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TRANSCRIPT OF Q & A

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AUSTRALIAN INSTITUTE OF COMPANY DIRECTORS

IAN MACFARLANE

GOVERNOR

RESERVE BANK OF AUSTRALIA

Q & A SESSION

TUESDAY 14 JUNE 2005

SHANGRI-LA HOTEL, 176 Cumberland St Sydney

LEGAL TRANSCRIPTS Level 6, 104 Bathurst Street, Sydney - Telephone 9266 0277

FIRST QUESTIONER (Unknown)

Governor, you talk about the quantitative effects of the rural sector, the terms of

trade, and the building sector. I wonder if you might comment on the

quantitative effects on growth of industrial relations reform. If the Government is

successful in its industrial reform agenda, would that have an impact on growth of

a quarter per cent per annum or half a per cent or whatever?

MR MACFARLANE: I think industrial relations reform is valuable and it does

contribute to higher economic growth, and the reform that's been undertaken to

date, although it's disappointed a lot of people, has I think had quite a profound

effect. It's meant that the economy can run faster without generating inflationary

influences to the extent that used to be the case. So I think there's undoubtedly

value in industrial relations reform. However, I am not brave enough to attempt

to quantify its effect in terms of percentage points per annum to GDP. If I start up

an economic consultancy I might pretend I'm able to do that, but at the moment, in

this job, I don't think I will try, thank you.

MR RYAN: Mr Macfarlane, Peter Ryan from the ABC's PM program.

There has been some commentary recently that last week's surprisingly strong

labour force figures are the only barrier to an interest rate cut later this year or

maybe in 2006? What are your views on this analysis and do you think a cut in

interest rates further down the track is in order?

MR MACFARLANE: I think this is a classic example of how I introduced my

speech. Someone picks one economic statistic and then immediately on the basis

of one month's economic statistics, tries to draw a conclusion about the future

evolution of monetary policy as far as a year ahead. That's an activity I cannot

endorse at all. I think it's very unhelpful to the economic debate to try and view

things in such simplistic terms.

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MR ERSKINE: Alex Erskine from Erskinomics, an economics consultancy!

I'm looking at the words of your peer in America who's dealing with a bond

market conundrum of very low bond yields while he's raising short-term interest

rates. Can you give us some views on how you see that?

MR MACFARLANE: One answer would be to say if Chairman Greenspan

thinks it's a conundrum who am I to solve it for him? I won't let myself off that

easily, Alex. I think there is some substance in the “glut of savings” argument.

But it's not simply savings in Australia or the US of course. We're talking about

worldwide. There is, particularly in Asia, a very big excess of savings over

investment. I think that is part of the explanation and I myself think part of that is

the delayed reaction to the Asian crisis. I think that what we saw around Asia was

not so much a big increase in savings but a big fall in investment as a proportion

of GDP. So we have Japan and China and lots of Asia, which is where the big

current account surpluses are, characterised by very cautious governments and

cautious investors with this massive increase of savings over investment.

They've got to invest it somewhere and they're investing it where the growth is

and where they feel confident in the rule of law and all the rest. So a huge amount

of it has found its way to the US. That's not a totally original interpretation. I

think more and more the debate is moving in that direction and I think the debate

to some extent has been led by the Fed, not particularly by the Chairman but by

some of the other board members like Bernanke. I don't think it would

necessarily provide a complete explanation but it's a significant part of the story.

When we turn to our own domestic capital markets we also see part of it

happening here in that our bond yields, responding mainly I believe to

international influences, have fallen and are lower than one would expect on the

basis of past economic relationships.

MR WILLIAMS: David Williams from Hewsons International.

Can you tell me what are the personal challenges that you see to a business leader

leading a business in the economic environment that you’ve just outlined?

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MR MACFARLANE: I don't know that it's any different than it ever is. I think

I'm giving a reasonably comforting picture. I think the basis of the speech was to

say we've been waiting and hoping for some slowing in domestic demand for

some time. It's now happened. Don't feel upset about it. Feel comfortable that

that means that the sustainability and the stability of the economy overall has

improved. So I don't think what I've said would make life difficult for a business

leader. I think if anything, it would be slightly reassuring.

MR LONGWORTH: Norman Longworth, Ausman Engineering.

Would you agree that the foot was left on the accelerator of home lending,

particularly a principal place of residence lending, for too long?

MR MACFARLANE: I don't know whose foot you're referring to! I think there

is no question that house prices and housing activity grew at a dangerous rate in

those early years of this decade which we went to great pains to point out

whenever we had an opportunity to do so. I think the most overheated part of that

was in fact not the principal residence but investor housing, and I think that is

turning around the way it should. I think the nature of these capital markets is that

even though we'd like everything to move ahead smoothly at a sustainable rate,

that's not how the world operates. Particularly in these asset markets, you have

periods of overheating followed by periods of cooling. You hope that it’s a period

of cooling which is, I think, what we're having now and not anything more

extreme than that.

MR VANDORE: Jim Van Dore from New SouthWales State Development.

Mr Macfarlane, the terms of trade for primary commodities has kind of taken the

heat off the need for value adding in this country in some respects. I wonder if

you and the Bank have any comment to make on the long-term need or the

long-term outlook for value adding in relation to primary commodities?

MR MACFARLANE: I have mixed emotions on this one. I think maybe there is

some basis to what you’re saying at the moment because of the phenomenal

returns to resource industries. But again, on the other hand, you can have the

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opposite situation which we saw in the years 2000 and 2001. Whenever I went to

a function such as this someone got up and preached how we should have been

pouring money into paying Intel to build a chip factory in Australia and how we

were an old economy and we had no future. And all I can say is I’m glad we

didn’t build those chip factories. Maybe if we had bought potato chip factories it

might have been better.

MS HENDERSON-SELLERS: Ann Henderson-Sellers, from the Australian

Nuclear Science and Technology Organisation.

Governor, thank you for your speech, I enjoyed it very much. I wonder if you’d

be prepared to say something about in the light of the Millennium report and the

statement last week from most of the world’s academies regarding global

warming how do you feel that our economy and those economies around the

world will be affected by the increasing push to value what have previously been

termed free goods?

MR MACFARLANE: Now we’re getting away from my central area of

competence rather quickly. I don’t really think I wish to add to the global

warming debate other than to say I think that that aspect that you happened to

draw attention to - which is pricing things which were formerly regarded as free

that weren’t free - I think that is a move in a helpful direction.

MR PAULIN: Governor, Keith Paulin from Imazighen Capital.

You began your presentation with a look at long-term economic trends and how

things take time to develop. What are your thoughts regarding what appears to be

an accelerating short termism in, particularly, public companies’ approach

responding to analysts and short-term investor requirements, versus long-term

investment propositions?

MR MACFARLANE: They’re getting harder, I think, these questions. I don’t

really know that I am sufficiently knowledgeable about the behaviour of CEOs

and chairmen of listed companies in responding to events to be able to give a

really considered judgment on that one. I think I’d be sort of over-exceeding my

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competence if I were. I think it’s an interesting subject but sometimes I have to

plead that I don’t know a lot about a lot of interesting subjects.

MR BASSANESE: David Bassanese, The Financial Review.

Governor, just a question on those employment numbers and juxtaposed with the

GDP numbers. Are you surprised with the continued strength in employment

given the slowdown in GDP we’ve apparently had over the past year? Is it

suggesting something wrong with the numbers either on GDP or employment or

maybe that the productivity revolution we have had has really fallen away?

MR MACFARLANE: The answer to the first part of your question, yes, I find it

very hard to believe that employment could be growing that quickly and GDP to

have slowed that much. I suspect in five years’ time if we look back we’ll find

that some of those figures are a bit different than they are now and it’s unlikely to

be the employment ones.

There’s a related question which I thought you were going to ask which is how

come there can be capacity constraints and yet employment is increasing so

quickly? We’ve thought about that one quite a bit too and it’s not as surprising as

it seems. For some cases the capacity constraint is actual shortage of physical

capital. That doesn’t stop you increasing employment. In fact, sometimes it

might encourage you to increase employment to make up for a shortage of

physical capital or run more shifts or do things like that and involve the use of

more labour.

Secondly, when we talk about capacity constraints it’s not all labour or all capital.

I think in the labour market where the constraints are we keep hearing from the

people we speak to that there are shortages of certain skills; some at the trades

level, some at the very high end professional level. And the capacity constraint

there means that you are perhaps forced to hire people who haven’t got quite as

much skill as you thought, or hire people and train them or whatever way you do

it. It’s probably going to be more expensive and in the short run may look like it’s

not enhancing labour productivity very much.

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I think it’s entirely plausible that you can have capacity constraints but at the same

time businesses can be going out there competing for labour at the rate that they

have been over the last year.

MR GREEN: Thank you, Ian, for answering those questions that you felt were in

your area of expertise. I’d now like to ask Karl Morris, managing director of our

sponsors, Ord Minnett to formerly propose a vote of thanks. Karl.

MR MORRIS: Thank you, Mr Macfarlane, for a most entertaining and

informative speech. I look forward to the ten interpretations of it tomorrow.

While you said that there are many outside influences it goes without saying that

we’ve had a number of great ones with the Asian crisis, September 11,

commodity booms, property booms, ore price rises in China, but we still managed

14 years of great growth in Australia. I think that goes to show that the policy of

the Reserve Bank has obviously been very good in that period of time, and surely

during the last nine years of your tenure.

While there are many experts in monetary policy I, for one, am glad that you’ve

got your foot to the pedal, or not to the pedal, of monetary policy. So Mr

Macfarlane, thank you very much for your speech today. Ord Minnett was very

pleased to be a proud sponsor of the Australian Institute of Company Directors

function here today. It’s a quality number of people, one of the largest number of

gatherings that I’ve seen for one of these speeches. Thank you very much for

coming, Mr Macfarlane.