DEBELLE, Dr Guy, Deputy Governor, Reserve Bank of Australia

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

LOWE, Dr Philip, Governor, Reserve Bank of Australia

Committee met at 10:00

CHAIR ( Mr Coleman ): Good morning, everyone. I declare open this hearing of the House of Representatives Standing Committee on Economics and welcome representatives of the Reserve Bank and members of the public and the media.

Since the previous RBA hearing in February 2016, monetary policy remains accommodative, with a cash rate at 1.5 per cent following the RBA's decision to cut official interest rates by 25 basis points on 2 August this year. In September the RBA governor stated:

… having eased monetary policy at its May and August meetings, the Board judged that holding the stance of policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.

Inflation remains low, and the RBA expects:

Given … subdued growth in labour costs and very low cost pressures elsewhere in the world, this is expected to remain the case for some time.

The governor has noted recent data suggesting continued strong GDP growth. The committee will examine these issues in more detail and will ask the RBA about whether it is confident the current monetary policy settings will effectively encourage growth and inflation consistent with the target in coming years.

I would like to take this opportunity at the outset of the hearing, on behalf of the committee, firstly to acknowledge the retirement of Mr Glenn Stevens from the role of governor after 10 years of service. We thank him and congratulate him on his service. Importantly, we also welcome the new governor, Dr Lowe, and congratulate him on his appointment to this very important role.

I remind you all 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.

Dr Lowe, would you now like to make your opening statement before we proceed to questions?

Dr Lowe : Thank you, Chair and members of the committee. Thank you very much for those words of welcome. It is a great honour for me to be appearing before this committee. These hearings have become a really important part of our calendar. They are an important way in which the Reserve Bank is accountable to the public. I myself have been attending these hearings in various capacities for more than 10 years. I look forward, in my new role as governor, to continuing the history or the tradition of productive engagement between the committee and the Reserve Bank of Australia, and you can be assured that I will do my best to answer your questions as constructively as I can. I look forward to regular meetings over the coming years.

In my opening remarks this morning, I want to cover three sets of issues. The first is the monetary policy framework, the second is recent economic developments in Australia and elsewhere, and the third is some of the major projects that the Reserve Bank is currently undertaking. Earlier in the week, you might have seen that the Treasurer and I released an updated statement on the conduct of monetary policy. These statements, which were first released in 1996, record the common understanding between the Reserve Bank and the government on key aspects of Australia's monetary and central banking framework. They also set out the agreed arrangements that promote transparency and accountability of the bank, including appearances before this committee.

Over recent times, there has been quite a lot of public commentary in Australia and elsewhere about monetary policy frameworks. As you can expect, we have been studying the various arguments very carefully, and we have followed the debates. Our view is that a flexible medium-term inflation target does remain the right monetary policy framework for Australia, and this was reaffirmed in the new statement, which has also been endorsed by the board of the Reserve Bank. The goal remains for CPI inflation to average between two and three per cent over time. The current framework was introduced in the early 1990s, and my view is that it has served Australia very well. It provides the community with a reasonable degree of certainty about how the average level of prices is likely to change through time. This helps people when they are making decisions about their savings and investments. Low and stable inflation remains an important precondition for strong and sustainable growth in both employment and incomes.

It is worth emphasising that, since the adoption of inflation targeting in Australia, the Reserve Bank has been a proponent of what is known as flexible inflation targeting. We have not seen our job as trying to keep inflation always within a very tight, narrow range. We have not been what some have called 'inflation nutters'. We have had a more balanced perspective, recognising that some degree of variability in inflation from year to year is both inevitable and appropriate. Particularly, a flexible, medium-term target is the best way for us to deliver low and stable inflation for the community in a way that contributes to our other broad responsibilities, including both employment growth and preserving financial stability.

We want to ensure that we deliver an average rate of inflation in Australia of between two and three per cent over time. It is in the public interest that we do this. It is also in the public interest that we pursue this objective in a way that promotes good employment outcomes for the country and preserves financial stability. It is in this way that we can best contribute to the economic prosperity and welfare of the Australian people, as required in the Reserve Bank Act. Our judgement, then, is that a flexible, medium-term inflation target remains the right monetary policy framework for Australia. While there are arguments for other types of arrangements, none of them are sufficiently strong to move away from the current framework, which has helped promote both stability and confidence in the Australian economy for more than two decades.

The new statement represents continuity with the previous statements, but there have been some drafting changes. The main ones make clearer the link between monetary policy and financial stability. In the previous statements, monetary policy and financial stability were dealt within in completely separate parts of the document, yet over years financial stability considerations have been a factor in our monetary policy deliberations. Recently, for example, we have considered that a very quick return of inflation to the two to three per cent range, at the cost of a material deterioration in the health of private sector balance sheets, is unlikely to be in the public interest, so the revised drafting recognises that the inflation target is pursued in the context of the bank's broader objectives, including financial stability. That is the monetary policy framework.

I now would like to turn to the recent economic data. The economy continues its transition following the boom in commodity prices and mining investment. According to the latest national accounts, GDP increased by 3.3 per cent over the year to June. This was a better outcome than many, including us, had earlier expected. It is also a little above most estimates of trend and growth in the economy and, partly reflecting the above-trend growth, the unemployment rate has declined by around half a percentage point over the past year, which is very good news and is a better outcome than we thought likely a year ago. Always, though, these aggregate outcomes mask significant variation across the country and in different regions and industries. Those parts of the economy that most benefited from the resources boom are now experiencing difficult conditions and other areas are doing considerably better. In these areas, business conditions have improved, employment is growing and there have been some signs of a pick-up in private investment. So, overall, the picture is of an economy adjusting reasonably well to the unwinding of the biggest mining and investment boom in more than a century. It is a quite significant achievement. We are managing this partly because of the flexibility of the exchange rate and the flexibility of wages and through the support that is being provided to the economy through monetary policy.

The story on income growth, though, is less positive, with growth in nominal GDP being disappointing. Over the past five years, nominal GDP has increased at an average rate of three per cent per year. To put that number in context, between the years 2000 and 2007, nominal GDP grew at an average rate of 7½ per cent. So we have gone from an average increase of 7½ per cent to three per cent. That is quite a change. I think it goes some way to explaining the sense of disappointment in parts of the community about the recent economic outcomes.

The main reason for the weak income growth over recent times is a large fall in the prices of our exports. Since late 2011 export prices have fallen by around one-third. It is a large fall, but it does need to be kept in perspective, because export prices do remain considerably higher than they were in the 1990s and in the early 2000s, especially relative to our import prices. Of course, some of the fall in the price of our exports is because Australia has increased its production of some important commodities, so we are receiving lower prices for our exports, but the more positive news is that we are selling more.

The recent news on commodity prices has also been a bit more positive than it was earlier in the year. For the past couple of months the prices of our key exports have risen partly in response to production cutbacks by some of the high-cost producers elsewhere in the world, especially in China. It is difficult to predict the future, but if these recent increases were to be sustained then we could look forward to the drag on our national income from falling commodity prices coming to an end fairly soon.

A second factor that has weighed on growth in nominal GDP is the slow rate of wage increases. This is a common experience across most industrialised countries at present—even those with fairly strong employment growth. In Australia the current rate of wage growth is the lowest in around two decades. It is part of the adjustment following the resources boom. Importantly, it means that many more people have jobs than would otherwise have been the case.

This low wage growth and the lower commodity prices have meant that the CPI inflation rate has been quite low over recent times. Inflation has also been held down by increased competition in parts of the retailing sector and some cost reductions in the supply chain. Slow growth in rents has also played a role in holding inflation down. These low-inflation outcomes have provided scope for monetary policy to provide additional support to demand. The Reserve Bank decided to reduce the cash rate by 25 basis points in May and again in August this year. Lending rates have come down as a result of that. Deposit rates have also come down, and the board is very conscious that the lower deposit rate means lower interest income for savers. Overall, though, our judgement is that easing monetary policy is supporting jobs and economic activity in Australia and in so doing it is improving prospects for sustainable growth and inflation outcomes consistent with our medium-term inflation target.

Looking forward, we expect the economy to continue to be supported by low interest rates and the depreciation of the exchange rate that we have seen since early 2013. Importantly, the drag from the fall in mining investment will also come to an end before too long. While mining investment does have some way still to fall, our estimate is that around three-quarters of the total decline is now behind us. Inflation is also expected to remain low for some time but then to gradually pick up as labour market conditions strengthen a bit further.

One issue that has attracted a lot of attention recently is the housing market. The construction cycle appears to have a bit more momentum than we earlier expected. This is adding to the supply of housing in the country—again, that is good news—and the increased supply partly explains the slow in rents we have seen over recent years. The rate at which established housing prices are increasing has also moderated a bit, although there do remain some pockets where prices are increasing quite briskly. Credit growth and turnover in the housing market are also lower than they were a year ago, and under APRA's guidance lending standards have also been tightened a bit.

Overall, then, the situation is more comfortable than it was a year or so ago, although we continue to watch the housing market very carefully.

I would now like to make a few remarks about the international environment. Here is the overall picture as it is and as it has been for some time. The global economy is continuing to expand, but the rate at which it is expanding is a little below average. Growth in global trade and investment is subdued. Inflation is also generally low, and in most countries it is below the central bank targets. Interest rates in many countries are also at very low levels.

One issue that continues to attract a lot of attention is the global monetary environment. As we have talked about on previous occasions in front of this committee, at the global level there has been a very heavy reliance on monetary policy to stimulate growth. Some central banks have taken truly extraordinary actions, including very large scale money creation and setting their policy rates in negative territory. This inevitably has had global ramifications. While these actions have generally not been taken with the direct intention of influencing exchange rates, these actions have inevitably affected international capital flows and they have affected exchange rates. We have seen these effects here in Australia. The monetary expansion elsewhere around the world and the very low rates on offer in many overseas countries have meant that foreign investors have found Australian assets, with their relatively high returns, quite attractive. In this way, what is happening elsewhere in the world with monetary policy is affecting us here in Australia.

In the past 24 hours, there have been much anticipated policy meetings by the Bank of Japan and by the Federal Reserve in the US. These meetings followed a reassessment in markets about the potential for further stimulus from the major central banks. This reassessment has seen bond yields rise in the past month from historically low levels. In the event, the Bank of Japan and the Federal Reserve did not make material changes in the past 24 hours to their policy stances. In both cases, though, policy remains highly accommodative. The Federal Reserve's statement did note, though, that the case for an increase in the federal funds rate had strengthened recently.

Another area that continues to be watched very closely is the unfolding transition in the economy of our largest trading partner, China. As we previously discussed, growth in China has slowed as China, too, makes a difficult economic transition, in its case from growth being driven by large investments in industrial capacity and property to a more consumption-focused and service-based economy. China is also dealing with the consequences of a large build-up of debt in the private and state-owned business sectors. Overall, the latest available data suggest there has not been a major interruption to growth in China, although this is partly because the economy is still being supported through fiscal policy, including expenditure on infrastructure.

The Chinese authorities face a difficult trade-off. Measures to address industrial overcapacity and the very high levels of debt in parts of the economy are necessary over the longer term but they are not helpful for growth in the short run. It remains a work in progress, and we all have a strong interest in their managing this trade-off as smoothly as they can.

That is the Australian and international economies. I would like now to say a few words about some of the major public interest projects that the Reserve Bank has been working on recently.

You will, I hope, have noticed that a new $5 banknote was issued on 1 September. At the bank we are incredibly proud of that. The new banknote has innovative security features, including the world's first clear top-to-bottom window, and if you have had one of these new banknotes in your hands you will also have noticed a tactile feature in the banknote to assist the vision impaired. We anticipate releasing a new $10 banknote next year, and in the following year, hopefully, we will release the $50 note, which has the greatest number in circulation.

The rationale for introducing these new banknotes is that we want to make sure that counterfeiting rates in Australia remain very low. Our current banknotes have stood the test of time, but as technology has improved so too have counterfeiting capabilities, and there has been some increase in counterfeiting in Australia, so investment in the new high-tech banknotes will help ensure that Australians can continue to have confidence in their banknotes. As part of this project we are building a new large vault and a technologically sophisticated, more efficient cash-processing in Craigieburn in Victoria. Our existing cash storage arrangements were running up against capacity constraints.

A second major project is what is known as the New Payments Platform. This project has been under the guidance of the Reserve Bank's Payments System Board. It is a cooperative effort between the bank and the payments industry to modernise key parts of our electronic payments system. When this work is finished we will be able to make instantaneous payments to one another, with the money transferring between our accounts in a matter of seconds—and that is regardless of who we bank with. The addressing will also be simplified. All you will need is an email address or a mobile phone number. The payer will no longer need to give their bank account number or their BSB; just the mobile number or the email address will do. We will also be able to send a lot more information with the payments. You will no longer be restricted to just sending 14 characters if you go onto your internet bank to make a payment. You will be able to send whatever information you like with your payment. The first payments using this system should be able to be made late next year. And as one of the contributions of the Reserve Bank to this project, we are building the necessary infrastructure to allow the funds to be transferred in real time between financial institutions.

A third major project that we are currently undertaking is the renovation of our banking infrastructure. The Reserve Bank is the main transactional banker for the Commonwealth government. Like other financial institutions, we need to keep investing in technology so that we can provide a high level of service to our customers. As part of this work, we are developing systems so that the government can use the new payments platform that I just spoke about to make quick and efficient payments to the community.

So, with these large projects being undertaken, it is a very busy time at the Reserve Bank. Further details on these projects and other projects we are working on will be available in the bank's annual report, which will be tabled in parliament and released in the middle of next month. Thank you very much. My colleagues and I are here to answer your questions, and we look forward to the hearing.

CHAIR: Thank you very much, Governor Lowe. We will kick off with questions. You talked a bit about the transition of the economy away from the mining boom and the strong economic growth we have seen. Non-mining economic activity, as you know, has increased by about 2.9 per cent over the past year. What do you see as driving that growth?

Dr Lowe : It is fairly widespread. The housing construction cycle is in a strong upswing, and that is providing a reasonable amount of impetus to aggregate demand. Consumption growth has been okay. It has not been too different to trend. And public demand has been growing reasonably as well. There are some signs that private business investment, particularly in the non-resource states, is picking up as well. So it is reasonably broad based. As I was saying in my opening remarks, it reflects the depreciation of the exchange rate, the low interest rates and the underlying population growth of the economy. Our population is still growing at 1½ per cent a year, so that naturally creates demand in the economy.

CHAIR: More generally, with the overall 3.3 per cent growth rate, which, as I understand it, exceeds all the nations of the G7, why are we doing better, so to speak, than those G7 nations?

Dr Lowe : There are a whole range of reasons there. The population growth is an important factor. Our banking system did not get impaired. Our banking system is performing the job that you would want it to do. The economy has turned out to be remarkably flexible. If you think about the broader context of what has happened here, we had the biggest resources boom in a century and the highest price for our commodity exports in more than a century and a half. The economy dealt with that; it digested this huge amount of capital spending and huge boost to our income without overheating. Now we are dealing with the downside of that, with growth still being quite respectable. In many ways, it is a remarkable achievement. It is the underlying flexibility of the economy that comes from the exchange rate, from the flexibility that we do see in the labour market and the ability of monetary policy to adjust to the changing circumstances. I think we can often kind of get carried away with the fact that the economy is not doing as well as we would like it to do. But from where I sit, if you look at the bigger picture—the nature of the resources boom and the difficult global environment—we are doing a decent job here. We should remember that.

CHAIR: A related question around exports: we have had a particularly strong year in export growth in the past 12 months. I think a lot of that is driven by LNG, but not all of it, because services exports have been quite strong as well. How do you see the outlook for exports, particularly in the non-mining categories?

Dr Lowe : In the mining area—and I might get Chris to talk about this in a minute—the very large increases in LNG exports are still to come, and that is going to make a significant contribution to GDP growth over the next couple of years. And, in the non-resource parts of the economy, we have seen a marked change in net service exports. More overseas people are coming to have holidays in Australia. It is not as expensive anymore. That is the exchange rate adjusting, and we are seeing that. And fewer of us are going overseas, because it is more expensive for us to go overseas, so more of us are holidaying domestically. We see the effects of that particularly in Queensland and even in some of the hotel markets in the capital cities, where vacancy rates are quite high.

So the movements in the exchange rate have affected people's choices on where to take their holidays. We are seeing it in the education sector, where it is more affordable now to come and study in Australia, and people respond to changes in affordability. We even see in some parts of manufacturing that there is a chance that businesses, having gone through the difficult adjustment period with a high exchange rate, can look for export markets again. They are kind of in niche markets, but the exchange rate has made a material difference. Chris, do you have any more comments on exports?

Dr Kent : Really just to make two points. One is that, in the improvement in non-mining economic activity that you alluded to earlier, people often focus very much on the role of monetary policy in driving dwelling investment, but its contribution has been of the same order of magnitude as net service exports, which the governor was just emphasising, and that is pretty broadly based. And it is not just that we are exporting more; it is that Australians themselves are responding to that price difference now that the exchange rate is lower, and using more of our own services at home, whether that be for travel or even business services. So I think that is an important dimension—the exchange rate really has been very helpful over the past few years.

CHAIR: And just to pick up on the exchange rate point: Governor Stevens, going back probably 18 months ago, was, I think it is fair to say, uncomfortable with where the exchange rate was at. Is the bank now broadly comfortable and thinking that the exchange rate is about right, and fairly valued?

Dr Lowe : Well, a lower exchange rate would be helpful; that is pretty clear. These positive effects I was just talking about from the exchange rate depreciation that we have already had would be amplified if the exchange rate was a bit lower than it currently is. Of course, most central banks say the same thing: most people would like a slightly lower exchange rate, and I think it reflects the deficiency in aggregate demand in the global economy. The Reserve Bank of New Zealand had its monetary policy statement this morning, and in their statement they said that a lower exchange rate is needed—full stop. And many of my peers think the same. But of course we cannot all have lower exchange rates; they are relative prices.

So in answer to your question, the exchange rate has appreciated recently. It is partly reflecting the higher commodity prices and the continued attractiveness of Australian assets to foreign investors, because the returns here are still higher than you can get in many other countries—not just because of our cash rate but because the underlying returns on real assets are higher here, and that is good news. It is understandable that the currency has had an appreciation over recent months, but it would be good if we had a slightly lower currency. It would amplify some of these positive things that we are seeing. I do not want to put a number on that, but it would be good if it were a bit lower.

CHAIR: Just to pick up on the point around GDP growth and labour market growth, as you alluded to in your statement we have seen the unemployment rate at about half a per cent lower than was anticipated. Is that, as I understand it, a reasonably broad-based situation in the economy in the non-mining sector—that we are seeing employment growth that was greater than anticipated?

Dr Lowe : We have been particularly strong in New South Wales and Victoria, so it is really in the south-eastern states that employment growth has been strong. In Western Australia the level of employment has been largely unchanged for a while. That labour market is much weaker than it had been.

One of the things we are seeing is very, very strong growth in part-time employment whereas growth in full-time employment is relatively weak. So the parts of the economy that are doing the best at the moment are the service sectors—in particular, the personal services sector, and part-time employment tends to be more characteristic of those sectors. I suspect that the labour market is not quite as strong as the headline unemployment rate data suggests because the jobs growth is not in full-time employment, it is predominantly in part-time employment. So there is probably a bit more slack in the labour market than suggested by the unemployment rate. But that is a qualification on what has been a very positive story.

We thought a year ago that the unemployment rate would now be above six per cent, and here we are now at between 5½ per cent and 5¾ per cent. A lot more people have jobs. There are a lot of people who work too many hours but there are a lot of people who think they would like to work more hours, and if we continue on the trend that we are on, I think there will be opportunity for them to do that. The various forward-looking indicators of the labour market that we track—job ads and job vacancies—are on a gradually improving trend. So I think we can look forward to continuing reasonable employment growth.

CHAIR: I want to take you to your updated statement this week on the conduct of monetary policy. You did talk about it a little bit in your statement but I just wonder whether you could crystallise for the committee, from your perspective, the key implications of that statement and any changes from the previous statement that you see as important to the bank's mission.

Dr Lowe : There aren't any, really; it is really a continuity. As I said, I think the current arrangements that we have had for nearly two decades have served the country well. They add to the sense of stability and confidence that people have in the monetary arrangement. So we really want to continue with that. Really, the changes that were made were to give a more accurate reflection of what we do in practice—in particular, the link between monetary policy and financial stability. As I said, those two things are closely intertwined, and I was keen to recognise that in the statement.

CHAIR: How do you define financial stability? How do you interpret that?

Dr Lowe : What people normally think of is the stability of the banking system: is the banking system sound and what are the risks to distress in the banking system? That is one part of it. My own concept is slightly broader than that: I am talking about the overall health of balance sheets—in particular, private sector balance sheets—in the economy. One of the issues that we have discussed internally within the bank is how quickly we should get back within the two to three per cent range of inflation. A due consideration there is what is happening with private sector balance sheets. I read that some analysts would like to have seen a more aggressive easing of monetary policy to try and get inflation back there more quickly. I think there is a respectable argument to be made here. But the other side is that very low interest rates just encouraged people to borrow even more and pushed up asset prices even more. We might be able to get back to 2½ per cent inflation quite quickly but it could be at the cost of a deterioration in the health of balance sheets and building up risks—maybe not for financial institutions but for the future health of the consumer balance sheets and the economy. So I very much see the inflation targeting arrangements being nested within our broader responsibility to promote the interests of the Australian people.

So the question we ask ourselves is: what is in the best interests of the Australian people—to try and get inflation back very quickly to two to three per cent at the cost of a deterioration in financial stability broadly defined, including the balance sheets? Our judgement to date has been that that would not be consistent with our mandate of doing what is in the best interests of the Australian people.

CHAIR: Obviously something of great importance to the committee is the banking system and its activities and their impact on consumers. In August you cut official interest rates, but the banks did not pass on that interest rate in full to consumers. What is your view on that?

Dr Lowe : It was not unexpected that they did not pass that through. That was what we thought was likely to happen. Over many years we have said we have taken into account the decisions of the banks in adjusting their margins in setting the cash rates, and that remains the case. It does not fundamentally adversely affect the transmission of monetary policy to the rest of the economy. There are a lot of other channels through which monetary policy affects the economy. At the margin it probably weakens one of the channels but it does not fundamentally undermine the transmission of monetary policy to the economy. I anticipated the committee would be interested in this set of issues, so I have prepared an additional handout that I could give to the committee to talk through some of the issues if you found that helpful.

CHAIR: Sure.

Dr Lowe : This whole area is so confusing. People use different language. They talk at cross-purposes to one another. There is a spread to this, a spread to that. If you are like me, after listening to the debates, you are very confused. I really feel like the job the Reserve Bank can do here is to provide you with a decent fact base that you can question other people with.

CHAIR: Why don't you speak to the issue and then we can distribute a document if you would like to as well. But could you speak to the issue in terms of your view on the action of the banks in not passing on the interest rate reduction? I know in your chart pack you do cover issues like net interest margin of the banks, cost of funding to the banks and so on. I suggest you speak to it and then we can distribute a document as well if you would like to.

Dr Lowe : If it is okay with you—the document has a series of graphs and there are not many words on it. It is basically graphs.

CHAIR: Okay. Sure.

Dr Lowe : There are a lot more graphs than words. If that is okay, one of my colleagues could circulate that, because I think it helps. I hope you find it useful. I have certainly found it useful preparing it.

A question that often gets asked—and you were touching on it—is: what is going on with the banks' net interest margins? There are two measures of that. This is part of the problem. There are more than two measures, but there are two commonly used measures, and I have reproduced them here for you. The first one is the net interest margin, and this is what the banks report in their annual reports and their quarterly statements. It shows the spread between the borrowing and lending rates. It shows the interest-earning income less the interest-earning expense relative to the interest-earning assets. The basic picture there is that that came down a lot in the 1990s and 2000s and, for the better part of the past decade, it has gone sideways.

Another measure, which is one that we calculate, is the difference between the average lending rate and the average cost of funding. That is the second graph there. In the broad sweep of history, that has a similar pattern to the first graph, but you can see in recent times there has been some widening of the margin between the average rate on loans and the banks' average cost of funding. Why has that occurred?

If you look at the next graph you can see that, over time, there has been a very substantial increase in the share of the banks' assets that are held in securities. Securities have gone from about 15 per cent of the assets to 20 per cent, and the reason that has happened is that the banks have been required, as a result of international regulatory developments, to hold more liquid assets to meet potential liquidity strains. So the banks are holding a lot more of these assets, and the average return on these assets is a lot less than they get on loans. The average return on these liquid assets globally is less than one per cent. So they are holding a lot more of these low-return assets, and that is holding down their net interest margin. I think what has happened is they have partly compensated for that by charging slightly higher rates on their loans because they have got more of these low-earning assets.

Another thing that has happened—and you can see it in the next graph—is they are holding a lot more capital, and capital is quite expensive. If you turn to the next page, the return on equity in the banking system has basically been steady at around 15 per cent. It is similar to the Canadian banks but it is much higher now than in the US, Japan and Europe.

The next couple of graphs speak to the issue of the pass-through. You can see that in graph 6. That is showing you the standard variable mortgage rate—that says SVR—relative to the cash rate. You can see that margin came down a lot in the 1990s, and then we went through what is historically an unusual period where the cash rate and the mortgage rate moved in lock step. Then, since the financial crisis, the mortgage rate has moved up quite a lot relative to the cash rate. The same is true, although even to a larger extent, for the small business rate, because in the middle of the crisis the banks repriced the credit risk and charged higher credit risk margins, so the small business rates went up by even more than the mortgage rates, and that differential has been maintained.

If you look at the other side of the banks' balance sheets, on their funding costs, the next graph there shows the cost of long-term debt relative to the cash rate. It too went up two percentage points in the middle of the crisis. It has come back a little, but the cost of bank long-term debt relative to the cash rate has gone up by 1½ percentage points since the crisis started.

If you turn to the next page, something that is underappreciated, I think, is that the cost of deposits relative to the cash rate has gone up a lot as well. Before the crisis, the average deposit rate that the banks paid was about two percentage points less than the cash rate. Today, the average rate paid on deposits is very similar to the cash rate. This is reflecting two factors. There was increased competition in the deposit market. Some foreign entrants came in, particularly the online banks, and that paid us all better returns on our deposits. Then, in recent times, banks have really wanted to increase the deposits on their balance sheets, so they have been prepared to pay up to get deposits, and you can see just in the last six months deposit rates have risen relative to the cash rates.

I think the broad picture is, since the crisis, what has happened is that the whole structure of interest rates relative to the cash rate has risen. Credit spreads went up a lot in financial markets, and banks competed much more aggressively for deposits. That is where the focus of competition is. The deposit rates have gone up, so basically the whole structure of interest rates has moved up 1½ to two percentage points relative to the cash rate, and that is the broad story about what has been going on. It does not explain any month-to-month movement, but I think it is important to have the context in which this has occurred. The fact that there has been an increase in the spread between the average interest rate paid and received reflects to a significant extent, I think, the fact that the banks have had to hold more of these low-yielding securities, and they have been able to do that in a way that has not affected their underlying return on equity.

Another outcome here—and this is, I am sure, what you will pursue in your hearings—would have been that the need to hold more liquid assets could have led to lower profits in the banking sector and the banks could have accepted a lower return on their equity. My assessment is that the borrowers have largely borne the cost of that, not the shareholders of the banks, and it is an interesting question about who ultimately should bear the cost of that: the shareholders or the borrowers. I hope you found that useful.

CHAIR: It was very helpful. Thank you.

Dr Lowe : It is an incredibly complicated issue. If you are like me, you will be bamboozled by the spread to this, the spread to that—and then it kind of moves around. What we are trying to do is provide a reasonable information base where the community can make an assessment on what is a very contentious issue.

CHAIR: Thank you, Dr Lowe. I am just conscious of time. I will pass to Mr Thistlethwaite in one moment. I just wanted to ask you about this: particularly in your first meeting as governor, you obviously have an operational responsibility, as you are effectively the chief executive of the bank. I just wanted to get you to give us a quick comment in relation to the internal operations of the bank. Are you happy with what you see in terms of its internal operations and in relation to some of those matters that have arisen in the past around the Securency issue? There was obviously the concern expressed last year about a potential leak of information about interest rate decisions. I just want to understand your level of satisfaction as the incoming governor regarding the internal culture and operations of the bank.

Dr Lowe : I have very high regard for the staff of the bank and the way they go about their job. I do not have any concerns. Governor Stevens and I worked closely together. We were a team in making sure the bank met the high standards the community expects of us. There was, as you say, some speculation last year that the monetary policy statement was made available to people earlier than it was publicly released. We looked at that forensically, as you could expect. ASIC has also looked at it. We have had an external firm come and look at the way we did the investigation. I am 100 per cent confident that our processes stand up to scrutiny.

The biggest operational issue I face is really this very heavy project load. These big national financial infrastructure projects have all come together, so the bank staff feel like they are working incredibly hard—and they are—to get these really major projects underway. My job is to manage that process, and we are doing well. On the other problems that we have had, which this committee has talked about before with NPA and Securency, the previous governor has answered the questions of the committee for hours and hours on that.

What I have done is to make sure that the governance arrangements of NPA are the best possible practice governance arrangements. I have forensically gone through their strategic direction, their policies and their procedures with the NPA management and the board. I have gone through it forensically to make sure that I am comfortable with how they are operating. NPA was recently accredited under the Banknote Ethics Initiative, which is an international, independent auditing arrangement to examine the policies about bribery and corruption in the banknote industry. NPA was one of the first organisations to be accredited there. I am very confident, but the bank staff do have a very heavy workload with these projects.

CHAIR: Thank you.

Mr THISTLETHWAITE: Congratulations, Dr Lowe, on your appointment, and congratulations to the bank for the development with the five dollar note. We represent a lot of vision impaired people who welcome this development, so I thank you for that. I would like to ask you a series of questions about the international environment firstly, and then I will move into the domestic environment. The OECD released a report overnight which paints a pretty pessimistic outlook for international growth. I think the words they used were 'low-growth trap has taken root'.

That would seem to imply that there is this uncertainty that still exists internationally, there is sluggish growth and there is still this great vulnerability to a shock and potentially a recession in the future given the open nature of Australia's economy and our vulnerability to that. There is fact that internationally, particularly in the Eurozone and Japan, they appear to be running out of policy options when it comes to boosting growth. There does not seem to be an appetite for increasing government spending; it is basically monetary policy at the moment. In some countries, it does not appear to be working. Are we heading down that direction in Australia? Is there a concern in the bank that we are beginning to run out of policy options as well?

Dr Lowe : Not at all. I think it is very unlikely that we will find ourselves running out of monetary room. The path that we are on is reasonable and a degree of confidence will continue on that without the need to do incredibly unusual things. The global sense is that monetary policy is not working as effectively as it might have in previous years. I think there are three possible responses to that. The one we have been doing is to just do more monetary policy: if it is not working, do a bit more until it does work. This is why we have found ourselves in some countries with interest rates in negative territory and unprecedented balance sheet expansion. You can keep doing more of something in the hope that it finally works, and my judgement is that that has not been particularly useful. That is one option.

Another option is for some entity in the economy to use the low interest rates to increase its spending. The reason why monetary policy is not working globally is that no-one wants to use the low interest rates to increase their spending. Some entity could do that. Governments are one entity, but governments typically do not want to do that. One thing that I find attractive is the idea that government uses either its balance sheet or its planning capacity to do infrastructure spending, not more recurrent spending. We do not need that. If someone in the economy can use their balance sheet to build assets within a rate of return greater than two per cent, that is another option.

The third one—and I have been involved a lot in the G20 process—is improving the business investment climate through structural reform so that the private sector actually wants to use the low interest rates to increase its own spending. That would make the economy more competitive or whereever to get the private sector to say, 'We can take advantage of the low interest rates and spend.' Because of the path we are on, we are very unlikely to get into the situation where we have to confront highly unconventional monetary policy, but we do have options, as other countries have options. The central banking community, when we get together at Basel, often laments that not enough is being done on those other two areas: in the G20 growth agenda and in the government facilitating infrastructure spending. A point that is made at almost every international meeting that I go to is that we do have options here and too much globally has been relied on for the monetary option.

Mr THISTLETHWAITE: You did mention governments using their balance sheets and the low cost of capital at the moment. Are you happy with the level of infrastructure investment, in terms of government investment at the moment, or do you think it could be increased?

Dr Lowe : Of course, it does not just have to be the government using its balance sheet. The government has a fantastic ability to plan and make projects possible and it can use its planning capacity. The private sector has a huge demand for infrastructure assets that earn reasonable rates of return. So the government can be a facilitator to allow the private sector to use its balance sheet and the low interest rates to undertake infrastructure investment. My own view is that many of our cities could do with better transportation infrastructure. Sydney is amongst those. We are making progress. Better transportation infrastructure would not just have benefits in the short term for the economy but it would make a material contribution to improving the lives of the people we and you serve. I have said this repeatedly. To me, it has many dimensions and a win-win. It would be good for the economy, it would be good for society, and there would be spare capacity for spending. It does not need to be the government borrowing to do that, but the government can do that. The government can facilitate the private sector to do it, and I think our society would be better off if we did a bit more of that.

Mr THISTLETHWAITE: When Brexit occurred, it had a dramatic effect on the UK stock market. It was the biggest overnight fall in history—$2 trillion was wiped off stocks. It affected the exchange rate and the value of the pound. Many commentators are saying that were Donald Trump to be elected as the President of the US a similar phenomenon could occur on international markets. Is that something that the bank is conscious of? Are you looking at that scenario potentially playing out? Given that you mentioned earlier you have a role of ensuring stability within financial markets in Australia, are there any contingencies you are looking at if Trump were to be elected president and it did have a dramatic effect on international markets?

Dr Lowe : On Brexit, the result was surprising and it surprised many people, but the system coped remarkably well with that. There were some large price movements, as you say, but the price movements were broadly in line with the fundamentals, and the financial system globally coped very well with those large price movements. So from a financial perspective, the event occurred relatively smoothly.

If we had President Trump, that would probably come as a surprise to me and, at the moment, it would be a surprise to many people in financial markets. We, like you, would be watching what the response of the markets was. We do not have a particular contingency plan for that event but we would be watching what was happening in the markets and we have the capability to respond if there was an adverse response. But I think Brexit, in many ways, from the financial side, was a relatively positive story; the markets adjusted and it did not cause massive dislocation. In the last couple of years, people worried that if there were some political event that caused big movements in prices, the system could come under incredible strain; it did not happen. The global financial system has been strengthened a lot since the crisis.

What Brexit showed us was that the market has a demonstrated ability to adjust. It did that smoothly, and I would expect that would happen in the US if there was President Trump. We would all be watching and looking at how things evolve.

Mr THISTLETHWAITE: If there was a shock, would this not be one of the rare circumstances where you can actually plan for your response? In some respects, when it happens on other occasions, it catches everyone off guard and people suffer. Could you not actually plan?

Dr Lowe : No, our plan really is to keep the system liquid, to be a source of stability and confidence in the Australian economy to make sure that the financial markets are operating smoothly. The broad elements of that plan are in place and deal with a whole series of adverse events. There are a lot of other things can happen in the world that can cause dislocation as well. We do not have a specific plan that depends upon the outcome of the US election; what we have is a generic plan that can deal with a whole range of adverse events.

Mr THISTLETHWAITE: I want to ask a few questions about China. The Bank for International Settlements and the IMF have expressed concern recently about the level of debt, particularly private debt, in China and the pace of accumulation of private debt. Is this developing as a concern for the bank? And is there a certain level that you think that if it gets to that then it does become a concern for Australia?

Dr Kent : We publicly, in our quarterly statements, have flagged the possibility of problems developing because of the high level of debt in China for some time now. I think the concern fundamentally is the quality of that debt and the assets that underpin it. While the Chinese growth story is an exceptionally positive one, to date and even into the future—I think they have got so much potential—there are pockets, particularly in the industrial sector, within some of this state owned economies within the mining sector, within China where there is clearly excess capacity, where profits are low—in fact in many circumstances companies are losing money. Normally that would lead to these sorts of companies shutting down and then you would have to have some debt resolution process and so on. But there are incentives for various reasons, particularly at the regional level, to keep some of these companies going. I do not want to overstate the problems. The authorities there are extremely aware of them and monitoring them closely and would like to see excess capacity worked off in a gradual, carefully managed process. But they are trying to balance these pressures of maintaining reasonable growth and maintaining employment while dealing with trying to deleverage in particular sectors, particularly the industrial sector, in some of the state-owned enterprises. It is a difficult balancing act, and you do not want to come in and suddenly just sort of call quits to some of these companies and leave large numbers of people unemployed—out of work. So they are trying to balance this, and it is a challenge but it is one we have been talking about for some time and watching very closely.

Mr THISTLETHWAITE: I might just move to some domestic questions. On crude measures of income per capita, living standards in Australia are falling. Income inequality appears to be increasing. All of the statistics that I read about the issue point to income inequality in Australia having been growing over a significant period of time now. Given that, in the RBA act, there is an objective of monetary policy to look for the economic prosperity and welfare of the people of Australia, is this a concern for the RBA board—income inequality, and that living standards are falling?

Dr Lowe : You are right: the real income per capita has fallen a bit recently. But, again, I think it is important to have this in context. From the early 1990s up to 2006 or 2007, we had annual growth in real per capita income of almost three per cent a year for more than 15 years. No other Western country has had anything like that. It was kind of a remarkable period. We had very strong productivity growth in the 1990s, and there was a demographic dividend as the share of children in the population was in decline, so more of us were actually working. Then, most importantly, in the latter part of the period, commodity prices went up a lot, and that boosted our real average incomes a lot.

So it was a kind of remarkable period, and I think many of us started to think that that was the normal state of affairs. It would have been nice if it was, but it was the confluence of three very favourable developments: productivity growth, demographics and the terms of trade.

That period now looks like it is behind us. Productivity growth is okay at the moment, but it is slower than it was in the 1990s. The demographic dividend has passed. The share of children in the population has stabilised and there are more older people now, who will be, at some point, exiting the workforce, and so there will be a smaller share of the population working—or, at least, it will not be increasing anymore. And the terms of trade are coming down. The decline in the terms of trade is the main explanation for declining real income per capita. So I think you have to look at that whole thing in context.

What can we do about it? We cannot do very much about the terms of trade; they are determined by global markets. And the demographics are pretty hard to change. So the only way that we can go back to having anything like the previous rate of growth in our living standards is by focusing on productivity growth. And that is not just a concern for the Reserve Bank; it should be a concern for the parliament and for the whole 24 million people in our country. What do we do to get productivity growth up again, to get the living standards rising again?

On income inequality I share your concerns, but monetary policy cannot really do very much about that in the end. Income inequality is best addressed through the parliament and developments in the private sector. The central bank, in the end, cannot do very much about income inequality. The structure of income across Australia is really determined by things other than the level of interest rates.

So I think the key point that I want to emphasise is: if we are concerned about slow growth in our real incomes, we have to have a laser-like focus on lifting productivity growth. We are not going to go back to having the growth in real per capita incomes of three per cent a year, I do not think, because of the demographics, and we are not going to get another big increase in our terms of trade. But we can go back to having very respectable growth in real per capita incomes through productivity growth. As I said in my prepared remarks, I hope that the decline in the terms of trade is almost behind us, so that drag that has been operating, really, for three or four years will soon start to dissipate.

Mr THISTLETHWAITE: What about the argument that a looser monetary policy at the moment is exacerbating a transfer of wealth to people in the asset classes—asset owners, particularly around housing—and that is exacerbating the income inequality issue?

Dr Lowe : It is true that the lower interest rates do tend to push up asset prices and owners of assets benefit disproportionately from that, obviously. Put that in the broader context: the more important effect of the low interest rates is that they are helping the economy. So more people have jobs. And that is the best thing that we can do for income inequality—to make sure that people have jobs. It is true it affects the distribution of financial wealth across the economy—monetary policy does that. But it also means that more people have jobs. So that is the first-order effect. If we did not have interest rates where there are now—let's say they were one half or two percentage points higher—a lot fewer Australians would have jobs. So that is what we are doing for income inequality, and that is the really big first-order thing that we can do. So we can focus on the distribution of financial wealth, but, from my perspective, making sure people have jobs is the first-order priority.

Mr THISTLETHWAITE: You mentioned earlier your mandate in terms of financial systems stability. There has been a whole host of scandals in recent years with the banks, particularly with their wealth management arms. It is an issue that this committee is going to inquiry into in the coming months. This is a bit of a left-field question, but, from a regulatory perspective, if you were redesigning our financial system regulation in Australia what would you change?

Dr Lowe : I do not think a whole redesign is required.

Mr THISTLETHWAITE: Would you change anything?

Dr Lowe : APRA is the financial regulator, so it is not the Reserve Bank. And APRA has made many changes to the nature of financial regulation recently—really around capital and liquidity. So I think the finance sector feels like it has gone through a period of very accelerated regulatory change. It is best, probably, to kind of let that settle and see how the system adjusts to it. I sense that you are asking about other types of regulation that really go to the issue of bank culture.

Mr THISTLETHWAITE: Is there anything you want to say about that?

Dr Lowe : I cannot help but agree with you that there have been too many examples of poor outcomes, particularly in the wealth management and insurance industries. That is disappointing to us all.

Maybe I can make two other remarks—and, again, a broader perspective. The Australian bank system has performed well over a couple of decades. We did not have the excessive risk-taking culture in the lead-up to the financial crisis. I think that is really important. If we had a really bad risk-taking culture, we could have ended up in the same situation as many other countries did. Part of it is due to APRA's good regulation, but the banks did not develop this culture that we saw overseas. So that has given us more stability. Again, that is a first-order point.

In terms of behavioural issues—it is hard. I think it comes down to incentives within the organisations, and that is largely remuneration structures. That is a responsibility of management. And, probably, APRA can play some constructive role in encouraging remuneration structures that create the right incentives within organisations. If there was one thing that I could focus on—it is not my responsibility; it is not the Reserve Bank's responsibility—is making sure that the remuneration structures within financial institutions promote behaviour that benefits not just the institution but its clients.

What I would like to see is, really, banking return to be seen as a strong service profession. I do not know how far away from that we are. Banking, historically, has been a profession—a profession of stewardship, custodians, service, advisory, counsellor. Is not a marketing or product-distribution business; banking is a profession.

I like the Banking and Finance Oath. I do not know whether you have seen this, but a number of people have signed up to this, including me, and I encourage others to do it as well. Its first line is: 'Trust is the foundation of my profession.' We have got to move beyond people just signing this oath to actually making that in practice. I do not run a commercial bank. I do not know how to embed within a commercial bank the idea that trust is the foundation of the noble profession that we do. It is largely about incentives and remuneration. I wish you good luck as you pursue the issue.

Mr THISTLETHWAITE: In many respects you are Australia's chief economist. I always remember, at university studying economics, the economics professor salivating at the prospect of the ABS census data being released for every census and the importance of that data for economic modelling and planning into the future, not just for economists but for governments as well. I read today that there are still five million households that have not completed the Australian census. There is a view developing that this census data will never be as good as previous censuses. Is that something that is a concern for you as a person with that position and for the bank more generally?

Dr Lowe : I think it is a concern for us all, isn't it? Many areas of government and in the private sector rely on these data to allocate resources and make decisions. It is a concern for us all.

Mr HOGAN: As with the chair and the deputy chair, I congratulate you, Dr Lowe, on your appointment. I only have four or five questions, and they are really on two themes, the first being monetary policy. I take your point about productivity growth and what governments can do to help that—and I do note our $50 billion infrastructure spend. But let us go back to the monetary growth targets, if you like. We had two to three per cent inflation targets for a very specific reason, because of the benefit that brought. Would it be fair to say that you are much more tolerant of lower inflation for longer?

Dr Lowe : I would not say our tolerance of inflation being outside the two to three per cent range has changed. What we are trying to do is provide a clearer explanation to the public about how we think about this issue. If you look over the inflation-targeting period, I think 46 per cent of the time inflation has been outside the two to three per cent range. I think 23 per cent of the time it has been above and 23 per cent of the time it has been below. It has averaged, over that whole 25-year period, to 2½ per cent. But it moves up and down and, as I said, we have never been a central bank that felt our mandate is to keep inflation kind of in the range. When inflation targeting was first introduced, there were many people who advocated having 'electric fences'—where, if you touch the boundary of, say, two or three, there should be some penalty. There were people, I remember, at the time in the academic literature arguing that the central bank governor's salary should be cut if you touched a boundary or that there should be some kind of penalty to a central bank to keep inflation always in a very narrow range. We have never had that perspective. What I would like the community to understand and believe is that, over long periods of time, inflation in this country will average two point something or other. That has always been my view.

Mr HOGAN: The cash rate is at 1½ per cent now. In the short term could you see it potentially going lower? Could we go to one per cent on different scenarios?

Dr Lowe : The market pricing currently has some probability—50 per cent probability—of a further cut. That is possible. It is going to depend on a whole range of factors: what happens overseas, what the next inflation data look like, how the labour market is performing, how the housing market is performing. Certainly there are scenarios where rates would fall again and there are scenarios where they would not need to fall again.

Mr HOGAN: Obviously lower interest rates have been good to lower our currency, and that has benefits for us as an exporting nation. That was part, I suppose, of May and August. If you had not lowered rates this year, then our currency would probably be a lot higher. You mentioned earlier, though, you have issues with interest rates going too low, in the sense of the effect that it has on the private sector, or the balance sheets in the private sector. Do you think that has had an impact on housing prices? We have seen a lot of increase in housing prices in the last little while. Do you believe there is a relationship between those two?

Dr Lowe : Lower interest rates do affect housing prices. That is part of the way that monetary policy trickles its way through the economy. The housing prices go up. There is a bit more wealth. Some people will spend a bit more. And there might be a bit more housing construction as a result of that, as well. My assessment is that the housing market has slowed down a bit over the past year. The rate of price growth has nationally slowed to around five per cent. It is quite different to where we were a year ago. The rate of credit growth has slowed down. The turnover—the share of the housing stock that is being sold each year—has also declined a lot. I think we are in a better position than we were a year ago, but we are watching it very carefully. It is not in our society's interest for house prices to keep rising a lot faster than our incomes; that progressively corrodes the health of our balance sheet. So, we watch this very carefully. I am more comfortable about the state of affairs than I was before.

Mr HOGAN: Would this be roughly how we look at it: lower interest rates are great for the currency—there are so many positives about that—but the offset is that we are going to have assets potentially increase in value because of that?

Dr Lowe : It is not just the higher asset values; it is the borrowing that can go with that. Again, I do not think it is in our interest to encourage households to borrow a huge amount of money on the back of higher house prices or borrow against future income to do spending today. That might help us today but there is a cost for that later on.

Mr HOGAN: I thank you for your secondary handout here. I am interested in the debt interest margins that you have been talking about. On a big picture, long-term perspective—I have just seen this morning—net interest margins have gone from 350 basis points, or even more, to what looks like 200 basis points on what banks earn and pay on their liabilities and assets. I would like you to comment more on that. What is your view on that? You said it has been stable over the last decade. Are there international comparisons to that? How are we looking with our net interest margins on what banks charge to borrow and lend at compared to other banks? What is your big picture comment on that?

Dr Lowe : It is hard to make direct international comparisons because the data are always tricky. The rate of return on bank equity in Australia is higher than in most other countries now. That is another summary statistic. Before the crisis, US banks were earning rates of return close to the Australian banks, and subsequent to the crisis they have come right down. The same is true in the UK and in Europe: the rates of return were always a bit lower, and they are very low now. The longer term context of the net interest margins has, as you said, come down a lot, and two factors are at work here. The first and the more important is competition. In the early 1990s the margin between the mortgage rate and the cash rate was huge; it was four-plus per cent. The banks were earning what I would judge to be very, very healthy rates of return on that. What happened was the securitisation industry emerged. New institutions emerged and offered much better deals to people, and the banks in time had to respond. The other thing that happened through that period is the banks lowered their costs. So they were to be able to respond to the margin by lowering their costs through both technology and changes in processes. It is interesting that we saw this very large decline in spreads but it did not affect the return on equity, because the banks found cost savings. In the end, that was a good news story for the consumers, really, and for the banks, because they gave us more cost-effective mortgages and it did not affect their profitability. That process of reducing unit cost seems to have largely run its course now.

Mr KEOGH: Recently we have seen and discussed the improved unemployment figures. However, you have noted that there has been quite a spread of those unemployment figures across the country and that that is impacting. We have also seen a decline in the participation rate, which also seems to be having an effect, in particular on low wage growth. I was wondering if the bank is concerned about that low wage growth in its impact on bringing inflation back into the target range or inhibiting getting inflation back into the target range.

Dr Lowe : It is an issue. I would not express it as a concern, though, because the low wage growth is one of the factors that have helped strong employment growth. Workers are not expensive to employ, and so there are more people employed. That is the good news. If you have got a job, it is not that great that your wage is not rising that quickly, but the positive element of that is a lot more people have jobs. So it is part of the adjustment.

Another point that I think is relevant here: this is an international phenomenon. In most countries—even with very low unemployment rates—wage growth is very weak. If you take the average unemployment rate across the US, Germany, Japan and the UK, it is the lowest in 30 years. People who worry about or focus on the weak growth in the world economy do not focus on the fact that a higher share of the labour force have jobs in these countries than at any time for the last 30 years. But the low rates of unemployment in many countries are not leading to wage pressures.

There are various explanations for that. The one that I tend to favour is that workers in industrialised countries feel like there is more international competition: more service jobs and manufacturing jobs can be shifted offshore. And we all at some level feel that and are all responding to this heightened sense of competition by being less demanding in our wage rises. That is a kind of phenomenon right across the Western world. I think that is temporary. It is persistent but temporary. I am confident that in Australia we have not lost the desire to ask for larger wage rises if the labour market is strong. If we can continue to eke out modest growth in employment, hold the unemployment rate and actually get it to come down a bit lower then wage growth will gradually pick up here. It is not going to race away—I am not worried about that—but I think it is quite unlikely that we get stuck in a very low wage growth world, because, if we can get enough employment growth, workers will again ask for slightly larger wage rises, which will then return inflation to the two to three per cent range.

Mr KEOGH: You mentioned security there. Do you see that part of what is keeping down that wage growth even though we have got low unemployment is a greater sense of job insecurity? While they are in job—which is great—is there a higher degree of concern about whether they will keep that job or the nature of that employment and whether it is made part time or casualised?

Dr Lowe : I do not know that it is the casualisation. I really think of this in a global context. We can look at what is happening in Australia and dissect that, but I find it actually more useful to look at common patterns across industrialised countries. The two things that I see almost everywhere are increased global competition and more industries being subject to global competition, and we all kind of internalise that somehow. Businesses feel this as well. They do not feel like they have got very much market power. None of us feel like we have got much market power, and businesses do not feel that they have got market power either. I think that is one reason why inflation is so low. So that is a common thing.

The other common thing is an increase in uncertainty, because the global financial crisis was a wake-up call for many people. Remember: before that, Alan Greenspan used to tell us it was the great moderation. Everything was kind of stable. Unemployment rates were low, employment growth was good and we had a kind of remarkable decade and a half. Then the financial crisis reminded us all that that was not the normal state of affairs, and we all feel slightly nervous at some level as a result of that. The nervousness or uncertainty we feel from that and the global competition is making Western workers less demanding in their wage rises. As I said, I do not think that is going to last forever.

Mr KEOGH: Does that then translate into a decline in the confidence of workers to spend their money? When rate cuts are passed through and they don't have to make quite as much of a repayment on their mortgage or they have come into an increase in wages, does it mean that it is not just those who feel vulnerable because they are in a casual employment position but that the entire workforce overall is much more concerned and therefore going to have a lesser degree of confidence? That is, when you as the bank take action to try and increase that confidence and spending to grow the economy it is not going to pass through in the same degree to the actions of people?

Dr Lowe : It still passes through, but maybe in a slightly different way than—

Mr KEOGH: A bit more muted, would you say?

Dr Lowe : It would maybe take longer. The uncertainty aspect is one part of it, but the other is that many households feel like they have too much debt, so when interest rates come down what we are seeing is that many households decide to pay off the debt more quickly rather than to spend. We see this in the offset accounts that people hold. When interest rates come down the balances in those tend to grow a bit more quickly as people make the same nominal payment—it just doesn't go off the principal; it goes into the account. The main effect of that is to delay the transmission of monetary policy to the rest of the economy. The lower interest rate helps those people get back to their desired debt levels more quickly than would otherwise be the case. Then once they get back their spending behaviour is the same as it once was.

Mr KEOGH: So there is a greater lag.

Dr Lowe : There is a lag in that particular part of the transmission mechanism. Monetary policy works through a whole range of channels, and this is one that I think is a bit slower because of the combination of high levels of debt and the perception that we all have a bit less market power in the labour force. It is something that we understood and we have researched this a lot internally. At the last board meeting—you might have seen the minutes we released—we had an extensive discussion about how our interest rate changes passed through to spending by people who have debt and to less spending by people who rely on interest income.

Mr KEOGH: More specifically in relation to Western Australia, we see that the unemployment rate has been steady, but it is a whole percentage point higher than the national unemployment rate and participation has fallen more in Western Australia. Full-time employment, in particular, is falling in WA. There has been a suggestion that WA is likely in a technical recession, or in recession, as a discrete economy. What is the bank's view on that?

Dr Lowe : Western Australia has had a cycle. It was not that long ago that we were talking at these hearings about Western Australia and unemployment starting with a three and very high levels of labour force participation because basically everyone was drawn into the labour force. There is a cycle and we are on the other side of that cycle now. Actual production in Western Australia, if we think of that as the kind of benchmark for recession, is actually doing okay, because there is all this extra iron ore being produced. So production is okay, but that does not require that many workers, so the labour market is weak.

Mr KEOGH: Is that production in the mining part of the economy in WA—it has obviously had a big effect nationally, previously—masking a whole heap of the negative or, as you say, the other end of the cycle in Western Australia?

Dr Lowe : The number of jobs in the industries supporting the mining industry has clearly declined. There are a number of people doing all the engineering and planning and all the spin-offs from that is all in decline, so the parts of Western Australia that are finding it very difficult. I would not characterise it as a technical recession, because it is so hard to know at the state based level what that means, because the actual export production has been very strong, and that is not captured very well at the state based level. They are on the other side of the cycle. The Western Australian economy is adjusting, it will continue to adjust and it will come out of the other side of the cycle. Just as it went up it comes down and it will come back.

Mr KEOGH: On the basis of that and the observations you have made previously—I think in the minutes from your last meeting—about growth in housing in Sydney and Melbourne being the opposite of what we are seeing in Western Australia as a result of being at the other end of the cycle, we are seeing the opposite two-speed economy. Where Western Australia and Queensland were previously charging ahead of the rest of the country, they are now very much lagging behind, so the way in which the bank is responding to the national economy is not going to be able to service Western Australia as well.

Dr Lowe : That is a very good summary. We had parts of the economy four or five years ago—Western Australia and Queensland—doing remarkably well, and the rest was not; it was subdued. That is what happens when you have the biggest mining investment boom in a century: the exchange rate goes up and the exchange rate sensitive parts of the economy are weakened. Those adjustments, picking on the exchange rate, helped the overall economy get through that. Now we are on the other side and the reverse of that is playing out. As I said before in answer to a question, I think from the chairman, it is kind of testimony to the flexibility of the economy. We have been able to digest what have been huge global shocks. The nature of these external shocks that we have been through are kind of unprecedented for our economy at least for a century, and we have managed that. But it is this ebb and flow between different parts of the economy. That is why we have been able to manage it. I am confident that Western Australia will adjust after going through a difficult period of adjustment, including in the housing market. The economy is sufficiently flexible that we will come through this and await the next cycle.

Proceedings suspended from 11 : 31 to 11 : 42

Mr CRAIG KELLY: Dr Lowe, graph 6 on the handout that you gave us this morning—page 2—the variable interest rate spread for the cash rate between the standard variable rate, housing and small business: you mentioned that it shows that there has been an increase in the spread for small business paying higher rates, and you put that down to the repricing of the credit risk. Does that imply that the credit risk was underpriced previously, or that things have changed that make the credit risk greater?

Dr Lowe : That would be a good question to ask the banks. My take would be that it is primarily the former, that there was some underpricing of credit risk before. The banks found going into the financial crisis that their credit losses on many of these loans turned out to be larger than they had previously thought, and they judged that they were underpricing it, and they moved quite early on during the financial crisis to reprice the credit spreads they charge over the indicator rates on many small business loans. Whether they have gone too far or not—

Mr CRAIG KELLY: Do you think that is a good question to ask, though?

Dr Lowe : It is a very good question.

Mr CRAIG KELLY: Also, wouldn't a lot of those small business loans also be residentially secured? I am struggling to see, if they are residentially secured, where there would be such a significant increase in the credit risk that would require such a significant repricing.

Dr Lowe : Well, the probability of default might be higher, but the security in the house gives the bank protection against losses—you are right. I am afraid I cannot really help you any more other than to make the observation that this is what happened during the crisis. Whether it is justifiable and whether it should now be unwound—it is a good line of inquiry.

Mr CRAIG KELLY: So, that is an area of inquiry that we should pursue with the banks for a greater explanation of why that has actually occurred for small business lending?

Dr Lowe : It is entirely up to you, but it seems to me a fruitful line of inquiry, yes.

Mr CRAIG KELLY: The other line of questioning I have in relation to the measurement of data: there have been some articles written recently expressing some concern that there are so many goods in the digital economy that are effectively free. The example they gave was photography products. Where, in the past, you would buy a separate camera and you would buy film, and the film would get developed and you would need printing and paper, through whoever it was, today you do not do any of that; it is all on your phone; it is all basically a free service. And that has not actually been showing up in GDP. It is the same with things such as media, where you may no longer buy a newspaper that requires journalists to write articles and is printed; that is going through Facebook and social media. So the service is still being provided, but it is effectively being provided for free. Is that something that, going forward, we are likely to see more and more of? Is there some concern that the GDP numbers that we are seeing are actually understating what the real level of GDP is?

Dr Lowe : It is an issue. Many of these services you talk about appear to be free, but they are actually taking people to produce. All this technology does not just come out of thin air; there are people, somewhere in the system, being paid wages, producing and supporting the technology. So that all gets captured in GDP. It may be that what the economists think of as consumer surplus—the additional value that we get from it—is not accurately being measured. But the actual production of the services is measured.

Mr CRAIG KELLY: How about in the measurement of the inflation figures? Is this being measured correctly in inflation? Have you looked at the cost of photography and taking photographs? Whereas, before, there was the camera you bought and there was the developing of the photograph, today, on your phone, there are no developing costs whatsoever, so the marginal cost of taking an extra photo is effectively zero. I am not sure whether the statistical data for inflation is actually picking that up.

Dr Lowe : I do not know the answer to that question. I would be very surprised if the ABS was not measuring the cost of producing and printing a photo, which has come down a lot. They would capture that. The ABS does try to make adjustments to the price series for quality. So the cost of computing has come down a long way, and you see that very, very clearly in the ABS's series on information technology costs. But how well they do it I do not know. I agree with you: it is a difficult area. Chris, I do not know whether you have got any observations on that?

Dr Kent : I think that the problem you allude to is one that has been there for a long time, because we have had technological progress which has now manifested in a slightly different form, but it has been with us for a long time and it is often the case that the consumer price index maybe has a slight bias because it is not picking up these sorts of quality—

Mr CRAIG KELLY: Do you mean a bias—

Dr Kent : Well—

Mr CRAIG KELLY: showing greater inflation than there actually really is?

Dr Kent : Slightly. So, just to echo I think what the governor said: to the extent that there are some services that you are not spending money obviously on, that means you have got money to spend elsewhere. So, ultimately, it is not lost to the economy; it is just showing up somewhere else.

Mr CRAIG KELLY: I am making the point that perhaps the inflation rate is actually lower than what the official statistics actually show, and perhaps GDP is actually higher than what the official statistics show, because some of these new technologies are so hard to measure when so many of them are—the marginal cost is actually free.

Dr Kent : The bias may have increased at the margin, but I think it is modest and it has been, probably, with us for a long time, because we are always getting technological progress; it just takes slightly different forms.

Mr CRAIG KELLY: One other quick question: when you are making your assessment on moving rates, how much weight do you give to where the differential between the Australian rates and rates in Europe and North America actually are? Is that something where you may think, 'Look, we need to raise the rates in Australia,' or, 'We need to lower the rates in Australia,' but, because we either shrink or enlarge the differentials between our rates and overseas rates, it prevents you from doing so?

Dr Lowe : It is a very good question. I cannot give you a precise answer, but I think what I can say is that developments overseas have a material bearing on what happens here, and the rate differential is important because, while we set the price of money in Australia, we are doing it in a very constrained way, and the constraint really comes from the price of money globally. If interest rates round the world are very, very low and we have a higher rate, money will want to come here, it will push up our exchange rate, we will be less competitive and then, as a result of that, we will feel the need to lower our interest rates. Money is fungible around the world, so we do not think that because foreign rates are lower we automatically have to have lower rates. But low rates elsewhere around the world will affect our currency and capital flows, and that will have an influence on our interest rates. There is nothing mechanical, but it is certainly an important influence and, as I said in my opening remarks, it has been a substantial influence over recent times. The fact that interest rates are so low in most of the rest of the world is why they are so low here.

Mr CRAIG KELLY: Do you have some concerns that other foreign central banks may have erred by reducing rates to negatives?

Dr Lowe : I do not know whether they have erred. The Bank of Japan made an announcement yesterday. To a large extent, their announcement was that the policy change yesterday is to address an issue that has arisen in the Japanese financial system where the banks' profitability is under very severe strain because they are earning negative interest rates on so many of their assets. It has become a major issue. Guy, do you want to answer that?

Dr Debelle : I think it is an interesting thing. For a long time we assumed that interest rates could not go into negative territory.

Mr CRAIG KELLY: Otherwise, you are better off hiding your money under the mattress.

Dr Debelle : Well, that at least puts a constraint on how far you can move them into negative territory, because the mattress does become attractive at some point. But a number of central banks have moved them into negative territory over the past couple of years, and I think it is fair to say that we still do not know exactly how that is going to play out. As Phil mentioned, yesterday the Japanese adjusted things a little, in part because one of the ways that was playing out in Japan was not going quite as they might like. One thing which is interesting is that when central banks have moved their rates—which are the rates that the banks basically pay—into negative territory, in a lot of cases, particularly for households' or people's bank accounts, rates are not going into negative territory. So if you are in Switzerland or in Japan or in Europe and you are a regular household, your rate on your deposit is not negative. It might be zero, but it is not negative—and that has issues for the banks, who are paying negative rates on the one hand and are not able to pass that through to their customers. If you are a big corporate you are probably paying negative. Globally, we are in this territory where we have not been before. A number of central banks are seeing how that is playing out, and we have the ability, at least here, to sit back and observe.

Dr Lowe : There are better ways to stimulate the economy than to set the interest rate at zero or below zero. To me, the central banks feel that this is how they are trying to make a positive contribution if those other things are not being done.

Mr CONROY: Congratulations, Dr Lowe, on your appointment. It has been very well received, as it should be. I want to go back to your excellent chart pack—thank you for tabling it—and graph 5: the return on equity. You comment on the return on equity internationally. Do you have any information on whether our market is relatively more concentrated than the banking market in the United States, Europe or Japan?

Dr Lowe : I do not have the precise figures to hand, but my recollection is that most banking systems are now very heavily concentrated. They have a similar concentration to us because, in the financial crisis, there were quite a lot of mergers around the world, so we are not unusual in having four or five banks that account for the vast bulk of financial intermediation.

Mr CONROY: Can you provide to the committee graph 5 mapped against the United States, Japan and Europe? Secondly, if I am not pushing a friendship, can you provide a graph marking market concentration in those markets? It would be exceedingly useful if we receive that before 4 October. Is that acceptable?

Dr Lowe : I am sure we will do it. I saw the former graph yesterday, so I know we have that, and I am confident that our staff can provide the concentration measures to you.

Mr CONROY: Thank you so much for that. I want to go to the bank's performance. Do you know offhand: what has been the dividend paid to the government since the $8.8 billion equity injection that you received in 2013?

Dr Lowe : I do not have those figures to mind. There was a substantial dividend payment last year. The bank earned a substantial profit. The exchange rate came down and we earned profits on our foreign reserves, so we made a dividend. We will make another reasonably sized dividend this year. The details of that are in our annual report, which will be released within a month.

Mr CONROY: Would you mind taking on notice providing it after your annual report—the dividend payments since the $8.8 billion equity injection—if that is doable?

Dr Lowe : The dividend payments that we make are in conformance with the Reserve Bank Act, which sets out a very disciplined process for how much of the profits from the Reserve Bank can actually be returned to the government as a dividend. I can provide—

Mr CONROY: I am just interested in getting an understanding of the bank's performance post an equity injection.

Dr Lowe : In recent years, we have made a decent profit.

Mr CONROY: Which is a good thing.

Dr Lowe : Which is good because it is largely due to the depreciation of the currency. The running yield on our assets is quite low because we are investing overseas in euros and yen. As you can imagine, we are not getting high returns there. The underlying running yields are not particularly high, but we have made capital gains on the foreign holdings.

Mr CONROY: That would be useful when your annual report is available. Thank you for talking about your other projects and particularly your banknote project. I have a very simple question. Who decides who goes on banknotes?

Dr Lowe : The current series was introduced 20 years ago and the Reserve Bank made the decision about who was to go on them. When we decided to upgrade these banknotes, it was all about security and technology. We did not want to change any of the people of the banknotes, so we took the decision that this was not about changing the fundamental design and people on our banknotes; it was about security and technology.

Mr CONROY: So there was no temptation at the same time to replace the Queen with an Australian, for example?

Dr Lowe : We took the decision to keep all the people the same.

Mr CONROY: So, for the record—

Dr Lowe : One could imagine that it would be quite a controversial decision to change any individual on our banknotes.

Mr CONROY: One could, but—

Dr Lowe : We wanted this to really be about technology and security, not the debate about—

Mr CONROY: I understand, but, on the current series of bank notes, it is correct to say there is only one foreigner.

Dr Lowe : That is correct—yes.

Mr CONROY: Thank you, Dr Lowe. I was a bit cheeky and I apologise.

Dr Lowe : No need to apologise.

Mr CONROY: I just want to go to infrastructure. You touched on it earlier. You are asked about it every time you are here. You made an excellent speech in 2013 on infrastructure that you consistently return to. It is fundamentally a political problem, but we all act in the political economy. What you are saying is intensely logical—in an era of low interest rates; in a year of searching for increased productivity; that the win-win from infrastructure investment is massive—but you are also regularly asked at these hearings about the public sector debt levels and the need over the medium and long term to reduce that. There is obviously good and bad debt. How does a government borrow to invest in productive infrastructure and survive the ire of the ratings agencies?

Dr Lowe : That is a very good question. It largely depends upon the story that the government has around what is being done with the money. If governments are borrowing to fund recurrent expenditure, it is hard to have a good story. I do think we need to be very disciplined about borrowing to fund recurrent expenditure, because ultimately that does have to be paid by somebody. It is going to have to be paid by our children or us later in our lives, but probably by our children, and there is a question about whether that is the right thing to do. If we keep on borrowing to fund recurrent expenditure, then essentially we start to lose our insurance, and we do not have very much insurance against something going wrong, because we will have done the spending and if we need to increase spending in a downturn the debt levels will already be high and we will not be able to borrow that much. This is what happened in Europe.

So for the sake of our children, for our own sake and for the sake of having decent insurance, I think we need to be very disciplined about recurrent expenditure. That does not mean that you cannot simultaneously borrow to build assets. That is what most businesses do; they meet their ongoing costs through their revenue flow and they borrow to build assets. So the test is: can the government, can any of us find assets to build that generate a return for society? If you can do that in a structured, disciplined, rigorous process with good governance, I am hopeful you could have a conversation with the rating agencies about that—but whether you could convince them, I do not know. If we are going to have any hope of convincing them, it is really about the governance of infrastructure selection—the project selection, the way the risk sharing is between the private and public sector, the control of the construction costs and then the business case for infrastructure. Our world faces many problems but solving this one is not one of the biggest problems the world faces. You could, with discipline and good governance, solve this problem.

Mr CONROY: Related to that, do you think there is merit within the budget papers—they do it to some extent—of breaking out boxes on capital expenditure in the budget versus recurrent? Do you think more could be done there to look at not only the structural balance of the budget, so removing the cyclical factors, but also the capital versus recurrent breakdowns?

Dr Lowe : I do not want to comment on the structure of the budget papers; that is beyond the area of my expertise. I think the general point you are making is thinking about recurrent and capital expenditure quite separately and being very transparent about capital expenditure and, importantly, the business cases that underlie that. The communities that we are all serving become sceptical. They see projects but they do not see the business case and so wonder what the motivation is. So if we really want this to work for us all, we have got to have a high level of transparency about the business cases and the way the projects are constructed. If you could put a really disciplined, strong process around that, you could bring both the community and ultimately the rating agencies with us, and our society would be better off.

Mr CONROY: My final question is on a different topic that has been covered slightly before. Obviously we have economists like Paul Krugman talking at the moment about the global economy being in a classic Keynesian liquidity trap. You have got the foreign affairs opinion piece by Larry Summers talking about the age of secular stagnation. I am wondering if you have any insights on whether the globe is facing such a period. Monetary policy obviously in that thesis is very limited. Are they accurate? And what can be done to break out of this period?

Dr Lowe : That is a big question. If I thought I could provide you with an answer, I could get a Nobel prize. A couple of things are going on. Debt levels are very high around the world and that is restraining people's ability or their desire to spend—we talked briefly about this before. That is one factor that is constraining growth. Another is the demographics. Western societies are ageing and, in many of them, the population growth has stopped—fortunately that is not the case here. So those two factors are putting a break on growth. I do not see those going away any time soon. Getting debt levels back to more acceptable levels will occur in time. So that break will go away but the demographic one will not.

Ultimately it comes down to whether or not you are an optimist about technology. I see some experts say we have basically invented all the transformational things—electricity, construction technology. It took us the better part of a century to get all the benefits from it. The things we are inventing now—the iPhone or digital camera—do not have the same transformational quality. So with less technological progress, the world is doomed to lower growth. That would be one view.

Then there is another school of thought, which would be closer to my own. It is that of the technology optimist—that information technology and the developments in science in the past decade have been so profound that, by the time my children are my age, they will once again transform how we do things and organise ourselves. Driverless cars are a good example of that, and building technology is another one. If the technology optimists are right then I do not think we are in for a very protracted period of very weak growth. I do not know the answer to that, but they are the issues, and it depends where you sit on the—

Mr CONROY: Let me put it a different way, just to finish. If their thesis is essentially right—that we do not have a supply problem and it is not about productivity, although that is a factor; it is about how you stimulate demand—and we have reached the end of the monetary levers globally, although Australia has a bit more room to move, how do you increase demand?

Dr Lowe : I go back to my previous answer, really. Someone in the economy has to be prepared to use the low interest rates. Government can do that or it can facilitate the private sector to do that on infrastructure. As the G20 has repeatedly emphasised, it is creating an environment in which the private sector wants to take advantage of the low interest rates. It seems to me logically that they are the possibilities: get more monetary easing to try to stimulate, government using the low interest rates, or government creating an environment where the private sector wants to use the low interest rates. Logically, they are the option.

Mr CONROY: Thank you, Dr Lowe.

Mr BUCHHOLZ: Firstly, let me congratulate you, Dr Lowe, on your recent appointment, along with Dr Debelle. Congratulations to you and Dr Kent on your new appointments. Please pass on my sincere thanks to the former governor, when you get the opportunity to catch up with him, for the service that he gave to the Reserve Bank.

When the former governor addressed this committee, he often referred to the glass as half full. How do you see the glass?

Dr Lowe : I am glad you asked that, because I see the glass as half full. The governor left me one thing. When I moved into his office earlier in the week, there was one item he left me. It was a coffee mug, and the coffee mug is emblazoned with 'Half full'. He had had that in his office for quite a long time, and it is the one thing he has left me. I am very pleased he did that, because that is my mindset as well. Our country just has so many opportunities. We have so many things going for us. I would not want to be the central bank governor in any other country than this one. So I am fundamentally optimistic about our prospects, I am fundamentally optimistic about technology, and I see our economy having adjusted through an incredibly large external shock. I used to talk about this all the time—and how we could convince other people to have their glasses half full as well.

Mr BUCHHOLZ: That is very comforting. I pick up in your opening comments, where you said this 'is a better outcome than we thought likely a year ago'. You were referring in the increase in GDP growth to three per cent and the decline by about half a per cent in unemployment. I have not had a look, but I know that you guys model. Given that you have missed your forecasts in a positive way, what do the next 12 months look like in those two spaces?

Dr Lowe : Could you talk about the forecasts.

Dr Kent : We have not formally gone through the details of revising our forecasts in light of the more recent data, particularly from the national accounts. Things were a little bit stronger than we thought in the June quarter, but not especially so. I think that is where we were in August, when we published our forecasts in the statement as being a reasonable starting point, and that was for sustaining reasonable growth and particularly holding on to some of the good growth we have had in the non-mining sector. I think the other key feature of our forecasts is that the big drag that we have seen from the fall in mining investment has affected WA and Queensland as well. Those forecasts of ours over recent years have been pretty accurate. There is more of a fall to come in the current financial year, but the biggest drag is behind us as best we can tell and, in terms of the sort of annual numbers, occurred last financial year. That is a good thing.

I think the other thing is that one can never tell—we have made many errors on this in the past, just like everybody else—with commodity prices, but this year is the first year where we have not had another big markdown in commodity prices. If anything, commodity prices through the course of this year have picked up from what had been quite low levels. I think there is a good reason for that. If we are seeing the end of the mining investment fall and if we have got some stability in the terms of trade, I think there are reasonable prospects that we will continue to see good activity in the non-mining economy that will see a stabilisation and even a gradual pick-up in wage growth. That will feed through in time to inflation. Indeed, we have seen some of that in some of the wage numbers. Over the past six quarters, private sector wage growth has not fallen further. It has stabilised. That is a good start.

The other thing I will just mention very briefly is that we see that some further progress is possible in terms of a lower unemployment rate, but our sense is that that might be quite gradual and more gradual than you might have thought by just looking at the headline GDP numbers. That is partly because there is still a lot of growth in resource exports. They tend not to need very many workers. When you turn these big LNG plants on, you actually are saying, 'Thank you very much,' to lots of workers who put them in place and then there is a much smaller workforce to keep them operating. That is another thing I would emphasise: further improvements in the unemployment rate, but quite gradual over the course of the next year or two.

Mr BUCHHOLZ: Again, let me join with my colleagues in thanking you for some of the graphs that you have provided in your opening comments. I was interested in the spread and the margin. You had indicated from four per cent back over to two per cent in the short term. I want to go to the particular profitability of the banks in and around the space of credit card debt. I just googled some credit card interest rates and, for a quick snapshot, Westpac is 13.49 per cent, St. George is 12.74 per cent, NAB is at 13.99 per cent and AMX is at 14.99, just on various sites. My question is: from a monetary policy, when you factor the cash rate, why doesn't that flow through to credit cards? If it did, what would be the stimulatory effect in the economy if you are looking for other levers?

Dr Lowe : I wish I knew the answer to that. If you ask the same questions in your subsequent hearings, I will be interested in the answers. This is something that happens right around the world: credit card interest rates do not seem to be very sensitive to the central bank rate. One of the explanations that I hear is that the main focus of competition is not on interest rates; it is on reward points or temporary interest-free periods. The consumers, for whatever reason, when selecting a credit card, are not particularly sensitive to the interest rate on that credit card. They often want to get a one-year, interest-free period; they are quite sensitive to that. They are quite sensitive to the reward points or the reward scheme. That is where the effort of competition, or the focus of competition, has been. The result of that is the rates do not move very much over time and people who are borrowing on credit cards pay very, very high interest rates.

There was a Senate hearing—I think it was last year—and we did some work for that. Our calculation was that the average interest rate actually being paid on credit cards is close to 17 per cent. But not all credit card balances accrue interest. At the moment, I think 60 per cent of the balances on credit cards accrue interest. There are a lot of people who just use the credit card as a revolving payment mechanism and pay it off. The total balance that is accruing interest at the moment is a bit over $30 billion.

Mr BUCHHOLZ: Of credit card debt?

Dr Lowe : Credit card debt is $50 billion, which is only three per cent of total household debt, so in the overall scheme of things it is relatively small. Of that $50 billion, $32 billion attracts interest. The rest is just kind of revolving credit. So my calculations are that the total interest bill in a given year, on credit cards, is around $5 billion, so the household sector is paying to banks $5 billion a year. If the interest rate were to fall five per cent—let us say the average interest rate were to fall from 17 down to 12—that would give the household sector an extra $1½ billion a year in cash flow.

Mr BUCHHOLZ: That would have a significant—

Dr Lowe : That is the equivalent of somewhere between 0.1 and 0.2 per cent of household income. One and a half billion dollars is something. It is not a huge number. And of course the bank profits would be lower and so the dividends that the other households would get—it is different households, because presumably the ones that are borrowing and paying on credit cards and paying interest are not the ones who are holding bank stocks. So there would be a change in the distribution of who is getting the income.

Mr BUCHHOLZ: On the other issue: if the banks claim that the cost of raising funds, and allowing for a margin for the cost of raising funds for unsecured lending in the credit card space—it would appear that the margin in that credit card space is far greater than the two per cent average spread that exists at the moment. Where is that offset elsewhere in the banking system? If they are making 12 per cent yields—on your assumption that the average is 17 per cent—in the credit card space, where is the benefit elsewhere?

Dr Lowe : I am afraid I cannot answer that. Again, it is important to keep in mind the magnitude here. This is three per cent of total household debt, and then banks obviously make a lot of business loans as well. If you think about the overall share of the banks' portfolio in credit cards, it is probably one, 1½, two per cent. So it is quite a small thing. And I do not know where the offset is. Again, that is a question really for the banks. The invariance of credit card interest rates to the monetary policy rate is a phenomenon not just in Australia but in many other countries as well.

Mr BANDT: Congratulations, Dr Lowe. Can I just ask you first of all some more questions about the charts that you handed out. Do I understand the commentary you gave with those charts correctly to be saying that the increase in liquid assets is a response to requirements from governments and from regulators post-GFC with respect to stability and liquidity but that you are suggesting that is in the main being passed on to consumers in the form of interest rates on their mortgages that are higher than they would otherwise be?

Dr Lowe : It would appear that that is one of the things that has happened—that the banks are holding more of these assets which earn very low returns, and the spread between lending and borrowing rates has widened a bit in response to that and left the return on equity broadly unchanged. There are other things going on as well, because there are so many moving pieces in this, but this is a significant increase, or the banks will think it is a significant cost impost, because there is an extra five per percentage of their portfolio earning maybe one per cent rather than the five per cent which they would get if those assets were in loans. They will say that that has to be compensated somewhere in the system, and it is an interesting question who should bear the cost of that—should it be the equity holders, the borrowers, the depositors?

Mr BANDT: But it does not appear that it has come out of profitability or return on equity?

Dr Lowe : Not at this stage. I would expect that, over time, the return on equity in the Australian banking system would decline, because the rate of return on every other asset has declined. It has happened internationally. It has happened on a lot of Australian assets. So I would expect that that would happen over time as well. The way that that happens is through competition. If the rate of return on bank equity is out of alignment with the rate of return on other, similar assets with the same risk, then competition should gradually push that down through time. We cannot be 100 per cent confident that that will happen, but my expectation is that over time it will gradually happen.

Mr BANDT: It has not happened yet.

Dr Lowe : But, again, if I look back for the past two decades, I have seen three major examples of where competition has changed the pricing of banking products to the betterment of the consumers. One we talked about before—the mortgage originators coming in, in the early nineties, when banks were earning excessive rates of return on mortgages—that transformed it, as well as the entry of foreign banks offering much better deposit rates. I remember when the first foreign bank came in and offered basically the cash rate on deposits, some of the existing institutions said, 'This just can't work.' And before long they were all doing the same thing. And the third one is electronic stockbroking. The charges for stockbroking used to be huge, and then the electronic guys came in and transformed that business when the rate of return was there. These examples do not happen as quickly as any of us really want, but they do happen. The system has sufficient safeguards in it that if rates of return are too high then eventually someone comes in and says, 'Well, okay, I can take advantage of that.' Society is frustrated by how long that process takes, but I am confident that over time it does happen.

Mr BANDT: On the infrastructure point, you mentioned that one of the things government can do is open up the space for private investment. I just want to ask you some questions particularly about the level of public investment. As we have referred to, the OECD has made some comments in the past 24 hours about what countries, including presumably Australia, are able to do. Do you have a view about how much more could be borrowed by governments in Australia, provided that it was invested in the kind of productive infrastructure you have been referring to?

Dr Lowe : I would just make one introductory comment: it is not really private or public; the important thing is infrastructure investment, and it can be done by the private sector within an envelope that is developed by the public sector, and in many cases that is probably the better way of doing it, rather than the public sector building and owning and managing infrastructure assets. In some cases that is going to be what you want to do, but not always. As to how much more we can borrow, I do not know the answer to that. I do not feel that is the major constraint—our ability to borrow here. The constraint is coming up with the projects that pass the strong business case and have the good governance around them. That is the constraint. I do not feel that access to funds, either by the private sector or the public sector, is the constraint. It is developing the solid business case.

Mr BANDT: Say there were solid business cases around public transport. Do you think there is a limit on how much the federal government could borrow to invest in public transport without affecting, say, what the rating agencies say?

Dr Lowe : Well, as a matter of logic there is a limit. The question is, how close are we to that limit?

Mr BANDT: And what do you think?

Dr Lowe : I am not sufficiently expert that I want to give you a number. I am just repeating myself, but it depends upon the strength of the business case. If we can develop strong business cases, just as a private business does, we can find the money. And I think you could convince enough people, in our society as well as the financial markets, that this was a wise thing today. But it is the transparency of the business case that is key.

Mr BANDT: If I could just ask about housing: house price growth is routinely outstripping wages growth, and house price growth seems to have decoupled itself from general inflation quite some time ago and is rising faster than general inflation. But in your opening statement you did not seem to express concern about that. It was one of those factors that the RBA is watching but not something that you seem to be concerned about. Is that accurate?

Dr Lowe : There are two elements to this. There is the current cyclical conjuncture and then the longer-term one. The current cyclical position is better than it was a year ago. The house price growth has slowed down. That is four or five per cent, so that is a better position than double digits. The other measures of housing market conditions are more comfortable than they were a year ago. Again, if you put what has happened in the last year in a longer term context there was a very big run-up in the 1990s in the ratio of house prices to income. That was because we could all borrow more as inflation came down and the financial system was liberalised. We all borrowed more, and the main effect of that was to push up the average house price relative to our income. Then, since 2002-03, the ratio of house prices to income has moved; it is up and down, but it has broadly moved sideways and it is a bit up over the past year. As the father of three children, I worry about that because people are paying so much for their housing. The solution to that—and I am going to sound like a broken record here—is housing supply and investment in transportation infrastructure.

We pay a lot for our houses not because of the kinds of materials and the construction costs; it is because of the land. The value of our land relative to our income is incredibly high. Why is that? Because we all want to live in these fantastic cities close to the coast, and we have not invested enough in transport. The locational value of land is really high, and that is the underpinning factor to high house prices. We can do something about that through zoning and through transportation. That is the best thing to do about it. Again, that is not something the central bank has any involvement in. So, my day-to-day focus is on what is happening right now in the market—and I am a bit more comfortable about that. The other issue—I worry about it really as a parent.

Mr BANDT: Focusing on what you do have control over—and you said they are not things that you do have control over—it seems to me and certainly a number of commentators have suggested that, given the lever that you have to pull, lower interest rates get transmitted quite quickly to the housing market in the form of higher prices but much more slowly or perhaps with much more muted effects to other parts of the economy. The lever that you are pulling has a significant impact on pushing up housing prices to the point where house prices are so high that, for people like your children, as you were referring to, and for many of the people that I represent, particularly in an inner city like Melbourne, where we have seen house prices go through the roof, now cannot buy their first home. And not only that, it is being transmitted in a way that assists investors more than first home buyers. Is that something that the Reserve Bank thinks about or agrees with?

Dr Lowe : The high level of house prices relative to our incomes is not primarily a result of our interest rate policy. This is the broader point that I was making there of some of the broader things that are going on in the society—the access to credit, where we want to live and location restrictions or zoning restrictions. That is why house prices are high relative to our incomes. From quarter to quarter, I agree with you that our decisions do influence housing prices, but those movements are really ripples around a longer term trend which is determined by these more fundamental factors. I have observed that the two interest rate cuts we have had this year do not seem to have stimulated a new round of house price increases. In fact, house price growth has slowed over the course of the year, and I think that is good.

Mr BANDT: Does the Reserve Bank think houses are overpriced?

Dr Lowe : I do not have a strong view on that. They are high. I think it would be good for us all if the cost of our housing relative to our income were a bit lower, but I do not want to say that the housing is overpriced. It really is reflecting the choices on access to finance—I do not want to go over it again—that collectively we have made as a society. We have what we have as a result of those choices. It is not primarily about interest rates. Low interest rates have probably pushed up house prices a bit, but it is a bit more around this longer term thing.

Mr BANDT: Lastly, does the bank do any research or forecasting on the impact of climate change on growth in Australia?

Dr Lowe : We do not do any of our own. We read what other people do, but we do not do any of our own. It is not a core area of expertise that we have.

Ms BANKS : Congratulations on your appointment, Dr Lowe, and thank you very much for your common sense and succinct appraisal. In my business experience, leadership certainly defines the culture and mood, so I thank you for your glass half-full approach and your fundamental optimism about our country and our economy. Likewise, the Turnbull government is all about delivery and a commonsense approach that really targets the consumer, so I would like your comments on the Turnbull government's legislated ban on excessive surcharging and how you think that is progressing in terms of its implementation.

Dr Lowe : This is the surcharging on credit cards?

Ms BANKS : Yes.

Dr Lowe : This is something that has come out of the Reserve Bank's Payments System Board. To take one step back, the argument for allowing companies to surcharge is that the cost of accepting credit cards, and particularly some types of credit cards, for merchants is very, very high. Merchants often do not have any ability to influence that; the cost is set by the international card schemes. The Payments System Board's view was that merchants should be able to, if they so choose, pass those costs directly onto the consumers, hopefully, leading to consumers to choose a different payment instrument which is not as expensive. Going back a decade or so, they were not able to do that; the schemes had rules that said you could not do that. The Payments System Board said, 'No, as a matter of competition, you should be able to do this.'

Then, some companies took this freedom to pass on very high surcharges, perhaps excessive surcharges, and there was, obviously and understandably, a community reaction to that. Then, the Payments System Board looked at it again and toughened up the rules and said, 'You can pass on a surcharge, but it has to be directly related to the cost of acceptance of the credit card,' and the government gave the ACCC the power to enforce that. The new rules came into effect on 1 September for large businesses, and we have seen, encouragingly, an immediate reaction by the airlines which is where the community angst was highest. So my understanding is with Qantas and Virgin on domestic airfares now, the surcharge is 1.3 per cent. So, if you get a cheap $100 fare it is $1.30, whereas it was $7 before. That is a great win to consumers.

The next round will apply to small businesses and it will come into effect next year. I expect that we will see lower surcharges as a result, and the surcharges, by law, will have to be directly related to the merchants' cost of accepting the cards. I think this is a much better situation and I look forward to it being spread right across the community.

Ms BANKS : In terms of extending that to the taxi industry, which, as we know, is governed by various state governments, is there a move there?

Dr Lowe : The taxi surcharges have been very high but there is a process that is being undertaken by the state governments and in a number of states now the surcharges have been halved. We have taken the view to date that while ever that process was underway and delivering lower surcharges for taxis, that we would let that run its course, rather than introducing yet more regulation, when there was already a reasonable process that seemed to be addressing what is a legitimate area of public concern.

Ms BANKS : My next question is in relation to counterfeiting. You mentioned that there had been an increase counterfeiting in Australia. Could you explain or describe that a bit further, in terms of what level of increase over what period of time and at what cost to the economy?

Dr Lowe : In the last year, we had 18 counterfeits per million banknotes in circulation. A decade or so ago, we had eight to 10. So it has roughly doubled from where it was a decade or so ago. Eighteen is a low number internationally. Not so long ago in the UK and in Canada the number got to 300—300 notes per million. So that was high, and then they introduced new notes. What we did not want to happen here was to get to 300. We did not want to go much higher than the current rate of counterfeiting. In total, the value of the notes that we had got that were counterfeits last year was a bit less than $2 million. So it is too high, but it is quite a small number. Obviously, if the counterfeiting rates went from 18 to 300, that $2 million would become a very large number quickly, and it would also undermine confidence in the community in using currency—and that is not in any of our interests. So we decided a number of years ago to make this investment in new banknotes, and I am really confident that, given the security features in these new banknotes, the counterfeiting rates will be really low. It turns out that the $50 note is the one where the most counterfeits are. So we are very keen, after doing the $5 and then the $10, to do the $50, because that is where the problem has been. I think these notes have the best security features of anywhere in the world. We are really proud of our scientists down in Victoria that have developed this, together with some of the international ink manufacturers, to put security devices on our banknotes that no-one else in the world has.

Mr EVANS: Thank you, Dr Lowe. Congratulations on your appointment. I will start in a lighthearted way by just noting that your predecessor sometimes copped negative headlines about being Australia's highest paid public servant and asking whether that applies to you as well.

Dr Lowe : I do not know!

Mr EVANS: Well, you do an important job. On the topic of financial stability, the governor's statement on 6 September said pretty early on, 'Financial markets have continued to function effectively.' Can I ask you to expand on that and talk a bit about the factors or measures that are front of mind for you when the RBA talks about financial markets functioning effectively?

Dr Lowe : If it is okay, I will ask Guy to answer that, because up until recently he was the head of the financial markets part of the bank.

Dr Debelle : Phil mentioned earlier, in response to Mr Thistlethwaite's question about Brexit—that was one of the largest stress tests we have had of the financial system, particularly in this new regulatory environment, that you could think of, and, actually, that went pretty well. The things we are looking at in terms of saying that things went pretty well included whether there was reasonable liquidity in the market, so whether it was easy for people to transact. The answer, through that period, was basically: yes, it was. In fact, if you look at what happened after Brexit, that was one of the largest amounts of turnover in financial markets we have seen in a long time, so this was not a case where everyone was sitting on their hands and watching things unfold. There was actually a large volume going through the market. So the market can process a large amount of volume in a fairly effective way. The fact that prices move is not a sign of any sort of stress; it is just how they move. As I said, we look at things like liquidity, whether prices jump a lot, and whether markets trade continuously. Those are the sorts of things we look at in terms of assessing whether markets are functioning effectively.

I suppose the other way to look at it is whether people can issue debt—banks, companies, governments—and whether those markets continue to function effectively. Remember, back in 2008 or 2009, that was not always the case, and, again, over the course of this year, notwithstanding things like Brexit, those sorts of issuance markets have actually functioned exceedingly well. People have been able to go and issue large amounts of debt at pretty cheap prices—for them, at least.

Mr EVANS: Thank you for that. There has been a little bit of discussion today about finding players out there who can maybe utilise low interest rates. Do you want to expand a bit on the role of psychology—say, certainty and stability, factors like that—in achieving sustainable growth?

Dr Lowe : One of the issues that we have grappled with over recent years is the fact that business investment outside the resources sector has been relatively weak. We puzzled over why that is, because there are so many medium-term positives that there is an opportunity for businesses to invest early to take advantage of those. But they have not been doing that to a large extent.

I think that one of the underlying reasons for that is a high level of uncertainty. There is a lot of global uncertainty. There was the whole euro problem. There has been uncertainty about China. There is a lot of uncertainty about technology. We had this discussion before about how technology is going to work out. There was a lot of uncertainty about how the economy was going to adjust post the resources boom. There has been some political uncertainty as well. There are a whole bunch of dimensions that businesses have felt uncertain about. Most people, when they are uncertain, use that as an excuse to delay a decision—especially if it is a capital decision that is costly to reverse. If you make a capital decision and then you have to reverse it, that can be very costly.

The answer, I think, is that the psychology is incredibly important. I see it as around uncertainty: what can we all do to provide a bit more certainty to people when they are making their spending and investing decisions? The Reserve Bank's contribution here is to be seen as a sensible institution that is predictable and operating within the normal bounds of what central banks do—being predictable and competent. We hope that helps bring a bit of certainty. We are only playing a small part here. There are many other things that are influencing business. The psychology is incredibly important, particularly for the businesses.

Mr EVANS: Would you say that those comments apply equally to certainty in politics and government at all levels?

Dr Lowe : Political uncertainty is one thing that does affect people, but it is only one of the things. There are a lot of other uncertainties in the world that dominate political uncertainty. It is, kind of, technology and the whole shape of the world post the monetary easing that is going on and how China is going to develop. There are a lot of things there. The problem we can get ourselves into is that we all wait so long to commit to something—to commit to spending or investment—that the economy ends up being much weaker, and then our reticence to spend gets validated when it need not be. I feel—and Glenn Stevens felt this—we need a voice of cautious optimism for the community to give people a bit more certainty to invest. I would like to continue that.

Mr EVANS: I was very interested to hear about your work in a number of different areas, including the new payments platform, particularly around the idea of substituting accounts for emails and phone numbers. Does that involve looking at the portability of bank account and credit card numbers for customers looking to switch banks?

Dr Lowe : It does not, but it may make that issue redundant. I do not want to go too much into the technical details about how this works, but you can think of a central database that might have your phone number in it and a link to your account. You can change that link if you subsequently want to change where your money is going to if someone sends you the payment through this system. It may well make the whole issue of BSBs and account numbers less important and people will be able to change their transaction accounts more easily by changing the links between the central database and where their money resides. People are going to find this new payment system fantastic—that is my hope.

If you go onto your internet bank account at the moment and want to make a payment to someone else, you have got 14 characters to fill in about what the payment is for. The origin of that is that the message length is either 80 or 120 characters long—and it was originally 80, because 80 was the number of segments on the punch cards. When I started university, people were still using punch cards. Our payment system in 2016 is still being constrained by punch cards. It has been a major problem, and we have decided, with the industry, to do something about that. It will help competition but it will also deliver actual value to consumers—being able to make payments. You and I could sit here and make a payment to one another, and it would be across our banks' accounts in 10 seconds. So these delays people experience in moving money between banks—and it can take a day or two, or in the old days much more than that—are all going to go, and I think it will help competition as well.

Mr EVANS: On the topic of interchange regulations, I think an equivalent committee to ours may be in the US, which is a little bit further down this road and I think is actually looking at the moment at repealing some of the interchange regulations that were introduced. I think they are talking about there being unintended consequences for consumers, including higher deposit fees and sometimes the introduction of annual fees on debit cards. Do you think we are going to go down that road here in Australia?

Dr Lowe : I do not see that. I think the main benefit of the interchange regulation is that the merchants are paying a lot less for payment services. Before we became involved in this, merchants were charged very high fees for accepting credit cards. So it was very profitable to issue credit cards, because you would get the fees that the merchants were paying. What happened was that the banks started competing very aggressively for credit card business, because they would get this high fee flow from the merchant. So we had this huge proliferation of points and rewards, and many consumers thought that was quite good, because they would get these rewards from using their credit cards. But the rewards were being paid by someone, and they were being paid by the merchants. I think what happened in the end was that the merchants had to charge higher prices across their whole range of goods and services to pay these higher fees. And there was no competitive discipline on the process, and the competitive process was to push these interchange fees up all the time so that you could offer more reward points to your cardholders.

So the Payments System Board decided that because of the lack of effective competition in this market the interchange fees needed to be regulated, and we have seen credit card acceptance fees for the merchants come down a long way as a result of that. I think it has been a good set of reforms. If you are just worried about earning your reward points, you might feel that it is not so good. But it has lowered the cost of card acceptance to merchants, and we had a very significant review last year. Our judgement is that things are working well. We have tightened up in some areas, because with all regulation—and we see this everywhere—the businesses being regulated find ways of trying to move around the regulation. So we felt that we needed to tighten up in some areas, and there was an extensive review process—endless consultation. My judgement is that this is working out okay and has benefited consumers.

Mr THISTLETHWAITE: I have just a couple of follow-up questions. Dr Lowe, you mentioned earlier, in the context of the statement on the conduct of monetary policy, the inflation target. You referred to achieving the two to three per cent band over time, and the second time you referred to it you referred to the medium term. Can you be a bit more specific on what 'medium term' means in number of years?

Dr Lowe : No, I am afraid I cannot, because I do not think of it in that way. And I am not trying to avoid accountability here. What I think the central bank can do for the community is create a strong sense that over time inflation will be 'two point something'. Whether it averages two point something over five years or seven years—I do not ultimately view that as the test; it is: have we created in the minds of the community a strong sense that inflation is going to be two point something?

So I want our institution—and this is the board's view as well—to be able to deliver that two point something in average inflation. I cannot say over exactly what horizon. We want to be able to do that in a way that promotes both employment growth and the stability of the financial system.

Sorry. That is the best I can do. I know to some people it feels like we are trying to find ways out or be less accountable, but I can assure you that that is not our rationale here. It is really to deliver an average inflation rate of two point something. This is why I focus on the medium term. We want people to think that if you are asking yourself the question, 'What is the inflation rate in Australia going to be over any reasonable planning horizon for business?' it is going to be two point something. I think most people can cope with inflation moving within a reasonable range from year to year, whether it is 1½ or two or 2¼. For most people, that does not really affect their lives that much. Uncertainty about exactly what the rate of inflation is in any given year is not one of the really big uncertainties that people worry about. I really want people to understand that inflation is going to average two point something here.

Mr THISTLETHWAITE: I suppose it depends on your perspective. If you are 18 years old, the medium term probably means 15 years, but if you are 80 years old the medium term might mean six months time.

Dr Lowe : Yes.

Mr THISTLETHWAITE: From a government budgeting perspective, it tends to mean anywhere from four to eight years.

Dr Lowe : We have done the calculations. I think it is taking any eight-year or maybe nine-year moving average of inflation since the inflation target was introduced. Over any nine-year period you could select over the last 25 years, inflation has always been between two and three, and I would hope that remains the case.

Mr THISTLETHWAITE: Thanks for that.

Dr Lowe : And if it is not then we would feel a responsibility to do something about it.

Mr THISTLETHWAITE: The last time the board cut rates, you referred to the banks not passing on the full amount, and you said that you did not expect them to. Did you or the board have an expectation of how much you thought that they would pass on, and did they meet that expectation?

Dr Lowe : I do not think our pencils are so sharp that we can do those calculations! But what happened was not that different to what we had expected. You can argue over two or five basis points one way or the other. As you would understand, we try to have very close contact with the financial institutions to understand what is going on with their funding costs and what is going on in the market for deposits, because it is very hard to get a good read of that at any point in time. We talk to them about the effects of regulation on their balance sheets, structures and strategies. So we do not have a perfect insight into what is going to happen, but through our extensive liaison with financial institutions we have a feel for their thinking and for the pressures they feel they are under.

Mr THISTLETHWAITE: Thank you.

CHAIR: I just have a few quick final questions, Governor. There is just one thing I wanted to quickly address that came up earlier in the hearing: this issue about the census. My understanding is that the census completion rate, with two days to go, is 95 per cent, and the 2011 census was 96.5 per cent, so the difference relative to the last time is in fact very small, with two days remaining. I just wanted to put that in context and see if you had any response to that given your earlier questioning on this.

Dr Lowe : I did not know those figures. That is encouraging if that is the case. As we talked about before, those data are incredibly important for lots of public policy, so that is good to hear.

CHAIR: Thank you. I just want to come to this issue about credit ratings and our AAA rating and so on. Could you just explain, in simple terms, why our credit rating matters to us as a nation and what is the impact on consumers if it changes.

Dr Lowe : The main impact of a changing credit rating would be on the interest rates that the government pays on its debt and that banks pay on their borrowings, but the effects are fairly small. For the type of credit rating changes that we might face, the effects on borrowing costs are quite small. I just have to draw to your attention the experience of the United Kingdom recently. Their credit rating was downgraded, and the week that that happened their borrowing costs fell quite a lot, because there are lots of other things going on. The markets have already made their own judgements about what type of credit premium they need to get to hold any particular debt obligations. So I do not think the effect is overly material. There is an effect. We pay more. To my mind, this focus on the credit ratings agency serves as a useful reminder that we need to make sure the recurrent budget is on a good path. That is how we should be thinking about this. It is not so much the cost of borrowing—it is low. I think it was two weeks ago that the Australian government could borrow at the lowest rate since Federation. So for the borrowing costs, lower is better, but we need to keep our mind on the recurrent budget.

CHAIR: Thank you. Finally, you talked a bit earlier about competition issues in relation to the banking sector—and these questions might be more for APRA, but you have probably given some thought to them in your role of broad oversight. In terms of measures to help stimulate competition in the banking sector and, in a sense, remove impediments to competition, have you looked at things like some of the actions of the UK regulator in effectively simplifying, for want of a better term, the process of setting up as a bank and do you think that there is anything that we could learn from that?

Dr Lowe : It is a good question, but again it is not my core area of competence. APRA, I know, is looking at various elements of this and I think the Treasury probably is as well. The observation I would make from looking back over the last 25 years is that the competition really comes from new entrants. In the three examples I talked about—stockbroking, deposits and mortgages—it is the new entrants that bring the competition. The existing institutions have a large back book and if they are earning high rates of return on that, they do not want to compete aggressively for new business and reduce the profitability of their large existing customer base. So it is the new entrants. So I think you are right to kind of focus on what can be done to make it easier for new entrants in our system. I think there is merit in kind of systematically thinking about what the barriers are to new entrants, and, on those barriers to entrance—some are completely legitimate—what is the public policy case for them. Because inevitably competition comes from the new entrants. It is not likely that all of a sudden existing incumbents will decide to compete a whole lot more aggressively. If there is a high rate of return being earned in a particular business line, what we want is another entity to come in and compete that away and then the existing institutions respond, and we saw that again with deposits, mortgages and stockbroking.

CHAIR: Thank you, Dr Lowe. We are out of time, so I will formally conclude the meeting. Dr Lowe, Dr Debelle and Dr Kent, thank you very much for your appearance before us today. I declare this public hearing closed.

Resolved that these proceedings be published.

Committee adjourned at 12:58