There's hope if a large negative shock hits Australia: RBA's Glenn Stevens

The Reserve Bank of Australia governor Glenn Stevens has urged the Federal government to stay the course on meaningful budget repair or it will face consequences as the debt blows out.

"We're not on the correct path for the long run and we need to get onto a better path I think during benign times," RBA governor Glenn Stevens said on Friday.

We don't have a budgetary crisis, he added.

But during questioning Glenn Stevens told an Australia America Chamber of Commerce lunch that the budget repair should happen during "benign times" to build resilience for the next downturn.

"We should be taking early measured steps that build up in their effect over the long term so that we sustain the position we have," he said.

"If God forbid a large negative shock came along right now, we still have macroeconomic scope to respond to that" with the fiscal firepower to respond, he said.

"A deficit that's 3% of GDP right now that would be at 5 or 6 or 7% very quickly if we had a significant recession. If you were then thinking we'd like to do some discretionary stimulus on top of that then you are talking about pretty big deficits," Stevens said.

But scope for discretionary stimulus on top of that could be limited, if the deficit was already high.

"When you go into a downtown the deficit gets bigger anyway because the government does nothing because of the so-called automatic stabilisers and that's appropriate," he said.

His formal notes advised that looking back at the history: "If we come through this terms of trade event with neither a major outbreak of inflation in the upswing nor a major crash in the downswing, even if we have a period of sub-average growth in the process, we will have done far, far better than in any previous event of this kind, let alone one of this magnitude."

"I still think that is the most likely outcome.

"Even so, the lower terms of trade mean that, all other things equal, the path of future incomes is not as high as it might have looked a few years ago.

"Even allowing for the fact that we all knew, intellectually, that at least part of the boom was not permanent, there is a human tendency to project what we see now (good or bad) into the future. Eventually reality intrudes and we have to re-evaluate.

"That has happened countless times before and will again, no doubt."

Glenn Stevens noted while that the economy continued in its adjustment to the end of the investment phase of the ‘mining boom’.

"The massive run-up in resources sector capital spending that was a natural response to earlier very high prices is reversing, causing a drag on demand.

"So we hope for other sources of demand to speed up to help make up the difference.

"Some of them are, though not as seamlessly as any of us would like.

"It is a major transition.

"We can hope to assist it, and the Reserve Bank is doing that, and will continue to lend what support it can, within the limits of its powers and consistent with its mandate.

"The decline in the exchange rate is assisting the transition (as it assisted in absorbing the earlier phase of the mining boom).

"But we have always said we cannot hope to fine-tune this transition, however much we may wish otherwise."