No guarantees amid the forces of turmoil, says RBA boss Glenn Stevens

IN an exclusive interview, the Reserve Bank governor ponders the future.

MASSIVE forces are at work on the Australian economy and it is beyond the power of the Reserve Bank to finetune the outcome or guarantee a smooth path.

Governor Glenn Stevens remains confident that Australia’s economy will emerge with the ability to service its great Asian markets with a much greater div­ersity of goods and services, but the path over the next year or two is highly uncertain.

In his exclusive interview with The Weekend Australian, Stevens underlined the impact of the resources boom and the likely disruption created as central banks, led by the US Federal Reserve, start lifting their official interest rates from their current level of just above zero.

“There’s just inevitably, I would say, a wider margin of uncertainty around any central view,’’ Stevens says. “There’s no way of avoiding that. There are very large forces moving in various directions.’’

In the resources sector, companies are drawing to the end of their construction phase, while exports are rising rapidly. Partly as a result of that new supply, but also because of planned slower growth in China, commodity prices are falling. The European Central Bank is adding fresh stimulus measures while the US Federal Reserve and the Bank of England are contemplating raising rates across the next year.

“We’ve got very low interest rates but quite a high exchange rate — so things pulling in opposite directions — and the truth is, it would be foolish, I think, to pretend that one can precisely forecast in that effect of all those forces,’’ Stevens says.

“I don’t think we can, and nor do I think that it’s within our cap­acity to guarantee some kind of finetuned, very smooth outcome. I think the tuning is roughly right for circumstances, but there isn’t much in the way of precision here. There can’t be.”

The Reserve Bank has not shifted its cash rate since last Aug­ust and, since February this year, has been saying that the “prudent” course for rates is a “period of stab­ility”. Stevens won’t say how long that is likely to last.

“I think it’s a little early actually for people to be contemplating early rises in rates,” he says. Stevens notes that in financial markets the current pricing suggests that if there were to be a move in the near term, it would be more likely to be a cut than an increase, while rate rises will not reappear until the longer term.

“Our central outlook is for growth … to be a little below trend for a little while yet and then to pick up somewhat further out. That forecast is predicated on an assumption of no change in interest rates for that period, but that’s not a commitment to deliver that. It’s just a working assumption.”

Interview full transcript

So far, the economy is evolving much as the Reserve Bank expected. “We’ve anticipated a very large decline in mining capital expenditure over several years,’’ Stevens says. “If anything, my sense is that this probably took a little longer to start than we initially thought. But there’s not much doubt it’s going to decline quite a lot. The exact timing of that’s quite uncertain.

“Our forecast … is for things to on average be probably a little below trend. Not a long way below, but a little below trend over the coming year.”

Stevens says that so far the economy has handled the resourc­es boom well. He distances the bank from the conclusions of the new book by his independent board member John Edwards, who argues that the importance of the resources boom has been exaggerated, saying the bank believed the “terms-of-trade boom and all the things associated with it is a big deal. But the economy is actually coping with it quite well so far.” (He says the book is “beautifully written” and welcomes the fact he has a fellow optimist about Australia’s outlook on his board: “I felt lonely in the optimist camp.”)

In previous resources booms, Australia suffered disastrous inflation followed by recessions as high wages in the hot corners of the economy spilled across the nation and the exchange rate failed to ­adjust.

“The key things that help the economy cope with the upwards part of the terms of trade, I would nominate obviously a flexible exchange rate, which we never had in the booms of the mid-70s or the 1950s or the earlier ones in history,’’ Stevens says. “We didn’t have that stabilising price movement we’ve had here.

“I think the second thing that should be said is that, notwithstanding discussion over whether we need more labour market flexibility, the fact is that by and large the labour market responded pretty well to what was a couple of fairly sector-specific shocks.”

The good performance while export prices were soaring does not guarantee Australia will do similarly well as they fall, but it is a good start. Says Stevens: “Pro­vided we can keep that kind of suppleness and flexibility, provided that the exchange rate more or less does what it is supposed to do, and provided that we keep the prudent macro-economic frameworks — which I think has also been a factor in helping in this period — you should be able to have some grounds for confidence that we can manage the next phase. It may be difficult but certainly not ­impossible.”

While the rise in the exchange rate helped Australia to manage the boom in iron ore and coal ­prices, it has not fallen nearly as far as the RBA would like since commodity markets started to fall.

Part of the reason is that global central banks and sovereign wealth funds have been buyers of the Australian dollar to diversify their risks. “You have a phenomenon that particularly sovereign investors want AAA-quality assets, but the list of countries (that have) AAA ratings has gotten smaller, and I think we’re quite prominent on that list because of basically a sound economy by global standards.

“We have strong banks and government finances — for all our current debates, actually the government finances overall are in very good shape compared with the case in many other countries.”

However, Stevens is not convinced that if global markets get a shock and start fleeing for safety, funds will flood into Australia. “I suspect we might well see the Australian dollar go down in such an event, time will tell.”

The pivotal time will be when the US starts lifting its interest rates. “I think that when that day comes, and starts to get closer even, the likelihood of some disruption in markets is probably pretty high because it always is when the Fed eventually changes course. And that will be the case even though they will be very careful and measured and signal and so on, as they’re doing.”

A rise in US interest rates could be expected to bring falls in global bond and share prices and tidal flows of capital back from emerging countries and Europe to the US. However, Stevens does not expect the Australian economy to suffer. “I think the atmosphere in international financial markets would be different in a world where the Fed is on a path, however gradual, to raise its rates. I think it would be no secret that our feeling is that we hope to see that.

“I happen to think the US economy is going pretty well and it’s going to be just fine, but further confirmation of that would be when the Fed feels confident enough that they start to normalise the policy rate.

“I think overall that’s a good story. It’s a good-news story. It’s simply that there’ll be some bumps along that road for some people. I wouldn’t anticipate serious problems for Australia in particular.”

Stevens shares concerns of the Bank of International Settlements (the Swiss-based central bank for the world’s central banks) that the extraordinary monetary policies pursued by advanced-country central banks may be storing up problems for the future.

The intention of easy monetary policy (whether through cutting rates to zero or central banks buying government bonds) is to encourage risk-taking. However, Stevens worries that it may be only financial investors taking risks in bond, share and derivatives markets, not companies taking a gamble on new expansions.

“We should be trying to form an assessment of how much is the risk-taking of the kind that we want by entrepreneurial business in the so-called real economy: a new product, a new factory, a new process, an innovation and, by extension, some employees as well.

“It’s that kind of risk-taking that is good because that’s how soci­ety advances, and that’s the inherent growth dynamic of a capit­alist economy that makes them so productive and wealth-creating over time.

“My view is that we’re not in a position as yet to form a good judgment on whether the risks involving the policy settings are earning the adequate pay-off in terms of the support to the real economy. They may be, they may not quite be — it’s a bit early to know yet.”

The Reserve Bank is proud of the fact Australia has managed the period since the global fin­ancial crisis without taking rates down to near-zero levels and remains firmly committed to its inflation-targeting framework. Stevens would like to see central banks everywhere moving to more normal interest rates, but he acknowledges that this may not be possible.

In some countries, such as Japan, a shrinking population and only average levels of productivity growth mean there is no positive level of interest rate that would encourage people to invest their savings. “So their potential growth rate and their natural interest rate is actually a very low number, regardless of what inflation target they might have chosen.

“I think that’s actually the more fundamental problem. I personally think Japan’s bigger problem isn’t deflation. That is a problem but the bigger problem ... has been a relatively unattractive potential growth path and what (Prime Minister) Mr (Shinzo) Abe is trying to do is lift that path.”

However, Stevens does not accept the argument, advanced by Harvard economist Larry Summers, that this applies to the US.

“I feel more optimistic about the US certainly than that,’’ he says. “I still think that’s a very dynamic, productive, innovative country and I find it hard to believe that their natural rate of return on capital is a negative number.”

Stevens says it is too soon to conclude that Europe has set its troubles behind it, although the forthright stance by the president of the European Central Bank, Mario Draghi, in declaring he would do “whatever it takes” to keep the euro together appears to have “put to rest the notion that the euro is going to come apart”.

“I still think it’s some time yet before we can all safely conclude, ‘Well, that issue is now done and dusted and it’s behind us.’ We’re on the way to that but we’re not there yet.”

Stevens is quite confident about the outlook for China, which he acknowledges is the biggest source of concern for many economists about the outlook for Australia. He says the Chinese authorities are slowly easing the economy’s reliance on unsustainable levels of investment to drive its growth in favour of greater household consumption.

“The key thing is whether we’re adaptable enough to adjust our offering to China in line with the various adjustments that we’re making in their economy over time. It seems to me that it’s possible for us to do that as long as we’re on the ball …

“China growth targets now, they’ve got a seven at the front, we’re not going to see 10 per cent again. I think a lot of people took quite a while to get their mind around that, even after Chinese made it very explicit. In due course, I imagine we’ll see sixes and five, going way out over the next 10 years or so, or more.

“That’s our assumption, but those are still pretty strong growth rates for such a large economy, and I think ample opportunities for other countries, including us to play our part in engaging with them and having mutually beneficial gains from trade. It’s just we have to be sufficiently adaptable to see those opportunities and go and take advantage of them. They don’t just drop in our lap.”

Stevens expects the industries that can capture these opportuni­ties to develop as the economy adjusts to lower levels of investment in the resources sector. The latest business-investment report provided encouraging signs that the economy was finding new sources of growth. The most obvious of these is housing construction, which he says will be much stronger this year.

“Outside of that, one would think that there are some service-oriented sectors of the economy, health education and so on, where there will be stronger-than-average growth for quite a long time in the future.” Some sectors of the tourism industry will do well while, even in manufacturing, there will be niches where Australian businesses prosper.

However, it will require greater confidence and that is not easy to engineer. “There isn’t a lever called ‘confidence’ you can go and tug. It doesn’t work quite like that,” Stevens says. “I think eventually that confidence will improve but one can’t say how quickly and how strongly that will occur.”

Although the Reserve Bank believes it has made the right calls in the rate moves it has made since the crisis, Stevens says the ability of central banks to influence the course of economic growth and prosperity has its limits.

There are debates over which the central bank has no influence, such as the current concern about inequality. Stevens says he has read the recent book by French economist Thomas Piketty, which forecasts that the rich will keep on getting richer until there is a social breakdown but notes that returns to wealth at present are falling.

“I have the sense that inequality issues are becoming more important in public debate, and that’s not something that I want to express strong views about. It’s not my job.

“Generically, the central banking community finds itself with more expected of it than it used to and I think there is some risk that too much is expected.” In some countries, though he stresses not in Australia, that is the result of the political process being incapable of making the needed decisions.

“This then leaves a central bank, viewed by its markets and the population, as the remaining actor who can do something and that’s a very awkward position to be in. But, this being the environment, I think there is a risk that too much is expected of what monetary policy can do. We do have to retain a certain modesty about what it is we can do and what we can’t. I think that’s important.”