The Reserve Bank, its operations and its key policy objective of holding inflation between 2 and 3 per cent would be the focus of a review under a Labor government amid warnings the institution is being left behind by overseas central banks.
Oppositions and critics often call for reviews of particular policies, but demanding a review of a cornerstone of economic policy such as the Reserve Bank is highly unusual.
But in a sign of how much economic policy is in flux in the wake of both the global financial crisis and the coronavirus recession, the step by Labor to promise its own review of the bank is one that has some support within the government and the broader economic community.
Shadow Treasurer Jim Chalmers says the bank should acknowledge its contribution towards the persistent weakness in the economy between the end of the global financial crisis and the coronavirus recession. A review would also look at how monetary and fiscal policy were working together.
“It’s a crucial institution but not beyond criticism or reproach after a long period of stagnant wages, underemployment and weak business investment, which is more a failure of government policy settings,” Chalmers says.
It has been 40 years since the RBA and its policy objectives have been reviewed. It is one of the few central banks in the world to have avoided such an analysis, with most either in the process of, or having just completed, their own reviews.
Such a review would look at the bank’s failure to meet its own inflation target for the past six years, with RBA forecasts not expecting it to be reached until sometime in 2024 or even further out. Wages growth had already slowed to its lowest rate on record before the 2020 coronavirus recession, while business investment was also around record lows.
The Sydney Morning Herald and The Age this week began a special series on the RBA, monetary policy and the state of the economy both before the pandemic recession and looking forward. Among monetary policy experts, former RBA governors and staff, former treasurers and academics, there is strong support for a review of the bank and its key objectives.
‘Time for a review’
The RBA’s charter requires it to set monetary policy that delivers a stable currency, full employment and “the economic prosperity and welfare of the people of Australia”. These key parts of the charter have been unchanged since the bank started operations in 1960. Its inflation target was started under then-governor Bernie Fraser and treasurer Paul Keating in the early 1990s before being formalised by Peter Costello when the Coalition took office in 1996.
Chalmers says given the issues that have confronted the RBA in recent years, it is time for a review of its operations.
“I support a review of the RBA’s goals and objectives, tools and levers, processes and public commentary, and have an open mind on the best way to go about this if we come to government,” he says. “Failing to hit the inflation target or full employment objective is disappointing but no reason to abandon either of them.”
The last time the RBA and its functions were reviewed was as part of the Campbell inquiry that reported to the Fraser government in 1981.
Headed by Sir James Campbell, this inquiry advocated such reforms as a free-floating currency, deregulation of the financial system and the entry of foreign banks. These reforms were acted upon by the Hawke government.
The inquiry, which produced an 838-page report, generally supported the RBA and its then operation. It did, however, recommend the bank make its views on monetary policy more open to the public, provide ongoing analysis and commentary about economic conditions and continually review the structure and operation of the financial system.
At the time, the RBA’s advice to the government was in effect filtered through the Treasury secretary. Monetary policy was focused on the national money supply, a system that would break down by 1985 in part due to the deregulation of the financial system and the free-floating currency.
The RBA’s position in economic policy changed with Keating’s move to float the Australian dollar in 1983. Then-governor Rob Johnston backed a free-floating currency while Treasury secretary John Stone was opposed.
Keating had Johnston attend the momentous press conference announcing what is now perceived as one of the most important developments in the opening of the Australian economy. Stone was not invited.
The Wallis inquiry of 1996-97 resulted in the creation of the Australian Prudential Regulation Authority. Responsibility for banking supervision was moved from the RBA to this new entity.
The inquiry was set up by then-treasurer Costello with the aim of improving the regulatory framework around the financial system and responding to the huge change in technology that was affecting the sector. The RBA’s structure, charter, inflation target and broader role in the economy were not part of the inquiry.
Almost two decades later, then-treasurer Joe Hockey set up a financial system inquiry headed by former Commonwealth Bank chief executive David Murray. The terms of reference for this inquiry explicitly precluded Mr Murray from making any recommendations about the objectives or procedures of the RBA.
Former Treasury official and current Blueprint Institute chief economist Steven Hamilton says there is no larger economic imperative than a formal review of the RBA.
“The decades-long unspoken pact between the government of the day and the RBA – we won’t raise rates during an election or comment critically on sensitive areas of government policy and you leave us to our own devices – is a cancer on our democracy, which must be excised,” he says.
“The Treasurer should launch an independent review of the RBA and our monetary policy framework, ideally chaired by a foreign-based, independent expert with intimate knowledge of the way foreign central banks operate.“
Treasurer Josh Frydenberg would not be drawn directly on a review of the bank, saying the RBA had worked closely with the government in dealing with the coronavirus pandemic.
“It’s been an important partnership that has been focused on the key objectives of creating jobs, boosting confidence, providing greater access to capital while promoting stability across our financial system,” he says. “The RBA has acted swiftly and effectively in responding to the greatest economic shock since the Great Depression.”
While Frydenberg – who famously held an impromptu press conference alongside Philip Lowe in late 2019 after the RBA governor urged governments to increase infrastructure spending – defends the bank, there are critics within the government.
At senior levels of the Morrison ministry, there is disquiet at its handling of monetary policy (although the same MPs believe fiscal policy is running smoothly). Some of that disquiet is driven by the almost reverential approach taken towards the RBA by political commentators and even many MPs, but an unspoken rule of both sides of politics is not to criticise the RBA.
That means even if ministers believe the bank has erred – such as on an interest rate movement – they cannot publicly mount that argument.
Among day-to-day political battle, Lowe has attracted criticism from the Labor Party after he publicly suggested wages would not grow as fast if there was an increase in the superannuation guarantee. Less than a year later, he came under fire from the government for openly stating an increase in JobSeeker was justified on fairness grounds.
Every six months the governor faces the House of Representatives’ economics committee where, invariably, MPs from both sides of politics attempt to get Lowe to agree with their party’s policy or rubbish a policy from the opposition.
Lowe has always been prepared to answer even ticklish questions if he believes there is a legitimate economic point to be made. The situation, according to some critics, has led to the RBA governor becoming the “economic-commentator-in-chief” or an “economic oracle”.
Hamilton says Lowe is now Australia’s “chief economist”. Other nations have public bodies specifically dedicated to that role, he says. Even an Office of Chief Economist, modelled on the Office of Chief Scientist, would enable the RBA governor to stick to monetary policy issues.
“This is a terribly corrosive situation that compromises his apparent independence, imparts him with a degree of power that is well beyond his remit, and draws him frequently into commenting on political questions that are well outside his wheelhouse,” he says.
Review a ‘cop-out’
Economist John Edwards, a former RBA board member and former Keating adviser, says a review of the bank is a cop-out.
“If you’re going to look at the economy, then look at the economy and not just one part like monetary policy,” he says. “Fiscal policy is a major issue in this whole discussion.
“So if you want to have a review, do everything. We haven’t had that type of inquiry since the 1960s.”
‘If the economy had not grown or there had been allegations of corruption then you could mount an argument for a review of policy. But that’s not the experience.’
Former RBA governor Bernie Fraser
Former RBA governor Bernie Fraser is also not a fan of a review, saying the economy’s performance is proof of the bank’s effectiveness.
“If the economy had not grown or there had been allegations of corruption then you could mount an argument for a review of policy,” he says. “But that’s not … what we’ve had.”
The issue of a review has not been put directly to Lowe. But earlier this year, he pointed to the level of scrutiny and accountability the bank already faces.
“I’m explaining myself to the population all the time. I’m explaining every month, sometimes more frequently, what we’re doing, why we’re doing it and how we’re achieving our objectives,” he said in February.
“If the government of the day wanted a different accountability mechanism, there’d be options that could be considered. But at the moment I feel we’re doing a reasonable job at explaining ourselves to the public.”
Stephen Kirchner, program director for trade and investment at the US Studies Centre at the University of Sydney, says central banks around the world have had or are in the process of reviews.
The United States Federal Reserve reviewed its policy settings through all of 2019, leading to the bank changing its inflation target. Other banks, including the European Central Bank, the Bank of Japan, the Bank of Canada and the Reserve Bank of New Zealand, are in the process of reviews or have completed them. Each is looking at their inflation targets.
Kirchner says the RBA has escaped real scrutiny of its remit and performance for 40 years.
“The RBA is very happy with the arrangement at the moment because it is very forgiving for big errors,” he says.
University of Melbourne economist Chris Edmond says a review could canvass issues such as the number of times the board meets a year and whether the current make-up of the board is best for monetary policy setting.
“Beyond the ups and downs of individual monetary policy decisions, it’s important that serious thought is given to whether the RBA’s processes line up with central banking best practice,” he says. “One way to work through such issues is via periodic review by external experts, say every 10 years.”
‘The RBA is very happy with the arrangement at the moment because it is very forgiving for big errors.’
Grattan Institute household finances program director Brendan Coates, a former Treasury and World Bank official, says the time is right for a far-reaching review that is independent of the bank and Treasury.
“Any review should be broad, considering changes to the Reserve Bank’s objectives and framework, including whether our inflation-targeting regime should be replaced by a price or nominal level target, ” he says. “And a review will have to tackle concerns over the impact of interest rates on asset prices, and how best to manage those collateral impacts.”
Price stability v price-level targeting
The inflation target used by the RBA to guide monetary policy was put in place in the early 1990s. In the decades before that, it had used other measures to help set policy, including targeting the money supply or pegging the Australian dollar to another currency.
But as other central bank reviews are completed and their policy settings modified, there is now an open question of whether an inflation target is best for the future.
In late March, the New Zealand government announced a suite of policies to take heat out of the nation’s property market which – like Australia’s – is being pushed upward by ultra-low interest rates and government programs put in place to deal with the coronavirus recession. Among those policies is an end to the ability of property investors to deduct interest costs on new purchases, similar to Australia’s negative gearing arrangements.
Former RBA board member Warwick McKibbin says if the bank just focuses on inflation then it is unlikely to get the economy growing fast enough to bring down the debt levels being carried by governments, businesses and households.
Rather than price stability, keeping inflation between 2 and 3 per cent, he has examined the case for price-level targeting.
Under price-level targeting, the RBA would actually try to get inflation above its 2-3 per cent target for a little while to make up for any inflation shortfall.
McKibbin says while inflation targeting has worked well in the past, it may not be up to the task of dealing with future shocks. These include climate change, the emergence of a “fourth industrial revolution” driven by artificial intelligence, and the impact of the growth of new large economies such as China.
Any one of them could upend monetary policy.
“Just having the Reserve Bank meet its mandate but do nothing else for the economy, that’s not going to do anything for growth,” he says.
But former prime minister Keating says rather than a review, it is more important for the government and RBA to have fiscal and monetary policy working together as the economy recovers from the recession.
“What is required is an understanding of the shifting basis of need between monetary and fiscal policy from time to time,” he says. “Both monetary and fiscal policy are arms of policy which act as financial stabilisers within the economy. Now, with monetary policy in regression, fiscal policy is taking the policy slack.
“The key is to [also] see fiscal policy as a swing instrument … and not see some kind of surrogate household balance sheet that needs to be in structural surplus.”
RBA the international outlier
In 2014, the Bank of England – the world’s second-oldest central bank – reviewed the number of times its monetary policy-setting committee met. At the time, it was required to sit once a month. It cut that to at least eight times a year after finding a shift in monetary policy would require persistent changes in economic data and “rarely would a single four-week period be sufficient” to see that type of movement.
At 11 meetings a year, the RBA is now the international outlier. The gatherings, on the first Tuesday of every month except January, last about 3.5 hours, not including about 30 minutes when non-RBA board members catch up over a cup of tea before the deliberations. There is strong support on the board for sticking with 11 – an annual survey by the governor has found no appetite for change.
The BoE review found one of the problems with so many meetings was that staff spent most of their time compiling reports for board members that were often little different to the previous month’s.
An RBA official, who cannot be named for legal reasons, says on many occasions it was a case of “whiting out the dates on one graph and putting in the next meeting’s date”.
The bank has almost 1400 staff plus another 384 who work for its note-printing operation. The federal Treasury, by comparison, has 1008.
At the top is the governor. Total remuneration for Lowe in the 2019-20 financial year was almost $1.1 million. Among world central banks, he is among the best paid. The head of the US Federal Reserve, Jerome Powell, is on just $A263,000. Christine Lagarde, the head of the European Central Bank, is on $A622,000. New Zealand Reserve Bank governor Adrian Orr earns $A743,000.
Between 2000 and April this year, the bank held 234 meetings. Interest rates were changed at 53 of those, or about 23 per cent of the time. More than half of those changes occurred in the month immediately after the release of the quarterly consumer price index (February, May, August and November).
On 16 occasions, the change was made in November or May. March 2020 is the only month this century when the bank cut rates twice in a month (in response to the coronavirus pandemic). And rate watchers can largely give July a miss – the RBA has changed rates just once in this month.
Australia is almost alone in the developed world in getting its inflation reported every three months. The RBA has for years pressed the Australian Bureau of Statistics to move to a monthly inflation gauge. This would take the focus off the RBA meetings immediately after the quarterly CPI releases and give it a more consistent insight into price pressures.
One reason the RBA believed it would lift interest rates through 2018 was the inflation reports of the September and December quarters of 2017. The December-quarter figures (which went to the RBA board meeting of February 2018) showed inflation at 0.6 per cent after a similar result in September.
Expectations inside the bank grew of a lift in inflation. But that meant waiting for another three months when the March-quarter result would be published in late April. That showed quarterly inflation at 0.4 per cent. Three months later, another 0.4 per cent result.
Instead of inflation accelerating, the quarterly reports upon which the RBA was depending actual showed a slowdown. A monthly inflation report could have revealed this turnaround much quicker, giving the bank a chance to recalibrate its own forecasts – and the cash rate – earlier.
The bank does move quickly in the face of major economic dislocations. During the dot-com slowdown of 2001 and global financial crisis of 2008, the bank changed rates on six occasions. But outside of these triggers, the bank moves interest rates on average just over twice a year. In 2004, 2017 and 2018 it didn’t move at all.
Connected to the number of times the board meets is its actual composition. The RBA is unusual among its international peers in having a board with a majority of non-monetary policy experts.
The governor and their deputy are members, as is the secretary of the federal Treasury (who themselves are rarely monetary policy experts). The other six are appointed by the Treasurer of the day after consultation with both their department and the bank. This has led to occasions when the treasurer has faced resistance to suggested appointees who were not on the bank’s preferred “list” of potential board members. There was pushback against the idea of Edwards and recent board member Catherine Tanna when they were proposed by then-treasurer Wayne Swan.
One of the six is traditionally an “independent” economist (Professor Ian Harper holds the current position) while the others can come from any part of the community, although history shows these people are unlike most of the community.
There have been 75 board members since 1960, dominated by men with close connections to the business community. Seventeen of the 75 had or have received knighthoods, 38 have received an Australian award while three have been recognised with public service medals. Six have had the first name John.
The first woman appointed to the board was West Australian Janet Holmes à Court, who served a five-year term between 1992 and 1997. The following year, respected businesswoman Jillian Broadbent began what would be a 15-year term. When Carolyn Hewson took up her position on the board at the end of March, she became the ninth woman to have served.
The gender balance of the RBA board has been sharply improved, but members’ life experience has actually narrowed over recent years.
Two board members are also board members of the Business Council while two have close connections to the right-aligned Centre for Independent Studies think tank. The last union official on the board was then-ACTU secretary Bill Kelty, who resigned in 1996 after the election of the Howard government. (Another unionist to have served on the board was Bob Hawke when he was ACTU secretary in the 1970s). The bank does keep in regular contact with the ACTU, including through meetings with senior executives.
‘Maybe if you had someone from the union movement on the board over recent years, the executive and the board would have been told that wages weren’t going up.’
AMP Capital chief veconomist Shane Oliver
Lowe, pressed on the dominance of people with business backgrounds on the board, this year defended their experiences.
“What they bring … is an appreciation of the difficulties of decision-making under uncertainty,” he said.
“I feel, with due respect to the economists, that these business people are better at grappling with making decisions under uncertainty than economists. I think it would be, at least in our context, a backward step to have all people of the same background on the board.”
But AMP Capital chief economist Shane Oliver says it is not just business people who could make difficult decisions during periods of uncertainty.
He notes since insights from the “economic frontline” are useful, unionists or people from the social sector have good insights into wages and employment conditions.
“Maybe if you had someone from the union movement on the board over recent years, the executive and the board would have been told that wages weren’t going up,” he says.
While Lowe is attacked for bank failures, his fellow board members keep a low profile to the point they are almost anonymous.
Several central banks overseas either record and publish the voting records of board members or give their members the scope to speak publicly about their views on the economy.
Australia has taken a very different approach, with the governor or his deputy the main conduits for public comments about monetary policy or the economy. The independent economist of the day can also share their views, but the “non-expert” members are in effect mute.
Bank insiders maintain the board plays a pivotal role in decisions and will push the executive. One notes that under former governor Glenn Stevens and now Lowe, board members have been given much more latitude to question any official recommendation put to them by the governor of the day. Yet any criticism is focused on the governor rather than the board members who collectively take responsibility for all decisions.
Independent economist Saul Eslake says the board needs people who can challenge key economic assumptions or arguments from senior staff. They also do not have to come from such a small part of the community.
“The idea from Lowe and Stevens that business people are in a good position to deal with uncertainty quickly might be true, but it’s not just business people who can do that,” he says.