glenn stevens : overview of economic developments affecting australia opening statement by mr glenn stevens, governor of the reserve bank of australia, to the house of representatives standing committee on economics, brisbane, 20 august 2014. * * * chair members of the committee thank you for the opportunity to meet with you today. since the hearing in march, the global economy has continued its expansion at a moderate pace, and australia ’ s trading partner group has been growing at about its long - run average rate. with the abatement of the adverse winter weather, the us economy recovered in the june quarter and the labour market has continued to strengthen. growth in china has remained close to the target of 7. 5 per cent, though chinese residential property prices have declined in recent months. chinese authorities at various levels are responding to these developments with the aim of maintaining stable macroeconomic and monetary conditions. in japan, consumption and output grew strongly in the march quarter ahead of the increase in the consumption tax in april, and then contracted sharply in the june quarter. this is a normal pattern surrounding such tax changes, but complicates reading the underlying pace of japan ’ s economy. economic growth in the rest of east asia has continued. commodity prices important to australia have declined this year, as global supply – including from australia particularly – has increased. the terms of trade have now fallen by about 18 per cent from their extraordinary peak three years ago, but they remain over 50 per cent higher than their twentieth century trend level. perhaps the most remarkable feature of the international scene at present is the exceptionally low volatility of financial prices – the lowest observed over the past 25 years for sovereign bonds, equities and foreign exchange. yields on sovereign debt of the major countries are also very low, the lowest on record in some cases. spreads on investment grade and financial corporate bonds have reached multi - year lows and in europe yields on so - called “ peripheral ” sovereign bonds have in some cases fallen below previous historic lows. it is not as though there has been a dearth of geo - political or financial events which might ordinarily trigger more caution among investors. but compensation for risk on financial instruments remains scant. the reasons for these remarkable trends, including the extent to which they reflect the effects of the exceptional monetary policies being conducted by the major jurisdictions, or other things, could be debated at length. what is clear though is that a combination of forces has resulted in financial conditions remaining remarkably accommodative.

financial services are a key intermediary input into the production process. a severe curtailment of those services has a material impact on the capital accumulation process, unemployment and the long - run growth prospects of the economy. it is in the interests of society to ensure that the public sector provides a backstop in such circumstances to mitigate the externality caused by the individually rational risk - aversion of financial sector participants. finally, the financial innovation of the decade or so prior to 2007 saw the development of a large number of derivative products whose goal was to disperse risk around the financial system. this was done, in part, to enhance the robustness of the system to any idiosyncratic shock and to ensure that the core process of financial intermediation was not significantly compromised when the shock hit. this worked up to a point, in that the situation, as bad as it was, may have been even worse if all the losses resided on the books of financial intermediaries rather than also on the books of pension funds etc, where the immediate effect of the losses was diffused somewhat ( although less of it turned out to be diffused than originally thought ). whether this is true or not will be an interesting research question in the years ahead. conclusion the argument i have been seeking to make today is that the mis - assessment of risk has been a key element of the financial crisis. one of the contributing factors to this misassessment was an over - reliance on a model - based approach to risk management, which focussed too much on measurable risk without taking full enough account of unmeasurable uncertainty. taking account of uncertainty is not easy, after all, it is uncertain! but at least a focus on ordinal as well as cardinal probabilities, in part by stress testing with scenarios that fall outside the model ’ s history, would surely be beneficial. but stress testing and the assessment of uncertainty is still constrained by the difficult decision as to what is the relevant set of stresses that the framework should be subjected and what is the relevant history. a healthy dose of judgement needs to be brought to bear on these decisions. given these difficulties, it is important to try to make the system as robust as possible to the inherent irreducible uncertainty. one key element of this is restraining leverage, which can limit the number of illnesses that turn into fatalities. bibliography ahamed l ( 2009 ), lords of finance : the bankers who broke the world, penguin,