The AFR is running a section on an interview they held with Glenn Stevens today. The interview transcript is here, and it is extremely comprehensive, covering many topics we have regularly discussed here on MB over 2012. I haven’t got time to day to provide an in-depth coverage and analysis of the interview but I would recommend that you read it in full, if you have the time, because it is a good frame of reference to where the mind of the RBA is at as we enter 2013.
In short, Captain Glenn isn’t going to push against the currency or ‘Dutch disease’ and believes that the economy can make a transition from mining to construction in such a way that incomes will continue to grow and economic stability will be maintained.
I’ve listed a couple of the Q&As below that I found the most interesting, but again I recommend you read the interview transcript in full as many of these particular questions have related follow-up questions that provide additional clarity.
Captain Glenn on the dollar:
AFR: How big a problem is the Australian dollar in all of this, including in this difficulty of forecasting the future of output and inflation?
Stevens: The currency is today a little stronger than we had been assuming if you went back a year – there’s not a huge amount in that but it is stronger.
I think one of the potential forecast difficulties is that previous experiences with the exchange rate – we certainly had quite big cycles around what was clearly a lower mean level than we have today.
We didn’t have an extended period of a much higher level.
So, it’s possible that it turns out to be quite difficult to forecast the full effects of a very persistent shift up, because the modelling experience and so on of the past 30 years doesn’t have such an episode in it.
That’s possible, I think more generally though the exchange rate being persistently quite high, and I mean we can come back to whether it’s too high or not, but I don’t think it’s any surprise that it’s persistently much higher given what’s happened to the terms of trade in the global economy.
We’ve had a very big shift in relative prices, unless you think all of that is temporary, we can’t know, but if that turns out to be persistent and it certainly has been pretty persistent so far, that means a couple of things.
One is – you would expect the exchange rate to be persistently high but you’d also expect that the structure of the economy is going to change. Some sectors will grow, some will shrink, that’s what happens when relative prices alter.
It’s not pleasant, the people who are on the downside of the relative price shift don’t like it obviously – who would? But that is what the global economy has handed us by the look of it.
And so structural adjustment will occur, you can’t really stop it. Exchange rates are part of that but it is reflective of this deeper thing that I think has happened in the global economy.
Captain Glenn on controlling bubbles in the “new normal” environment:
AFR: Alright but does this not mean something difficult or dangerous in monetary policy? Correct me if I’m wrong, but interest rates wouldn’t be at 3 per cent now if it weren’t for the dollar. You’ve got to make up for the dollar, but in the process you’re stoking up a whole lot of interest rate sensitive demand including asset prices and so forth. Don’t you end up in a bit of a wedge there?
Stevens: It’s the thing we have to be wary of – I mean the classic problem in a situation like this can be that you seek to compensate for a very high exchange rate with cheaper, lower interest rates.
That can – in some circumstances – give you the asset credit build-up that then gets you into trouble later.
So we’re mindful of that, I don’t really think we’re seeing that though at the present time.
We’ve seen some pick-up in housing prices, as you’d expect with interest rates coming down, but I don’t think we’re seeing at the moment a dangerous leveraging up there by households.
Household credit growth is actually still pretty moderate and I think there’s plenty of people still seeking to get their leverage down.
So, that’s a potential danger but I don’t think it is one which is being crystallised, at least not that we see at present.
Captain Glenn on the hope for what comes next:
AFR: Can I just take you back to this point about the new areas of growth at low interest rates. You’ve said a number of times you’re looking for growth in non-mining investment to take up where mining investment leaves off. We’ve seen some signs of life in housing but there’s no sign of life in the capex surveys or in services and manufacturing. If that non-mining investment turns out to be a bit of a growth hole, where does the growth come from? Do we end up having to rely on a much stronger rebound in housing?
Stevens: I think we always get this question, where will the growth come from? And most of the time it comes.
On business investment, my pretty strong recollection of quite a few cycles I’ve lived through is that you get to a point where the fundamentals of that investment look okay and you’re wondering why aren’t they doing it?
And eventually they will, but quite often that is slower to show up than one would have ideally liked. That’s the nature of things.
I’m not sure if it makes sense if it is a bit slower to come through, it doesn’t make sense to stoke up other things in some effort to overly fine-tune a short-term path of the economy.
We’ve got to recognise that monetary policy has limits to fine-tuning.
We’re not going to be able to absolutely guarantee seamlessly every handover from one source of demand to another.
The economy has actually done pretty well in recent years when you think about it with all these various handovers. Private demand slowed, the government stepped in, the fiscal contraction or consolidation was scheduled to occur, the question was will mining investment pick up? It did. Now, the mining investment is going to slow, will the other pick up?
We don’t know but it’s not as though it’s completely fanciful to expect that there will be a reasonable handover there, but we can’t promise that we can fine-tune that to the last of the …
Captain Glenn on falling income:
AFR: One of the striking features of the national accounts, perhaps the most striking feature of it in the September quarter, was the fall in the income we earn from GDP, the real income. How do you expect that to make its way through the economy? I presume for example that there is a smaller surplus for the unions and employers to argue over. What does that mean, for example, for industrial disputation? How does that all affect monetary policy?
Stevens: There’s some reversal of the big quantum gains in income that we had in the preceding years.
As we’ve said before, those income gains were shared amongst a number of groups – foreign investors own significant chunks of the resource sector and they will now get lower profits as a result.
Governments typically get some through various taxes and revenue streams and that’s obviously going to suffer a partial reversal.
The shareholders, the workers and so on share some of the other gains and you’re right, nominal income of the country is not rising and in certain periods it might actually fall.
Whether that means higher industrial disputation I’m not sure, I think you could argue actually that the disputation level might be greater the more income there is to share around and that it might well diminish when times are tougher.
On monetary policy I suppose the question there is, what’s the overall impact of all of this on the balance between demand and aggregate supply, price expectation and the exchange rate? What it does and doesn’t do is a key element to that.
The possibly slightly too cute answer is that we try to work out what is going on, embed that in the forward-looking framework and ask the question, what’s going to happen to growth relative to trend and inflation and so on over time and go from there.
And finally, Captain Glenn on housing
AFR: As you know every pet shop galah that comes to Australia says our housing prices are too high and that may be arguable. But if you’re thinking about perhaps cash rates below 3 per cent, given that household leverage has only levelled off, are we at all vulnerable?
Stevens: My position as you know on the level of housing prices has been they are high.
I think that when you put it fully into international perspective – that is, don’t just compare with the US, compare with a whole range of countries – it’s actually a lot harder to make the case that they’re grossly overpriced and due for a crash. After all, we’ve been around this level of house prices/income for 10 years – [it’s] taking a long time to burst if it is a bubble.So I’m not so much concerned about a crash, but as I have said also before, it’s seems to me we would be flirting with danger were we to see a very big run-up from these present levels.
Now, we have seen some gain in house prices over the past year or so that’s reversing a little bit of an earlier decline.
That doesn’t trouble me, I think that’s probably part of [the] cyclical transmission mechanism working.
But it would be, I think, troubling if you saw a return to very strong 10 to 20 per cent per year persistent rates of growth of housing prices, especially if that was accompanied by a return of rising leverage.
I think that would be a very dangerous thing to do and we would be imprudent in the extreme to preside over that.
I don’t think that’s what’s going to happen by the way – I don’t think that is what is happening and I don’t think it’s that likely because I think the household sector has worked out.
As I said above, there’s much more in the interview so check it out.