Well, Governor Glenn Stevens gave a remarkably interesting account of himself in Parliament today. Decoding the central banking speak, this transcript is nothing short of amazing...
1. GOVERNOR CONCEDES LOWER STIMULUS = LOWER RATES
Mr CIOBO—The flip side of that coin is of course that that increase in expenditure also leads to a tightening of monetary policy. In the economic context in which both your opening statement and other comments from the Reserve Bank have been made, is it reasonable therefore to assume that somewhere around that $10 billion or $15 billion increase in expenditure would see a similar tightening of monetary policy along the lines of what Mr Richardson said?
Mr Stevens—If there is a $15 billion increase in projected government spending in a single year, beyond what is already built into the forecasts—if that is proposed and enacted—then obviously that has a material impact on demand versus supply in the economy and will have a significant bearing on decisions that we would make. Let me be clear: this is an increase of a per cent of GDP compared with a baseline. It is not the increase that is already in the baseline, because that has already been factored in.
Mr CIOBO—I note that Paul Bloxham—who, as you know, spent the last 12 years of his working life inside the RBA’s economic analysis group and a few months ago left to take the chief economist position at HSBC—wrote this week in the Financial Review: “… by choosing not to tighten fiscal policy sooner, the government has implicitly chosen higher interest rates than might otherwise have been the case.”
Mr Stevens—It would have been lower had the stimulus measures not occurred. We would have had to lower the cash rate further. I think that has to be true. I think it is a different thing to say, though, that that would necessarily be a better mix of policies. One could debate that, I think, because there was scope to do discretionary fiscal stimulus. The whole point of having budget surpluses, really, over a run of years is that when a rainy day comes you can do something if you feel you should. We had that scope. Many countries do not, but we did. It has to be true that, if that had not occurred, interest rates, I think, would have fallen further, and then of course eventually they would have had further to come back up to normal in due course than they did have. Would that have been a better world? That is a very interesting question that we can debate if you want to, because there are plenty of things that can get you into trouble with really low rates, particularly if they persist for a while. I think your analysis is correct. The interesting question is whether a world of no fiscal easing and more monetary easing would actually have been the ideal mix. It is an interesting question.
2. GOVERNOR RAISES LABOUR MARKET RIGIDITY CONCERNS
Mr Stevens—…As to the regulatory changes, it is an important question to what extent these changes may have flexibility. It is very hard for me to tell. Many people that we encounter from a business background are quite concerned.
Mr Stevens—People I have spoken to are concerned that it will be harder to get productivity gains and harder to contain costs in the future and that the flexibility of the system is not as great as it was. Whether those concerns are fair and valid, whether they turn out to be validated by experience, time will tell. I cannot know yet. I can only record that many people from a business background that I have heard talk about these things do have these concerns. It will be important that the new system is administered and implemented in a careful and flexible way.
3. GOVERNOR HIGHLIGHTS “HUGE MORAL HAZARDS”
Mr Stevens—On ‘moral hazard’, there is a moral hazard everywhere in the world because governments and central banks did extraordinary things. Some of the things we did were unprecedented for us but by the standards of what some other countries did were pretty mild. So there is a huge moral hazard because governments and central banks did these things. They had to be done, because the system faced a catastrophe in the absence of these measures. But them having been done, and even though we are withdrawing them, the issue we will face—and this is what you were getting at, I guess—next time there is some pressure is whether there will be another guarantee. My very firm view is that we ought to try to get to a position where at that time, whenever that day comes—hopefully not soon—our government will be in a position to say, ‘No, we are not going to give a guarantee and the system can cope with that.’ I think we are much closer to being able to say that than most countries, but we still have some work to do to get a permanent set of arrangements, particularly for deposits, which can stand the test of time. That is on our agenda at the moment and for the early part of next year. I expect that at future meetings we will probably come back to that. It is a very important question.
This is why, to hark back to the questions Ms Owens asked about the global regulatory work that is being done, people are very conscious of this, very conscious of the need to try to lessen the moral hazards surrounding some of these very big global banks by making them safer, less likely to fail and easier to resolve if they do fail and so on. It is very much, though, still a work in progress. That is the best I can tell you at this point.
4. GOVERNOR ACKNOWLEDGES CONTINGENT LIABILITIES + NEED TO PRICE IMPLICIT GUARANTEES
Ms O’DWYER—Governor, would you consider that these guarantees are contingent liabilities—that they increase the risk profile of the Commonwealth prior to its position pre the crisis?
Mr Stevens—We are getting into areas where it is very difficult to talk about this publicly, so I will be a little bit guarded. But, from a strictly accounting point of view, they have taken on a contingent liability that they did not have before. What is the probability that you would actually have to make good on the entire deposit base of the banking system? It is extremely low. So, if you were trying to measure this obligation, it would be the size of that times some probability of having to make good on that, and that is very low number. I think you would also, to be honest, have to in the back of your mind pose the question: in the previous world, without this guarantee, would a government stand by to let the system collapse and do nothing? I cannot think that they would. There was always some unspoken, unquantified support. But it is a very interesting question: should that be made explicit and priced or shouldn’t it? That is one of the issues that I think would probably have to have a discussion about, but today is probably not quite the moment.
5. GOVERNOR ADDRESSES TOO BIG TO FAIL RISKS + MORAL HAZARDS
Ms O’DWYER—That leads pretty nicely into my next question, which is: can you tell us whether there is a risk in the fact that Australia has four ‘too big to fail’ banks that effectively benefit from implicit taxpayer guarantees.
Mr Stevens—We have four large institutions, but the number in a crisis is not necessarily limited to four because in crisis conditions, if people are panicked enough, even a smaller entity can end up being quite disruptive if it is in distress. The other side of that, of course, is that those institutions are supervised very intensively by the supervisor, who is quite prepared on occasion—and has done so—to require banks to do this or that additional thing over the minimum, if they think that is appropriate from an individual risk or even a systemic risk point of view. But this is the nature of banks. It is a tricky area because banking just is not like any other business. A bank failure, even for a not-so-big bank, is not like the failure of any other business, where someone else comes in, buys the assets, employs the people and everything keeps going. It is not that simple in banking, which is why we have regulation that is much more intrusive on a bank than it is on your average industrial company. It is for that reason. It is why there is this very difficult, delicate balance with the problem of moral hazard. To make moral hazard go away entirely is probably impossible. It is a tricky area.
6. RBA LISTS SUPPLY-SIDE INFRASTRUCTURE INVESTMENT PRIORTITIES—NO NBN
Ms O’DWYER—The RBA has repeatedly communicated its concern that the Australian economy is operating near full capacity, and given expected above-trend growth over the next one to two years faces the spectre of inflation pressures. In March of this year Assistant Governor Dr Philip Lowe gave a speech in which he argued that, for Australia, the main task is to expand the supply side of the economy so that demand can grow solidly without causing inflation to rise. Can you shed some light on the key supply side deficiencies that the RBA has identified and is concerned about?
Ms O’DWYER—If the private sector is not willing to fund some projects that would be related to this and 100 per cent of the equity risk is to be borne by the Australian taxpayer, can you explain what economists mean when they talk about the opportunity cost of capital?
Mr Stevens—The opportunity cost of capital would be, ‘I use it in area A; I can’t use it in area B,’ assuming that the quantity of capital available is finite. You have to be a little careful there, because there is a global supply of capital that is very big and the real question is how well we use it. This is really making very general points, but we are probably going to need more investment in electricity, are we not, over the years ahead, and water? Some of that is being done. There is a fair bit of urban infrastructure that would be desirable, as anybody who lives in any of our major east coast cities—or west coast, for that matter—would think. All of that has to be done, but we have to try to do that at the same time as we build more houses and build more mines. So it is going to be a tall order, I think, to fit all this in without overheating things, if you think about it that way. That is part of the reason that I suspect a little more caution on consumption—which I think we do see amongst households, anyway, at the moment—is probably no bad thing if we are going to fit all these other things in as well.
7. RBA SAYS WE NEED NBN COST-BENEFIT ANALYSIS
Ms O’DWYER—This is my final question, because I realise I am running out of time. I noticed you did not actually mention $27 billion of taxpayer capital and another $10 billion of taxpayer debt issuance on the National Broadband Network. So I suppose my question is: is there a risk if the government ends up allocating vast amounts of taxpayer capital to projects that the private sector has rejected which do not work materially to improve the supply side of the Australian economy? What hurdles should these projects face to satisfy us that they warrant the commitment of taxpayer dollars?
Mr Stevens—I do not want to get into the NBN in any detail. It is an area that, to use Phil’s words, is outside our core area of expertise. As a general proposition, there probably are some projects that the private sector will not fund that still ought to be done. Whether this is one of them would be another question. But I think you can imagine some projects that the private sector just does not feel it can take the risk on but on which the public sector—which, after all, has a stronger balance sheet than anyone else—might on some occasions be able to accept that risk. But there ought to be, of course, a proper cost-benefit analysis of that case in those instances. It is not unreasonable to expect that more interconnectivity around the country can be a benefit to productivity—that is a reasonable claim, it seems to me—but, as I have said on one or two other occasions, much hinges on how much you pay to do it and how efficiently it is done. But that is not for me to adjudicate on in that particular case. Much as I am sure you would like me to, I don’t think I can.
8. GOVERNOR EXPLAINS CHANGES TO THE STATEMENT SIGNED WITH TREASURER WAYNE SWAN IN RELATION TO INSOLVENT INSTITUTIONS
Ms O’DWYER—I want to refer to the new statement on the conduct of monetary policy that was signed in September 2010. As I understand it, the RBA added the following new text, which has not appeared in previous statements since the first one was signed by the former Treasurer. That statement is: “The Reserve Bank’s mandate to uphold financial stability does not equate to a guarantee of solvency for financial institutions, and the Bank does not see its balance sheet as being available to support insolvent institutions.”
As you of course know, the RBA has a responsibility to serve as a lender of last resort to deposit-taking institutions that are adversely affected by these liquidity shocks, as it did during the global financial crisis. If a bank can no longer fund itself because of an external shock and the RBA is the only counterpart in the world willing to lend to it, how can this not represent the RBA using its balance sheet to support insolvent institutions?
Mr Stevens—The distinction, though, is between illiquid and insolvent, so, in the classic central banking setting, if an institution is illiquid but it does have assets it can pledge as collateral the central bank, on the assumption that it has some reasonable look at the quality of those assets, can lend against them at an appropriate rate of interest. This is Bagehot’s classic— in a liquidity crunch, lend freely at a high rate to sound banks. We would do that. Nothing in this statement on the conduct of monetary policy changes that fact. The Reserve Bank will always play the role of provider of liquidity against collateral at an appropriate interest rate. The statement about not seeing the balance sheet as being available to support an insolvent institution is making a different point. It is saying that we do not regard it as proper, and no central bank would, for a bank which is actually insolvent to be bailed out by the taxpayer through us. If it is going to be bailed out by the taxpayer, the government should make that decision and should fund it itself. We would probably have some role in facilitating that in the event it occurred, but the government would have the credit risk, not the central bank. I think that would be, in central banking circles around the world, the way all central banks would think about it. So our role is in liquidity and we will always be prepared to do the right thing there by the system and by participants in the system in a crisis, and we have done that and we basically doubled our balance sheet in 2008-09, for a brief period, for that very purpose. As to the financial rescue of an institution which is not solvent, there may or may not be a public policy case to do that but that is a government call. We would obviously give them our views if they asked, but that would be their call, I think quite properly.
