Transcript
RORY ROBERTSON
Rory Robertson, Westpac Group, just a quick one for Professor Gregory. You say that Australia's going to get stuck in this low interest rate trap. Just clarifying, so you're saying 3.5 to zero isn't going to be very helpful? And the other question was what unemployment rate are you assuming at that point, where it's five now?
PROFESSOR BOB GREGORY
The first part of the question I heard; I didn't hear the second part. I don't think the interest rates will be 3.5 by then.
PROFESSOR PETER DRYSDALE
No, he's saying that they're going all the way down.
PROFESSOR BOB GREGORY
They don't have to be zero to be ineffective. I reckon 1/1.5 is, you know, getting in an ineffective range, so I think there are going to be more interest rate cuts between now and the end of this crisis because when this downturn really starts seriously you can already see with... while investment is still increasing and we haven't got that downturn yet, you can still see when there are more terms of trade falls to come, in my view, already the bank is signalling interest rate reductions. So I think by the time we get into a serious problem the interest rate is going to be very, very low.
RORY ROBERTSON
What does the unemployment rate have to be before you get [inaudible]?
PROFESSOR BOB GREGORY
The unemployment rate?
RORY ROBERTSON
Yes.
PROFESSOR BOB GREGORY
We haven't done the work on that, but I think the implications are clear it will be higher. Now, on that...
RORY ROBERTSON
The Central Bank [inaudible].
PROFESSOR BOB GREGORY
What?
RORY ROBERTSON
[Inaudible]
PROFESSOR BOB GREGORY
I'll give the answer to that. In the United States the unemployment rate today, given the participation rates of eight years ago, would be roughly 14/15%. The unemployment rate in the US is eight. The way it got to eight – as was hinted by this morning's paper – is this massive withdrawal from the workforce. So if you want to talk about the unemployment rate you have to figure out what that will be, but I think it will be much higher than it is now – but we haven't done the labour market work.
PROFESSOR PETER DRYSDALE
I'm going to apply the Gruen Principle here and positively discriminate in favour of the Irishman later on, but let's take some more questions around this set of issues if people have them.
PAUL BLOXHAM
Paul Bloxham, HSBC. This question's for Professor Gregory as well. There are a few things. The first would be you're quite clearly assuming the terms of trade has to come down a fair bit from here over some time horizon. I wonder how much sympathy you have for the view that global growth has changed. It's now being driven by emerging economies. Those emerging economies need a whole lot more commodities to drive their growth than the developed world-driven growth we saw in the 80s and 90s when commodity prices were low. The second point would be your model seems to be very one sector focused and I wondered, given that the mining sector is about 10% of value added, whether the rest of the economy actually will be able to pick up a bit and provide some support for the economy and therefore it will somewhat mitigate the impact that you've described. And the third point, and it's related, is as the exchange rate has done a fair bit of positive work in slowing down some parts of the economy, keeping inflation contained on the way up, will not the exchange rate do the same thing on the way down to mitigate the impact of the fall in terms of trade?
PROFESSOR BOB GREGORY
I think they're all the right questions to be asked. It does turn crucially on the... Not only, but the terms of trade are the biggest part of the story. There's no doubt the investment will peak and come down, that's part of the... There's no doubt that exports will go up. There's no doubt that a large fraction of that export receipts will go to the [unclear]. The terms of trade is a big issue, I think, and you can see it in our pictures. The essence of the terms of trade is that... Or maybe I shouldn't say the terms... The essence of the export prices is it turns crucially on the demand side and the supply side. In this country we have been excessively demand-side focused. That is we've talked continuously and rightly about the increase in China and it's because supply was not responsive that we got the large price increases. So what I showed you that basically we've had very few... very little export increase relative to GDP to this point, that's true of virtually all countries. It takes time to get minds in place.
We think, or I think, basically on prejudice that all those supply things that are coming on stream here are coming on stream everywhere and it's usually a characteristic of commodity cycles, food cycles, animal cycles, but on the way up prices will go up dramatically because supply is slow to adjust. Once the supply adjusts the prices will come down. So I think fairly confidently that the terms of trade are going to come down a long way over the next two or three or four years because that's the time when the supply side should start coming in here and everywhere. After that then you're back into this balancing game again – how much is India growing, how much is China growing and how much will supply grow compared to demand – but in the short term it just seems to be inevitable that the supply side increases are going to surprise us all because what's been... We know that the supply side increases are big here. That must be true all around the world basically.
PAUL BLOXHAM
That's a fair proposition in principle, Bob, but I think the policy makers need to actually look at what the facts are of oncoming supply. Have you done that, Peter, in trying to predict what the terms of trade will shift down to over the next [overtalking]?
PROFESSOR PETER SHEEHAN
I'm glad you asked me that because I would like to stress – at least from my point of view – this is not a prediction. We're not trying to say this will happen or that will happen. We're trying to say most people on historical record would suggest that the terms of trade at some stage will fall fairly significantly over the next few years and the exchange rate will follow them down. We can tell from the project data that the resources investment will turn over. Now, other people, you can have different views. I heard someone say that the exchange rate will stay up till 2020.
PROFESSOR BOB GREGORY
Not me.
PROFESSOR PETER SHEEHAN
Not Bob, but there are other people in the world. So what I say this is, what we are trying to do is to explore the implications of one widely believed scenario that this is the way the key variables go out, and if I could just pick up a couple of points that have been made. The point about monetary policy is if you see the world this way and it does evolve in this way there is a substantial deflationary shock over one to five, this is a long term phenomenon. Not to say there's going to be a recession, but I think there are real issues about monetary policy. For example, if we exhaust our resources of monetary policy in the first six to 12 months then that won't be a serious instrument. So we're really arguing for the need to think in long and medium term framework about the whole realm of policy.
PROFESSOR PETER DRYSDALE
Next question.
JAMES BOND
James Bond, MI5 and the Australian Services Roundtable. You guys add your voice to the many in policy and the business community talking about broadening your interest in the GST and the Business Council of Australia, the Financial Services Council, the Institute of Chartered Accountants, the Grattan Institute, almost everyone's done research and done modelling showing that this is the thing we need to do. What my concern is and it's very important from if services is the future and New South Wales economy... government has to rip $1.9 billion out of education because they want to balance their budget, then it starts to become even more important and so you can understand the political pressure that they're under. My concern is that the political pressure that's keeping these governments to have balanced budgets or surpluses is as strong or is similar to the political pressure that's going to stop the GST being broadened or increased. And if I can provide a possible answer it is there's only really one group or two groups who are stopping this from happening, especially once we have the States on board, which we think we do – and that's the Social Welfare Lobby and the Union Lobby – and so I think it's probably collectively everyone in this room we need to... but if we can get everyone on board – and that includes the Social Welfare Lobby and Unions – then we can get to the point where we have a united voice on this.
PROFESSOR PETER DRYSDALE
Which one of you would like to have a go at that?
PROFESSOR BOB GREGORY
Even though I'm not the only one in the room? Look, the politics are hard ie if you're as old... well, you don't have to be as old as I am to remember one of our most effective Prime Minister's saying at some stage in his career that the GST was ridiculous, we should never have one, and there was some funny story about birthday cakes and candles, and lo and behold we got the GST. There's been a lot of discussion that you can't increase GST. New Zealand has just done it. So you can't expect political things to shift instantly, they take time, and I want to emphasise that if this scenario that we're talking about is at all likely, the process of shifting the views has to change over a long period. So you've got to get started now. And so the way I actually think it's going to happen is I think the States are going to start clamouring for GSTs and I think that will make it easy for the Feds to go in there moaning and groaning and weeping and crying, but actually increasing them, and I just think that's going to be the way it happens. Otherwise we're locked in. I really do think that if a scenario like this happens, we're locked in our monetary policy, we're locked in on fiscal policy, we've got to find a way out and I think the Fed/state relationship infrastructure is the way out and I think once you do that you make up for the GST on the table. That's the place to start doing it. That's politics by the way.
PROFESSOR PETER DRYSDALE
We'll take one question from anywhere now and then if it's not in the right direction I'll give preference to Philip.
UNKNOWN
This one is for Philip actually and first of all I'd just like thank you as someone who does global macro. Your emphasis on IIP positions over the last decade has been of great use to all of us. Now, from what you know about Australia's international investment position from previous work and today's paper, and bringing it together with some of Bob's comments about foreign capital eventually repatriating their profits, gets back to something about Australia's external accounts which is quite idiosyncratic for an advanced country in that we have a very, very large income deficit in the current account and we actually have a very high rate of return on foreign liabilities and a relatively low rate of return on our foreign assets which is different scenario for an advanced country and it has some Asian aspects to it, if you will, for very different reasons. So based upon those stylised facts about our international investment position and what Bob and Peter have put up there as a hypothetical, are you more or less worried about Australia's international financial sustainability?
PROFESSOR PHILIP LANE
So the other country which has this characteristic is also another country which has a lot of foreign owned capital, which is the Irish economy. So a huge section of our export sector is foreign element, so it's basically they produce a lot outputs, but then the foreign owners receive the profit. So, if you like, that is it should be a stabilising factor to the extent that if the mining sector does well, yes, the domestic Australians won't benefit. On the other hand, if the terms of trade collapse, the falling export prices will be mostly absorbed by the foreign owners. So in other words it should be a stabilising factor relative to an alternative scenario by which Australian enterprises develop these mines and use debt financing to do so. So in that sense it's important to interpret the fact that foreign equity has financed that in a benign way. I know there's a big issue about how much tax they should pay and all of that, but in terms of the risk characteristic that should be a stabilising feature. Bob was talking about this possible big decline in terms of trade and to an extent if there is a fall in natural resource prices, part of that is going to fall on these foreign owners, so in that sense it's partly hedged, but there is... The ongoing issue though is Australia and New Zealand do have this intermediate case which is they've been running these large... well, it's come down a bit, but they've got a large amount of international liabilities, part of which are equities, but they have more debt liabilities than a lot of developing countries and the mystery has been that they've always been able to manage the currency risk with that and it is a question with the change in the global financial system whether it's going to be permanently the case that foreign investors are willing to take on essentially...
Because the flipside of saying that the Australian dollar has been this big shock absorber for Australia is that some counterparties in the world have been willing to take on that risk and the question is whether the price at which that risk can be transferred to foreigners will be as low in the future as it has been up to now. So I do... I don't know. I'm going to go into the Reserve Bank of Australia on Friday because I'm going to talk to the experts there, because from the outside that is one of the features I've always found a bit striking, that Australia's going to... Maybe it should be a but quieter... say, great, we have this fantastic stabilising exchange rate. Because to the foreign investor saying, well, it sounds a bit risky to me that whenever the world goes into recession I'm going to lose money on lending in Australian dollars.
PROFESSOR PETER DRYSDALE
I think it's Ross, is it?
PROFESSOR ROSS GARNAUT
Yes. Thanks, Philip. There you answered something that I was interested in, so I won't ask you another one. For the Australians it's a complex story that's going to unfold over the next few years and I broadly buy the story you're putting forward, but there's a number of other complexities in it and I'd just like to ask you what you think about one that goes by the name of Redzinski. We learnt in our 1960s micro theory that if you've got a rapid expansion of your most capital-intensive sector – and that's what's going on in stage two – that you've got to have a reduction in real wages to maintain full employment. It puts stress on the rest of the economy and of course that depends on having an absolute constraint on the supply of capital whic
h we more or less have, at least since 2007. We haven't had a large blowout in the current account deficit to pay for the resources investment boom. If Redzinski's part of the complicated story of the present then won't we get a little bit of help from the unwinding of that – capital becomes available to other sectors and that takes some of the pressure off employment and incomes in other sectors once we're in phase two?
PROFESSOR BOB GREGORY
I want to say a couple of things in response to that. First of all, if there is a deflationary shock, the exchange rate is going to help. It is going to devalue. I think it will go down a fair way, but I had building in the back of my head that the responses are slow, so it's going to take some time. Now there's some debate about that. Tourism responses will be quick, for example, and so on. Secondly, and this goes to the real wage [unclear] which I think is really important and not well understood, and I feel very uneasy about that because I've always been a pro high real wage sort of person, given my background, but half the real wage increases in the last decade have come from the terms of trade effects. That is half the real wage increases, as far as I can work out, come because of the prices of imports and the put price level generally is smaller because of the terms of trade. So I think it follows from that that monetary policy has been made easier in all sorts of ways. One of the reasons why the exchange rate pressure...
One of the reasons why the labour market pressure has not been so great is that workers have got real wage increases without going through the nominal wage path; they've essentially got it on the price side, on the CPI side. That process will disappear as the terms of trade deteriorate and the exchange rate goes in the other direction. So this question of the wage level and the inflation rate that comes out of the downswing is going to be really quite difficult because it may well be that at the very time the economy is becoming more deflationary prices actually start to go up more – partly through the fact that the downward movement in the prices is going to find... Sorry, the upward movement in the import prices are going to find it hard to feed into, quote, real wage cuts and that's something which has to be thought about and explored and that's all I have to say really.
PROFESSOR PETER DRYSDALE
Yes, down here.
PROFESSOR FARIBORZ MOSHIRIAN
Just a question... Fariborz Moshirian, New South Wales University. Philip, just a couple of issues regarding regional financial architecture, you alluded to a number of issues such as enhanced information – we need more information in Asia. During the Great Depression we didn't have economic data. We started collecting what is now referred to as GDP. We started measuring for the first time how can we measure a country's economic activities, so we ended up with what is called now GDP as part of UN financial system account. Now, we have got this challenge globally as well as regionally how to enhance our financial data when we talk about regional financial integration, regional financial stability. I think the other issue you commented was regional financial safety net. I know that Asia Development Bank wants us to have more and work harder on regional financial safety net just in case we end up with some other financial challenges down the track. And the third issue is related to systemic risk in banks. We know that some of the Japanese banks are listed as part of what is referred to as global systemically important financial institutions, 29 banks around the world, but then we also know that Chinese banks are contributing to systemic risk for different reasons. So I'm just wondering, you alluded to a number of issues on your presentation, but on a practical side – because we are interested in regional architecture – how to bring, if you like, Asian countries closer to each other and, of course, the world of finance is important for us and we would like to see more insight on a practical side of some of these issues.
PROFESSOR PHILIP LANE
So on the information issue, just what I had in mind was during the crisis it really was a big surprise. Regulators in Europe, investors were really surprised how much risk European banks have taken on in the US. It's just something you could not tell from the way the banks were reporting their activities. So while saying there is that cross-border information about who does what, right now it's way below what is needed. And the point I was making vis-a-vis Asia there is that there was a selloff in Asia during the crisis. Why? The fundamentals are good. Why are these guys selling their positions? And quite often it might be involuntary because it could be in America their Mutual Fund where the monitor might know that the fundamentals are good [unclear], but his retail investors are panicking or they need to make a margin call or whatever and it's forced selling. So again you could have a financial situation that's quite stable, but you don't know what's going on in the life of your counterparty. So to know what's going on in terms of leverage investors especially is a big issue. In relation to banks, one issue argues that the [unclear] to globally systemically important banks, but I think we're finding out from Spain and from Ireland and elsewhere is that you can get into a lot of trouble from the activities of small banks. If enough small banks misbehave, even if your big banks are perfect, your financial system is in trouble. So I wouldn't be specific just about the role of global banks. Every corner of the financial system can have a bomb waiting to go off in it.
The regional architecture: So I didn't say too much there because there's been so much written on this and I think it's good understanding that a regional safety net is helpful if one country gets into trouble or a small country gets into trouble, but if the whole region gets into trouble that region will need help from the global system, so there's counter mentality there. There's no one answer to that and the other point I was trying to make there is it's not necessarily only regional and only global, it could also be the type of economy to the extent that the large emerging economies in Latin America face a similar risk profile to those in emerging Asia. They could pull those risks and people like Eswar Prasad, Art Cornell and some others are essentially saying that's part of the answer, an alliance of large emerging markets could do quite a bit as well. So that debate doesn't need yet another contribution to it, but I was just pointing out there that that is part of the agenda that needs to be addressed.
PROFESSOR PETER DRYSDALE
We could go on talking about these papers all afternoon and beyond. Unfortunately we haven't got the indulgence to do that. I think both papers have established really excellent and rigorous frameworks for looking at two quite different sets of policy issues that arise out of Asia's rise and how we respond to it in policy terms in these two different dimensions. I think what they've done very nicely is set up an agenda for us to get into the prediction and use the framework for thinking carefully and rigorously, empirically, about what it is we really will have to face down the track in the case of the Australian paper and also the policy agenda that Philip just touched upon there in his response to that last set of questions for regional financial management. So join me in thanking Philip, Bob and Peter very much for [inaudible].