As a review is set to begin into the Reserve Bank of Australia, questions are being asked about its opaque operations and the absence of qualifications on its board. By Mike Seccombe.

Reserve Bank: ‘If you know about monetary policy, you’re disqualified’

RBA governor Philip Lowe addresses the American Chamber of Commerce in Australia in Sydney.
RBA governor Philip Lowe addresses the American Chamber of Commerce in Australia in Sydney.
Credit: Dan Himbrichts / AAP Image

In April 2009, with much of the world plunged into recession by the global financial crisis, there was deep division between the government and Australia’s central bank about how bad it would be in this country and how to respond.

According to a long and confidential cable prepared by the United States embassy in Canberra, there was “a real divergence” between the Reserve Bank and the Rudd government, which wanted it to cut rates more aggressively. The cable says there was also a split between bank officials and board members.

“Steven Kennedy, Chief Macroeconomic Advisor to PM Kevin Rudd, told us April 1 that he and his Treasury Department colleagues are increasingly frustrated with the RBA,” the cable says.

“He complained that the RBA is ‘schizophrenic’ in that the Banks (sic) simultaneously believes that Australia will be hit hard but that it should hold off on further rate cuts in order to ‘keep its powder dry’ in case things get worse.”

Some on the bank’s board worried Australia could be headed for a recession potentially “worse than Australia’s recession in the early 1990s, which lasted for five quarters and led the economy to contract by a total of 1.25 per cent”.

Others, the cable says, believed “that China will recover in the second half of 2009, which will pull Australia out of recession in the same time frame”. These officials believed Australia would be spared the worst of it, as it was in the 1997 Asian financial crisis.

The cable notes that RBA board member Warwick McKibbin was particularly firm in this view. Treasury and the government were annoyed with him because “other members of the RBA Board have been swayed by McKibbin’s argument”, as had some officials.

Details like this are extremely rare. The inner workings of the Reserve Bank are largely unknown. The opinions of individual board members are almost never revealed.

“The reason I can say some of these things is because they’re in WikiLeaks,” McKibbin, who served on the board for a decade until 2011, tells The Saturday Paper. “Because Kennedy told somebody in the American embassy, who then reported it back to Washington, that I was a pain in the arse. Isn’t that a sad situation, that you cannot find out what’s going on in the institution that’s supposed to be acting in the national interest … unless you go to WikiLeaks?”

McKibbin, who is now distinguished professor and director of the Centre for Applied Macroeconomic Analysis in the Crawford School of Public Policy at the Australian National University, is one of a string of eminent economists calling for the new government’s promised review of the operations of the RBA to be as broad as possible, encompassing its charter, its communication with the public and the composition of its board.

The review is expected to begin this month or in August and to take about a year, although Treasurer Jim Chalmers has given little detail other than that it would look at the size, composition and experience of board members, and seek “lessons” from the bank’s past decisions on interest rate settings.

This will likely be of more than academic interest, given the bank has begun putting up interest rates. It will almost certainly raise them again on Tuesday and likely every month until Christmas.

In a letter calling for root-and-branch reform, economists including McKibbin stress that the review should be entirely independent of the bank and also of Treasury, whose secretary has a seat on the RBA board. They want it done by a foreign expert.

There are many good reasons for an inquiry. For a start, there has not been one for several decades. There are also questions about the bank’s stewardship of the economy over recent years. The widely held view among economists – including the new assistant minister for the Treasury, economics professor Andrew Leigh – is that the RBA kept rates too low in the pre-Covid years, 2016-2019, and did not raise them fast enough when Covid lockdowns had passed and inflation became a problem.

Observers wonder about the extent to which the structure of the bank and its board made it prone to error by fostering groupthink, discouraging dissenting voices and failing to communicate its reasoning to the public. McKibbin has a couple more stories that speak to that.

“I actually worked there most of my life,” he says. “I joined the bank in ’75. And I was there for 16 years.”

In 1989, when he was head of research, he published a paper “warning there was going to be a recession if they kept doing what they were doing with interest rates. And I was told I’d never be promoted again. And I better go and look for another job.”

He did. But more than a decade on, he was tapped by then treasurer Peter Costello to join the bank’s board. At one level, there was nothing unusual about that. The process then, as now, was that the treasurer of the day can appoint whomever they like, without any scrutiny or formal selection process.

But McKibbin was an unusual choice in a couple of ways.

First, he was an actual expert in monetary policy, whereas the great majority of RBA board appointments are senior businesspeople – and occasionally, under Labor governments, union representatives – with no relevant formal qualifications.

Second, he was not there simply to rubberstamp whatever decision was put to the board by the bank governor.

“I used to sneak downstairs the day before [a board meeting] and go and talk to the juniors to find out what the debates were before they got to the boardroom. Because by the time you get the board papers, everything’s been sanitised,” he says. “I actually got told by Glenn Stevens at some point not to do that anymore.”

RBA board members are given no staff so McKibbin enlisted PhD students to help him keep up with data and contemporary thinking among international experts. “Over time, I managed to convince several of the other non-economists on the board to back me,” he says. “Two or three or four.”

These anecdotes say a lot about the organisation’s structure and culture, particularly about the board.

“Australia’s Reserve Bank board is unusual in that – and I’m caricaturing a bit – it’s almost like if you know something about monetary policy, you’re disqualified from membership,” says independent economist Saul Eslake, another signatory to the letter.

“I certainly think that the conduct of monetary policy would be enhanced if there were more people around the table who knew something about it.”

As things stand, five of the nine members usually have no expertise in setting monetary policy, which is the RBA’s prime purpose. Furthermore, they tend to represent sectional interests, which can and sometimes does lead to conflicts of interest as these sectional interests may benefit or not, depending on how rates are set.

Three other board members are ex-officio appointments: the governor and deputy, who are long-term bank bureaucrats, and the head of the Treasury department, who is currently Dr Steven Kennedy, the same man whose complaints about McKibbin informed that US diplomatic cable. Then there is usually one academic economist.

Australia is unusual in having the Treasury secretary on the board. Other countries have recognised that this can compromise their central bank’s independence.

“I mean, the secretary to the US Treasury was taken off the Fed board in the 1930s,” Eslake says.

“Our central bank also isn’t nearly as transparent as most others. For example, the minutes of our board meetings do not record how people vote, whereas the minutes of almost every other central bank do.

“Board members are actively discouraged from talking about monetary policy whereas in most other economies, board members give speeches about it all the time.

“It also arguably has a very insular employment culture. It’s very, very rare that outsiders are appointed to senior positions in the Reserve Bank. They grow their own.”

An even harsher critique of the bank than those of McKibbin and Eslake comes from Peter Tulip, another former senior RBA economist, who also worked for the US Federal Reserve and who is now chief economist at the Centre for Independent Studies. He also signed the letter.

He thinks a review is desperately overdue. “In my view, the Reserve Bank has made very big mistakes,” says Tulip. “But more importantly, it has a very bad process. So when they do make a bad decision, how would they know?

“The board is composed of business leaders, and they’re very bright people [but] they don’t have the training to ask, ‘Hey, but Phil, doesn’t the research say the exact opposite to what you’re telling us?’ ” 

Tulip would like to see the composition of the board reformed. “Other central banks around the world have monetary policy decided by experts. In fact, if you look at the composition of the boards of the Federal Reserve or the Bank of England or the ECB [European Central Bank], they’re not just professional economists, actually: they’re typically stars in the profession. I mean, the people that wrote the textbooks that I learnt monetary policy from.”

Tulip says the bank has a history of being slow to act, extending back to before Philip Lowe became governor in 2016.

Before the global financial crisis, the bank didn’t raise rates fast enough, which allowed the economy “to seriously overheat”. According to Tulip, “It took the GFC to put them back on target.”

Before the pandemic, the bank erred in the other direction, keeping rates too low. “And so we went over five years of undershooting the inflation target, and even longer with unemployment being too high,” Tulip says.

It took the pandemic to seriously lower unemployment, and put inflation up – too much, as it turns out.

“Needless to say, a system where you rely on large external accidents, external catastrophes, to put you back on target, is an unreliable way of stabilising the economy,” he says.

“We need more experts. We need more people that are willing and able to challenge the governor. And that requires external accountability. We need public votes [of the board] and public explanations of disagreements.”

Setting monetary policy, he says, differs from many other arms of policy in that its objectives are pretty straightforward: to keep inflation stable at 2-3 per cent and to maintain full employment.

“It’s essentially a technical question as to how do you best achieve those given objectives. That should be decided not by who’s representing the biggest [sectoral] group, but by looking at the available research, and technical analysis.”

The board, he argues, should include some policy hawks as well as some doves. “You do want a diversity within experts. But what you don’t want – which we have at the moment – is a diversity of competence.”

In research published this month in the journal Economic Record, Andrew Leigh and Dr Isaac Gross analysed the RBA’s performance, using the bank’s own model.

They found that between 2016 and 2019, with Lowe at the helm and working to an agreement made with then treasurer Scott Morrison that emphasised “financial stability”, the bank “dramatically under-performed” because it held rates too high.

Economic growth fell, wage growth was anaemic and inflation was consistently below target. The result, they calculated, was equivalent to an extra 270,000 people being out of work for one year.

The timing of Leigh and Gross’s work is interesting, coming on top of the other criticisms of the RBA. Leigh has a history of well-informed and stern grilling of bank representatives before parliamentary committees. Now he is a minister in a relevant portfolio.

The ultimate decision about the form and scope of the government’s inquiry into the bank will be made by Treasurer Jim Chalmers, but it seems a safe bet that Leigh’s counsel would be for something big and broad.

To date, Chalmers has been Delphic in his answers on the question, saying he has a “mountain of respect for Lowe” but leaving open the possibility of changes to the size and composition of the board.

He has refused to be drawn on the possibility of appointing a representative of organised labour.

Clearly, there is a push for bigger changes than that.

The RBA has not served the country as well as it might have in recent years, says Chris Richardson, former partner at Deloitte Access economics and now an independent economist.

Trust in institutions in Australia is down, and maintaining trust in one as important to national welfare as the RBA “is more important now than at any point in our history”.

For Richardson, that means opening up the black box of RBA decision-making. “They love being inscrutable and inscrutable does not cut it. It’s not good enough.”

He says it means appointing more experts – particularly if they are dissidents. “Your dissidents are your best friends. The best boards have members prepared to say ‘But why?’ ”

Maybe there are such people on the current board. We don’t know. The only one recorded in the bank’s history was McKibbin.

And we know about him only because of the US government and Julian Assange.

Is that really good enough?

This piece was modified on July 4, 2022, to correct a reference to rates before the pandemic. 

This article was first published in the print edition of The Saturday Paper on July 2, 2022 as "Reserve Bank: ‘If you know about monetary policy, you’re disqualified’".

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Mike Seccombe is The Saturday Paper’s national correspondent.

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