Maybe only a recession will fix macroeconomic management

In the economy, as in life, it helps a lot if you learn from your mistakes. Or, if you’re in public life, from the mistakes of your predecessors.

Accordingly, the caning that former Reserve Bank governor Dr Philip Lowe got for his assurance that interest rates wouldn’t rise before 2024 does much to explain why his successor, Michele Bullock, has been so persistently cagey about the future of rates.

Even as she’s announced a decision that the official cash rate was to be left unchanged, she’s warned that it may need to rise in future. And indeed, that the case for raising it had been seriously considered.

Reserve Bank governor Michele Bullock has been cagey about the future of interest rates.Credit: Dominic Lorrimer

But last week, with the herd sniffing in the wind the smell of rate cuts, she took her life in her hands and got a lot more specific – though not before muttering the incantation that she was not providing “forward guidance” (that was the crime Lowe was convicted of).

In a carefully rehearsed line, she said that a “near-term reduction in the cash rate does not align with the board’s current thinking”. Oh yes, and what does “near term” mean? The next six months, she said.

“Current” thinking. Get it? In other words, that thinking could change over, say, the next six months. Especially because, as she repeated, the board’s decisions would depend on what the economic indicators were telling it. And, as she keeps saying, “the outlook remains highly uncertain”.

It’s clear many people aren’t convinced the board’s thinking against cutting rates will stay unchanged for the next six months. Because the financial markets are so heavily into betting, their predictions are almost always based on what they expect the Reserve will do.

But there are plenty of other, simpler souls, whose emphasis is on what they believe the Reserve should do to ensure it avoids the recession it says it wants to avoid.

The other point about learning from your mistakes and adventures is the familiar problem that those who were around at the time of lesson-learning pass on, handing over to people who weren’t around to have learnt.

This is what worries me as the Reserve ploughs on, determined to ensure the inflation rate returns to the centre of its target range within a time that the Reserve itself judges to be the maximum time acceptable. This determination seems to be regardless of the source of the forces that are slowing the return to mid-target and making it “bumpy”.

Former Reserve Bank governor Dr Philip Lowe got a caning for his assurance that interest rates wouldn’t rise before 2024.Credit: Dan Peled

When the Reserve was granted operational independence by the elected government in the mid-1990s, its bosses at the time understood a truth I’m not sure their successors still understand. When you’re not free of the politicians, you can leave the politics to them. But when you are free of them, you have to do your own politics.

Now, I’ve been a great supporter of central bank independence. It’s been one experiment that time has shown to be a big improvement on leaving interest rates to the pollies. But we, and the central bankers, must understand that central bank independence is an uneasy fit with democracy.

We now have a situation where the central bank has the most control over whether the economy is plunged into severe recession, but the only people the voters can punish for this are not the central bankers, but the government of the day.

So, to get specific, if the Reserve Bank decides inflation can’t be fixed without a recession or, more likely, miscalculates and leaves interest rates too high for too long, it won’t be Michele Bullock that voters punish, it will be Anthony Albanese and his government.

Guess what? Should that happen, Labor is likely to be angry and vengeful. And, as Bullock’s predecessors understood, should government pass to the Liberals, their strongest emotion is likely not to be gratitude, but a determination that the Reserve won’t be allowed to trip them up the way it tripped up Labor.

With independent central banks being the long-established convention throughout the developed world, would any government of ours be game to strip the Reserve of its independence? Probably not.

But politicians have other, less noticeable ways of bringing independent institutions to heel. The usual way – practised by the previous federal government with the Administrative Appeals Tribunal and the Fair Work Commission, and by Donald Trump with the US Supreme Court – is to stack appointments to the board with people who share the government’s predispositions.

So there will be a way for the politicians to pass the voters’ punishment on to the Reserve should it stuff up. This is why it does have to do its own politics.

And there’s another, far more positive way that could be used to clip the Reserve’s wings. This episode of tightening, much more than any previous episode since the day-to-day management of the macroeconomy was handed over to the Reserve in the 1980s, has revealed just how unfair and ineffective it is to make the manipulation of interest rates the dominant instrument for managing the strength of demand.

As research by Associate Professor Ben Phillips of the Australian National University has confirmed, the much-lamented cost-of-living crisis has been imposed on households with big mortgages far more than on any other households.

When you take account of the way rents actually fell during the lockdowns, renters haven’t been hard hit, while those who own their homes outright have been laughing. People on pensions or the dole have been protected by indexation.

So the reliance on interest rates to reduce demand is hugely unfair. But it’s also lacking in effectiveness. All of us have contributed to the excessive demand for goods and services, but only the minority of us with big mortgages have been pressed directly to pull back our spending.

This is why our management of the macroeconomy needs reform. We need another, much broader-based instrument that could be used as well as, or in place of, interest rates. Temporary changes in the rate of the goods and services tax are one possibility, but I’m attracted to the idea of temporary changes to the rate of compulsory superannuation contributions.

The two instruments – one interest rates, and the other budgetary – could be controlled by a new independent authority.

Despite all the Reserve’s apologies for having just a single, blunt tool and all the hardship it causes home buyers, we’ll wait a long time before it suggests sharing its power with a rival independent authority.

As well, the banks have ways of ensuring they benefit from rising interest rates, while financial markets want to keep betting at Reserve Bank race days.

So I’m tempted by the thought that only if the Reserve stuffs up and causes a severe recession are we likely to see the reform to macroeconomic management we so badly need.

Ross Gittins is the economics editor.

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