Philip Lowe and the Reserve Bank will face a moment of truth

Now the bank faces what is shaping up to be the biggest overhaul of the country’s economic policy in decades, with the RBA’s formal review.

The release of the terms of reference for the review by Treasurer Jim Chalmers is imminent.

This will mark the bank’s first review since the 1981 Campbell report – when Australians used Bank Cards, people kept $1 and $2 notes in their wallets and mortgage interest rates were capped by the government at the time.

Reserve Bank Governor Philip Lowe has maintained an upbeat economic assessment throughout his tenure.

The review was prompted by concerns about the bank’s handling of monetary policy prior to the COVID-19 pandemic. A series of articles in this masthead in April last year, outlining criticism among the bank’s economics, handling of its policies and governance structure, provided a staging ground for the demand for review.

Both political parties went to the election promising a review.

Chalmers describes his review of “RBA goals and objectives, tools and levers, processes and public commentary”. He also wanted to see “the most appropriate relationship between fiscal and monetary policy”.

Developments in monetary policy since last year only add to the argument for reviewing the bank.

The director of the Grattan Institute’s household finance program Brendan Coates, a former Treasury and World Bank official, said the investigation should be broad, taking into account the mandate, structure and policy tools of the RBA.

He said all central banks, not just the RBA, faced substantial problems which meant the framework that guides monetary policy in the country – the 2 to 3 percent inflation target – had to be debated.

“Monetary policy has come under pressure globally in the years before COVID, as interest rates have fallen and conventional monetary policy has become less robust,” he said.

“Many of the drivers of rate cuts – an aging population, rising wealth inequality – are global, and are likely to persist even if inflation has picked up in the short term.

“Is inflation targeting still the best approach, or should we look for alternatives like average inflation or nominal income targeting? It is healthy to consider alternatives, even if the review decides the RBA should stick with what is already there.”

EY chief economist Cherelle Murphy said while institutions like the RBA had performed well, there was room for review.Credit:

EY chief economist Cherelle Murphy said the case for review was clear, especially given that central banks from Europe to New Zealand have gone through similar checks in recent years.

“There are many challenges ahead, and how we navigate them is critical to our economic prosperity and the well-being of the Australian people,” he said.

“I would like to see a review that examines the institutional arrangements that drive monetary policy decision making, rather than one that only examines governor statements and interest rate changes during recent economic cycles.”

At the heart of the Reserve Bank’s operations is the inflation target. The theory, embraced by central banks around the world, is that by moving interest rates to keep inflation within narrow limits, economies can thrive.

The problem is that for the best part of seven years, inflation has been running below the 2 to 3 percent target or recently above it.

Some economists, such as former RBA board member Warwick McKibbin, believe the whole concept of inflation targeting should be revisited. He told the Australian Economic Community this week that, given that hitting the inflation target is proving nearly impossible, alternatives (such as nominal GDP) should be examined.

Chalmers’ terms of reference will refer to the inflation target but also take lessons from the rest of the world. When the European Central Bank conducts a review between 2020 and 2021, it examines issues including the emergence of shadow banking, whether the way to measure inflation needs to change, its communications strategy, the future impact of digitalization and productivity.

A series of papers were prepared by him and other European central banks examining economic modeling, the level of digital acceptance across the Union and the impact of globalization on policy settings.

After a review, the bank stuck with its 2 percent inflation target, but is now looking at ways to incorporate house price movements into its inflation measure. The Bank also assesses the impact of climate change and the shift to carbon neutrality on the economy.

Apart from the inflation target, there are several things that will be included in the study.

Independent economist Margaret McKenzie said there were question marks over the reliability of the macroeconomic model that underpins monetary policy.

“A review should take into account much broader issues for the RBA than simply inflation targeting spells through tweaking interest rates,” he said.

Treasurer Jim Chalmers will soon announce the terms of reference for the RBA review.Credit:Alex Ellinghausen

“Years of doing this doesn’t convince anyone that it actually works, like the previous discarded models did.”

McKenzie, a former economist at ACTU, argues that full employment should be the Reserve Bank’s goal. He said even the RBA’s actions during the pandemic, when real interest rates are negative (after inflation is taken into account), are open to debate.

“Wealth is transferred from lenders to debtors through stock gains rather than bonds, and wealth shifts upward in distribution. Is that what the central bank wants?” he says.

McKenzie also argues that councils should be far more representative of the general public, including the trade union movement. Chalmers has signaled that someone with a trade union or small business background would join the board of directors.

The Reserve Bank’s board is like no other in the world of central banks. The majority of its members are drawn from the public, which oversees not only bank operations but also monetary policy.

Ted Theodore, treasurer in the Scullin administration, wanted the central bank’s board to take representation from the public. The idea has become one of the hallmarks of the RBA.Credit:Staff photographer

The idea of ​​the general public having a direct say in monetary policy dates back to the early 1930s, when the treasurer of the Scullin government, Ted Theodore, proposed changes to the Commonwealth Bank (which acts as Australia’s central bank) to include a board with five outside boards. individuals involved in agriculture, commerce, finance, industry and labour.

Theodore’s plan was scrapped by the conservative Senate, but the idea stuck.

The current board features Lowe, his new deputy Michele Bullock and Treasury Secretary Steven Kennedy. Then there’s the independent economist, Ian Harper, plus five people from outside the economic community or central bank.

They include Mark Barnaba (whose five-year term ends on August 30), Wendy Craik, Carolyn Hewson, Carol Schwartz, and Alison Watkins (last appointed person to the board).

Two members have ties to the Center for Independent Studies (Barnaba and Watkins), while two are non-executive directors with CSL (Watkins and Hewson).

While Lowe has borne the brunt of criticism over his handling of monetary policy over the past few years, the board he is responsible for has escaped unscathed.

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Communication from board members was limited to Lowe, Bullock and Harper (while Kennedy spoke more often about macroeconomic trends). The non-economists on the council, which oversees the setting of interest rates in the country, are effectively mute.

Former RBA economist (and now chief economist at CIS) Peter Tulip said it was important that the review examines the way debate is handled within the institution. He worries that there will be too much discussion around the bank’s “official narrative” rather than a contest of ideas.

An explanation of the reasons for taking the policy approach, and why alternatives were not taken, should also be examined.

“Regular reviews of the central bank should check whether the bank’s processes for accountability, transparency and decision-making are optimal based on the latest research and developments, especially among foreign central banks,” he said.

“The most appropriate people to answer many of the questions above are current and former staff. It is important that the terms of reference free them from confidentiality restrictions, so that they are authorized to communicate fully and honestly with the review.”

The RBA is the only major central bank in the world that has not gone through an out-of-the-century review. The last outside check of the bank was part of a Campbell report submitted to the Fraser government in 1981.

That inquiry, while pivotal to many of the economic reforms undertaken by the Hawke-Keating government, is a relic of its time. In the case of the Reserve Bank, it supports the continuation of the now discredited money supply growth targeting policy.

Within a decade, the RBA – due to a major shift in global attitudes towards central banks – moved to its current policy of keeping inflation between 2 percent and 3 percent.

Since Campbell, there have been a series of investigations into the financial and banking sector (including the banking empire commission) but none have gone into the heart of the RBA and its role in the economy.

One of the driving reasons for the review is the bank’s handling of the pre-COVID economy. In 2018, Lowe argued that the likelihood of the next rate move would increase. But just days after the 2019 election, he revealed the bank would use its next meeting to cut interest rates.

Research by economics academic Zac Gross and Labor Secretary Andrew Leigh this year estimated the failure to cut interest rates ahead of the pandemic left 270,000 people a year unemployed.

Banks’ handling of the post-COVID period, especially the recent rate hikes, could also put people out of work.

University of Victoria economist Janine Dixon said the review should examine monetary policy settings during the pandemic.

The RBA cut its official interest rate to an all-time low of 0.1 percent as it engaged, for the first time, in quantitative easing. That includes the purchase of about $300 billion of federal and state government debt plus the extension of more than $100 billion of cheap cash to commercial banks.

Now the bank (along with its peers around the world) is rapidly releasing its COVID-19 policy settings due to a spike in inflation.

“It’s not clear that the low rates are necessary in the presence of expansionary fiscal policy and may yet contribute to the failures that would put people in mortgage or housing stress,” Dixon said.

People flocked to the opening of the Commonwealth Bank building at Sydney’s Martin Place in 1916. The bank would become the forerunner of the Reserve Bank.Credit:Reserve Bank of Australia

The Commonwealth Bank was founded by the Labor government of Andrew Fisher in 1911. Thirteen years later, the Scullin government decided to formally make the Commonwealth the nation’s central bank.

The only problem was that he didn’t explain to the bank director what he meant by central bank.

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Since then, the bank has grown to become an important part of the Australian economy. It stands alongside the federal government in terms of policy direction. His decision to raise or cut interest rates affects employment, wage growth, and business opportunities for millions of people.

While important to the lives of nearly every Australian, it remains largely unknown.

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