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Standing Committee on Economics
16/02/2018
Reserve Bank of Australia annual report 2017

BULLOCK, Ms Michele, Assistant Governor, Financial System, Reserve Bank of Australia

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

ELLIS, Dr Luci, Assistant Governor, Economic, Reserve Bank of Australia

LOWE, Dr Philip, Governor, Reserve Bank of Australia

Committee met at 9:32

CHAIR ( Ms Henderson ): I declare open this hearing of the House of Representatives Standing Committee on Economics and welcome representatives of the Reserve Bank of Australia and members of the public and the media. Since the previous hearing with the RBA, in August 2017, monetary policy has remained accommodative with a cash rate of 1.50 per cent following the RBAs recent decision to leave interest rates unchanged. In leaving rates on hold, the RBA governor said:

The low level of interest rates is continuing to support the Australian economy. Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual.

The governor noted a broad-based improvement in the global economy in 2017, with above-trend growth in a number of advanced economies and low unemployment rates.

The RBA expects growth in the Australian economy to pick up to average a bit above three per cent over the next couple of years. The data over summer has been consistent with this outlook. The RBA has noted that employment grew strongly over 2017, 'accompanied by a significant rise in labour force participation'. In addition, the governor commented:

One continuing source of uncertainty is the outlook for household consumption.

This morning, the committee will examine these issues in more detail and will ask the RBA whether it remains confident that current monetary policy settings will encourage growth and inflation, consistent with the target for coming years.

I remind you that although the committee does not require you to give evidence under oath, the hearings are legal proceedings of the parliament and warrant the same respect as proceedings of the House. The giving of false or misleading evidence is a serious matter and may be regarded as contempt of parliament. Would you now like to make your opening statement before we proceed to questions?

Dr Lowe : Good morning, Chair, and members of the committee. It is fantastic to be able to meet you here in this room full of history. It is a real privilege. My colleagues and I really value the opportunity to meet with this committee to explain our thinking about the Australian economy and to answer your questions. We really view it as an important part of the accountability process for the Reserve Bank of Australia.

Since we met last, in August, the improvement in the global economy has continued and forecasts for world growth have been revised up again. Rather than just one or two economies doing better, the improvement has been broadly based. There is a synchronised upswing taking place. Partly as a result of this, both international trade and commodity prices have picked up and both of these things are helping the Australian economy. The stronger economic growth has resulted in unemployment rates around the world coming down further. In a number of countries the unemployment rate is now below conventional estimates of full employment. Inflation has also remained low, partly reflecting the fact that wage growth is subdued. Low inflation has also meant that interest rates are low and for much of the past year volatility in asset prices was also unusually low.

Over recent times many investors have been proceeding on the basis that this combination of strong growth, low unemployment, low inflation and low interest rates would persist. Many also expected the low volatility in asset prices to persist. A couple of weeks ago we saw a reassessment of some of these assumptions by at least some investors, with the catalyst being a pickup in wage growth in the United States. The result has been an increase in bond yields, a decline in equity prices and increased market volatility.

While the exact timing of changes in investors' assumptions is difficult to predict, the fact that some reassessment took place at some point should not be that surprising. Above-trend growth at a time of low unemployment should be expected to see inflation lift, even if that lift is quite gradual, because of factors that are affecting wage and price dynamics around the world. To add to the mix, fiscal policy in some countries, most notably the United States, is now becoming more expansionary. So, I expect rising inflation pressures will figure more prominently in discussions of the global economy over the next little while than they have for some time.

Another important influence on our economy is what happens in China. Like other economies, China is benefitting from the global upswing. At the same time, though, there are ongoing efforts to increase the sustainability of Chinese growth, both in terms of its financing and its effect on the environment. These efforts are affecting the structure of the Chinese financial system and they are affecting commodity markets. The Chinese authorities continue to face the difficult challenge of getting the balance right between containing medium-term risk and supporting near-term growth. We continue to watch developments there very carefully.

I would now like to turn to the Australian economy. On balance, the news over summer has generally had a more positive tone than it has had for quite a while. For some time, we had been expecting GDP growth to be a bit stronger in 2018 and 2019 than it has been in the recent past, and the recent data has been consistent with this. Over this year and next we expect GDP growth to be a bit above three per cent, which is faster than our current estimate of potential growth in the Australian economy. This outlook has not been affected by the recent volatility in the equity market. The Australian labour market has been noticeably stronger than we were expecting, and this is unambiguously good news. Over the past year the number of people with a job has increased by more than 400,000 and there has been a marked increase in the participation rate for women. We don't expect a repeat of these very strong outcomes again in 2018, but we do expect employment growth to be fast enough to see a further gradual reduction in the unemployment rate. The unemployment rate, though, is likely to remain above conventional estimates of full employment in Australia for some time.

A range of business indicators have also improved since we last met. Business conditions have lifted and so too has the outlook for capital expenditure. It would be an exaggeration to say that animal spirits have fully returned, but the mood has certainly brightened in much of the business community. There are a number of reasons for this, but in parts of the country the lift in mood is being supported by the large infrastructure investment that is underway. Not only are these projects adding to jobs today but they are building much-needed productive capacity for the future.

Against this general backdrop of improving conditions, one uncertainty remains the strength of consumer spending. In the September quarter, spending growth was quite weak, especially for discretionary items. More recently, the retail trade figures have been better and they suggest a stronger outcome for the December quarter. But most households are experiencing only slow growth in their incomes and many expect that this will continue for some time yet. The lowering of expectations about income growth is likely to be affecting spending, especially in an environment of high levels of household debt. A pick-up in income growth by way of an ongoing increase in jobs and stronger wage growth would both help here. So we continue to look very carefully at household balance sheets. On balance, our assessment is that there has been some containment in the build-up of risk in this area. Again, this is a positive development. Lending standards are stricter than they were previously and there has been a welcome decline in the share of interest-only loans following the measures undertaken by APRA. Housing credit growth has also slowed a bit, especially to investors.

In the property market, prices are no longer rising in Sydney and they have fallen for some higher priced houses. The Melbourne market has also cooled a little. The increasing supply of housing, changes in the nature and availability of financing, and some reduction in foreign demand have all played a role here. While the Reserve Bank does not target housing prices or household debt, it would be a good outcome if we now experienced a run of years in which the rate of growth of housing costs and debt did not outstrip growth in income, as they have in recent years.

In terms of CPI inflation the picture is pretty much the same as when we met six months ago. Inflation in headline and underlying terms is still running at a little under two per cent. This is higher than the inflation rate a year ago but inflation remains low. The most recent data confirmed themes that we have been seeing for some time. Strong competition from new entrants and changes in retailing business models are putting downward pressure on the prices of many consumer durables and groceries. The prices of many of these goods are lower than they were a few years ago. This is good news for consumers, although not for all retailers. We do expect to see some lessening of this downward pressure on prices at some point, although not for a while yet.

A second ongoing theme is higher prices for utilities and tobacco. Both of these have added materially to the CPI over the past year and further increases are expected.

The third theme is subdued increases in wages, feeding through into subdued price increases, particularly for a range of market services. This too is likely to continue for a while yet. We have discussed on previous occasions the reasons for the subdued wage increases. They include continuing spare capacity in the economy after the unwinding of the mining investment boom, the heightened sense of competition due to globalisation and technology change, and changes in bargaining arrangements. These factors are still at work, although through our liaison program we hear reports of pockets where the labour market is tight and firms are finding it harder to find workers with the right skills. In some of these areas wages are now rising more quickly than they were previously but many firms remain wary of adding to their cost base in the current environment.

Over time, though, we do expect wage growth to pick up as the labour market strengthens further. The pick-up, though, is likely to be gradual. The increase in wages growth and the more general reduction in spare capacity in the economy are expected to contribute to inflation picking up as well. But, to continue the theme, this pick-up too is expected to be only gradual. This year and next, we expect CPI inflation to be between two and 2½ per cent.

As you would be aware, the Reserve Bank board has left the cash rate at 1½ per cent since August 2016. This represents an accommodative setting of monetary policy aimed at supporting the economy and employment and returning inflation to the midpoint of the medium-term target range. As we have discussed with this committee on previous occasions, the board has sought to strike a balance between these benefits of monetary stimulus and the medium-term risks associated with an increase in the already high levels of household debt. We have sought to steer a middle course here, promoting sustainable growth in the economy.

Over the past year, the economy has been moving in the right direction. Progress has been made in reducing unemployment and having inflation return to around the midpoint of the target range. On the financial side, the build-up of risk in household balance sheets has been contained, although risks clearly remain there.

Over the coming year we expect to make steady progress. Our central scenario is for the Australian economy to have a further reduction in the unemployment rate and to see an increase in inflation towards the midpoint of the target range. Of course, that is just a central scenario, and there are other scenarios as well. But, if this is how things play out, at some point it will be appropriate to have less monetary stimulus and for interest rates in Australia to move up. This is already happening in other countries. In other words, it is more likely that the next move in interest rates here will be up rather than down. The timing of any future move will depend upon the extent and pace of the progress that we make in reducing the unemployment rate and having inflation returned to target. As things currently stand, we expect that progress to be steady but to be only gradual. Given this assessment, the Reserve Bank board does not see a strong case for a near-term adjustment of monetary policy. We will, of course, keep that judgement under review at future meetings.

Before finishing, I would like to mention a couple of developments on the payment side of the banks responsibilities. The first is the launch this week of the new payments platform. This is a major piece of national infrastructure and it will benefit households and businesses. Its development is the result of a very complex collaborative industry effort over many years. This new payment system will allow Australians to make faster, simpler and smarter payments on a 24/7 basis. One element of this is the use of pay IDs instead of having to know people's BSBs and account numbers for many transactions. A major focus of the development effort has been security and to protect people from fraud. The process for initially registering pay IDs, which is now underway, requires users to verify their identity, and the new platform also requires users to confirm the recipient before a payment is completed. I would be happy to discuss further details of the new arrangements during the course of this hearing.

The second development on the payment side is the release yesterday of the design of the new $50 banknote. This new banknote will be issued into circulation in October this year. There are more $50 notes in circulation than any other note, so it is a very big task. All up, at the moment, there are around 700 million individual $50 notes in circulation. They are used very heavily in transactions, as well as being the main ATM banknote. The new $50 note will feature the same world-leading security features as the $5 and $10 notes, including a clear top-to-bottom window. It will also have four bumps to help people who have vision impairments.

As with the current $50 note, the new one honours two very significant Australians—David Unaipon and Edith Cowan. While these two Australians came from very different backgrounds, they were both significant pioneers. David Unaipon was Australia's first published Aboriginal author, writing about—in his own words—'Aboriginal customs, beliefs and imaginings'. The microtext on the banknote is an extract from his book Legendary Tales of the Australian Aborigines. And Edith Cowan was the first female member of an Australian parliament, being elected to the Western Australian parliament in 1921. I am pleased to be able to say that the new banknote contains text from her speech to that parliament. We are very proud to have these two distinguished Australians on our most widely used banknote. I have some of the notes that have just come off the printing press if you would like to see them.

CHAIR: We would love to.

Dr Lowe : I have to return them to the bank! I have some of the first ones from the printing press. You might like to see those.

CHAIR: I have to reprimand Mr Kelly already!

Dr Lowe : Thank you very much. My colleagues and I look forward to answering your questions.

CHAIR: Dr Lowe, thank you very much for your opening statement. I would like to begin with questions. I would like to ask you more about your comments in your opening statement that 'animal spirits have fully returned and the mood has certainly brightened in much of the business community'. Can you explain the drivers of that confidence in the business community and across the economy in more detail please?

Dr Lowe : There are a number of things going on. The improvement in the global economy has clearly helped. There is the global upswing taking place that I talked about. Commodity prices are lifting around the world, investment is rising around the world and international trade is picking up. That is having flow-through effects into Australia. That is an important background element. Another thing is that the unwinding of the mining investment boom has almost come to an end. For quite a while, that was a drag on the economy. There was an underlying improvement taking place but mining investment was declining and that was acting as a drag. That drag has almost come to an end, so you are seeing the underlying strength of the economy there as well.

I think the low interest rates are helping. Financial conditions are accommodative, so firms can get access to finance if they need it. Many businesses have not undertaken very much capital expenditure for a run of years. With the population rising, the economy growing, they're finding their capacity constraints are starting to bite instead of starting to invest as well, and that itself is creating a reinforcing dynamic.

The final thing that I'll mention here is the pick-up in infrastructure investment. You see this particularly here in Sydney but also in Victoria—the very large pipeline of infrastructure investment that's being undertaken, largely by the private sector, meaning order books of many firms are full. They're finding it hard to get workers. It's creating a positive business environment. So the pick-up in the world infrastructure investment, low interest rates and the end of the mining investment boom are all helping.

CHAIR: Dr Lowe, you mentioned mining investment, and that process is almost complete now, in that we're transitioning away from the mining investment boom. What implications does that have for growth in the economy?

Dr Lowe : As I said, it was acting as a drag. Over recent years, the economy has grown an average rate of 2½ per cent. I expect, in the next while, it will grow a bit above three per cent, and partly that's because that drag has diminished. We do, though, see in parts of the economy, particularly in Western Australia, some signs that mining investment is picking up a little. We're not going back to the boom days, obviously. But, after a number of years of very high levels of investment, firms need to do extra investment to replace the depreciation of the capital stock. So we're starting to see more self-sustaining investment growth in Western Australia in the mining sector, and that's picking up conditions in Perth. Again, it's not a boom, but there's more sustaining investment going on, and that's good news—and it's helping the Western Australian economy, which I think now has finally turned the corner.

CHAIR: How would you characterise strength in the non-mining economy, particularly for investment? Specifically, what does the bank think of the outlook for business investment, going forward?

Dr Lowe : Over the last year, investment in the non-mining part of the economy has gone up eight or nine per cent, so that's quite a decent increase. For many years at these hearings we were discussing why non-mining business investment wasn't picking up. It was a puzzle. In our forecasts, it was one of the things that we kept on missing. We'd think that the turnaround would come, and it was slow in coming. There are a lot of reasons for that. Firms had a lot of reasons to delay capital spending. There was a long list that we talked about in previous hearings. But I think now we've got to the point where fewer firms are deciding to delay. They're saying, 'We've delayed long enough and we finally need to undertake capital spending,' and that's for the reasons I talked about—the world infrastructure, low interest rates. So firms are now deciding, 'Now's the time to do investment,' and it has a self-reinforcing nature. As businesses see other firms investing, they say, 'I'd better not delay as well.' The population is still rising at 1½ per cent, so we need to invest to keep pace with that as well. So it's creating a positive self-reinforcing dynamic. And, finally, for the first year, non-mining business investment has grown by more than we expected. That hasn't happened for at least half-a-dozen years, probably longer. So it's a positive story.

CHAIR: Your forecasts for growth in the SMP have GDP growth increasing to above potential for the next couple of years, and you made some further comments about that this morning. Can you explain in more detail what is driving this improvement?

Dr Lowe : The pick-up in investment is an important part of that story. I expect consumption growth will gradually pick up as well—not to the rates we saw before the financial crisis but faster than we've seen on average over the past four or five years. As we've talked about previously, one of the things that has held back consumption growth is low growth in household incomes. But, with firms investing and starting to employ people, there are more jobs there and the jobs create income, and we're expecting that gradually that extra income will flow through into a pick-up in consumption spending. It's going to be a gradual process, but higher incomes do mean more spending. And, as consumption growth picks up, that'll give businesses more confidence to invest. So that's an important part of the story.

We expect to see further increases in LNG exports, which is going to add maybe a quarter of a percentage GDP growth over the next couple of years. We're not expecting very much growth in residential construction. The level seems to have plateaued out now, so that's going to stay at that high level for a while. But the main story is businesses feeling better, investing and hiring workers; income growth stronger; people spending a bit more of that—and we're all feeling a bit better.

CHAIR: You've made some comments about the recent jobs growth, the very strong jobs growth. How do you believe that that will improve the outlook for household incomes in particular?

Dr Lowe : Well, more jobs mean more income, don't they. With 400,000 people getting jobs over the past year, that generates a lot of extra income for the household sector, even if wage growth is kind of moderate. What we really want to see is strong jobs growth and stronger growth in wages. At the moment we've got one of them. I expect that in time the other will come as well. We do hear—as I said in my opening remarks—of pockets, or stories of pockets, where labour markets are quite tight and wages are starting to rise a bit more. The normal forces of demand and supply still work in the Australian labour market; they're just kind of slow and gradual. So this strong growth in employment as a positive thing.

Perhaps I could ask Luci to talk about the very strong growth in participation in the labour force of women, because that's a really central part of what's going on at the moment. There have been a lot of women joining the labour force, and they're finding jobs, and that's creating a better environment.

Dr Ellis : Thanks, Phil. The participation rate at the end of last year reached within 0.1 per cent of the multidecade record high that we saw during the mining boom in 2010. One typically sees, when employment growth is strong, that participation comes with it, and across the board we have seen some increase in participation across age groups across both male and female members of the labour force.

What is most striking about the recent period is that, while male participation has come up a little bit after having dropped a little in previous years, there's been a real break in trend over the last couple of years and particularly over the last, say, six months in the participation of women. Initially it was particularly marked amongst older women. We have seen quite an increase in participation of older workers. It's still below the average of the whole labour force, but it has increased quite a bit. But what's really remarkable about the last three to six months in particular has been that there's been a lift right across the age groups for all women, from mid-20s all the way up.

There's been some speculation about exactly why that's happening, whether it's increased flexibility in the jobs that are available that's making it more feasible or it is just a continuation of the longer term trend to higher participation of women. Each generation of women participates more in the labour force than the previous generation did at the same age. Unlike in other countries, that particular dynamic still seems to have some legs, and that seems to have been overlaid with an encouragement factor of strong employment growth, particularly in health and education, which seems to have enabled not only strong participation. It's not women coming in who weren't looking for work and are now looking for work unsuccessfully; it's women who are effectively going straight from not being in the labour force into jobs—remembering of course that over the last year much of the strength in employment has been overwhelmingly in full-time jobs, so this is actually net net, people going into full-time jobs.

CHAIR: Dr Ellis, you gave a recent speech, and you talked about your confidence that you expect to see an eventual pick-up in wage growth, and of course Dr Lowe mentioned this as well. How important is continued jobs growth, including of course in relation to the boost in the number of women participating in the workforce? How important is jobs growth to this?

Dr Ellis : It's extremely important, firstly noting that participation does seem to move with employment. We're currently in a position where there is still spare capacity in the labour market. As I said in that speech a couple of days ago, we think that, broadly speaking, an unemployment rate of around five per cent is what you would call our best estimate of a conventional measure of full employment, below which you start seeing a pick-up in wage growth. It's not the minimum employment rate you can have, but it's the rate of unemployment below which you would see a pick up in wage growth. We're still a bit above that—we're currently at 5½ per cent. That estimate is estimated with considerable imprecision, but, supposing that point estimate is more or less right, it says that we still have about half a percentage point of spare capacity in the labour market. As I mentioned in that speech, one of the things you tend to find is that, if you approach that point gradually, there are processes by which it tends to bring the full rate of unemployment down a little, in any case. It's important to have strong employment growth in order for the employed labour force to grow stronger than the rate of population, or the rate of labour force growth, in order that you can start absorbing some of that spare capacity to get to the point at which wage growth starts to pick up. You will start to see it in pockets before you hit a national five per cent, or whatever the level may be—that's exactly what the governor was talking about in terms of seeing it in pockets. But, in order to see a generalised pick-up in wage growth, we would most likely need to see unemployment reasonably lower than where it is—half a percentage point or so.

CHAIR: Dr Lowe, if I could just change tack a little, why is it so important for a small, open economy like Australia to remain internationally competitive? Could you talk about that issue in a global context?

Dr Lowe : The Australian economy has always been an open economy. We've benefitted more than any other economy in the world, almost, from being able to access international trade markets for goods and services, being able to attract capital from the rest of the world, and being able to attract fantastic people from the rest of the world. After all, we're the great immigrant country of the second half of the 20th century. We've made a fantastic country out of being able to sell our stuff to the world, have capital come here and have people come here.

Openness is key to our economic success. That's been the case in the past, and it remains the case in the future. That has a number of elements—importance of open trade—and Australia has more at risk here than many other countries from a decline in open markets and an increase in protectionism. We benefit from foreign capital from the rest of the world, so we've got to be an attractive place for foreign capital, and people as well. It's been fundamental to our success to date, and I believe it remains fundamental to our success in the future.

CHAIR: Over the past few months, consumer confidence has rebounded from levels seen mid-last year. Why do you think that is the case, and what do you think is the economic impact of that?

Dr Lowe : The main thing is the growth in jobs. The improvement in confidence is correlated with the improvement in the labour market. The consumer confidence survey asked people how concerned they are about future unemployment. The results on that survey question have come right down, so people are not particularly concerned about unemployment at the moment. When you're not concerned about unemployment, you feel a bit better. The thing that would make them feel a lot better is a pick-up in wages growth. But at least they're getting the jobs growth now, and that's helping. The economic news has been stronger as well, as we've talked about, and that affects how people view the economy. The results on the questions about the prospects for the economy have improved quite a lot in that survey. The growth in jobs, I think, is really key.

CHAIR: But it does appear that you have some quiet confidence that, over time, there will be a pick-up in wages growth, with the conditions that we're seeing and with your forecasts.

Dr Lowe : I think it'll be steady, but it'll be gradual. We're not hearing stories, through our liaison program, of firms moving away from two to 2½ per cent wage increases across the board. We do hear stories of pockets where there's very tight labour demand that wage growth is picking up. Part of it is due to the infrastructure investment in Sydney, some parts of IT, some project management skills, some business services—wage growth has picked up a bit. But, by and large, when we talk to businesses, there seems to be a lot of anchoring of wage growth around two to 2½ per cent, and we don't see that changing.

Another thing going on is that the new enterprise agreements that have been signed over the past six months have had much lower wage increases built into them than the ones they replaced. Those enterprise agreements, typically, remain in place for three years. So that's going to act as a weight on wages growth for a while. It will happen, but it's going to take a while.

CHAIR: Dr Lowe, could I just ask you about the ratings agencies? They've indicated that should fiscal consolidation not proceed as outlined that this would put pressure on Australia's AAA rating. What would be the macroeconomic consequences of a credit-rating downgrade? And what would be the implications for monetary policy, including the impact on households?

Dr Lowe : I think a credit-rating downgrade is more of a political event than an economic event. Bond spreads would go up a bit, but not very much, and those higher bond spreads wouldn't be particularly problematic for the economy.

It wouldn't have any implications for monetary policy, but what could happen in that scenario is that we all run around, saying: 'Oh, this is the end of the world! Australia has been a AAA country for a long period of time, it was fantastic and we're no longer fantastic. We're on the road to ruin!' We shouldn't—

CHAIR: Are you saying it is about—

Dr Lowe : We shouldn't say that, but people in the media—at the political level, the media and the business community—might say, 'Look, were on a bad track here!'

CHAIR: Confidence is a key factor, isn't it?

Dr Lowe : It's confidence, yes. So, in and of itself a credit-rating downgrade is not that big event—if it doesn't dent confidence. We've seen many countries around the world have credit-rating downgrades and they go on. I'm not saying it doesn't matter, because it would matter, really, through the confidence channel. I think it's a very good thing that we've got these AAA credit ratings, but it could act as a dent to confidence. For that to happen, everyone would need to play their role in making sure that it didn't dent confidence. Let's hope it doesn't happen!

CHAIR: You've also made some comments about the macroprudential measures announced by APRA in relation to the impact on housing prices and the increase in housing prices. Can you make some further comments in relation to that, including in relation to the pipeline of dwelling construction that's yet to come online?

Dr Lowe : Perhaps if I could just step back to the background of these measures? We've been concerned for quite a few years that the rate of growth of credit was outstripping that of income. For quite a few years, credit growth was running at six or seven per cent a year and income growth was at three per cent. You can do that for a little while, but we shouldn't be in a world where we are doing that year after year after year.

When credit was growing quickly, we thought that some of the credit standards the banks were applying were a bit loose. At one point, more than 45 per cent of the new loans being made in Australia did not require the borrower to make one dollar of principal repayment on a regular basis. When I talk to my peers in other countries and I tell them that fact they go, 'Are you crazy?' So we thought that that needed addressing, that on the bulk of housing loans people should be paying back principal. That was one of the macroprudential measures, to say that banks can make interest-only loans, but that in the flow of new loans interest-only loans can only be up to 30 per cent.

That was one issue. The other was that at one point investor credit growth was running at 12 per cent a year. So when prices were rising quickly and interest rates were low, people thought: 'Well, I'll borrow to buy an asset. There are low interest rates and prices are rising quickly.' It meant that a lot of investors were doing that and that was creating unhelpful dynamics in the market. So the macroprudential measures were aimed at addressing that, and to deal with the interest-only issue. At the same time, APRA required the banks to tighten up their lending standards.

None of those things were aimed at addressing housing prices. They were really aimed at addressing the accumulating risk in household balance sheets, and trying to get the lending growth that was occurring into a more sustainable pattern. And I think they've done that. We see the share of interest-only loans in new lending at the moment at around 20 per cent. Investor credit growth has slowed a lot and aggregate household credit growth is now fairly moderate. And lending standards have been improved a lot. So we feel like the risks that were building in the household sector have been contained a bit. There is still risk there, because the level of debt is high, but the risks have been contained.

CHAIR: We have seen, of course, an adjustment in the growth of housing prices—particularly in Sydney, and also in Melbourne. Generally, housing prices across the board were running at around 15 per cent-plus and now are sitting at just one per cent. To what extent do you attribute those measures to this change in growth? And how successful, generally, do you think these measures have been?

Dr Lowe : I think they've been successful in containing risk, which was their ultimate objective; it wasn't to address the housing price issue—

CHAIR: But there has been an impact in that, hasn't there?

Dr Lowe : There has been an impact, but remember there are a lot of other things influencing the housing market as well, other than just APRA's lending guidelines. There has been a very big increase in supply. The rate of growth of the number of dwellings in Sydney and Melbourne is the highest it has been for quite a few decades with all the construction that is taking place, particularly of apartments. So supply has gone up a lot. There has been less foreign demand as well. The Chinese tightened up capital controls, so it was harder for people to get money out of China, and state governments across the nation put up taxes on some foreign investors. So there has been some reduction in Chinese demand. There is also, ultimately, the weight of gravity: prices get so high that people find it very difficult to afford them—and I think that has happened in Sydney—and then that reduces demand. So all those things have been at work, in addition to the tightening of lending standards. I don't think the tightening of lending standards is the primary thing that has changed the dynamics of the Sydney housing market; it's the full supply, less foreign demand, better transport—the things that should ultimately weigh on housing prices doing that. I'm much more comfortable, probably, than I have been in recent years when I have been appearing before this committee when I was quite worried; housing prices were rising very, very quickly—much faster than people's income—and the level of debt was rising much faster than people's income. And now we seem to be getting a better balance. We've got to keep an eye on it, because it could turn either way, but at the moment I feel the balance is much better than it has been for a few years.

CHAIR: Dr Lowe, I will leave my questions for the time being and invite the deputy chair to ask a few.

Mr THISTLETHWAITE: Dr Ellis, I want to start with some questions about your speech on 13 February. Well done. I thought it was a good speech, and well done on explaining for lay people the non-accelerating inflation rate of unemployment! It's not an easy task, but you did a good job. I just wanted to ask some questions about this notion of spare capacity. In the speech, you said:

In Australia, we estimate that there is still some spare capacity in the labour market. Last year we published a central estimate of the NAIRU of around 5 per cent … Since then we have not seen a reason to change that broad assessment. But we are mindful that, as we approach that figure, there's a risk we find there is more room to come down before wage growth picks up in earnest.

Are you saying there that, on the current wage price index figures, we could see that fall further?

Dr Ellis : Thanks for the question. I'm not suggesting that the wage price index will decelerate. We seem to be close enough to wherever the NAIRU is that the balance of tight pockets of the labour market that the governor referenced, and the spare capacity that we've got overall, seems to be not putting much additional downward pressure on wage growth, although, as Phil did mention, we are seeing a bit of downward pressure in some bargaining streams—namely, the enterprise agreement stream. I think what I'm suggesting there is: these are very imprecisely estimated concepts, and so the degree of uncertainty around that five per cent central estimate is quite large, and so there is not a lot telling you that 5½ per cent is greatly different from full employment. We're not seeing such a deceleration in wage growth that we'd be telling you, 'Yes, we're definitely well above the NAIRU.' It could actually be at 5½ per cent. I think that's unlikely, but you could, based on the behaviour. So the way these things are estimated is essentially: you don't know where it is, really; you have to look at the behaviour of wage growth and the behaviour of inflation. So the fact that wage growth has been low but steady, the fact that inflation has been picking up a tiny bit, is telling you that, as we come down on unemployment, we're approaching the NAIRU, but we're not quite there yet. You wouldn't adjust your central estimate for every 0.1 miss on your inflation forecast; you have to be mindful of the imprecision of these estimates. So, no, I don't believe that where we are is putting a great deal of downward pressure on wage growth from here, but it's certainly not yet putting upward pressure. In some sense there's sort of a zone of imprecision around the NAIRU.

The point I was making in the speech is simply that—and particularly because, again, another of those unlovely technical terms 'hysteresis'—the more your people are employed the more they're employable, the tighter the labour market gets, the more some people seem to have better prospects to be employed than they would have had when there was plenty of spare capacity in the labour market. In some sense that experience of employment makes people more employable and therefore less likely to be marginally attached and out of the labour force, and therefore are actually competing in the labour force and part of the spare capacity that's relevant for wage determination.

So what we tend to see, both on the upside and on the downside, is a path dependence. A big upswing in unemployment tends to result in the estimate of the NAIRU going up. A gradual downswing in unemployment tends to eat away at your estimates of the NAIRU as well. We've seen overseas repeated downward revision to estimates of the NAIRU as unemployment has come down and wage growth has picked up a little but not that much. It's a statistical process. The NAIRU is unobservable. You can only estimate where it is based on what happens to wages and inflation. It falls out of the fact that wage inflation and price inflation have been relatively stable in a range of countries.

Mr THISTLETHWAITE: But the bank's current guesstimate is that it's around five per cent—

Dr Ellis : Around five, yes.

Mr THISTLETHWAITE: and we're at 5½ per cent at this point. That accounts for the spare capacity in statistical terms.

Dr Lowe : I would hope that over time that five would come down. It is too early to say that. Hopefully, we'll find out. As we approach five per cent we will see what happens to wage pressures in the economy.

Mr THISTLETHWAITE: You basically conclude with that point, but you say that there is no guarantee of this and therein lies the risk. That's really the issue, isn't it? It could keep coming down. There is still a bit more spare capacity there than we think.

Dr Ellis : But that's good.

Dr Lowe : If full employment was really 4½ in Australia that's going to better than if it were five. More people would be employed—

Mr THISTLETHWAITE: I agree with that, but the point I'm getting to is about forecasts. In another publication that the bank put out last year, 'Insights into Low Wage Growth in Australia', a paper by James Bishop and Natasha Cassidy, they say in the introduction, in the opening sentence:

Over recent years, Bank forecasts for wage growth have been persistently too strong … The forecast errors have been largely the result of there being more slack in the labour market …

That's true, isn't it?

Dr Ellis : Those two colleagues are in the economics team and so, essentially, that paper is an accounting of where we were going wrong. The estimate of the NAIRU that I've been talking about has come from a new—we've got some new, improved models of how to think about this. We've learned from those forecast errors, and more recently, I think, both on inflation and on wage inflation the outcomes have been closer to what we are expecting, particularly in recent quarters. That team has evolved a lot of their models to rethink where we are about that. Of course, we have been incorporating a bit more sensibility around this idea, as the governor mentioned, that, as you get there, the act of getting closer to the NAIRU actually tends to bring it down itself, that path dependence. You're quite right to reference that, and in some sense that's us saying, 'What can we learn from that past experience and how can we improve the forecasting process so that we don't keep making that same directional mistake?'

Mr THISTLETHWAITE: I'm not being critical. I think most economic commentators have been getting this wrong about when the upswing is going to occur. In that paper they've got a handy graph of forecasts and actuals for the wage price index. The bank was forecasting the upswing to stay in 2011, but it's persistently come down and down and down. I might add that you're not on your own, there. Treasury forecasts for these things have been persistently wrong, as well, and I want to ask a few questions about that. In the 2013-14 budget they forecast the wage price index to be 2¾ per cent for the 2016-17 budget. That was wrong. In the 2014-15 budget, they forecast the wage price index to be 2½ per cent for the same year; that was wrong. In the latest MYEFO, the forecasts for the wage price index for this year are 2½ per cent. We're not going to get to 2½ per cent for this year for wage price index data, are we?

Dr Lowe : I don't know. We've been wrong. Treasury's been wrong. Right round the world, people have been wrong. It's the most frequently discussed issue that I talk about with my colleagues, the governors of the other central banks, and they're all struggling with the same issue. They thought wage growth would pick up as their unemployment rates came down, and it hasn't happened. So we're not alone here.

The issue is: why is this happening? I think it's these forces of technology and global competition. Workers feel like they just can't put their wages up, and firms aren't aggressively bidding for workers in tight labour markets. The Japanese unemployment rate is 2.7 per cent, the US is 4.1, the UK unemployment rate's the lowest in 40 years, and in Germany it's pretty much the same thing. But in none of those markets do you really see firms bidding workers away from other firms by paying higher wages. Everyone's worried about their costs. They're finding more efficient ways of operating the workforce. So it's a global thing, and no-one really knows how long it's going to last. I suspect that, as these labour markets get tighter and tighter, the pressure builds and firms start to say, 'Well, we will poach workers and pay them higher wages.' As I said, we do see some pockets of that in Sydney. But you're right to identify it as a risk, because it's such a strong global influence that it's hard to know when it's going to end.

Mr THISTLETHWAITE: In this year's MYEFO, it is 2½ per cent for this year and 2¾ per cent for 2018-19. We're probably not going to make those figures, are we?

Dr Lowe : It remains to be seen. The current trends will have to change a bit to get there. We're expecting wage growth to pick up but for it to be fairly gradual.

Mr THISTLETHWAITE: But if there's still spare capacity there, as you're saying, surely most economic commentators would have to admit that that 2½ per cent for this year, given that we're at around 1.9 and we're halfway through the year, is too ambitious.

Dr Lowe : It's possible. As I say, we do see areas where wages are picking up. How that translates into the WPI I don't know. It's certainly a risk factor, and I think you're right to identify it as a risk factor.

Mr THISTLETHWAITE: It gets even worse as we go on. In 2019-20 it's 3¼ per cent. I don't think anyone could say—based on the spare capacity notion and the errors of forecasting in the past by a lot of organisations, not just the Reserve Bank—that we're going to get anywhere near those figures, are we?

Dr Lowe : I don't know. From memory, in New South Wales the unemployment rate—the trend measure at the moment—is 4.8 per cent. In large parts of Sydney, the unemployment rate has a 2 in front of it. So we're starting to see things. It's very hard to know how that's going to play out at the national level. Again, I can say it is a risk factor, and the pick-up in wage growth is going to be gradual. That's kind of the simple thing of what I was saying in the introductory remarks. There's an improvement going on, but it's gradual. Whether we get to those particular numbers remains to be seen.

Mr THISTLETHWAITE: You mentioned in your opening address that you're forecasting CPI inflation to be between two and 2½ per cent over the coming year. Again, in Treasury forecasts, they've got it at 2.75 per cent for 2018-19. You'd have to say that's a bit ambitious as well, wouldn't you?

Dr Lowe : Well, it's higher than ours. If that's the number they've got, that's higher than ours. I don't know what the differences are.

Mr THISTLETHWAITE: The reason I'm asking these questions is that these are assumptions that are made by Treasury, and they have implications for revenue forecasts, particularly the wage price index data on income tax receipts and the like. If those forecasts are overly ambitious, one would think that the forecasts for the budget deficit would be overly ambitious as well, particularly the notion that we'd return to surplus in 2020. You'd have to agree with that, wouldn't you?

Dr Lowe : Well, you're looking at the wage growth side, but remember: employment growth has been much stronger than we had been forecasting. We had not forecast 400,000 new jobs opening last year. The tax revenue is driven off the combination of both wages and jobs. One is a bit weaker than expected; the other is a lot stronger than expected. So how that ultimately plays out over the coming years in the fiscal revenue, I don't know, but you've got to look at both sides of the equation here. One side is a lot stronger, and that is good news. The forward looking indicators of employment growth, the business surveys and job ads and job vacancies posted are all saying the labour market is going to continue to be strong for quite a while.

Mr THISTLETHWAITE: If the forecasts for consumption—which appear to be particularly overly ambitious—and the wage price index are overly ambitious then there would be some effect on revenue, surely.

Dr Lowe : There would be. The terms of trade have been stronger than we had thought as well. This lift in global commodity prices does help the budget as well. I am not in a position to tell how all those things balance out, but there are certainly things moving in the direction you suggest, but there are other things that are moving in the other direction as well. It is up to Treasury to balance those out, not the RBA.

Mr THISTLETHWAITE: Going back to your speech, Ms Ellis, you point to it but you don't go into much detail about how there could potentially be a new phenomenon in the labour market that we haven't seen before and that there is a structural change behind what we are seeing, particularly in relation to the notion that we haven't reached the upswing yet in terms of wage price index data. That is also pointed out in that paper, although it is inconclusive. The government has mentioned on many occasions the unprecedented international competition in markets, particularly retail, and competition from robots—to be simplistic. You point out that in the new enterprise bargaining agreements the wage increases seem to be smaller. I would add to that the fact that for the first time in our history we are actually seeing a decline in the number of enterprise agreements that are being made since enterprise bargaining was instituted. Is it possible that those structural changes are more predominant than we think?

Dr Ellis : Structural change is always one of those things you can never really know that that was the driver until you are well past the process. There are a number of different possible explanations for the slow wage growth that we are seeing. Whether something is truly structural or a particular manifestation of how an upswing works nowadays is also hard to disentangle. As the governor mentioned, there is a bit of a global phenomenon around wage growth being quite slow to pick up, even in really tight labour markets. I would point out that in a lot of those countries we are seeing some increase in wage growth, it is just really small, and the rate of wage growth remains very low. For example, in Japan, wage growth is low but it is positive, and that is a change from where they were in previous decades. Similarly, as the governor mentioned, the thing that seemed to have triggered some re-evaluation by some investors in financial markets and some repricing of financial assets was a stronger than expected wage outcome in the United States. There are certainly parts of the euro area where wage growth is picking up; it is just not picking up a whole lot. So, in some sense, it is not that wage growth is completely unresponsive to the tightness in the labour market; it is just not as responsive as we've seen in the past. It is not a structural change in the sense that wage growth will never pick up, but it is a change in the balance of how much wage growth responds to a particular degree of labour market tightness. That is another way to think about it, as well as, as we already discussed, a potential change in where that labour market's tightness starts to manifest as a pick-up in wage growth.

Mr THISTLETHWAITE: I have a couple of questions for you, Dr Lowe. Mark Carney, the Governor of the Bank of England, has been writing quite a bit lately, I have noticed, about the threat of climate change to the international economy. It is his view that currently investors don't have the information they need to respond to the threat of climate change and that more information in financial markets is going to be required if capital is going to be allocated to manage that risk. Is that a view that you share with the Governor of the Bank of England?

Dr Lowe : It is a view that I share. The Council of Financial Regulators, which I chair, late last year established a working group to look at these issues about disclosure, and Guy is on that working group. If you have time, he might be able to talk about the issue.

Mr THISTLETHWAITE: That would be good.

Dr Debelle : As Phil mentioned, it was set up last year with APRA, ASIC, us and Treasury on it. One of the main issues we are addressing first up is exactly what you just said. Obviously, disclosure matters for ASIC in particular, as well as for APRA, particularly around what financial institutions disclose. So that is absolutely something that we are looking at right at the moment.

Mr THISTLETHWAITE: The Financial Stability Board have recommended a set of voluntary consistent disclosures to help lenders and insurance underwriters manage those risks, and they look at governance, strategy, risk management and metrics. Is that something that the bank would encourage Australian businesses to start doing?

Dr Debelle : The Financial Stability Board piece that you're talking about is exactly what we are looking at in the Australian context, yes.

Dr Lowe : I think it's exactly the right direction to be heading.

Mr EVANS: Thank you, Dr Lowe, and everyone for being here today. I thought I'd just start with a very general question. Over many years, in my dealings with the RBA, it was always proudly noted how you could average out that inflation rate that's been achieved at any point in time, and the average number was 2.5 per cent—the exact midpoint of your target range. We are now entering a sustained period where the inflation rate has been lower. If you do that exercise today, and I must confess I haven't done it, are we now underneath that 2.5 per cent point or are we going to get there soon, and is that trend going to continue? And, just generally, are you concerned about that?

Dr Lowe : It depends what period you average over. If you average over the last decade, I think it's exactly 2.5 per cent. If you just take the last eight years, it's below 2.5 per cent because inflation has been low for a while. So it depends over what period you do your calculations. I think the more fundamental point is that what we are trying to do is deliver for Australians a low and stable rate of inflation of two point something or other, the average somewhere between two and three per cent. But what we want the Australian community to understand is, if you're thinking over the long term in Australia, inflation is going to average two-point-something per cent. Whether it turns out to be 2.4 or 2.5 per cent, I suspect most people in the business community don't really care that much, but what they want to know is that we're going to have low and stable inflation. That's what we've been able to deliver, and we want to deliver that in a way that doesn't imperil the stability of the financial system.

As we've talked about at these hearings before, we could have had lower interest rates over the last couple of years to try and get inflation up more quickly, and our judgement was that it was not in the national interest to do that because the way we would have got inflation up more quickly would have been to encourage people to borrow yet more than they were already borrowing and push up asset prices even further. So our judgement, rightly or wrongly, was that it was not in the national interest to do that. We were prepared to have inflation pick up gradually. Maybe it was a bit below 2½ per cent for a bit longer than we really would have wanted, but that was worth paying in the interests of longer term stability—as long as we can deliver you an average rate of inflation of two-point-something per cent, and I'm very confident we will do that.

Mr EVANS: Okay. Diving into the topic of house prices, the growth rates in house prices seems to have approximately halved over the last year or so, looking at the data in front of me. You talked in your presentation earlier about that cooling—I think that was the word you used—and you noted that there's been a price halt in Sydney and that the prices are cooling in Melbourne. That's obviously been over a period of time, or following a period of time, when interest rates have continued at record lows; you haven't raised them. How much of that softening or cooling do you attribute to regulatory actions like APRA's curb on lending? I am going to get you to expand a little bit on how that softening is playing out in specific housing markets, both in a geographical sense—in places like Brisbane and Perth—but also in housing segments, like new apartments.

Dr Lowe : I'll maybe ask Luci to deal with the segment issue. The regulatory tightening, as I said before, has played some role, but I don't think that's the main thing going on here. There's been a big increase in supply. All these apartments that have been built are adding to the supply, and that ultimately weighs on the price, and so there's been less foreign demand from China because of what's been happening in China and what's happened here. Both those things have played some role. And you do get to the point where prices get to the level where an increasing share of the population find it just very, very difficult to pay those prices, and, once that happens, some of the heat comes out of the market.

Mr EVANS: So, if you're going to conclude that it really is market force, fundamentally, rather than regulatory tweaks, which have driven the cooling, do you think that that increased supply is happening in the places where we needed it to happen to address some of those housing affordability issues in particular markets, like Sydney and inner Melbourne?

Dr Lowe : Luci, do you want to talk about the geographic composition?

Dr Ellis : Yes, sure. Most of the big increase in supply we have seen in Australia has been in the eastern states. It has been in the very inner part of Melbourne. It has been in the inner ring—not the CBD—of Brisbane. Across Sydney it has been much more widespread but a lot of it, of course, is primarily along transport corridors. It has certainly been much more widespread geographically across Sydney. In each case, it is quite large relative to the size of the existing stock. In Brisbane, for example, there are parts where the housing stock is increasing at double-digit rates in terms of what has been completed over the last couple of years and what will be completed in the next year or so.

The question is: is that the sort of housing we need? I should point out that, in Melbourne, there is actually quite a deal of detached housing being built on the fringe. The governor mentioned that transport improvements do essentially increase the supply of well located land—because, once you've got good transport, it is now well located. So there has been a real phenomenon of the west and south-west fringe of Melbourne now becoming better connected to both the Melbourne CBD and Geelong. That whole conurbation is infilling, and that has enabled quite a strong increase in the detached housing supply in Melbourne.

But you're right: primarily the increase in supply has been apartments. That is unusual in Australia. It has been primarily inner city. You can understand why that might be the case for a couple of reasons. One reason is that Australia's cities are physically very large, so there is a real premium to being close to where the employment is and where the various amenities are centred. It also reflects the changing nature of the incremental population that we are getting. A large fraction of new Australians are people who arrived on student visas and subsequently got permanent residency. They are disproportionately younger and more likely to want to live in an apartment and be near a university. That kind of demand for housing is more likely to be close-in apartment demand than fringe detached demand.

Mr EVANS: Would you agree with the broad proposition that the forces that are at play here—whether they are regulatory or market driven—have been working more strongly in those areas where housing affordability issues were sharpest compared to, say, an interest rate adjustment, which obviously would be a broad-brush approach which would have impacted markets right across the country?

Dr Ellis : I think that is a very good point. An increase in interest rates would affect all mortgage holders and their capacity to bid more for housing—or to bid for more housing. Town planning is not something that the Reserve Bank has in its remit, and it is quite hard to do right. There are a lot of competing concerns. There are environmental concerns—is there enough green space? There are all those things, which some people would regard as constraints and some people would regard as necessary protections. The bottom-line message I would draw from what has happened recently is that Australia used to have a very internationally atypical urban form whereby you could have anything you wanted—as long as it was a brick veneer detached house. What has happened over the last 20 years is that apartments have become a bigger share of the housing stock—as well as a lot of medium density. It is not just big towers; it is medium density as well. That has given people more choice. It has meant it is possible for more people to live close in and, therefore, have better access to services and employment centres. That has probably been to the benefit of the economy.

Mr EVANS: I have one minor question before I move on from the topic of housing. I think it was mentioned at our last hearing that about half of household debt is carried by the top one-fifth of households on the income scale. Is that still the case?

Dr Ellis : I couldn't swear to those particular numbers but the proportionality is there.

Ms Bullock : I think around 40 per cent of the debt is held by the top two quintiles.

Dr Ellis : No, it's—

Ms Bullock : It's more than that, is it?

Dr Ellis : Yes.

Ms Bullock : But it is disproportionately held by the higher income and higher wealth families.

Mr EVANS: Perhaps we can just talk a little bit more, Dr Lowe, about your opening comments in relation to the new payments platform. Specifically I guess I was going to get you to expand on some themes around competition. We understand pretty well about the increased competition for consumers in terms of their ability potentially to switch banks or switch between financial institutions. But I want to ask you a question about the competitive neutrality issues, potentially, between different types of banking institutions. Are the costs of working with that system or complying with it falling disproportionately on the smaller financial institutions or having any other adverse competition effects?

Dr Lowe : Those are good questions. If it's okay, perhaps I could ask Michele to answer that—

Mr EVANS: Of course.

Dr Lowe : because she's much closer to the detail than I am.

Ms Bullock : I'd like to step back just a little bit to explain the New Payments Platform, because I think some people don't quite understand what it does. Essentially what we're talking about here is a central infrastructure that allows for exchange of payment messages between financial institutions and ultimately settlement of those payments between financial institutions. That is a banking function, just like the way the cheque system works or the direct entry system works and so on. And in all those systems there are a variety of small and large institutions.

The way the New Payments Platform is set up is that the larger institutions are in fact bigger shareholders; they've had to make larger contributions. Smaller institutions that want to participate have made smaller contributions in relation to the sorts of volumes they'll be using it at. And then lots of smaller institutions have opportunities to come in behind what we'd we call aggregators. There are three main aggregators who are involved in the payments platform, and they link up hundreds of small credit unions and building societies and banks behind them. So I would say that it is quite competitive in that sense. It's allowing equal and fair access to financial institutions that want to be involved in this system.

Mr EVANS: If I'm hearing that right, that certainly seems like a sort of equitable contribution to the costs of setting up that infrastructure in that third place. But, equally, the financial institutions participating would face their own internal cost burdens to make them compliant with or able to work with the security and safety arrangements that are in place, and those would be approximately equal between different sized banking institutions.

Ms Bullock : Well, I'd actually say probably not, because the larger institutions typically have more complex and larger legacy systems. So, in fact I think what we've observed in linking up to these new systems is that the legacy and back-end systems of the large institutions have had much more complex jobs than some of the smaller institutions. The other thing is that a lot of the smaller institutions, as I said, are coming in via aggregators, so a lot of the heavy lifting for them is being done by something that can scale, if you like. So, I think you'll find that if you ask the big banks they would tell you that it has been a very complex and costly—

Mr EVANS: I'm sure they would say that, yes. Dr Lowe, I can't help myself: to come back to a conversation we had last time here, I asked you some questions about Australia's international competitiveness, specifically in relation to corporate tax rates around the world. If I can paraphrase, I think you told me something along the lines that the headline tax rates matter less than their relativities. And to quote, you also told me at that time:

… international tax competition discussion seems to have gone away a bit, because the prospect of the US having a very large reduction in its corporate tax seems less, and if they're not going to have that big reduction then others presumably don't do the same thing as well.

Obviously that turned out not to be the case. The US has indeed passed those tax cuts. So, consistent with your comments then, do you agree that the fact that the US has now passed those tax cuts means that that competitiveness debate in Australia is now more relevant than it was last time we met—that other countries around the world are now more likely to follow through on their proposals and, equally, that increases the importance of Australia making adjustments to maintain or improve its competitiveness?

Dr Lowe : Well, you're right: the debate here has moved on internationally, and it does look like there is a form of international tax competition going on. The US has moved. The UK has plans to lower its corporate tax rates, and a number of European countries do as well. And you can view this competition as good or bad. If you want lower taxes it's probably good. If you need to fund a budget then maybe it's not so good. So, whatever side of that debate you come down on, it is actually occurring, and it's hard to ignore. In the last IMF annual review of Australia they noted that relative tax rates were something that did influence capital flows. So, it's going on, and we can't ignore it. We mightn't like it, but we can't ignore it.

I think another point I'd make is that if we were to respond to this competition by having lower corporate tax rates here then it's really important that that doesn't come at the expense of higher budget deficits. And in the US what we're seeing at the moment is exactly the reverse of that. The budget deficit in the US got to two per cent of GDP just a couple of years ago, but the official estimates at the moment are that for the next five or six years the budget deficits are going to average almost five per cent of GDP. In an economy that's growing very strongly, with low unemployment, they're going to have budget deficits of five per cent of GDP. This is largely on the back of the tax cuts. I think that's very problematic, and if we were to go in the direction of having lower corporate tax rates then I think it would be a big mistake to do that on the back of higher budget deficits.

Mr EVANS: Just to confirm one point there, and maybe following on from some of the questions Mr Thistlethwaite asked about budget projections and the fiscal balance, MYEFO showed that we were tracking ahead of budget, didn't it?

Dr Lowe : Yes, a little ahead of budget—the MYEFO projections for the government to be on track to get back to balance in 2021. It's important that we stay on broadly that track—from two perspectives, really. One is from the perspective of generational equity. As the father of three teenage children, I don't like having to explain to them that we're racking up debt and they're going to have to pay it back. The other perspective is that running sensible, restrained budgets is a form of insurance, and we saw that during the financial crisis. Because of our history of fiscal discipline, the government was able to respond, and that helped the economy. One day we will have another downturn in Australia and it'll be in the national interest to have a fiscal stimulus to offset that. We'll be able to do that effectively only if we've run a sensible budget policy in the interim. We saw during the financial crisis that those countries that had not run good budget policy actually had to contract fiscal policy in the crisis, making it worse. So, from an insurance perspective we need to make sure that we kind of remain broadly on that track.

Mr EVANS: Thank you. I think I'm out of time.

CHAIR: Thank you very much.

Proceedings suspended from 10 : 47 to 11:04

CHAIR: Good morning everyone and welcome back. We will now continue our hearing with representatives of the Reserve Bank of Australia. For those who are listening on the website and who, obviously, can't see these proceedings, my name is Sarah Henderson. I'm the chair of the House of Representatives Standing Committee on Economics. I will now invite Mr Wilson to ask questions.

Mr JOSH WILSON: I just want to go back to the question of low wage growth. The conversation seems to be that we just haven't had enough employment growth to start to turn that low-wage-growth trough around. But, equally, there seems to be some concern that perhaps the model, or our assumptions in that regard, have become disconnected—the things that we used to see as being stable relationships aren't any longer. I was interested to look at a graph that showed the RBA cash rate inverted and the unemployment rate. Prior to 2015-16, those things matched up very well. But from 2015-16 they have really separated. Can you make some comment on the danger that our model—our way of understanding—for how wages relate to other factors just may not be what we thought they were?

Dr Lowe : I think that at a very high level I still believe in the laws of supply and demand. When you have tight markets, prices will adjust. That must still be the case; part of the model isn't broken. But what we are struggling with is how quickly they adjust and at what point do we get what is considered to be full employment. Maybe full employment is lower than previously thought, following the discussion we had before. And as we approach whatever full employment is, how quickly do wages adjust? Those things could be changing, but I haven't given up on the basic faith that at some point tight labour markets will lead to stronger wage growth.

Our basic strategy has been twofold. One part is to have low interest rates to support the economy and to get strong employment growth that gradually gets the labour market tighter so that then wage growth picks up. The other part of my strategy has been to talk publicly about the benefits of stronger wage growth. That is quite an unusual thing for a central bank governor to do. For most of the history of the Reserve Bank they have been more concerned about wages growing too quickly, inflation rising and interest rates having to go up! My fear was that the community had become adjusted—that people's expectations had adjusted—to two per cent wage increases, and that they thought that was the norm. In this country we should be able to deliver workers, on average, wage increases faster than two per cent.

If we're going to deliver average inflation of 2½ per cent we should probably have average wage increases over long periods of time at 3½ per cent, if we can get decent productivity growth. My concern was that we were getting used to—and we didn't like it—wage increases of two to 2½ per cent. I've spoken publicly about the benefits of a pick-up in wage growth, to try to lift wage expectations and to reduce the probability of us getting stuck at this very low equilibrium.

So, lifting wage expectations over time and having the labour market grow sufficiently tightly and strongly so that it creates more pressure with tightness means wages eventually adjust. That basic model still works, but it's taking time and patience is called for here.

Mr JOSH WILSON: Are there any other structural aspects of the Australian economy that you think need to be looked at in a relationship? I've seen your comments about trying to set cultural expectations and suggesting that people should feel the confidence to seek wage increases. But I think in practical terms that's not really how that happens—that shift in mass consciousness, where one day tens of thousands of people go and talk to their boss. Are there are some other structural features of the bargaining framework in this country that have perhaps led to that tyranny of low expectations?

Dr Lowe : I think there may have been some earlier misreporting of what I said. I never said that workers should just go and demand a bigger pay rise at the employer's door! I know, as you said, that it doesn't really work like that. But the point that I had been making, which I think is still right, is that over time wage growth should pick up, and it's a combination of workers setting higher wages and being prepared to move to firms where there are higher wages and firms being prepared to offer workers higher wages. It's that latter part that doesn't seem to be operating at the moment, because, as I said before, even in countries with very, very low unemployment rates, we're not seeing firms aggressively compete for workers by paying high wages.

It partly comes down to the psychology that has existed since the financial crisis, and that psychology is about cost control. Everyone feels there's so much competition; they're so uncertain about the futures of the firms—a lot of competition, and they feel uncertain about the future—that the last thing they want to do is increase their cost base. Paying workers more increases their cost base. Eventually I think they'll have to because the labour markets become so tight that you have to pay workers more.

It's really a global phenomenon. We can look at Australia and think that there are things particular and peculiar to us that are causing this. My judgement is that it's not really Australian-specific factors; it's global factors at play. Workers are less inclined to push for wage increases, and firms are less inclined to pay them because of this pervasive effect of competition. It's affecting the whole psychology. That's the primary thing that's going on, and the only way to solve that is for labour markets to be sufficiently tight that we go back to the old way of doing things and firms pay workers higher wages to keep them and attract them.

Mr JOSH WILSON: Thank you. If that doesn't happen soon, and if, as the forecasts suggest, the growth in employment is gradual and wage growth follows that only gradually—I'll go back to what Mr Thistlethwaite said; I'm also quite taken by the graph that shows the actual wage price index with all of the annual forecasts from the RBA that actually seem to get steeper as time goes on, approaching 45 degrees by the time we get to 2017, this sort of jump that doesn't seem to happen—and if what we've seen so far persists, what are the risks in terms of consumption levels in the Australian economy? We've seen that consumer confidence is low; discretionary spending seems to have really dropped; non-discretionary costs on households are rising. What are the risks to our economy over the next few years if the further tightening of the labour market doesn't magically produce what it hasn't produced over the last few years?

Dr Lowe : I think that would be a significant issue. It would mean that really we had no real wage increases for quite a run of years, and with no increase in real wages there's not the ability to increase consumption. That would be a significant issue. If we get stuck in a world with wage increases just being two per cent, we're going to have trouble delivering you 2½ per cent average inflation—unless productivity is incredibly weak, which I don't expect it to be. So we'll have a problem in delivering you the rate of inflation that we've set out to do, and it will clearly weigh on people's spending.

But I'm sufficiently optimistic, and I still believe in the basic laws of supply and demand that eventually, when you have tight labour markets, prices respond. It would be a very strange world if that didn't happen, if we got down to very low rates of unemployment and wages didn't respond. One reason I retain confidence in that model is that I do see parts of our labour market where this is already happening. Businesses I meet do say, 'It's so hard to get workers,' and some are saying: 'Well, we've got to finally pay more. We don't like it, because it's very competitive out there, but we have to do it.'

I expect that, if the labour market performs as we forecast, we'll hear more and more of those stories. If we can make it acceptable to have wage increases of three per cent rather than two, and the labour market's a bit stronger, I think it will change. If it doesn't happen, we're going to have a significant issue—both the Reserve Bank, because we won't be able to deliver you 2½ per cent inflation, and the parliament will have a significant issue as well. Because people won't be having rising living standards, they'll be unhappy. Lots of things have to get rethought.

Mr JOSH WILSON: Indeed. I come back to what you said earlier about the capacity of the economy and of the government budget sheet to deal with a crisis. At the moment, as you know, the proposition is to provide further business cuts to make Australia more competitive but also in the hope that that would be one of things that would flow through to wages. It obviously has a fiscal element to it as well. I've seen some reporting that suggests that countries that have gone down that path take a revenue hit by engaging in this sort of international race to the bottom. As you made the point before, the best circumstances would be that you'd have an even rate everywhere. It wouldn't then matter how low it was. It would probably be better for all countries if you could have an even rate at a higher level to give every country the capacity to look after its people with those means. But I've seen evidence that suggests that, when governments give away that revenue, they have to fix it in times to come, often through increasing consumption taxes. If that were the sort of pattern we saw over the medium term—that we gave away corporate tax revenue and then had to fix that hole by increasing consumption taxes—what kinds of effects do you think that would have?

Dr Lowe : I don't know where we would need to do that. However we finance these, it can't be by running bigger budget deficits. There could be some other changes to the tax system.

Mr JOSH WILSON: There is some evidence that that has happened. The trend is that the corporate or company tax take decreases and that countries pursuing that path end up fixing their revenue problem by increasing consumption taxes. It just seems to me that, with household income falling as a share of the economy, wages growth being flat and consumption being poor, if that's what you saw over the medium term, that would present some risks.

Dr Lowe : The IMF and other international observers, when they look at the structure of the Australian tax system, make a couple of observations. One is that we still have fairly high taxes on income and profits, and relatively low taxes on consumption. So we stand out in international comparisons in that dimension. That's the choice the parliament has made. We could make a different choice is really what you're articulating—lower taxes on income and profits, and higher taxes on consumption. That would be a structural choice that we would make about the design of the tax system, and I think that could work, and it's really up to the parliament whether that's in the national interest.

Mr JOSH WILSON: But do you have a view about the kinds of impacts that follow from that shift?

Dr Lowe : It would depend upon the timing and what was happening in the economy at the specific point in time you made these shifts, and how the compensation would work. There's kind of an underlying issue about what type of structure we want to have in our tax system. We remain fairly unusual in having relatively low taxes on consumption. The parliament has decided that's a good place to be; it's the job of the parliament to decide that.

On the design of tax systems, the other observation the IMF and others make is the way we tax land in this country, with stamp duties versus having a generalised land tax.

They are the kinds of high-level structural issues that people point to about the design of the Australian tax system, and both of those issues should be on our agenda over the medium term. I'm not saying we need to change, but they are issues that the parliament should be thinking about.

Mr JOSH WILSON: I want to come back to one of the things that you said in, I think, the equivalent session last year around our exposure to the Chinese economy, or the way that the strength of the Chinese economy impacts on Australia. You said last year:

Each year … I get more nervous about the medium-term risks.

Have you become more nervous in the 12 months since then?

Dr Lowe : Probably not. I think that's one area where there's been a slight change. It's only a slight change. At the last Chinese Communist Party congress, the emphasis was on sustainability of growth. I talk to the Chinese officials, particularly at the central bank, and they used to talk about the growth figures. They could recite endless figures about how strong the economy was growing. In the discussions over the past year, it's much more about the measures they're taking to increase the sustainability of growth, particularly on the financial side. They're taking that much more seriously than they have in the past. That's a healthy development—rather than just focusing on very fast rates of growth, focusing on the sustainability of that growth on the financial side. So that's a positive development. They've got a big task ahead of them. We know from our own experience, and that of other countries as well, that when you're changing direction on the financial side and tightening up it's very hard to calibrate that exactly correctly. But they're actually addressing that more seriously than they have in the past, so I haven't got more nervous than last time. I was worried that maybe this would be just too hard to address and they'd let it go.

Mr JOSH WILSON: I have just one last question, and it is a bit out of left field. Obviously, the Reserve Bank does its work, for which we're all grateful, according to some imperatives, including the prosperity and wellbeing of Australians. I noticed—and I wish I'd had time to look into it more closely—some work that was done back in, I think, 2015 around the question of rising income and consumption inequality in Australia. Does that continue to be a focus for the RBA, and is there anything you can tell us about that?

Dr Lowe : It's something we pay close attention to, because the level of income inequality and wealth inequality affects how the economy operates. So we've got to understand how it works. It's not an objective of ours. Our broad objectives are low inflation, low unemployment and financial stability, in an effort to promote the prosperity of the Australian people. Income inequality is not specifically an objective in there, but we—

Mr JOSH WILSON: No, but the prosperity and wellbeing of the Australian people are, and if rising income and consumption inequality has a deleterious effect on the economy then presumably that's something you'd look at.

Dr Lowe : We have to understand how any changes in income and wealth inequality affect the economy, so we certainly look at what's going on there and try to understand the trends.

Mr JOSH WILSON: On that, what, broadly, do you think is the relationship? Do you think that rising inequality is good for the economy or bad for the economy?

Dr Lowe : The changes in Australia in recent times have been fairly small. Wealth inequality has risen over a couple of decades. The main thing that we're doing to improve income equality is jobs generation, because nothing helps people like getting a job, does it? The fact that 400,000 people have got jobs over the past year has helped. We have relatively limited tools—most of the tools are actually in the parliament's hands—but what we can do is promote a strong economy, which promotes strong jobs growth and, ultimately, wages growth. We're playing our role there.

The link between income inequality and economic growth is an area that's subject to a lot of research at the moment. When you look at countries where there are very disparate incomes, there are two effects at work. One is that there's a strong incentive in those countries to get skills and get training, because you can move from a low income to a high income and the benefits are very high. But the effect working in the opposite direction is that if you have low income it's hard to actually access the kind of education and other things—finance—that can actually move you from being a low-income person to being a high-income person. There's quite a debate in the economic literature about how income inequality affects longer term growth and how these two effects work in opposite directions. I think the changes we've seen in Australia in recent times aren't really that large.

CHAIR: Thank you very much, Mr Wilson. I'd now like to invite Mr Kelly to ask questions.

Mr CRAIG KELLY: Dr Lowe, you mentioned at some of our previous hearings that you had some concerns about the link between wages growth—that it was actually a worldwide phenomenon. You were saying what we were seeing in Australia was very similar to the rest of the world. I think recently we saw the US wage rises in January. I think they said it was about 2.9 per cent, one of the largest increases since 2009. The US seems to be breaking that cycle. Is that the first breakout we're seeing, across the world, of a more significant increase in wages?

Dr Lowe : I wouldn't describe it as a breakout yet, but it did surprise people that wage growth in the US had picked up. For me it was confirmation that the laws of supply and demand still work. Tight labour markets eventually result in firms paying higher wages, and that looks like it's starting to happen in the United States.

I think it's going to be a gradual process, because these forces about competition they've been talking about are pervasive and strong. This is going to continue operating, but they're not going to last forever. Markets took some fright from that, which is understandable. On the other hand, it was perplexing me how people could think that we could have above-trend growth, very low rates of unemployment, low rates of inflation, low interest rates and low volatility forever. It's good when it's happening but normally it doesn't last forever. We're starting to see the first reassessment of that: we've seen bond yields go up and the stockmarket become volatile. In a way, this is a positive sign.

Mr CRAIG KELLY: Because that wage growth in the US in January was also accompanied by a fairly large lift in employment. Often we think: there are more jobs being sucked up, and that's keeping wages down. However, you had the wage growth at the same time as the employment growth.

Dr Lowe : It's a positive story, and remember the unemployment rate in the US at the moment is 4.1 per cent. It wasn't that long ago that people were estimating the NAIRU, which we were talking about before, as close to five per cent. So they've gone almost a full percentage point below that, and wage growth is picking up.

Mr CRAIG KELLY: For those good results in the USA, do you think that has anything to do with the announcement of the reduction in the corporate tax rates?

Dr Lowe : Certainly, cutting the company tax rate has helped lift business confidence in the US. Whether that's led to more direct hiring in the last couple of years, I don't know. We saw the US have a fairly strong labour market over the past year and a bit before the tax cuts got through Congress.

Mr CRAIG KELLY: It's all speculative, I understand.

Dr Lowe : It certainly gives business confidence. I think it's a stretch to attribute the strong employment growth in the last six months to the corporate tax cuts in the US.

The other point about the US that I'd like to make—and it refers back to the point I made before—is that this is coming at the expense of much larger budget deficits. The US budget deficit blew out in the financial crisis—that was understandable. It was on track to come back to balance a couple of years ago, and it got down to two per cent of GDP. However, the Congressional Budget Office are projecting budget deficits of nearly five per cent of GDP for year after year after year. That is starting to concern the financial markets. Bond yields have gone up, the US dollar is down and there is stockmarket volatility. It may make economic sense to cut the corporate tax rates—I'm not endorsing it, but you could understand why people say it made economic sense. If it's at the expense of ongoing budget deficits, I think there's a very big question mark over that. How it gets ultimately resolved is going to affect how financial markets perform.

Mr CRAIG KELLY: If we look from an Australian perspective, our corporate rate of tax is now 30 per cent; I think, in the eighties, it was something like 49 per cent. So we've reduced it substantially. The last reduction was from 36 down to 30 per cent back in about 2001—I think it was a staged fall. When we reduced that corporate rate of tax, looking at the numbers, it actually didn't hurt the budget deficit at all. In fact, it did the opposite: it appeared to assist the budget deficit, and we increased not only the rate of tax in monetary terms but as a percentage of GDP.

Dr Lowe : These comparisons are always difficult because you've got to control for all the other things that were going on in the economy at the time, and I haven't passed out the various effects here. At least in the short term, cuts in company tax rates do reduce government revenue. You might then argue that that creates stronger growth and that you pay for that over time.

Mr CRAIG KELLY: Isn't that the question about where the optimal level of your corporate rate of tax is? If you had the corporate rate of tax at 100 per cent, you may not get any corporate tax. What's the point of anyone investing, if the corporate rate of tax is 100 per cent? If the corporate rate of tax is zero, there's no revenue coming in. Isn't there a sweet spot that you need to get to?

Dr Lowe : We know two points on the curve; they're at 100 per cent and zero, and they both deliver you zero. There's a curve that goes—

Mr CRAIG KELLY: Correct. So isn't there some sweet spot that we need to try and find?

Dr Lowe : There may well be. Whatever that sweet spot is, it is influenced by what's going on in other countries. You made the point that Australia has reduced corporate tax over time, and that's entirely understandable, but so has almost every other country. If you look at a graph of corporate tax rates in developed economies, they've been on a downward trend. Partly, there's this kind of international tax competition—countries feel they can get more investment into their country if they cut the corporate tax rate. That's true in the short run, but where does it lead? We've ultimately got to be able to get the tax revenue to deliver all the fantastic services that—

Mr CRAIG KELLY: I've often heard you talk about animal spirits. If the company tax rate's 100 per cent, the animal spirits are crushed and driven into the ground. So isn't there a chance that the lower the rate of tax you have, the more you're unleashing these animal spirits that you like to see in the economy?

Dr Lowe : I think that's true. But there is another set of animal spirits to report: the animal spirits in financial markets. If you finance this through debt, those animal spirits can turn against you. It hasn't happened in the United States, but it's certainly a focal point for investors in where this is all going to end. The corporate tax cuts are sufficiently large that they've reduced the revenue base, and they're going to run much bigger budget deficits. Those animal spirits could turn the wrong way.

I think the other point in this whole debate about tax that is important to make is that tax is only one element that makes Australia an attractive place to invest. Last Monday night I spoke at the A50 forum, which is something the government has organised to showcase Australia to international investors. Not many of those investors were here just because of the corporate tax rate in Australia; they were here because of our stable and productive economy, infrastructure investments, our natural resources, our educated workforce and our education system. All of those fantastic things draw people here, so they're all important as well. We should have the debate about corporate tax, but we shouldn't have it at the exclusion of all these other things. When you say, 'How many of you are here because of Australia's corporate tax rate?' no-one says yes—

Mr CRAIG KELLY: It's a multiple—

Dr Lowe : Yes, it's multiple things. We've got all these balls in the air—

Mr CRAIG KELLY: We need to have a competitive economic regime to attract foreign investment, and corporate tax is one factor in that. Is there a risk, then, to the economy if we're out of kilter with the rest of the developed economies, where we're competing for international capital and international investors?

Dr Lowe : There is a risk if we're not an attractive place for international capital. As I said before, in answer to another question, Australia has benefited tremendously from the flow of capital building the country that we are now lucky enough to live in.

Mr CRAIG KELLY: But an uncompetitive tax rate has to be something we should be concerned about?

Dr Lowe : As would an uncompetitive education system or labour regime—any of those things. We've got to pay attention to them all; I agree with that. As the global standards shift on tax rates, we have to pay attention to that. It's really up to the parliament to balance that with all the other things it has on its agenda.

Mr CRAIG KELLY: What about energy costs? Is the competitiveness of energy costs in this nation, compared to the USA, a concern to the RBA? In some of the figures that I've seen—I'm talking about electricity—our energy costs are double, and in some circumstances triple, what they are in the USA.

Dr Lowe : It is a significant issue. A number of people have made the point that the outcomes here have been disappointing, because energy should be part of our competitive advantage. Low-cost, accessible energy, given our natural resource base, should be part of the competitive advantage Australia is selling to the world. At the moment, that's not the case. In a way, it's turned into a liability rather than an asset, and the government has plans to turn that around. I think delivering on the final plans and making electricity more affordable is important. It's having an effect on the economy now. It's having an effect on investment in a production capacity in the electricity generation sector, in terms of uncertainty—that's having a first-order effect.

Some businesses that we talk to have been delaying investment, because they're not sure about the future cost and availability of electricity. Even though investment is picking up generally, there are segments where they are saying, 'I am not so sure about what the future price of electricity is going to be, so I will just hold off.' That is an issue, and it has affected consumer budgets. CPI growth is low, but one of the things that is pushing it up is utility prices, which are up 10 per cent over the past year. It is having multi-faceted effects on the economy. It is another one of these issues that we need to give very close attention to.

Mr CRAIG KELLY: Could it also be affecting wage growth, as well—that companies all of a sudden have to use a lot more of their income to pay for higher electricity bills that they could perhaps give to salaries for staff.

Dr Lowe : Perhaps in some cases. I don't think it is right across the economy. We do hear many businesses say that the higher electricity costs have had to be absorbed in the profits, because the pricing environment is so tough and competition is so strong. It is very hard to pass that through—

Mr CRAIG KELLY: But that ultimately has to affect their ability to increase the wages and salaries they pay to their staff?

Dr Lowe : In some specific firms, but for most firms electricity costs are not the major cost. There are other things going on. I would not deny that in some individual firms that is an issue. It is not a first-order explanation for what is going on with wages.

Mr CRAIG KELLY: So, at the moment we have energy costs that are making us uncompetitive and we have a corporate tax rate that is above the rest of the world. Are we starting to give away our nation's competitive advantage? Is it starting to slip away?

Dr Lowe : These investors I spoke to last Monday evening think Australia is a fantastic place to invest, and why wouldn't they—the rule of law, the macro stability, the financial stability, our education system, our natural resources and our growing and diverse population. So, it is a fantastic place, but we shouldn't just rest on that. We have to keep making it fantastic and keep an eye on these things you are talking about.

Mr CRAIG KELLY: My other question is on minerals exports. They have been substantially higher in 2017 than you predicted—or most analysts predicted.

Dr Lowe : Have they been higher than predicted?

Mr CRAIG KELLY: Yes.

Dr Lowe : I don't know. I don't think so. We've had a pretty good eye for some years on the capacity expansion, particularly in coal, iron ore and LNG. The growth in exports there is playing out pretty much as we expected, with probably one exception: the building of the LNG projects is taking a bit longer than we thought, so the ramp-up in LNG production is taking a bit longer than we thought, but it is coming.

Mr CRAIG KELLY: I saw some numbers, released last week I think, showing that the value of our coal exports was up about a third last year. Last year, I think it was $54 billion, as compared to $46 billion in 2016. Was that factored in—

Dr Lowe : Coal prices have gone up and down—

Dr Ellis : That must have been values.

Dr Lowe : There hasn't been very much expansion in productive capacity.

Mr CRAIG KELLY: But the value has gone up?

Dr Lowe : The value depends on what the prices are. At some points there are shutdowns in the production chain, which affects it.

Mr CRAIG KELLY: But that was an extra $10 billion in export revenue—

Dr Lowe : I think that is largely the prices—

Mr CRAIG KELLY: Which was price. But from an economist's point of view I think the price is more important than the actual tonnage.

Dr Lowe : That is real income. I mentioned before that commodity prices have been stronger and that is one of the things that has helped lift the Australian economy. There is more income coming in from our exports. The example you are pointing to is one of those. That is a positive thing. More income, more tax revenue, helps the budget deficit and provides some offset to the other factors we were talking about.

Mr KEOGH: I want to pick up on some of the questions from Mr Kelly and the statement that was about the issue of the relativity of tax rates. When you are looking at the relativity, I suspect it is more than just the relativity of the headline rate at a national level as opposed to effective rates, and also looking at sub-national imposts. Can you go into that a bit?

Dr Lowe : My capability to do that is fairly limited—

Mr KEOGH: I reckon you can give it a crack!

Dr Lowe : Tax policy is not one of my core areas of expertise. I agree with the general point that the way you treat depreciation and how quickly you can write an investment off are really important, and the type of deductions you get are really important in the tax system. As best we can tell, when you take account of all those things the differences across countries narrow a bit. I wouldn't like my comments to be taken as saying that I think the Australian tax system is uncompetitive. My basic point is: we need to keep a close eye on this, and it's really up to the parliament to decide how much weight they want to put on tax in making Australia an attractive place to invest, versus some of the other things that you could do—invest in education or transport, blah, blah, blah. So it's really up to you. But we do need to keep an eye on it because the ground is shifting here.

Mr KEOGH: As to the previous point that you were making about increased commodity prices and that being a boost to the economy: we saw, through the mining construction boom, of course, a massive expansion of capacity to export resources, and we've seen that very much so across the nation—Mr Kelly was just referring to coal exports; obviously there were iron ore exports, in volume—and therefore the dollar value much higher than it was previously. That has an impact on GDP, but a lot of that money is profit, and a lot of that profit ends up back outside of the country. So does that impact on our high-level macroeconomic figures to sort of mask other—not necessarily weaknesses, but to make things look a lot stronger than they may necessarily be for people on the ground in Australia?

Dr Lowe : No, I don't think so. The extra revenue is providing income for Australians. You are right: some of it gets sent offshore in the form of higher dividends. But the tax revenue is up because of the higher commodity prices. My sense is that—you are closer to this than I am, but—in Western Australia the higher commodity prices have lifted the mood in Western Australia and there is more investment going on in exploration and replacement of depreciated capital because commodity prices are up. Firms have the capability to do it; they've got more profits and they feel like they're prepared to do the sustaining capital expenditure. And businesses feel better in Perth than they have for quite a while. I think Luci was just there earlier this week, and the mood is not buoyant but it has certainly improved, and partly that's the high commodity prices. So these prices kind of filter through the economy in lots of different ways that are hard to track, but it does work.

Mr KEOGH: One of the impacts of increasing your capacity to mine is that you mine through your mine faster and have to start building new ones!

Dr Lowe : Yes, and your machines wear out, so you've got to spend money on replacing your machines, and that takes workers, and that's happening.

Mr KEOGH: There was an interesting point about unemployment being now down around 5.5 per cent. In your previous statement, back in December, I think you referred to effectively 20,000 new jobs being created a month—or net jobs being created a month—but in January that did come down to only 16,000. I understand there is a seasonal component to that. In particular, once that was broken down, I was looking at: while there were nearly 66,000 new part-time jobs created in January, there was a loss of nearly 50,000 full-time jobs, which would suggest that, in terms of total working hours being created, there may even be a negative effect there. Does that go some of the way to explaining why we're not seeing the wage growth pressure coming along with the reduction in unemployment or the creation of jobs? While there's a headline increase in the number of jobs, the number of hours of job that they are producing, or the instability that may go with that, is not the same as, say, putting on a full-time job?

Dr Lowe : I wouldn't draw that conclusion. I think, when you look at the monthly data, you've got to kind of put a filter through it. You mentioned seasonality, and one of the things we've noticed in the last three Januaries is that there have been very big declines in full-time employment and big increases in part-time employment. It may be that the seasonal patterns in the labour market are changing. So I wouldn't read very much into—

Mr KEOGH: Usually we see that at the end of the school year, pre Christmas—we see a lot of part-time employment put on or short-term employment put on for the Christmas season. That would explain an increase in the December period. Is there any explanation for why we're seeing that in the January period?

Dr Lowe : No. It looks like a change in seasonal pattern or that seasonal factors need adjusting. It has happened three years in a row. What has also happened three years in a row is that in February that kind of gets reversed around. Well, it has happened for two years; we'll see whether it happens three years in a row in a month's time. So I wouldn't draw any conclusions from looking too much into the detail of the January data, given the seasonal patterns.

Mr KEOGH: Are you concerned that, as a general rule, part-time or casual employment is increasing in comparison to full-time employment?

Dr Lowe : That was true a year ago but in the last year we've had extraordinary growth in full-time employment. And even after the January numbers—

Dr Ellis : There were 400,000 jobs in total. The bulk of that increase has been in full-time employment over the past year and, in particular, in the past three quarters. Up until December, we had an extraordinary run of full-time employment. Within that, you do get these months where one or the other of those two components does actually fall in the month, and then it bounces back. But the reality is that, over the last year, we've had more than double the rate of total economic growth that we need to keep pace with the growth of the working-age population.

Mr KEOGH: We are keeping pace with population growth. But if there is, say, a difference in the number of hours worked by each of those people, doesn't that change the—

Dr Ellis : Average hours worked stopped falling because there was so much full-time employment being created over the past year in comparison to part-time jobs. To put it in perspective, we have just seen 16 consecutive months of employment growth. That is the first time that has ever happened in the history of the labour force survey. The previous record was 15 months, in the recovery from the early nineties. It is actually quite common to have the odd month where total measured employment growth falls. But we haven't seen that for 16 months. There have been a number of months over the past year where the full-time number fell and the part-time number rose, and the total was still strong—and that just turns around next month. It is much better to look at it quarterly and over the full year. Over the full year, full-time employment grew by more than three per cent.

Mr KEOGH: You said that trend is quite unusual for Australia. Is that reflected globally as well, or are we an aberration there?

Dr Ellis : These are sample surveys of households. The reason for that is that, when you take a sample, there will be some sampling noise—so these things will shift around. It is unusual for Australia to have such a long consecutive run of total employment growth month to month. I think it would also be unusual for household surveys in other countries. But the reality is that I don't know the answer because people don't get excited about the month-to-month variation; everyone knows to smooth through the variation in monthly surveys.

Mr KEOGH: I am interested in the run of growth. If you are having that run of growth, and the lack of wage growth is a global phenomenon, is that also a global phenomenon?

Dr Ellis : There have been a number of countries where employment growth has been strong. That's how they've got to their low unemployment rate. The sorts of number you are running, at double the rate of working-age population growth, is relatively unusual but it's not unheard of at various points in time in various countries. Indeed, total employment growth running that fast for a while is not unusual in Australia; it does cycle around the longer run averages.

Mr KEOGH: But usually you would see that paired with some more significant increases in wages, I would have thought.

Dr Ellis : It depends on the level of unemployment. As we talked about before, we still believe there is some labour market slack. Even in the past, we would have expected the rate of unemployment at which wage growth starts to pick up to be a bit lower than where we are now. That is something we have always thought. As new information comes in, that estimate can evolve. But we have had a number around 5 in our minds for some time.

Mr KEOGH: UBS Global Research released a report on 5 February this year on the Australian banking sector. They looked at data that has started to be provided by CBA, NAB and Westpac about their mortgage borrower gross income. It showed that the average household income for owner occupied borrowers was $208,000 and for investment borrowers it was $238,000. They benchmarked that data against disclosures from the census and the household income and wealth survey and ATO data, which showed much lower household income levels and far fewer very high income earners. One of the potential implications they've drawn from that is that many borrowers are materially overstating their household income to secure a mortgage. If that were the case, would that be of concern to you in your role? Obviously, I will ask APRA about this, but, as the central bank, would that be of concern if that were starting to creep into the banking sector?

Dr Lowe : If it were the case, it would be a concern if borrowers weren't telling the right information to the banks and the banks weren't verifying income statements; that would be a concern. But there can be other reasons for why there is a disconnect between these various measures as well. APRA has spent quite a lot of time recently both on the income and on the expense side. What had been happening is that many banks had been assuming that the borrowers could live on relatively small amounts of money—much smaller amounts of money than in practice many people can live on. So there has been a concerted effort by the regulators to make sure that the banks are using appropriate expense calculations when working out what the size of the loans could be.

Mr KEOGH: Do you think that would put pressure on people to then start overstating their incomes?

Dr Lowe : It may put pressure on people to do that—

Mr KEOGH: Maybe behavioural economics is not the bank's forte.

Dr Lowe : but the banks have a responsibility to verify the income. APRA has standards about that and the banks' internal policies require them to verify income. If they are not doing that, I would agree that that is a very significant issue, but I haven't seen the evidence to suggest that they are not doing that.

Mr KEOGH: UBS also drew another potential implication—they admit there may be a combination of factors here, and they effectively excluded the notion that the banks had an extraordinary particular portion of the demographic of Australia—and that is that Australians are consistently understating their income to the ATO, the census and the ABS and that that would have an effect on understating GDP and other statistics. What is your view on that?

Dr Lowe : I don't know whether Australians are doing that. They shouldn't be able to do it, because the wage and salary information gets transmitted to the ATO by employers. If people are not telling the truth here, I would have to agree that it is a major issue. I don't know whether that is the case or not on a widespread basis.

CHAIR: Mr Keogh, I'm sorry, we will have to finish up your questions. Your time has run out, regrettably. Could I now move to Mr Hogan and invite him to ask questions.

Mr HOGAN: Thank you all for being here. Governor, you have often spoken in the past about the Aussie dollar. I think when it was around 80c you thought it was a bit too high. It fell lower, actually, after you made that statement, which was a while ago, and it got down to the low seventies. It has crept back up to 80c again. How are you feeling about that? You talk about household debt when we look at interest rates and you are concerned about putting rates up while debt levels are this high. Obviously, the Aussie dollar comes into this equation as well. Do you want to elaborate on that?

Dr Lowe : I generally think about this in terms of the trade-weighted index, which averages across all the different currencies that we trade with. On a trade-weighted basis, the Australian dollar is basically in the middle of the range that it has been in for the last couple of years. I think that is manageable. As I have said to this committee before, I would prefer a lower currency at the moment than a higher currency, because a lower currency would mean stronger growth in jobs, probably, and we would be a bit more competitive. And it would push inflation up a little bit, which is kind of what we need. So, a lower dollar would be better than a higher one at the moment, but we are where we are.

The rate against the US dollar is very interesting, because that is largely a US dollar story. The US dollar has been weak in global markets for quite a few months now, and that has perplexed a number of people. Guy, do want to comment? We struggle with why it is that we are seeing the weakness in the US dollar, and so our dollar has gone up against the US dollar.

Dr Debelle : Normally, you would expect that a country which was tightening monetary policy and was expanding fiscal policy would have a higher currency rather than a lower currency. I don't know whether some element is people are getting a little concerned about the sustainability of the US fiscal position and that is starting to kick in. The other thing to bear in mind is that other countries have looked better over the past six months or so, and that has probably had something to do it with as well. As Phil said, by and large, it has been somewhat of a mystery to most people as to why that has happened, but, as he also said, most of the movement has been the US dollar rather than anyone else. If you look at us against almost every other currency in the world, we haven't done much at all.

Mr HOGAN: Just staying on the US for a second, you mentioned in your opening address the volatility that we saw appear a few weeks ago. A lot of that was in the bond market. You mentioned that wage growth maybe caused some of that volatility initially, and you saw bond prices spike up or yields go up. Is that maybe part of it? Also, would you like to segue, if it's appropriate—because I'm always interested—to where we are with quantitative easing, which was the topic of the month every month about three years ago, and how that is fitting into this and playing out as well? I've seen that some of the bond auctions lately over there have been not that impressive.

Dr Debelle : I think it's interesting. To go back to something Phil said earlier, most of the volatility has actually been in the equity market rather than the bond market. If you go back a couple of weeks, bond yields started to rise mostly because the global outlook was looking even better, and wage pressure was starting to appear in the US, so bond yields were starting to rise. Equity prices have been very strong in the US—particularly strong in the US over the first part of this year, in January. If bond yields are going up then those equity valuations start to look a little stretched, and you started to see some of an adjustment to that. That generated a bit of volatility. Then combine that with the fact that a number of investors had piled into these products, which were predicated on volatility staying low. When it didn't, they lost their money, and some of the people who'd sold them those products had to hedge. That exacerbated the volatility. But, if you go back to the root cause of this, this was mostly because the global outlook was looking even better, which is a good thing. Bond yields were starting to rise.

One thing worth bearing in mind, though, is that bond yields in the US haven't quite got to three per cent yet. If you go back before 2007, it would be extraordinary that they would be as low as they are. So we're only getting back to what used to be regarded as an extremely low number. We haven't actually even got quite there yet. So I think that's one thing to bear in mind.

In terms of quantitative easing, to update you on where we are on that one now, the US is actually unwinding gradually—very gradually—the size of its balance sheet—the Fed is. They're not selling bonds; as they mature, they're just not buying more of them. That's another thing to think about in terms of the bond market dynamics at the moment. The US government is issuing more debt to fund its budget deficit, and the central bank is no longer buying the amount of bonds that it was doing; in fact, it's letting those holdings run down. So there's a bit of a change in dynamic there.

In the rest of the world, the Bank of Japan is still buying, basically speaking, about as many as it has done for the last number of years, but the European Central Bank has started to run down its bond-buying program, and there's some expectation that, come the end of the year, that may cease. So those dynamics, particularly in the US and to a lesser extent in Europe, have actually changed somewhat over the past six months.

Mr HOGAN: I won't get involved in the debate about corporate tax rates, but I take your point that initially there's a budget hit. The empirical evidence of that is quite evident. But obviously, as Mr Kelly alluded to, there is a lot of empirical evidence that says that that can be great for the economy and that you can use that to increase your tax take after a few years—the percentage of it as the size of the economy. But I would invite you to make a comment—obviously it's a competitive business—on what corporate tax cuts, not just in the US but indeed in a lot of major economies, such as the UK as well, have been doing for global growth rates—how you see that.

Dr Lowe : I don't know whether it's a thing that's really lifting global growth, because, if everyone's cutting their tax rates to get a competitive advantage, it doesn't improve global growth. It's a bit like exchange rate depreciation.

Mr HOGAN: I've got a lot of reports saying that some countries have revised up their growth rates because of that. You don't agree with those revisions?

Dr Lowe : In the short term it can, because you get a fiscal stimulus: the government's taking less money out of the economy, and that can give it a short-term hit. But in the longer term, if everyone cuts their corporate tax rates from here to here, do you get stronger global growth? Maybe. Maybe not. I think that's an open question. But certainly in the short term, when you cut the corporate tax rate, for a period of time you do get stronger growth. The government's taking less money out of the economy, and there's more in the private sector.

Mr HOGAN: Yes, sure. I want to touch on something you raised, again in your opening address, and it's obviously a concern for, I think, everybody—regulators, legislators—and that is the level of household debt. We really are a stand-out globally in our household debt levels, and you spoke about watching that and said you were hoping for a variety of factors that suggest it might be starting to steady now, with housing prices et cetera coming off a little bit. What's your explanation as to why we are up there at the top of that? Someone tried to explain it to me once as our interest rates being low. But in the UK and the US they've had interest rates much lower than ours, yet our level of household debt is much higher than theirs. What's your rationale for that?

Dr Lowe : I don't think there's a single answer. It's a complicated set of issues that interact with the structure of the financial system and population growth. You've got a liberal financial system where, if people want to borrow, most of the time they can provide the finance as long as they're of reasonable credit quality, and people have been prepared to borrow.

I think the other driving dynamic here is the population growth: strong population growth, which has pushed up housing prices. Housing prices go up; people decide they'll borrow to take advantage of that. That might push housing prices up more, and we get a dynamic where you end up with a higher level of housing prices and higher level of debt relative to income.

Luci might talk more about this, but the other dynamic on the housing market is that we have made choices as a society to give us high housing prices, on average, and that goes with high debt. The choices we've made are to live—most of us—in fabulous cities like this. We want large blocks of land—it's changing, but we've wanted large blocks of land—and we've underinvested in transport, so we've restricted the supply of well-located land. And we've got a liberal financial system and zoning restrictions. If you asked anyone how a country would deliver high housing prices, you'd find we've made all those choices: live in fantastic coastal cities, most of us; underinvest in transport; have a liberal financial system; and not want high density. We've done all that, so there are high housing prices and this interaction between housing prices and debt. I think that's a sustainable equilibrium. Our debt's high relative to income, but so is the average housing price relative to income, and that's perfectly sustainable. Absent some major shock, I don't have a particular worry about it.

CHAIR: Thank you very much, Mr Hogan. I'd now like to invite Mr Thistlethwaite to ask any supplementary questions.

Mr THISTLETHWAITE: Dr Lowe, I just want to go back to the issue of the macroprudential measures that were introduced by APRA over the course of the last year and the effects that they've had on the housing market. The banks pointed to household debt as an issue over previous years—as a drag on the economy, if you like. When the new macroprudential measures were introduced there was some criticism of the banks in that they passed the cost on to their customers. Whilst APRA was certainly targeting interest-only loans, the cost was borne by other customers through other loans as well, and the banks were criticised for that. What's your view on that? Do you think that the banks were worthy of criticism for the way they passed on those costs to other customers as well?

Dr Lowe : If we take the interest-only loans—I think that's the easiest example to think about—the regulatory restriction was to have no more than 30 per cent of the flow of new loans being interest only, so it was very much focused on the flow of new loans. When we discussed this at the Council of Financial Regulators, that was the focus—not the existing stock of loans but the flow of new loans. It did not come as a surprise to me that banks would introduce a premium on new interest-only loans. That's how the market works: if you restrict the supply and there's strong demand, you've got to charge a higher price. So that did not come as a surprise to me.

I think a more interesting issue is about whether the banks needed to reprice the whole back book of interest-only loans—all those interest-only loans that were already on their balance sheets—because that was not part of the regulatory restriction. That was really on the flow, and we were very explicit about that. You'll have to ask the banks why they did that, why they repriced the whole back book, because that did not come from the regulatory side. They were able to do it and they did it. Why? Sometimes I see it written that that's because of the regulation. I think that's a misreading. It's a reflection of the state of competition in the banking system; it wasn't a result of the regulatory restrictions.

Mr THISTLETHWAITE: When that new regulatory restriction was put in place did you expect them to pass them on across a broader customer base, or were you only expecting them to apply them to new loans?

Dr Lowe : I certainly expected the price of new interest-only loans to go up, and I wondered what would happen on the stock of existing loans. The banks kind of have this standard variable rate and they apply it to both new and existing loans. I thought it was a possibility that they would just have a new standard variable rate for interest-only loans and it would apply to the back book and to the forward book. Another way they could have dealt with it, which is what I was hoping would happen, but I wasn't sure whether it would happen, was that the discounts the banks use, or give people, on new interest-only loans would decline. Most people don't pay anything like the standard variable rate. At the moment for many loans it's like 5½ and the average mortgage rates were four or 4¼. This is a factor of the Australian mortgage market which I kind of find slightly disturbing. There are high posted rates and then there are discounts that aren't particularly transparent. The banks could have kept the high standard variable rate on existing interest-only loans and greatly reduced the discount on new loans. That was a possibility, but I didn't have a clear expectation that that would happen.

Mr THISTLETHWAITE: Do you think that the fact that they all did it at once and they all extended it across the loan books is evidence of a lack of competition in that market?

Dr Lowe : It reflects on the nature of competition—let me put it that way. It also reflects on the way they price mortgages, with the standard variable rate discounts and the standard variable rate moves. You could imagine a different pricing structure in the market, where the flow of new loans attracted a different rate from the existing stock of loans. Arguably, in a truly competitive market that might be how it works, and it could have worked this time if they'd changed the discounts, if they'd got rid of the discounts, and so you did pay the posted rate on new loans. I don't know whether it's a lack of competition. It's a reflection on the nature of competition and the structure of the standard mortgage contract in the Australian market.

Mr THISTLETHWAITE: Some of the smaller banks have criticised the measures as being anticompetitive because they lock in market share for the bigger players. They believe that the restrictions on the growth, particularly, in interest-only loans has locked in market share. That is something that was identified by the Productivity Commission in their recent report. Is that a philosophy, if you like, that you agree with, that it has locked in market share for the bigger players and is anticompetitive?

Dr Lowe : Certainly not on the interest-only loans, because, again, it's the flow. If your portfolio is growing very quickly then you can make up to 30 per cent interest-only loans, so it doesn't restrict the growth in the size of your aggregate portfolio. So I don't think that's affected the competitive environment for interest-only loans. It's more of an issue on the 10 per cent growth on investor lending. Initially, that was constraining some institutions who wanted to grow more quickly than that. At the moment, investor loans are growing at three per cent or four per cent in aggregate, so for the system as a whole they're way within the constraints. There's been a recalibration. I think at the moment it's not that big an issue. This is a decision for APRA, but one could imagine, given the way within the constraint, that the nature of that constraint could evolve over time and be adjusted. That might address some of these competitive concerns that people were legitimately raising.

Mr THISTLETHWAITE: Where do you see this whole phenomenon of cryptocurrencies playing out in the next couple of years?

Dr Lowe : Where do I see it playing? I don't have a crystal ball here. The one point that I've made publicly a number of times is that I think bitcoin is speculative mania, and people should be very, very careful. It's a very inefficient payment system. It's very costly. The electricity use is very high. There was a fear of missing out there, for a while. I got an example of this when I caught a taxi back from the airport recently—occasionally people recognise me. The taxi driver recognised me and said, 'Should I be buying bitcoin?' He first thanked me for the low interest rates and then asked should he be buying bitcoin. It was just an illustration of how this mania has taken hold. I think people need to be very careful there.

There are broader issues though that the central bank community's thinking about. The underlying technology—distributed ledger technology—could actually be used to change payment systems a lot in a way that actually helps the public welfare.

Mr THISTLETHWAITE: Can I just jump in there? Does that have implications for the bank in managing the money supply?

Dr Lowe : Not directly. Just let me quickly take you through the technology possibilities at a higher level. One is that, rather than issuing these polymer banknotes, we could issue electronic tokens that moved around a kind of electronic wallet. That's technologically possible. I don't see the public policy case for doing that but, in time, that might be possible. Another way is for us to issue certain electronic liabilities in a tokenised form that could be used with an inside closed settlement system that could allow more efficient business-to-business payments. They're the two options.

People also say, 'Well, the central bank could offer everyone a bank account and offer payment services.' I have no interest in doing that. That would fundamentally change the structure of our financial system—not just monetary policy but everything in the financial system—so we have no interest in that. The most likely use of distributed ledger technology for the central bank—and we've got an open mind about this—is the issuing of tokens into closed highly-permissioned systems that could then be used for efficient business-to-business processes. We've got an open mind, and I think the public policy case for any of these things hasn't been established. We've got a team at the bank looking at the possibilities, how the technology works and what the public interest in doing these things would be. I don't think any of them undermine our ablity to operate monetary policy. The only one would be: we could offer every single Australian an exchange settlement account at the Reserve Bank. That would reshape everything.

Mr THISTLETHWAITE: I understand that the Bank of England is doing some research on the potential of developing their own cryptocurrency. Is that something that the Reserve Bank is looking at?

Dr Lowe : When you say developing their own cryptocurrency, what they're thinking about are electronic versions of the banknote—can you call that a cryptocurrency? From my discussions with the other central banks, I don't think any of them think that's a sensible thing to do. The most efficient way to move money from account to account is through the existing banking system, rather than creating a new form of electronic liability that can be passed from electronic wallet to wallet.

We've got the NPP in Australia and a fairly efficient domestic payment system. People are looking at that because it's now possible because of technology, but I don't think anyone is particularly keen. The use of these kinds of tokens, which you could call a cryptocurrency, is just another form of electronic liability the central bank offers. We're looking at how that would work in certain closed highly-permissioned systems and we're talking to the Bank of England. We're involved in a lot of working groups at the international level and we're pretty much the same as where everyone else is.

CHAIR: Dr Lowe, earlier in proceedings the deputy chair referenced some forecasts not being accurate. I know you mentioned in the August hearing that there's a lot of moving parts when it comes to forecasting. Given the most recent financial statements show revenue is ahead of what was forecast at MYEFO—and we've heard this already—of around $2 billion, are you encouraged by this, particularly when you consider this in the context of the very strong jobs growth that we've seen in Australia in the last 12 months?

Dr Lowe : I don't pay particular attention to the exact budget numbers. That's not my area of responsivity, but what I am encouraged about are the factors that are driving any improvement in the underlying budget: the pick-up in commodity prices, which we talked about, the strong jobs growth and the restraint in spending. These are the things that are helping, and I'm encouraged by those. It's a positive development for reasons we talked about before: the need to have sustainable fiscal policy and, if we're moving in that direction a bit quicker than was originally projected, I think that's good.

CHAIR: You've made particular reference to the strength of the growth in full-time jobs in your outlook. How does that compare to previous years and, again, what sort of confidence does that give you as to the current state of the Australian economy?

Dr Lowe : I think when this committee met this time last year, there was a lot of hand-wringing about the full-time, part-time slip. We were saying that full-time jobs weren't growing very quickly and part-time jobs were growing very, very quickly. The committee asked about why that was happening. A year later that's completely turned around. Luci, would you like to add something.

Dr Ellis : I haven't got the exact figures with me but it's not unusual to have periods of declines in full-time employment at a time when overall employment is increasing. That is the labour market's way of telling you it is having a soft patch, and that is what we saw in 2016. There have been two or three other episodes like that, of about a year's length, over the last 15 or 20 years; it is not unheard of. Usually what happens is that you then have a period where full-time employment is stronger and part-time employment growth continues but is not quite as strong as full-time employment growth. That is what we saw in 2017—much stronger full-time employment growth than what we had seen in the previous few years. But, again, that this not unheard of relative to the rate of growth in the working-age population.

Dr Lowe : In many other countries the distinction between part-time and full-time employment is not made in the official statistics. I wonder whether too much is made of it here—because, increasingly, employment is part-time. A third of the workforce work part time and most of them actually want to work part time. I know that, at my own organisation, people want to work part time. It is a positive thing that people can get part-time jobs: it fits in with their family and it helps people up the job ladder. So when we see strong growth in part-time employment we shouldn't always be thinking: 'This is a bad thing; if only these jobs were full-time'. Many people don't want full-time jobs. In fact, the vast bulk of people who work part time want to work part time—a number of them want to work more hours. But we shouldn't think 'full time, good; part-time, bad', because it just isn't like that anymore.

CHAIR: I want to return to the issue of the government's proposed tax cuts. I want to make an important point and that is that, as distinct from the US, the cost has actually been built into the budget. The budget is forecast to return to surplus in 2020-21, so we are not looking at the same inherent risk that you mentioned in relation to the United States. There is also data from the Oxford Centre for Business Tax which shows that Australia's headline and corporate tax rate are the 27th highest of the 33 OECD countries. Given that we spoke today about Australia being internationally competitive, does that give you a sense of confidence in relation to this particular strategy?

Dr Lowe : I am comforted by the fact that the budget is on a decent track. I think we should keep on that track and shouldn't go and have a period of bigger budget deficits in a strong economy. So, if that is the track we are on, I'm confident. As to where we sit on the league table of tax rates and what effect that has on us as a destination for capital investment, should we be aiming to be 15th or 20th? I don't know the answer to that. But we do need to keep an eye on it, and it is really up to the parliament to decide where we want to be there. But the ground is shifting and we've got to pay attention to that. I don't know what the right answer is.

CHAIR: You made the point before that Australia is a very attractive place to invest. But we've got to be nimble and continually reviewing our place in the world, and that is very—

Dr Lowe : It is a competitive world out there, and other countries are using tax policy as a way of attracting capital investment. That is as it is. I have my own view about whether that is a good thing or a bad thing, but it is the way it is. We can pretend and wish it wasn't happening, but it is happening.

CHAIR: Dr Lowe, I thank you and other members of the Reserve Bank of Australia very much for your attendance today. We greatly appreciate your giving evidence before this committee and we very much appreciate your time.

Dr Lowe : Thank you very much.

CHAIR: Before we finish proceedings, I would like to have a resolution that the committee authorises the publication, including publication on the parliamentary database, of the proof transcript of evidence given before it at the public hearing today. There being no objection, it is so resolved. I again thank everyone very much for appearing today. I declare this public hearing closed.

Committee adjourned at 12:19