer size of it. It is the biggest thing of its kind since the gold rush. It is the biggest terms of trade event in more than a century, and it is the most persistent one probably in our history. That is why it has loomed so large in the way we have talked and in public discussion.

Most of the time, in normal times, at any point in time there will be some sector booming and another sector in a slump, and the average is okay.

Occasionally, we get an episode where they all boom and slump together and that is called a boom then a recession. We have not had that in those terms for some time now. It is pretty typical for sectors to be going in opposite directions. As I say, what we would like to see is for some significant bits of the non-mining part of the economy, which have been quite slow in recent years, speed up. I think that is happening in certain areas and, hopefully, this is going to work out about right. It will be no small achievement if that turns out to be the case.

Mr BUCHHOLZ: I see that Deloitttes and some in the agri-finance sector are quite bullish about the long-term outlook, the 10-year outlook for the agriculture sector.

Mr Stevens : You would be, I think, if you think about the basis for that—that China and Asia generally, as they keep growing, keep becoming more affluent, change their diet and their tastes. What people do when they are more affluent is a big opportunity for our agriculture, provided we organise ourselves to take advantage of it because you can be sure that American and European agriculture have also spotted this. So we have to go get it.

Mr BUCHHOLZ: You might organise some rain for us and that will be the end of my questioning.

CHAIR: You are a miracle worker now, Governor.

Mr Stevens : I fear our power even over financial markets and exchange rates is already elevated beyond what it really is.

CHAIR: Before we go to the break, it gives me great pleasure to introduce a number of students who have been listening very attentively to the discussion. I invite Rachel Hembrow from Holsworthy High School in the Hughes electorate.

Mr HUSIC: This is the moment where they show the deficiencies in their local member through their questioning.

Mr Stevens : Their questions usually are very good.

CHAIR: They are of a very high standard, I am happy to say.

Mr Stevens : Do not feel any pressure though.

Rachel Hembrow : Good morning, Governor. My question today is: we hear about governments borrowing hundreds of billions of dollars. Does this mean that today's generation has been spending in an unsustainable manner and that this will result in my generation having to pay it off through higher taxes, fewer services or both?

Mr Stevens : Thank you, Rachel. That is a good question, which I will need to answer with great care. The way to think about government borrowing in principle is that it depends what they do with the money. Let us suppose that governments borrow money but they invest in assests—infrastructure of various kinds. If that is what they do, then what they have left you is, yes, a debt, but an asset which has an earning to help service the debt. So the country is richer. If, on the other hand, they borrowed the money and wasted it somehow on current spending, then we are more likely to end up in a situation where the debt lingers but the good things we got have gone. I suppose the simple answer to the question—I think it is simple but, without wanting to sound immodest, this is the profound point—is that it matters what you do with the money. In some of the countries that are in the most fiscal trouble, and I do not think we—we have issues and problems that need to be dealt with but we are not in the same camp as, say, many countries in Europe where the problem is they have not used the borrowed money to build the wealth of the country, so debt then goes forward to the next generation; they have perhaps done less useful things. So it matters what you do with the money—that is the point.

CHAIR: Great question, Rachel. I think you should be up here one day. Our next questioner is from Rooty Hill High School, in the Chifley electorate, which is the electorate of Ed Husic, the deputy chair.

Siddharth Mahorat : My name is Siddharth Mahorat, from Rooty Hill High School. My question today is: with issues such as the decline of Australia's car-manufacturing industry and with Qantas to cut thousands of jobs, what actions by government do you believe will or should ensue to ensure economic stability?

Mr Stevens : Thank you, Siddharth. I think both of those industries actually are the subject of very powerful global forces that have been in place for a long time. That is true for both cars and airlines. There is not really much choice but for those companies to adapt to the market situation that they face. I think what governments can do—mostly what they can do—is try to promote an overall environment of macro-economic stability, and really the Reserve Bank plays a big part in that. Our job is to try to keep the macro-economic situation stable. That is only part of what is needed.

The other thing I think is needed is to try to foster a culture of innovation, of investment in skills and of flexibility and competitiveness in the economy so that, even as industries are shrinking because they face pressures, even as that occurs, new industries can grow up. So we can do more of, say, making ailerons for Boeing 787s in Melbourne, even as we do less of car assembly in Melbourne. We have got to, I think, remember that there are industries that are growing, and that can keep happening. What we have got to do is try to think about how to foster that even as older industries are, I suspect, unavoidably shrinking. That is my answer to that question.

CHAIR: Thank you very much. You have three other questions, apparently, waiting for you from students, Governor, right towards the end.

Mr Stevens : Thank you.

CHAIR: Thank you again.

Proceedings suspended from 10:42 to 11:01

CHAIR: We will resume the hearing. I invite Mr Craig Kelly to ask questions.

Mr CRAIG KELLY: Governor, I have got a three-part question. Firstly, do you believe that governments ever have a role in guaranteeing the debts of a private company? If a government guarantees the debts of one company in a market, does this risk distorting a competitive market? If a government guarantees one competitor in a market, does this have the potential to become a barrier to entry by discouraging new entrants and discouraging innovation because that potential new entrant would be at a competitive disadvantage?

Mr Stevens : I am not sure what company you would be referring to! I do not want to comment on the Qantas case per se. I would offer the observation that people have drawn the parallel between a guarantee to a private company and the guarantees that were not given, but sold, to the private banks during the crisis. Probably my only contribution to this discussion would be to point out that that was a global emergency. It affected the whole world. It potentially very adversely affected the funding of our financial system. The guarantee was priced and it was priced in such a way that it would be attractive to use in an emergency but, the moment things were normal, it would be very unattractive to use, because of its pricing—and indeed the usage ceased once things did normalise. So, in my opinion, that is a very different national situation to the one faced by a particular airline or any other company. Whether governments see a case for some intervention in this instance or others really is not for me to say. I think I will leave my comments at that point.

Mr CRAIG KELLY: Alan Greenspan has suggested that the US banks, because of their size, actually receive an implicit subsidy because they are able to borrow at lower cost because lenders believe that government will actually step in. Do you believe that also applies here to the Australian banks?

Mr Stevens : The question of so-called too big to fail banks—and it is not just confined to banks in the financial space—is a very live question in the current international discussion. As you may know, one of the work streams that are underway in the Financial Stability Board is the report on so-called G-SIFIs, or global systemically important financial institutions. That line of work is about trying to end the problem of 'too big to fail' by making failure less likely—that is, there is a capital surcharge for these G-SIFIs, and working to improve our capacity to resolve them in a way that does not involve the taxpayer being called on. That is a pretty tall order and a complex work stream, but that is seeking to address the issue that you raise—that a borrower commonly believed to be likely to be bailed out is likely to, all other things being equal, attract a lower borrowing cost. That is why there are these other devices to put capital charges and such on them.

There is a domestic counterpart to the global systemically important stream, and that is the so called D-SIB—domestic systemically important banks. Our four largest banks will attract an additional capital charge from APRA in, I think, 2016 in recognition of their systemic importance. I think that is appropriate. On the broader question of who gets what advantage from what intervention, it is a little more complicated because I rather suspect that the guarantee of deposits—up to $250,000, which is free—benefits the small institutions more than the majors. I think the majors would be regarded as safe anyway, so in some ways I think the playing field is a bit levelled by that device. I would not claim that is a perfect levelling necessarily, but my point is simply that there are things going on in both directions in this area.

Mr CRAIG KELLY: Do you believe that our four large banks are too big to fail?

Mr Stevens : Well, it is clear that they are systemically important, and APRA has designated them as such—that is an overt recognition of what everyone knows—and there will be a capital charge that goes with that. They also get more intense supervision and the so-called pillar 2 devices as well, as they should. To be honest with you, contemplating the failure of an institution of that size is not something that I am comfortable speculating about in public, but I think everyone knows that should such an event come along it would be a very, very big problem.

Mr CRAIG KELLY: Are you suggesting that, if they are too big in size, they are too big to fail?

Mr Stevens : They are systemically important. If any one of those four were to encounter serious difficulties, there would be many problems that would flow from that, and it would have to be dealt with. I do not think it is appropriate for me to openly speculate about how that would be handled. The more capital they have, the better, because the more we would be able to resolve it.

Mr CRAIG KELLY: I note that Alan Greenspan in the USA has suggested that maybe some of the US banks should be broken up through divestiture. Do you think there is a theoretical argument that that could apply here in certain circumstances?

Mr Stevens : These large global banks are very large. They are much, much bigger than any of ours. With Citibank or something, you are talking about a quarter of a million employees or something like that, across pretty much every country on earth. Such a large organisation is inherently very difficult to manage, let alone supervise. So some people have said—and it is a very colourful quote—'If they're too big to fail then they're just too big.' I am not saying I would necessarily apply that to the big American banks but even if you did, I think our institutions are in a different tier of size to those.

Mr CRAIG KELLY: Thank you.

Dr CHALMERS: Can I add my thanks to the representatives of the RBA for coming and also say how pleased we are that we are continuing the tradition of having the high school students join us. So welcome to the students and the teachers. Rachel's and Siddharth's questions were fantastic already. Governor, I want to ask you about wages—specifically about wages growth. You say in your statement that the pace of growth of wages has declined noticeably. Could you please just elaborate on that and perhaps give us a historical perspective on where wages growth is right now.

Mr Stevens : The growth of wages, as measured by the wage price index, has slowed down quite noticeably in the past year to 18 months—while I am talking, I am looking for the relevant figure. It is at about its lowest rate of growth in a decade or so, at about 2.6 per cent—call it 2½ or 2¾—over the last year, and that is down from the most recent high of just under four per cent. It is below average and I think it is the lowest for at least a decade.

Dr Kent : I think it is about the lowest in the history of that particular series. It is about a percentage point below the average over that period, so they are low.

Dr CHALMERS: When did the series begin?

Dr Kent : I think that series began in about 1997 or thereabouts.

Dr CHALMERS: So it is the lowest wages growth since the series began in 1997.

Dr Kent : On that measure, yes.

Dr CHALMERS: How does that compare over the last year or so with the inflation rate?

Mr Stevens : The inflation rate is also 2½-ish over that year, so as it happens they are pretty similar numbers at the moment.

Dr CHALMERS: Has the wages growth number dropped below the inflation rate at any point over the last year or 18 months or so? Has there been a real wages cut?

Dr Kent : No, I do not think that is right, but real wages are not growing at the same time. It is about the same. While it is low, real wages did fall a little for a time around the GFC, and they were similarly low at this sort of point back in the early 2000s, when we had a bit of a slowdown.

Dr CHALMERS: Governor, what would you say in response to commentary that has been around quite recently that there is some sort of wages explosion or that wages growth is unsustainable? That is not borne out by the facts, is it?

Mr Stevens : We have not said there has been an explosion. What we have said is that, with the slow labour market, the rate of growth of labour costs has slowed down. We have been saying that fairly consistently, I think.

Dr CHALMERS: A moment ago—I think I am remembering this right—in response to a question from the chair you said that unemployment would probably peak next year and then start declining. Do you think that unemployment will stay at 6¼ per cent for the two years beyond this current year? If I am reading you rightly from what you said at the start, you think it will edge up and then start declining.

Mr Stevens : I will get Chris to talk about the general shape of our forecasts.

Dr Kent : Roughly speaking, we see unemployment continuing to drift up a little bit from here but probably peak sometime around early 2015. It is a little hard to say. But it should stay at those levels for a while. In our forecast, according to the central tendency, it is not until late 2015 that there will be sufficient growth for that growth to make inroads into the unemployment rate. So we do see employment growth gradually increasing, but not sufficiently to bring the unemployment rate down. In fact, it is insufficient for a while and that is why the unemployment rate is drifting up. You must remember too that population growth is still growing pretty strongly. It might peak some time around early 2015, according to our forecast, but there is a significant range of uncertainty around that, as we like to remind people regularly.

Dr CHALMERS: Thank you for that. Dr Lowe, I will follow up on a question before from Ed Husic about the multinational profit-shifting agenda. I know that both you and the Governor had some information—not a great deal—to share on that. In principle, what is a good first step in terms of satisfying the G20 agenda on profit shifting? Would a good first step be to understand more about how much some of these companies are paying? Is transparency part of the tool kit when we are talking about advancing the G20 cause?

Dr Lowe : That has certainly been a focus of the discussions of the G20 group, about how the tax authorities around the world get a better visibility of this. It is not just an issue in Australia. Many developing countries also feel aggrieved by the profit shifting that is going on. So everyone is looking for greater transparency. The tax experts are working furiously on how to do that and how the international rules could be written or rewritten. But it is not an issue that we at the central bank have any expertise in. I am not in a position to be able to help you out with the details of that. I can just reaffirm that it is something that I know that the treasuries around the world are looking at very intently, and so they should be.

Dr CHALMERS: And greater transparency is part of that.

Dr Lowe : It must be part of that. But I think it is the first step, because the international rules probably do need rewriting here. They were drafted in an earlier world where capital was not as mobile and where businesses were not as multinational. International tax rules have not kept pace with the change in the globalisation of business, and governments, as a result, are getting less tax revenue than they probably should be. Given the fiscal positions that many governments find themselves in, it is obviously an area that people want to fix. I would not say it is an easy job to fix, because essentially it requires international coordination. Some countries are actually doing quite well out of the current rules and they are not as willing participants in the discussion as some others.

Dr CHALMERS: I bet. My final question is to Governor Stevens and picks up on the question asked by Rachel about the current levels of debt and Australia's fiscal position. You recently attended the G20 meeting here in Sydney. Part of those discussions is always the relative fiscal positions of various countries. Where does Australia sit amongst those 20 big economies in terms of the strength or weakness of their fiscal position?

Mr Stevens : There was not a great deal of discussion about fiscal policy that I recall. The general answer is that in comparison with I would say many, if not most, advanced countries we have comparatively low debt at this point. Some of these other countries are making quite a bit of progress now on reducing budget deficits. The US is down under four per cent of GDP now, which is good to see, but of course their debt burden is considerably higher than ours presently is. I have never said that we face an imminent fiscal problem. Our fiscal issue is medium term—I have said this before. There are some social programs that we all think are very good that we have committed to and they are not fully funded. That is coming into the sort of horizon that gets discussed now with forward estimates arising. So our issue is not 'are we in a surplus or deficit this year or next year,' it is, 'have we funded the things we want to do in the medium term.' I am not sure that we have at this point in time, and I think that really is the big question for us fiscally.

Dr HENDY: We have had a lot of economic questions and I have got some for a little later if I have time. I have a governance question. In an article this week, I think 5 March, in the Fin Review titled 'Keep superannuation rebates' Heather Ridout, who is a member of the RBA board, made some strident statements about government policy. Throughout the article she was described as an RBA board member and only right at the end of the article she was described as the chair of AustralianSuper. Since that article have you counselled Ms Ridout about being careful about media commentary, given her position on the RBA board?

Mr Stevens : I haven't. I am not in a position really to dictate terms to members of the board about things that they say. Pretty much all of our board members have other roles as actually their main job; being a Reserve Bank board member is very much a part-time role. There is an agreement that when it comes to discussing monetary policy I speak for the board, but beyond that members talk about things that they are interested in or expert about and I am not in a position to stop them doing that. It is certainly true that any time any of them open their mouth the press will write RBA board member because I think that is seen as adding a bit of credibility to what they say. But I cannot change that, and if we want to have a board of the kind we have where we have a majority of outside members that come from other fields and take part—that is the model and the model has worked quite well—I cannot stop them talking about the other things they know about.

Dr HENDY: As a follow-up, when Heather Ridout joined the board of the RBA in 2012 she was not the chairman of AustralianSuper. When she was appointed chairman of AustralianSuper, did she submit her resignation to you as chairman or to the Treasurer at the time?

Mr Stevens : No.

Dr HENDY: AustralianSuper has $65 billion in investments under management. That is probably the largest of our super funds in Australia. Probably all those investments are impacted to some degree by movement in Australian interest rates. Has Heather Ridout at any board meeting absented herself from discussions of the RBA board?

Mr Stevens : No. She is perfectly entitled, and indeed expected and required, to take part in discussions about monetary policy. That is why she is there. If we had a discussion—we haven't, but if we ever did—about something that directly affected that entity then I think we would expect that she would offer to recuse herself from that discussion. But I think it is quite proper for her take part in the monetary policy discussion given that she does not run the investment committee of AustralianSuper, she chairs the board. It is a governance role, it is not a day-to-day fund management role. Those considerations were thought about and talked about and agreed at the time she was appointed.

Dr HENDY: There is a very big difference between being a board member of an entity and a chairman of an entity. Are any other board members directors or chairpersons of major financial institutions?

Mr Stevens : You are not allowed to be associated with an authorised deposit taker, so that is ruled out. Pension funds and super funds are more of a grey area. The view that we have taken is that it is appropriate for somebody who is on our board not to be involved in any way in the day-to-day decision making of a fund manager or a super fund or anything like that. To my knowledge that requirement is met.

Dr HENDY: You were saying before that, when Ms Ridout was appointed, these issues were discussed?

Mr Stevens : She resigned her position with AiG. I think, from memory, it was discussed whether the AustralianSuper position was manageable and acceptable. We discussed that, and it was agreed that, provided that there was separation from the day-to-day decision making of what asset you buy or sell, it was acceptable. That is the position we reached.

Dr HENDY: But the board of AustralianSuper would set strategy overall for the entity.

Mr Stevens : Yes. They would agree a strategy, but they are not sitting there each day hanging on the RBA rate call to decide whether they buy a bond or not.

Dr HENDY: But you would not have the chairman of Westpac sitting on your board.

Mr Stevens : You would not, because that is expressly ruled out by the legislation.

Dr HENDY: But we have an entity that has $65 billion under management. How is that different from a bank in terms of talking about interest rates and monetary policy around the board table?

Mr Stevens : It is not expressly ruled out, for a start, by the legislation. It could be, if the legislation were amended, but to date it has not been. It is a grey area, certainly, because we have had—and we have—directors, occasionally CEOS or chairmen, of large listed companies, all of which would have a big treasury organisation. If we are going to have a board of people drawn from the business world, then, subject to the explicit restrictions in the act, which I mentioned, we have got to have a workable way of them separating themselves from day-to-day financing decisions that the entity that they are associated with takes if they are to take part in the Reserve Bank Board. That is the model that we have. If we cannot make that work in a pragmatic way then we cannot have this kind of board.

Dr HENDY: But you are saying that people have actually excused themselves from discussions?

Mr Stevens : No.

Dr HENDY: No? They have not?

Mr Stevens : I am saying that any of these people in some sense could be seen as having a potential conflict, but they have got an approval and there is a standing approval from the Treasurer for them to take part in the monetary policy decision, and there has to be; otherwise, they cannot take part.

Dr HENDY: But you yourself have acknowledged that this is a grey area. Superannuation has grown phenomenally over the last few decades. This is, I think, Australia's largest superannuation fund. I said it before: $65 billion under management. Basically the portfolio that it manages, the whole of its operations, is significantly affected by monetary policy and interest rates. You cannot say with a lot of manufacturers or service industries that that is the be all and end all of a lot of what they do. It is a different kettle of fish. There is a question about perceptions, I would have thought. Conflicts of interest are not just about actual conflicts of interest. It is about perceptions of conflict of interest.

Mr Stevens : I certainly would agree that, in the spectrum of things where you have banks at one end and things that are entirely unrelated to financial conditions—if there is such an entity—at the other, a superannuation fund is arguably a bit further along the spectrum than a manufacturing shop. I think that is true. But, in principle, a large number of people potentially have the possibility of a perceived conflict here. If we are to have the kind of board we have, we have to accept that and then manage it as well as we can. I think that has been done to date and, so far, okay.

Dr HENDY: I have just one last question to ask you on notice, if I could. Is there an example, or how many examples are there, of chairmen of superannuation funds sitting on the Reserve Bank Board?

Mr Stevens : How many examples are there now?

Dr HENDY: No, how many have there been in the recent past, say in the last 20 years?

Mr Stevens : Historically?

Dr HENDY: Historically.

Mr Stevens : Okay.

Dr HENDY: Take it as a question on notice.

Mr Stevens : I will agree to take that on notice.

CHAIR: Terrific. You will take that on notice.

Mr CONROY: Thank you, everyone, for appearing. I just have a quick question following on from Dr Hendy's questions. Can you restate. You said earlier that there have been a number of board members of the RBA who have also held positions on companies that have potentially had interests in markets that might be moved by RBA decisions. That would be a correct summary of what you just said?

Mr Stevens : Many large corporations have a treasury operation. They have foreign currency exposures and interest rate exposures. Many, many entities of any size will have that.

Mr CONROY: For example, Jillian Broadbent, one of our most highly respected business leaders, appointed to the board by Treasurer Peter Costello, was on the RBA Board while a director of ASX Limited. That worked perfectly well, didn't it?

Mr Stevens : It did, in my opinion. There is a relationship between the Reserve Bank and the ASX of a regulatory nature, but it is the Payments System Board that oversees that, not the Reserve Bank Board, so I did not feel that there was a conflict there.

Mr CONROY: Thank you, Governor. I want to follow on from a question from Siddharth from Rooty Hill High School about investment in the economy. I note that in your opening statement you had an expectation that non-mining related capital investment would come on this year, or hopefully would come on in the next couple of years, to fill the gap from mining investment. I would be interested in your view and perhaps the view of your colleagues on why you are reasonably optimistic about this, given that, for example, the latest capex figures had a 4.7 per cent fall in non-mining investment; expectations for the next year were below what markets expected; and we have quite low capacity utilisation rates at the same time.

Mr Stevens : It is true that non-mining investment has been declining. As I said earlier, it has been very low, which, to be honest, is one reason to feel that eventually it has to pick up. It cannot stay that low indefinitely. I will get Chris to speak to the expectation component. My recollection is that that lifted just a little.

Dr Kent : Yes. The expectations are still pretty subdued for the current financial year, which we are about halfway through, but for 2014-15 a very small pick-up in non-mining business investment was flagged in that release. So it is small. That is true. I think the thing, though, is that it is worth making two points. The first is that the capex, the capital expenditure survey of the ABS, was designed some time ago, and designed well, but not designed to capture quite a bit of investment. For the non-mining business sector, it actually misses something like half of the non-mining business investment, and that includes investment in some slightly faster growing parts of the economy such as health and education. It also misses investment in the agricultural sector, which is non-trivial, and it misses investment in intangibles—things like software, which is increasingly an important part of business investment.

That is one thing to keep in mind. The other thing—this is entirely in line with the Governor's comments earlier—is that through our liaison program we hear that businesses still have quite a degree of caution about their investment plans. Perhaps that is a bit unlike periods in the past. In the past they may have said, 'We have an expectation of slightly better times in the future; let us commit to some more investment on the back of that expectation.' Now they are saying that they want more tangible increases in conditions here and now. We have seen that in the business survey indicators but it has only been a month or two in which things like the NAB business conditions index, for example, have moved higher. That index is now above average.

I think we have seen tangible signs of some improvement in recent months—but it is fairly recent—across a number of indicators. So it is not inconceivable that, if that is sustained, businesses will revise up their expectations and make more commitments to investment in the 2014-15 year.

Mr CONROY: What is your view of where the economy will be if that slight improvement—that momentum—does not continue, so we still have quite low capacity utilisation rates in the economy and confidence is still quite fragile? If we do not see that non-mining investment picking up the slack, where do you think the economy will be this time next year?

Dr Kent : It is in our forecasts that the central tendency is one where there is that gradual improvement. It is not especially strong but it would be helpful, nonetheless, particularly for things like employment. Clearly, if that does not come to pass one would expect our growth—other things being equal—to be a little bit weaker. We always have quite a bit of uncertainty about our forecasts.

Mr CONROY: Governor Stevens, I am going to ask this question, perhaps vainly. You noted, after Scott Buchholz's excellent questions, that you perhaps might have engaged in talking about the exchange rate when you thought it was above the long-run equilibrium value. Do you still think it is above the long-run equilibrium value?

Mr Stevens : I have said that I thought that in the 90s or over a dollar was rather higher than any plausible assessment you could come to based on our costs and productivity relative to other countries. I have not changed my view about that. So I do not resile from what I have said before, but I have nothing new to say.

Mr CONROY: So, somewhere in the 80s would be consistent with the economy's fundamentals?

Mr Stevens : One cannot be especially precise here but I stand by the things I have said before.

Mr CONROY: Going back to your forecast for the year, and your view that you are looking at stability in monetary policy based on your current forecasts, how high does the unemployment rate need to peak, above your current projections of roughly 6¼ per cent at the start of 2015, before you think you need to take an easing bias again?

Mr Stevens : I do not think I would calibrate things entirely on the unemployment rate. It would obviously be important as one gauge of capacity in the economy. One would be looking at all the other things that are happening, as well. If, for example, it went to a higher level in the short term but it was obvious that the economy was going to gain speed in a big way before long, it would probably be the wrong thing to do to try to egg that on faster, for example. But you could get a situation where the expected pick-up in some areas does not come through. That would raise the question, obviously.

Mr COLEMAN: I have a couple of questions with regard to valuation, particularly housing valuation. Governor, you talked earlier about the conventional wisdom around housing—that the capacity to pay and service debt is very important in terms of working out whether or not the housing market is sustainable. I wanted to ask about the alternative approach of looking at the underlying capacity of the asset to generate income. Do you think that is also a sensible way of looking at valuation of housing and, if so, does that lead you to a different conclusion?

Mr Stevens : It is perfectly valid, especially in the investor space, to think about what the rental yield is, and I think investors ought to be doing that when they make their decisions about how much they should pay. Chris, would it be fair to say rental yields have gone down a bit?

Dr Kent : Yes.

Mr Stevens : Rents have not done much lately—this is at an aggregate level, obviously—and valuations have risen, so the rental yield has declined, and that ought to be a relevant consideration for those who regard themselves as investors.

Mr COLEMAN: There is no underlying reason, is there, why rental yields should have structurally changed such that it is no longer necessary to get yields that you could typically achieve from property?

Mr Stevens : Suppose that the whole structure of global interest rates is permanently lower. That would be expected to flow across all other assets, and their rates of return would similarly be arbitraged down. That could be a reason, in principle, for the rental yield to be at a new lower equilibrium level than it used to be at. If global interest rates—and we are talking here about not just central bank rates but the whole structure—are permanently going to be lower then that is an argument for that adjustment.

Mr COLEMAN: I have a question on exchange rate valuation. I do not want to mischaracterise your position, but I think it would be fair to say that you think there has been a persistent misvaluation of the Australian dollar over a period of time. Do you see structural distortions in the exchange rate market, and if there are not distortions, isn't the value of the dollar simply what the market says it is?

Mr Stevens : Whatever I, or any of us, might think or say, in the end this is a market that turns over in excess of $100 billion a day, and there are a lot of buyers and sellers there putting forward their views and the weight of their money. So we might talk all we like, but there it is. As to whether I think there has been a persistent misalignment, I am not sure I would say that in quite those terms. In the period during which the terms of trade were rising, in their biggest event for 100 years, and the exchange rate was rising, I think it was quite hard to say, 'This is all wrong.' It might have been, but I think the confidence with which you could form that assessment would be quite weak.

The point we were making was a different one. The point was that the terms of trade had turned down and clearly the high level of the exchange rate was squeezing significant parts of the economy, but the exchange rate had not turned down. It was in that period that we started to say, 'That seems a bit odd.' It is very hard to have a doctrinaire view about a particular level, but, when there was that contrast between what the exchange rate was demonstrably not doing and what the things that we think about as fundamental drivers of it were clearly doing, and likely to keep doing, that is when we started to say, in effect, 'That seems odd.'

Mr COLEMAN: But do you see the activities of the central banks or anyone else behaving in that market in a way which is inconsistent with simply just a supply and demand based market?

Mr Stevens : I think some central banks have been part of the supply and demand. There has clearly been some reallocation or diversification of official reserve assets. Some of that has come towards Australia. Central banks are very conservative. They like AAA risk. If you look at the list of AAA countries now it is a smaller list than it was and still getting smaller. Guess who is near the top of that list? It is not just because it is alphabetical. So it is not surprising that there are central banks—and I will not name them—that have taken reserve positions in this country in the past five years. I never thought I would see that happen. But we live in a world that has changed in the last five years, and I never thought I would see that either. I think that has been a factor but, truthfully, I would say most central banks have less risk tolerance than most investors. But in other respects they are not that different to most investors.

Mr COLEMAN: There has obviously been quite a bit of commentary in recent weeks about the potential for a free trade agreement between Australia and China. I was interested in your views on how a free trade agreement might contribute to export income.

Mr Stevens : I do not know enough about the proposed agreement to comment specifically on that. The main points I would make about free trade agreements would be very high-level ones. They would be along the lines of the fact that it is important for bilateral free trade agreements not to, in fact, be trade diversion agreements. We actually want to add to the total amount of trade here, not reallocate from country A to country B. I am not against the proposed agreement at all, but it is important to remember that 50 bilateral free trade agreements with 50 countries is not necessarily the same thing as multilateral free trade with 50 countries. We do not want the spaghetti-bowl outcome. If bilateral agreements are all you can do, that is probably better than not doing it, I would imagine. But even better would be progress on genuinely multilateral agreements.

Mr COLEMAN: Sure. But presumably in the realm of bilateral free trade agreements, given that China is our largest trading partner, one with China would be particularly helpful.

Mr Stevens : I am really not qualified to say. You could argue that the fact that they are already our largest trading partner might be taken as evidence that we did not need a free trade agreement to get here. So I am not really sure how that follows. But I do not have any particular pro or con view to put about that agreement per se. It is not my field of competence to do so.

Mr HOGAN: I do not want to ask a question about the currency because you have had to make so many comments about it already today. But I would just observe how much focus we have an our levels of monetary settings, such as the level of interest rates. You have brought a chart in, and I am sure you as a board sit around and debate whether the interest rate on overnight cash will go up by 0.25 or something else. That has been the way for a long time. I would just make the observation that I think the level of the currency is as important and, in some instances in some industries, more important. I am certainly not arguing—please, do not read this into it—for a re-regulation of the currency. The currency was a great safety valve for us when it needed to be in the late 1990s with the things happening in Asia. I will just make the observation that, given that the currency is so important to so many sectors of our economy that it is left to float, which I am sure is a good thing, we focus so much on the price of money in one sector, which seems to me to be a bit out of kilter. I also think on the jawboning argument that was made before that we can certainly say that many countries and central banks have been manipulating their currencies in quite exaggerated ways, whether it be through talking, quantitative easing or direct purchases. I am interested in a comment from you about whether you think that trend is going to increase with currencies or decrease with central banks trying to manipulate their currencies.

Mr Stevens : I certainly agree with you that there is far too much focus on 25 basis points, yes or no, this month or next month. I have thought that for years. It is absurd the amount of media attention that generates. But the reason that happens, I think, is that there is not enough other news. That is a serious point.

Mr HOGAN: We can relate to that!

Mr Stevens : I would agree that there will be many businesses for whom a cent on the exchange rate is a lot more important than 25 points on the cash rate. If you are in construction of course you would have the reverse view, so it is going to vary by industry. If I listen to retailers or people in the housing sector, the world is going to stand or fall on those 25 basis points. So it varies by industry.

As to what other central banks do, amongst the major central banks it would be pretty rare for there to be overt intervention in terms of transactions in the market and it is actually pretty rare amongst the major countries for there to be explicit commentary on the exchange rate. It is much more common in emerging countries and of course in many emerging countries very substantial market transactions as well. That is driven by a different way of thinking about what the exchange rate does.

For us, we would say that the exchange rate is a shock absorber. If it wants to move you probably let it move usually because it is moving for a reason. It is a thing that helps us stabilise our economy. That would be the way we would think about it and, indeed, you alluded to that in your comments.

But around many countries in the emerging world, the exchange rate is not the stabiliser; the exchange rate is the destabiliser. In the way they think, it is the source of the shock. It is the shock; it is not the shock absorber. So they have a very different way of thinking about how you maintain stability in your economy and that is what drives their behaviour in terms of closer management and intervention and so on.

Personally, I think that in the long run you cannot fix this price. We spent probably 10 years, from the early 70s to the end of 1983, pretty much trying every exchange rate regime there is before we eventually convinced ourselves that we could not just fix the price, we just had to let it go. I think that most countries probably will reach that point at some stage. But the ones that have to do a lot of intervention at the moment—and I think I can see why they have this way of thinking—see it as a destabiliser for their economy and they are much less comfortable about letting it move.

Mr HOGAN: I certainly hear you and I certainly agree in the sense that it has been a great stabiliser for us. I want to ask two more questions, but just as an aside before I do ask those, I would like a quick comment. We have seen recently, for want of a better word, 'cryptocurrencies', things like Bitcoin appear and become very popular, albeit temporarily. Does the RBA have a view on whether that type of trend is permanent or temporary and what your involvement might be in that?

Mr Stevens : If others here wish to chip in, feel free. My own view is that it is a thing we watch. I am not inclined to feel that we have to rush in as a regulator. We have seen some pretty substantial losses incurred by Bitcoin holders in a couple of jurisdictions just in recent weeks. It is a potential alternative currency so how it will hold its value is the first question. There have been countless currencies through history and the ones that survive are the ones that hold value.

The second thing is that like any other money it can be stolen, and apparently it has been. That is going to be a bit of a problem for it developing, I would suggest, if that risk is that big. At this point, I saw some figures somewhere that there is exchanging of Australian dollars for bitcoin that goes on, and it is $1 million a day—or something like that—globally. Contrast that to, say, the domestic card schemes, where it is $1 billion a day, and we do intervene in a regulatory way in certain aspects of that. The orders of magnitude are very, very different. Some countries are contemplating regulatory initiatives in Bitcoin for either consumer protection or something like that. We have not done so; it is a space we watch. Is there any more to say?

Dr Lowe : No, I think it is mainly a consumer protection issue. It is because the price of the Bitcoins moves around a lot, and the security that people have over it is, in some cases, questionable. I do not see it as an immediate threat to Australian dollars as a form of exchange here, but it is a legitimate consumer protection issue.

Mr HOGAN: There are two more quick questions—one, I think, Governor, you have made a couple of comments on previously: the corporate bond market. There are a lot of calls from certain sectors that the corporate bond market be expanded to the retail market. Do you have any thoughts on that?

Mr Stevens : There is nothing wrong with retail investors being able to buy bonds, and they can. I think now there is an ASX initiative that allows that. Historically, I think, going way back, you were able to buy and sell bonds on the stock exchange. I do not see a problem there. I guess there is an issue of making sure that there is adequate disclosure, that retail investors know what it is that they are buying, and of that disclosure being in a form they can process, as opposed to 100 pages of disclosure. Beyond that, I do not see a problem. It is probably good for retail.

Mr HOGAN: Just one last question. There have been a few reports recently with some of the more—for want of a better word—fringy countries, or not mainstay economic countries. Some of the countries in South America—and South Africa, maybe—are under a bit of pressure in a sense of flight of capital from them. Capital is leaving the country quite quickly, and some of them are seen to be raising interest rates, in fact, to try to protect their currencies, as distinct from what we have been talking about. Does the bank have a view on what is going on there? Does it see an explanation for that type of trend appearing?

Mr Stevens : I think this goes back to some of the things that I was trying to set out in the opening statement. You have had some years now of very cheap money out of the major jurisdictions. It is not just the US but also Europe, Japan and the UK—pretty much free money at an overnight turn. In that world, it does tend to be the case that capital starts to flow to other jurisdictions where expected returns—adjusted for risk, hopefully—are higher. Actually, that is part of the idea. Easy monetary policy is designed—part of the point of it is—to get people to go out the term curve and the risk curve. That is what it is supposed to do, and that is what it did do.

But then the Fed started saying in May or so last year, 'If things work out okay, we're going to be able to start slowing down these purchases of assets and eventually start to normalise.' As I said at the beginning, that is a moment, historically—and this has happened numerous times—when the global investment community says, 'A bit of a change in course here, a change in atmosphere; I'm going to rethink all my risk positions.' It does not mean that they panic, necessarily, but they do review. That is the moment when, for risks that were under the surface, almost, in some of these jurisdictions, they start to pay attention and think, 'Well, this country's got a current account deficit,' or, 'They've got a budget deficit,' or, 'I'm not happy that their central bank's fully independent,' or: 'There are some other sets of issues here. Maybe there are foreign currency exposures in their banking system or their corporates. Maybe I'm going to worry about that more than I was before.' And that process leads to capital starting to move back. In some cases the capital-receiving countries have used the capital well—they are resilient and they cope. In other cases, maybe it has not been done so well. Rightly or wrongly, that is the set of distinctions the markets have been seeking to make over the last six months.

Mr TONY SMITH: Thank you, Governor. You have had a couple of hours of extensive questioning now. I just wanted to draw you out on a couple of issues. You made mention an hour or so ago of manufacturing—I think in Melbourne for Boeing—in the context of getting the policy settings right and removing the policy barriers to foster innovation for industries of the future. I think it would be useful if you elaborated a bit more on that, because, as these success stories often involve medium-sized companies, their success is often invisible in the public debate.

Mr Stevens : As you know, I dabble a bit in aviation as a hobby—not in a Boeing, but it is an interest of mine. As it happens, just a few nights ago I was at the farewell function for Ian Thomas, the head of Boeing Australia, who has been posted to China. It is quite interesting as you listen to him speak. He says that Boeing Australia is the company's largest footprint outside the US—they have 3,000 employees in Australia across commercial and military and so on. There is a plant in Melbourne that makes the trailing edge devices—that is, ailerons and flaps—for the Boeing Dreamliner 787 that is now flying in our skies. Boeing say this plant has 1,000 local suppliers. They say quite explicitly that these are not low-cost operations—they are very expensive, actually—but they are productive and innovative and are plugged into the global chain. And there would be others; I think General Electric would also say Australia is one of their largest operations, if not the largest, outside the US.

So while what is happening with Holden, Ford and Toyota is undoubtedly a wrenching change—no question—it is important to remember other positive stories. I think that as a country we can find a future in parts of very high-value manufacturing and services. It can be done; it is not impossible. My point simply was to note that there are successes that we might remember.

Mr TONY SMITH: On a different topic, you have taken a few questions on prudential issues, and it would be remiss of us not to seek an update from you on the Basel committee, particularly with Australia's leadership role with the G20 this year. Could you give the committee and the public an update. I do not want to bring back the nightmares of those never-ending flights, but if you could give us an update that would be good.

Mr Stevens : The Basel committee's work is continuing. Many jurisdictions now have published the text of their rules, so it is coming into place. There are a couple of things which are on the agenda in particular this year. One—this will get technical, so I will not delve deeply into it—is that there is a requirement called the net stable funding ratio, which is about matching the term of your funding to the term of your assets a bit more closely. There has been some work on trying to pin that down, and that is an issue in which Australia has quite an interest because it affects the requirements on our banks for funding the mortgage book. I think the outcome that has been reached there is a bit of a stretch for Australia but a manageable one, so that is okay. Other work that is going on involves understanding and narrowing the differences in the way the risk capital weights are applied across countries. It turns out that, if you take a hypothetical given portfolio and then you ask the supervisors of 27 jurisdictions how many dollars of capital are needed for that portfolio, you get different answers.

Mr TONY SMITH: Do you get 27 different ones?

Mr Stevens : You probably do. Partly that is because the underlying assessment of riskiness of that portfolio does genuinely differ by country, so that is okay, but part of it may be the way the rules are being interpreted and implemented, and that is not so good, because one of the things that everybody is very conscious of is not wanting to have regulatory arbitrage between jurisdictions. We do not want a world in which country A has tough standards and country B has lax standards and all the banking gets done in B. It comes across borders. So this is an important matter, and the Basel committee is working on how to narrow the unexplained gaps. I think that is important for the credibility of the regime.

There are other things being done more broadly on financial regulation. As you know, the FSB chair, Mark Carney, has, I would say, focused the agenda for this year to the four themes of 'too big to fail', continuing the implementation of Basel III, getting some things up to speed on so-called shadow banking and getting the oversight of OTC derivatives comparable—that is actually a minefield of complexity across jurisdictions as well. We support that as chair of G20—in fact, we encourage that kind of sharpening of the focus. The hope is to get agreements or concrete proposals, as the case may be, on the table at the Brisbane meeting later in the year. It is quite a journey to get to that, but that is where we are trying to go with this. Needless to say, this is an extremely taxing work program for the relevant officials of all the jurisdictions.

Australia is implementing Basel III. In some respects we are going a bit faster in doing that than other countries. This is really APRA's domain, but we can do that, and I think it is a good thing. The latest component of that, as we were talking about earlier, was the domestic SIFI framework that APRA announced for consultation just prior to Christmas.

CHAIR: Before I hand over to Mr Husic, I am going to ask you a very quick follow-up question. I had the good fortune to attend as a delegate at the meeting of the G20 finance ministers and central bank governors. On that point regarding the financial regulation, a number of G20 countries expressed a view that they wanted to bed down the existing financial regulation before adding additional financial regulation. Do you have a view on that, and how do you see the progress going in that regard?

Mr Stevens : The view that I put to both the previous government and the present one was that in this space, in the finance ministers and governors stream, we should be putting a view not that we are so much trying to stop regulatory initiatives that have come, though we probably have some reservations about some of them, but that the way the agenda was growing people cannot keep up, it creates additional uncertainty for the industry, I think unnecessarily, but we all know what the key reforms are: let's get them done. Then we need to follow up with checking implementation is proceeding and evaluate our early experiences with the new rules and, if need be, be prepared to adjust as the case may be. That has been the view that Australia has put and I think that is generally accepted around the membership.

Mr HUSIC: I don't want to get off the RBA Christmas card list—well, I'm actually not on it, but I don't want to push myself further back from getting on the list! You previously spoke down house prices but—here's the part that gets a bit tricky—house prices, from one stat I have read, have gone up in 34 out of 35 years. So, rather than using the blunt club of interest rates, is there any prospect of investigating macroprudential levers instead and looking at, for example, the New Zealand experience? Has any thought been given to that?

Mr Stevens : I said somewhere a few months ago that we had thought about this, we had had some preliminary discussions with APRA, which we had, and we promptly had a flood of FOIs for all the documents. That will all come out in due course. So we have thought about macroprudential tools. My view on them is they are a useful adjunct, but if we do use them we should go into this with a bit of realism.

Let's be clear. For a start, if we were to have, say, a loan-to-value cap, who do you think will be most affected by that? It will be first-time buyers. I can imagine at the political level you will find that uncomfortable, should we proceed down that track. Indeed, I think the New Zealand experience is that, when the central bank announced that, the government felt obliged to do some offsetting things. So this is not necessarily straightforward.

On the work that I have seen—and I can get Phil to speak here, because he knows more about it than me—the most effective tool could be that when banks test people for an interest rate, so you are supposed to be able to make the payments not just at the current rate but, say, 200 points higher, APRA could insist that the test be made 300 higher, or 400, or whatever, so that people do not get overcommitted. I should let Phil talk about it.

Dr Lowe : I think the benefit of that type of approach is it allows lower interest rates to feed through into lower servicing costs for both new and existing borrowers, but it does not mean that lower interest rates keep on increasing the size of the loan that people can get access to, because the bank is applying a bigger buffer to the actual interest rate you pay. I think there is quite a lot of merit in exploring that. I know APRA is discussing that at various levels with the bank lenders.

More generally, there is a lot of activity going on in different countries around the world in the macroprudential space and that is going to give us an opportunity to observe how those things work out. My tentative conclusion must be that it can work but it creates distortions, and in the end the distortions are quite costly and people work out how to get round the distortions. Macroprudential tools are very much like the tools we used in the 1970s and we ended up deciding we did not like those very much because you restrict one class of lenders, and the financial system is very flexible and another class of lenders comes up to fill—

Mr TONY SMITH: You had a cocktail.

Dr Lowe : The financial sector is very innovative. That does not mean these things are not worth exploring, but I do not think it is going to turn out to be a magic bullet, a silver bullet, particularly in countries like Australia where we have a flexible financial system, where there is a competitive fringe. In a more restricted system where you do not have markets and there is a lot more regulation you might be able to do this quite effectively, but our system is very flexible and we know that regulations create distortions and opportunities for people to take advantage of those distortions. So I think it is just a cautionary observation about how this can be used in practice here.

Mr HUSIC: This is my final question. I did flag that I would raise this with you, Governor. This has been raised with me from the perspective of visually impaired Australians: tactile banknotes. Has there been any thought given to what might be done on that, given that the RBA does have that technology available and is using it for other currencies?

Mr Stevens : We have given a lot of thought over the years to the question of how to help the visually impaired. The current set of notes is now coming up towards 20 years in circulation, but there was extensive consultation with the various organisations that help the visually impaired when we designed those. That is why they have such bright colours, for a start. There are actually devices available—I do not know if you have been shown these—that help people tell the notes apart. You can get this little card here, and you fold the note in. Because all the denominations are different lengths, you can measure the length of them, and there is braille on here to tell you what denomination it is. They are free. The Reserve Bank pays for them to be manufactured, and they are available through Blind Citizens Australia.

Mr TONY SMITH: Sorry to cut in. That would be world best, wouldn't it? I was just thinking that, if you were in the US, the contrast—

Mr Stevens : Yes, they are all the same size.

Mr TONY SMITH: Yes.

Mr Stevens : With this set of notes a lot of thought was given to size, physical length and colour for these sorts of reasons, and there is this device, as I say. It is true that other countries are experimenting with things actually on the note that would, in principle, be able to allow you to detect the domination. We have not made a final decision on this matter for the series that we are presently designing. There are considerations of things like, 'Does it wear off?' because wear in notes is a major issue. That is in part why we went to polymer. We are consulting with the other central banks about this, but the experience is not yet long enough to have a good sense of how durable they are. So it is a work in progress for us. It is an issue that we have given a lot of thought to. There are about a dozen organisations that work with the visually impaired community that we consult with on a regular basis, so it is on the radar, very much so. As to whether we will put a particular feature on a new series, that is not a decision we have come to yet. We are still evaluating what would work best, what would still allow the notes to go effectively through processing machines and so on, and all these sorts of considerations. It is a work in progress.

Mr HUSIC: Thank you, Governor.

CHAIR: Thank you very much. I will ask one final question before we go to the students who have questions for you. A lot of small businesses have been making a lot of commentary just recently about penalty rates. They have talked about the fact that this does not reflect the current working environment, that we are no longer in a Monday-to-Friday, nine-to-five environment. The commentary has been that it is impeding their ability to either open their shops, in some instances, or, in other instances, to employ people. Do you think that there are examples in our economy where penalty rates have been a handbrake on business growth and also on economic growth?

Mr Stevens : This is a fairly delicate topic into which I do not wish to tread very far. There are probably certain types of businesses and a certain type of employee that are happy to open on a weekend at relatively low wages, and both parties are better off, and other cases where people ought to be compensated for unsociable hours, so I don't know that I can give a blanket comment there. Whether there are specific instances of businesses who have had to not open on the weekend because of changed penalty rates, one reads about that in the papers but I do not have any more information than that and I would imagine the retailers would be the people to ask.

CHAIR: You do consultation with business right round the country, don't you? I would have thought that this—

Mr Stevens : Probably not with that many corner cafes, admittedly, but I don't know whether we can cast any light from liaison on that question.

Dr Kent : No, I mean we talk to small business representatives—

CHAIR: Is this issue raised?

Dr Kent : Not to the best of my knowledge, not specifically, because, again, we do devote quite a lot of resources to talking to businesses right across the country but that tends to be focused on the slightly larger end of town. It is not a specific issue.

Mr Stevens : I would say regulation is a broader theme. It tends to get raised more. Stuck in my memory is a one-day conference we held at one stage with some small business people and various organisations and lenders about small business finance, and we have the small business panel, as you know, that meets annually. The one thing I remember coming away from that was the complaints were not so much that 'the banks, won't you lend us more'; it was more: 'Could'—how do I put this politely—'government please just generally leave us alone.' There are too many forms, so regulation generally, which presumably may encapsulate labour market themes but it is more than that. I think that is a theme, both large and small.

CHAIR: We now have a couple more questions. If I can ask Isabella Pham to come up to the front—she is from St Georges High School, which is in the Banks Electorate; Mr Coleman's electorate.

Isabella Pham : Thank you, Governor. This is something you touched on earlier but my question is: currently, the Reserve Bank is employing monetary policy to encourage consumer demand and stimulate economic activity; however, with the mining boom ending, what does the RBA see as the next opportunity—hopefully, an opportunity that is not as finite as mineral resources—to ensure stable economic growth that is also long term for future generations?

Mr Stevens : Thank you, Isabella. I think the mining sector will continue to be generally positive for the economy into the long run after the initial downturn in investment that we are going to see in the near term. Elsewhere history would teach that economies evolve over time in the direction of more service sectors and less in the production of physical things. Alan Greenspan used to talk about how the tonnage of America's GDP had kept declining even though the value of it had increased, because more of what we do is knowledge based and service based. I think they are probably where most of the opportunities lie, including in trade in services into the future. That would be my answer.

CHAIR: This is a two-part question, so I invite Jeremy Kumar from Trinity Catholic College in Lismore and Josie Coles is from Richmond River High School in Lismore—both are in the Page electorate with Mr Hogan. I think Jeremy, you are going to start the question.

Jeremy Kumar : In around five years from now, I will have just graduated from university and will be looking for postgraduate employment. What I would like to know is what effects you think that the high levels of US, European and indeed Australian sovereign debt will have on the Australian economy in the medium to long term, especially with regard to employment.

Mr Stevens : Thank you very much, Jeremy. Provided we have a serious conversation about public debt, we will be able to stop it becoming a serious problem in Australia. It will be up to our parliamentary leaders to lead that discussion with the community, but I am sure they can do that. In that world, when you graduate in five years time, the economy will be bigger. There are 11.5 million jobs in it today and there will be more by then. If you study hard and get a good degree, the world will be your oyster really. Seriously.

CHAIR: There is a bit of good advice there.

Josie Coles : Hello, Governor. I am from Richmond River High School. I have a follow-up question with regard to employment. If the unemployment rate starts to head over seven per cent and inflation moves above your three per cent comfort level, would you raise the cash rate to fight inflation first or keep the cash rate low in order to support greater employment?

Mr Stevens : If that happens, Josie, I will be very uncomfortable indeed when faced with that choice. I think the answer to the question is that we will have to work out why that combination is occurring, because that would be unusual. If unemployment is rising because demand is weak, it would be pretty unusual for inflation also to go up, unless we had, say, an oil price shock or something. In that case we would be focusing on whether expected future inflation was still low. If it was, that would be good and we would not have to tighten. So it all depends on what the combination forces is that produces this result. I hope the combination you describe remains hypothetical rather than real. Thank you both for coming all the way from Lismore.

CHAIR: Terrific. Thank you everyone who made a special trip to be here today, those who have travelled far and those who have travelled across town. We have had a number of students here. Thank you for your participation and interest in this hearing. I would also like to thank you, Governor, and Dr Lowe and Dr Kent for your participation in this public hearing.

Resolved that these proceedings be published.

Committee adjourned at 12:27