RBA review: why it’s necessary and what it should recommend

Why the RBA review is necessary

The Reserve Bank of Australia is in the spotlight at the moment as there’s a risk its monetary tightening will crash the Australian housing market and the broader economy. Arguably, it should have acted earlier to raise rates and stop its quantitative easing (QE). Even though inflationary pressures were obvious from late 2021, the Bank still insisted the cash rate could remain at 0.1% until 2024 and it continued its QE – i.e. buying government bonds with money created from thin air-  until February this year (see the RBA’s Christopher Kent’s speech From QE to QT – The next phase in the Reserve Bank’s Bond Purchase Program | Speeches | RBA). Having let inflation accelerate more than it should have, the RBA now has to tighten much more than it would have otherwise.

So it makes sense the Albanese government is reviewing the RBA (see Review of the Reserve Bank). Peter Tulip, Chief Economist of the Centre for Independent Studies and a former RBA and US Federal Reserve economist, has been one of the loudest and most informed voices calling for changes to the RBA. Adept Economics Director Gene Tunny had a great discussion with Peter on episode 149 of his Economics Explored Podcast a few weeks ago. You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts and Apple Podcasts.

Some clips of the video of Gene’s chat with Peter have been uploaded to YouTube. First, here’s Peter explaining why the RBA review is necessary – i.e. among other reasons, other central banks are regularly subject to review and Peter thinks the RBA has made some big monetary policy mistakes in recent years, keeping interest rates too high before the pandemic and costing the economy hundreds of thousands of jobs.

Major recommendations for the RBA review

In the second clip, Peter talks about his main recommendations for the RBA which he hopes the review will pick up.

In Peter’s words:

“Number one, we want more monetary policy experts on the board.

Number two, we want those members to be individually accountable. That means public votes and public explanations of decisions.

And third, the bank needs to be more open and transparent. And, in particular, it needs to give clear reasons for its decisions, and why alternatives are not taken.”

Peter thinks these are the big recommendations the review should make as they would lead to big improvements in RBA board decision making.

Adjustments to RBA’s policy targets

Regarding the actual target or targets of RBA monetary policy, it’s unlikely the RBA review will recommend big changes here – e.g. moving to a so-called nominal GDP target, a concept Gene discussed with Stephen Kirchner on Gene’s Economics Explored podcast earlier this year (see Nominal GDP targeting w/ Stephen Kirchner – EP135). There is a widespread view in the macroeconomic policy community that the RBA’s inflation regime has worked reasonably well over the long-term since its introduction in the early 1990s. That said, it may need to be tweaked, as various prominent economists such as Peter Tulip and ANU’s Warwick McKibbin have suggested, as discussed below.

Peter would like an explicit full employment target, or more precisely a maximum sustainable rate of employment, and clear direction from the government regarding whether the central bank should target financial stability. Peter thinks the RBA has gone wrong when it was too worried about financial instability, because it meant the RBA kept interest rates too high in an effort to limit the amount of debt households were taking on. In Peter’s view, this had adverse economic macroeconomic consequences (i.e. costing the economy 270,000 jobs according to estimates by Andrew Leigh and Isaac Gross) and it should leave that job to the Australian Prudential Regulation Authority (APRA). Instead, in Peter’s view, it should focus on its core job of keeping inflation in the target band and achieving the maximum sustainable level of employment – i.e. a level where the economy would not be “over-heating.”

The RBA review was the subject of an excellent panel session at the Conference of Economists in Hobart last month (10-13 July 2022). Panel member ANU Professor Warwick McKibbin, a former RBA board member and one of the world’s leading macroeconomic modellers, suggested that the monetary policy rules for the RBA will need to accommodate (i.e. look through) any increases in prices coming from greenhouse gas mitigation policies. The prices of many products will need to rise to bring about greenhouse gas mitigation targets. It would not be appropriate for monetary policy to target these price increases, and it would be counterproductive, as it could deter necessary investment in low-emissions technologies in Warwick’s view. This is certainly an issue for the RBA review to consider.

Pulished on 12 August 2022. Please send any questions, comments, or suggestions to contact@adepteconomics.com.au or call us on 1300 169 870.

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