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Standing Committee on Economics
Reserve Bank of Australia annual report 2014

EDEY, Dr Malcolm Lawrence, Assistant Governor, Financial System, Reserve Bank of Australia

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

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

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

Committee met at 09:32

CHAIR ( Mr Alexander ): Good morning. I declare open this hearing of the House of Representatives Standing Committee on Economics and welcome representatives from the Reserve Bank, members of the public, media and school students. The global economy is forced to grow at a moderate pace, with financial conditions continuing to be very accommodative overall. The US has demonstrated stronger growth of late, while there has been further softening of conditions in China and East Asia. Growth in this region has been subdued recently, with developments in China linked to more volatile equity markets. Domestically, moderate economic growth is forecast to continue, although the economy is likely to be operating with a degree of spare capacity for some time yet. Inflation is expected to remain on target over the next one or two years.

In relation to the current global economic climate, the fundamentals of the Australian economy remain resilient. Monetary policy is currently accommodative, with low interest rates acting to support borrowing and spending. Lending in the housing sector has grown steadily over recent months, and in a recent statement the RBA commented that it is working with other regulators to assess and contain risks that may arise from the housing market.

The committee will scrutinise the RBA about its work in this area, particularly in relation to the committee's inquiry into homeownership. The committee will also examine the RBA about whether it is confident that the current monetary policy settings will effectively encourage growth and inflation consistent with the target for coming years.

I must remind you that, although the committee does not require you to give evidence under oath, the hearing is a legal proceeding of the parliament and warrants 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.

Mr Stevens, would you like to now make your opening statement before we proceed to questions?

Mr Stevens : Thank you, Chair, and thank you for the opportunity to meet with you today. The Australian economy continues to progress through a major adjustment in the midst of testing international circumstances. The terms of trade have been falling for four years and have declined by a third since their peak, though that was a very, very high peak. They are now back to about the same level as in 2006, though that is still 30 per cent above the 20th century average.

Resources sector capital spending has been following the terms of trade with a lag. From an extraordinarily high peak, about eight per cent of GDP, or nearly three times the peak seen in most previous cycles, this investment has been falling for about 2½ years now. By the time it is finished, the decline will probably total about five per cent of GDP. We are probably now about halfway through that decline. It is having a predictable impact on those industries in regions that had earlier experienced the effects of the boom.

Resources sector exports have risen strongly as the greater capacity resulting from all the investment has been put to use. Australia now exports about three times as much iron ore and twice as much coal as it did a decade ago. A very large rise in exports of natural gas is in prospects over the next several years.

Outside of the mining sector and the parts of the economy most directly exposed to mining, there are signs that conditions have been very gradually improving. Survey based measures of business conditions have been a bit above their longer run average levels for a while now, and the most recent readings are about where they were in 2010. A few of the non-mining sectors have shown quite marked improvements over the past 12 months.

To this we can add that the overall number of job vacancies in the economy has been increasing even as employment opportunities in mining and some other areas diminish. The increase has not been rapid, but nonetheless the trend has clearly been upward for about two years. Since this time last year, moreover, we have seen a rise of about 200,000, or around two per cent, in employment. The labour force participation rate and the ratio of employment to population have both started to increase. The rate of unemployment, though variable from month to month, seems to have stopped rising, and it is at a level a bit lower than we had thought six months ago that it might reach.

Of course, this performance is not uniform geographically or by industry. The two large south-eastern states show the largest increases in demand and employment and, for that matter, in dwelling prices, while conditions elsewhere are more subdued. By industry, the rise in employment has been strongest in services, especially those types of services delivered to households, though business service activities have also added to employment over the past year.

Monetary policy is seeking to support this transition, something it can do because inflation remains low. Very low interest rates coupled with financial institutions that are willing to lend have played a part in the improvement in conditions in at least some sectors. Residential construction is running at very high levels. Households are adding a little less of their incomes to saving than they were, and savers have been searching for higher returns. These are all indications of easy money at work.

Cognisant of the risk that very low interest rates may foster a worrying debt build-up, regulatory initiatives are in place to maintain sound lending standards and capital adequacy. I hasten to add that the objective of such tools is not to control dwelling prices but to contain leverage. The evidence is, I think, starting to emerge that those tools are doing their job.

More recently, the significant decline in the exchange rate is starting to have more discernible effects on the pattern of spending and production. The decline over the past two years is about 25 per cent against a rising US dollar and 18 per cent against the trade-weighted basket. We are hearing about the effects of this in our liaison and also seeing it in the data on such things as tourism flows, as well as exports of business services. This is to be expected as the exchange rate adjusts to the change in the terms of trade.

Over the year to June, real GDP grew by two per cent. That was in line with our forecast of three months ago. It was within the forecast range from a year ago, though at the bottom of that range. It is worth noting the effects of unusual weather conditions on exports meant that GDP as measured was very strong in the March quarter but much weaker in the June quarter, and that reflects in part those weather effects. So the March quarter exaggerates strength and the June quarter exaggerates weakness in the GDP as measured.

There are still some puzzles reconciling what has happened with real GDP with what has happened to employment and the indications from business surveys. Hopefully those puzzles will be resolved over time. Nonetheless, what is pretty clear is that the economy is growing, albeit not as fast as we would like. The adjustment of the decline in the terms of trade is well advanced, and non-mining activity is improving rather than deteriorating. If that latter trend continues, it is credible to think that we can achieve better output growth, particularly as we reach the later phases of the decline in mining investment, and that is what is needed to bring down the rate of unemployment.

As always, global factors will be important, and the international setting continues to be rather complex and, one would have to say, not entirely helpful. Since the last hearing, growth in the Chinese economy has continued to moderate. Growth in other parts of Asia was also weaker in the middle part of the year. Reflecting those outcomes, forecasts for global growth over the period ahead are a little lower than they were six months ago. That was the backdrop for a period of volatility in some financial markets recently. The unwinding of an equity market bubble in China appears to have served as the proximate trigger for a revision of equity valuations around the world. In this period, risk appetite diminished a bit and the currencies of many emerging market economies came under downward pressure.

Whether that financial volatility itself serves further to dampen growth prospects, I think, remains to be seen. Sometimes these financial events do portend broader economic events, but sometimes they do not. In the present instance, I think it is important to stress a couple of things. The first is that long-term debt markets and core funding markets for financial institutions have not been impaired. Those markets remain open, and it is still the case that highly rated private borrowers and most sovereigns can borrow at remarkably low cost. Things could change, but at present we do not see anything approaching the dislocation of funding channels that you tend to see in serious crises. To be sure, emerging market countries are under some pressure, and some of those have specific problems that markets recognise and are responding to. At the same time, though, I think it can be said that many emerging market countries have done quite a bit to improve their resilience over the years.

It is worth noting that performance in the US continues to improve. Everyone knows that eventually this has to be reflected in less accommodative US monetary policy. As you know, Mr Chairman, the Fed just a few hours ago announced no change in rates at the moment, but still the majority of members of the committee are indicating an expectation that they will probably begin to lift the funds rate this year. I think it is inevitable that there is going to be fretting about what will be the first rise in US interest rates for nine years, no matter how well telegraphed it is. The more important factor, though, I think, is not so much the timing of the first one as the pace of the subsequent increases. The Federal Reserve has indicated that this is expected to be very gradual, but of course that will depend, as it must, on what happens with the US economy. So there is a degree of irreducible uncertainty there—no-one can make that go away—and hence there is the possibility of further financial volatility at some point. Overall, though, it still seems to me very likely that global interest rates will be quite low for quite some time yet.

For our part in Australia, of course, we cannot determine our terms of trade. We cannot affect these large forces in the global economy. All we can do is adjust to them. I think the record of adjustment in recent years is good. We negotiated the financial crisis without a major financial crisis of our own, or a big downturn in economic activity. We negotiated the first two phases of the resources boom without major inflationary problems, and we are part-way through our adjustment to the third phase, so far without a major slump in overall economic activity. There is still, I think, a pretty good chance that we are going to come out of this episode fairly well, and certainly much better than we came out of previous episodes of this type.

I would like to turn briefly now to other areas of the bank's responsibilities, and, in particular, payments. I have a couple of things to mention here. The first is the new payments platform. This will enable real-time data-rich payments on a 24/7 basis for households, businesses and government agencies. The Payments System Board works to facilitate the private sector coming together to drive this project, and the board supports the industry's efforts. The Reserve Bank itself has to build some architecture of its own to make all this work, and we are making good progress in that.

In the card payments area, we have announced a review, and we released an issues paper in early March. Among other things, this review contemplates the potential for changes to regulation of card surcharges and interchange fees, and it provides an opportunity to consider some of the issues raised in the Financial System Inquiry, which reported earlier in the year.

As usual, the bank has been consulting widely, and that included holding a roundtable in June, including representatives from over 30 interested organisations. The Payments System Board has asked the staff to liaise with industry participants on the possible designation of some additional card systems. As to what designation is: that is the first in a number of steps the bank must take to exercise any of our regulatory powers in this space. It does not commit us to a regulatory course; it is a precondition for using regulation, should that be appropriate.

The Payments System Board will have further discussion on the case for that at future meetings. In the event that it were to propose changes to that regulatory framework, then the bank would, as usual, undertake a thorough consultation process on any draft standards.

The final thing to mention in the payments space would be in the financial stability element of this that we are responsible for. Here, our focus has been on central counterparties. These are entities that facilitate efficient and safe clearing of certain types of financial transactions, mainly derivatives. These entities are increasingly important in the system, given the way the global regulatory standards are moving. The bank has been focused on ensuring that their risk management meets the highest standards, and that they have the capacity to recover from financial shocks.

We have also done quite a lot of work to ensure that our regulatory framework is appropriately recognised by regulators in other jurisdictions. That is very important, because we need that in order to keep the Australian system adequately connected to the global system, rather than becoming isolated. With those remarks, we await your questions. Thank you.

CHAIR: Thank you, Governor. We will kick off with the news that the US has kept its interest rate where it is, and has cited their reasons. Could you give a comparison between their reasons and your most recent decision to keep interest rates where they are?

Mr Stevens : The United States economy is well and truly into recovery. They have been getting pretty reasonable growth. They had a pause earlier in the year, but returned to pretty solid growth—above trend growth, even—in the second quarter. Their unemployment rate peaked at about 10 per cent; it is down to just over five. Inflation is still low, but they have got an extraordinarily accommodative monetary policy setting, and, unless something pretty big goes wrong, it is a matter of time before they have to start adjusting that, very gradually, in the direction of 'normal'. I think it will be quite a long time, actually, before we see anything that you could call normal interest rates in the US, but that is the phase of their cycle that they are at. As I said, it is nine years since they last raised the rate, and I think they went down to the current setting in 2008 or 2009. So they have been down at zero for six years, and at some point they are going to have to start coming up. When that happens, it will be, without question, the most anticipated, fretted-about change in interest rates in the history of the world, I would say. But it is coming at some point.

Our situation is a little bit different. We did not have that very deep downturn. We have had interest rates which, by our standards, are very low but still not zero. For us, for some time, the question has really been: is this interest rate appropriate to promote growth without running undue risks in the financial space? We think we have got that balance right. But the question has more been, for us: do we hold or should we go down a little bit more? I think we are pretty content where we are right now, but we are not in the same phase of the cycle that the Fed is in.

The Fed, of course, is the most important central bank in the world. Dollar funding rates are so important right across the global financial system, so their decisions are of somewhat more moment than ours are for the global economy, which is why they get all the focus. I have not actually read the statement they put out, but my understanding is that a majority of FOMC members still think that they are likely to start raising this year. There are two meetings left, one in October and one in December, so, at this point, one would still think that an increase in the Fed funds rate is probably going to happen before Christmas. But, as I said earlier, I think the key question is actually how fast the pace after that will be, really.

CHAIR: Yes. I noted that the number of their board who believe that there is going to be an interest rate rise before the end of this year has dropped from 15 to 13—still a majority. The initial rate is one thing. Could you elaborate on your concerns on subsequent interest rates, once the first one is made?

Mr Stevens : I would not say I am especially concerned about the prospect that they will gradually go up. I think they need to, for the US's sake at least. I think one could be concerned about the possible spillover effects that might come from that. That is normally a potential concern when the US changes monetary policy because, as I say, dollar funding rates really reverberate right around the world, especially into the emerging world. What tends to happen is that many developing countries find that their credit conditions start to tighten a bit when the Fed starts to lift.

Given that everybody knows it is coming, people have time to think about it, to get prepared, to lessen their own vulnerabilities. I think one could say that, in many of the countries in what is known as the emerging world, they have been working on strengthening policy frameworks, coping more with the exchange rate flexibility, taking more care about the kind of money they borrow from offshore—thinking about all that. So I think in most respects they are probably, given that it is well telegraphed and given they have been working on strengthening fundamentals, in a better place to cope with this when it comes than they used to be. That having been said, it is the first time this has happened for nine years. There will be a lot of people in financial markets right around the world whose career experience to date does not encompass having seen the Fed raise the funds rate. So you would have to think there would be a few upsets here and there. I do not say that will be disastrous; there always are some upsets and things where people find their strategy turns out to be less than ideal in a world of rising US rates, and no doubt that will happen again. I think it is just the length of time they have been down here at zero that kind of adds that additional bit of uncertainty, perhaps, but that is where we are, and sooner or later it has to happen.

CHAIR: Does the RBA have any pre-emptive measures that may be put in place to mitigate the possibility of a Chinese economy experiencing a hard landing in the near future?

Mr Stevens : I am not sure what pre-emptive measures we really have. We can lower interest rates if there is a case to do that. If the Chinese economy were to experience the fabled hard landing that many people have talked about for years, which so far has not happened, you would expect in that world that the exchange rate is going to go down, probably quite a bit, and that will be one of the key mechanisms that help the Australian economy cope. From our point of view, really, they are the tools.

CHAIR: In the February cash rate decision, the RBA observed that the Australian dollar was above estimates of its fundamental value and a lower exchange rate was needed to achieve balanced growth. For the two most recent decisions the RBA has simply noted that the Australian dollar is adjusting to the significant declines in key commodity prices. Can you please explain the reason for this shift of view.

Mr Stevens : It is not a shift of view; it was a shift of the exchange rate. The exchange rate is now in the low 70s. I started saying things about how it was probably going to fall and that it needed to fall when it was in the 90s. It has fallen; it has made quite a significant adjustment. I think it is doing what it normally would be expected to do after a period where we were not sure that it was doing what it should do. So we change our language, describing the situation as the situation changes. I think that is what you would expect us to do. It is adjusting. It is finding its own level. That is what it is supposed to do, and it is what you would expect. So there is nothing much more to say about it, really, while ever that is the case.

CHAIR: If you were looking at the US75c exchange rate to achieve balanced growth, and there are some observers who suggest the dollar could go as low as 60c, does that present any potential for inflationary pressures?

Mr Stevens : What we have been saying so far is that we think we will hit the inflation target even with the lower exchange rate. Even if it went a bit lower than this, I do not think that is going to give us a serious inflation problem. You can always play the game of thinking of a lower and lower number and ask at what point that starts to be an issue, but I could get Chris to talk about the sensitivities of CPI inflation to exchange rate changes if that is helpful. But my sense at the moment is that core domestic inflationary pressures, which is what drives inflation once the exchange rate has done whatever it has done—the exchange rate change comes through the system but then it fades as long as the exchange rate does not keep moving, and then you come back to what the core inflationary pressures at home are giving you, and what they are giving us right now is pretty low. The rate of growth of wages is very low. Unit labour costs as measured in an aggregate level have not grown for three years—or is it four? Three or four years. So I think that is locking in quite a contained domestic inflation momentum, and that is why I cannot really see us getting into trouble with inflation being too high, short of a very, very large fall in the exchange rate. Perhaps you could say something about the sensitivities.

Dr Kent : Yes. We have published a couple of times in the statement what we think might happen to inflation directly from a depreciation. Just pick a number—say, 10 per cent for the sake of argument. A depreciation in the exchange rate such as that might increase inflation by somewhere between a quarter and a half of a percentage point each year for two years and maybe just a bit beyond that. What tends to happen is that movement in the exchange rate comes through pretty quickly to import prices coming across the docks—they move within a couple of quarters—but then it takes a long time before you see increases in those prices fully reflected in the prices that consumers pay at the store, so to speak. That is because the price of the import good coming across the docks is only part of the final price. The other reason is that many importers hedge the exchange rate and it might take a while for those sorts of hedges to roll off, so they have some protection there for a while from an unexpected and sharp decline in the exchange rate.

The other thing just worth mentioning when we think about these numbers is that it is important to think about what has caused that fall in the exchange rate. If that fall in the exchange rate has just sort of happened by itself, it is likely to be more inflationary than a fall in the exchange rate that reflects, say, a weakening in global trading conditions or a weakening in commodity prices, which would tend to weaken domestic demand. As the governor suggested, that sort of thing would downward pressure on wage growth and other domestic costs. So, while you would be having inflation pressures from the traded side of the economy, the non-traded, domestic cost pressures—the wage growth, profit margins and the like—would be subdued if the exchange rate were falling because of other bad things happening in the world, for example.

CHAIR: Just moving to another area close to our housing inquiry, the charter of the Reserve Bank is:

… the powers… are exercised in such a manner as, in the opinion of the Reserve Bank Board, will best contribute to … the stability of the currency … the maintenance of full employment … and … the economic prosperity and welfare of the people of Australia.

Given that a very large portion of Australians express their wealth with the holding of homes and other real estate and, in many people's minds, a bubble has occurred recently, and given the borrowing on those assets, are you satisfied, with your other regulators, that the action that has been taken in restricting the increase in borrowings on investment properties to 10 per cent is enough? Are there other tools? Is there any further consideration?

Mr Stevens : I think the effect of what they have done has been quite positive. I think we are seeing the flow of new lending to investors now not continuing to increase the way it was. I should add that it turns out that there have been some material concerns about the quality of data in the credit data. There have been some quite material revisions here, and it turns out that there was a lot more investor lending than we all knew in the past. That having been said, I think the evidence is starting to emerge that the very strong upward trend in approvals for lending for investors has not really gone up any further for quite some time now. My guess is that the rate of credit growth will gradually come back to that 10 per cent or a bit less. It is not that far above it anyway.

I would also say, and Malcolm may want to chip in on this too, the key things that APRA has been talking about are lending standards. I think it is very important for them to have an intensive check on the standards that are being applied and, in some cases, it is turning out that those standards were not quite as high as the banks might have said. So it is good to fix that. ASIC have looked into interest-only lending, and they have published some material there. There are some things to be sorted out. Higher standards really should be in place there. APRA has also emphasised the need for interest rate buffers to make sure that borrowers can handle a rise in interest rates one day, if and when that occurs. So I think they are all quite important. This is about prudent lending, adequately capitalised lending and it is about making sure that a leverage does not increase significantly.

The reason we were focused on investors is that that is where the faster credit growth was. I predict we will now see a number of people who used to call themselves investors are going to call themselves owner-occupiers because the relative pricing has changed. That will lead to some interesting dynamics, I suspect, over the next year. I think we were right to have the focus on the investors. As I said in my opening remarks, this is not a claim that we can control house prices by this measure. That may or may not be an effect, but it is about containing leverage, which I think is important. Malcolm, is there anything you would like to add?

Dr Edey : Just to emphasise it is about leverage and it is about lending standards. There are things that APRA and ASIC are doing that are going to be worth preserving in the long run to ensure that stronger lending standards are put in place and kept in place. But I think the timing of these measures is good because there is, clearly, exuberance in the housing market at the moment. This will help to contain some of that and we are seeing that already in the way that banks are responding to the measures. They are strengthening their lending standards. They have shifted their pricing. All of that is working in a direction that will help to make things more stable.

CHAIR: The primary objective of these measures was to protect the prudential standards of the banks. Would you agree that it has had the collateral benefit of also harnessing in some adventurous investors who may hurt themselves, but it may also cause a sharp downward movement in the event of interest rates going up?

Dr Edey : I think that is a good way of characterising it. It is about lending standards first and foremost. That is really what APRA's mandate is all about. But the timing of it is good for having those other beneficial effects, given the current situation in the housing market.

CHAIR: With the very sharp increases that have occurred over the last 12 or 18 months in Melbourne and Sydney, and understanding that it is only 37 per cent of the housing market, if you were to put the dollar value on that market, it would be far greater than 37 per cent. Do you think that these adjustments have happened early enough?

Mr Stevens : I do. We started talking about this quite overtly—it was about a year ago now. It was in the FSR that we published in September last year, I think. The market is still increasing. So whatever measures have been done and the things that have been said are going to be well in advance of the peak of the prices, anyway. If you think about this from a leverage point of view and a credit growth point of view, if the rate of credit growth is six or seven per cent a year, I think it is a bit hard to get on the soapbox and preach too much about that, especially in a world where we actually want the economy to speed up. Part of the way monetary policy works is, if asset prices are higher, people do borrow some more. That is part of how it works. You cannot expect to get a positive effect from monetary policy but at the same time be trying to turn off all the channels it works through. At a point in time, though, once credit growth to a pretty important segment is running at 10 per cent, that is now getting to the point where you have got to say, 'Hang on, we have to be a bit careful here, and we should look at lending standards and capital adequacy.' And that is what is being done. I am quite comfortable with the nature of the things, the degree of forcefulness and the approximate timing. I think that is roughly right, based on what we know now.

CHAIR: With the concern that the real estate market has become a speculative market for investors who are more concerned with uplifting prices rather than rental returns, would it create a more stable market if a higher percentage of those properties were bought by homeowners who might well be interested in their house going up or down in value, but it is not going to cause them to sell if the market turns because of higher interest rates?

Mr Stevens : Maybe. I am not sure that I want to give a definitive answer to that question off the top of my head. Presumably the dynamics between investors and owner-occupiers can be a bit different—for owner-occupiers the rate of unemployment is probably a more important variable for their ability to service the loan, and it is ability rather than willingness. It may be that some investors would be a bit more flighty if prices fell. Perhaps that is so; it depends how long-term a perspective they have. It will also depend on how leveraged they are. The more leveraged you are the more sensitive, one way or another, you are going to be to a decline in prices, should that happen. That is why we need to work on containing the leverage.

Mr HUSIC: Good morning, Governor. We have previously discussed, at our February meeting with you, the implications of any US rate rise. At the time I expressed surprise that there was talk about this, given that inflation is barely registering in the US or is barely an issue for concern in the US—so why would you raise rates? I think at the time you had indicated to me that if rates did go up it could be interpreted that this is a sign of a strengthening US economy, and that is a good thing for Australia. But given the rates have now been placed on hold, or they have deferred making a decision on a rate increase at this point in time, what do you think the implications of that decision are for us?

Mr Stevens : I would still say that the fact that they are talking about and debating when to do it is a positive sign in the sense that they have come to the view that they are close to the time when they do not need interest rates at zero in the context of a massively larger federal reserve balance sheet. If they get to the point where they can see their way clear to just lift off, as they put it, from zero and go to something that is still very low—still remarkably accommodating, but just not so remarkably expansionary—I think that is a good sign. It is true that, as you say, inflation is not a problem in the US. Core inflation has gone up a little bit and wage growth in America has increased a little bit. Neither of those is too high in any sense or is in any way seriously worrying. But the argument that as the vehicle is starting to speed up you do not need the foot right on the floor anymore—you are not jumping to the brake, you are just easing off the gas a little bit—which I think is essentially the argument they would run, makes sense. As for the on-holds, in this particular decision few financial market players will be very surprised that the pricing, as of a couple of days ago, was pretty low, and there will now be furious debate for the next eight or 10 weeks, till we get up to Christmas, on whether they will go in December.

What are the implications of all that for us? I still think it is a better thing, really, if the Fed can get the lift-off achieved. They do not want to kind of create some financial market problem globally, in doing that, obviously, and they are very conscious of that. But in the end there is always going to be some market dynamic, some weak piece of data or some argument to say, 'Don't do it just yet.' There is always going to be that, and one day you are just going to have to do it.

Mr HUSIC: During your answer you made reference to wages growth in the States. Turning to Australia, wages growth is still historically low and consumer and business confidence relatively weak. You have seen some evidence that living standards are falling. The bank has previously advised that its liaison officers are detecting a view from business that investment will not change until they see a pick-up in consumer sentiment and demand. Do you think those factors I have listed above—in particular wages growth, lower confidence and potentially the impact on living standards—are a serious impediment in the path of lifting consumer sentiment and therefore business investment?

Mr Stevens : I would take issue, actually, with the assertion that consumer and business confidence are low. We read this all the time in the paper.

Mr HUSIC: I did say 'relatively weak'.

Mr Stevens : But, if you go to what they actually say in surveys, they are probably pretty close to average. They are up and down around the average. It is not that bad. It is not great, and it is not the ebullient consumer and business community that we had from the late nineties through to 2006, but I am sorry: that is not coming back. That world was a world of continually escalating asset values, rising leverage and the early part of the terms of trade boom. That was a great period, but I do not think we are going to return to those dynamics. The actual measures of confidence are not as high as they used to be then, but they are not in the position that they ought to be in if the gloom and doom we keep reading about were actually true. So I think we should be careful in the way we characterise this.

That having been said, it certainly is the case that wages growth is running about two per cent on the WPI. That is pretty low. As I said at the previous hearing, surely that has saved jobs, and those households have to be a lot more confident than they would have been if they did not have a job. No doubt those people would be even more confident if wages were growing faster, but what is happening in the labour market is in some sense a response to the shock the economy faces. It is true that real income—real GDP per head—has been pretty weak. That is the terms of trade falling, and you cannot undo that. That is the world economy we live in, and we have to accept that, understand it and then think about how we lift productivity faster, because that is the only source of growth in living standards; we have had that conversation many times.

With investment, yes, investment in mining is on the track it is on. That is actually not doing anything different to what we had anticipated, really. Non-mining investment actually rose a bit, as best we can tell, in the June quarter. The forward indicator moved up just a little, but it is still quite weak. I think that is a thing that we do hear in liaison still. That would be true, wouldn't it, Chris—that business will at some point invest more but not just yet and, although particular gauges of confidence are not that bad, they are not sufficiently energised yet to step up faster?

Sooner or later, it will happen. But it is not happening now, and it does not look like it is going to happen imminently. That having been said, it seems to be the case that we are at least getting some growth—and pretty good growth, actually—in employment over the past year. And, to some extent, maybe that can happen in areas that do not need a lot of physical investment to put with the workers. I do not know if you can elaborate, Chris.

Dr Kent : I might just make a few quick comments. The Governor has emphasised that, yes, surveys of confidence, particularly amongst businesses, are not particularly high. They are not particularly low either. But if you look at some of those surveys, businesses tell you about current conditions. So the confidence is thinking about the future, but their current experience in the household services and in the business service sector—not so much in the goods side of things but in the services sector—are actually above average. Those sectors are accounting for much of the strong employment growth that we have seen over the past year or so.

There is this difference across different sectors. The mining is obviously weak; manufacturing is weak; other sorts of goods distribution and production sectors are on the softer side of things compared to household services and business services. The thing is: the goods sector is the one that does a lot of the investment. Manufacturing is very capital intensive. So weakness there is possibly holding back investment. But, even within the manufacturing sector, one thing that we are picking up in liaison is: there is some relief now that the exchange rates are moving lower. That is going to be very helpful for them, but it is also helpful for all of the services, including tourism, education services. The thing is: they tend not to do quite as much investment as the goods producers.

Mr HUSIC: Is business investment low because of the at-average or at-trend consumer confidence?

Dr Kent : If we look at the two main surveys on this, those surveys have been around average, or maybe a little bit below average of late. Those surveys are made up of and consist of many questions. When consumers are asked, 'How do you feel about the economy? How do you feel about the economy in five years' time?' they do respond by saying that things are below average—'I read about that and I'm just going to reflect that back.' But when they are asked, 'How are your own finances doing now compared to last year?' they are actually above average. They have been above average for a little while. I think that trend improvement in how consumers say they feel about their own wallet, their own pocketbook, their own bank account, is behind the gradual lift in consumption that we have seen. It is not particularly strong, but it is certainly better than it has been a couple of years ago. So there is an improving trend in many respects.

Mr HUSIC: For broader GDP growth, what is the estimate for the at-trend figure?

Mr Stevens : There has been a lot of commentary about this—some of it, apparently, triggered by things I have said. So let me give some context there. We have had, apparently, clearly below trend—trend used to be a bit over three. Over 40 years, whichever way you cut it you came up with an answer of three point something and the something was one or two or three after the decimal point. Growth has clearly been below that for a while, but the rate of unemployment seemed to stop rising, employment picked up and business surveys, as Chris was just saying, on conditions, as opposed to confidence, have been above average. How do you square that? How does that all add up? Maybe GDP is not true—not correct—and we are going to find more GDP in revisions. That could happen. Maybe the employment data are wrong—in which case they will be revised. Maybe something bad has happened to productivity growth—so, even with low GDP growth, you need a lot more workers. I struggle to believe that, really, but conceptually that is possible. And maybe the softness of wages—declining real wages—has actually shifted the relationship between employment and GDP for a while. Maybe all those things are happening. So I said that, and the media latched on. Another possibility is: potential growth is just lower now; that would be a productivity story, largely. The media latched on to that one, and did not pay much attention to the other possibilities.

I think in our assumptions, Chris, we are assuming slightly lower population growth than we were because the actual facts coming in on population growth have been lower, and I think this is to do with international students. We get a bunch of assumptions about immigration and natural increase and so on from various sources. We do not forecast those things. By and large, we make assumptions based on projections that others do. And, as it turns out, some of those projections were a bit high. The facts coming through are lower, and we have now factored that slightly lower; that would be right, I think.

Dr Kent : Yes. We have assumed slightly lower population growth over the next couple of years. It seems that the population growth from migration is reasonably flexible. It has not changed a lot, but it has come off a bit. Foreign students come in, and they count in the population numbers. They have been increasing in number. So there has been a big inflow of students, but the increased inflow was just less than had been predicted. The other thing is: other immigrants are coming in slightly less than had been predicted. Some of those are New Zealanders. There had been an improvement in conditions in New Zealand labour markets relative to ours, and people who had come here temporarily, including to work to help the massive resource investment stage of the mining boom, have gone elsewhere, as those jobs have left. These are highly skilled individuals and they go to other parts of the world.

Mr HUSIC: In the short amount of time that I have left, I want to go to the issue of the bank deposit levy in relation to the Financial Claims Scheme and the move to a prefunded arrangement. The bank, as chair of the Council of Financial Regulators, provided a strong recommendation to the then government back in March 2013. In the RBA's submission to the FSI last year, in the section 'Depositor protection', you effectively replicated that advice in support of a prefunded arrangement. There are a whole stack of quotes I could drag out of that but I do not want to take up too much time. But you indicate that the approach is supported by the bank and other Council of Financial Regulators agencies and was included in the advice provided to the then government in early 2013. I am just wondering if you can update the committee about whether or not the view expressed in that submission to the FSI last year about a prefunded arrangement for the FCS is still the RBA view and the view of the CFR?

Mr Stevens : I think it is moot, isn't it? I mean, that was our view. We had a Financial System Inquiry headed by an eminent Australian and with a very good panel. They considered this in the context of a whole lot of other things, including recommendations they were making to strengthen bank capital, which of course lowers the probability of the FCS been called on. And their recommendation, in the context of all those other recommendations, was: 'We think leaving it postfunded is the way to go.' That was the conclusion and, it would now appear, the government has adopted that view. And I would have thought: okay, that is their decision.

Mr HUSIC: So what are the risks to the financial system of not proceeding with this measure? And are there alternatives to that?

Mr Stevens : I do not think it is a risk to the financial system. It never was that. The question was: what is the risk to the taxpayer? That is actually what this is about, because you have guaranteed deposits up to $250,000. As to the likelihood that a typical Australian bank with a deposit-to-asset ratio of 60 per cent or maybe 70 per cent would fail so badly that there was not enough to pay out the deposit, the risk of that is very low. But, nonetheless, if that did happen, then is the taxpayer going to be on the hook? Well, there is an arrangement to recover that from the industry et cetera. My argument was always simply the government's giving insurance for free, you could charge for it—and, in an ideal world, you would. But what the Murray inquiry has said is that 'it is not that simple because there is a whole bunch of other things happening and we want to strengthen the capital adequacy of the banking system'. It said that, in that context, they felt comfortable leaving the FCS with the fee. That is the conclusion. I respect that conclusion, and the government seems to respect it also.

Mr HUSIC: You have had a number of questions regarding housing. In its submission to the home ownership inquiry, the RBA said:

The Bank believes that there is a case for reviewing negative gearing, but not in isolation. Its interaction with other aspects of the tax system should be taken into account.

I am wondering if you are able to expand on the statement, and what are the reasons behind why it should be reviewed?

Mr Stevens : We hesitate usually to opine much about tax matters. It does seem to be the case though that whenever housing, and investor housing in particular, come up, there are views about whether negative gearing is appropriate or not. The point we are making is it probably is worthy of being looked at, but the thing I would stress is there are other aspects of the tax system too that also matter here: capital gains tax, depreciation et cetera. All of these things interact, and I cannot help feeling it would be a mistake to just say we should or should not tweak negative gearing per se without thinking about the interaction of the various other bits. I think that was the point of that comment.

Dr Edey : As Glenn said, we are not holding ourselves up as tax experts here, but the thing we specifically had in mind in that comment was the interaction with the capital gains tax. You can make an argument that says you have an income tax system, so you add up all of your sources of income, deduct all of your expenses and then you pay tax on the net—and that is fine. That would be one argument, that you do not need quarantining provisions that quarantine one form of income from another. But the counter argument to that is that we have a discount on the capital gains tax, and if you are an investor in real estate, which is typically highly leveraged, then you are deducting your interest in full but benefiting from the capital gains discount. The point we are really making is: if you want to think about these things, think about them together and think about ways that they might interact with other parts of the tax system as well, which we are also not experts in. It is misleading to just think about one component of that in isolation.

Mr COLEMAN: I want to talk to the general tenor of this statement and some of the matters you were discussing with Mr Husic. It seems to me there are a number of matters in here that are expressed in quite a positive fashion: job creation, unemployment lower than expected, improving consumer and business surveys and so on, and obviously the dollar at a more sensible level. Then you talk in a couple of places about the potential for improving growth and for us to come out of the downturn in mining in a fairly positive fashion. Is it fair to say that the outlook that you have put in today is reasonably positive?

Mr Stevens : I think the things I have put in the opening statement are facts. It is a fact that, as measured in leading business surveys, conditions have improved over the past year or two and, as most recently measured, have been above average. That is true. It is a fact there have been more than 200,000 extra jobs created over the past year. Everybody knows our forecast had had the unemployment rate going up a little further. It is a bit variable month to month, so it is a little hard to tell, but it looks like, for the time being, that it has stopped going up. It is important to state those facts because I think we have a bit of a tendency right now in the general public discourse to be more negative than the facts actually warrant. It ain't all home and hosed and all happy days, but it is not as bad as much commentary that I read would lead one to believe. It is important to ground these things in the facts as far as we know them.

Mr COLEMAN: You were talking about the terms of trade and the deterioration in the terms of trade and so forth, and you said that there is still a pretty good chance that we will come out of this episode fairly well and much better than we came out of previous episodes of this type. Is that a reflection of our increased diversification of the economy? What do you base that on?

Mr Stevens : It is a reflection of a few things. One is that we have better economic policy frameworks today. If you think back to the previous terms of trade episode that was remotely near this size, it was the Korean War boom in the early 1950s. We are certainly a more diversified economy now than then. In that episode, we had a fixed exchange rate and we did not have as much capital mobility as we have now. When the extra earnings from the terms of trade come in and are converted to Aussie dollars, it inflates money and credit, which gives you a huge boom and inflation. Then, when the terms of trade turn down, all that goes with a negative sign, and you have a crash. Letting the exchange rate adjust has helped stabilise that so much more effectively; it is chalk and cheese. If nothing else, an exchange rate that is free to move, even though it often moves in ways we might not like, is so much better than trying to hold it.

We have a monetary policy framework with a credible inflation target. That is very important. We have a fiscal framework which, despite some strains, is still leaving us, by global standards, in pretty reasonable shape. We have some challenges to deal with in the years ahead, as you all know, but it is still credible in the eyes of the investment community. The economy itself is more adaptable than it used to be. It is not the case anymore that when a few powerful unions in the mining sector or the construction sector get big wage rises the rest of us all get the same wage rises. That used to happen; it does not happen now. Relative wages shift, and employment patterns shift in response to that, in one direction, and now they are shifting back.

So all those things mean that this economy has coped remarkably better with what is literally the biggest thing since the gold rush. The chances are good that we are going to come out of this, not unscathed, not without a bit of pain. But we are not going to come out of it remotely as badly as we did the previous three or four times we had these things. That is very important. I think it is an underappreciated success.

Mr COLEMAN: The exchange rate has, obviously, come down a lot, which you would be pleased about, given your previous views. Do you think it is about right now or would you like to see come down a bit more? What is your view?

Mr Stevens : I am not sure that what I want matters much in actually affecting it. A lot of prominence is given to comments, but the comments by the very nice lady in Washington overnight probably matter more for various exchange rates than my comments, if the truth be told. If we were to try to line up the current exchange rate with various fundamentals and models that we have, we would be hard pressed to say it is seriously misaligned at this point. But what happens from here depends on what the fundamentals do and we do not know what they will do. It also depends on market dynamics; exchange rates have a habit of overshooting, frankly, so it could easily be that it goes down further from here. I am not particularly forecasting that or calling for it; I am not really making much comment now about it. I think it is finding its own level, responding to the big forces in the way that it should and it is doing its job.

Mr COLEMAN: On a different subject. We obviously talk a lot about China, and rightly so, and its outlook for growth. The US has obviously improved significantly. Do you expect to see that continue? Do you think the US now has a period of relatively strong growth ahead of it? And what does that mean for us?

Mr Stevens : I do not really see any reason why the US economy cannot continue to enjoy pretty good performance. They dealt with the financial problems, fixed the banks. They have overcome the headwinds that were in the housing sector there. The United States typically does well with low energy prices. That is a bit more nuanced now because they are also an energy producer now, so that is a new bit to the mix. I do not really see many reasons to be other than guardedly optimistic about American performance.

Mr COLEMAN: Thank you, Governor.

Dr CHALMERS: Thank you very much, Governor, for your time this morning. I wanted to pick up on some of the comments that you make in your opening statement about the payment system and credit cards and the like. In the 2012 review you did of innovation in the payment system, there were a whole list of strategic objectives you had for banks to implement for their payment services. And you noted in your introductory comments that you were pleased with the progress that people were making—yourselves at the RBA, but also the banks. I wondered if we could get a bit more detail from you on progress on things like the 2016 deadline for the ability to make real-time retail payments, low-value payments outside normal banking hours, more complete remittance information and then the 2017 deadline for simplicity and all of that. Could you just give us a more specific sense of the progress that the banks are making?

Mr Stevens : They have made pretty good progress. I think it is going run a bit late is probably the story. So we need to keep the feet to the fire to get as much progress as we can. It is a pretty big project, though. They are building the architecture, really, in two parts. There is the basic infrastructure which will give the ability to send the messages, do the settlement et cetera. And then there are going to be add-on services that connect into that that would deliver richer things. On the architecture, they have set up a corporate entity—NPP Australia, which is basically a corporate entity that is responsible for constructing the architecture. They have got a technology solution being chosen. Some of this is kind of a bit commercial, so I will not go into too much detail. What then has to happen is each entity has to build internally the architecture in their own systems to connect, so it will all work. They are pretty big projects. You are talking, for some of the major banks, in excess of $100 million worth of IT to build that capability. We have to build some capability ourselves at the settlement and to make it all work. We are doing that—that is probably a $25 million project for the RBA over a number of years.

One of the issues, I think, is going to be the demand for IT skills. We all want the same people, so that is a potential issue. We find it hard to recruit the relevant skills and then hard to keep them, and I am sure the other institutions find the same. But NPP co. was established last year. It has got a board. The work is underway. The technology, the architecture solution, has been chosen. The builds are underway. It may not quite meet the original deadline we had, but I am confident that it will not be too much later than that. I think, given the magnitude of the undertaking, our view is that we are pleased with the progress. Do you want to add any detail, Malcolm?

Dr Edey : Just to come back to your original question, where you listed the objectives of the NPP project: it is specifically designed to meet those objectives. When all of this was set up, what we did was that we called on industry to come forward with a proposal that would meet the objectives. They did that. It is their project, but obviously there is a big public interest in this, and the Payments System Board is very interested in it from the public interest point of view, so we are very closely engaged with what is going on. We are involved in all the governance committees, keeping a very close eye on it, and it seems to be well on track.

Dr CHALMERS: Governor, just to pick up something you said: do you think that it is an economy-wide problem that we are not churning out enough technology graduates?

Mr Stevens : I do not know. I am not confident to have an opinion on that, to be honest.

Dr CHALMERS: That is your experience though?

Mr Stevens : I think the market for the kind of IT skills you need to build payment systems seems to be pretty hot right now because you have four very large institutions, and some smaller ones like us, trying to dip into that pool.

Dr CHALMERS: We saw a fairly high-profile failure in the payment system, I think, last week at one of the big banks. There have been other examples over the last 12 months. In that 2012 review that you did, you indicated that you would be considering tougher regulatory measures on banks for these sorts of failures. Is that still your intention, and what would these tougher regulatory measures look like?

Mr Stevens : Which failure are you referring to?

Dr CHALMERS: The CommBank one last week. There was a three-hour period where people could not make payments.

Mr Stevens : What we have done in that space—I think it is pretty simple really—is to collate information, so there is a procedure now where, if there is a payment system problem, there is a process of advising and then periodic reports on how the remediation is going. In an average week, I reckon I am getting a couple of sets of emails about some bit of architecture somewhere that has keeled over for some reason. Often these things are a change to systems that has been put in place overnight; the testing did not quite uncover an issue. They have got to back it out, fix it and put it back in. Most of these things are resolved within a few hours. It is pretty common, actually, for you to have some kind of problem in a bank. Occasionally, we have a problem in one of our own systems. These things happen with complex IT systems.

I am not actually sure quite how much mandate we would have to try to regulate this anyway, but what is important is that there be proper attention given to operational risks in the banks. I think APRA has some standards over that as well. And I think the system where you have to report in, and people are looking and they are wanting to know when it is going to be fixed, kind of adds a little bit of edge. Of course, their customers are inconvenienced, which is the most acute form of pressure on them. I am not proposing that we do more than that at the moment, because I think, by and large, performance in this area has been improving. You are never going to get a system where there is never anything that goes wrong. As I say, every week there is something that goes wrong somewhere. Usually it gets fixed pretty quickly. I think, as to the commercial imperative on the private banks to keep the customer service up to speed, if you have that and you have some transparency, I suspect at the moment that is enough.

Dr CHALMERS: In your review of things like interchange fees in the card payment space, is the main issue, in your view, the uneven playing field between the American Express/Diners-style cards and the MasterCard/Visa-style cards? Is it better, in your view, in principle, to remedy that uneven playing field, to uncap interchange fees for all cards, or to impose caps on those that do not have caps at present?

Mr Stevens : It is complicated, because Amex does not really have a thing called 'interchange fees'; they have other fees. So if action were to be taken there, it would have to be configured appropriately. It remains our view that, were we to remove regulation on interchange fees, interchange fees would rise and costs to merchants would therefore rise, and these things are quite untransparent—they are very opaque. In our view, that would be contrary to the public interest. So I would note that the Financial System Inquiry—if I recall—supported having interchange regulation; it had a few suggestions about possibly extending it and bringing the caps down. We are in the process of deliberating on all this at the moment, so I do not foreshadow any particular outcome. But I do not think that the answer to the claim that the playing field is not level between the three party schemes and the four party schemes, if that is a problem, is to remove the regulation on the four party guys, as much as they would like that and continue to lobby for it.

Dr CHALMERS: Has the RBA been briefed on the government's final response to the Financial System Inquiry?

Mr Stevens : Malcolm, can you answer that?

Dr Edey : Yes, we are in discussions with Treasury about those things. As you know, we meet regularly as a council—the Council of Financial Regulators—

Dr CHALMERS: But have you been briefed on the final form of it? Is it finished?

Dr Edey : I do not think we could say that it is finished until it is announced, because it is always potentially subject to revision.

Dr CHALMERS: Are you aware of other stakeholders who have been briefed on the final government response?

Dr Edey : No, I am only aware of briefings that we have received.

Dr CHALMERS: What was your expectation for the timing of the release of the FSI response from the government, and has that changed this week?

Dr Edey : I am not really a party to that. I know it was reported in the media that it was expected to be released on Tuesday—

Dr CHALMERS: On Tuesday morning—correct.

Dr Edey : That was what we thought.

Dr CHALMERS: That was your understanding—that it be released on Tuesday morning?

Dr Edey : Yes.

CHAIR: Before we move to the next item, which is questions from students, I would like to ask the governor: do you remember a Tabitha Cartledge from Inaburra School in Bangor from our previous hearing?

Mr Stevens : Do I remember her?

CHAIR: To help you with your memory—

Mr Stevens : I have to confess, I am—

CHAIR: Tabitha asked a question with regard to our lowest interest rates—was there a danger for first home buyers being caught in the debt trap?

Mr Stevens : I remember the question, yes.

CHAIR: I would, therefore, like to warn the governors that we take our students very seriously, because that very question led to our home ownership inquiry.

Mr Stevens : Mr Chairman, I think that is testimony to the quality of questions that the students ask.

CHAIR: It might suggest that they ask better questions than we do!

Mr Stevens : I did not say that!

CHAIR: The chairman only seeks to get the best questions asked. With that, I would like to invite the students from Canberra Girls Grammar and Gungahlin College to ask their questions—Ebony Ferraro and Kieran Heid.

Ebony Ferraro, Canberra Girls Grammar : Growth of over three per cent is wanting to be achieved by 2017, according to the overview of the RBA. But with fewer mining projects going ahead, falling commodity prices and deteriorating terms of trade, how do you predict this growth will be achieved?

Mr Stevens : It has to come from other parts of the economy than mining. The big question, of course, is as mining slows down does the nonmining pick up. It is picking up—it is picking up a little bit more slowly than I would have liked but it is, I think, picking up. We need that to keep happening and strengthen further over the next several years. I think there are reasonable grounds to think that it will do that, and our policy settings are certainly designed to accommodate that and encourage it. What are those nonmining things? We build houses, we build things other than mines, consumers do okay and so on, and hopefully some of the export industries like tourism, education, business services, even some parts of manufacturing grow faster as they get help from the lower exchange rate. I think all those things are starting to happen. But of course it is just a forecast, so we have to wait and see how it turns out. I think there are reasonable prospects we will get those outcomes. A good question, thank you.

Kieran Heid, Gungahlin College: What is the Reserve Bank's reaction to the current housing bubbles in major cities like Melbourne and Sydney? How should my generation be expected to buy a house within the proximity of these cities without being subject to a lifetime of debt and without my future family inheriting these debts?

Mr Stevens : That is a very fine a question. There is a very significant issue of intergenerational equity at work in the housing market. We have talked about this at many previous hearings. It has always been the case that first-time entry into the market is a struggle—it was for me, it was for all of us here. That has always been true. I think it is perhaps a bit more daunting now because the size of the deposit that you need to accumulate is larger. That is why we are seeing many families helping their children and transferring the wealth through the generations that way. But I think the answer to easier access to housing for the future growth of population has to come from more supply of appropriately configured and located land and the transport infrastructure to connect it. That has to be the answer. The answer is not going to be government programs that give you money, because that money just ends up in the hands of the sellers. The answer has to come on the supply side of the market. In a country with this much land, something is wrong if we cannot do the marginal cost of housing a bit cheaper than we do. It is a very good question.

CHAIR: Thank you very much, students, and thank you, Mr Stevens.

Pro ceedings suspended from 10:58 to 11:15

Mr BUCHHOLZ: Welcome, gentlemen. I thought I would just start off by speaking about forecasts. Two years ago the Reserve Bank had some forecasts in place in and around the unemployment space. I am just interested in your commentary on how accurate your forecasts were on the softening of the capex in the mining sector and where you see unemployment heading into the future.

Mr Stevens : I will get Chris to come in on some of the detail. My opening comment would be that I spent 30 years being a forecaster, and I am these days a user of them. I am a great sceptic on forecasts, but we have to do them and we have to use them. But we use them advisedly. Two years ago we would have been saying—and I do not have those forecasts from two years ago in front of me, but I think our assessment of the profile of the mining capex build-up was actually not too bad as these things go, and the reason for that was we do a lot of talking to the large companies, particularly out of our Western Australian office. So I think we had a good sense that it was very powerful, that it was going to reach a peak and then that it was going to come down a lot.

On other investment, I think it is no secret, and I have said before, that I would have thought that by now it would have picked up, so that is a disappointment. On unemployment, my memory is we have always felt it was going to reach into the sixes—for a long time into the sixes—but not get to seven. I think by and large that has turned out to be approximately right; it is not exactly right. In the period ahead, if we can get the non-resource part of the economy to keep improving gradually, build some confidence there, see the jobs growth continue and in due course see businesses more inclined to invest and so on there, then we will start to get the unemployment rate to come down, and that is what we should want. Six point two or three is not disastrous, but it is too high. We ought to be looking to get back into the fives over time, and given enough time I think we will, unless we are hit by another bad shock from somewhere. I do not know whether, Chris, you want to add any more on those things—or any of my other colleagues.

Dr Kent : Maybe I will just reiterate briefly. On the unemployment, earlier in the year we had anticipated that it would continue to sort of drift up for a time. We had seen a gradual lifting in that over a couple of years, and we thought, with GDP growth a bit below average and likely to stay there, it would rise a bit further. It turns out that it has not, so that is sort of the positive element to the surprise. It turns out employment growth has lifted quite measurably over the course of the past year or so. While businesses are not doing a lot of investment, they are hiring people, so they are spending money on that front.

On the GDP puzzle—and the governor picked up on this earlier—GDP growth has been a bit below average. What we had forecast is it would pick up. It has not picked up, but it has not weakened. It just has not picked up quite to the same extent we had hoped. It is not so much because mining investment is weaker than we thought. In fact, those forecasts have been reasonably accurate. Household consumption growth has improved, just not as much as we had thought and hoped. We keep pushing back on the timing of this hoped-for pick-up in non-mining business investment. But, as I said, we have seen employment growth pick up and the unemployment rate stabilise. So there is still this puzzle. We have talked about that already today, so I will not go back over that.

Mr BUCHHOLZ: Still on forecasts, can I get your opinion on what growth rates will look like into the outward years, over the forward estimates?

Dr Kent : Sure. We are thinking it is going to pick up gradually from here and over the course of the next financial year be in the two to three per cent range—we really should not be too much more precise than that—and then gradually just continue to lift from that to be above three per cent over the course of 2017.

Mr BUCHHOLZ: That is great. Let's go back to your opening comments, with reference to the Federal Reserve last night leaving rates on hold. If there is an anticipation that by the end of the year they will move, what effect, positive or negative, can we expect here in the Australian markets?

Mr Stevens : You would hope that something that is pretty clearly telegraphed, when it finally emerges into fact, will not seriously derail financial markets here. I do not think it will. As I said earlier, there is bound to be a bit of turbulence around the world somewhere, but I do not anticipate major disruptions to our financial markets from the Fed move per se.

But the thing is it will not just be the first move. It is the slope after that. So the specific question actually is: when is the second move once they have done the first? When they do the first one, presumably they will say something about the likely pace, because it is that slope of the federal funds rate into the future, or the anticipated slope, that will potentially affect financial markets, and the Fed will obviously take great care with their language to try to finesse that. I do not see any reason to assume that that is going to seriously give us a financial shock. It will have some reverberations around global markets—it is bound to—but I do not anticipate that Australia will be materially affected in an adverse way.

Mr BUCHHOLZ: Staying in the forecasts, where do you see the long-term average borrowing rate in the US at?

Mr Stevens : This comes to the question of what is normal or neutral for interest rests in the modern world, and most people I think have accepted for quite some time that what we used to think of as normal rates we are not going to go back to. We are not going to have zero for the policy rate in the US but not four or five per cent in the way we once did, at least not for quite some time. There are a whole bunch of reasons people might think that, which we could go into, but all the indications appear to be at present that the policy rate in America—and I think everywhere else pretty much as well—on average in the next five years is going to be lower than the averages we used to think of prior to the financial crisis. I am not saying that is a good thing, actually, but I think that is the reality. Long-term rates in markets reflect that expectation.

Mr BUCHHOLZ: Just in closing, on a different part of the globe, China is out—can you just leave me with a comment there.

Mr Stevens : The current discussion is how much of a slowdown they are having. I think they are continuing to slow. That is what the totality of the data that we track would suggest. They are responding to that with policy instruments in a way that will be supportive of growth. It is impossible to know whether they might have a sharper cyclical slowdown. Plenty of people are saying that right now. Plenty of people are saying that they do not believe the GDP numbers and that the real growth rate is not seven at all; it is four or five. Plenty of people are sceptical about their capacity to manage this. They might be right. I can only observe that many people have been sceptical for years already, and so far the sceptics were not correct, but they might turn out to be. Longer term, China cannot keep growing at even seven per cent—assuming that seven is an accurate figure. No economy that is that large grows that fast indefinitely. Into the years ahead, as we go forward through the next 10 years, we should be expecting to see sixes and fives in growth rates, not sevens or eights or nines. I think that is now pretty widely understood. What comes with that is questions about how energy- and resource-intensive the growth will turn out to be, and there are differing views about that. That question is obviously of some importance for our country. Their economy will be more driven by services, more driven by domestic spending, by consumption, and less by physical investment spending and exports. That is the transition they are trying to make, not entirely without success, but still very much a work in progress. It is a huge transition, what they are attempting. This has never been done before in human history. It is quite a big thing.

Mr BUCHHOLZ: Thank you.

Mr CONROY: Thank you, Chair, and thank you again for appearing. If we can go back to capital investment for a second—and I appreciate the earlier commentary about how we have got relatively up-beat employment forecast, without the expected pickup in capital investment—I went back and looked at your opening statements to this committee over the last two years, Mr Stevens, and it is fair to say that, on non-mining capital investment, you have got slightly more pessimistic over the last two years. We had a good discussion around animal spirits last year, which did not seem to kick in yet. Why do you think, over those last two years, non-mining capex really has not met expectations?

Mr Stevens : Good question. I wish I had a neat answer. It is true that outcomes have been weaker than I had hoped. I think at one stage they were looking like they were turning up, and then that kind of turned down again. I do not actually have a terribly satisfactory answer for that, to be honest. I think the process of downward revisions to the expected non-mining investment may now be ending—I think—but that is a hunch or a judgement, rather than being able to be giving definitive proof.

As to why animal spirits have not been stronger, there are no doubt any number of reasons, but it is probably worth recording that we are living through, both internationally and domestically, you know, unusual times. We had a very large financial crisis globally. We escaped the worst of that, but that has infected psychology, I think, internationally, and you can't help but have some of that spill over. Domestically, we have got these very large swings in relative prices in the economy, to do with the terms of trade. Adjustment is always challenging. On top of that, you had the long gearing-up of the household sector, which came to an end in about 2006 and will not return, and strategies have been adjusting to that change, too, and no doubt other things. So there is a range of things. But, as I said earlier, I do not think business confidence is quite as weak as we commonly read—but you could not say it is really strong, either; that is for sure. It is one of the missing elements, and it is not something you can turn on, and it is not something that is easy to explain, really. Philip, do you want to—

Dr Lowe : My sense is, from a lot of the business meetings that I do, that business people just want to wait; they just want to wait until demand picks up a bit or they have a bit more certainty about how technology is going to play out. There was a period where they wanted to wait to see how Greece and the euro went, and now they want to wait to see how China plays out and see what happens with the Federal Reserve. So, while the underlying fundamentals, I think, have been gradually improving, there is this ongoing desire just to wait to see how the uncertainties resolve. My sense is: we are getting closer to the point where at least a few more businesses are going to be prepared to step forward, because you see them now hiring workers at a rate that they had not done for quite a while. As Glenn has said a couple of times, the current conditions are quite positive, at least from the business surveys. Interest rates are as low as they have ever been. And banks want to lend. If we just get a little decline in uncertainty, I think we are quite close to the point where we will see business investment start picking up—not dramatically, but a few more businesses will be prepared to say, 'Actually, given the improvement in fundamentals, I think I can now take the risk of committing to capital spending.'

Mr Conroy: If I could turn to unemployment: I acknowledge that, in your opening statement, in your testimony you have been relatively upbeat about the headline unemployment figure. I have asked you previously, and it has got worse since then: we have got underemployment at nine per cent, which is the highest since records began in 1978; we have got an underutilisation rate of 14.3 per cent, which is the worst since the 1990s recession; and we have got a long-term unemployment ratio of 23 per cent, which we have not seen since the late nineties; how do we fit into a picture of where the headline rate is not great, as you said, but it is also something we can be slightly more positive about versus these subindicators that are indicating huge excess capacity in the labour market?

Mr Stevens : I do not want to dispute the figures you quote, but what we will find, I think, is that, if the headline rate of unemployment stops rising and if we could get it to start falling then so will those other things. From a macro-economic point of view, which is where we sit, the best thing we can do is to try to generate growth in the economy above whatever its potential is, for a while, and start the headline unemployment rate coming down, and that will certainly help to bring those broader measures of underutilisation down. That is not to say that there may not be other things that might be done by way of helping those people be more attractive to employers and so on; maybe there are those things; I am not really in a position to talk about them. But, from our point of view, if we can get the headline rate coming down, those other rates are also going to start coming down and the durations of unemployment will, in due course, improve. In our world, that is the best thing we can offer, I think.

Mr CONROY: We had a discussion about consumer confidence before, and I am not going to track over that again, but, Mr Stevens, and maybe Dr Kent, do you think a factor in some flatness around there is the fact that we have got, according to the ABS, almost nine per cent of people who are in jobs wanting more work and unable to find it? Do you think that is a factor in consumer confidence being patchy?

Mr Stevens : It could be, but at the same time I think Chris earlier gave some facts about the responses in surveys to people's perception of their own financial wellbeing having improved. Though what you say is doubtless true for those people, at a broader level what the survey seems to be saying is: 'You asked me about the economy? I'm a bit worried. Ask me about how I'm doing? Actually, I'm doing better than I was.' There is a bit of a disconnect there, which I think may go to the narrative about the economy and the way we all collectively, through the media, conduct it—which is not to in any way diminish the difficulties for the people who would like more work.

Mr CONROY: I understand. If I can go to the trade balance for a minute, something that really has not featured in the public debate particularly heavily recently, we have a current account deficit of $57 billion in 2014-15, $52 billion in 2013-14—these are ABS statistics—and a big driver of the deterioration in the year, for example, was the trade balance moving from -8 billion in 2013-14 to -21 billion in 2014-15. I know part of the answer will be global weakness, but should we be concerned about where the trade balance is at at the moment?

Mr Stevens : A lot of the swing is going to be the terms of trade being weaker. I think that would be right, Chris? We are receiving less income from what is actually a significant increase in export volumes. That is, definitionally, the terms of trade story. So we know the terms of trade are falling; we conduct a narrative nationally about what that means for national income and per capita living standards and so on. That is valid. One of the ways that phenomenon is manifest is, by definition, through lower export earnings. But a 50 billion current account—let us say it was that—that is three per cent of GDP. Actually, the average current account deficit probably for about 35 years now is probably more than that. If anything, the current account, through much of the last four or five years, has been smaller than it had been.

What is the current account deficit? The other way of coming at this is that this is net capital inflow to our country—that is what current account deficit means—and the real question there is: are we using that capital wisely? That is the question. I am not really especially concerned about the current account deficit per se right now. Sometimes people fret about this—'How will we fund it' and 'Something will go wrong if the world doesn't want to fund it'—but I am not sure that is the right way to look at it. The fact is this country is attractive to foreign capital; capital wants to come here. We can invest whatever it is we are investing, which is probably not enough right now, and we can invest that without doing all of the saving to fund it. We can use other people's savings and share the risks and the returns with them, and we are a richer country for having done that. That is actually good. I think about the current account deficit more through that prism. I do not feel especially concerned about it. The question is whether we are using the capital sensibly.

Mr CONROY: If I can return to the trade balance for a second, and I do understand completely that the deterioration in part reflects the decline in terms of trade, but, as you made the point in your opening statement, our terms of trade are still 30 per cent above the historical average for this country. We may not see this, but if commodity prices continue to return to a more normal price, at some point surely we should be starting to worry about where the trade balance is at?

Mr Stevens : Maybe—

Mr CONROY: I put a couple of conditions there that I accept may not occur.

Mr Stevens : but the question is why you would worry. A larger trade deficit and therefore a larger current account deficit—the capital markets will fund that at some price. It may not be today's exchange rate. In your scenario, let us say that the terms of trade go down the rest of the 30 per cent. The exchange rate is going to go down too, and that will be part of the price adjustment mechanism that will, firstly, lessen the extent to which the current account deficit rises and, secondly, make the global investor community more amenable to financing it. That is part of the sort of natural adjustment mechanism.

Now, if the exchange rate went down a lot from where it is now, no doubt the newspapers would be full of drama and disaster and so on, but actually we have lived through those things before. They did not derail us. We could cope with them. I am not saying it will happen, but if it did I think we could cope, because we have before.

Mr CONROY: I will just finish, Chair, by going back to Dr Edey's testimony before about the interaction between negative gearing and the capital gains tax concession, which I found very interesting and quite pertinent to our other inquiry. Is there a strong economic justification for taxing capital gains at half the rate of other forms of income, leaving aside assuming instead an option of indexing it so you take into account nominal movements? But is there a strong economic justification for treating capital gains in a different manner?

Dr Edey : I am not really an expert on that, but, as you would know, the background to it was that the earlier capital gains tax was indexed, and then the decision was made some time ago to replace the indexing system with a discount, which is approximately the same thing, depending on what the inflation rate is. I do know that there are complexities here in the interaction between the capital gains tax regime for property and the way that it might affect other investments, and that has to be carefully thought about, so I am not suggesting that there are easy answers on this, but there is a tax inquiry going on at the moment that potentially can look at these things.

Mr CONROY: Would it be fair to say that we are in a different inflation environment than we were in when that decision was made? That decision was made in the late nineties. We had broken the back of inflation compared to the early nineties; I acknowledge that, but inflation nowadays is pretty subdued compared to then.

Dr Edey : We have a longer track record now of low inflation, so maybe that has to get factored into the mix.

Mr CONROY: Thank you, Dr Edey. Thank you, Mr Stevens.

Mr CRAIG KELLY: I was talking to Dr Kent during the break, and he mentioned that the Reserve Bank has a policy where the governor and the deputy governor have to travel on separate planes as a risk mitigation measure.

Mr Stevens : It is an audit committee requirement.

Mr CRAIG KELLY: Just along that theme, we have the different states with different state governments and we have the Reserve Bank with monetary policy across the nation. I noticed that the latest ABS figures that came out showed that full-time job growth for this calendar year in New South Wales has been 122,000, but full-time job growth in Victoria for the same period has actually been negative by 4,800. Could you maybe briefly outline some of the difficulties you have in applying monetary policy across the country when we have such divergent areas of the economy experiencing different rates of growth and different employment rates at the same time?

Mr Stevens : I think the first thing to say is—

Mr CRAIG KELLY: Those numbers were the seasonally adjusted numbers for the ABS figures.

Mr Stevens : Well, I am looking at total employment by state, so it is not full time, which you quoted. Victoria has been a bit more subdued lately, but over the past five years Victoria is nearly up there with New South Wales. The real weakness is in states like Tasmania and South Australia, actually. On the broader question of differences: there are always some differences in performance by region and by industry. Actually, that is what it means to be a diversified economy. We are not all booming or crashing together, and on the whole you would have to think that is a good thing. If we really were just one iron ore mine, we would have been through the roof and now through the floor all together. We are not that, so some parts have had that boom and slowdown, and others have been doing different things. On the whole, I think it is better to be a diversified economy. But it is an economy that is a currency area, so we have one interest rate—or one policy rate, certainly—and free flow of capital across state borders, just like we have free flow of goods and people across borders.

There is a whole literature on how you define what an optimal currency area is, but I think, by and large, the system works not too badly. When you think about it, as it has turned out, the parts of the country that were most affected by mining were very strong and the south-east was actually a bit slow for a while, and now they are swapping places. The total is a bit strong, then a bit weak, and now it is probably, I think, going to be okay. That is actually not a bad outcome. So we try to take account of all these industry and regional differences, make sure we are not being unduly swayed by what is happening to the price of the house just down the street from where we live or something, and set the right rate for the total. That is our job. This topic of regional differences often comes up, and it is a fair enough point, but every country has them. I do not think we have them any worse than others, and I think the system, by and large, is working not too badly. That would be my view.

Mr CRAIG KELLY: My other question relates to China. You mentioned that even China may not continue to have the significant high levels of growth we have seen in the past because the overall size of the economy will still be growing. In the forecast that you have, have you made any allowance for the possible increase in exports from Australia with the free trade agreement with China? Also, do you see that free trade agreement—the lowering of tariffs of Australian goods going into China—perhaps releasing some of those animal spirits that you talk about that are lacking in the Australian economy?

Mr Stevens : It could well be. I think freer trade generally is a good thing, and it is not just on the export side; it is also on the other side. Freer trade generally in economics is thought to help us make better use of the things we are good at and get more benefit by buying the things the other guy is good at. So we would be generally supportive of freer trade. I think there is the issue of whether 50 free trade agreements with 50 countries amounts to the same thing as multilateral free trade, and that is quite a complicated question, but in the present world it does not seem that getting a multilateral free trade agreement globally is on the table. So I think we would be supportive of that agreement. As to whether we have modelled it in our forecasts, I will let the forecaster answer.

Dr Kent : The short answer is no, in part because it is going to have some positive effects that build over time, and our forecasts tend to focus on the near term. So, while I think it has all of these sorts of positive effects the Governor discussed, the marginal effect on something like our GDP, our unemployment or our inflation is going to be modest but build over time, and that is not the sort of thing that we focus on. We are really focusing on the cyclical movements rather than these trend things. That is not to say it is not important—it is.

Mr CRAIG KELLY: You also mentioned uncertainty in the general business environment. Would the blocking of that free trade agreement if it did not go through possibly cause, or is the debate at the moment potentially causing, any uncertainty in the business community?

Mr Stevens : I think I am being asked to venture into political territory here, Mr Chairman. Would it affect business uncertainty? Maybe. You should ask the business community.

CHAIR: Now, you are sounding like a politician!

Mr Stevens : I will take that as a high compliment, Mr Chairman!

CHAIR: I would!

Mr CRAIG KELLY: Just on the inflationary environment: we have had a period of significantly low interest rates. We have had a period where the dollar continues to fall. Do you think it is possible that inflation could manifest itself in ways other than in prices?

Mr Stevens : Well, what other ways would there be? Asset prices, presumably.

Mr CRAIG KELLY: Potentially, deterioration of capital stocks.

Mr Stevens : I am not sure I understand the question. In goods and services inflation, CPI, which is our nominated objective by agreement with the government, typically, the way that people think about that is unit labour costs, imported costs and maybe an allowance for other sorts of material costs that are not specifically labour and then changes in profit margins. That is the way we would try to model that; that is the standard approach to doing that.

On the present set-up, because of the wages growth being subdued, that could change of course. But usually that is a fairly slow-moving thing, so for the next couple of years it would be very surprising to me if we have a problem of CPI inflation being too high, short of the exchange rate going down a lot—a lot.

Asset prices: well, we are obviously having a significant lift in housing prices in some parts of the country and not in others. There is also some push-up in commercial property prices, which is due to capitalisation rates falling as global yields fall and capital searches for a return. So those things are going up. I think they are understandable, at least in part, by the low-interest rate world. The risk with those things simply becomes if people expect that it is going to keep happening indefinitely then leverage up into it, and then we have a problem. That is why we are paying careful attention to household leverage in the investor space for housing. I think we will also be paying close attention to whether there is any leverage building up behind the commercial property stock as well.

So you think about those asset price dynamics in a different way to regular inflation, but they are very important so we keep an eye on them.

Mr CRAIG KELLY: Just in general, given the Fed's decision overnight: do you think it is possible that interest rates can be kept too low for too long? And if so, what would the consequences be?

Mr Stevens : It is possible and, if it happened, it would not be the first time. Many people hold the view that in hindsight, the Fed kept the rates too low in the mid-2000s—in that 2003-04-05 period. This is a common criticism. It is one that the Fed rebuts; it does not agree with it. But, anyway, that argument is made.

On the consequences of rates being too low for too long: usually in history you got standard goods and services inflation picking up and then you had to crunch the economy to get it down. I think in the present environment that the bigger risk is probably that ultralow rates for too long lead to too much financial risk-taking in the search for yield, and then those people run into trouble when rates eventually go up. That is more the thing that people think about in the present environment. That risk clearly exists, given that we have not only the Fed but the Bank of Japan having zero rates more or less for 13 years. The ECB has a zero, even negative, rate, and it will do so for some time. Clearly, that set of issues is on the minds of some people. That is a risk that attends these very unorthodox policies—very unusual policies. It is a risk that the relevant central banks think that they have to take.

Mr CRAIG KELLY: With the low interest rate environment around the world, are you concerned about the absence of domestic savings?

Mr Stevens : Australian households are saving more today, as a share of income, than they were, say, a decade ago. The saving rate is probably eight or nine per cent of income, maybe a little under 10. For a rich country, with a deregulated, fully-liberalised financial system, I would not say that is especially high or low. Government saving is a separate matter, and we all know there is a discussion about that. Corporate savings are actually in pretty good shape. So national saving is not too bad, actually. I do not think that is an especially big problem for us. We invest more than we save, which is why we have a current account deficit, a lathe previous discussion. But we have done that for 200 years, with some success. So I myself do not feel the need to mount the soapbox about saving being particularly unduly low. I do not know if my colleagues feel differently. If they do, speak up. But that is my view.

Mr CRAIG KELLY: There is a nod of the head.

Mr Stevens : Perhaps we should have some questions for the deputy governor, Chairman. He has gotten away without saying much today.

Mr CONROY: He can give a speech on infrastructure if he wants.

Mr HUSIC: Governor, in paragraph 3 on page 4 of your opening statement, where it commences 'in relation to the card payments area,' you indicated the bank had announced a review, or released an issues paper, in early March, and contemplated some changes in relation to regulation of surcharges and interchange, and you also said that it was an opportunity to consider some of the issues raised in FSI. I have a number of questions. One, was that review flagged to the sector in advance? Two, how much time did you give the sector to respond in relation to that paper in early March? Three, have you detected criticism from the sector that suggested that this had been sprung on them, and that the timeframe was too short?

Mr Stevens : I am not aware of that criticism. I will get Malcolm to answer the questions of detail and timing, if he can. But other than the normal undercurrent of complaining on the part of various people that they do not like to be regulated, which is always there, I was not myself on the receiving end of complaints about timing. But I do not know whether there are things I am not aware of.

Dr Edey : No, I have not heard any of those sorts of complaints. The way the interaction with the industry works is that RBA staff are talking to the regulated entities all the time. They often make representations to us saying that particular things should be looked at, and we will tell them whether we are going to go away and look at it or not. We had the FSI, of course, where this was a big component of what that inquiry looked at. All the key players in the industry and the RBA made submissions to the FSI. The FSI made an interim report, called for more submissions—

Mr HUSIC: I am not asking about the FSI, I am asking about PSB, and whether or not you flagged that you would be doing this review, and how long you gave people to respond.

Dr Edey : I do not remember what we said prior to the announcement of the review.

Mr HUSIC: You do not know, or you did not?

Dr Edey : I am just saying I do not remember what we have said to industry people. I do not think there was any announcement that we were going to do a review, but I do not think it should have surprised people that this would come out of the FSI, and the review that we announced in March was a response to an FSI that had been going for more than a year at that time. So we made the formal announcement in March with an issues paper, and we gave industry about six weeks to respond. We received a lot of submissions. We then followed that up with bilateral discussions with all the key players who made submissions, and then a roundtable with the industry collectively, and with consumer and merchant interests in June.

Mr HUSIC: So, for all the things that FSI canvassed that would have affected stakeholders interested in it and the PSB, they were not given any notice that this would be happening, and you gave them just six weeks to respond?

Mr Stevens : I do not think that is unreasonable, really. The inquiry had been underway for a year. It was pretty clear what they were focusing on. There was an interim report, and then the Reserve Bank came out and said: 'Okay, there are these issues on the table. We'll do our job and review them.' I do not think that was precipitate haste on our part. I think it was just us responding to the situation that was there.

Mr HUSIC: Dr Edey, in another inquiry being managed by the Senate economics committee, a number of questions were put to you about transparency. In particular, there was a point made about the way in which the RBA issues minutes of meetings, and the question was put to you, 'Would the PSB adopt a similar framework?' to which you said you were unlikely to, but you indicated that the PSB issues media releases to go through and respond to some of the issues at a higher level as to what is discussed at PSB.

I had some research done in relation to that for 2014. You had a meeting on 18 February, and there was not a summary of the PSB items discussed. On 23 May, you met. No media release was issued for that PSB meeting. On Friday, 22 August, again, no media release was issued for the PSB meeting. On 21 November, again, there was no media release for the PSB meeting. Do you want to revise the evidence that you have previously given, or have you made adjustments to that process since then?

Dr Edey : I am not sure which years you are referring to there.

Mr HUSIC: 2014.

Dr Edey : I would have to go back and check the record. The practice has been that, if there is something to announce, we announce it—not necessarily on the day, so you have to look at the weeks following a meeting, because sometimes it takes a while to put the conclusions into a form that is appropriate to announce. But usually, if there is something to announce, it will be announced within a week or two after a meeting.

But the way the PSB works is that there is not necessarily something that is up for a decision at a meeting. If there is something that is up for a decision, and a decision gets made, and we have to take an action, then we will announce that. A big part of the transparency process is not the media releases; it is the consultation processes that, by law, we have to go through whenever we are contemplating regulatory action. Those are very extensive. We publish issues papers whenever we are contemplating that. We then go through the consultation processes. We then have to consult again whenever we want to produce draft standards.

Mr HUSIC: I guess I am guided by your statement to the Senate Economics References Committee that says—this is you, Dr Edey:

We do a form of what you are asking for anyway—

this is in reference to releasing the minutes—

in the form of a media release that comes out after each PSB meeting—

each PSB meeting—

and that media release is a short summary of the issues that were discussed and the actions that were taken.

That statement seems to suggest that you do this on a regular basis, but it does not appear that you are doing them. Why?

Dr Edey : I think what I should have said was, 'If there is something to announce, we announce it.' I think that, if you were to go back and check the record over a longer period, you would find that there are a lot of these statements. Since whatever I say is going to get quoted back at me, I do not want to make any bold statements about how many of these we issue, but, if there is something to announce, we announce it. And, if there is any regulatory action being contemplated, we go through very extensive public consultation processes.

Mr HUSIC: Given the growth of online commerce and the way in which payments, particularly electronic payments, help facilitate or enable that growth to occur, the job of the PSB, I think, is taking on greater and greater significance. Do you believe there is greater scope (1) to be more transparent and (2) to be able to consult better with the sector; and (3) do you believe that there is now an opportunity to review the way in which the PSB sits within the RBA, and should it potentially be taken out of the RBA and handed over to another regulator, particularly to help enable the types of consumer protection issues that you said in the Senate committee hearings were not really the preserve of the RBA to manage anyway?

Dr Edey : All of those things really came within the scope of the financial system inquiry, and as far as I know nobody has made a strong case during that process that there was anything wrong with the current regulatory set-up, and the FSI itself concluded that the current arrangements have worked well. So it is open to you to raise all of these things again, but these things have just been under consideration by a major inquiry which did not come to those conclusions.

Mr HUSIC: But these issues have been put to you in the other committee that is investigating credit cards, and that is occurring right now. It does appear that, despite what the RBA or the PSB has been telling one committee, some of the things that have been indicated are not occurring, particularly in reference to transparency. Isn't there scope to improve?

Mr Stevens : With respect, I think the process is quite transparent. A parallel, I think, may be being drawn with the processes for the monetary policy decision, where we do decide something every month, there is a high focus on it, and we disclose a statement and the minutes and so on for the reasoning behind the decision. That is a monthly process, but that is a kind of pretty unique decision, I think, and it is one that is made every month. The Payments System Board makes different sorts of decisions. The issues on which it decides typically have quite a long gestation, and on any given particular topic that we might be working on—which might be, say, central counterparties and regulatory things there; it might be card payments; it might be surcharging; it might be some other set of issues—there is not a monthly decision on all of those things. There is a periodic point at which we decide, 'Okay, we're going to do X,' and then there will be a statement to that effect, not on the day but in short order, and it is not as though every financial price in the country is waiting on that decision that day, the way it is on the interest rate decision.

So I am not persuaded that the case that exists for disclosing the minutes of the monetary policy meeting, which is a standard thing central banks do, just flows over to the same thing with the Payments System Board minutes. If it did, we would have to be pretty careful, because a lot of those things are quite commercially sensitive at times, so they would have to be different sorts of minutes, really. So I do not think the case flows across in the way that perhaps is being assumed, and I think I would emphasise the other point that Malcolm made: that the consultative process is, to my mind, extraordinarily lengthy and detailed. That is not to say it cannot be made better, but I think it is a very consultative, open and transparent process. That is my assessment.

Dr Edey : Mr Chairman, if I may come in just briefly, I am reluctant to get into a chapter and verse argument about this, but it has just been pointed out to me that for last year's PSB meetings, from the four meetings, there were three media releases out of those four meetings.

Mr HUSIC: I noticed that one of your colleagues brought that to your attention, so I am going to come back to your testimony, which said that 'The media release is a short summary of the issues that were discussed and the actions taken.' Based on what you have just informed the committee, can you point to where that happened?

Dr Edey : I would have to go back and check the record again, but all I am saying is my general recollection is most of the time there is a media statement that comes out after a meeting. It is not immediately after, but we do put out media statements after most meetings.

Mr HUSIC: You have answered with a degree of confidence that does not seem to be backed up by that last statement. Thank you, anyway.

Mr Stevens : Well, we are doing this—

Mr HUSIC: Governor, I have gone to the media releases—they do not do what Dr Edey said, with due respect. The releases are issued but they are not in the form that Dr Edey advised the Senate Economics Committee. That is the issue—industry is saying they want to see some degree of transparency. You do not believe that that necessarily has to be the case, but I think this is going to be an ongoing debate.

Mr Stevens : Just so I am clear, a media release that says we have made the following decision, all of which comes after extensive interaction with the relevant parties bilaterally or occasionally with these roundtables, and for example on 18 December 2014 we announced we were going to vary the access regime for some card systems, so that is an announcement of what was decided. I do not think the industry would have been surprised to hear that we were thinking about the issue, because most of these issues are the subject of continuing discussion. Anyhow, if the industry is saying to you that they want more transparency then I will have to look at what we can do about that.

Mr HUSIC: I am just putting the statements of your senior people that are made to other committees back against what has been the reality or the experience, and I do not think it matches up. I do not think that is an unfair position I am putting to you.

CHAIR: To return to unemployment, earlier there was some purpose on the headline rate. Is that the lead indicator, or is that the underemployment rate?

Mr Stevens : When you say 'lead', do you mean the most important, or leading in a time sense?

CHAIR: Thinking of when things are turning around and unemployment is reducing. Would it not be the underemployment that is first chiselled away, and would that form a lead indicator of how things are going?

Mr Stevens : In some ways you might expect that hours of work start to rise before the number of people, so there may be some basis to expect that under some circumstances some parts of the underemployment measures turn first. I am not sure whether, empirically, that can be demonstrated systematically.

Dr Kent : Just to be clear, the underemployment is the unemployment rate and then it adds in a measure which captures those people who are employed but say they would like to work some extra hours. As the Governor suggested, if hours are picking up ahead of the number of people employed, you might expect that one to move slightly ahead of the unemployment rate. But my sense is, just glancing—it is really a glance at the history of these series—they tend to move together and indeed the unemployment rate has stabilised over the course of this year and so too has the underemployment rate. So too have youth unemployment rates. They follow a similar sort of pattern—they tend to move together, broadly speaking.

CHAIR: Do you know whether this pattern is similar to the United States?

Dr Kent : I could not comment on that—I am not really sure.

CHAIR: We have heard the term 'quite some time' in respect of interest rates remaining low. Could you put some range of years on that?

Mr Stevens : Well, maybe to try to give some backward historical context will help. We have had interest rates—the policy rate in the US reached zero in late '08 or early '09. It has been there since, so that is six or seven years. In Japan, it reached zero about 13 years ago, and they made an attempt at some point to get off it, very briefly. So these things can last a long time, and I hesitate to put time horizons on these things into the future, but, you know, I think it is going to be a number of years that we will see very low policy rates certainly in Japan and Europe, and even in the US if they come up a bit. I do not think within five years. I would be surprised if it were within five years that things looked normal in the way that they used to.

CHAIR: So, given the major volatility of the GFC and other tremors that have followed, wouldn't this serve to provide the business community with the stability and certainty that all businesses and industries wish for? So, therefore, aren't we hopefully entering a period of stability on which growth could be built?

Mr Stevens : I think the argument that you are making is that 'certainty' that interest rates will be low and not changing very much for some years could be helpful, and I think that is certainly what the central banks that are in this position would be hoping. That having been certain, you know, they have been giving this forward guidance, as they call it, for quite some time, and it has had some beneficial effect, I think, but it has hardly transformed the world. So more generally I would have to say I think the fact that interest rates on financial assets are this low for this long—many people would take that as a sign that underlying confidence and willingness to invest are actually pretty weak. That is why the rates have to be here, in some sense. So I am not sure that is altogether good news. It would be better news if there were a bit more zip and zing out in the real sector in the global economy and interest rates were able to return to normal, but I think that is going to be a very slow process. But on everything we can see now—I would love to be wrong about that, actually—that is the way the world looks right now.

CHAIR: Out of your concern for Dr Lowe not having enough questions, I might just finish with a question for Dr Lowe. On a number of occasions, the governor mentioned press comments and media comments. This is a week where we have had the comment 'poll-driven panic'. Does media reporting sometimes—if it is not accurate or if it is irresponsible, possibly, or poorly informed—have any adverse effect on your ability to work through your job or impact on you in any way?

Dr Lowe : I think the short answer to that is no. I mean, we all see—and you must see this as well—things in the media that do not accurately reflect what is actually going on.

CHAIR: Never!

Dr Lowe : And to some extent that does affect people's expectations and how they view the world. But I think, broadly speaking, the media do a pretty good job of highlighting the fundamental issues that our economy faces: the challenge of continuing to increase people's living standards at the rate that we had become used to, the challenge of lifting productivity growth and the challenge of improving business investment climate. These are all things the media are talking about all the time, and they are the types of things we should be talking about. So we all can get frustrated at how the media twist or portray a particular piece of information that we know a lot about, but I do not think we should get too hung up on that. They do a reasonable job at bringing to the public's attention the issues that we collectively should be talking about.

CHAIR: Thank you very much for that—very diplomatic. Do we have any other further questions? Can we have our students come forth, please. Again, from Canberra Girls Grammar, Ellina Woodgate and Dora Cordero.

Ellina Woodgate, Canberra Girls Grammar School : Thank you, members of parliament and members of the Reserve Bank, for being here today and allowing us the opportunity to ask several questions.

One of the largest themes of today's discussion has been the United States decision last night to maintain its current interest rates, and you have mentioned throughout your comments today, Mr Stevens, that the Federal Reserve will certainly normalise interest rates in the future, as it is not sustainable to continue at interest rates which are so low, although the current rates might be retained for quite some time, which was quantified into a number of years. Yet, when this increase does imminently occur, it has been predicted that global capital outflows will accelerate, negatively impacting Australia and our trading partners. What measures has Australia implemented, and, in your expert opinion, what measures should Australia implement in the future, in order to combat these anticipated negative impacts when the Fed does make this decision?

Mr Stevens : Well some of those impacts have already occurred, because the forthcoming interest rate increase, assuming it occurs, has been very widely foreshadowed. Markets have been reacting to that for quite some time now, so part of the adjustment has already occurred. The main thing that any country can do, including ourselves, in the face of capital ebbs and flows is to retain resilience, adaptability, have a flexible exchange rate, have a credible set of policy frameworks in place domestically, so that we can cope with the likely downward pressure on the exchange rate that would eventuate in the scenario that you have spelled out. As I say, some of this has already occurred; perhaps more will occur. I think we will be able to manage it.

Dora Cordero, Canberra Girls Grammar School : Regarding the standards of lending, it was recently reported that 42 per cent of new home lending was interest-only lending. Is this our subprime crisis in waiting?

Mr Stevens : The fact that it is interest-only is a possible risk factor in some ways, but it is not the same thing as subprime. Subprime loans were loans to people who had very poor credit quality, and towards the end of the subprime boom they were really starting to be loans to people who had no hope of repaying. That is not quite the same thing as an interest-only loan. There are some people who are quite good credits who would have an interest-only loan for reasons of financial strategy, among which would be some of the tax elements that we were talking about earlier. That having been said, interest-only lending does mean that the borrower is not paying down the principal, so they are remaining exposed to the debt if something goes wrong. So it is a thing to be watched and managed. I do not think it is the same thing as the subprime crisis in the US but it is, along with some other things in the housing market, a potential risk that we do need to watch, and we are. Thank you.

CHAIR: Thank you very much, governors, for your generous time. I declare this public hearing closed.

Resolved that these proceedings be published.

Committee adjourned at 12:24