The Reserve Bank of Australia review panel will have to grapple with central questions on the bank’s governance and culture, writes AICD chief economist Mark Thirlwell MAICD.
On 20 July this year, the Treasurer announced “the first wide‐ranging review of the Reserve Bank of Australia since the current monetary policy arrangements were instituted in the 1990s”. The review, to be delivered to the Treasurer by March 2023, will be conducted by a three‐person panel comprising one international and two domestic experts — Carolyn Wilkins, an external member of the Bank of England’s Financial Policy Committee and former Bank of Canada senior deputy governor; Professor Renée Fry‐McKibbin, one of Australia’s leading macroeconomists and interim director of the Crawford School at the ANU; and Dr Gordon de Brouwer PSM, an eminent Australian economist and Secretary for Public Sector Reform with experience in public policy and administration including at Treasury and the RBA itself.
The review’s terms of reference are broad. It will assess current monetary policy arrangements and consider the RBA’s objectives, including “the continued appropriateness of the inflation‐targeting framework” as well as their interaction with fiscal and macroprudential policies. It will also consider the performance and governance of the central bank as it relates to monetary policy, including the selection and use of policy tools, implementation and communication of policy, the structure and composition of the RBA Board, and accountability, culture, management and recruitment. It will not consider the RBA’s payments, financial infrastructure, banking and banknotes functions.
Beset by inflation
This scope would represent a significant undertaking in normal times. And times are far from normal. The RBA is grappling with headline inflation rates that — outside the introduction of the GST — haven’t been seen in Australia since the early 1990s, and an international economic environment that Treasury Secretary Dr Steven Kennedy PSM MAICD recently described as the most complex in 70 years. Likewise, the policy response is unprecedented in the inflation‐targeting era in terms of its pace and the size of hikes to the target cash rate. Ideally, it might have been better to have conducted the review in more stable economic circumstances. Still, an assessment of the RBA was long overdue, and now that one is underway, we must hope not only that it delivers some useful conclusions, but also that it doesn’t prove too distracting from the delicate task of steering the Australian economy between inflation and recession.
Top of the issues under consideration are the RBA’s mandate and the future of the inflation‐targeting regime. The RBA’s duties are set out in the Reserve Bank Act 1959, which requires the Reserve Bank board’s monetary policy actions to contribute to the stability of the currency, the maintenance of full employment, and the economic prosperity and welfare of the Australian people. Since the early 1990s, the RBA has sought to achieve these goals via a flexible medium‐term inflation target, which RBA governor Philip Lowe and the Treasurer have agreed should be an inflation rate of two to three per cent, on average, over time. This was reaffirmed by the 19 September 2016 Statement on the Conduct of Monetary Policy.
The review will assess whether this framework remains appropriate, or whether an alternative policy regime, such as one based around nominal income targeting, might be more attractive in a world increasingly characterised by large supply shocks (such as from the pandemic or from climate change) as opposed to the demand shocks that have typically been the focus of central banks. If the recommendation is to persist with inflation targeting, that will still leave questions around the target itself — should it be higher, lower or the same? And how it should interact with other macro policies?
Performance review
Then there is the RBA’s performance. Until recently, this might have seemed difficult to fault. During Australia’s record‐busting 30‐year recession‐free run — only ended by the onslaught of COVID‐19 — the RBA was often described as one of the world’s most successful central banks. But that shine has since come off. The first wave of criticism was that in the period leading up to the pandemic, the RBA kept rates too high for too long, saddling us with an unnecessarily high unemployment rate. The more recent critique is that in the aftermath of the pandemic, it kept rates too low for too long, thereby delivering us into high inflation. Notably, the RBA tends to receive relatively little offsetting credit for the current historic low unemployment rate. The pandemic experience of monetary policy has also brought criticism of the RBA’s forecasting abilities (described by Lowe as “embarrassing”), its policy tools and choices (some market participants were unhappy with the RBA’s exit from its yield curve control policy — and the bank’s own post mortem conceded that a “disorderly” exit had inflicted “some reputational damage”) and on its approach to communications (many borrowers are furious with the forward guidance suggesting that rates were unlikely to rise before 2024).
Clearly, if the judgement is that the RBA has done a decent job, the case for radical change will be less persuasive than if the verdict is one of policy mistakes and missteps. So, where the panel lands here will inevitably influence its thoughts on governance and culture. Common criticisms include that the policy-setting process lacks transparency; that the bank board is unrepresentative (too many businesspeople) and too lacking in the appropriate subject knowledge to challenge the internal view (too few independent monetary economists); that overview of the institution itself should be separate from overview of the policy process; and that the bank is too cautious, too inward-looking and too prone to groupthink.
There are cases to be prosecuted along several of these lines, although sometimes the advocates of change overdo their arguments. For example, pointing to the “best practice” of the Bank of England or the US Federal Reserve does rather beg the question: if their institutional set-ups are so superior, why is the misery index (the sum of the inflation and unemployment rates) in both economies worse than in Australia (13.2 and 12.7 per cent vs 9.6 per cent, respectively)? Indeed, instead of being unique to the RBA, Martin Place’s recent policy errors look similar to those of many of its peers. This implies the current review will effectively be evaluating not just the RBA’s experience, but also the modern practice of monetary policy more generally.
Ultimately, the contemporary verdict on the RBA’s policy legacy is likely to rest heavily on how well it manages the current inflationary outbreak. After the July 2022 bank board meeting, Lowe acknowledged that in the RBA’s quest to return inflation to its target range while also keeping the economy on “an even keel” the “path to achieve this balance is a narrow one and clouded in uncertainty”. Successfully deliver disinflation and a soft landing, and the RBA’s reputation will regain some of its lost lustre. Otherwise, calls for change will grow louder.
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