Reserve should lie low and keep its powder dry

The board of the Reserve Bank should confine itself to thinking and talking today, as there is no case to alter the stance of monetary policy.

We shall outline the questions board members will (or should) ask, and the points that should be made by officials in response. The overall point is that, while there are plenty of problems, none of them would be helped by a change in monetary policy at this time.

Q. What is happening in Europe?

A. The eurozone crisis stumbles on. Clearly there is a concerted effort to keep the eurozone intact, even keeping Greece in the single currency area that it is so unsuited to. Countries in as much trouble as Greece - Ireland, Malta, Portugal and Spain - would benefit from far lower currencies, and generating recovery with an uncompetitive currency for these weaker nations is far more difficult than it need be.

Politics aside, those striving to save the eurozone must fear a serious banking crisis if the weak nations took the lower currency road to recovery, leading to the break-up of the eurozone.

Q. How bad is the China slowdown?

A. Our view is still that the slowdown is mild and will create no great problems for Australia. There are others with a bleaker picture. For example, our favourite critic, Henry Thornton, has been worrying since January when a leading European journalist drew attention to the large drop in the Baltic Dry Index of freight movement, an indicator that was a favourite of a former member of this board, incidentally.

China's various statistics generally have been worse than expected since then, and the forward price of iron ore is now below $100 a tonne and still falling. This canary in the coalmine is far from dead, but is wobbling on its perch.

Q. Is Ben Bernanke going to print more money and does that matter?

A. Bernanke has been dropping hints that do more to confuse even fellow central bankers than to clarify his true intentions, which may indeed be unclear in his own mind. The US recovery is far slower than seemed likely at the start of the year, and if "Operation Twist" (depressing short bond yields at the cost of raising future dated yields) works at all, the chairman must be tempted to engage in more of the same.

But the US Fed's monetary policy looks like a prime case of pushing on a string. The real issue is US fiscal policy. Confidence will be improved only when one party or the other finds and imposes a policy to give promise of reining in budget deficits in the not-too-distant future without imposing ludicrous austerity in the immediate future. We shall be monitoring the presidential election closely.

Q. All this sounds pretty downbeat, Mr Stevens. Surely another rate cut would do no harm? A. I agree that the risks are more nearly on the downside than on the upside, but I am inclined to wait a bit longer. Let's come back to the question when we have reviewed domestic conditions and prospects.

Q. So what is the overall state of the domestic economy?

A. Well, as the governor has said, the glass is more than half full. Resources Minister Martin Ferguson recently said the resources boom was over, but what he meant was that the commodity price boom was past its peak, a proposition with which we agree. We are well into the investment phase and, despite the reductions in plans of the big companies, there is still a lot of investment under way.

A senior mining man told me recently that when projects already announced are cancelled, that will be the time to worry. Gina Reinhart's massive development may end up postponed or requiring help from BHP Billiton or Rio Tinto.

When investment comes off the boil, export volumes will ramp up, phase three of what will be a three-part mining boom in a 10-speed economy. The average speed will be about 3 per cent a year, about the best we can do with current fiscal, industrial relations and welfare policies.

This is our best guess, of course. If Europe implodes and China's slowdown is noticeably worse, all bets will be off.

Q. That 10-speed economy includes several sectors hurting badly: manufacturing, tourism and education, to name three. The dollar is too high for these sectors to flourish. I must ask again why it is not possible and desirable to engineer a lower Australian dollar?

A. As I have said, Mr Board Member, it is not possible to have all 10 sectors booming at once. The lagging sectors are in effect providing resources for the booming sectors, including mining but also services generally and the public service in particular.

If the federal and state governments played their part and produced a genuine underlying fiscal surplus, which is what the economy needs at present, it would be possible for us to cut interest rates and produce a sustainable lower dollar.

Trying to engineer a lower dollar by swapping overseas currencies for dollars would be useless and might just produce an even greater inflow of overseas currencies that we would be forced to turn into dollars. Our own version of Operation Twist.

Q. What about all those people Roy Morgan says would like more work and cannot get, and those who say they cannot get a job or live on existing welfare payments?

A. Sadly, these matters require integrated industrial relations, welfare and taxation reform, and there is virtually nothing we can do to help by reducing interest rates at this time.

Q. Inflation is low and seems destined to remain low, certainly that is what the forecasts say. That's our main job, so why not give a bit of help to the unemployed and other battlers with a lower interest rate?

A. (Mr Stevens takes this question.) That is a fair point, but it isn't that simple. You know that my consistent line has been that modest "real" interest rates, after adjusting for inflation, are an important part of a sensible set of policies. I accept there are some signs of deflationary pressures globally, and if these persist or get stronger we shall be recommending further cuts to interest rates.

Just at present, however, I would prefer to keep our powder dry. If there is a substantial deflationary shock, I will talk to you all even if it is between meetings and seek your agreement to a cut of 50 basis points in the cash rate.

Leaving rates where they are now for the time being feels right to me, but I assure you we will be watching developments overseas with the utmost diligence, and we have the ability to move decisively if that is needed.

Now if you are happy with the press release circulated earlier, we can have a bite to eat.