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The most important recommendations in the review of the Reserve Bank of Australia advocate keeping things as they are. A nine-person board of the Reserve Bank, chaired by the governor and including the deputy governor and Treasury secretary, will continue to set interest rates independently of government. They will continue with the regime of flexible inflation targeting. The inflation target remains at 2-3%.
This may seem unexciting. But it is sensible. The inflation target has been successful. Inflation has averaged 2.5% and inflationary expectations are anchored around this rate. Until the Covid-19 shutdowns, Australia had no recession during the inflation targeting period. This may have been the longest uninterrupted economic expansion in history. Unemployment is at its lowest in almost 50 years.
As I argued in my submission to the review, Australia’s record under inflation targeting is at least as good as its peers. Australia has had similar inflation with fewer recessions than the UK, Canada, US or New Zealand. So there is little reason to think that adopting the procedures of other central banks, in an economic “cultural cringe”, will lead to a great improvement.
But even a good system can be improved. A review of monetary policy was overdue. There had not been any public process of consultation when the inflation target was gradually adopted in the early 1990s. There have been some criticisms of the bank’s performance. Other central banks have been subject to independent reviews in recent years, although notably they have often moved towards the framework used consistently by the Reserve Bank.
The review calls for “dual monetary policy objectives of price stability and full employment”. But this is not the radical change it might appear. Full employment has always been a goal set in the Reserve Bank Act (as indeed it had previously been when the central bank operated as the Commonwealth Bank). No quantitative goal has been set for unemployment and the flexible inflation target remains in place.
In practice, the Reserve Bank has never been what then Bank of England governor Mervyn King called “inflation nutters”. The governor explained recently how employment considerations were crucial in determining the bank’s current interest rate settings. The bank envisages getting inflation back below 3% by 2025, while some other central banks aim to lower inflation more rapidly. The governor commented:
We’ve discussed that at our board meetings: whether it would be beneficial to get inflation back down to 3% a year earlier. There’s an argument for that, but it would mean job losses – more job losses – and our judgment at the moment is that, if we can get inflation back to 3% by mid-2025 and preserve many of those job gains that have been delivered in the last few years, that’s a better outcome than getting inflation back to 3% one year earlier and having more job losses.
Requiring the bank to consider employment consequences is therefore requiring them to continue their current practice.
The main change recommended by the review is splitting the responsibilities of the board between two new boards. One will concentrate on governance aspects, such as personnel and premises, auditing and risk management. Managerial experience will be the most important qualification for this board. The other will be a monetary policy board. This will comprise members with economic, and especially monetary policy, expertise and diverse backgrounds. These board members will be expected to devote more time to their deliberations than do the current board members. There may be advantages in the two boards specialising in this way.
The main criticism of the bank concerns the governor’s comments during the Covid recession about future interest rates. The governor consistently stated that the bank’s decision to increase interest rates would depend on inflation. He made a forecast, not a pledge nor a promise, that inflation was unlikely to be sufficiently high for this to occur before 2024. The bank’s forecast error was shared by almost all forecasters, who similarly failed to foresee the Russian attack on Ukraine and that scientists would develop a Covid vaccine faster than initially expected.
The average inflation forecast for 2022 from a survey of economists in early 2022 was that it would stay under 3%. The most pessimistic thought it might reach 4%. It actually reached almost 8%. So even adding a wider range of economic experts to the board may not dramatically improve the forecasts and therefore the interest rate settings.
The problem for the bank was that elements of the media misrepresented the governor’s comments as a promise that, come what may, interest rates would not rise until 2024. Some borrowers then acted on this misreporting. So there is merit in the review’s suggestion that the bank appoint a chief communications officer who may strive to ensure the bank’s stance is more accurately reported.
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