The review of the Reserve Bank of Australia delivered this week is, according to one economics professor, “a watershed moment in Australian economy policy, on par with floating the dollar in 1983”. That’s probably an overreach but, hey, it’s okay for economists to disagree about things.
Thanks to the decisions of the current RBA board, a young couple with a mortgage of $600,000 a year will spend an extra $16,400 this year on repayments. That pain is no accident – it is the plan. According to the RBA, the best way to control inflation is to make millions of people spend hundreds of dollars a week extra on their loan repayments.
The logic is that if billions of dollars a week are diverted from spending on groceries, clothes and holidays, then the firms selling those things will have to stop lifting prices. And if shops lay-off staff because customers are buying less stuff, then that lowers consumer spending as well. In formal economic language, that brutal calculus is known as “the monetary policy transmission mechanism”.
It’s not polite to say out loud that the point of lifting interest rates is to cut consumer spending and increase unemployment. That’s why it’s more common to describe the RBA’s strategy as “taking the heat out of consumer spending”. But whatever weasel words are used, the fact is the RBA’s approach to interest rate policy imposes big costs on those with large mortgages – think younger people – and delivers big benefits to those with lots of savings – think retirees.
Which brings me back to the review. The RBA Act is 64 years old and was drafted before EFTPOS was invented, let alone the gig economy. The world has changed rapidly since 1959 and it should come as no surprise that the legislation and the RBA needs some significant changes.
Unfortunately, those changes aren’t to be found in the review, which focuses overwhelmingly on the process rather than provoking conversations about the role of monetary policy in a rapidly changing world.
One of the “big” recommendations to reform the RBA is the creation of a new expert advisory board to make decisions about interest rates and a separate board to oversee the organisational operations of the RBA itself. Heady stuff.
Another “big” recommendation was to “affirm the independence of the RBA”. Unlike any other statutory body I can think of, the RBA is unique in how frequently it is referred to as “the independent RBA”. I’ve never heard the Australian Competition and Consumer Commission referred to as “the independent ACCC”.
But just as some countries that include the word “democratic” in their name are not very democratic, the RBA doth protest too much. One explanation for this defensiveness is that the RBA is the only statutory body to rely heavily on a letter from the treasurer, rather than the act of parliament under which it is established, to clarify its role and objectives.
A big thing that’s not mentioned in the RBA Act is the 2-3 per cent inflation target – the target that has prompted the RBA to boost mortgage payments by $16,400 a year. To be clear, the “independent” RBA’s obsession with delivering 2-3 per cent inflation has no statutory basis. This inflation target is spelled out in a letter from the treasurer of the day, not by the parliament.
A more thorough review of the RBA would have made a strong case for why this arbitrary 2-3 per cent inflation target was superior to a 1.5-2.5 per cent target, or 2-4 per cent target. It would have explained why, even if the existing target was the right one in the 1990s, it remains suitable for an economy buffered by pandemic-related supply shocks, climate-induced food and insurance price shocks and a war in Europe.
A more thorough review might have engaged with the uncomfortable question of whether excess corporate profits pose a greater risk to inflation than the ostensible re-emergence of union power that the RBA has long feared.
The economics profession is far more diverse in its opinions about the role of interest rates and inflation-targeting than those economists chosen to review the RBA or sit on the RBA board or work on its staff. What does broadly unite the profession is that setting interest rates is hard and getting it wrong imposes enormous costs on those whose mortgage payments soar or whose job prospects plummet.
It might be comforting to believe that the RBA makes objective decisions about interest rates in the pursuit of objectively determined goals for inflation, but the reality is messier. The choice to target 2-3 per cent inflation may have been made long ago, but it is still arbitrary and the choice not to enshrine it in legislation likely reflects a fear of debating the merits of other ranges.
But irrespective of the target, making the choice to pursue it by dialling up the pain for vulnerable people will always require judgement.
In the words of the review: “judging how much employment can be achieved without causing undue inflation requires complex modelling and judgement, as it cannot be directly observed and changes over time”.
Judgement matters, no matter how independent the board thinks it is.
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This article was first published in the print edition of The Saturday Paper on April 21, 2023 as "Flaws in the RBA review".
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